Planning ahead for success
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It’s no secret that the deal making environment has reached a frenzied pace over the last decade. There is an unprecedented level of competition in the private equity industry. The numbers tell the story. Deal volume in the middle market reached a total of $427.9 billion with 2,971 deals in 2018, that’s an increase of 14.8 percent and 15.1 percent year-over-year, respectively, according to Pitchbook Data. Additionally, private equity firms have not had any challenge accessing fresh capital from limited partners. In fact, recent reports put the amount of dry powder in private equity firms’ coffers at around $1.4 trillion, which is at an all-time high. And leverage is also at a record level. In 2018, almost three quarters of large LBOs were levered at 6x EBITDA or higher; well over a third were levered at 7x or higher.
With so much capital and debt available, to remain competitive private equity firms have had to move forward quickly when they have the opportunity to purchase a quality asset. This has resulted in compressed due diligence processes. This is unfortunate. Private equity firms that spend the proper time due diligencing companies usually have a much smoother transition process and greater long-term success than those who rush into a transaction.
During due diligence, buyers should also be conducting due diligence on the human capital at the portfolio company. Human capital is often viewed as a critical asset to any company and an important component in the deal process. Yet, human capital is often not considered until later in the transaction process.
According to a research study conducted by SourceMedia Research on the use of human capital management solutions (HCM), 44 percent of respondents said they needed an HCM solution during the implementation phase after buying a new portfolio company, while only 26 percent said they needed HCM solutions when they were preparing for a transaction and only 13 percent said they needed an HCM when they identified assets for purchase.
However, there are real benefits to engaging earlier on. “Getting HCM consultants involved earlier on allows private equity firms to accomplish more, and in a quicker period of time, because they will be able to hit the ground running when the acquisition is complete. Employees are expecting change during the first 100 days and management will be ready to execute if they prepare ahead of the close,” says Jason Favreau, Vice President of Strategic Partnerships with ADP, a large provider of human resources, payroll and benefits solutions.
The use for HCM varies as every company has different needs. One middle market private equity firm implemented an HCM solution because its portfolio company is national and kept getting sued in California by employers because the employee laws differed in California from the state the company was headquartered in. “We had a director of human resources, and we had employees in New York, Florida, California and Texas. He didn’t know human resource employment practices and requirements in the state of California. We ended up parting with him and we outsourced the department. Our provider has people on the ground nationally who understand local employment laws. The lawsuits stopped,” says one private equity professional.
In some cases the HCM function needs to be optimized or stabilized, and in other cases it needs to be built out because there essentially isn’t an HCM function at all. Reviewing the HCM function with an HCM specialist during due diligence allows the consultant to assess and define what the function currently looks like, what it should look like and put together a plan that is deliverable during the first 100 days when employees are already anticipating change. “The plan may change once we are executing, but going in with no plan is a sure way to fail,” says Favreau.
Interestingly, according to the survey, almost 80 percent of respondents said that retention of key employees was one of their top initiatives during the first 100 days.
A little more than 40 percent said employee selection and downsizing and creation of new policies to guide the organization were top initiatives. Compensation strategies were also listed as important in the first 100 days. “It’s not surprising that things like retention of top employees and development of compensation strategies is important to private equity owners given the tight labor market and how difficult it has become to train and retain C-suite, and other talent, at organizations today,” says Favreau. “Human capital is more important than ever.”
One private equity respondent who owns healthcare staffing companies and uses HCM solutions regularly says that after getting the finance function and financial reporting under control, the next priority is making sure that the company is HR compliant. Hiring, assessing the existing employee base, and looking at HR, benefits, payroll, finance and accounting is next on the to-do list.
“Human capital is incredibly important in our world because the entire success of the operation is contingent on happy employees. The first touch point with employees is how we handle the payroll and benefits
so it’s incredibly important that we do it seamlessly, transparently and in a way that’s as good as—if not better than—their current structure,” says one private equity professional.
In addition to solidifying employment benefits and human resource functions, HCM solutions give portfolio companies and their private equity owners access to accurate reports, ensure companies are compliant with government regulations while eliminating redundant payroll and HR data entry. HCM solutions also give users a single source of employee information. This can all lead to management and private equity firms having the ability to leverage data and use it to understand compensation, hiring and overall employee trends at a company. This type of data will allow management to predict turnover rates or turnover by job description, for example.
“Given today’s competitive environment, HCM is becoming more important than ever and is being pulled up the priority list. It is clear that HCM impacts more than the C-level today. The bottom line is owners need to have a happy team to be able to execute on their vision. The return on investment when executed correctly can be truly tremendous,” says Favreau.
ADP takes a holistic view when advising clients on HCM matters. The firm engages with private equity firms on three fronts: financial, transactional and operational transformation. From a financial perspective, private equity firms get the benefit of pooled purchasing power when they work with ADP. When a private equity firm is spending on labor and benefits across multiple portfolio companies it can add up. Pooled purchasing can be an effective way to save spend across an entire portfolio.
On the transactional front, ADP has dedicated professionals who understand that private equity firms move at a rapid pace and need strong support from their partners. ADP’s team of professionals understand the most complex M&A transactions, and that time is always of the essence and that seamless execution is paramount.
Lastly, once the transaction is complete, the ADP team is ready to roll up its sleeves and help clients reduce general and administrative spend, professionalize back- office processes and provide the infrastructure necessary to take the portfolio to the next level.
*In the second half of 2018, SourceMedia Research conducted a survey on Human Capital Management. 39 high-level, middle market private equity professionals responded.
To learn more, visit adp.com/pe