Private equity firms urged to adopt a ‘back to basics’ approach

PRIVATE equity firms will have to think differently and work smarter if they’re going to successfully get a return on their investment.

So says Tom Jamieson co-founder of newly founded Harrogate-based ‘operational’ due diligence service Navigoes.

Mr Jamieson believes that with more than 1,600 funds on the road seeking capital, the challange for private equity (PE) managers seeking to raise capital in the coming year will be able to stand out from all their competitors.

He says that creating more value and minimising costs at the portfolio level are now primary areas of focus for PE firms – a claim backed up by a recent report by Gotham Consulting Partners, which showed that 77% of investors cited operating value improvement as the most important value creator of the next five years.

However, with the PE investment world facing a liquidity crisis achieving such ambitions could prove difficult.

“The stock market crash has put a block on PE houses selling their investments, so they can’t return cash to their investors to recycle new deals,” says Mr Jamieson.

“With these investors struggling the value of new buyout deals has shrunk to a 14-year low. Even more damming and worrying is the data from the Centre of Management Buy-Out Research (CMBOR) that three quarters of all UK buyout exits ended in administration in the three months to June this year.”

He continues: “So if PE is to remain as a significant part of investors’ portfolios, PE teams will have to demonstrate both an improvement in the methods they employ in first making investment decisions and in the methods by which they manage investments.”

Mr Jamieson believes that if PE investors can get it right the potential rewards will be significant.

“Just a 10% improvement in acquisition performance would give a massive £2bn additional return on the £20bn invested by UK-based PE houses in 2008 and completely change the failure profile that has so troubled the industry.”

To achieve that, investment managers will need adopt and ‘hands-on’ approach.

“Over the years PE firms have all followed a very similar path in helping to arrive at an investment decision,” explains Mr Jamieson.

“Recruiting the brightest staff from the best business schools, engaging in the latest financial modelling and sensitivity techniques, scrutinising the company, the market and the competition to bewildering levels and undertaking an array of expensive and elaborate psychometric tests on the management.

“The real problem is that these days, very few investment managers actually get their hands dirty. They have neglected the one area that makes the real difference between success and failure both in selection of the investment and its subsequent management – the work place operation of the company itself.”

Such an approach according to Jamieson requires an understanding of how processes and people work together. For example, what happens on the distribution floor on the night shift or how do employees make sense of initiative overload and the inefficiencies that companies create.

“Managers need to know before they make the investment and that’s what they need to keep a close eye on after the investment has been made,” he continues.

Understanding, assessing and evaluation of the operation to enable accurate and fact-based investment decisions to be made (otherwise known as operational due diligence) is not new. But Jamieson believes it it has fallen into diuse.

“It demands a different skill set, one that sits alongside the traditional methods used by PE houses and it can only be delivered by people who have been there and have run businesses from the shop floor to the boardroom,” he adds.

“These are the managers who can go openly and confidently into all parts of businesses – night shifts, production lines, employee canteens and who can live and breathe the inner workings of companies, who are then able to bring out the data – mining the diamonds under the soles of your feet – and deliver it in meaningful ways such that for the first time fact based investment decision making can take place – that’s how operational due diligence works.”

Going back to basics has become a widely lauded approach in the wake of the credit crunch. And with full economic recovery some way off, traditional values may help green shoots to grow.