Private Equity Operational Value Creation

Many of the PE firms that I have dealt with have had difficulty in deploying an institutional approach to operational value creation post investment. Most simply revert to expending a large amount of resources in the pre-investment analysis and due diligence phase and then settle on one or two board seats to manage their assets post investment. The large imbalance resource expenditure pre and post investment leads is a warning flag. Although the board is the correct way for a PE firm to manage its assets post investment it cannot rely on the standard model of a board member acting independently. The same resources that analysed the investment need to support the board directors in governing the investment.

What is being asked of directors of the board? Usually they have to approve annual budgets against a longer term business plan. Directors will then receive and review financial and other performance data to ascertain how the business is doing on a quarterly basis or possibly more frequently. The main issues include:

  1. Has the management executed on the business plan? Have they done what they said they would do?
  2. Has the business performed as expected?
  3. If the business has not performed as expected is it because management did not execute, the business plan was flawed or the environment was not as forecast? My experience is that management usually blames the environment when the real issue is their execution or problems with the business plan. More on this later.

Finally directors will decide whether they need to take any action.

What I have found effective is for my PE team and I to meet a month before a board meeting to review the business performance based on the information we had and then deciding what information we needed from management to properly analyse the business. It is critical at this point that the PE team take into account how the business environment has developed so as to preempt any management excuses. The information request is sent to management and agenda requests are sent to the chairman of the board.

Directors usually receive their board information packs one week ahead of the board meeting. These packs are typically anywhere between 100 to 200 pages often of dense data. There is simply no possible way for any one human being to absorb so much information, analyse it, synthesize it and come to any meaningful conclusions all in a single week. This is precisely why a good supporting PE team is invaluable.

I have seen many a board meeting get hijacked by management using the fact that the business environment was not exactly as forecast. Since it is necessary to research the economy to understand such a discussion a PE investor can efficiently use their investment analysts to prepare their appointed director for the board. Management of a contractor complains they can’t get business because oil prices dropped and government stopped spending? Then why does MEED report record project awards? Management of an asset management firm complains customer fund outflows due to a bear market? The why does Zawya report record increase in sector AUM?

This performance attribution is critical for the board to understand what is happening which is the foundation for their ability to make effective decision in adding operational value to the company. Once implemented and institutionalised it is an extremely smooth process that pays fantastic dividends on an ongoing basis.