PE Operating Pros Lead the Way

As private equity adapts to Covid-19, new research from McKinsey & Company illustrates how operating groups play a vital role in a downturn.

The COVID-19 crisis has caused epochal disruptions to social and economic systems, posing a threat to lives as well as livelihoods. For private equity firms, which often own businesses in multiple industries and geographies, there are complex decisions to be made, as they strive to safeguard employees, customers and their companies.

Over the last 2 weeks, McKinsey has interviewed 12 heads of portfolio company operating teams at both private equity firms and institutional investors across Asia, Europe, and North America. These firms range from midmarket specialists to global buyout giants. The picture that emerges is of an industry in rapid response via diverse strategies, varying partly by region.

In North America and Europe, a more common strategy has been to establish a crisis-response team to assess the risk each portfolio company faces. Many operating groups have adopted a “red–yellow–green” triage system to indicate the level of engagement and support each business will need. Acknowledging the primacy of cash in sustaining businesses, firms have also often requested 13- to 26-week cash forecasts from portfolio companies to better manage liquidity.

“A common theme in our interviews has been how communication between private equity firms and their portfolio companies is on the rise,” said Jason Phillips, a partner at McKinsey who led the interviews. “Monthly or quarterly check-ins have quickly shifted to weekly—even daily—ones. Firms want access to data fast, so they can respond to emerging issues as swiftly as possible.”

In Asia, macroeconomic forecasts proved relatively ineffective for decision-making, as initial forecasts were well behind the curve. As such, private equity operating teams have been drawn to more immediate, operational sources of data. Asian private equity executives told McKinsey that they quickly reassessed their mode of interaction with their portfolio companies, feeling that previously this had been unclearly defined.

“Operating teams are taking a comprehensive view of the evolving economic environment to help their firms make rapid yet well-informed decisions that can have a dramatic impact on how their portfolios emerge in the recovery—when it arrives,” added Mr. Phillips.

McKinsey also analyzed what strategies successful private equity firms embraced during the last economic downturn, searching for hints on what may drive value in this one. For this research, McKinsey analyzed 120 of the largest private equity firms, which included many with specialist teams focused on driving value creation in portfolio company operations, and many without such teams. McKinsey compared their investment returns and their fundraising from 2004 to 2018, looking at five-year periods before, including, and after the global financial crisis that started in 2008.

This research found that during the crisis years, firms with portfolio company value-creation teams meaningfully outpaced the others – achieving about 5 full percentage points more in annual IRR (23 percent) than firms without portfolio-operating groups (18 percent).

Private equity firms with value-creation teams also saw less disruption in fundraising during the crisis period. This fundraising advantage proved durable, as firms with value-creation teams saw fund size rise by 53 percent in the post-crisis years, while those without experienced 15 percent further declines in fund size.

“The lesson for general partners today is intuitive – private equity firms that have a portfolio value-creation team appear to outperform in tough times,” said Bryce Klempner, a partner at McKinsey and the lead author of the report. “The extent of this outperformance is striking, though, as well as the fact that we did not see similar outperformance in periods before and after the last crisis.”

For free access to McKinsey’s report on private equity operating groups click HERE and for access to how private equity performed during the last downturn click HERE.

McKinsey & Company was founded in 1926 and is a worldwide management consulting firm serving the private, public and social sectors. The firm is headquartered in New York City and has offices in 133 cities in 66 countries.

Private Equity Professional | April 21, 2020

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