Column: Smooth operator

by Contributor 5 January 2023

For a full decade after the global financial crisis, private equity enjoyed benign market conditions, with a positive investor landscape, low interest rates, robust economic growth and low volatility. It’s fair to say that all that has now changed.

As macroeconomic conditions become increasingly challenging – characterised by rising interest rates and energy prices, soaring inflation, war and political turbulence – private equity firms are faced with tightening markets and fewer exit opportunities.

Against these volatile market conditions, the power dynamic between GPs and LPs is shifting, and the market is becoming more and more competitive. On top of this, there are other knock-on effects that impact private equity further, such as the denominator effect, which may force some LPs to reduce their allocations to private equity, either by cutting the number of GP relationships they have and/or by dropping down in terms of ticket size.

So, during these tough times, how can operational leaders best support investor-relations functions? What makes the difference between success and failure? First, it is vital to ensure you are using the very best, state-of-the-art systems and ensuring smooth operations at the firm level. In this business, you must stay ahead of the competition by constantly revisiting systems – including your IT, internal processes and standards, efficiency checks and so on – and ensuring they are fit for purpose.

Why is this so important? When speaking to investors, all shortcomings are likely to be exposed. Imagine the embarrassment if it takes forever to produce responses for due diligence requests or, worse, if the responses disclose gaps in internal processes. Investors deal with many GPs simultaneously and are very well positioned to identify the champions and the losers, and to identify when internal documents are missing key information.

Modern infrastructure is the backbone of a firm. You can make great investments and hire top-class talent, but if the machine room is not running smoothly, you are bound to fail in the long term. One clear warning sign is the number of internal email chains with a growing CC list, in which relatively minor details are discussed at length. Especially in light of the raft of new regulatory requirements, there is a risk of inefficiency when processes are not working.

Increasingly, ESG is also becoming one of the biggest factors for LPs. And we are being judged not just in terms of our investment processes, due diligence and operation of portfolio companies, but also at the firm level as well. This means we need to look closer than ever at what we are doing internally, to identify areas where we can improve.

This starts by defining the areas where the GP wants to boost performance, such as energy efficiency, use of renewables, diversity of the team, and training and education programmes, to name just a few. Once these parameters are identified and defined, the GP can then set targets and KPIs for these areas and start reporting on them and tracking progress.

It can also be comforting for portfolio companies to know that for their backers, ESG starts at home. We are not asking our portfolio companies to do anything we are not already doing ourselves!

Of course, operational best practice is not the first thing LPs look for. Track record, team stability and a clearly defined strategy still top that list. But in a more competitive market, operational best practice and having a strong ESG framework can increasingly make the difference between success and failure.

Categories: AnalysisESGESG regulationFundraising & fund structuringFund docsFund financeODD / DDQReporting & Transparency Accounting standardsReporting software

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