Generating Organic Growth from Portfolio Companies in the PE Industry


A host of recent studies from the likes of Deloitte, Bain & Company, McGladrey and others have all concluded the same thing: The PE Industry and the broader middle market have reached a critical tipping point where organic portfolio company growth is perhaps the preeminent need. However, as most PE firms and middle market companies know already, one of the only things clearer than the need for growth is the difficulty associated with attaining that growth.

  • Organic growth requires action – growth will not come from riding a wave of broader market strength as markets are predicted to remain flat for years to come.
  • Growth requires behavior change and specialized training – PE firms are not expert in or predisposed to generating organic top-line growth from their holdings. And,
  • Growth requires planning and execution skills that most middle market companies do not have.  Most middle market companies do not have the sophistication needed to generate significant growth in today’s challenging, low growth markets.

Finding growth under these circumstances requires PE firms and their portfolio companies to act differently. PE firms need to find new processes for growth planning that can deliver real results while working seamlessly with all parties involved. One such process is outlined in this article.

The process outlined below is designed to work specifcally with the needs of PE firms and their portfolio companies. The process has a proven track record of success with many firms and companies and if it were implemented on a broad scale it could help solve the industry’s unprecedented need for organic growth and value generation.

An Industry in Trouble

In the October 2007 issue of the Private Equity Professional Digest, Jeffery Long listed out what he believed were the “8 Pillars of Private Equity”. Whether Mr. Long’s list of industry pillars is the definitive list is not the key issue at hand for the industry (the list is probably a fair representation of the industries activities). The key issue for the industry is trying to figure out ways to deal with at least 5 of those 8 pillars currently underperforming.

Jeffrey Long’s 8 Pillars of Private Equity

(Underperforming Pillars in Bold)

  • Capital Formation
  • Generation of Investment Opportunities
  • Investment Opportunity Processing
  • Transaction Processing
  • Portfolio Management
  • Portfolio Exits
  • Investor Relations
  • Firm Management

The extent of how poorly these pillars are performing was recently reported by the Private Equity Growth Capital Counsel (PEGCC). In Q1 2012:

  • Capital formation in the U.S. PE industry declined by 17% to only $20 billion-a multi year low.
  • Generation of Investment Opportunities declined by a staggering 70%. Q1 2012 deal volume fell from $42 billion in the previous quarter to only $13 billion in Q1 2012.
  • Portfolio exits declined by 22% in the quarter to only $24 billion.

Investor relations are also being challenged due only in part to the inane political focus on the PE industry that is now peaking. What is really challenging investor relations is the relatively low investment returns being generated by the industry.

To be sure, the PE Industry is still one of the best investments for large and institutional investors. As a recent  Pitchbook analysis concluded: “Private equity has outperformed the public markets in three- and five-year returns, with horizon IRRs of 6% and 10%, respectively, compared to 4% and 3% for the public markets”. While these results are impressive on a competitive basis, the results are below the historic returns that have made the industry a draw for trillions of dollars in investments over time.

Portfolio Management – A Strong or Underperforming “Pillar”?

It has been in part because of excellent Portfolio Management that the PE industry returns have remained highly competitive. Portfolio managers have driven improvements in portfolio company operations, financial and human resource management that have created strong value and investor returns. Yet, while these returns have been strong enough to out-pace the returns of many other investment vehicles, they have not been high enough to meet PE industry expectations and that has created many other issues for the industry.

As Bain & Company just pointed out in their Global Private Equity Report for 2012, the poor returns within the industry have resulted in “nearly $1 trillion in dry powder still waiting to be put to work. Almost $2 trillion worth of assets remain on general partners’ books, and more than 75% of them are currently valued at below carry hurdle rates”.

Accordingly, while portfolio management is one of the reasons the industry has performed adequately over the past few years; it is also an area of underperformance. In today’s PE Industry, portfolios need to also be managed with an eye on ensuring top-line growth. In a continued challenging market, the industry cannot conceivably return to historic rates of value creation and returns without generating more organic, profitable growth from its current portfolios.

The Challenge for Finding Growth for PE Firms and Their Portfolios

The solutions to driving organic portfolio growth are not easy. In order to generate profitable organic growth from their portfolios, portfolio managers have to overcome broad market issues, take themselves out of their comfort zone and likely change the behavior at their portfolio companies.

