1/15/13

This week I thought I might do a little writing on my time in private equity. Specifically, I'd like to compare and contrast life in private equity when a fund's portfolio companies are performing well with life in PE when a fund's portfolio companies are performing poorly.

To be clear, I can only provide the perspective of an Associate, so I've never been in a position to have money tied up in a fund. I imagine the stresses of being a Partner are far different than those of a pre-MBA Associate, given that your net worth can change drastically based on whether or not your portfolio companies meet or beat their forecasts.

With that said, let's dive into today's post in which I'll focus on life as an Associate when one's portfolio companies are performing well.

Let me give some background to those among you who aren't as familiar with the way a private equity firm operates. When a newly minted Associate joins a PE shop, he / she is assigned a set of portfolio companies to cover. Generally, portfolio coverage revolves around the following responsibilities:

  • Monitoring financial performance - this entails receiving monthly financial statements and forecasts, digging into the details to understand what's driving growth and profitability, and identifying potential problem areas
  • Attending Board meetings - unless you're slammed with a new deal or attending to issues at another one of your coverage companies, you'll get to attend most quarterly Board meetings. Board meetings are a great way to get to know your management teams better and dive deep into strategic issues facing the company. Not to mention a decent meal on the company dime
  • Quarterly valuations - perhaps my least favorite part of PE, but a necessary evil. Once a quarter, you'll be tasked with updating a valuation of your coverage companies. This includes running a DCF, public comps, and precedent transaction analyses. The results of the valuation lead to potential write-ups or write-downs of a company's book value
  • Ad-hoc analysis and misc. projects - you'll occasionally have the opportunity to work on side projects with a company's management teams. This might entail running some numbers for the CFO or doing some market research
  • Evaluating and pursuing add-on acquisitions - you'll see plenty of potential add-on targets during your stint as an Associate, though few move beyond the early stages

Sounds like quite a bit of work, right? Well, the answer to that really depends on two things. How active are you pursuing add-ons and how well are your portfolio companies performing?

If you aren't actively pursuing add-on acquisitions and your portfolio companies are performing at or above their forecasts, then your coverage work will be fairly light and most of your time at work will be focused on new platform acquisitions. Your interaction with your portfolio companies will center around high-level coverage of financial performance, quarterly board meetings, and valuations.

Depending on your fund's strategy, you may find yourself actively pursuing add-on acquisitions for your coverage companies. This is especially true if the portfolio is performing well. I had the fortune of covering a group of healthy companies that were, for the most part, consistently meeting or beating their forecasts, so I spent a great deal of my time in coverage analyzing add-ons.

Frankly speaking, life when one's portfolio companies are healthy is somewhat boring from the perspective of the Associate. While it's certainly fun to attend upbeat Board meetings and work with Partners who are in high spirits every time a new set of financials rolls in, it gets routine. Companies living up to the hockey-stick projections they laid out in their CIM is great if you've got Carry, but not so great if you're looking for a unique and challenging experience.

After you get a couple of deals under your belt, the work involved can become reasonably routine. You get a book, you build a model, you go through diligence, you hash out legal docs, and close. Obviously it's a lot of work, much of it is interesting, but it's still a fairly straightforward process. Yes, the companies you look at can vary a great deal in terms of their industry and business model, but the X's and O's of acquiring a healthy company remain the same.

So, what happens when your coverage companies aren't meeting expectations? That's where things can really get interesting. That's where tempers start to flare and routine processes start to go out the window. While I never had the (mis)fortune of covering a poorly performing company, I've got plenty of friends in the industry who have.

I'll cover some of their stories along with an overview of life in PE when a portfolio is underperforming in my post on Thursday.

Comments (28)

1/15/13

Great post, very informative and detailed.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."

1/15/13

Great post TK.

Out of curiosity, how many portfolio companies are you currently covering?

1/15/13

Great post - I was always interested to hear more about the day-to-day life on the PE side.

Quarterly valuations - how much of this is BS? Your fund's investor statements depend on it, but is this a similar game to IB where an MD has a ballpark figure in mind for how much a company is worth and your DCF / comps / model are there to support it?

If you went to your boss and said "my quarterly valuation says the Company is now worth 2% less" would your boss say "no, run it again"?

How dramatic are the changes in valuation on a quarter to quarter basis? If you are using public comps I would imagine there could be some pretty wild fluctuations.

In reply to grosse
1/15/13

grosse:
Great post - I was always interested to hear more about the day-to-day life on the PE side.

