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Guide for Executives in Working with Private Equity


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For many executives, the opportunity to work in a private equity backed company requires a mindset shift.

Understanding of both the unique management challenges and heightened expectations that come with managing a private equity backed company are crucial to success.

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Guide for Executives in Working with Private Equity

  1. 1. 1 Abraxas Group Guide for Executives in Working with Private Equity February 6, 2017 David Johnson Interim Executive Restructuring and Turnaround Advisor
  2. 2. “We have no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow.” ‒ Lord Palmerston Abraxas Group 2
  3. 3. Overview • For executives new to the experience, the transition to working with a private equity (“PE”) owned company can be a jarring, but very rewarding one, especially for those looking for a challenge. • Too many executives make the leap to a private equity backed company without first gaining a full understanding of the differences in mindset, pace, and structure that come with private equity ownership. • Taking the time to understand the manner in which private equity investors assess opportunities and measure success is crucial for building a positive working relationship. Abraxas Group 3
  4. 4. Investing Model Abraxas Group 4 Source: Wikimedia Commons • PE firms will typically look to have a hold time of 3 – 7 years • Some firms will remain invested in a portfolio company for 10 years or more • Hold times will vary by firm and situation
  5. 5. Classical Fund Structure Abraxas Group 5 Source: Wikimedia Commons PE firms traditionally have raised investment funds, usually with a 10-year duration. The senior private equity professionals are the General Partners (GPs) of the fund, making investment decisions. The Limited Partners (LPs) are generally endowments, pension funds, family offices, sovereign wealth funds, and other institutional capital sources.
  6. 6. Family Offices • Wealthy family or group of families seeking PE-like returns • Patient Capital, allowing for longer hold times • Often more tightly focused by industry or geography Search Funds Fundless Sponsors • Small group with backing seeking a single investment • Highly focused search, generally due to areas of expertise • Group making the investment to serve as executive team • Entrepreneurial professionals with no formal backing • Seeking to leverage existing relationships to source a deal • Financing arranged after a target is located Emerging Models Abraxas Group 6 As the asset class matures, a number of new models are gaining prominence in the private equity landscape. Each of these represents some divergence from the classical PE fund structure, while retaining the focus on value creation in a compressed timeframe.
  7. 7. • From its early manifestations in the 1960s, through a formalization in the 70s and 80s, private equity has sought to optimize the capital structures of portfolio companies with more debt than would be common outside of a PE context. • The implications of this approach can be profound for executives, as the capacity to generate outsized equity returns is increased, while the risk of bankruptcy also increases. • Navigating the demands and limitations of a more highly levered capital structure is one challenge that executives new to a private equity environment often under-estimate. The Role of Debt Abraxas Group 7
  8. 8. Financial • Efficient use of debt to fund growth • Opportunistic add-on acquisitions • Opportunistic leveraged recapitalization(s) Governance Operational • High-energy, engaged board of directors • Rigorous strategic review and guidance • Quick to act in cases of underperformance • Driving revenue and profit growth • Fostering organic growth and integrating acquisitions • Driving margin improvements through operating leverage KeyValue Drivers Abraxas Group 8
  9. 9. Hypothetical Deal Structure Abraxas Group 9 Amounts in $ millions Purchase Exit Notes Revenue $ 250.0 $ 393.6 Assume 5 year hold time at a CAGR of 9.5% EBITDA 30.0 59.0 EBITDA Margin 12.0% 15.0% Assume 300bps increase in EBITDA margin Multiple 8.0x 12.0x Multiple expansion due to increased size and scale Enterprise Value 240.0 708.4 Less: Net Debt (165.0) (354.2) Increased debt to fund add-on acquisitions ($100MM) and dividend recap ($89.2MM) Equity Value 75.0 354.2
  10. 10. Hypothetical Deal Structure (Cont.) Abraxas Group 10 Amounts in $ millions Year 0 1 2 3 4 5 Total (Investment)/Return (75.0) - - 89.2 - 354.2 368.4 Internal Rate of Return 49.1% Cash on Cash Return 4.9x • Internal Rate of Return (IRR): A metric for measuring the profitability of projects. IRR is the discount rate that makes the Net Present Value of the cash flows of a project equal to zero. • Cash on Cash Return: Total Cash Returns / Total Cash Investment Source: Investopedia
  11. 11. Common Covenants Abraxas Group 11 Covenant Leverage Fixed Charge Coverage Capital Expenditures Formula Debt / EBITDA [EBIT + Fixed Charges (before tax] / Fixed Charge (before tax) + Interest Maximum allowable capital expenditure # Common Measures Varies, Commonly 3 – 5.0x senior, 6 – 7.0x total 1.15 (minimum) Varies Notes Generally a senior and junior component Key solvency ratio Generally focused on unfinanced capex • Debt covenants, which set the requirements a borrower agrees to as a condition of borrowing, require constant attention at many private equity backed companies, especially those that have recently experienced challenges. • Anticipating any failure in covenant compliance (“default”) in advance is crucial for managing lender relationships.
  12. 12. • Challenged to drive growth while being extremely capital efficient. • Increased focus on metrics. Demands by Functional Area 12 Abraxas Group LLC Operations Finance Sales • Heavy demand for complex forecasting and reporting. • Need to assess ROI prospects of various initiatives. • Focus on pipeline tracking. • Demand for data-driven growth initiatives, and aggressive targets.
  13. 13. Successful Executives • Leaders able to inspire, delegate, and drive performance • Accountable • High energy, action oriented • Data-driven • Forthcoming regarding challenges and setbacks Unsuccessful Executives • Focus on management, not leadership (unable to inspire a team to action) • Uncomfortable with accountability • Wait and see approach, slow to act • Management by rule of thumb • Unwilling to acknowledge challenges and setbacks Abraxas Group 13 Characteristics of Successful Executives Executives who are successful in a private equity backed company are those who posses, and are quick to emphasize, certain key characteristics
  14. 14. • Executives looking to make the jump to a PE-owned company should assess not only the company, but the PE firm. • Take the time to understand the PE firm’s investment thesis, timeline, and general philosophy. • A successful partnership between a PE firm and an executive team can yield incredible results, but there must be alignment. Choosing a Private Equity Partner Abraxas Group 14
  15. 15. 1) Emerging Structures. The structure of private equity is changing, as the variations on the classical private equity fund model proliferate. 2) Leverage. A more heavily leveraged capital structure is very common in private equity backed companies, with a number of implications that executives should take the time to understand. 3) Active Ownership. Private Equity ownership is generally marked by heavy demands on all areas of a business, though the value creation potential of the private equity model remains compelling. Key Takeaways Abraxas Group 15
  16. 16. • David Johnson is a career change agent who has served as interim manager or financial advisor for dozens of middle market companies. • David has served as advisor or interim executive to numerous private equity backed companies, and has guided those clients through acquisitions, financings, restructurings (in and out of court), and various value creation initiatives. David Johnson Abraxas Group 16 Email: Ph: 312-505-7238 Twitter: @TurnaroundDavid