Steadying the ship
With the business, investment and macroeconomic landscapes facing fresh waves of uncertainty, can private equity ﬁrms restore a sense of balance by bolstering their operations?
Perhaps the greatest Warren Buﬀett quote: “Only when the tide goes out do you discover who’s been swimming naked,” might start ringing true when it comes to GP operations. It’s very possible the recent wholesale distribution will reveal those GPs operating from shaky or unstable platforms. Whereas houses that have been diligently investing in their systems and technological infrastructure are better positioned to navigate the choppy waters ahead.
We are already hearing reports that LPs are reserving future allocations into the asset class for larger and seemingly more robust managers. Coller Capital’s latest survey: Global Private Equity Barometer Summer 2020, found that three-quarters of its LP respondents (107 globally) predict the largest GPs will collect a growing proportion of total commitments over the next ﬁve years. In order to stem the tide of larger pools of capital ﬂowing into fewer PE ﬁrms, the ﬁrst port of calls is the investor relations function.
Since the onset of the crisis, many houses sought greater ﬂexibility over holding periods and even investment mandates, evidenced by a spike in LPA amendments.
While it’s wholly understandable as to why managers are seeking greater ﬂexibility - to preserve or boost returns - deviating from one’s mandate or contractual obligations needs careful handling.
Not only is a safe and steady pair of hands needed in the shape of experienced IR executives, equally as important are the right tools. Says Mats Eklund, CFO and COO of Triton, “It is imperative to have robust reporting processes in place, all the way from portfolio companies, via the GP itself to the LPs. We have invested over many years in resources as well as digital workﬂows, data mining and reporting tools.”
And recent events have clearly hammered this message home. According to Pete Witte, EY’s global private equity lead analyst, “Having the infrastructure in place to get LPs those granular insights is something that ﬁrms are doing now and this will be a big investment in the future. Firms want to be doing this much faster and deeper, to be pulling information from disparate sources.”
But that’s not to say all GPs are considering longer holds or tweaks to their investment mandates. “We haven’t been in a situation where we’ve seen any potential in holding assets longer,” explains Andrew Harrison, Silverﬂeet Capital’s head of IR. “Adhering to the 10 year fund life is our objective; that’s what we’re getting paid to do. And we haven’t done any restructuring where we’ve needed to pull things out. If you do end up with longer holds, and continuation vehicles, it’s another layer of complexity that we’re not interested in.”
But, even those with the best intentions to meet LPA promises could be forgiven for having to extend hold periods given the scale and depth of the current crisis.
“If you have unusual times like we do now, no one knows for how deep or how long we’ll see a recession or crisis. But what we do know is that we have to be open and opportunistic to take advantage of opportunities that arise in the next 12-24 months. If your infrastructure is solid, you’ve got good ﬁgures and a scalable organisation, then you’re able to use your resources to expand your mandate and the platform.”
Diana Meyel, Cipio Partners
Thankfully, today’s private equity funds operate alongside a mature and sophisticated secondary market. Longer hold periods or a shift in focus might be unsuitable for some LPs, but instead of enduring a messy break up, CFOs and operational leaders can get ahead of the game by thinking about what options they have, and what would suit them best.
While there haven’t been signiﬁcant levels of secondaries trades just yet, the market’s maturity provides GPs and LPs with options. “It’s never too early to start thinking about this. Whether or not it’s the right time to take something concrete to LPs, we just don’t know what we’re dealing with right now. We’ve been talking about a see-saw recovery where we’re back and forth; but it’s still too early from a macro perspective to know how this will play out. Despite this, GPs are looking at their options,” notes Witte.
Cipio Partners’ CFO Diana Meyel says operational heads act as vital facilitators for supporting LPs in whatever they need to do. “CFOs and COOs can oﬀer alternative solutions. There’s a big secondaries market so LPs can stay in the fund and you can discuss the potential of the investments, or if they need to get out, it’s much easier if you recognise this early on, then you can react and ﬁnd a replacement, rather than waiting for LPs to start a sales process on their own.”
While Meyel hasn’t needed to have those sorts of conversations with her LPs, she has been approached by new investors. “I’m nurturing lots of relationships where investors want to know if there’s ever a secondaries opportunity in our fund.” Clearly, LPs are already on the lookout for new opportunities, which could mean pulling out of existing positions.
Even if the LP base is satisﬁed, an exploration of the secondaries market is a worthy exercise for operational heads to undertake in the current climate as it can help in other areas - namely, valuations.
Pieces of eight
Undoubtedly, valuing assets and portfolios since the onset of the pandemic has been the greatest challenge faced by ﬁnance teams.
Prior to the outbreak, levels of standardisation were being achieved, notably through the IPEV Guidelines. However, the standard’s requirement to value assets at ‘Fair Value’ - what the asset could be sold for and what it could be bought for in an orderly market - left many feeling unsure.
According to Sunaina Sinha Haldea, managing partner of Cebile Capital, “Up to 25% of GPs we spoke to decided not to perform valuations for Q1. They didn’t know how to as the quarter had been so uneven.”
There appears to have been a wide range of responses from GPs when it comes to valuations. Some felt conﬁdent in sticking closely to the guidelines, others developed new processes, while some sought advice.
Lovell Minnick partner Jason Barg was part of the former group, who felt conﬁdent in using their process based on the FASB ASC 840 standards. “We have a very robust process, which has been vetted many times. It allows us to look at public comparables, transaction comparables and DCFs. While there may be more considerations in times of volatility our process doesn’t need to change because of Covid-19 as it allows us to take in all of the necessary factors. Our process was set up to deal with this kind of scenario.”
