Life in PE when Things AREN'T Going According to Plan
On Tuesday, I wrote a post about life in PE when thing are going according to plan. My focus was to give everyone a general feel and a high level overview for what portfolio coverage is like since it takes up a great deal of your time as an Associate. And, let's face it, the health of the portfolio is the lifeblood of a fund. It not only determines the net worth of the partners over the course of five to seven years, it also determines the true longevity of a private equity firm.
If your portfolios perform well, your valuations will show it. The value creation will be evident and you'll probably look at a couple earlier-than-expected exits. And when it comes to raising a new fund, this goes a long way. Locking in solid returns with timely exits is an absolute boon for fund raising, both for bringing back existing investors, increasing their stakes, and attracting new LPs.
But, what if the portfolio isn't performing up to par? What are the implications?
What is life like at a private equity firm when things aren't going according to plan?
As with my post on Tuesday, this post is primarily concerned with life as an Associate in PE. The stresses of an underperforming fund on a more senior employee of a PE shop are far different. Having money tied up in an underperforming fund can cause massive stress and shows what it really means to have skin in the game, so to speak.
Having several friends who work(ed) at various PE funds throughout the country, I've gotten to hear a myriad of perspectives. I was fortunate to work for a fund that performed pretty well, without any massive hiccups. Others were not so fortunate.
Or were they?
Typically, firms have weekly meetings in which all of the Partners of the firm, along with the junior employees, meet to discuss the state of the portfolio and any new deals that are working their way through the pipeline.
When things are going well, these meetings are pretty straight forward. The Partners have a pep in their step and act as the rightful masters of the universe that they are. Things change quite a bit when companies start shitting the bed.
Tensions rise. Tempers flare. And while things are analyzed appropriately with facts taking precedence over emotional responses, it's hard to restrain frustration and hard feelings when so much money is at stake.
Now, the vast majority of the time, a company's poor performance doesn't happen overnight. Like a floundering relationship, the warning signs have been there for a while and it's been on a steady decline. You try and work through the problems, and sometimes you can. But, when you can't, that's when things get tough. And, unlike a relationship, you can't just break up and move on. You're stuck with the company until you either fix the problems, exit via a sale, or it's forced into some sort of bankruptcy process.
A friend of mine's fund had just such a company. It was an industrial services business that was crushed by the slow economic recovery and a slow but steady displacement of its technology. Over the course of six months to a year, the problems grew larger and larger. And their weekly firm-wide meetings grew more and more intense.
It started slowly, with the lead Partner on the coverage team putting the company's management team on notice. As things continued to erode, it led to weekly update calls. Before long, the banking group was starting to get nervous. This is where PE can really get interesting for an Associate. While it's definitely stressful and Partners are starting to lose their shit, an Associate can really dig into some unique stuff.
As the company continued to falter, my buddy got to work on some really interesting stuff. For one, he worked with a Partner and a search firm to find potential replacements for members of management. The management team was great during boom times, but seemingly impotent in dealing with the company's trouble areas. He was sent to work with the company on-site for weeks at a time, pitching in on just about any project he could. This meant getting his hands dirty in the real nitty-gritty details. Digging through the rawest financials imaginable to help better understand what areas management needed to focus on to right the ship.
With the banks' worries growing, it was up to the PE firm to work up a short-to-medium term action plan to restructure the business. This meant putting in additional equity and diluting returns, but it also gave the banks confidence that the fund was serious. The Associate worked alongside a group of turnaround consultants and the lead Partner on the coverage team to help put together a thorough turnaround plan for the banks. After several months of hard work and some time under the turnaround plan, the company's performance started to improve. While the return on equity will be diluted, it's still better than the alternative.
My friend who got to work on this company said it was among the best work he's ever been involved in. Challenging, interesting, and very unique amongst his peers. For a guy who wants to go to b-school, this ought to go a long way towards helping him craft some fantastic essays. It's also a great deal more interesting than my experience was. So, while you want to go to a winning fund, it's worth noting that a fund with challenged portfolio companies can lead to a unique and potent experience for an Associate.
