What private equity can learn from public companies

Transcription

1 What private equity can learn from public companies Limited partners are looking for clear, differentiated strategies, with relevant and proven capabilities.

2 In January 2015, Antoine Drean, founder and chairman of Palico, wrote, It s safe to say private equity will see more innovation this year than ever before, as investors actively adjust to the growing complexity and diversity of the asset class. 1 With increasing competition for capital thanks, in part, to the regulatory changes with regards to marketing and compliance, as well as growing limited partner influence many private equity firms will need to be innovative just to keep pace with peers. Ironically, as private equity looks for inspiration for innovation, it should look no further than the public markets, where issuers have been dealing with a number of the same challenges for years. In this paper, we will look at three of the biggest issues confronting private equity today differentiation, transparency, and succession planning and how effectively adapting public-company approaches to investor engagement and communications could enable them to compete for capital more effectively and efficiently. Differentiation The head of a prominent and active family office recently told me, I see multiple investor presentations from various private equity firms every week, and they all say the same thing. This is particularly problematic given that 2015 is likely to be yet another year where money is committed to a relatively small number of fund managers. 2 This is further complicated by the fact that shifts in the industry are pushing limited partners to rethink their general-partner selection capabilities track record is no longer a reliable indicator. General-partner selection is becoming more focused on understanding the capabilities that have driven past returns and assessing whether those capabilities are still present, relevant, and sufficiently differentiated to continue to drive outperformance into the future. 3 Limited partners are looking for a line of sight to the desired future state of the investment by extrapolating data and putting it into context. This should not be a surprise to anyone given that only about 20 percent of the best managers have two top-quartile funds in a row and 30 percent are one-hit wonders. 4 In fact, top private-equity firms now seem less able to produce consistently successful funds. 5 This might explain why first-time private equity fund managers are expected to gain market share in Therefore, private equity fund managers like their corporate issuer brethren need to learn that the numbers no longer can speak for themselves. To raise capital in a newly competitive era, private-equity firms must be able not only to point to a track record of success but also to say how that track record was achieved and, even more critically, how it will be maintained. [This will require] a more detailed understanding of their past performance and be able to describe its fundamental underpinnings in particular, the skills, brand, focus and other capabilities that the firm brings to its deals. 7 In other words, tomorrow s market leaders will effectively expand their narrative with investors beyond historical data to provide the broader context of both the fund strategy, the market dynamics at the portfolio company level and, the ongoing cohesiveness of the general partner principals. This is needed to fully appreciate the value-creating opportunity that creates a distinctive competitive advantage. Limited partners are looking for clear, differentiated strategies, with relevant and proven capabilities. 8 2

3 THE PATH TO DIFFERENTIATION STARTS WITH THESE THREE STEPS: 1. Ask yourself tough(er) questions: Why is now the right time to invest with your firm or this fund? What makes your fund more attractive than those offered by peers? What don t current or potential investors fully understand / appreciate about your firm, your fund, or the market opportunity? How does your firm evolve its capabilities to stay ahead of the competition both in deal flow and operational improvements with portfolio companies? 2. Think like a brand strategist: What is your firm s investment brand? What makes your investment brand authentic? Does every touch point with current or potential investors genuinely reinforce your investment brand? How do you build and preserve trust? 3. Act like a marketer: How can you simplify your value proposition and/or deflate potential value inhibitors? How can you make it easier for limited partners to stay current on their investment? What s your channel strategy, and how can you better capture and maintain investor interest in between capital campaigns? How can you foster a candid and ongoing dialogue with investors? Transparency The compliance checklist for private equity firms continues to grow in the wake of rapidly evolving regulatory requirements. From the formation of the Securities & Exchange Commission s (SEC) Asset Management Unit in 2010 designed to analyze private equity issues and practices to the creation of the SEC s Office of Compliance Inspections and Examinations ( OCIE ) in 2012 to the most recent changes within Dodd-Frank, private equity firms face greater reporting scrutiny than ever before. These actions are driven by the SEC s heightened concern of fraud in light of difficult fundraising environment, the need for steady private equity returns, conflicting interests between investors and management companies, and a lack of transparency in valuing illiquid assets. 9 This is compounded by the fact that the number of hedge and private equity fund managers registered with the SEC has increased dramatically. 10 Private equity firms need to understand how to balance their SEC compliance imperative with their investor communications obligation. At the same time, private equity is facing increasing demands from limited partners, who are looking for more timely and insightful information on both the current performance of their investment and expectations going forward. Today s private equity investor is looking to generate deeper insights into the drivers of [performance], follow these insights to identify high-potential geographies and sectors and have the conviction to use these insights to select external managers. 11 3