Triton decided to adapt its approach in response to the disruption, developing at least two valuation scenarios for each portfolio company, then forming a view based on both. “We have also seen an increased need to calibrate the multiples used and discounts / premiums to listed peers,” explains Eklund. “We have much better access to earlier and more detailed information and earnings estimates from our portfolio companies than participants in the public markets. We also have access to a network of experienced professional valuation ﬁrms as well as internal resources in both a technical accountant and a very experienced former PWC partner, heading up our audit committee.”
Silverﬂeet sought professional advice as well as consultations with LPs. “Historically, we’ve always used the ILPA guidelines and this time round we took on lots of advice from industry experts and spoke to our LPs. In the end we took a fair value approach; what we would be prepared to sell at, and what we would buy at. If those ﬁgures were diﬀerent then there’s a problem. But if they match, then there’s where we go to on the valuation,” explains Harrison.
For Dunedin’s ﬁnance and operations manager Karan Darroch, the immediate response was to speak to advisors and other PE houses to ﬁnd out what other market participants were doing, and which metrics to focus on. “We got some good advice and found most PE ﬁrms value in the same way. Fundamentally, we didn’t change our process, we still used all of the same inputs, which was then taken to the valuation committee to debate and discuss. We’ve landed on a process that we’re comfortable is in-line with the IPEV guidelines, while being reﬂective of wider market movements and representing fair value.”
Whatever the approach taken, the key to valuation methodologies, according to Cebile’s Sinha Haldea is consistency. “If it’s being changed then you must explain why. That consistency is key; the LPAC has to believe the valuation provided by the GP. Most LPs are happy to accept what their GP says but they want to be conﬁdent in how the GP is coming up with that number. It’s not uncommon for LPs to call in an independent valuation now and again, just to check, but that’s expensive.”
“CFOs and COOs can oﬀer alternative solutions. There’s a big secondaries market so LPs can stay in the fund and you can discuss the potential of the investments, or if they need to get out, it’s much easier if you recognise this early on, then you can react and ﬁnd a replacement, rather than waiting for LPs to start a sales process on their own.”
Diana Meyel, Cipio Partners
By and large, the private equity community adjusted to the new working conditions pretty quickly. Many ﬁrms had made their move to cloud-based systems, making the transition smooth sailing.
Triton serves as a neat example. “We had already migrated to Microsoft Azure EU cloud by May 2019 and launched mobile and remote access to all applications. This meant that all important work streams, including accounting, reporting, HR processes, fundraising, and making investments could continue without technology challenges,” says Eklund.
Silverﬂeet’s Harrison points out that their systems upgrade was initially driven by practical needs, but has since evolved. “Fundamentally, we put these systems in place because it was selfserving. It was set up to enable more accuracy and to save time. As we’ve evolved, we’ve integrated ESG onto the platform, which now feeds into our reporting tools. Streamlining our back oﬃce does help investors get comfortable because the margin for error is tighter, and because we’re working from one source of truth.”
For others, the disruption provided a good opportunity to complete tech upgrades. Says Cipio’s Meyel, “We decided last year to develop our own database. The ﬁrst task was to have it programmed, which wasn’t an easy task! Second was to back ﬁll all of our historical data. With lockdown we’ve had time to work on the system and now we have the best database we could have ever wished for. We made the best use of our time from an operational perspective to ﬁnish this project.”
On the horizon
Indeed, with the recent disruption holding up new investments and delaying growth plans, some private equity houses have been exploring uncharted waters. Dunedin has been boosting its digital and social media eﬀorts. Says Darroch, “Our digital marketing managers has been developing our digital marketing strategy. She’s really brought it to life and shown us the value of it. The partners have been impressed by social media’s reach and so we’re focusing more time and eﬀort on this now.” Unable to meet contacts and management teams in person, Dunedin has been using social media to promote the work and successes of its portfolio companies.
But regardless of whether time in lockdown has enabled progression or provided rest and time out, it’s clear that operational robustness has never been more important.
“This has elevated the importance of integrated operations for the industry,” says Barg. “We’ve invested heavily in personnel and systems on this side of our business, driven by very comprehensive ODD processes.”
Cipio’s Meyel sums up the situation neatly: “If you have unusual times like we do now, no one knows for how deep or how long we’ll see a recession or crisis.
“This has elevated the importance of integrated operations for the industry.”
Jason Barg, Lovell Minnick
But what we do know is that we have to be open and opportunistic to take advantage of opportunities that arise in the next 12-24 months. If your infrastructure is solid, you’ve got good ﬁgures and a scalable organisation, then you’re able to use your resources to expand your mandate and the platform.”
Major disruptions and crises cause deep and often permanent changes to the way in which we live and work. A quick scan of post-GFC regulations highlights how these events reveal ineﬃciencies and unseen risks, and then re-shape structures and processes.
We’ve already experienced considerable and extensive changes to how we both work and play. And it seems evermore certain that many of these transitions will continue post-pandemic.
The GFC was arguably what brought private equity operational functions to life. Few GPs prior to 2008 had large IT, HR, ﬁnance, operations and legal teams, few even had full time CFOs. This time around, given the nature of the current crisis, its permeance across all aspects of everyone’s lives, operational functions will undergo their next stage of evolution, bringing this work into the spotlight; revealing the absolute need for strong, robust steady ships from which to navigate increasingly stormy seas.