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Why good financial management matters to PE | 27 July 2010
Great article in the FT this Sunday by Tony Jackson on some analysis of private equity returns. This is the good bit: "One study he cites unpicked the returns on 110 completed deals in the UK and Europe between 1995 and 2005. The average internal rate of return was 39 per cent, of which debt accounted for 22 per cent and a rising stock market 9 per cent. That left just 8 per cent as the contribution of the private equity managers."
It goes on: "Considering that Mr Morris puts the average annual fees in private equity at 8 per cent – some put it higher – this is thought-provoking. It means, in effect, that the pension funds which provide the bulk of the money would have been as well off investing in the market directly and borrowing the leverage from the bank." At a time when fundraisings are under pressure and the PE model is in danger of over-regulation, firms are going to be looking hard at deals where there is a strong "management" component and where growth contributes a higher level of the overall return. (Of course, this kind of analysis usually focuses in on the big LBOs - in the mid-market, leverage has never played such a major role...) Growth and development means having financial management in situ that goes beyond box-ticking, solid reporting and cost control. Great news if you're a forward thinking, value-adding FC or FD, then.
Some weekend reading | 23 July 2010
Every week, I gather lots of interesting snippets about financial management, private equity and entrepreneurialism from around the web. So what's news this week?
Let's start with the Carbon Reduction Commitment. I recently did an article on the FDs of PE firms, and this is a biggie for them. As far as the Environment Agency is concerned, PE funds are conglomerates, so every "subsidiary" (i.e. portfolio business) stands to get caught by the new rules on September 30th. Worth boning up on carbon credits if you're going for a job... especially since CO2 is now the CFO's responsibility, apparently.
Then I'm recommending the Wall Street Journal PE blog. For example, this entry has a link to a PBS report on the PE takeover (and subsequent bankruptcy) of Readers' Digest. If you're getting involved with PE for the first time - don't panic. It's an extreme example. But the WSJ (and other) PE blogs are good at explaining sentiment for the industry.
Third up, more video - this time coverage of a recent Grant Thornton survey that has positive news for the UK where the firm predicts "billions" will be invested over the next 12 months. Deal churn is good - especially for FCs and FDs looking to get into a new position. And the year is looking better for MBOs in the UK, too. So keep 'em peeled...
Looking for something a bit more technical? How about a scholarly paper on why buy-outs are leveraged? This PDF download posits a model for the capital structure in MBOs and might be worth a read if you plan on getting down and dirty on the technicalities with your bakers.
Finally, stat of the week, courtesy of Reuters: "Private equity-backed M&A in the second quarter was up 125% from a year earlier to $40bn, and up by a third from the first quarter. For 2010 [H1], it totaled $70bn, more than double a year earlier." BUT... "The $70bn of PE-backed deals this year through June 22 compares with the record $542bn in the first half of 2007."
The equity gap: don't call it a comeback | 21 July 2010
Remember the equity gap? In more buoyant times, it was the chief malaise for companies seeking PE backing. Too small to get a nice big slug of debt and equity from the serious PE players, too big to be viable on the backing of early-stage funders and angels. What to do?
Well, it's back. I was chatting to a lawyer specialising in VC deals this week, and he says it's worse than ever. The problem is that less debt is ratcheting up the risk for equity providers - and a sluggish economy means that they know they need a watertight business case if they're to get the confidence they need to take the plunge and buy a company still in development. It's a contributory factor to the Dearth of Deals™ - and to the slow recovery.
One way to address the central problem - perceived risk for equity providers - is to show the business is clearly out of start-up phase and has the chops to move forward decisively. And that means hiring a decent finance exec.
For many business suffering from the equity gap, that might not be a fully-fledged, six-figure FD. But at the least, they need a decent controller to nail the cash-flow and related processes and put in place working budgeting and forecasting systems. And they need FD-like advice - from a part-time or interim FD, or perhaps a finance-minded non-exec.
Claiming you can't afford "back office" talent in a growth phase is false economy - and that applies whether you're an entrepreneur or an early-stage investor wondering whether you'll ever exit...
Piles of cash seek finance brains | 14 July 2010
Every finance director knows the value of cash. But there something odd going on the business world right now. There's lots of it about - and no-one knows what to do with it. So what does that mean for PE-backed finance executives?
My data is largely from the US. OK, most of you are looking at UK opportunities - but I think the lessons still hold. For example, this chart shows the amount of liquid assets held by US corporates (and I know from anecdotal evidence that the picture is similar over here):
That's a lot of cash without a home. The picture gets worse: private equity funds around the world have been wrestling with "overhang" (funds committed by investors or "LPs", limited partners) for some time. The best recent estimate of PE's undeployed cash? Check out this PwC article on the subject. It says: "The current private equity overhang at nearly $850 billion (three and a half times the overhang in 2000) represents 54% of all capital commitments made between 2004 and 2009. Over 85% of the $850 billion is in funds larger than $1 billion, including 48% in funds larger than $5 billion, according to Cambridge Associates."
