Private equity investors are sitting on a record $1.5 trillion in committed, unallocated funds—more than double the amount just five years ago. With increased competition for the same deals, these war chests will be more difficult to spend than ever, as finding attractive investments with acceptable returns becomes more burdensome. How can private equity firms effectively deploy and create shareholder value from this stockpile currently sitting on the sidelines?
One solution: outsource certain types of work to high-quality private equity consultants. Beyond the traditional consulting services provided to PE firms (e.g., transaction services), freelance finance consultants can enhance and expand a PE team’s firepower internally (through projects like deal screening) and externally (through projects like operations and management of portfolio companies). Many are surprised at how easily and quickly a senior-level freelance private equity consultant can plug into a project and hit the ground running.
The Private Equity Value Chain
We have found that freelance PE consultants are most useful for internal services such as deal origination and integration as well as external services geared toward portfolio companies such as restructuring, growth, M&A, and operations.
How exactly do private equity firms generate value for their shareholders? The first principle is that they must identify companies that are undervalued and buy them at an acceptable price. Furthermore, they need to be able to sell the company (or support it when going public) at a multiple of the original price. However, a lot of the real value is created in the intermediate period. Private equity funds work closely with their portfolio companies and their management teams to support growth, help reduce costs, and generally transform them.
The theory of comparative advantage teaches that it is best to focus on what you are good at and outsource what you are not as strong in. Diversity of skills means that cooperation is beneficial and that it is more efficient to focus on your strengths and hire others for tasks that fall outside your key competencies. In private equity, this could mean outsourcing operational support for portfolio companies while focusing internally on deal-making and structuring. We illustrate how consultants can add value in these situations.
Private Equity Value Chain
Augmenting the Internal PE Team with Deal Origination & Analysis Freelancers
Having a steady supply of attractive deals is the lifeblood of a successful fund and an essential skill for its partners. It is a time-consuming process that is either proprietary, carried out internally through professional and personal networks, research, and cold-calling, or through intermediaries such as investment banks and other advisors.
After a potential target has been identified, there is a first quick assessment of its viability as an investment. Only about one-fourth of all deals that are looked at by a fund make it to the next step: the investment committee. Reducing the time that the fund’s investment professionals spend on leads that are not relevant or not suitable has a clear advantage: It frees their time for other, higher-value activities.
The initial step in the screening process is normally quick and easy to standardize. It is only a check against the fund’s investment criteria and will most likely involve an analysis of the company’s financial performance, a brief screening of the sector the company operates in, and an evaluation of the main risks to the investment. The output will probably be a short document containing a “yes” or “no” answer.
This is an excellent opportunity to utilize external staff. The accuracy of the picks is important as the fund may otherwise miss important investment opportunities. An expert in private equity or in a relevant sector will likely be able to provide a succinct and accurate analysis, leaving time for the associates to focus on other work.
Private Equity Investment Funnel
As the potential investment target moves through the process, the analysis deepens (and thus takes more time). At this stage, before bringing the company to the investment committee, the report will focus on whether the acquisition target is a leader in its market, whether it has a comparative advantage, and if it is sustainable as well as on the macroeconomic and sector trends that could affect it during the holding period for the fund (typically, 5-10 years). Understanding these factors requires extensive research. This is another task that can be outsourced to a senior-level freelance private equity consultant.
Finally, before the investment can be completed, the private equity fund will need to have a clear view of the company’s value and what price it can offer. Thus, the fund will build a comprehensive valuation model, which will be a crucial input into any proposal to the investment committee. Leveraged buyout models are very complex and project each line of the target company’s balance sheet. An additional outside perspective from senior freelance finance modeling consultants, particularly for the “macro” component, can reassure and validate the assumptions used.
Providing Portfolio Companies with Top-tier Talent
Top-tier talent that can be plugged in as needed can help unlock value in portfolio companies during ownership. This is one of the areas in which freelancers can add the most value—they can marry financial projections with specific strategic goals. Freelance private equity consultants come with specific experience in the relevant industry, a high level of expertise, and a background in plugging into new companies quickly, thus providing portfolio companies the necessary support flexibly and effectively. The primary areas we’ve seen freelance finance consultants thrive within portfolio companies include management services (e.g., CFO, CEO), operational support, growth, restructuring, and M&A.
When the Management Team Needs to Change
Often, private equity funds will evaluate the management teams of the companies they have acquired and decide to replace some of the critical individuals strategically. Given the record amount of PE assets under management, funds are finding that their usual cadre of operators is already deployed in other projects. Yet, the process of finding the right professional can be long—on average, hiring a CEO or other C-suite executive can take four to eight months. Appointing a vetted, experienced interim professional can help the company stay on track during change, which could otherwise be disruptive to the operations (and thus costly). Fractional CFOs, for instance, are effective from very early on and can successfully guide a company through a transition period.
Operational Support and Management Consulting Services
Operational support can include optimization services such as digitization and pricing as well as initiatives focused on real estate, people, communications, metrics and reporting, data management, M&A, and IP monetization and protection.
While PE firms are highly adept at cutting costs and financial engineering, an often overlooked area can be the topline: pricing. A freelance private equity consultant with specific industry expertise will (1) evaluate current supply and demand to better understand current pricing “tone,” (2) determine the company’s product market strategy using market research tools like focus groups and conjoint analysis, and (3) perform transaction analysis to manage the exact price charged for each transaction.
While this side of the equation is often underappreciated or underinvested in, its impact on shareholder value cannot be understated. For a company with average economics, increasing volumes by 1% leads to a 3.3% increase in operating profit, assuming no decrease in price, according to a Harvard Business Review study. However, a 1% improvement in price, assuming no loss of volume, increases operating profit by 11.1%. Improvements in price typically have 3-4x the effect on profitability as a similar increase in volume.
While many of the services listed above can be performed ad hoc by freelance consultants, an investment in digitization of certain functions can lead to economies of scale and efficiencies that can create a competitive advantage in a highly competitive market. Changes in technology happen quickly, which can create uncertainty when planning a digitization path forward and sticking to it. Further, it can be difficult to achieve team buy-in. A seasoned digitization team can help choose the right technologies, guide the firm on what is worth digitizing, and build consensus among team members.
The increased returns to shareholders from digitization (when done right) are significant. Those that have most successfully digitized their business are 26% more profitable than the least digitized, according to a study in Leading Digital: Turning Technology into Business Transformation on 400 public companies.
While value creation doesn’t happen in the first couple of months, a growth expert with experience launching successful growth strategies can help a portfolio company cut through the noise and find a tailor-made solution without having to make the mistakes the consultant has seen in the past. There are some cautionary tales of investments that failed because of an excessive focus on financial engineering and cost-cutting and a lack of emphasis on growth: above all, the investment of 3G Capital Partners in Kraft Heinz. The stock lost nearly 25% in February 2019 after Kraft Heinz was forced to write down $15.4 billion on two of its most famous brands, Kraft and Oscar Mayer.
Early consultation can be important for growth efforts as industry experts can give a clear picture (even pre-acquisition) of how a company fits into a broader market and where the achievable opportunities lie.
Maximize Opportunities While Staying Flexible
In a recession, private equity funds need to be nimble, cost-effective, and focused on their comparative advantage. Their main focus should be on strategic and opportunistic acquisitions and on protecting their existing portfolio companies’ value. Hiring seasoned, experienced professionals to relieve their investment teams and support their investors is smart, particularly when it can be done flexibly.