Quarterly valuations - how much of this is BS? Your fund's investor statements depend on it, but is this a similar game to IB where an MD has a ballpark figure in mind for how much a company is worth and your DCF / comps / model are there to support it?

If you went to your boss and said "my quarterly valuation says the Company is now worth 2% less" would your boss say "no, run it again"?

How dramatic are the changes in valuation on a quarter to quarter basis? If you are using public comps I would imagine there could be some pretty wild fluctuations.

Yeah, I thought this sort of thing would be enlightening. So much focus is on PE at a high-level without a realization of what actually goes on at a nuts-and-bolts level.

Valuations are pretty thorough. Generally, you run the valuation, then get all your drafts together and have a meeting with the Partners. Valuations are discussed based on the output and how that reflects the reality of the company's performance. They can definitely swing from quarter to quarter due to public comps and (sometimes) precedent transactions that take place. The key is that they go out with written narratives and are discussed on a call with members of an Advisory Board.

All of the work in the valuations has a grounding in hard numbers along with a narrative. And, even though companies might fluctuate up or down a bit, it's important to remember that you're looking at an entire portfolio. So, even if a couple companies are lagging, the real winners of the portfolio can carry the day. That, and the fund's LPs know that a sale process will maximize value on exit. A well-run process can get you a valuation a good deal higher than what your valuation tells you. The CFO of my fund had stats on this, and it was something like companies tended to go for a 15% - 20% premium to our valuations of them (upon exit.)

Still, an important exercise because it keeps you on top of company performance and helps alert people to trouble areas and keeps Partners on their toes. It is, however, a giant pain in the ass, especially when you're really busy.

In reply to grosse
1/15/13

grosse:
Great post - I was always interested to hear more about the day-to-day life on the PE side.

Quarterly valuations - how much of this is BS? Your fund's investor statements depend on it, but is this a similar game to IB where an MD has a ballpark figure in mind for how much a company is worth and your DCF / comps / model are there to support it?

If you went to your boss and said "my quarterly valuation says the Company is now worth 2% less" would your boss say "no, run it again"?

How dramatic are the changes in valuation on a quarter to quarter basis? If you are using public comps I would imagine there could be some pretty wild fluctuations.

Quarterly valuations will be audited so this isn't an inconsequential banking exercise; methodology needs to be set/defensible and consistent between quarters. One major reason why a PE fund might want to fudge their unrealized gains is if they are already fund-raising for the next fund and want something to show for it but generally from my experience there isn't that much pressure to inflate unrealized gains as the goal is to have an accurate convergence towards your exit.

In reply to Falcon
1/15/13

Falcon:
Great post TK.

Out of curiosity, how many portfolio companies are you currently covering?

I'm not with the fund anymore, but I started out with three companies and ended up covering five by the time I was done (due to two platform acquisitions that I closed.) I also completed three add-on acquisitions. My companies performed quite well, so I had a pretty clean experience. I'm hoping to share some alternate experiences I've heard about through friends about what it's like when things aren't going so hot. While I don't envy some of the stresses they had to deal with, they definitely learned a ton.

In reply to kingb
1/15/13

kingb:
grosse:
Great post - I was always interested to hear more about the day-to-day life on the PE side.

Quarterly valuations - how much of this is BS? Your fund's investor statements depend on it, but is this a similar game to IB where an MD has a ballpark figure in mind for how much a company is worth and your DCF / comps / model are there to support it?

If you went to your boss and said "my quarterly valuation says the Company is now worth 2% less" would your boss say "no, run it again"?

How dramatic are the changes in valuation on a quarter to quarter basis? If you are using public comps I would imagine there could be some pretty wild fluctuations.

Quarterly valuations will be audited so this isn't an inconsequential banking exercise; methodology needs to be set/defensible and consistent between quarters. One major reason why a PE fund might want to fudge their unrealized gains is if they are already fund-raising for the next fund and want something to show for it but generally from my experience there isn't that much pressure to inflate unrealized gains as the goal is to have an accurate convergence towards your exit.

Great point. Valuations are audited and you have to follow a pretty specific set of guidelines. It's essentially to ensure that you don't inflate values since this stuff does get used for new fund raising, especially if you haven't had an exit in your current fund yet.

Also - there can only be one King of WSO!

1/15/13

great king, thanks. and yes there can only be one king on wso

1/15/13

Thanks for this. Very accurate based on my PE experience as well.

