Driving Value Creation in a Low/No-Growth Economy
Driving Value Creation in a Low/No-Growth Economy
During the most recent Accordion Private Equity Roundtable, the assembled group of private equity professionals met to talk about best practices in empowering and getting the most out of portfolio management teams, supporting them and putting in fail safes if things don’t go to plan – especially during tough times.
Given private equity fund structures, investment hold periods are typically planned to be 3-5 years (in more recent years this hold period has lengthened significantly) which creates a natural “race against the clock” to make significant operational changes within a business. In a low/no-growth economy leverage may often have to be more conservative, further emphasizing the need for operational changes and transformation.
Create the Playbook
The post-acquisition period is a delicate time for a portfolio company management team in the best of times, let alone in a volatile or sideways market, where sponsor and management teams are forming a working relationship and dynamic. Getting all parties on the same page – quickly – is essential to ensuring a productive long-term partnership.
There is no short cut: the most effective way to define success following the acquisition of a portfolio company is to create a 100-day plan that outlines monthly metrics, milestones and KPIs from the outset. There are multiple benefits of this process, including aligning strategy, setting clear targets and expectations by the sponsor and linking compensation plans to key targets.
This “playbook” bridges the investment thesis and findings from due diligence to an executable plan and should be built jointly by the private equity sponsor, the portfolio company management team, and the board, in order to get alignment, open up the lines of communication, and set out the strategy.
Separately, as private equity firms have built up operating teams, knowledge and experience, many of the participants noted they have created or started to create their own “playbook” to help investment professionals and operating professionals alike to move quickly and draw upon the institutional knowledge and learnings from past deals.
GETTING TO GREAT
An incredible effort goes into exploring the business and possible opportunities for improvement during the due diligence process, but often that information is not shared with the management team of the portfolio company. Sharing what consultants have found and concluded about the market, as well as the company’s opportunities and short-comings with management is a very good way to build trust and momentum with management teams. Over the first year or two of the investment, the findings can be validated, pivoted and translated into actionable insights.
A critical component of this is to define key metrics at the beginning of the relationship to be able to benchmark progress. Metrics should then be tracked and reported on a monthly basis. While the frequency can often be difficult for smaller teams, it creates a common language and continuous communication loop among the sponsor, the management team, and board members.
Create a “Roles & Goals” framework – clearly outlining who is in charge of which aspects of driving the business forward, along with what success looks like. Management teams new to private equity ownership often don’t know what “great” looks like until the metrics show them. Setting clear KPIs and tracking against them on a regular basis will give you the insight needed to stay on top of progress – and allow you to detect any early warning signs of potential setbacks.
Have an Avalanche Preparedness Plan
Make sure that you have a contingency plan built into your playbook so that, when a problem is revealed, a solution is triggered to fix it. Particularly during a volatile or down market, acting quickly can mean the difference between overcoming a stumbling block and setting yourself back to step one.
“In an avalanche, you have about five or six seconds to act before that soft, fluffy snow turns into concrete.”
If things reach a point of no return, our panelists suggest ripping the Band-Aid off quickly. If the management team (or a particular member of the team) is not right for the job, it is more effective to replace them with a team that can keep the company on track to meet its goals. People wait too long to replace a member of management because of all the issues that come with the change, but the moment you think that this is not the right person, you should pull the trigger.
By communicating regularly with the management team and reiterating initiatives and metrics, you can keep tabs on areas that are consistently falling short and address them before they turn into an irreversible problem. Often, management teams will acknowledge shortcomings themselves and work to put a plan in place to fix the present issues. Furthermore, communicating frequently during “peace times” helps build a trust and partnership with management, which can help keep the channels of communication wide-open in challenging times; a necessity in order for both sponsor and management team to be able to make quick and meaningful decisions to course correct.
Carrots vs. Sticks
Once the success metrics are in place, they can be used to reward teams as well. The incentive structure set up for management during the first few months following an acquisition should be clear, quantitative, and achievable – albeit demanding. Increased transparency of how management teams are remunerated helps with alignment and relationship building. But one size does not fit all – work with the management team and the Board to determine the specifics early on. If the management team is making progress, it’s important to reward that work.
Beware the Unnecessary Add-On
When growth is slowing or flat, it can be an attractive option to look for add-ons to expand a product line, add complementary services, or grow a geographic foot-print. However, our panelists warned against unnecessarily turning to the add-on as a way to kickstart growth.
“Don’t do add-ons to buy growth. It should be about the team’s ability to integrate and be successful, not by an idea that we’re slow here so we have to do a deal. If times are down, it’s dangerous to just do add-ons for the sake of it.”
Make sure to go back and review your investment thesis every couple of months to ensure you are not straying from the path of what got you initially excited about the company. While add-on acquisitions can be a key strategic move if done with a long-term view, be careful not to automatically look for levers to pull outside of the business when you can’t easily find any to pull within.
BUILD AN ENGAGED BOARD
Having an ongoing dialogue with management teams helps to foster trust and promote open communication with you as an investor – which leads to more transparency when issues arise, as well as a better environment to align interests for growth.
“Pivots are necessary all the time – the world is changing so quickly these days. If you can’t reevaluate your strategy over time, you’re doomed to fail.”
One key aspect of the sponsor-portfolio company relations is the creation of the Board of Directors. A good Board can be invaluable in situations where there is low- or no-growth and when the company needs to pivot and undergo significant change. Board member selection becomes even more important in an uncertain market. Directors should be willing to “dig into” the company and have their own point of view. Whether chosen by industry experience or functional expertise, whether known previously to the management team or not, what you don’t want is an independent director who joins a conference call four times a year, asks the obvious questions, and leaves it at that. “Yes men” are not useful.
When it comes to the board meetings themselves, our panelists recommend going one step beyond the top brass from the portfolio company side. By inviting employees one level below the management team, you get to see different perspectives within the company, the depth of the bench, and how the broader team interacts together. It is also an opportunity to “audition” potential future leaders within the company. Whether you are in touch with management twice a day, or you hold monthly board meetings to align and track against targets, communication is key to creating an effective relationship between the sponsor and the portfolio company.
“Good partners are not just around when times are tough. Trusted and lasting partnerships are forged by working towards shared goals, celebrating the good times and buckling down together in bad.”
By putting into place a clear set of metrics early on and providing ample opportunity for feedback, you can keep the management team focused on a shared end goal. For many management teams, coming under private equity control presents a unique set of advantages and challenges – helping them adapt successfully to the new partnership will benefit everyone.