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Anyone on WSO get to work on any challenging portfolio companies? Anybody have any PE war stories they'd like to share? Or better yet, does anyone have any fun stories of Partners going wild when their companies start to shit the bed? Leave your thoughts and questions in the comments.
Comments
I'd love to hear from someone
I'd love to hear from someone at a PE firm which has a debt desk who have thought about or executed debt purchases through their other desk, and not on the behalf of the portfolio company.
Oreos: I'd love to hear from
I'd love to hear from someone at a PE firm which has a debt desk who have thought about or executed debt purchases through their other desk, and not on the behalf of the portfolio company.
You mean a firm that bought some distressed debt and flipped it a short time later? If you're getting at that, I have a buddy who worked at a place that did that. His main focus was middle market buyouts, but as I recall, they made a monster return flipping some debt in like three months.
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TheKing: Oreos: I'd love to
I'd love to hear from someone at a PE firm which has a debt desk who have thought about or executed debt purchases through their other desk, and not on the behalf of the portfolio company.
You mean a firm that bought some distressed debt and flipped it a short time later? If you're getting at that, I have a buddy who worked at a place that did that. His main focus was middle market buyouts, but as I recall, they made a monster return flipping some debt in like three months.
Not really. More enabling the PE firm to have a voice at the restructuring table when things get messy. E.g., buy a blocking stake c.>25% of the fulcrum debt and try to swing the process in the favor of their original equity participation. So not pure loan-to-own.
My initial comment wasn't clear. So you'd LBO, it goes bad, your other desk buys its debt, you (as a firm, hopefully working in cohort) have a voice later on.
Oreos: TheKing: Oreos: I'
I'd love to hear from someone at a PE firm which has a debt desk who have thought about or executed debt purchases through their other desk, and not on the behalf of the portfolio company.
You mean a firm that bought some distressed debt and flipped it a short time later? If you're getting at that, I have a buddy who worked at a place that did that. His main focus was middle market buyouts, but as I recall, they made a monster return flipping some debt in like three months.
Not really. More enabling the PE firm to have a voice at the restructuring table when things get messy. E.g., buy a blocking stake c.>25% of the fulcrum debt and try to swing the process in the favor of their original equity participation. So not pure loan-to-own.
My initial comment wasn't clear. So you'd LBO, it goes bad, your other desk buys its debt, you (as a firm, hopefully working in cohort) have a voice later on.
Ahhh, gotcha. I'm not so familiar with that. To be honest, it would seem like that would present some level of a conflict of interest and that the existing banking group might not allow it. But, I'm really shooting in the dark here. Ideally, someone on WSO has either experience doing that or works for a firm that does. I'd be interested to learn that as well. Good question.
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Another great one. Thanks,
Another great one. Thanks, King.
TheKing: Oreos: TheKing:
I'd love to hear from someone at a PE firm which has a debt desk who have thought about or executed debt purchases through their other desk, and not on the behalf of the portfolio company.
You mean a firm that bought some distressed debt and flipped it a short time later? If you're getting at that, I have a buddy who worked at a place that did that. His main focus was middle market buyouts, but as I recall, they made a monster return flipping some debt in like three months.
Not really. More enabling the PE firm to have a voice at the restructuring table when things get messy. E.g., buy a blocking stake c.>25% of the fulcrum debt and try to swing the process in the favor of their original equity participation. So not pure loan-to-own.
My initial comment wasn't clear. So you'd LBO, it goes bad, your other desk buys its debt, you (as a firm, hopefully working in cohort) have a voice later on.
Ahhh, gotcha. I'm not so familiar with that. To be honest, it would seem like that would present some level of a conflict of interest and that the existing banking group might not allow it. But, I'm really shooting in the dark here. Ideally, someone on WSO has either experience doing that or works for a firm that does. I'd be interested to learn that as well. Good question.
There is a conflict, that's the point. But the existing lenders have no say in it, you only need at a max., borrower's (ie, your fund's) consent (for bank loans) to buy the debt. However, debt buy-backs by the issuing company can be limited; depending on the docs.
It does happen, but it'd be interesting to have an insiders view of when to pull the trigger.
