Operating resources 2.0

Transcription

1 Operating resources 2.0 How the role and structure of PE operating resources is evolving in today s competitive market Jay Bartlett May 11, 2017

2 Research context We are now in our third phase of research on operating resources Limited partner (LP) perspective September 2014 Portfolio CEO perspective May 2016 Private equity (PE) executive perspective April 2017 Interviewed 25 LPs across various fund types Interviewed ~10 general partners (GPs) and 30+ portfolio CEOs Interviewed 20+ PE executives, including operating partners and GPs What we asked: What trends are you seeing in the world of operating resources? How do you measure the effectiveness of your operating resources? How are your operating resources compensated? EY-Parthenon Page 2

3 PE firms are operating with significant competition, uncertainty and scrutiny Dry power and multiples are near record highs North American PE dry powder Private Equity Guards Its Public Image Wall Street Journal September 29, 2016 This Is Your Life, Brought to You by Private Equity New York Times December 24, 2016 US M&A transaction multiples Private Equity's Big Dry Powder Mountain Bloomberg March 8, 2017 PE firms look ahead in uncertain times Bloomberg February 7, 2017 Private Equity and the SEC s Quest for Transparency Summit Executive Resources February 2, 2016 Note: *As of 3/31/2017; US M&A transaction multiples includes buyouts Source: PitchBook's 1Q 2017 US PE breakdown; EY s PE year in review and outlook EY-Parthenon Page 3

4 As competition intensifies, so does the need for operational improvement in order to create value Operating Executives on the Move PrivCap/RSM 2016 Rethinking Private Equity Operating Partner and Board Models Summit Executive Resources February 10, 2016 The Rise of the Private Equity Operating Partner Axial June 8, 2015 Private Equity: What s the receipt for success? Elixirr December 29, 2016 How Private Equity Firms Hire CEOs Harvard Business Review June 2016 EY-Parthenon Page 4

5 Operating resources are not going away LPs value them CEOs value them GPs value them Operating partners are part of the value proposition now. Operating partners are no longer window dressing. [Our operating partner] was very helpful in building clarity, getting thoughts aligned, working with me to create different work groups, and really put in motion all the necessary things. The need for operating improvement to generate return has grown in the current investing environment; we needed to build our capacity and improve in this area. We are investors and not operators. Having an operating partner is huge to be an intermediary between [me and the finance team]. They can translate to people that have never run businesses. As a generalist fund, we need people that can be deployed across the portfolio. Source: EY-Parthenon interviews EY-Parthenon Page 5

6 The pool of operating resource continues to grow, albeit, likely at a slower rate The number of operating resources in the market continues to grow These groups are more complex, and often include part-time resources Index of change in size of operations groups within PE firms we interviewed, Change in percentage of tiered operating groups across PE firms we interviewed, % % % Operating resources used to be unusual for PE shops to have 10 years ago just a few had operating capabilities. It s grown dramatically over the past 10 to 15 years. That said, the growth is declining. It may have peaked three years ago, but recently, growth has slowed. There has been some backtracking among large cap firms who acted too quickly, while small/mid-market firms are catching up. Source: company websites; EY-Parthenon interviews, April 2017 (n=23) EY-Parthenon Page 6

7 However, there remains disparity in the way models are used we observe no real convergence in the market Types of operating partners Level Type Skill set Retired CEO Advisor Generalist Peer-level resource Partner Industry expert Junior analyst Arms and legs Functional expert Background Working style Purpose Operator Mentor Strategic Consultant Doer Tactical The key is for the model to align with the PE firm s investment strategy EY-Parthenon Page 7

8 We see firms involving operating resources earlier in the deal cycle Deal generation Due diligence First 100 days Holding period Exit Operating resources have traditionally been focused on the holding period Firms increasingly involve operating resources earlier in the process in order to: 1) Leverage senior members networks for deal generation 2) Help identify opportunities to create value during diligence 3) Get a head start on 100-day planning and build relationships with the management team EY-Parthenon Page 8

