Many private equity firms have already taken the first crucial
step: They know they must become portfolio activists. In recent
surveys, respondents from nearly four out of five firms agreed that
helping their portfolio companies achieve operational improvements
will be the key source of value creation over the next five years.
More than 75 percent said they have begun to increase their
involvement in portfolio company management, typically by beefing
up standard financial and operating performance reporting.
Pitfalls
Some firms used the downturn to go further, assembling dedicated
internal portfolio teams to ferret out new growth potential in
their portfolio companies and helping their managers to achieve
them. But bringing talent and resources together to unlock value in
their portfolio companies has led many into one or more of
these common pitfalls:
- Processes break down in the hand-off from the deal team, which
manages the pre-acquisition due diligence and consummates the
buyout, to the portfolio team, which takes charge of implementing
the value-creation plan.
- Mistrust arises between the private equity owners and their
portfolio company CEOs and senior managers, who are wary of the
prying eyes of the "portfolio police" on their businesses.
- Private equity firms that own complex portfolios with
international holdings face challenges finding talent with the
right blend of management experience, industry or functional
expertise, and cultural awareness to serve their portfolio
companies' widely varying needs.
The search for a perfect solution can leave private equity firms
floundering. Some act too hastily, throwing resources at the
challenge without resolving how best to deploy them. They cycle
through one approach after another without settling on one that
works. Still others endlessly debate how to get started, assembling
reams of data and losing precious time.
Our experience working with a wide range of private equity firms
around the world has shown that there is no single "killer app"
that is right for all circumstances. Rather than try to do
everything at once, private equity firms might borrow a page from
Calvin Coolidge's playbook and do something at once. Specifically,
those that set out to become portfolio company value creators can
begin by adopting a prevalent approach that best suits their unique
combination of firm and portfolio company characteristics.
Choosing the right model hinges on five factors. The first is
the house style and dominant investment thesis. Does the firm look
for challenging turnaround situations? Or does it buy strong
companies with strong management teams in search of breakthrough
performance? The second consideration is the size of the portfolio.
What is its total value and how many companies does it include?
Third is the portfolio's complexity. Does it include companies
that span several industry sectors, geographies and business
challenges? The fourth is to assess its portfolio companies'
potential to realize strategic and operational gains. Are they
likely to produce only marginal improvements or are they capable of
achieving major transformations? Finally, the firm needs to
appraise the strength of the companies in its portfolio. How
healthy are they financially? Are there gaps in their senior
management teams that need to be plugged?
A prevalent approach is a starting point and a guide for action,
not the ultimate destination. Because it captures the most common
situations a firm and its portfolio companies face, the approach a
private equity firm chooses becomes the foundation for developing
the disciplines of a repeatable model.
Six approaches
Bain has identified six approaches that suit a full array of
portfolio management needs, from limited oversight of performance
to more hands-on involvement in setting a new strategy and actually
running the business.
1. Monitors play a broad supervisory role. They
typically have a board seat, sign off on management strategy and
determine which metrics of business performance they will track and
with what frequency. Every private equity firm needs to be able to
take on this minimally invasive oversight responsibility and it is
a common starting point. Indeed, for some that prefer to maintain a
light approach and delegate most key decisions to portfolio company
management, it may even satisfy their needs.
2. Seasoned mentors help portfolio company management
define their value-creation plan and priorities. They
bring their expertise to bear by providing strategic and
operational advice to their CEOs and serving as a sounding board to
management in critical areas. This approach tends to work best in
situations where portfolio company CEOs are new to private equity
and would benefit from the support of an experienced adviser but
does not require a hands-on executive chairman.
3. Facilitators work with their portfolio companies to
map out a value-creation plan and define the priority initiatives
they will need to undertake to achieve it. Then, they help
bring in external support the portfolio company may lack. These
firms tend to acquire smaller companies that have strong executive
teams and solid value-creation plans at a conceptual level but need
hands-on support to translate the plan into "Monday morning" action
and facilitate its implementation.
4. Owner-operators take a more interventionist approach,
setting their portfolio companies' strategic direction, defining
operational priorities and engaging deeply in the day-to-day
running of the business. Typically, the private equity
firm will name one or more of its own to take on senior executive
roles and assume ultimate decision-making authority on most major
issues. Situations best suited for this model are those where the
portfolio company needs a major change in strategic direction and
there are gaps in the management team, or the CEO is inexperienced
working with private equity owners.
5. Functional experts deploy their portfolio teams to
play an active role in specific areas of the day-to-day operations
of the business. This approach is well suited to private
equity firms that invest in companies that have significant
opportunities to improve profit margins by parachuting in experts
who are skilled in high value-added areas-such as procurement, Six
Sigma process reengineering or supply chain management-that are not
specific to a single company or industry. As they refine their
approach, they roll out their expertise across the entire
portfolio.
6. Strategic architects take a far more comprehensive
role in shaping their portfolio company value-creation initiatives
and leading their implementation. Private equity firms
that commit to this approach typically see a need to overhaul the
portfolio company's strategy because the company is in distress,
its profit pools have shifted or they perceive an opportunity to
reshape an industry.
We've observed that as private equity firms learn to apply their
prevalent approach to help their portfolio companies knock down
barriers and seize opportunities, their competence as value
creators grows and evolves. So, too, does their confidence in their
ability to expand and strengthen their portfolio management teams,
as the technical, strategic, cultural and financial situations they
encounter require them to add in-house specialists incrementally,
forge relationships with outside advisers or recruit talented
industry insiders.
Growing in this organic, experience-driven manner enables firms
to shift confidently from the initial phase of following a single
prevalent approach to a second phase-adeptly pursuing multiple
approaches. Getting to this stage requires PE firms to anticipate
the unique needs of each portfolio company and customize their
approach and resources to meet them. It also calls for
sophisticated assessment and decision-making skills to be flexible
and responsive.
By mixing and matching approaches and resources, private equity
firms ultimately evolve into a third phase, becoming master value
creators. At this more advanced level, PE firms can dynamically
flex their approach to suit portfolio company needs at any stage in
the ownership life cycle-from creating a post-acquisition blueprint
to paving the path to an exit three to five years later. The hurdle
at this stage is having the ability to combine fact-based insights
about the business with the emotional intelligence required to read
the needs of their portfolio company management teams in order to
achieve a great plan within a performance culture that delivers
over the entire life of the deal.
Possessing the elusive traits of emotional intelligence allows
directors to move beyond the binary tough-love approach of either
motivating portfolio company management teams with attractive
incentives for hitting their targets or firing those that don't
measure up. Instead, these elite value creators will use a broad
array of inducements, backed up with the right combination of
in-house support, external advisers or specialized experts to work
collaboratively on delivering the full potential of the business.
They coach management on implementation where they can, supplement
their skills where called for or supplant them when they must.
It takes patience, exposure to a wide range of issues presented
by their portfolio companies and smart investment in their own
capabilities before private equity firms can master the art of
value creation. Few firms are yet adept at putting these higher
order techniques to work. But as the challenges to extract value
from their portfolio companies continue to compound, the time to
get started is now.
Alan Hirzel and Charles Tillen are partners with Bain &
Company's Private Equity Group. They are based in London and
Boston, respectively. Catherine Lemire is a Toronto-based senior
director and practice manager with the Private Equity
Group.
