Private equity: The effectiveness of operating resources in creating incremental value

The increasing importance of operational value creation has driven PE firms to have to diversify their role and develop in-house capabilities or look outside the organization

19Feb

Increased reliance on operational value creation in recent years, especially in fund vintages since 2011, has required PE firms to diversify from their traditional "financial engineering" role.

Private equity (PE) firms have had to develop in-house capabilities or look outside of their own organization for the operational expertise they require to achieve rapid, measurable results. Approximately 50% of middle market and larger PE firms utilize operating resources internally and most are working with various third parties to achieve improved operating results. The question is, how effective are these operating resources in creating incremental value?

A recent Maine Pointe snapshot survey, "Effectiveness and Financial Impact Derived from the Use of Operating Partners in North America and Europe", revealed a lack of appropriately skilled and qualified resources, time constraints and difficulties getting CEO/management co-operation are major barriers preventing PE firms from driving more value in cost reduction and cash flow. Over the last decade, this has sparked the trend for PE firms to hire in industry expertise to drive operational improvement across the value chain. This is a significant shift in thinking from past practices where cost reduction and supply chain and operations process improvements were not generally viewed as high priorities when a portfolio company wasn't performing to plan.

Why do PE firms need operating partners?

That's changed in the last few years, with many leading PE firms shifting focus towards supply chain cost reduction as a means of quickly generating cash, EBITDA improvements, growth and, ultimately, value creation. As a result, supply chain improvement is frequently being seen as a priority in the 100-day plan.

However, PE executives increasingly recognize that they lack the in-house operational and management experience required to drive these improvements and, as a result, are more open to the idea of bringing in experienced operating partners as early as the due diligence stage. Bringing in an operating partner at due diligence and continuing with the same partner post-acquisition means supply risks can be resolved, new value creation opportunities found and previously identified opportunities implemented all within an accelerated period. Nonetheless, the Maine Pointe survey also showed that finding the right talent and skilled resources continues to be a significant concern for many PE firms and operating partners trying to drive more value and improved operational performance. As one operating partner for a global PE firm told Maine Pointe, "resource constraints, both at the company and within our firm are barriers preventing us from driving more value in cost reduction and cash flow as an operating group".

The challenge is the competing initiatives that inevitably exist in every firm to drive continuous improvement on cost and working capital. Those efforts are always in play but are often a secondary issue for the CEO, whose primary focus tends to be on growth.

Evaluating operating partner performance

It's common for operating partners to have their performance primarily driven by the financial performance of investments. Measuring performance and acting accordingly is a natural process, although it often stops action from occurring proactively to prevent performance dips or accentuate performance.

Despite this, many PE firms don't have the processes or tools in place within their organization to conduct any meaningful evaluation of performance. In fact, according to Maine Ford only 44% of PE firms have a formal evaluation procedure in place. This makes measuring success extremely challenging.

The challenge for PE firms

The importance and value of operating partners continues to grow within the PE marketplace and it is clear that operating partners are driving value. However, not as much value is being driven as desired and there are some difficulties in measuring performance. While an increasing number of firms are coming around to the idea of using operating partners to drive value, there is a distinct lack of clarity around what model is the most effective.

A growing focus on value creation to achieve returns has forced PE firms to evolve their skills set. Investors demand results and want to know how the PE firm plans to deliver them. Do they have an operating partner and, if so, what value are they driving? The challenge, as survey results support, is finding the right individuals with the right experience on the ground.


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