4 This is not unlike the pressure institutional investors are placing on publicly traded companies, who are looking for greater context and insight into the business. These investors have neither the time nor the patience to unpack a company s value proposition. [Investors] want companies to communicate and explain, rather than simply disclose. 12 Common topics investors want communicated and explained that would be applicable for ongoing limited partner communications would include: Review of strategy Sector dynamics and projected growth rates Use of cash (i.e., transparency as to fees taken by general partner over the life of the fund) Portfolio operational management execution Progress on achieving key goals Corrective actions needed/taken Forward-looking financial guidance Forward-looking operational guidance Financial results Segment performance Products and services CSR/sustainability initiatives Succession planning Few segments of the financial industry are more personality driven than private equity. When a PE firm is launched, it s largely done so on the founder s reputation more than anything else. Subsequently, regardless of whether or not the founder s name is on the door, he/she is the personification of the firm, the embodiment of the investment strategy, and the owner of the vast majority of longest-tenured limited-partner relationships. The reputation of the firm and its founder (or founders) is intrinsically linked. Add in the fact that, because PE firms do not transition leadership anywhere near the frequency of publicly owned companies, internal and external stakeholders have little appreciation for life after the founder. As a result, the stakes and anxiety levels are especially high when ushering in the next generation of senior leadership at a particular PE firm and aligning them with limited partners. Because most PE firm leadership succession plans rely on internal candidates, there are a number of unique communications issues to consider. For example, while the newly named Senior Managing Director is known among stakeholders, he/she also is likely to be a first-time Senior Managing Director. As a result, this individual will face internal and external skeptics, as well as existing perceptions that may need to be dislodged. Therefore, it will be critical to establish the new Senior Managing Director s: Experience that will help make the firm even stronger in the future Leadership philosophy Broad observations on the firm and the markets served Unrelenting commitment to strong ethics and integrity Presence in civic and industry organizations 4

5 Clarifying and creating buy-in for changes in priorities, procedures, etc., under new leadership Establishing an authentic and differentiated leadership voice and communications style especially given the founder s typically strong presence and engaging persona Other areas of emphasis during a leadership transition include: Creating realistic and measurable near- and long-term expectations to help create a common focal point for the organization, as well as to stem the flow of inaccurate information and speculation Building credibility for reconfigured leadership team (i.e., who will step into the previous role of the new Senior Managing Director and who will fill roles of other internal candidates who might be leaving the organization) Redefining the working relationships with limited partners, directors of the portfolio companies, colleagues and business associates Many industry experts expect 2015 to be the third consecutive year of strong, $400 billion-plus private equity fundraising. 13 Interestingly enough, this continued growth is considered by some to a harbinger of the continued migration of this alternative asset class towards the mainstream. 14 Doing so not only helps in the fund-raising efforts, but it also helps demonstrate the value derived from the management fees. And with this growth comes an added burden of actively managing the gap between fund performance and investor expectations (or what we refer to as the P/E ratio of investor relations). Without question, those firms that are able to maintain a consistently narrow performance-toexpectations gap will have a competitive advantage in the marketplace. In order to create this advantage, private equity firms should look at the IR play book of forwardthinking public companies to better understand how to successfully balance their SEC compliance imperative with their investor communications obligation. Doing so not only helps in the fund-raising efforts, but it also helps demonstrate the value derived from the management fees. Notes 1 Ten Predictions for Private Equity in 2015 Forbes.com 2 Ibid. 3 Private equity: Changing perceptions and new realities 4 Ten Predictions for Private Equity in 2015 Forbes.com 5 Private equity: Changing perceptions and new realities 6 Ten Predictions for Private Equity in 2015 Forbes.com 7 Private equity: Changing perceptions and new realities 8 Ibid. 9 Private equity funds face increased scrutiny from SEC Winston & Strawn (Spring 2013) 10 Private equity and the SEC: A Brave New World of Scrutiny Pepper Hamilton (May 21, 2014) 11 Private equity: Changing perceptions and new realities Investor Survey: Deconstructing Proxy Statements What Matters to Investors Stanford Graduate School of Business (February 2015) 13 Ten Predictions for Private Equity in 2015 Forbes.com 14 Private equity: Changing perceptions and new realities 5

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