Brief

Is Your Portfolio Company Ready to Run through the Finish Line?

When the exit dam finally breaks, sellers will need to show evidence of clear business momentum in what promises to be an overcrowded market.

著者：Brian Kmet, Lars Dingemann, and Kiki Yang

First published on 10月 11, 2024
min read


概要 Given a historic exit overhang and rapidly changing market conditions, selling portfolio companies will be anything but easy in the coming years, even as interest rates moderate. For the large number of companies held longer than anticipated, there is likely work to be done to generate the returns you’re looking for. The most effective fund managers aren’t waiting around—they’re taking steps now to define the next leg of growth and build speed toward a strong exit. If the past 24 months have demonstrated anything about private equity, it’s that the industry knows how to pivot in the face of adversity. Just look at the myriad ways funds have scrambled to generate cash flow amid a historically moribund exit environment. When we recently asked a representative sample of general partners (GPs) and their institutional investors to break down where their cash distributions came from, by far the largest segment (44%) said that less than half flowed from outright sales of companies. The rest were generated by continuation funds, dividend recapitalizations, net asset value loans, and other forms of financial restructuring (see Figure 1). Figure 1 For many market participants, selling companies hasn’t been a major source of cash distributions 出所 Bain & Company live poll of general and limited partners, July 9, 2024 (n=234) That kind of maneuvering may work in a pinch. But given that buyout funds hold $2.9 trillion in unsold assets, these tactics alone won’t ease the pressure on GPs to generate liquidity for investors. A full 53% of companies in buyout portfolios have been sitting there for four years or longer, suggesting that funds will need to resume selling assets in volume to generate adequate DPI (the ratio of distributions to paid-in capital). And for portfolio companies where the extended hold period has outstripped the original value-creation plan or market conditions have changed, that’s likely to require some heavy lifting. While dealmaking will undoubtedly get a boost in the coming months as central bankers continue to ease interest rates, selling companies will remain challenging for several reasons. Number one is the massive overhang of unexited companies. It almost guarantees that the market will be flooded with assets when dealmaking picks up, making it increasingly difficult to stand out from the crowd. Second is the fact that the finish line has moved for so many companies amid rapidly shifting market conditions. Artificial intelligence was hardly a factor for most industries when all those companies were purchased four years ago. Add-on strategies dependent on easy financing often don’t pencil out in a world marked by still-elevated financing costs. Growth has slowed in some sectors, supply chains have been rewired postpandemic, and the threat of recession continues to hover in the background. Finding the next gear Against this backdrop, it’s more important than ever to position longer-held portfolio companies so they can run hard through the finish line. That means developing a fresh plan for maintaining business momentum today while clearly defining the “next thing” strategically and putting some early points on the board. Here’s how a few of the most proactive funds are responding to some typical scenarios. It’s year four, and we’ve executed the original value-creation plan. Now what? The most common challenge we see for portfolio companies held longer than anticipated is that management has already run through the major plays of the original value-creation plan. The company may still be a solid performer, but the job you had assumed would be the next owner’s challenge—defining and executing on the next leg of growth—is now up to you. Consider an industrial parts distributor. The original deal thesis had called for aggressively expanding into new US markets. The company had done such a good job of executing that the opportunity was beginning to tap out. Based on a strong Net Promoter Score^SM, the owners saw a way to continue to grow organically by broadening the company’s product offerings and taking share from rivals. But getting there required committing to new investment in the company’s underdeveloped go-to-market capabilities to sharpen the team’s ability to segment customers and expand share of wallet. A midsize leader in specialty freight faced a different challenge. Although it had grown rapidly through acquisition, it hadn’t had time to fully establish the platform benefits that would make the combined company worth more than the sum of its parts. Unlocking full potential meant capturing scale advantages across the platform and creating a clear strategy for investing differentially in the most promising segments. But that required more work to identify the smartest integration opportunities and to gather reliable size and growth data for markets outside of the mainstream. Maximizing value, in other words, not only meant mapping out the next journey but backing it up with hard evidence. Business conditions have