I agree with you that these
I agree with you that these kinds of experience must be really interesting (as long as you don't have any money in !).
That's why I'm looking for a turnaround consulting job and not generic MBB or IB/PE.
I figure these types of
I figure these types of situations are common at deep distress / value PE shops that engage frequently in these transactions.
Oreos: TheKing: Oreos:
I'd love to hear from someone at a PE firm which has a debt desk who have thought about or executed debt purchases through their other desk, and not on the behalf of the portfolio company.
You mean a firm that bought some distressed debt and flipped it a short time later? If you're getting at that, I have a buddy who worked at a place that did that. His main focus was middle market buyouts, but as I recall, they made a monster return flipping some debt in like three months.
Not really. More enabling the PE firm to have a voice at the restructuring table when things get messy. E.g., buy a blocking stake c.>25% of the fulcrum debt and try to swing the process in the favor of their original equity participation. So not pure loan-to-own.
My initial comment wasn't clear. So you'd LBO, it goes bad, your other desk buys its debt, you (as a firm, hopefully working in cohort) have a voice later on.
Ahhh, gotcha. I'm not so familiar with that. To be honest, it would seem like that would present some level of a conflict of interest and that the existing banking group might not allow it. But, I'm really shooting in the dark here. Ideally, someone on WSO has either experience doing that or works for a firm that does. I'd be interested to learn that as well. Good question.
There is a conflict, that's the point. But the existing lenders have no say in it, you only need at a max., borrower's (ie, your fund's) consent (for bank loans) to buy the debt. However, debt buy-backs by the issuing company can be limited; depending on the docs.
It does happen, but it'd be interesting to have an insiders view of when to pull the trigger.
Could other lenders not argue for equitable subordination based on that creditors obvious conflict of interest?
Thanks for posting this. I
Thanks for posting this. I was just at a conference a couple days ago where one of the sessions was dedicated to how sponsors should deal with distressed portfolio companies, so this post is a very timely inbound.
...well, he's no use to us if Detroit is his idea of a small town!
brandon st randy - Glad you
brandon st randy -
Glad you enjoyed. It's really a fascinating process and I do envy my buddy who got to live through it. It's also something that's going to happen to even the best-run funds, so it's the sort of thing everyone should think about.
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Awon Eleyi Awon Eleyi Won Bad
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Could other lenders not argue for equitable subordination based on that creditors obvious conflict of interest?
Good point. There's nothing in the bankruptcy code to describes what constitutes equitable subordination so i suppose there's an argument. But the actions of the PE as a debtor wouldn't be to put other classes of debt in an obviously disadvantaged or deleterious position in that the PE action would likely, by not limited to, reduce debt-to-equity or to favour a plan including an equity injection (by way of rejecting plans to the contrary). Further, equitable subordination would infer that debtors of a same class were being treated differently, but in this example we're not trying to prioritisel liens over those that should be on the same level, just steering the process in a certain way while being in the fulcrum.
A classic case is if near to the brink of bankruptcy the debtor raises super senior (not DIP with the court's permission)when it is imprudent to do so as is ignoring its duty to the other debtors.
But please, I'm British, someone correct me if im off base.
TheKing: Oreos: TheKing:
I'd love to hear from someone at a PE firm which has a debt desk who have thought about or executed debt purchases through their other desk, and not on the behalf of the portfolio company.
You mean a firm that bought some distressed debt and flipped it a short time later? If you're getting at that, I have a buddy who worked at a place that did that. His main focus was middle market buyouts, but as I recall, they made a monster return flipping some debt in like three months.
Not really. More enabling the PE firm to have a voice at the restructuring table when things get messy. E.g., buy a blocking stake c.>25% of the fulcrum debt and try to swing the process in the favor of their original equity participation. So not pure loan-to-own.
My initial comment wasn't clear. So you'd LBO, it goes bad, your other desk buys its debt, you (as a firm, hopefully working in cohort) have a voice later on.
