Just as early astronomers argued about the correct celestial composition of the universe, many fund managers are struggling to harmonise the talents of both dealmakers and operational experts.
It’s harder than many realise, in part due to the way the private equity industry has developed over the years, what levers were pulled to produce market-beating returns and what sort of professionals were pulling them. To get a sense for this, we took a quick look at the backgrounds of the most senior figure at each of the top 20 firms in our most recent PEI 300 ranking. Just five came from consulting or industrial backgrounds, four from investment roles and the remaining 11 were all investment bankers who had specialised in M&A. It’s a back-of-envelope piece of analysis, but still seems to support the idea that some of the largest, oldest firms in the industry – for those tend to lead the league tables – were formed with a strong sense of adding value via M&A.
Today, however, the industry has reached a stage where a typical private equity firm is no longer just a collection of former investment bankers that fancied trying their hand at buyouts. That is in part a reflection of changing market environments: you’d be hard pressed to find a GP today that tells you multiple expansion and leverage are the road to returns. Indeed, a Partners Group study earlier this year suggested 75 percent of expected value creation would be generated by direct operational improvements at portfolio companies.
So while executives with M&A-orientated skillsets still feature prominently in many firms’ rosters, those from operational backgrounds are increasingly finding their way into private equity (and indeed, many of those top 20 firms we mentioned have led the way in strengthening and formalising operational capabilities).
But finding the right model and figuring out how to integrate those operators into firms that have traditionally had a transactional focus is by no means straightforward, as speakers and delegates noted in London last week at our Operating Partners Forum.
An “us and them” situation can occur, for example, if the operators and dealmakers don’t value each others’ skillsets, are compensated differently or get involved at different stages of the investment process (operators not invited to participate in due diligence and sourcing, for example, may be more likely to tell a colleague on the deal team that a company isn’t fixable and they shouldn’t have bought it in the first place).
One panellist used the metaphor of F-14 fighter crews (who sit one behind the other) to illustrate the divide/divergent views that can occur. Rather than feeling and acting as a team as they should, the pilot in front may sometimes think he’s running the show while someone occasionally plays with the dials behind him. Meanwhile, the radar intercept officer in the back may be thinking, as he manages the battle, that the guy in front is just a chauffeur.
McKinsey & Company director Conor Kehoe noted how critical it was that the various teams within a firm operate well together: “Getting the ‘one firm’ feeling is important, and getting compensation schemes and internal status right is very much part of that process.”
Of course, there are many ways to go about it and that depends largely on the operational value creation model being used by the GP. Some firms have internal portfolio enhancement teams. Others use full-time operating partners that were former titans of industry. Still others keep high-level senior advisors on call or rely on third-party consultants. Some have hired investment professionals with operational and consulting expertise. A number use a combination of all those methods and also have views on specialist versus generalist operating professionals.
But another key take-away from the event this week was that there was no silver bullet: firms must find a model that fits well with their existing DNA, as pointed out by speakers including Helen Steers, head of Pantheon’s primary investments in Europe, Jonny Maxwell, former head of Allianz Private Equity and Standard Life Investments, and Vindi Banga, who became an operating partner at Clayton Dubilier & Rice after 33 years at Unilever.
“You can’t build your operating model overnight,” Banga told delegates. “It’s a cultural transformation. Think carefully about who you are as a firm, where you have come from and where you want to go.”
PEI will take an in-depth look at current trends and challenges facing operating partners and value creation teams in our upcoming Portfolio Monitoring supplement, which will also feature our inaugural operational awards for excellence. Stay tuned for details.