1/15/13

I'm assuming this is for an LBO shop?

How would this differ at a growth equity shop?

Super Nintendo, Sega Genesis - when I was dead broke man I couldn't picture this

1/15/13

Great post!! Could you share some perspective on the operations management stratigies you perform on any of your current projects?

In reply to angelinajolie
1/15/13

angelinajolie:
Great post!! Could you share some perspective on the operations management stratigies you perform on any of your current projects?

You might have to elaborate a bit on what you mean. Unless you are asking about the mythical "operations" aspect of PE.

If you're referring to the misc. projects I mentioned in my post, these can include the following:

--Digging into internal financials to analyze the company's revenue and profitability on a product by product basis (digging in and looking for trends, etc.)
--Helping with modeling and analysis for refinancings
--Misc. financial analysis / competitive analysis

Most of the work you'll do with your portfolio companies outside of add-ons and the other things I listed above will be financial in nature. I'm sure there are some different examples out there from other people, but this is generally the case.

I'm always bugged by the myth of operations in PE. As an Associate in PE, your main job is to work on and complete acquisitions (new platform and add-ons.) The rest of your work revolves around monitoring portfolio companies, helping out with misc. projects like the ones I listed above, and fund administration (i.e. valuations.)

Let me know if you have any more specific questions.

In reply to idragmazda
1/15/13

idragmazda:
I'm assuming this is for an LBO shop?

How would this differ at a growth equity shop?

I can't speak from experience, but I imagine it's quite similar. The biggest difference would be how you go about evaluating companies you invest in and your expected goals for them. That, and the type and amount of ownership you take. In growth equity, your capital is used in large part for growth, whereas in buyouts you are simply taking control of the business and providing liquidity to the existing shareholders.

Note, though, that management teams in PE almost always retain some level of ownership post-close so as to align incentives with the PE fund.

In reply to TheKing
1/15/13

TheKing:
angelinajolie:
Great post!! Could you share some perspective on the operations management stratigies you perform on any of your current projects?

You might have to elaborate a bit on what you mean. Unless you are asking about the mythical "operations" aspect of PE.

If you're referring to the misc. projects I mentioned in my post, these can include the following:

--Digging into internal financials to analyze the company's revenue and profitability on a product by product basis (digging in and looking for trends, etc.)
--Helping with modeling and analysis for refinancings
--Misc. financial analysis / competitive analysis

Most of the work you'll do with your portfolio companies outside of add-ons and the other things I listed above will be financial in nature. I'm sure there are some different examples out there from other people, but this is generally the case.

I'm always bugged by the myth of operations in PE. As an Associate in PE, your main job is to work on and complete acquisitions (new platform and add-ons.) The rest of your work revolves around monitoring portfolio companies, helping out with misc. projects like the ones I listed above, and fund administration (i.e. valuations.)

Let me know if you have any more specific questions.

Thanks for your reply!

I guess I was talking about the 'myth' of operations management in PE. I guess that's what I though you meant by add-ons.
So your work is 100% financial based/ financial analysis? No process improvement/value creation for the projects you undertake?

Thanks again for your insight!!

In reply to angelinajolie
1/15/13

angelinajolie:
Thanks for your reply!

I guess I was talking about the 'myth' of operations management in PE. I guess that's what I though you meant by add-ons.
So your work is 100% financial based/ financial analysis? No process improvement/value creation for the projects you undertake?

Thanks again for your insight!!

Well, when a fund like the one I worked at acquires a company, they often have third party consultants come in and develop plans for things like process improvements, sales force realignments, new markets to enter, etc. We review the reports they produce with the consultants and with management and provide support if necessary. Mostly, however, it's simply reviewing and letting the management team implement things.

Think of it this way, if you're an Associate with two - three years of banking background, and your fund buys a washing machine components manufacturer...what can you possibly do to personally deliver process improvements or create value? Unless you spent ten years in the washing machine business before joining a bank, it's gonna be tough and will mostly be left up to consultants. Note, again, that you will be involved in the process in so far as you'll have access to all the reports and sit on plenty of calls with consultants and management.

Sometimes when a firm buys a company, they'll bring in someone to sit on the Board of Directors because they have connections in the portco's industry. Oftentimes they can open doors for the company that they couldn't previously access. Sometimes Partners will call friends in the industry or old colleagues that work in fields related to the company they own to do the same. Again, it's the kind of thing that you can't really do much of as an Associate, so it's best to absorb as much as you can and find ways to be helpful.