Result? LPs are reluctant to commit new cash, and while the big LBO players aren't that fussed - that unspent pile of cash is the bigger concern - the mid-market and VC end of the scene is taking a hit. Witness the recent drop in US VC fund allocations.
So what does this all mean for you? First, brush up your capital allocation skills. Investors (and corporates - although the fact you're here suggests you'd rather not work for a plc!) need to deploy money. But they're petrified that they won't make a return on it. That's a pretty damning indictment of the economy when interest rates are so low. And I think it means there aren't enough creative finance execs with good communication skills out there, standing up the business case for investments. Great entrepreneurs and marketing people are one thing; but without a proper investment appraisal, properly communicated, that cash is going to remain dormant.
Second, pick your markets. PE firms - particular in the mid-market and at the VC level, but across the board now that financial engineering is a dead duck - need growth right now to turn a penny. And with the economy flirting with a double dip, that means plumping for companies that have a compelling case whatever the climate. In short, some sectors are more resilient than others. Choose wisely.
(By the way, here's a link to a rather goo, rather long article on PE at the moment - worth a read if you have a few minutes spare.)
PE watch: will summer sizzle or burn out? | 12 July 2010
Finance execs looking for PE-backed opportunities need to keep a weather eye on the private equity world. But after two years of mixed messages, are we any clearer about whether the industry is recovering? And what might that mean for opportunities?
Well, the bad news is that messages from both sides of the Atlantic - and in both the large buy-out houses and the (more interesting) mid-tier firms - continue to confuse. So on the one hand, we have some mega-deals in the secondary buy-out market in the US; on the other, fundraising continues to fall there, especially for the mega-funds. (That might have something to do with the fact that investors around the world are starting to ask tough questions about PE returns...)
What about this side of the pond - and what about those mid-tier players whose deal-flow creates openings for smart finance execs? The news is, again, mixed. At the bottom end - where many of you might reasonably spy exciting start-up and development opportunities working with creative entrepreneurs - VC funding is approaching record lows. A NESTA report says fewer funds are raising less capital for smaller early-stage investments. The one glimmer of hope for FDs and FCs is that VCs are taking a longer view of investments - giving you more time to get it right.
The good news? I'm still hearing lots of PE players talking about a flight to quality. Sure, they're nervous about overpaying for businesses - especially when competitive auctions result in very rapid and sometimes hasty due diligence. But if the business looks good and shows opportunities for strong organic growth (i.e. generating more cash without needing a ton of debt to do aquisitions), they want to buy.
That's doubly good for you because it means PE firms looking to sell - and boy, do some of these funds need to churn investments - need both great financial management in place and the kind of broad finance functions skills that will help them dress a business for sale. Time, perhaps, to brush off those financial reporting and investor relations skills.
Global PE: mixed blessings, but hope for new deals | 7 June 2010
The global private equity (PE) industry seems to be coming out of hibernation, according to a number of recent reports. That's not to say if you're looking for a PE-backing position you shouldn't remain realistic - about terms, business plans and finances. But there is definitely good news around if you know where to look.
Take this article on fund raising. LPs (limited partners are the people who commit money to PE funds) are back on the trail for investment opportunities in PE - and although they still have "concerns about capital overhang [that] may keep the flow of new money to modest levels," there's clearly a view that there are returns to be made in new deals. The pressure is on GPs (general partners, who manage the investments) to prove they've got a use for the cash.
Meanwhile, emerging markets PE is doing really well. In India, for example, Ernst & Young is reporting conditions set fair for a boom in deals. And Iraq is also an unlikely source of joy for PE investors. (Compare and contrast Spain, where the picture is less rosy.)
It's worth adding that as well as tickles for new deals and new funds, the industry is re-shaping in other ways. We blogged last week about Barclays selling its PE arm - now HSBC is flogging its own PE divisions (and, like Barclays, it's letting management have the businesses for next to no money... read into that what you will). And, if you're looking for a much more obviously troubled example, Dubai International Capital looks like it might fold.
All change then - keep your eyes peeled and make sure you know what your backers are going through before you commit.
Social media - first steps | 4 June 2010
Do you tweet? Are you on LinkedIn? How about blogs - which ones do you read (apart from this one)? I ask partly because an interim FD I know has recently started using twitter - you can find him at twitter.com/PHooperKeeley.
This got me thinking about how finance execs can use social media, partly to stay in touch with their industries and their colleagues - and partly to project themselves into the "interwebs". For an interim like Paul, that's probably more important than for FCs and FDs looking for, on working in, perm positions. But it's still an interesting way to be connected to a wider community.
