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PE Funds Becoming More Hands-On to Drive Returns

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January 24, 2014

One of the less-publicised aspects of the private equity (PE) industry is how involved PE funds get with the companies they have invested in. Often, it has been the case that we don’t hear about it because it doesn’t happen.

 

Historically, involvement from PE funds in the companies they have invested in has been little more than putting a logo and a paragraph of information on their portfolio page. As it becomes harder to be a success in the PE markets and returns start to get ‘leaner,’ funds are starting to put pressure on their portfolio companies, as this article by Forbes reports.

 

The report cites figures from The Cambridge Associates U.S. Private Equity Index that shows roughly a 6% decline in returns when you compare the performance investments in the last 10 years to that of the last five. It is no surprise that PE funds are concerned at this trend and, for themselves, their investors, and ultimately for their portfolio companies, they are looking to arrest and reverse this.

 

The easiest way for PE funds to get involved is to target companies where they have knowledge of their industry, whether this is through previous successful (or maybe even unsuccessful) investments or because someone within the organisation has their own direct experience.

 

At the same time, funds recognise that if they were to do this they would potentially narrow the markets they can enter to a harmful degree. Therefore, they look to hire consultants and in some cases put independent directors – who themselves are often outsourced consultants – onto the boards of the companies they have invested in.

 

This allows PE funds to achieve a number of goals. First, they can brief the person they’re working with on what their objectives are. For example, the Forbes article looks specifically at business operations, which is typically an area where many companies are missing huge opportunities to eliminate inefficiencies and boost their profits.

 

Many PE funds will be looking for improvements in this area, but depending on the client’s industry they could also look at everything from employee remuneration down to the product buying process and even utility bills and facilities, if they wanted to. Secondly, the fund will always have a voice and, perhaps more importantly, a set of eyes and ears within a company, so they can always have an update on where things stand rather than waiting for periodic and often sporadic reports.

 

An important part of this whole process in terms of the growth of the PE marketplace going forward is how balance is achieved between what the fund wants to do and how the company is run. While most Boards of Directors and CEO’s will understand that investors want to know what is going on, few will want to be in a position where they are effectively reduced to puppet status.

 

At the same time, it is important to recognise that if PE funds are putting pressure on their portfolio companies, it’s to increase their own returns. Returns will only increase if the business’ profits do the same, so it is therefore in the best interests of all parties to work together and for businesses to accept and even ask for any input that PE funds might want to make that could be beneficial.

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