That make sense?

In reply to TheKing
1/15/13

TheKing:
angelinajolie:
Thanks for your reply!

I guess I was talking about the 'myth' of operations management in PE. I guess that's what I though you meant by add-ons.
So your work is 100% financial based/ financial analysis? No process improvement/value creation for the projects you undertake?

Thanks again for your insight!!

Well, when a fund like the one I worked at acquires a company, they often have third party consultants come in and develop plans for things like process improvements, sales force realignments, new markets to enter, etc. We review the reports they produce with the consultants and with management and provide support if necessary. Mostly, however, it's simply reviewing and letting the management team implement things.

Think of it this way, if you're an Associate with two - three years of banking background, and your fund buys a washing machine components manufacturer...what can you possibly do to personally deliver process improvements or create value? Unless you spent ten years in the washing machine business before joining a bank, it's gonna be tough and will mostly be left up to consultants. Note, again, that you will be involved in the process in so far as you'll have access to all the reports and sit on plenty of calls with consultants and management.

Sometimes when a firm buys a company, they'll bring in someone to sit on the Board of Directors because they have connections in the portco's industry. Oftentimes they can open doors for the company that they couldn't previously access. Sometimes Partners will call friends in the industry or old colleagues that work in fields related to the company they own to do the same. Again, it's the kind of thing that you can't really do much of as an Associate, so it's best to absorb as much as you can and find ways to be helpful.

That make sense?

Oh absolutely-I'm finding however, that more and more PE shops are performing the role that would have been done by consultants themselves, to cut costs. Maybe this is only in smaller shops who have a very specific emphasis on one industry though?

In reply to angelinajolie
1/15/13

angelinajolie:

Oh absolutely-I'm finding however, that more and more PE shops are performing the role that would have been done by consultants themselves, to cut costs. Maybe this is only in smaller shops who have a very specific emphasis on one industry though?

Would be curious to see examples. I'm not saying it never happens, but people need to be realistic about what they'll actually be doing in PE.

If one wants to work in operations, they should probably work in operations / marketing / sales / whatever else at an actual company instead of working in finance / PE.

1/15/13

Another great post from TheKing - thanks a ton for this.

Could you talk about what you would be doing in a leveraged (or other) recap situation? I don't know if these were common with your fund but it would certainly be enlightening to learn more.

In reply to Plato
1/15/13

Plato:
Another great post from TheKing - thanks a ton for this.

Could you talk about what you would be doing in a leveraged (or other) recap situation? I don't know if these were common with your fund but it would certainly be enlightening to learn more.

My fund didn't do much in the way of recaps. I presume you mean dividend recaps? My understanding is that you can only really pull that off if the portfolio company is absolutely blowing expectations out of the water, you're way ahead of plan, and you're looking to take some money off the table.

Someone else might be able to chime in on this one with more / better info.

1/15/13

This is a gem of a post. Thank you.

Read my blog: Bateman Begins

In reply to TheKing
1/15/13

TheKing:
Plato:
Another great post from TheKing - thanks a ton for this.

Could you talk about what you would be doing in a leveraged (or other) recap situation? I don't know if these were common with your fund but it would certainly be enlightening to learn more.

My fund didn't do much in the way of recaps. I presume you mean dividend recaps? My understanding is that you can only really pull that off if the portfolio company is absolutely blowing expectations out of the water, you're way ahead of plan, and you're looking to take some money off the table.

Someone else might be able to chime in on this one with more / better info.

Yes, I was referring to dividend recaps; thanks for the insight. This gets bandied quite a bit in the financial press so I'm guessing it's not quite as prevalent as the media make it out to be...surprise, surprise.

Thanks again.

In reply to Plato
1/15/13

Plato:
TheKing:
Plato:
Another great post from TheKing - thanks a ton for this.

Could you talk about what you would be doing in a leveraged (or other) recap situation? I don't know if these were common with your fund but it would certainly be enlightening to learn more.

My fund didn't do much in the way of recaps. I presume you mean dividend recaps? My understanding is that you can only really pull that off if the portfolio company is absolutely blowing expectations out of the water, you're way ahead of plan, and you're looking to take some money off the table.

Someone else might be able to chime in on this one with more / better info.

Yes, I was referring to dividend recaps; thanks for the insight. This gets bandied quite a bit in the financial press so I'm guessing it's not quite as prevalent as the media make it out to be...surprise, surprise.

