After the PE fund successfully closes a deal, a new phase starts, with the PE fund having skin in the game. A close watch on the new baby is required, in order to prepare for a successful exit

In the last instalment, we examined how Mastering Private Equity covered deal identification, negotiation and closing (click here). Yet the purchase is only the beginning for the PE fund: now the PE has skin the game, and needs to work continuously for a successful exit. Unlike the multitudinous consultants, advisors and debtholders – who fade away after the ink dries on the deal – the PE fund stays on with the investee company, and needs to insure that the hoped-for return on investment will materialize at exit time.

Pulling in the same direction
This implies a tighter partnership with company management, so as align three sets of priorities: those of the PE fund, those of company management and those of other investors (or debt holders). Corporate governance therefore takes on a very special importance within private equity investments. A sense of urgency permeates, with both company management and PE partners working feverishly to set 100-day goals and implement them. In buyouts, the PE fund also becomes an active owner, with close engagement thanks to board seats and tight links to company management. Such links are embedded in the management incentives defined and set up contractually.

Can this C-suite get the job done?
Although due diligence may reveal management weaknesses that a PE fund will need to remedy, the overriding wish is to work with a reliable management team within the company. At times the PE firm may need to resort to a more granular, “roll up its sleeves” approach to tackle operational issues. Its access to a pool of valuable resources from other deals may provide help.

At the heart of a good working relationship between a PE fund and the management team in the investee company are proper incentives, based on well-defined key performance indicators (KPI). Even so, constant monitoring and fast decision-making – even those hard-to-make headcutting calls – are a necessity.

Within the subset of venture capital-backed startups, aligning PE interests with the management is also paramount, but differs slightly in that entrepreneurs/founders and their startup teams are tightly bound and trickier to replace.

Five years to boost value
If the PR fund invested in a company, it believed that it could make that investment more valuable within its 5-year timeframe. This implies operational value creation, by weighing on several levers: increasing revenues and operating margins immediately come to mind. Yet the author’s link to INSEAD (and more specifically to the INSEAD Global Private Equity Initiative), and their development of the INSEAD Value Creation model (IVC 2.0) led to a more precise analysis of value creation levers: revenue growth, gross margin improvement, overhead reduction, capital efficiency, and shared services. The IVC 2.0 model enables precise measurement of the “alphas”, those increases in value that each improvement generates. For example, if the increase in company revenues is say 51%, vs. an industry average of 10%, the net alpha is of 41%, corresponding to value creation from sales growth. The IVC 2.0 model then accumulates the alphas over the various value creation drivers (six in all) to assess the net alpha for the PE investment.

Proof is in the exit
“In private equity, the proof is in the exit (rather than the pudding)…” as the authors explain (page 185). Indeed, until the cash proceeds from sale lie safely in the PE’s bank account, any preliminary estimates of the company’s value are pure conjecture.

Since exit can be almost as tricky as entry, exit preparation – also known as “exit shaping” – is a key preparatory process that starts well before the sales contract gets signed, which is why it is referred to as the 500-day plan. Exit shaping includes both strategic reflection on the suitable exit paths, and tactical steps to prepare relevant documentation and analysis. This exit preparation can even go so far as to line up staple financing, whereby a bank makes financing available to an eventual buyer.

Four exit paths are available: sale to strategics, or to another PE fund; initial public offering (IPO); and, as a last resort, dividend recapitalization (recaps). Each of the possible paths has its advantages and drawbacks, whether in terms of transaction speed, cost or competitive considerations. In the end what counts is that the PE partners get the expected return, whether assessed in terms of return on investment, or multiple-of-money invested.

Stay tuned for more
Given the depth of the material in the book, we are planning to publish four instalments of which the first three cover theoretical aspects, while the last article will focus more on the numerous case studies:

in Issue 59 we examined the basics of private equity;
* in Issue 60 we looked at deal sourcing for PE players;
* in the current issue (Issue 61) we examine how PE funds are managed;
* in Issue 62 we’ll cover how the authors see the outlook for the industry.

