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Private equity operating resources 2.0

PE Hot Topics

With competition increasing and prices high, PE firms are relying on value creation more than ever. In this edition, we examine the continuing evolution of the models that firms are using to maximize the impact of their operating resources.

Operational value creation is keenly important amid high price environment

It’s no secret that private equity firms are in the midst of one of the most challenging environments for capital deployment on record.

High valuations, continued competition from corporate acquirers and record levels of dry powder have sent average acquisition multiples well north of 10 times earnings before interest, taxes depreciation and amortization. With limited potential for multiple expansion, driving returns through operational improvements is now front and center for PE firms.

The current PE model is to overpay for an asset, and earn it back through value creation.

– participant at the recent Harvard PE/VC conference

Overall growth rates are slowing, but smaller firms are catching up

Currently, the industry has approximately one-third more operating resources than it had just four years ago. Much of this growth is occurring at smaller and mid-market firms.

Where perhaps a decade ago, operating resources were concentrated at larger shops with the scale and deal sizes to make them more cost effective, midmarket firms are increasingly catching up.

Three key trends define ‘operating resources 2.0’

A number of developments is defining the next phase of the model’s evolution.

  • Firms are involving operating resources earlier in the deal cycle
    • Traditionally, operating resources have focused on adding value during the hold period, with resources brought in post-close. However, many firms are now involving operating resources earlier in the process. As targets are identified, they’re being brought in during the diligence phase in order to help build the investment thesis and flag opportunities for value creation.
  • Firms are increasingly using specialized operating resources
    • While generalists remain an important part of the playbook, firms are increasingly involving specialist resources as well across a range of disciplines.
  • Firms are increasingly using 1099 contractors — either in addition to or in place of full-time employees
    • Two years ago, most operating resources were comprised of full-time employees of the GP; today, many firms are now increasingly using contractors in their place, or sometimes using hybrid models that utilize both.

No ‘one-size-fits-all’ solution

It’s important to note that there’s no one-size-fits-all solution. For every model, there’s a firm out there that’s using it successfully.

As such, the question isn’t “what’s the right value creation model?” It’s “what’s the right model for your firm, for your strategy and for this particular portfolio company?” What’s keenly important is that the model aligns with or complements a firm’s strategy, competencies and key differentiators.

Firms need to consider a number of questions to determine the approach that’s right for them:

  • How are we going to add value and generate return?
  • What resources are required to execute against our thesis?
  • What’s the most effective and efficient way to get these resources?
  • How do we recruit, motivate, compensate and retain our talent?

Careful consideration of these elements, and indeed of all aspects of the operating resource model, can help maximize the impact of these increasingly essential resources.