It seems wherever you look at the moment, you see private equity, whether it was the recent TXU, Clear Channel or Hertz deals. Much has been written about how much tax private equity pays and the perceived lack of transparency across the industry. The increased public scrutiny already has led to private equity firms committing to greater transparency and better communication with key audiences. What has been far less debated is how private equity can be more successful at building value in the companies it invests in. The Value-Creation Question
The central question for both critics and supporters of the sector is how private equity builds—or unlocks—value in the companies it acquires. Is it simply the failure of previous management and ownership structures to deliver or adapt? Is private equity just more efficient at realizing value through "asset stripping"? Or is the sector just more efficient at managing and operating businesses?
Private equity has a fearsome reputation both for identifying value and the unsqueamish delivery of it. Critics point to cases where a highly leveraged buyout has been followed by redundancies and a quick sale of assets. The sector, however, claims to create value through sound management and investment in companies, enhancing the management team, reinvigorating a company's strategy, creating new jobs and delivering improved performance. In April of 2007, the private equity industry claimed it created 1 million European jobs (net) between 2000 and 2005, yet the image of the industry still remains one of "casino capitalists" and wealthy asset strippers whose aim is the pursuit of maximum return.
It's clear that results are mixed, but the specter of a "size-zero" portfolio company—superficially attractive, but risking its long-term health—because of under investment continues to haunt the private equity industry. The concern is that financial engineering and cost controls can create undernourished companies starved of capital and operating at a level where their fundamental health could be endangered.
Leveraging People and Process
To be successful, almost every company must put people at the heart of improving business performance and delivering sustainable, market leading operational performance, or at least "peer-equaling," performance. People are as important as process. Private equity companies are increasingly aware of the need for a hands-on consulting approach in delivering certain and lasting results of measurable value. All stakeholders—including unions—should be reassured by this kind of approach, where people are put at the heart of delivering long-term business benefits.
Successful private equity investments, where a company builds value, have made much of using targets and incentives to drive the right behaviors—financial, service, logistical and governance. These "high-level" objectives drive the outcomes of specific functions and activities across a company, thus ensuring all actions across all parts of a company are aligned toward the goals and milestones set by the private equity owner at the outset.
In nearly all businesses, these processes and targets ensure transparency of interdependent activities. Key metrics are known and understood, a necessity of staying in business in the 21st century. The difference with private equity is the focus on time and the one-step-removed nature of their relationships with the companies they own. Equity owners have visible timeframes and well-defined plans for their investments, which are aligned to their investment portfolios, and typically they ensure management is incentivized to participate in the achievement of these plans. This is different from, say, a corporately owned company or government departments where the emphasis is on ownership and perpetuity. Private equity exercises appropriate control to ensure the targets and time-plans are properly followed through.
These steps need to be taken with the aim of building sustainable improvements. One of the great challenges facing not just private equity, but any company, is ensuring that the time and investment made in enhancing the performance of an organization is not wasted. Change has to be sustainable and therefore so do the results that go with it. This change is achieved through a combination of all the elements already outlined—having a clear plan, ensuring that people are fully engaged, making sure the right processes are in place and, finally, clearly communicating the company's targets and the part each person plays in delivering them.
This is never easy, and often management teams need hands-on support to achieve the changes, something the equity holder neither has the skill nor the time to provide. Traditionally, private equity has turned to management consultants to ensure their plans are realistic and provide skilled support to help management push through improvements. As the financial size and risk involved in deals grows, so, too, will the need for consultant help. Greater focus is being given to finding the "hidden value" in acquisitions, which is typically "locked up" in day-to-day operations. This is where specialist consultants with strong operational skills will be of significant value, not only to private equity, but also to management teams and employees involved in unlocking such opportunities.
Good Management
As private equity works hard to improve its reputation, the paramount need is to demonstrate that it delivers long-term sustainable value, as opposed to short-term purges or clever financial gearing. This alternative approach, which is equally palatable to workers, unions and private equity—could be simply called "good management." Harnessing the human potential in an organization to create operational transformation may take a little longer than other methods available to private equity, but it is the only guaranteed way to delivering lasting value.
Paul de Janosi can be reached at paul.dejanosi@celerant consulting.com. For more, watch Paul de Janosi discuss the private equity market on Consulting magazine's One on One video podcast at www.consultingmag.com.
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