Capital Roundtable. The Limited Partner perspective: how LPs are increasingly seeking evidence for how PE firms drive value creation

Transcription

1 Capital Roundtable The Limited Partner perspective: how LPs are increasingly seeking evidence for how PE firms drive value creation September 11, 2014

2 Key questions? What is the Limited Partners level of awareness and understanding of operating resources?? Do Limited Partners think there is a superior approach to leveraging operating resources?? How do LPs react to the different characteristics of operating resources models? EY-Parthenon Page 2

3 The conventional wisdom of the role of the operating partner Operating partner (noun /äpə-rāt-ing,part-nər/) This is the guy who can probably add the most value inside your portfolio, but no one listens to him. Ever. The portfolio CEOs think he s trying to take their jobs, and your partners don t quite know what to do with him because he doesn t find deals for them. While he ll get a lot of attention at your annual meeting, he rarely sees the light of day the rest of the year. But if you want to know what s really going on at your firm, get a couple bourbons into him the next time you are out at a portfolio company together. He ll tell you everything. Source: I Have a Meeting in Westchester and other essential code words for PE newbies, PE Hub August 2014 EY-Parthenon Page 3

4 The evolution of private equity has dramatically increased the importance of operational improvements to create value Source of value (%) 100% 80 Leverage Multiple arbitrage 20 Operational Improvement 0 Leverage era (1980's) Multiple expansion era (1990s) Earnings growth era (2000s) Operational improvement era (2010s) Source: Goldman Sachs, BCG-IESE estimate EY-Parthenon Page 4

5 Recognizing most GPs can no longer make it on the buy, LPs are universally aware of the role of operating resources Q: Have you observed an increase in the presence of operating partners at private equity firms? 100% 80 Used to be that during fundraising in the 80s and 90s every GP talked about having proprietary deal flow, now everyone is talking about their operating partner Yes I am hard pressed to think of a GP at scale who doesn t have some form of the operating model Operating partners are part of the value proposition now Operating partners are ubiquitous in PE these days. 0 Increasing presence EY-Parthenon Page 5

6 However, LPs recognize there is not just one operating resource model across GPs I don t relish your task to explain why there are 750 different models for operating partners out there. It doesn t seem like any two are alike. I d love some advice on how to judge which model is really creating value. Operating partners are no longer window dressing, we really have to dig in to understand how they are being used because every approach is so different. EY-Parthenon Page 6

7 LPs do not think there is one superior operating resource model Q: Do you think there is one operating partner model that is better than all the rest? 100% Yes No Superior model? EY-Parthenon Page 7

8 but look for an alignment of firm investment strategy and operational resources structure It s not a question of what model works best they all can work it is a question of how it fits with the firm s approach and strategy and how the firm integrates the resources Operating partner approach needs to reflect the needs of the deal they are doing Firm investment strategy Operational resources structure Important to explain why GP has chosen this structure and give examples of how it will (or has) worked Not one model that works better it depends on alignment and how the pieces of the puzzle fit together EY-Parthenon Page 8

9 Though there are no absolute truths, LPs articulate examples of how operating resources support investment strategy Firm investment strategy Invest in highly complex engineering companies Invest in large, highly complex businesses Hyper focus on one vertical Invest in middle market companies with B-team management Invest in turn-around businesses Operating resources structure Functional specialists (engineers) are the operating partners Team of generalists on staff to marshal the requisite resources Operating partners as specialists with extensive line experience and networks in the targeted industry Management-in-waiting on retainer that can help with sourcing, value creation plan and execution of the plan post-close Team of functional specialists deployed on an as needed basis to companies EY-Parthenon Page 9

10 There are many levers private equity firms can utilize to align operating resources to their investment strategy Generalist Expertise Specialist (industry or function) Full-time employee Staffing Bench players Sourcing Deployment Post acquisition Salary Compensation Carry & co-investment Internal resources Resources External resources EY-Parthenon Page 10

11 While there is not one right model, some LPs have opinions on the various levers that can be pulled Q: Do you prefer investing in GPs with operating partners that have functional expertise or are generalists? It depends 60% I don t think one is superior...tell me why they chose that route and give me examples of how it works Functional specialists 27% It depends on the investment strategy if they are doing turnarounds, it makes sense to have functional experts with turnaround experience. Generalists 13% % Ex-consultants/ex-c level are good because they can work across portfolio companies with different issues. It depends on the companies they buy, generalists can engage at a more strategic level to impact value creation. EY-Parthenon Page 11

12 LPs are less enthusiastic about the big name CEO as advisor model, but see its merits in some cases Q: Do you have a preference for a bench player approach or do you prefer operating partners who are fully employed by the GP? It depends 33% Full-time 56% When I see a big name CEO on the page, I wonder what he is actually doing at the firm. I question the level of commitment of bench players, so I like full time employees. In some situations it works to have advisors that are on the pay roll full time and can help with one-off projects. Advisors 7% % EY-Parthenon Page 12

13 LPs believe that operating partners should be deployed early in the life of the deal Q: When do you think operating partners should first be deployed in the lifetime of a deal? During sourcing 63% Get them involved as early as possible to justify the cost. During diligence 37% These are the guys who can identify the value creation plan so get them in for diligence so they can hit the ground running day one of ownership. After close % EY-Parthenon Page 13

14 Most LPs want the operating partners incentives aligned with their own at the fund level Q: How do you think operating partners should be compensated? Fund level/carry 81% Co-investment 19% I want to make sure Operating Partners are paid well so they will stick around. I like when their incentives are aligned with those of the LP. Specific deal co-investment makes sense for the bench players who are just working on individual deals. Salary % EY-Parthenon Page 14

15 The choice between internal resources vs. external resources depends on the needs of the portfolio Q: Do you have a preference for a model where there are a few internal resources who marshal external resources or a large team of internal resources that are deployed? It depends 80% External 10% Internal resources can be limiting it is hard to have the tool kit for all the portfolio companies, but it can work. Feels like a rent vs. buy decision it depends Internal 10% External model has the advantage of being able to bring best in class resources for every situation % EY-Parthenon Page 15

16 Transparency is most important factor when it comes to the economics of resources Q: How do you prefer operating resources are paid for by the portfolio company, through management fees, other? Any approach okay as long as transparent 75% There is less impact on cash return if charged to the portfolio company. Since may only have 90% ownership makes sense for portfolio company to pay for it. Portfolio company 17% Either approach is fine as long as we know what they are doing. Management fee 8% I want to know what they are doing, I don t want it to be another profit center for the GP. Convince me you are in this for the carry % EY-Parthenon Page 16

17 How do you prove to limited partners that your model is working? Have operating partners take an active role in fundraising, at the annual meeting and during portfolio reviews Make sure your operating strategy is clearly laid out and clearly articulate how it supports the investment strategy of the firm Show specific examples of how the operating model is making a difference. Don t hesitate to highlight challenges and how operating resources alleviated a problem Provide specific details about how the operating resources are spending their time, and why EY-Parthenon Page 17

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