9 There is value in involving operating resources earlier Deal generation Identify where there is value Get a head start Today our operating resources are involved in sourcing opportunities, evaluating opportunities, attending first meetings. Sourcing deals has become more and more critical. Some of our [operating resources] can open doors that wouldn t have otherwise been open and they can explain why it makes sense to work with us. They are moving in earlier in the investment decision into the diligence stage, attending the management meetings, working hand in hand with the deal partner and team to evaluate the asset and investment thesis. Our operating resources are much more hands-on for two reasons trying to be smart about where we invest and being strategic and thoughtful about how to achieve additional value. You want to hit the ground running, so the more [operating resources] are involved in diligence, the more quickly they can get off the ground and moving. Bringing that generalist ops partner in-house earlier allowed us to get more visibility within the portfolio company earlier. Our operating resources need to ensure the management team is able to drive the growth we want and that evaluation is now done earlier in the process. Source: EY-Parthenon interviews, April 2017 (n=23) EY-Parthenon Page 9

10 Last year, we heard CEOs resoundingly favor the generalist CEOs desired operating partner expertise 100% Depends Functionalist Industry expert Generalist CEOs value generalists for their fresh perspectives and holistic approach to problems. The generalist is good at certain things framing complex issues into bite-size portions to digest and join the dots. CEO, technology company The entire team has benefited from his insight into similar businesses but not identical. [Generalists] are helpful because we can see different aspects of our business through a different lens. CEO, education company 20 0 Expertise type Source: EY-Parthenon interviews, April 2016 (n=31) EY-Parthenon Page 10

11 Yet, the market is shifting towards the specialist s side of the continuum Percentage of PE firms we interviewed with specialization 100% % 65% The specialist is something that the deal team doesn t have, whereas the generalists are less different from the deal team. The specialist is more incrementally valuable it brings a level of expertise to decision-making that is complementary to the deal team. Given some of the challenges with underwriting deals as prices are going crazy, we re seeing a lot of earlier involvement of the group as part of deal thesis development. People want to understand and quantify the whole process. There are the low hanging fruit procurement, strategic sourcing those are becoming very much absolute Industry Functional Source: company websites; EY-Parthenon interviews, April 2017 (n=23) EY-Parthenon Page 11

12 Finance, talent and procurement were the functional needs we heard most Breakdown of functional specialties across the PE firms we interviewed either existing or planned Specialization in finance is a key area. It s difficult to hire really good CFOs 100% of the time. They re amazing at 80% of what we want them to do, but there s always 20% that could be better even more so if you re in the situation that has a company in a crisis. I think there is just a growing awareness of the importance of human capital. If you sit down and think about when things didn t pan out, it always comes back to a bad CEO or executive team. Talent has been a big theme and a hot button. Assessing management teams, conflict resolution post close, onboarding or changing CEO the whole life cycle of talent acquisition and helping execs be successful in the portfolio company has been a focus. Source: company websites; EY-Parthenon interviews, April 2017 (n=23) EY-Parthenon Page 12

13 There are legitimate reasons for the specialist shift Specialists are easier to quantify and deliver a faster return on investment (ROI) My sense is that leading firms try to own less than a handful of those of core functions and do it in a highly leveraged way. It s easier to have someone on-site thinking about X across the whole portfolio. I think there is a very tangible results benefit to it. Specialists tend to cost less [Specialists are] cheaper and you get more of them for less money, compared to the heavyweight OPs who are more expensive. High multiples require the best in order to deliver returns The portfolio companies generally have procurement or pricing people; they don t know what great looks like in these functions. They just don t know how much money there is in each of these capabilities. Specialists are doers rather than advisors We don t want the CEO to hire some cost person we don t know. We like to lean forward a bit more and be more directive. Source: EY-Parthenon interviews, April 2017 (n=23) EY-Parthenon Page 13

