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The seven deadly sins of portfolio management

… continued from The role of operating partners in private equity-backed companies

Private equity firms’ core competency is doing deals, so their skill levels for the deal process are high. But their real understanding of, and strategy for, the businesses they acquire, is usually much weaker.” – Chairman, Electronics sector

Private equity directors vary widely in the way they interact with portfolio companies; some actions are helpful while others not. Respondents were very clear on the latter and from their experience gave advice on how to avoid common pitfalls.

The pitfalls of portfolio management

1. Fail to win hearts and minds of management; taking the attitude of “we own the business therefore you’ll do as we say.”

2. Overwhelm management with interference which is not helpful or constructive; especially when the business is performing on plan.

3. Lose focus after the deal is done as shown by missing board meetings or being distracted during meetings.

4. Manage by spreadsheet so focus only on historic numbers without understanding KPIs and what is really happening with the business.

5. Turn the deal over to a portfolio management department so that management has to try to establish a relationship with an executive new to the deal who may see it in a different light.

6. Be a frustrated CEO who thinks he or she can run the company but in fact has no relevant management experience.

7. Have an unclear internal decision-making process or lack support from senior colleagues so that management does not know who can speak for the firm.

According to Robert Ohrenstein, KPMG Global Head of Private Equity in the UK:

This research adds a different perspective to the debate over the ability of private equity firms to add value within their portfolio companies. With the challenging current economic circumstances likely to persist for some time, private equity is refining its model and some firms are already at the forefront of this evolution. Given the more difficult fund-raising environment, portfolio value creation will increasingly be seen by limited partners as a point of differentiation. Even firms with above average investment performance are being challenged to demonstrate how they will add value to their investments in the future.”

Investment professionals don’t always get it right

According to Ken Brotherston, Executive Chairman of Directorbank:

Although it would be easy to dismiss avoiding these pitfalls as ‘just common sense’, senior executive respondents remarked that investment professionals are not always getting the basics right. Some private equity firms may benefit from taking a critical look at themselves and asking how they can improve the way they interact with portfolio companies.”

Feedback from respondents:

They will charm the birds out of the trees to get the deals, but most have never worked in industry and so have no real experience of running a company.” – NED, Several sectors

Although private equity people I’ve worked with are extremely clever and analytical, their inter-personal skills are not as strong.” – Chairman/CEO,Technology sector

It is unhelpful when they ask for loads of data but don’t focus properly on where the business is going and how it’s going to get there.” – CFO, Business Services sector

As an NED I have had to try to find a solution for a private equity director who was constantly on his Blackberry during the board meeting. Management took a lot of trouble with preparing the board papers and they got really upset about this behaviour.” – NED, Logistics sector

They brought me in to drive change but failed to back me when I had to confront the CEO and majority shareholder.” – NED,Telecoms sector

The industry is adapting to the harsher economic environment and there appears to be a general recognition that generating value within the portfolio will increase in importance as a source of returns as leverage, arbitrage and ‘asset trading’ opportunities become less prevalent. As a result, we have seen some evidence of a shift in skill sets within firms; notably through in-sourcing operational and sector expertise. This has been the case for larger firms, and this trend is also being seen in the mid-market.

Download the full report: [download id=”3″].

David Okwara

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