Restructuring the Hold

Optimizing Private Equity and Portfolio Company Partnerships

Thomas C. Anderson, Mark G. Habner

• Publisher: Wiley
• Year: 2020
• ISBN:
  9781119635208
• Edition: 1
• Topic: Business
• Subtopic: Private Equity
• Index: Business

Establishing an effective partnership and achieving improved outcomes for investors and management teams during the hold cycle

Private equity represents a productive and fast-growing asset class—building businesses, creating jobs, and providing unlimited opportunity for investors and management teams alike, particularly if they know how to work together in candid and effective partnerships. Restructuring the Hold demonstrates how investors and managers can best work together to optimize company performance and the associated rewards and opportunities for everyone, not just the investors.

Through brief references to the parable of the Gramm Company, a middle market portfolio company, readers will follow the disappointments and triumphs of a management team experiencing their first hold period under private equity ownership, from the day they get purchased through the day they get sold. Restructuring the Hold provides the reader both general knowledge and more detailed better practices and frameworks relating to specific time periods during the hold. Within this book readers will find:

• An examination of a typical middle-market private equity hold period
• Guidance for newly acquired management teams on what to expect during the hold period
• Descriptions of better practice operating cadence between investors and management teams
• Examples of effective partnerships between investors and management teams
• Discussions of topics relevant to typical hold periods, including organizational structures, operations improvement, selling pipelines and acquisition integrations

With guidance from Restructuring the Hold, private equity principals and portfolio company executives can take steps toward greater collaboration and better outcomes. Through updated practices and strong relationships, they can partner effectively to improve portfolio company performance, which will lead to better outcomes for both investors and management teams.

Chapter 1
Private Equity

“…it's our land. We measured it and broke it up. We were born on it, and we got killed on it, died on it. Even if it's no good, it's still ours.

That's what makes it ours – being born on it, working it, dying on it.

That makes ownership, not a paper with numbers on it.”

– John Steinbeck, Grapes of Wrath

The Gramm Company (GrammCo) designs and manufactures heavy‐duty all‐terrain service vehicles (ASV) for rugged and remote deployments, primarily serving the North American pipeline, transmission, and forestry industries. Headquartered in Denver and employing around 300 people, the company retains a fabrication plant outside the city as well as service depots in Houston, Calgary, and Las Vegas. After 20 years founder Russ Gramm stepped back from the day‐to‐day, handing the reigns to Dianne Franklin three years ago.

Originally a mechanical engineer from Poly Tech, Dianne spent her formative professional years in Big Oil. An entrepreneur at heart who loves hiking and camping, it didn't take much for Russ to convince her to leave the fancy glass corporate buildings of downtown Houston to move to Colorado and serve as CEO of a middle‐market company with $165 million in revenues enjoying 15 percent net profit margins.

Patterson Lake Capital is a private equity firm based in Chicago specializing in middle‐market acquisitions. With $750 million currently invested across seven portfolio companies, Patterson Lake is particularly active in the industrial and business services space. Among its small but dedicated staff, Patterson Lake has an investing partner and an operating partner specifically associated with the GrammCo deal, each well‐respected and in the prime of their careers. They love what they do and do it well – finding valuable middle‐market companies and helping them grow.

Operating Partner Shed Cooper started as an engineer in the aerospace industry out west, and after working his way through b‐school he moved east and progressed through several successful executive roles in the automotive space, then served five years as CEO of a national distributor before transitioning to private equity. Shed has been at Patterson Lake for seven years now.

Olivia Charles Gleason – Ocie – has been with Patterson Lake for almost twice as long as Shed. Ocie joined the firm after cutting her teeth at a well‐known Wall Street I‐bank. Though she attended business school in Boston, she's become a committed Midwesterner and loves Chicago. Like Shed, she's married with kids and has figured out how to balance raising a family and traveling for work.

Throughout this book, we'll regularly check in with the happenings at GrammCo and Patterson Lake Capital as their worlds quickly come together. We'll watch as they form an authentic collaborative partnership and note the intentional steps they took to get there. We'll see them grow and optimize the enterprise value of the company despite the challenging headwinds facing private equity. Most importantly, we'll see how they navigate together the various ups and downs of the investment period, growing their own capacities and abilities and the company's bottom line in ways they never would have imagined.