PE firms cannot count on riding a wave of growth from their broader markets. Most prominent forecasting organizations including the Fed, the Conference Board and the IMF predict GDP growth to be in the range of only 0%-3% between Europe and the US for at least the next 2-3 years.

PE firms also have to get out of their comfort zone in order to demand and then generate growth from their portfolio companies. While fund managers in general are bright, hard working and committed business people, they are usually untrained and unfamiliar with the arts and sciences of marketing and sales. Yet, knowledge of how to deal with the nuances of sales and marketing issues and with the often dissembling sales and marketing people in their portfolio companies is a requirement for successfully generating profitable top-line growth at the portfolio company level.

Finally, in order to generate real top-line results from portfolio companies – especially those within the middle market, PE portfolio managers will likely have to overcome systemic issues found within most middle market companies.

Growth for a middle market company in a slow or no growth economy requires pro-active planning, a well articulated point of difference, a sales generation versus a customer service mentality, situational awareness of business conditions, effective resource allocations and performance metrics. These attributes however are not generally found within most middle market companies.

Using a Growth Planning Process

The most appropriate growth planning process for the PE/Middle Market industry is a straight-forward, back to basics marketing and sales planning process that focuses portfolio companies on how to best leverage their assets. It is a process designed so that it can be mandated by a PE sponsor, but run almost entirely by and through the PE portfolio company. Accordingly, the process is a good fit for portfolio managers and as it is basic, the process compensates for some of the shortcomings of unsophisticated middle market companies.

The process we have utilized is a core competency based model. Core competency management has been a main stream process for many years and was even the subject of a bestselling business book in the 1990’s:  Competing for the Future penned by Prahalad and Hamel.

The essence of a core competency based business planning process is that it focuses companies on business growth by directing the companies into plans that have fewer, higher impact strategies and tactics. Plans are developed by an internally driven process which includes the following steps:

  • Gathering and analyzing relevant data
  • Building consensus on a unified core competency and its strategic implications
  • Writing tactical plans and forecasts
  • Developing performance metrics and compensation schemes linked to the plan
  • Implementation
  • Measurement

While the process looks deceptively simple and rooted in common sense, the results driven by it can be anything but simple. This process has been put to use in dozens of large and middle market companies and has delivered hundreds of millions of dollars in new value for those companies and their investors.

While the potential top-line results may be the most important outcome for the parties involved in this process, there are other positive outcomes from The Core Competency Based Business Planning Process as it is fast, sensible, inclusive and repeatable.

  • Fast-Plans can be researched, written and put in the market within weeks.
  • Sensible-The process focuses companies on what it is that they do best. Surprisingly, many companies do not have a common understanding of their core competency which by extension means that they are not optimizing their collective effort and are likely wasting human and financial capital.
  • Inclusive-The process is run by the management teams of the portfolio companies and as such, it has a greater chance of success at implementation. Moreover, it does not require extensive involvement at the PE firm level (something that PE firms are generally loath to do).
  • Repeatable-Once run successfully in one company, a PE portfolio manager can repeat the process across any or all of the portfolio companies he/she manages.

For the portfolio companies, the process also delivers other important benefits. Through the execution of this growth planning process, portfolio companies will develop a pro-active plan for growth, a well articulated core competency at the heart of their plans, situational awareness and have in place metrics to be rewarded on or held accountable to.

No Time to Waste

The PE industry and the much larger middle market are in severe need of organic growth. Portfolio management has already produced most of the value that can be generated from efficiencies alone. Paraphrasing the recent Deloitte Middle Market Study – Mid-market Perspectives, the time for tinkering is over – now is the time for growth.  Without that growth, billions of dollars that will be put in play by the PE Industry over the next few years will likely have sub-par realizations, sub-par returns and potential multi-year negative effects for the industry

At this point in time, it is generally concluded that organic growth must emanate from the industry “pillar” of portfolio management. For that to be the case however the pillar of portfolio management will have to adjust to the current market and to the limitations of the portfolio managers and middle market companies they manage. Yet, with more success within the pillar of portfolio management, the PE industry can go a long way to reinforcing all of its other underperforming industry pillars and by that, the industry can return to the deal flow, value creation and returns expected of it.