At PEI’s Operating Partners Forum in New York, investors shared some of their forensic techniques with us…
For limited partners, assessing a private equity firm’s operational expertise can require some good old-fashioned detective work.
In the same way crime scene investigators have to piece together clues and eye-witness accounts to solve a case, LPs at times need to perform what has been referred to as “forensic due diligence”.
This phrase was recently used by one LP speaking at PEI’s 2013 Operating Partners Forum in New York in November. The focus of the panel was the role of the operating partner in fundraising – and the speakers, all of whom were LPs, had plenty to say about how they determine the true value of a GP’s operational expertise.
One of the first points made by the panellists was that, while nearly all GPs claim to be “operationally oriented”, only around 80 percent actually invest using an operating partner model of one kind or another. As for the rest… Well, as one LP put it, you can’t claim to have operating talent because someone at your firm walked through a warehouse one time.
Simply boasting about your brilliant team of in-house operators isn’t going to win you any popularity contests with LPs by itself, the panellists said. Whether you use external consultants on a freelance basis or have full-time operators augmenting your investment team is not the point, they suggested. What’s more important is having worked with an operating partner on multiple successful investments – or even better, having an external operator who works exclusively with your firm.
“That tends to give more comfort,” said one of the panellists. “There are no one-hit wonders.”
Essentially, LPs don’t care how GPs get the job done – as long as they’re demonstrably adding value and can replicate that process again in the future.
Investors recognise that it’s simply unrealistic to expect a lot of GPs to be able to hire a big in-house operating team. While the mega firms may have a massive bench of fulltime operators, not to mention the resources to (as one panelist put it) “buy McKinsey”, a small shop focused on the lower mid-market might not be able to justify one full-time in-house operator, much less three or four of them.