The "staying in touch" part is important, too. It's well worth setting up Google News Alerts for topics that are relevant to your business - and to businesses you'd like to be in. And why not set one up to feed through coverage of "private equity" or "MBO" to your inbox each day or weekly? It's a great way of staying informed so that when opportunities do arise, you've got plenty of background knowledge to throw into the conversation.
I'll do a link list in a few days of sites that I find useful for staying on top of the PE scene. In the meantime, check out Mashable's advice for VCs on using social media.
Physician - heal thyself! | 3 June 2010
The private equity industry continues to focus on good portfolio management, the profitability of fund investee companies and growth. But it's interesting to note any shifts in the industry ahead of a potential upswing in deal activity. Which leads us to a very interesting MBO announcement.
It seems Barclays Private Equity is buying itself out from its parent bank. Naturally, this is in part due to a new conservatism in banking (although Barclays was far from being the worst-hit in the financial crisis in 2008). But it also hints at a readiness to get daling again. Reuters reports sources claiming: "Barclays PE will target between 1.5 billion and 2 billion euros for its first independent fund." That's its first new money since a fund launched in 2007 and suggests there's going to be some acquisitions towards the end of the year.
It also suggests the guys at Barclays PE will have a new-found understanding of the pressures of being an MBO team. We'll see (and if anyone does an MBO with them after their own buyout in the summer, let us know how it goes!).
Management churn: an opportunity | 13 April 2010
We've been talking recently on the blog about banks incentivising PE firms - and PE firms incentivising management - to keep going despite bad results, iffy debt scheduling and missed targets. But after chatting to an interim FD mate yesterday, it looks like the downturn has had another effect on management teams: bloody-mindedness.
Ed specialises in turnarounds, so he's used to turning up, identifying problems and coming up with a "like it or lump it" fix. (He used to joke that his first job on an assignment is to find a desk in credit control - it's amazing how much better things can look once those guys have been hitting the phones all day for two weeks.) In better times, he tells me, you'd often get a situation where the incumbent management would bristle at the proposed changes and walk out - usually to a job with another company "across the street".
For Ed, that was often a problem solved. Those were usually the guys who'd caused the business to run onto the rocks and bringing in fresh blood can be crucial to fixing the strategy, the culture and the day-to-day running of the company.
Now? Not so much. Thanks to lack of management churn - and a shortage of growing businesses - management teams are clinging onto their posts for grim death. That means more fights in the boardroom, more diplomacy and psychology ("the first step to recovery is admitting you have a problem") - and more hassle.
The good news if you're looking for a PE-backed finance job? The banks are still calling the shots on many deals and they want a solid finance function to work with. And as Ed's busy schedule attests, interim FDs and smart financial controllers are much in demand to fix basically sound companies that have lost their grip on the financials. Just make sure you're ready to handle the fifth columnists in the board room...
PE firms pay it forward | 8 April 2010
All the talk of PE-backed businesses facing a debt roll-over problem thanks to reduced liquidity in the leveraged loans market has been a little overblown. True, it's not just the $500bn owed on big LBOs that falls due between now and 2015 (that's just in Europe). Reuters quotes Jon Moulton as saying £30bn pounds of debt in small and medium-sized British companies needs to be repaid in the next three years. That's nothing to be sniffed at.
But I watched an interesting snippet (podcast? vodcast?) from Standard & Poor's earlier this year pointing out that although the banks are wary of making new big loans to PE-backed businesses - largely thanks to a more conservative approach to their own balance sheets, but also because of THE RISK! - other sources of finance are coming in. A variety of investment funds need yield, and higher-risk LBO loans can deliver.
Better yet, said the S&P guy, many lenders are cutting PE-backed firms some slack in the interim. What choice to they have? Sure, in really bad cases they can grab the equity, but that rarely ends well. So all sorts of mezz-type finance and coupon roll-overs get layered in and everyone hopes for the best. (Good news for finance functions, politically at least. You can get a lot of status for carrying that much water...)
PE firms are also paying that (rather forced) good-will forward bt being nice to entrepreneurs and their teams. I noticed this entry at a Wall St blog on the subject of VC-backed management scoring their bonuses even if things have gone a bit "off plan":
I thought it was pretty funny how VCs have to handle entrepreneurs with kid gloves these days, if for no other reason than if you won't another VC will. That probably speaks volumes to the fact that there are too many venture capitalists chasing too few deals these days. But I was more struck by the expectations of the entrepreneurs than I was by how the VC's deal with them today.
Interesting. In short, if you're in a good team with a business that has obvious potential, perhaps the rewards (bonus, equity etc) will come even if you've been troubled by the recession.