Private Equity Fund Managers take a New Perspective in Troubled Times

The turmoil in global financial markets and a continuing global economic downturn have blown a serious hole in most business forecasts for 2009 and beyond.  In adjusting to this new reality, managers of private-equity funds and their portfolio companies face a series of stark challenges.

These pressures include a lack of availability of debt; the ever-present risk of breaching banking covenants; inventory levels pressurizing cash-flow; dramatic falls in the values of portfolio companies; delays to planned exit timetables and deteriorating fund performance. Although management fees are important, most fund managers make their money on “carry” or carried interest. All this has seriously reduced the likelihood of fund managers earning much hoped-for bonuses via carry, as these are normally triggered only after pre-determined hurdle levels for fund performance have been achieved.

Apart from possibly sheltering funds in listed companies, private equity fund managers have now refocused on the portfolio management of their existing investments rather than on deal-making.

Focus on cost and efficiency - additional challenges facing private equity

This increased focus on the performance of portfolio companies will in many cases mean looking to improving costs and efficiencies today, even if building value and brands remains the longer term proposition. This is easier said than done and fund managers face another set of less obvious but nevertheless serious challenges in “righting the ship” and delivering appropriate returns for investors. Why is this?

Firstly, many portfolio companies are run by managers who have expertise in building brands and managing growth, but who have not had to deal with managing cost and efficiencies in a severe downturn – something which will require a different skill set and management style.

Secondly, recent re-forecasting exercises will in many cases have revealed woefully inadequate forecasting and capacity planning processes, particularly in smaller and medium-sized enterprises. Forecasting can be more political than scientific and will lead to costly mistakes in the future allocation of resources if assumptions are not tested.

Thirdly, fund managers may feel less than comfortable “undermining management” by robustly challenging assumptions and data underlying their revised business plans – or in any case, not challenging these as robustly as was the case during the original acquisition due-diligence.

Fourthly, it is also possible for shared “blind spots” to develop, where management and investors fail to identify risks or opportunities which simply don’t appear on the radar, or where they struggle to acknowledge that the original value creation model behind the acquisition is now flawed. Even the most active investor will not necessarily have the deep insight or information necessary to see these issues, particularly in more recent acquisitions.

Finally, although many businesses may well be looking to financial restructuring today, many overlook the opportunity to seriously reconsider and reconfigure supply chain operations, unless of course they are entering restructuring as a result of going into administration, by which time it is often too late.

Renewed due-diligence in Operations provides a way forward

As a result of these challenges, some private equity groups are already asking supply chain and operations consultants to use their “due-diligence” skills to test and refine managers’ business plans, in even the healthiest of investments. Done correctly this can deliver enormous value to the investor and the management of the portfolio company.

"Done correctly" in my experience means:

• fully involving senior management in a genuinely collaborative style
• identifying upsides as well as blind spots and vulnerabilities
• testing and refining revised plans
• clearly demonstrating “how to” improve performance where this is not clear
• creating a clear project plan, with milestones and responsibilities, for implementing the business plan
• providing the tools and a process to enable monitoring of business plan delivery.

With this renewed due-diligence and risk assessment undertaken and clear benchmarks in place, investors can mitigate risk and avoid unpleasant and unnecessary “surprises” later on. By highlighting new opportunities to improve within operations, investors can help rebuild management confidence and create a platform for sustainable performance and improved returns.

Sean O’Hara
CEO, ANPRO Group
30 January 2009