The Asset Class

Although this book will not investigate the entire investment cycle and inner workings of private equity, it's helpful to start with a brief overview. A snapshot of the private equity asset class not only presents the opportunity to introduce and explain the terminology we'll be using but also provides a useful framework for understanding why this book's focus is on the operational side of the investment period.

Private equity is the idea of investing capital to acquire an ownership stake in an existing established business, with the expectation of realizing future profits when the company is sold to another party. Private equity is different from venture capital, which is a term most often used for capital applied to accelerate new startups or early‐stage businesses. By contrast, the term private equity has typically been used to indicate an ownership stake in more established organizations. It's worth noting these distinctions have blurred somewhat as both venture capital and private equity have become increasingly competitive and investors seek investment opportunities in both markets.

The Players in Private Equity

• Limited partners (LPs) are the individuals and institutions (e.g., pension funds, endowments, insurance companies, sovereign wealth entities, etc.) who provide investment equity. LPs are the investors in the fund, which is managed by a private equity group (PEG). In other words, they provide the capital that the private equity firms use to invest. LPs are typically not involved in the day‐to‐day activities of the general partner. They simply select the private equity firms and funds in which they want to invest, monitor performance remotely, and expect sufficient returns on their capital. For larger private equity firms, the limited partners are often large institutional investors, while for smaller firms, they might be high‐net‐worth individuals or family funds. Often, a private equity firm will raise their funds from dozens of limited partners, including both institutional and private money.
• Private equity group (PEG) is the catchall term we will use in this book to refer to the terms general partner, private equity firm, buyout firm, and private equity fund synonymously. While there are differences in definition and scope among these concepts such that the term PEG is not a perfect fit, those differences need not concern us here. What is consistent is that the PEG decides (within prearranged bounds) where to invest the limited partners' money. It does this by accumulating portfolio companies and monitoring and influencing those investments over time to optimize performance. The PEG decides when to sell or “exit” each company in its portfolio so that they can provide sufficient returns to the investors.
• Portfolio companies are purchased with LP equity and augmented with debt capital as determined by the PEG. Each portfolio company (or portco) in the PEG's portfolio represents an individual investment. The PEG monitors and manages each investment to optimize returns to the limited partners. The LPs may have investments in specific portfolio companies, in the broader portfolio of companies, or both. Either way, each company in the portfolio is critical to the performance of the entire fund. If fund performance is poor, meaning that one or more portcos underperform, the PEG will have a hard time attracting future capital from LPs, thereby risking the PEG's ability to continue investing and operating.
• Professional services firms such as accountants, attorneys, and consultants are employed to guide and support portfolio company performance improvement. Typically, it's the portco that retains the service providers, but the PEG will have a say in their selection and provide guidance and steering to those providers.
• Commercial banks provide the debt capital (the leverage on investment equity), enabling the PEG to invest in bigger opportunities and more of them. While the PEG will certainly play a big role in bank selection and relationships, each portfolio company will incur the debt on its balance sheet. Servicing that debt through high monthly interest payments is often a fresh hurdle for companies new to the private equity world. Throughout the hold period, the portco and PEG will work to pay down the debt, reducing monthly interest expense and also increasing the future net exit value when the company is later sold.

Participants in private equity and their roles are summarized in Figure 1.1.

Figure 1.1 Private Equity Participants

Private Equity Groups: Firms, Funds, and Process

There are many PEG variants in the private equity space. Many firms are small, having fewer than a dozen people focused on a single specific sector, but others are quite large with hundreds of employees investing across multiple sectors. Regardless of its size and focus, most PEGs typically have four core functions and organizes themselves accordingly:

• Fundraising. Responsible for investor relations (IR) and courting limited partners. The PEG raises a new fund every few years, during which time the IR team is particularly busy.
• Investing. Responsible for investment and exit decisions, as well as for structuring and securing sufficient equity and debt funding for each deal. The investing team typically has the most people in the PEG, ranging from new associates to partners with lengthy tenures.
• Operating. Responsible for operational oversight of the portfolio companies. The PEG's operating team is usually quite small, consisting of very experienced practitioners, typically former CEOs and executives or senior expert consultants.
• Administrating. Responsible for overall fund administration, accounting, and reporting on investment performance to the limited partners. Compliance requirements are certainly not insignificant, and fund administration is an important but behind‐the‐scenes player.

Risk and Return

The process of raising and operati...