shifted, and we need to pivot our strategy. As the postpandemic period has demonstrated in spades, the world can change dramatically in the space of just a few years. Technology, innovation, and product substitutes can all transform competitive dynamics. Investor appetites often shift amid new market or macro conditions. Sometimes these disruptions are unknowable at the time of acquisition, and other times they become much more pronounced over a long hold cycle. In any event, the solution is often a strategic reset: Is the roadmap we started with still relevant given what we know today? If not, how should we adjust? This was the dilemma facing a fast-growing company that had built a platform of specialized tools used in biopharmaceutical research and development. At the time of acquisition, venture money was pouring into the industry, and the company’s customers were spending it enthusiastically. But when interest rates took off and VCs pulled back, it crimped industry momentum and left the company vulnerable to the perception that its offerings were too narrow. While several of its products targeted high-growth R&D modalities, some of those segments were starting to plateau. Moreover, the company was absent from the process development and manufacturing sides of biopharma, which tend to be seen as “stickier.” A key acquisition added exposure to several new modalities and customer segments. But making the most of the broader, more complex portfolio meant the company had to redesign its commercial organization and match talent to new roles and responsibilities. The owners of a specialty physician practice group in the middle of a buy-and-build strategy also found themselves at a crossroads as interest rates took off. Should the company continue its original strategy of increasing earnings before interest, taxes, depreciation, and amortization (EBITDA) through rapid M&A? Or should it improve organic growth and broaden the company’s revenue sources? A close analysis showed that M&A would surely boost EBITDA more quickly. But it would also be more expensive in a high-rate market and would soak up resources that could otherwise be devoted to internal business improvement. Doubling down on organic growth initiatives might end up producing a smaller platform and lower EBITDA. But a company capable of generating strong long-term growth on its own would fetch a higher multiple from buyers. Earning that multiple involved hiring more physicians, improving referral flow, expanding key procedures, and capturing back-office synergies. It required limiting key-person risk by diversifying the age mix of the physician group while training newcomers in the procedures that matter most. To the extent M&A remained an opportunity, the company also codified a proprietary playbook for entering and integrating new markets. The overall objective: Show buyers that we are building a better company, not just a bigger one. The company has known risks that need to be resolved. There’s no doubt that the market these days has become much more cautious about underwriting risk. What buyers were willing to accept in the boom years may be a nonstarter in the current environment. For one company in the financial services space, that involved launching several key initiatives to give investors comfort that growth and profitability were, in fact, bankable and sustainable. Over several years of private equity ownership, the company had been a clear winner. It had generated strong top- and bottom-line results by establishing a solid leadership position selling into a fast-growing industry vertical. Still, there were concerns. Not only could the company’s solution be viewed as narrow, with limited ability to expand into other verticals, but the customer concentration posed a risk—one defection could dent the P&L. The answer was to diversify the company’s revenue sources by accelerating a nascent effort to sell through channel partners into other sectors. That involved capability building, sharpening sales motions, and learning to track the metrics necessary to prove out both current performance and future growth potential. Full value was hardly out of reach. But capturing it would require decisive steps to derisk the investment and lay down tracks for the next owner. Time to move Trying to predict when exit markets will truly return to normal won’t get you very far. But there’s plenty you can do now to ensure that your portfolio companies are building momentum for when activity resumes. While deciding what to do and how hard to push is highly case-specific, a few key questions can help you get focused: What story do you want to tell buyers in 12–24 months that makes for a compelling deal thesis? How much of that story could you credibly tell today? Is your strategy still sound, or do you need to define the next wave of growth? Where do you already have traction, and where do you still need to prove it? Are your resources and talent allocated to the most critical initiatives? Have risks emerged that might make buyers walk away in today’s more challenging market? One thing is clear: Thinking through these issues today—and taking action to spur momentum through exit—is the best insurance against a lackluster sales process when your portfolio company finally hits the market.

