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Private Equity Operating Resources 2.0 (EY)

The views reflected in this article are those of the author, and do not necessarily reflect the views of the American Investment Council.

By: Jay Bartlett, Managing Director, Co-Head Of Private Equity Parthenon-EY

PE firms are in the midst of one of the most challenging operating environments on record. High valuations, continued competition from corporate acquirers and record levels of dry powder have sent average acquisition multiples well north of historical averages. Successful deals depend on the ability to move faster, drive rapid and strategic growth and create greater value throughout the transaction lifecycle. As such, accelerating returns through operational improvements is now front and center for PE firms.

One result is that the role of operating resources has become an increasingly important part of firms’ strategies for driving returns. In a series of interviews conducted between September 2014 and April 2017, EY documented the evolving role of the operations teams at PE firms, seeking to more fully understand the changing ways that groups are structured, how they’re deployed, how firms use them to maximum effect and the ways they’re measured and compensated.

The industry has approximately one-third more operating resources than it had just four years ago. Much of this growth is occurring at smaller and mid-market firms. A decade ago, operating resources were concentrated at larger shops with the scale and deal sizes necessary to easily amortize their cost. Today, mid-market firms are increasingly catching up, driven by necessity, as competition for deals and high valuations permeate increasingly deeper into the middle market.

Three key trends define ‘operating resources 2.0’

A number of developments is defining the next phase of the model’s evolution.

1) Firms are involving operating resources earlier in the deal cycle

Traditionally, operating resources have focused on adding value during the hold period, with resources brought in post-close. However, many firms are now involving operating resources earlier in the process to help build the investment thesis and flag opportunities for value creation. And as sourcing becomes increasingly competitive, many firms are looking to their more senior operating partners to help uncover new opportunities. With their wide networks, they’re often able to open doors that might have otherwise been shut.

2. Firms are increasingly using specialized operating resources

When operating resources first started becoming commonplace, deploying generalists was typical. CEOs value generalists for their ability to think holistically about the business, for their insights from working across a range of industries and issues, and for the perspective of someone who has been in their seat. They continue to remain an important part of the playbook. However, firms are increasingly retaining specialist resources for a number of compelling reasons:

  • They can typically work across an entire portfolio.
  •  They offer insights that are differentiated from the deal teams and management.
  • They often deliver a faster and more quantifiable return on investment than a generalist, whose impact can sometimes be widely seen but hard to measure.
  • While PE firms are using specialists across a wide range of disciplines, finance and HR were the most commonly cited.

3. Firms are increasingly using 1099 contractors — either in addition to or in place of full-time employees

Two years ago, operating resources were often comprised of full-time employees of the GP; today, many firms are increasingly using contractors in their place, or sometimes using hybrid models that utilize both. In our interviews, 45% of firms used a contractor model; another 30% used a hybrid internal/external model.

Align your solution to your business model

For every model, there is a firm out there that’s using it successfully. What’s keenly important is that the model aligns with or complements a firm’s investment strategy, competencies and key differentiators. Firms need to consider a number of questions to determine the approach that’s right for them. Careful consideration of these elements can help maximize their increasingly important impact. For more details on the study, click here.

EY is an AIC Gold Level Associate Member.