Ahhh, gotcha. I'm not so familiar with that. To be honest, it would seem like that would present some level of a conflict of interest and that the existing banking group might not allow it. But, I'm really shooting in the dark here. Ideally, someone on WSO has either experience doing that or works for a firm that does. I'd be interested to learn that as well. Good question.
Most smart credit docs will impose 5-10% limits on sponsor ownership of a tranche. I've seen docs for a club deal that specified individual sponsors though, not total equity group, so between them and their co-invested LPs they were able to buy a blocking position.
Generally though, the sponsor just buys debt at cents on the dollar to retire it and try to hit covenants they need to be in compliance with to avoid rate steps, issue new debt, pay their special dividend etc.
Equitable subordination won't come into it given that the sponsor is now a holder of the tranche and if anything they are the disadvantaged party. The more effective limit on what you can do is your bank tends to get pissed because you being in the fulcrum can draw out bankruptcies and thus hurt their recovery, and you likely need them to sign off on some covenant waivers/extensions given how screwed the company is.
meabric: [ Most smart credit
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Most smart credit docs will impose 5-10% limits on sponsor ownership of a tranche. I've seen docs for a club deal that specified individual sponsors though, not total equity group, so between them and their co-invested LPs they were able to buy a blocking position.
Generally though, the sponsor just buys debt at cents on the dollar to retire it and try to hit covenants they need to be in compliance with to avoid rate steps, issue new debt, pay their special dividend etc..
Another great point. Current LMA standard docs state that Sponsor Affiliates have no voting rights under the finance docs. I would assume this would aim to include Scheme of Arrangements (dunno though). But yea, this is the current standard, not too sure about the '07 standards.
The above also includes sub parts. However, I have seen banks with good sponsor relationships act for the fund but with no legal connection.
EDIT: just looked through a few of our loan docs from the '07 vintage and some post RXing ones where the initial LBO was '07, none of them had the Sponsor Affiliate language. In addition, a recent RXing (loan-to-own) has excluded it vs. LMA standard (for obvious reasons).
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Equitable subordination won't come into it given that the sponsor is now a holder of the tranche and if anything they are the disadvantaged party. The more effective limit on what you can do is your bank tends to get pissed because you being in the fulcrum can draw out bankruptcies and thus hurt their recovery, and you likely need them to sign off on some covenant waivers/extensions given how screwed the company is.
but them drawing it out is quite unlikely, incentives are generally aligned.
meabric: Equitable
Equitable subordination won't come into it given that the sponsor is now a holder of the tranche and if anything they are the disadvantaged party. The more effective limit on what you can do is your bank tends to get pissed because you being in the fulcrum can draw out bankruptcies and thus hurt their recovery, and you likely need them to sign off on some covenant waivers/extensions given how screwed the company is.
Great point here. You will definitely lean on the banks for covenant waivers and extensions. This will happen even if a company is doing decently well. First time they waive a covenant, it's not the end of the world, but all of this stuff comes at a price (i.e. a fee.) You obviously know this stuff, but I probably should've included it in my post. You can get into a real death spiral if you keep busting covenants and asking for waivers / extensions / a whole new set of them.
For those that are less initiated to the way debt works, when you borrow money from ABC bank to fund your LBO, the debt comes with a set of covenants. Covenants are a set of hurdles and rules that the company must comply with or else face penalties and problems. Typical covenants include meeting a minimum Total Debt / EBITDA ratio and a Total Senior Debt / EBITDA ratio. Total Debt, Senior Debt, and EBITDA are all very specifically defined in the credit documents. As mundane as this stuff sounds, you can spend a lot of time going back and forth with the banks agreeing on definitions and covenant ratios. And, again, as mundane as it sounds, you actually can learn a decent bit about negotiations by going through the process on a deal.
Last thing I'll add is that mezzanine players can really throw a wrench into things when shit starts to hit the fan. It's very personality dependent, but if they've got a little bit of equity in the deal, they'll start to rile things up during any sort of restructuring.
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prospie: TheKing: The
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Just started in a PE firm in
TheKing: I'm always bugged by
Informative post. Thank you
Did you have any experience
[quote=Oreos] meabric: [ ED
[quote=meabric] Oreos: me