概要

Given a historic exit overhang and rapidly changing market conditions, selling portfolio companies will be anything but easy in the coming years, even as interest rates moderate.
For the large number of companies held longer than anticipated, there is likely work to be done to generate the returns you’re looking for.
The most effective fund managers aren’t waiting around—they’re taking steps now to define the next leg of growth and build speed toward a strong exit.

If the past 24 months have demonstrated anything about private equity, it’s that the industry knows how to pivot in the face of adversity.

Just look at the myriad ways funds have scrambled to generate cash flow amid a historically moribund exit environment. When we recently asked a representative sample of general partners (GPs) and their institutional investors to break down where their cash distributions came from, by far the largest segment (44%) said that less than half flowed from outright sales of companies. The rest were generated by continuation funds, dividend recapitalizations, net asset value loans, and other forms of financial restructuring (see Figure 1).

For many market participants, selling companies hasn’t been a major source of cash distributions

That kind of maneuvering may work in a pinch. But given that buyout funds hold $2.9 trillion in unsold assets, these tactics alone won’t ease the pressure on GPs to generate liquidity for investors.

A full 53% of companies in buyout portfolios have been sitting there for four years or longer, suggesting that funds will need to resume selling assets in volume to generate adequate DPI (the ratio of distributions to paid-in capital). And for portfolio companies where the extended hold period has outstripped the original value-creation plan or market conditions have changed, that’s likely to require some heavy lifting.

While dealmaking will undoubtedly get a boost in the coming months as central bankers continue to ease interest rates, selling companies will remain challenging for several reasons. Number one is the massive overhang of unexited companies. It almost guarantees that the market will be flooded with assets when dealmaking picks up, making it increasingly difficult to stand out from the crowd.

Second is the fact that the finish line has moved for so many companies amid rapidly shifting market conditions. Artificial intelligence was hardly a factor for most industries when all those companies were purchased four years ago. Add-on strategies dependent on easy financing often don’t pencil out in a world marked by still-elevated financing costs. Growth has slowed in some sectors, supply chains have been rewired postpandemic, and the threat of recession continues to hover in the background.

Finding the next gear

Against this backdrop, it’s more important than ever to position longer-held portfolio companies so they can run hard through the finish line. That means developing a fresh plan for maintaining business momentum today while clearly defining the “next thing” strategically and putting some early points on the board. Here’s how a few of the most proactive funds are responding to some typical scenarios.

It’s year four, and we’ve executed the original value-creation plan. Now what? The most common challenge we see for portfolio companies held longer than anticipated is that management has already run through the major plays of the original value-creation plan. The company may still be a solid performer, but the job you had assumed would be the next owner’s challenge—defining and executing on the next leg of growth—is now up to you.

Consider an industrial parts distributor. The original deal thesis had called for aggressively expanding into new US markets. The company had done such a good job of executing that the opportunity was beginning to tap out. Based on a strong Net Promoter Score^SM, the owners saw a way to continue to grow organically by broadening the company’s product offerings and taking share from rivals. But getting there required committing to new investment in the company’s underdeveloped go-to-market capabilities to sharpen the team’s ability to segment customers and expand share of wallet.

A midsize leader in specialty freight faced a different challenge. Although it had grown rapidly through acquisition, it hadn’t had time to fully establish the platform benefits that would make the combined company worth more than the sum of its parts. Unlocking full potential meant capturing scale advantages across the platform and creating a clear strategy for investing differentially in the most promising segments. But that required more work to identify the smartest integration opportunities and to gather reliable size and growth data for markets outside of the mainstream. Maximizing value, in other words, not only meant mapping out the next journey but backing it up with hard evidence.

