Private Equity (PE) firms strive to add value to an investment or portfolio company. This can be achieved in three ways:
• Financial engineering
• Strategic initiatives
• Operational improvements
Within operational improvements there are two areas to leverage:
• Improve organic business
• Make add-on acquisitions
At Global PMI Partners, we have seen many approaches by PE firms – from low levels of direct oversight and involvement to a much more ‘active ownership’ in executing these operational improvements.
Use these 3 Private Equity approaches to improve operations and evolve operational value creation:
#1 The basic low-involvement scenario
In this scenario, the PE firm’s representatives sit on, and selects, board members of their portfolio company. The board oversees the execution of the operational improvement plan, sometimes called the 100-day plan, that the PE investment team created pre-investment and selects a CEO to drive that plan without deeper involvement in the portfolio company. The logic of this is clear accountability and governance.
The PE will have a good method of selecting board members and the right CEO to drive the operational improvement plan that delivers the value. The division of responsibilities is clear – the PE excels at the investment analysis, strategy, financial engineering and exit. The PE will have a lean organization and keep costs down, which is liked by Limited Partners (LPs) or shareholders. However, PE’s have also explored ways to create value through other approaches.
Industrial advisors, as directors in the portfolio company board, use their relationships and experience to create value together with the C-level in the portfolio company. Industrial advisors could also be engaged as consultants on special activities in the strategy execution, sales growth or operational improvement plan – such as entry into a new geographical market, the launch of a new product, or improving core processes. The industrial advisor signs off on the improvement plan pre-investment and before add-on acquisitions.
If the advisor selection is astute, and the expectations are clearly defined, this works very well for large PE’s or those with a specific industry focus. Mid-sized PE firms that are addressing more or less the full market as generalists struggle with this approach because of the breadth of industry verticals, each with their individual niches, and they at times struggle to find expert advisors of the right caliber. They could use headhunters, interim agencies, or management consultancies to cover that. To counter this loss of sector expertise, PE firms normally structure their own business in this way – dividing industry verticals within the investment organization of its Partners, investment directors and managers.
#2 Employment of one or many Operation Directors
These are seasoned generalist with excellent line management track records, managing learnings and cooperation across the PE’s portfolio companies in functional areas such as finance, sourcing, sales efficiency, IT, digitalization, people and culture. At larger PE firms there could be several Operations Directors with different backgrounds driving operational improvements within a function at the portfolio companies. There are also examples where the Operational Director has a carried interest.
An alternative to this at mid-size PE firms is to divide operational functional focus areas in the investment organization to its Partners, investment directors and managers. Outsourcing the Operations Director role on retainer to an external specialist or management consultancy company have also emerged as an alternative, reducing cost and resulting in access to more industry-specific profiles.
#3 Build a Project Management Office (PMO) into the portfolio company directly after the initial investment
The task of the PMO would be to drive strategy execution and the operational improvement plan. In most cases the PE looks for deep analytical abilities and high throughput in the PMO role, often delivered by an ex-strategy management consultant rather than someone with an operational line management, leadership or people background, which we believe should be added to most PMOs.
Most PE’s hold networking events for portfolio companies’ boards, CEOs, functional heads and high-potential employees to share leading practices, case studies in value creation and to create peer pressure. These also serve to build direct relationships across their portfolio companies, across which movement of talent is common.
Evergreen PE firms (meaning there is no time limit for exiting the investment) have also been known to do job-rotation of high-potentials between the PE investment team and the portfolio company to second talent, create a one-team feeling, transfer knowledge and ensure good communication.
What is the ultimate approach to operational improvements that will emerge in the next 5-10 years?
For small PE’s, an outsourcing approach is necessary to enable access to the breadth of resources and tools to drive operational improvements. This complements board composition, CEO selection and the PE’s network of trusted individuals and advisory firms with an aggregator of operational improvement knowledge and resources, an outsourced Operations Director, plus the team to support, on a retainer or on-demand. This will keep costs down at the PE while securing relevant, fast and quality assured access to industry-relevant knowledge and resources.
The outsourced Operations Director would work in the investment deal team with writing, validating (in Due Diligence) the operational improvement plan pre-investment. And then take responsibility to resource and deliver implementation post-closing. The outsourced Operation Director would ideally come from an organization that has PE understanding, project management capabilities of complex projects and access to international best-of-breed specialist consultants and agencies. Additional to the quality of consultants, access to a number of investment and M&A playbooks should be criteria when selecting an outsourced partner.
For medium-size PE’s: have a mixed approach as firms recognize the need to have mission-critical operational capabilities in-house but not being able to cover all operational aspects and therefore need access to external resources, say the ambition could be that 50% is done in-house.
For larger size PE’s: have an in-house team covering the operational and value creation trends, then to supplement by using external best-of-breed resources as expertise is needed in particular areas that are not strong in-house. In short, adding operational engineering capabilities so that 80% is done in-house.
Global PMI Partners experience and methodology has a large focus on soft factors in M&A; leadership, people, communication and culture, to succeed in post-merger integration and Integration Management Office (IMO) mobilization. PE’s and acquirers who rather select leadership that is known in their network rather than use human resource methods and tools to build the optimal leadership and middle management structure often partly neglect this or do not approach it in a structured way.
Looking even further ahead, PEs could start to use psychometric and other human resource analysis tools to evaluate portfolio companies management layers and recruit to build solid leadership teams – the area of leadership engineering?
Michael Holm is a partner at Global PMI Partners, an M&A integration consulting firm that helps mid-market companies around the world bring their operational, technical and cultural differences into alignment. Global PMI Partners has a reputation for delivering exceptional consistency, speed & customized execution on the complex operational, technical and cultural issues that are so critical to M&A success.