What is an "operationally hands-on" PE firm?

Question in the title - what makes a "good" PE firm from the portco's perspective? Surely the PE firm's 26 year old associate isn't expected to tell industry veterans how to run their factories or whatever? 

Comments (18)

Sep 26, 2022 - 9:50am
Jman_PE, what's your opinion? Comment below:

I think you're severely overestimating how good "industry veterans" are at running their factories...

More seriously, being operationally hands on is understanding the balance between being involved and not being too involved. For lots of these portcos in the middle and lower middle market (harder to be operationally hands on in UMM/MF) the management team has likely been at this company for a very long time and really don't know what "good" looks like. It seems silly, but that 26 y/o associate has seen a lot of factories and probably has portco's with better run facilities (and I guarantee his VP and Partners have). So a lot of it is knowledge sharing and best practices with a management team that probably hasn't optimized their facility in 20 years and likely isn't tracking (or not tracking correctly) any KPIs.

Last point I'd add is a big part of being "hands on" is bringing in the right consultants. The associate likely knows little about operations, but he can hire and direct a six sigma consultant on the outcomes the company is trying to achieve and let them do the work.

Sep 27, 2022 - 12:16pm
dinganddong15, what's your opinion? Comment below:

To build on this, many very successful LMM PE firms are founded by people who worked in an industry and sold their company. I know of at least 2 of these just in the city I work in which is a tier 3-4 city. They don't come across as "financy" to potential portco's and have real industry and best practice knowledge where they crush it returns wise gobbling up underperforming, random industrial/manufacturing companies that are family run like it's 1985.

 

Sep 26, 2022 - 10:02am
OverlyAdjustedEBITDA, what's your opinion? Comment below:

Jman_PE's response is a good one and is accurate.  I'm also in the LMM PE space...you'd be surprised at how many management teams have done something for one way for many years and have never thought about how a process can be improved upon.  For that same reason, many entrepreneurially run businesses also don't ask themselves the hard questions or have motivation to dive deeper into tracking KPIs and digging into the data that could otherwise help them improve their business.

  • Associate 1 in PE - Growth
Sep 26, 2022 - 6:49pm

Along these same lines, a lot of small business grow over time by linearly scaling legacy processes, but never pick their head up to think through how they can leverage economies of scale in the business (i.e. throughput in my factory is 3x higher so now the payback on automation equipment makes sense)

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  • Associate 2 in PE - Growth
Sep 26, 2022 - 10:42pm

A few answers:

  • From my experience, many businesses don't have the latest and greatest analytics or strategies implemented to manage complex processes. In other words, they often have pretty poor internal accounting, sales, and operating systems that worked to get them to where they are, but they aren't operating as efficiently as possible. As an example, one of the companies I worked with didn't forecast accurately and had recurring significant inventory issues.
  • Many businesses aren't optimized to operate effectively-in my experience this can be two flavors: 1) They have bloat in the organization whether it's crap employees or unnecessary expenses or expenses that could be better spent somewhere else 2) They might not have the best people or funds in positions to encourage growth and need help finding those employees or knowing the type of employees and/or spending that could take the company to the next level.

All this is to point out in theory what hands on operating looks like. That said, a few things that occur in reality:

  • Fixing internal systems and processes in a company is very very frustrating. It often involves a 26 year old associate devoting 70+ hours a week for months or even close to years to solve a critical issue that employees in the company don't want to devote the time to solve or aren't motivated to solve. There isn't usually a shortcut to fixing these issues, you just need someone who is a very motivated problem solver working on that problem for months and there aren't that many of those motivated problem solvers running around that are cheap. As an example, I know a friend who spent nearly 2 years fixing the HR and benefits for a multi-billion dollar company-the several million (maybe even 10s of millions) he saved by doing so, ultimately is what paid his ~400k salary. I myself have spent nearly 6 months fixing the way a company reports their financials and tracks their customers. This involves trying to understand the fucked up internal processes and working with 9 to 5 employees to try and get them to give a shit to change their behavior. This can be very frustrating and difficult. People think learning operations is glamorous and that going to a PE firm they will learn to operate and make great business decisions. In reality, if you do end up doing portfolio company work, it ends up being you potentially devoting 1000+ hours to a narrow issue that plagues a business's ability to grow fast or operate efficiently, while surrounded by employees who at best are usually appreciative, but not that smart or motivated, and at worst are straight up hostile to you helping. Then, once that 1000+ hour process is complete the company might make a little more ebitda, or you can make a data driven business decision to spend somewhere or cost cut.
  • From my experience, LMM and MM companies can be way more internally messed up than one might think from a data and financial perspective. It would surprise you how many companies might not be operating efficiently because they haven't done a careful data driven analysis of which customers they should sell to or drop and/or returns on spending in areas. A business will survive as long as it turns a profit. Most businesses out there could be growing faster or operating more efficiently and they might be more focused on continuing the process they have going versus thinking about if they could change the way they do things.
  • Most PE firms don't do this. They go to consulting firms and have them do it. That is why there are many PE firms that are ex-consultants (Bain Capital, Golden Gate, Serent being examples at different ends of the market). Most PE firms are in the business of using financial engineering, i.e. they add leverage to a company and arb the growth and potential multiple expansion (historically, but probably not in the future). 

Truthfully, I think the lack of understanding of getting what PE "ops" looks like is because many young professionals don't understand how long business problems take to solve. Like to accurately gather a company's historical data and forecast, it could take months of 70+ hour weeks to solve, which is something undergrads tend to have a hard time wrapping their brain around. Often the work is just to organize a company to be able to get to the point where you can make a strategic decision, or the work done is something that needs internal organization and just lots of hours to fix, so they throw a highly motivated PE associate at the problem.

Sep 29, 2022 - 11:44am
Alt-Ctr-Left, what's your opinion? Comment below:

Most PE firms are in the business of using financial engineering, i.e. they add leverage to a company and arb the growth and potential multiple expansion (historically, but probably not in the future). 

And thank God for this. I can't recall how many sponsor portcos I sold in my 10 years in banking where the sponsor made no/few underlying operational changes, but still realized a massive MOIC exit due to multiples arbitrage, cheap leverage, and a 10-year run of increased consumer spending. Now we get to see which sponsors are truly "operationally hands-on"

"I don't know how to explain to you that you should care about other people."

  • 2
  • Associate 2 in PE - Growth
Sep 29, 2022 - 1:15pm

Two ways to make money in PE:

  • buy cheap sell high
  • Be rewarded for superior management ability 

It will be interesting to see how the landscape changes when the first bullet ceases to be true due to competition and rates. Are longer holds and consulting going to be higher valued? Intuitively it seems like that would be the case, but it's interesting thinking about how private market investing will change in a post 0 rate or declining rates environment.

Sep 27, 2022 - 8:09pm
chihayafull, what's your opinion? Comment below:

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