Business conditions have shifted, and we need to pivot our strategy. As the postpandemic period has demonstrated in spades, the world can change dramatically in the space of just a few years. Technology, innovation, and product substitutes can all transform competitive dynamics. Investor appetites often shift amid new market or macro conditions. Sometimes these disruptions are unknowable at the time of acquisition, and other times they become much more pronounced over a long hold cycle. In any event, the solution is often a strategic reset: Is the roadmap we started with still relevant given what we know today? If not, how should we adjust?

This was the dilemma facing a fast-growing company that had built a platform of specialized tools used in biopharmaceutical research and development. At the time of acquisition, venture money was pouring into the industry, and the company’s customers were spending it enthusiastically. But when interest rates took off and VCs pulled back, it crimped industry momentum and left the company vulnerable to the perception that its offerings were too narrow.

While several of its products targeted high-growth R&D modalities, some of those segments were starting to plateau. Moreover, the company was absent from the process development and manufacturing sides of biopharma, which tend to be seen as “stickier.” A key acquisition added exposure to several new modalities and customer segments. But making the most of the broader, more complex portfolio meant the company had to redesign its commercial organization and match talent to new roles and responsibilities.

The owners of a specialty physician practice group in the middle of a buy-and-build strategy also found themselves at a crossroads as interest rates took off. Should the company continue its original strategy of increasing earnings before interest, taxes, depreciation, and amortization (EBITDA) through rapid M&A? Or should it improve organic growth and broaden the company’s revenue sources?

A close analysis showed that M&A would surely boost EBITDA more quickly. But it would also be more expensive in a high-rate market and would soak up resources that could otherwise be devoted to internal business improvement. Doubling down on organic growth initiatives might end up producing a smaller platform and lower EBITDA. But a company capable of generating strong long-term growth on its own would fetch a higher multiple from buyers.

Earning that multiple involved hiring more physicians, improving referral flow, expanding key procedures, and capturing back-office synergies. It required limiting key-person risk by diversifying the age mix of the physician group while training newcomers in the procedures that matter most. To the extent M&A remained an opportunity, the company also codified a proprietary playbook for entering and integrating new markets. The overall objective: Show buyers that we are building a better company, not just a bigger one.

The company has known risks that need to be resolved. There’s no doubt that the market these days has become much more cautious about underwriting risk. What buyers were willing to accept in the boom years may be a nonstarter in the current environment. For one company in the financial services space, that involved launching several key initiatives to give investors comfort that growth and profitability were, in fact, bankable and sustainable.

Over several years of private equity ownership, the company had been a clear winner. It had generated strong top- and bottom-line results by establishing a solid leadership position selling into a fast-growing industry vertical. Still, there were concerns. Not only could the company’s solution be viewed as narrow, with limited ability to expand into other verticals, but the customer concentration posed a risk—one defection could dent the P&L.

The answer was to diversify the company’s revenue sources by accelerating a nascent effort to sell through channel partners into other sectors. That involved capability building, sharpening sales motions, and learning to track the metrics necessary to prove out both current performance and future growth potential. Full value was hardly out of reach. But capturing it would require decisive steps to derisk the investment and lay down tracks for the next owner.

Time to move

Trying to predict when exit markets will truly return to normal won’t get you very far. But there’s plenty you can do now to ensure that your portfolio companies are building momentum for when activity resumes. While deciding what to do and how hard to push is highly case-specific, a few key questions can help you get focused:

What story do you want to tell buyers in 12–24 months that makes for a compelling deal thesis?
How much of that story could you credibly tell today?
Is your strategy still sound, or do you need to define the next wave of growth?
Where do you already have traction, and where do you still need to prove it?
Are your resources and talent allocated to the most critical initiatives?
Have risks emerged that might make buyers walk away in today’s more challenging market?

One thing is clear: Thinking through these issues today—and taking action to spur momentum through exit—is the best insurance against a lackluster sales process when your portfolio company finally hits the market.