Why is Active Management the Most Important Trend in Private Equity?
The way to achieve above-average results without excessive risks is through resolutely controlling your assets’ business vision. If you are not ready to give your private equity investment a new impetus and to navigate it successfully from acquisition to divestment on a daily basis, then you needlessly forego profits for yourself and your co-investors.
The Case for Active Management
As a partner in a private equity firm, I have helped breathe new life into 25 industrial enterprises in 20 years, achieving a cash-on-cash multiple of more than three times. Our primary objective over the years has hardly been shocking: it is to achieve high returns without excessive risks. Surprisingly, the path we have followed in accomplishing this is one not so commonly taken among private equity professionals as I would have expected. With the good reputation of the entire private equity sector in mind, I would like to argue for a more active approach towards assets’ management. Here are my thoughts on why the “hands-on” daily management of your portfolio companies is the right way to maximize your profits and gain the trust of external investors.
You do not achieve high returns by running a factory from the comfort of your computer in a warm office.
Passive Management Leads to Increased Risks and Lower ROI
The control you can exercise over your acquisitions is one of the greatest added values of private equity investing as opposed to investing in stocks and bonds. So why is it that I so often see private equity firms stepping into the role of a broker, investing solely in the incumbent management? The lesson I have learnt through my career is quite a straightforward one: you do not achieve high returns by running a factory from the comfort of your computer in a warm office. It takes much more than just being a financial expert. As an experienced investor, you must purposefully influence the risk associated with the investment. Your task is to design a long-term vision, to make sure it is being implemented, and, most importantly, to confront your vision with reality and the opportunities and threats on the market. Every day. In my experience, that is the only way to increase the intrinsic value of an acquisition. So, how do we do it?
Prepare to Do the Dirty Work Yourself
When we acquired one of the largest suppliers to the freight railways industry in Europe, we let the managers do their job as best as they could, but we were far from being idle ourselves. We focused strongly on R&D. We were aware of the high fees railway operators had to pay to the national railway provider for every kilogram transported, so the idea suggested itself: if we managed to develop lightweight bumpers, we could sell a product with high added value and shift upward the position of the whole company on the market. This idea would not have been born without an active approach and a fresh perspective on our part, coupled with cooperation and communication with the incumbent management.
Succinctly put, our approach to private equity works like this:
My colleagues and I actively manage each company we buy. Our team has experts on strategic, tactical, and crisis management, and often with extensive experience from the industry. That is why we only buy companies in sectors we genuinely understand, and each purchase decision is backed by a lengthy decision-making process and detailed due diligence. In acquired companies, we replace ineffective management and provide the impetus to move businesses in new directions. Moreover, we seek to build robust platforms in specific industries, taking advantage of synergies within our portfolio, and while also selling off unproductive assets.
Money Is the Best Incentive
Furthermore – and this is important – the remuneration of a project director is entirely dependent upon the success of his or her projects (the plural here means no more than a couple, as none of the project managers on our team is allowed to handle more than two projects so as not to distract his or her focus). This ensures that every one of us gives to the work all we’ve got. Last but not least, we have yet another stake in seeing that our factories achieve the best possible results. We own 10–40% shares in our private equity funds. We are motivated to achieve the highest possible returns for our investors. I dare say this is why successful businesspeople and managers trust us, repeatedly, with their money.
The Incumbency Dilemma and in Praise of a Fresh Perspective
To be clear, I am not arguing against cooperation between the private equity investor and the management of the company. Quite the opposite. The closer it is, the better. There is no one else who understands running the business and dealing with the employees better than the hard-core matadors who have often tied their lives to the prosperity of your new acquisition. However, being so intimately acquainted with the daily operations inevitably brings about creative blindness. That is where you step in. A good project manager knows almost everything about the firm, down to the substantial detail, but has the privilege of not being concerned with the practical running of the company. His mind is free to wander, to consider new paths, to imagine what is unimaginable for the management, simply because the managers lack time to do so – and when the time comes, to predict crises and changes on the market in order to allocate or reduce investments more effectively.
A good project manager knows almost everything about the firm but has the privilege of not being concerned with the practical running of the company. His mind is free to wander.
Thinking outside the Box: The Example of Carbon Fabrics
We knew right from the beginning that the know-how of 70 years embodied in one of our acquisitions, a leading manufacturer of technical fabrics, was strong enough to keep the company on top of its industry sector. We also anticipated, however, that such potential could be used to drive forward change. After assessing the business risks, we embarked on a brand-new path to produce carbon fabrics – a product the current management had heard of but was not entirely keen on producing. It took a lot of convincing, but the outcomes more than paid off. In a few years, we had not only a fully capable production line up and running, but we also achieved, through acquiring another company, the integration of an entire production chain from manufacturing textiles through to their impregnation, and then to the production of final components. Embracing a bold idea all those years ago led us to the production of state-of-the-art, high-tech materials for the automotive and aircraft industries.
10 Things We Do Differently from Other Private Equity Firms
I have entitled this article “a blueprint”, and I intend to honour this pledge. I will leave you with a list of managerial approaches that differentiate us from other private equity companies. Feel free to use it as a source of inspiration for how you may or may not change your own practice.
Investment Focus and Return Profile
The focus of investment in terms of its stages, types, and industries often tends to be too broad or too narrow and in return brings either a too-low or too‑high risk/return ratio. We have discovered that a mixture of buyouts, growth, late-stage venture, and rescue/turnaround projects ultimately delivers better return due to the balance of regular and growth paybacks.
We find short-term, passive management of investments is quite poorly suited to supporting value creation. Instead, long-term strategies leading to a repositioning of investments, like buy-and-build, hands-on growth, business roll-out, platform consolidation, spin-off or restructuring, have proven to be most efficient in value creation.
A scattered portfolio reduces risks but does not necessarily translate into above-average results. On the other hand, controlled investment strategies that contribute to the development of diversified industrial platforms deliver an attractive return and low risk profile.
By focusing on a short-term horizon (up to 5 years) and quick exits, you might miss out on a lot of growth and return opportunities. In 8–10 years, you can open the window of opportunity for value initiatives wider, and you might be rewarded with stronger growth and higher return.
Concentrating solely on the financial performance of your investment without active management severely limits your ability to adapt to market challenges. That, in turn, increases risk. Taking full responsibility for active, hands-on management of your portfolio companies facilitates flexible and proficient decision-making that reflects market challenges and prevents crises.
Being experienced in M&A and finance is often not enough. If your goal is to have a sustainable, competitive business, you might want to build your team with experts on strategic, operational, restructuring, and crisis management. Never forget that your most valuable asset consists in the team members you invest in who have direct experience in the industry.
Forget about the idea that one manager can handle more than two projects. Every project requires professional decision-making based on in-depth knowledge. No project manager is a Superman, and an overambitious workload will almost certainly jeopardize his or her ability to make the right decision or come up with an interesting idea at the right time.
Be smart in setting rules for success fees. Distinguish between the remuneration for the representatives of the companies in your portfolio and that for your project managers. Do not forget that their respective goals are achievable in different terms (long term versus medium term).
A strong team is your most significant advantage. Bring in external advisers only as a last resort. Focus on building your investment company’s vision in parallel with the internal capabilities of portfolio companies.
Why not use service providers wisely? Share them across your portfolio to control the costs and support business opportunities.