In its extensive analysis of the Private Equity Industry for 2011-2012, Bain and Company correctly identifies many of the problems and solutions for the PE industry, but then comes up short on the proper tactics needed to solve the problems. What is worse is that this may be emblematic of the fact that the PE industry itself is incapable of solving one of its most pressing industry problems.
The PE Industry’s Most Pressing Problem
On March 15, 2012 Bain and Company published an exhaustive report on the state of the Private Equity industry. The report is well done and it should be read by anyone looking to get a holistic understanding of the state of the industry.
Yet, while the study correctly identifies many, if not all the industry’s main issues and needed fixes, it misses the mark on how the industry must tactically adapt itself in order to get back on track. Of concern for the industry is that it may be that Bain and Company misses the real tactical plan needs of the industry because, even a preeminent company like Bain does not have the history, understanding and actual internal skill sets needed to fix the industry’s most pressing problem.
What might be the PE Industry’s most pressing problem? – The $2 trillion of unrealized capital frozen in PE firms’ portfolios.
As Bain and Company’s describes the situation:
“The value of unsold assets swelled to nearly $2 trillion, two times more than all of the dry powder GPs were looking to invest and up from one-and-a-half times just a year earlier. Working through the backlog will not be easy. The vast bulk of the unrealized capital stems from huge buyout fund vintages that closed from 2006 through 2008 and is tied up in investments made at peak value before the downturn. That puts GPs in a bind. They cannot return cash to LPs and their investment professionals until they liquidate these frozen holdings, but the assets are not ripe for sale in today’s market on terms that are attractive to GPs. PE fund managers have successfully nursed their high-priced portfolio companies through the downturn, but GPs still hold the overwhelming majority of them at valuation multiples below what they need to reap in order to earn their carry. They will need to continue to work with their portfolio company managers to prepare them for eventual sale by creating additional value.”
The last line of the above paragraph is the operable line vis-à-vis needed tactics. That is to say that portfolio managers need to step up and help their struggling portfolio companies to increase value. Specifically, portfolio managers have to help their portfolio companies to increase their value via the sales top-line. Via the sales top-line because portfolio managers have already found most of the operational savings in their portfolio companies during the “nursing” process noted above.
In fact, finding top-line based value is likely the most pressing task for today’s portfolio managers. It is a task however that is by no means easy and by no means getting any easier.
Again, in Bain’s own words:
“PE firms can no longer rely on market beta to lift returns but must assertively mobilize themselves to generate alpha that feeds business growth well beyond normative expectations— both in the companies that PE ﬁrms own today and the ones they buy tomorrow. The ﬁrms that build rigorous repeatable models for partnering with portfolio company management teams and climb the growth curve will be the long-term winners. For many ﬁrms, doing this will require dramatic changes in how they organize them- selves and go to market. For the PE industry as a whole, 2012 will be a year of watchful waiting to see who is clearly on the right path and who is not.”
More active portfolio management in top-line planning of their existing holdings is simply a required task today for portfolio managers. Yet, we know that portfolio managers in general do not like doing this – especially around top-line improvement planning. A recent McGladrey and Pitchbook Private Equity Survey – “Creating Value Spurring Growth”, concluded that over 60% of portfolio managers wanted no part of performance improvement planning and execution within their portfolio companies. We also know that few PE firms are comfortable with or even employ portfolio managers trained in growing the top-lines of their holdings.
This is precisely where Bain and Company missed the mark. In their study, they only gave lip-service to the needed tactics necessary to deploy in this area. This may be because of their unfamiliarity with the process needed to fix existing company top-line results. Instead, in the study, Bain fell back on how PE companies can better assure that new deal growth plans are in place when they do their due diligence process.
So, what are the tactics needed to help portfolio managers to supervise the growth of their portfolio companies in a low beta economy? What are that tactics needed for portfolio managers who do not want to get too far involved in the process because of behavioral, training and time constraint issues? What are the tactics that are needed for portfolio companies to produce growth plans in low beta markets when (as a recent Chief Outsider/University of Texas study shows that) over 60% of middle market companies lack a marketing/strategic planning function?
One process that has worked well in the past is called the “Core Competency Based Business Planning Process”. It is a straight forward top-line growth planning process that if run well is: sanctioned by PE firms, owned and managed by portfolio company management teams and monitored for success for the mutual benefit and accountability of both the PE firm portfolio manager and the portfolio company management team.
The process generates growth by helping companies to better focus on their strengths and by putting actual tactical business plans in place to deliver growth. Plans that are generated through this process are realistic, relatively easy to execute and are above all measureable.
The process has a strong track record of success, is basic so that it works well for PE portfolio managers and the relatively unsophisticated management of portfolio companies and the process is easily repeatable for PE firms with multiple holdings that require growth plans.
The Core Competency Based Business Planning Process is a product that Michael Roth Advisors has run on multiple occasions for companies, consulting firms and for clients of all sizes and in more than 20 different industries.