What makes for the most valuable value creation teams in Private Equity Beyond the Lipstick on a Pig

Private equity (PE) thrives on the strategic infusion of capital and expertise into portfolio companies to drive growth, operational efficiency, and profitability. However, the real magic lies in the hands-on experience that PE managers bring to the table. This newsletter explores why hands-on experience is crucial, the typical composition of value creation teams, the role of specialist consultants, and the transformative role of generative AI (GenAI) in the private equity landscape.

The Necessity of Hands-On Experience in Private Equity

Managing portfolio companies in the PE space is a complex, high-stakes endeavor that demands more than just theoretical knowledge or consulting acumen. Hands-on experience is vital as it equips managers with practical insights into the intricacies of operations, strategic decision-making, and the ability to navigate industry-specific challenges. According to a McKinsey report, operational improvements are crucial for realizing returns, highlighting the need for managers who can execute strategies effectively on the ground (McKinsey & Company).

Composition of Value Creation Teams

Traditionally, value creation teams in PE firms have been heavily staffed with ex-consultants. While consultants bring strategic planning and analytical expertise, their impact can be limited by a lack of practical, operational experience. A survey by McKinsey found that PE portfolio company CEOs often struggle due to a lack of tailored leadership development programs, which are essential for the unique challenges they face (McKinsey & Company).

For instance, a typical PE value creation team might excel in high-level planning but falter in day-to-day execution (many PE firms also do not want to be involved on a day to day basis unless there is an absolute need to be). This gap is increasingly being addressed by integrating seasoned industry professionals into these teams. These individuals offer invaluable on-the-ground insights and practical knowledge, which are crucial for implementing and sustaining value creation initiatives effectively.

Role of Specialist Consultants

To balance the need for specialized knowledge, PE value creation teams often rely on hiring specialist consultants for specific portfolio company needs. This approach ensures that the teams remain light and nimble, as a single team of three to five people cannot be experts in everything. Specialist consultants bring in-depth expertise in areas such as digital transformation, supply chain optimization, and regulatory compliance, providing the necessary support to address complex challenges and opportunities within portfolio companies (Bain).

Real-World Examples of Value Creation

Several case studies underscore the importance of hands-on experience, operational expertise, and specialist consultants in driving value creation:

1. CVC’s Investment in ?abka: CVC acquired ?abka, Poland's largest convenience store chain, and implemented a series of ESG-related efficiencies. These included reducing plastic packaging and launching a program to cut CO2 emissions. The hands-on approach significantly improved franchisee retention and customer satisfaction, resulting in a 20% increase in sales over three years (Moonfare).
2. Bain Capital’s Investment in Kantar: Bain Capital’s digital transformation of Kantar involved implementing advanced procurement technology and risk management tools. This hands-on digital overhaul improved procurement control and agility, ultimately enhancing the company's operational efficiency and value creation (Moonfare).
3. Vista Equity Partners and Finastra: Vista Equity Partners acquired Finastra, a global financial technology company, and spearheaded a comprehensive digital transformation. By investing in cloud technology and AI-driven financial solutions, Vista enabled Finastra to streamline its operations, enhance customer experiences, and expand its market reach. As a result, Finastra saw a substantial increase in its valuation, demonstrating the impact of hands-on digital transformation (Vista Equity Partners | Finastra).

The Role of Generative AI in Portfolio Management

Generative AI is evolving in how it is being used in the PE space (not revolutionizing it quite yet) by enhancing due diligence, operational efficiency, and strategic decision-making:

1. Enhanced Due Diligence: GenAI can analyze large datasets to identify risks and opportunities, streamlining the due diligence process and enabling more informed investment decisions (EY US).
2. Operational Efficiency: By automating routine tasks and optimizing processes, GenAI frees up human resources to focus on strategic initiatives, significantly enhancing operational efficiency (Roland Berger) (EY US).
3. Predictive Analytics: GenAI provides predictive insights into market trends, customer behavior, and financial performance, allowing PE firms to proactively address potential issues and capitalize on emerging opportunities (Moonfare) (EY US).

Preparing for Generative AI with Agency

As we approach a new era with generative AI systems exhibiting greater agency—often considered the first signs of artificial general intelligence (AGI)—the landscape of value creation in PE is set to undergo significant changes. Having seen some of these systems firsthand, I can attest that enterprise solutions typically lag consumer market solutions by about six months. Therefore, we can expect GenAI with agency as early as Q1 or Q2 next year. These AI systems will have the ability to make more autonomous decisions, analyze vast amounts of data in real time, and provide insights that are not just supportive but directive. This shift will require value creation teams to have even more practical, hands-on experience to effectively guide and advise their portfolio companies.

The expertise needed to harness and integrate these advanced AI systems into everyday operations will be critical. Teams will need to stay ahead of the curve, understanding not only how to deploy these technologies but also how to manage and maximize their potential within the unique contexts of their portfolio companies.

Real Transformation: Beyond the Lipstick on a Pig

True transformation in portfolio companies involves more than superficial changes. It requires a deep, systemic overhaul of operations, Target Operating model strategy, and culture (especially when it comes to use of technology to solve or improve pain points), akin to the metamorphosis of a caterpillar into a butterfly - the way the company looks and feels needs to look physically different for one to call it true transformation. This type of transformation typically spans at least three years, during which a new target operating model is implemented, new revenue streams are developed, and more efficient ways of working are established.

Strategic and Tactical Execution

Successful PE firms recognize the importance of embedding a comprehensive technology strategy throughout the investment lifecycle—from due diligence to exit optimization:

1. Due Diligence and Strategy Alignment: At the outset, aligning the technology strategy with the investment thesis is crucial. This involves assessing the target company's IT infrastructure, data security, and technology maturity to identify potential risks and opportunities (EY US).
2. Transformation During Holding Period: The holding period is the transformation window where value-creating opportunities must be pursued aggressively. This includes focusing on top-line growth, cost optimization, and capital efficiencies across various business functions (EY US).
3. Exit Optimization: Formulating an exit strategy from the beginning ensures that the technology investments and operational improvements made during the holding period are aligned with the ultimate goal of maximizing exit multiples. This might involve preparing for a strategic sale, another PE acquisition, or a public listing (EY US).

Conclusion

Hands-on experience in private equity is indispensable for managing portfolio companies effectively. It bridges the gap between high-level strategy and on-the-ground execution, ensuring that value creation initiatives are not only well-conceived but also successfully implemented. Coupled with the transformative potential of generative AI and the strategic use of specialist consultants, hands-on experience enables PE firms to drive significant value creation, achieve sustainable growth, and navigate the complexities of today's dynamic market environment. As we stand on the cusp of generative AI systems with agency, the importance of practical expertise in guiding these technologies cannot be overstated, making experienced, hands-on management more crucial than ever.

Warm regards, Danilo McGarry, Editor, The Tech Chronicles

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