Book Data 

Title: Mastering Private Equity; Transformation via venture capital, minority investments and buyouts.
Authors: Claudia Zeisberger, Michael Prahl, Bowen White
Pages: 350
Publisher: Wiley
Price: ca. $60.00

Book Data – Accompanying case studies
Title: Private Equity in Action; Case studies from developed and emerging markets
Authors: Claudia Zeisberger, Michael Prahl, Bowen White
Pages: 402
Publisher: Wiley
Price: ca. $55.00

Author/s Bio

Claudia Zeisberger
Claudia Zeisberger is a Senior Affiliate Professor of Decision Sciences and Entrepreneurship & Family Enterprise at INSEAD, and is the Founder and Academic Director of the school’s private equity centre (GPEI). Before joining INSEAD in 2005, she spent 16 years in global investment banking.

Professor Zeisberger is a founding investor of INSEADAlum Ventures (IAV), the business school’s first dedicated seed fund and she devotes a significant amount of her time to mentor early stage companies with a special interest in robotics and artificial intelligence.

She launched INSEAD’s popular MBA elective ‘Managing Corporate Turnarounds’ and built an intensive computer-based simulation involving an iconic car brand and its struggle with bankruptcy. As a natural extension, she teaches INSEAD’s Risk Management elective and the Private Equity elective in the MBA & EMBA programmes.

Professor Zeisberger is known for her extensive research on PE in emerging markets, and her close working relationships with GPs and their portfolio firms, institutional investors, Family Offices and SWFs.

Bowen White
Bowen White currently serves as the Associate Director of INSEAD’s GPEI, where he leads its research and outreach activities and has published on topics including operational value creation, responsible investment, LP portfolio construction and minority investment in family businesses.

Bowen has spent his career working in and conducting research on the global alternative asset management industry. In the New York hedge fund industry, he researched topics from statistical arbitrage investment strategies in commodities markets to macroeconomic trends and global hedge fund performance. Having worked for both a proprietary trading firm and a fund of funds, he has seen first-hand the challenges faced by investors and allocators of capital to the hedge fund industry. Bowen has also advised on a range of VC and growth equity fundraising opportunities across Southeast Asia.

An alumnus of INSEAD’s MBA program, Bowen earned a BSBA from the Kenan Flagler Business School at the University of North Carolina at Chapel Hill.

Michael Prahl
Michael is an INSEAD Distinguished Fellow at GPEI with a focus on LBOs and Asian Private Equity. Based out of Hong Kong, Michael is a founding partner at Asia-IO Advisors, an asset manager focused on implementing innovative, thesis-driven Asia/Asia-nexus private equity co-investment programs for an alliance of large institutional and corporate investors.

An INSEAD alumnus, Michael served as GPEI’s Executive Director from 2010 to 2015 and was instrumental in shaping all aspects of the centre’s activity and developing its core research agenda. During his tenure as Executive Director, Michael oversaw the expansion of the Centre’s research and outreach activities and drove specific research projects related to co-investments, risk & return propositions in emerging markets PE and family offices. Michael continues to engage directly with the INSEAD community as an Adjunct Professor teaching the MBA Leveraged Buyout elective.

Prior to joining GPEI, Michael spent nine years with Apax Partners, a global private equity firm. He worked on some of the most high profile retail and consumer investments for Apax in Europe and the US including regular buyouts, public to privates, PIPE’s, minority investments and privatisations. He moved to Hong Kong beginning of 2006 to help set up Apax Partners’ Asian operations. Prior to Apax Partners, Michael was associated with the Corporate Venture Capital arm of Deutsche Telekom and The Boston Consulting Group.

Michael is a graduate of INSEAD (MBA) and Handelshochschule Leipzig (MSc Business) and holds undergraduate degrees in business and law.

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Source: INSEAD Website/s