Maximizing Value

Private equity firms seek alternatives to create value

If there's one thing the economic downturn taught the industry, it's to use debt sparingly. Although lending markets are open and private equity firms are still leveraging their deals, there is more focus today on creating value through operational improvements. Mergers & Acquisitions convened a special roundtable to discuss the benefits and challenges associated with different strategies to create value in today's market. McGladrey LLP sponsored the event and the excerpted discussion that follows provides a range of perspectives from key players who are working in and with portfolio companies. Participants included private equity investors, a consultant and operating partners.

Fugazy (Moderator): This used to be called the leveraged buyout business. Now there's talk of not using leverage, and instead doing other things to enhance value. Would you say that's accurate?

Griswold (Argosy Partners): It's true that many funds today are not over-leveraging. Back in the 1980s, funds used to make money buying companies at five times Ebitda, selling them for five times and financing them with leverage of four times. And the deals generated 20 percent internal rates of return. Today, lots of funds are finding other ways to add value. Firms are building up their operating partner programs and identifying processes that consistently enhance their portfolio companies.

We invest in the lower middle market and the average senior debt we put on our companies is 1.7 times Ebitda, so it's relatively low leverage. If we're going to create value, it has to be through growing revenue and improving operations. We do that through operational improvements and professionalization. The old buyout industry is evolving and today there is less use of leverage as the primary tool to generate returns, which frankly means less risk.

Kelsall (LLR Partners): We are much more focused on growing businesses, rather than doing financial engineering or taking complete control. We are very comfortable doing minority investments, so partnering with management and any other PE firms involved up front is critical, and then we make decisions together.

We do put some leverage on companies, but we try to be reasonable with the amount of leverage, depending on the type of business. We invest in companies that have strong management teams, that have strong business models and strong markets, and we help them accelerate their growth plans.

Noonan (McGladrey): We've been paying close attention to the evolution of the operating partner, and it is amazing how many people have committed to that strategy in a big way. It is a sign that financial engineering is a thing of the past. If you can't figure out how to create success through industry expertise, operating expertise and a strong management team, your likelihood of staying in the business will be dramatically diminished.

Durbin (Vestar Capital Partners): If you can find an interesting security or a way to make money through leverage, of course, you'll do that. But value now needs to be created through growth, and that's where our focus is.

Masto (FFL Partners): When we got started 16 years ago, we had this idea that it could be really impactful to bring diverse skills together and to focus on active company improvement. There was a community of firms that did that back then, but it was much smaller.

Today, everyone says operating improvement is a part of their strategy, and it has to be. But there are a lot of different ways people approach that exercise, and with varying degrees of capabilities and experience. Financial engineering was a straightforward concept; there are more flavors of operational expertise.

Fugazy: When you're readying to buy a company, what are some of the first ideas that you implement when you take control?

Logan (The Riverside Co.): The first thing we do is to establish what we call an operating rhythm, which is basically a process of the monthly operating review, quarterly board meeting and then an annual plan, and a human resource review and a strategic plan. Many of the companies we buy are entrepreneurial and they never had any of those processes. We can help companies through their teenage years and teach them some of these processes, which are helpful in the future.

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Danielle Fugazy
David Logan