14 A number of firms are also employing 1099 contractors either in addition to or in place of full-time employees Employment status of operating resources within PE firms we interviewed, % % W2 Hybrid Until two years ago, everyone was W2; now, we re moving towards a contracting model. We re a hybrid today. Two years from now, we ll have a completely independent contracting model. Part of the reason we structure our group as independent contractors is because the SEC often requires a lot of transparency and disclosure about compensation Contractor 0 Employment status Source: company websites; EY-Parthenon interviews, April 2017 (n=23) EY-Parthenon Page 14

15 There are advantages to both the full-time employee and contractor Full time vs. Independent contractor Incentives are better aligned with the GP and management team $ Less expensive, which can be particularly attractive to smaller funds Dedicated and exclusive to the PE firm Have competing priorities Generate institutional knowledge Wider bench and easier to pivot when specific needs arise Can be difficult to find the right person with the right skill set Large supply of qualified resources EY-Parthenon Page 15

16 Despite the shift towards specialists and independent contractors, many still value the traditional generalist operating partner Many firms remain dedicated to the full-time generalists Though given difficulty in quantifying the value of a generalist, firms must be willing to just know The operating people are employees and get salary, bonus, and carry. Involving them directly with portfolio companies is a quagmire of regulatory mayhem. But the return on them is really high they more than pay for themselves. We have more W2 partners than we ve ever had because we want the good ones to be proprietary and exclusive, and give all of their time to us. We try to have an active network of people to draw from, but when we find a good one, we reel them in. There are multiple ways to measure success, but nothing really concrete. When you re in the board room and see that executive interact with the management team, that s when the magic happens. We don t have a formal evaluation process set up, but every six months to a year, you evaluate what s going on. We have a model that relies on: if it s not working, both parties will know. Source: EY-Parthenon interviews, April 2017 (n=23) EY-Parthenon Page 16

17 Compensation varies widely and depends on what incentives the firm wants to create for its operating resources A firm s philosophy around operating resources is reflected in the compensation structure Partnership Salary and bonus are potentially a minority of total compensation Operating partner, deal partner and LP incentives should be aligned A personal stake in the fund via-co-investment creates added incentive The team should pivot to where they are needed most Resources Resources should be paid at market value in line with the next best alternative Compensation can be aligned with the success of the specific deals resources work on, through carry or coinvestment Salary + bonus Investment carry or co-invest Fund carry EY-Parthenon Page 17

18 So what does this all mean? Questions for GPs and operating teams to consider How are we going to add value and generate return? What resources are required to execute against this investment thesis?? What is the most effective and efficient way to get these resources? How do we recruit, motivate, compensate and retain these resources? EY-Parthenon Page 18

19 About EY-Parthenon Parthenon joined Ernst & Young LLP on August 29, EY-Parthenon is a strategy consultancy, committed to bringing unconventional yet pragmatic thinking together with our clients smarts to deliver actionable strategies for real impact in today s complex business landscape. Innovation has become a necessary ingredient for sustained success. Critical to unlocking opportunities is EY-Parthenon s ideal balance of strengths specialized experience with broad executional capabilities to help you optimize your portfolio of businesses, uncover industry insights to make investment decisions, find effective paths for strategic growth opportunities and make acquisitions more rewarding. Our proven methodologies along with a progressive spirit can deliver intelligent services for our clients, amplify the impact of our strategies and make us the global advisor of choice for business leaders. About EY-Parthenon s Private Equity practice Private equity firms are constantly looking to make better-informed investment decisions, improve portfolio company performance and increase realized value. Over the last 15 years, our private equity strategy professionals have worked with clients to address these challenges utilizing our deep sector knowledge and efficient and flexible processes to complete more than 2,500 strategic due diligence projects around the globe. We have a winning combination for the entire range of private equity strategy and transaction needs. Contact us Jay Bartlett Managing Director, Co-head of Private Equity Parthenon-EY Ernst & Young, LLP jay.bartlett@parthenon.ey.com Executive Assistant: Dominique Clervil dominique.clervil@parthenon.ey.com Follow us for regular updates Facebook facebook.com/eyparthenon/ LinkedIn linkedin.com/company/ey-parthenon EY-Parthenon Page 19

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