Few things are debated as intensely in private equity and direct investment as how value creation in portfolio companies should be organised. Every model has its pros and cons, and the choice of model shapes who the “right” candidates are.
We’ll present the most common approaches in the coming posts, looking at them from an organisational and process perspective. Very popular, and probably the standard model, is having one and the same team look after an investment full circle, from due diligence to exit. We call it:
Part 1: the cradle-to-grave model
The deal team looks after the asset throughout the holding period
A strong focus on KPIs, especially financial ones
A lean, efficient model
How well it works depends heavily on the deal team’s operational skills
By operational skills we mean, above all, empathy and negotiating skill, a sense of which initiatives are feasible, an understanding of how customers, suppliers, authorities and service providers behave, and the technical and organisational knowledge that determines how well value is created on the ground
A good sense of which operational processes reliably produce which KPIs, and which may not produce them at all; in other words, where a feel for the business is needed to steer a process
And: the initiative, drive and appetite for risk of the CEO, CFO, COO and CSO are hard to capture or steer with backward-looking KPIs.
We repeatedly see the danger of an overly narrow focus on corporate finance or on the power of KPIs and targets
Objections from operational management (“that won’t work”, “that’s difficult”, “that’ll take time”) are hard for deal team members to judge
The deal team generally hasn’t got its hands dirty: it has no first-hand knowledge of the shop floor, customers or suppliers.
That can leave investors powerless when C-level management fails or falls short; often the only option left is to replace them (which then happens very late and carries its own risks)
It can also make change management with other groups (works councils, suppliers, customers) difficult if the portfolio company’s management can’t pull it off
Heavy dependence on external consultants, which brings its own principal-agent problem…
That’s why PE firms opt for other models, which we’ll present in the following posts.