Thanks again.

It's not to say that dividend recaps don't happen, but they are much more typical at larger funds. Also, it isn't necessarily easy to pull them off since you generally have to get your lenders to sign off on these sorts of things. Though, during the hey-day of the bubble, all sorts of insane shit was going down.

In reply to TheKing
1/15/13

TheKing:
Plato:
TheKing:
Plato:
Another great post from TheKing - thanks a ton for this.

Could you talk about what you would be doing in a leveraged (or other) recap situation? I don't know if these were common with your fund but it would certainly be enlightening to learn more.

My fund didn't do much in the way of recaps. I presume you mean dividend recaps? My understanding is that you can only really pull that off if the portfolio company is absolutely blowing expectations out of the water, you're way ahead of plan, and you're looking to take some money off the table.

Someone else might be able to chime in on this one with more / better info.

Yes, I was referring to dividend recaps; thanks for the insight. This gets bandied quite a bit in the financial press so I'm guessing it's not quite as prevalent as the media make it out to be...surprise, surprise.

Thanks again.

It's not to say that dividend recaps don't happen, but they are much more typical at larger funds. Also, it isn't necessarily easy to pull them off since you generally have to get your lenders to sign off on these sorts of things. Though, during the hey-day of the bubble, all sorts of insane shit was going down.

Dividend recaps are coming back, as we saw a number of covlite div recaps in 2012. I think you see them more often with companies that are middle market or larger with better access to capital markets.

In reply to HarvardOrBust
1/16/13

HarvardOrBust:
TheKing:
Plato:
TheKing:
Plato:
Another great post from TheKing - thanks a ton for this.

Could you talk about what you would be doing in a leveraged (or other) recap situation? I don't know if these were common with your fund but it would certainly be enlightening to learn more.

My fund didn't do much in the way of recaps. I presume you mean dividend recaps? My understanding is that you can only really pull that off if the portfolio company is absolutely blowing expectations out of the water, you're way ahead of plan, and you're looking to take some money off the table.

Someone else might be able to chime in on this one with more / better info.

Yes, I was referring to dividend recaps; thanks for the insight. This gets bandied quite a bit in the financial press so I'm guessing it's not quite as prevalent as the media make it out to be...surprise, surprise.

Thanks again.

It's not to say that dividend recaps don't happen, but they are much more typical at larger funds. Also, it isn't necessarily easy to pull them off since you generally have to get your lenders to sign off on these sorts of things. Though, during the hey-day of the bubble, all sorts of insane shit was going down.

Dividend recaps are coming back, as we saw a number of covlite div recaps in 2012. I think you see them more often with companies that are middle market or larger with better access to capital markets.


and, not always a recap situation but where the sponsor has fronted a lot of equity then wants to lever the structure.

"After you work on Wall Street it's a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side." - David Tepper

1/17/13

Div Recaps are also a good option if you have want to extent the life of a weak/average investment. Even a mediocre investment will typically have achieved some debt paydown over 4/5 years. Often your Bond Docs/Bank Agreements will allow you to re-up to the original leverage level and take some money off the table. If not, you might want to refinance anyway given that bond markets are very hot now. Or Of course, you might just offer the lenders a waiver fee to let you take equity out.

If you think about it, if markets would be happy to let a new buyer re-leverage the business and let you take equity off the table; why would they be averse to you re-leveraging it yourself.

...of course, this is more true for larger investments, which typically would have better access to capital markets.

In terms of work for an associtate, it is similar to running the financing for a new deal. You will need a updated bank model/case and to do the negotiations etc. for new financing.

In reply to PZ87
1/17/13

PZ87:
Div Recaps are also a good option if you have want to extent the life of a weak/average investment. Even a mediocre investment will typically have achieved some debt paydown over 4/5 years. Often your Bond Docs/Bank Agreements will allow you to re-up to the original leverage level and take some money off the table. If not, you might want to refinance anyway given that bond markets are very hot now. Or Of course, you might just offer the lenders a waiver fee to let you take equity out.

If you think about it, if markets would be happy to let a new buyer re-leverage the business and let you take equity off the table; why would they be averse to you re-leveraging it yourself.

...of course, this is more true for larger investments, which typically would have better access to capital markets.

In terms of work for an associtate, it is similar to running the financing for a new deal. You will need a updated bank model/case and to do the negotiations etc. for new financing.

Thanks for the insight. Do you happen to know where there are examples of models for this type of thing?

1/18/13

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