Insights from the Accordion Roundtable – July 2022
How PE Teams Can Protect Value in a Challenging Economic Environment
On Tuesday, July 12, Accordion joined a group of operating and deal partners from leading firms such as The Carlyle Group, Kelso & Company, Apax Partners, and General Atlantic for a Roundtable discussion at our New York City office.
We discussed how, amid persistent inflation, supply chain constraints, and markets moving into bear territory, it’s essential that PE teams and portfolio executives operate in sync to proactively mitigate these newfound stressors in order to create, or at least protect, value.
Here are a few of the headline learnings, lessons, and takeaways from our Roundtable:
On the Difference Between the COVID-Market and the Current-Market:
While COVID-19 catalyzed an unprecedented economic crisis, today’s downturn is different, requiring a holistic and strategic response beyond immediate crisis management:
“With COVID, we designed a rapid response, as opposed to a push model where we do the same thing every time. Our executives were calling us with problems that none of us had faced, and we were reactive. This is not a COVID situation. This is a downturn. So instead of being reactive, we need to be proactive – telling our sponsors and our portfolio companies: Here are the five things that we should all be doing now to get in front of it.”
“I question whether or not we’re being proactive enough, and telling every portfolio company that they need a break-the-glass plan.”
“We are starting to become more pushy and prescriptive at this stage. In fact, last month we had all of our portfolios in a room — the CEOs, CFOs, and Accordion — to help with a couple of sessions about what we are seeing down the road that’s different and how we need to prepare.”
On Why Sponsors Must Lean In (Now):
They’ve been there and done that. In many cases, management has not:
“Many of our teams have not seen real inflation and don’t know how to manage it. So we are helping. We tell them we are a starting post, and we are doing it in a training way. We say, ‘This has nothing to do with whether you are capable or not. This is just new, and you need outside help now.’”
“I’m sensing everybody in this room has actually seen a downturn. We’ve seen what pain looks like, whether it was the dot-com bubble or the Asian financial crisis or 2008. But, I get the sense that the bulk of our investing teams and the people who run the books have not.”
On Getting Back to Basics:
Our Roundtable found a perception among sponsors that many of their portfolio company CEOs and CFOs don’t do the foundational basics required to really understand the economics of the business. Without those basics, it can be difficult, if not downright impossible, for management to understand how to navigate a downturn, and/or understand which products/services should be invested in and which should be shelved.
“If I pulled on one thread throughout our portfolio, the one thing we are getting very, very focused on is understanding real economics. And what we see is most of our companies don’t really understand the economics very well.”
“We are beginning to put a lot of effort in trying to create the right level of visibility so that we can get to the heart of basic metrics.”
“The reason that CEOs and CFOs don’t understand the unit economics is because they don’t have the visibility into it. It’s important to put effort into trying to create the right level of visibility so that executives can get to the heart of the basic metrics, which then helps them to make beneficial capital allocations.”
“SKU rationalization decisions might become quite important. And while the underlying unit economics visibility for the coming years doesn’t exist right now, you must coach your CEOs on how to look at and optimize the business.”
“I think it’s still been a challenge to focus on getting the basics right, particularly around M&A integration. We see a lot of unfinished M&A and a lot of company building — or attempted company building — by jamming 3, 4, or 5 companies together at once.”
Digitization initiatives aren’t a question of “if,” they are a question of “when.” With mounting and occasionally novel external stressors, management is asking the “when” question. The consensus answer from our Roundtable is “right now.”
“During COVID-19, the things you thought about digitalization (and the need to simplify operations by leveraging technology) were all true. But because we were fighting the pandemic every day, no one had a lot of motivation then. But now, people have the mental bandwidth to do it.”
“This is what I think we ought to do, and what I hope we’re going to be able to do. I’m personally trying to push hard to take advantage of deeper and deeper digitization efforts inside the company right now.”
“If you don’t make these capital investments right now, three years down the line it is very unlikely that you’ll get them through the board. Fast forward five years from now and you’ll have an oversized FP&A team because they’re doing everything manually, and you’re spending more time collecting the data versus actually driving insights.”
“We’re talking about tools. Our firm has established more strategic relationships with many of these technology providers. So instead of having a $300 million topline company buying whatever dynamic tool, we’re actually taking a cross-portfolio view to invest in tech across our portfolio companies right now.”
Talent is universally one of the biggest cost expenditures. As a result, how to hire, when to hire, and when to automate are among the most pressing, critical, and confusing questions.
“Should we talk about labor? The macro news from last week is that we’re still adding 300,000 plus jobs. As I look across our portfolio, there’s almost this sense of relief that maybe people are actually starting to be able to hire — and it makes me nervous. Should we actually resist the temptation at this point? Should we stop the hiring?”
“I don’t think, at least for us, there is a blanket statement: we’re going to continue hiring versus we’re going stop. A lot of it is going be very situational, where we work with the CEO to say, ‘Here are the top 5 or 10 key roles that you say you need. What would happen if we don’t have this role, versus that role?’”
“I think the mistake that probably everyone made before, talent-wise, is to layoff and adjust the cost structure to be reactive to the downturn. And the reality is that you don’t really run a company on the downturn scenario — you run it and grow for the future.”
“We’ve not been able to figure out a framework where we can tell our companies to hold off on hiring. I think there’s still balancing this notion of the frontline versus the corporate, and what should that be in relation to size and speed. So I don’t really have a straight answer. I think we are approaching the digitization more in the back office.”
“I would encourage our deal partners to take a moment to invest in retaining the frontline talent and digitally streamlining the mid-office.”
On the Shifting Balance of Power in the Labor Force:
In addition to general hiring concerns and labor automation, participants believe the downturn will likely spark a wealth transfer: a shift in the balance of power between white-collar executives and blue-collar employees, which would have significant implications on business going forward.
“We have a lot of companies which are pretty heavy on blue collar logistics. We are saying to our CFOs, ‘What you are going to see is a massive transfer value from the white collar (corporate and ownerships) to the blue collar (labor).’”
“Already we’ve seen both in the U.S. and in Europe that it’s been much more difficult to find labor at the frontline level. Particularly in service businesses, it’s been hard to find anybody who’s willing to work.”
“We, as sponsors, are the ones who are pushing a renewed look at talent cost structure. That’s because, by definition, management tends to come and justify their salaries and bonuses as the managers. And that’s an environment we believe will fundamentally change as the balance of power shifts from the white-collar executive to the blue-collar executive.”
“White-collar workers cost three time as much as the productive workers on the front lines, and we mistakenly throw them at our companies in droves to solve for the fundamental lack of investment in system and process integration. If we invest in technologies, we can address that.”
On Struggling Sectors (Like Tech):
A booming economy brought with it extensive investment (perhaps overinvestment) in the tech sector. The probability of a downturn has already pushed sponsors to pull back. As a result, tech companies seeking continued investment will face an uphill battle, with some being forced to seek rescue financing at a far lower-than-ideal multiple.
“If you look at how venture capital funding has happened in the last few years, we suspect that we’ll see companies coming up for funding in Q1 and Q2 of next year just to keep the lights on.”
“Many tech company unit economics aren’t compelling structurally or operationally. Slam that into a downturn and the unit economics will go up dramatically. So you better get much better at process, otherwise you’ll be left with stranded assets. And stranded assets are much different than assets.”