The Covid-19 pandemic prompted a sharp refocusing of priorities for American businesses. The growth-focused objectives that many management teams presented to their board last year aren’t realistic for many industries given recent events. They have been eclipsed by larger objectives: maintaining solvency, keeping employees safe, managing disrupted supply chains, and defending key customer relationships.
This challenge is broader for private equity investors. In addition to protecting their own employees, many private equity firms also were called upon to help their portfolio companies navigate the crisis. Health risks and supply chain disruption prompted a variety of requests, ranging from providing expert advice on employee and workplace safety to managing the rapid virtualization of entire workforces. Many leading private equity firms were able to support these needs at a strategic level, recruiting top experts on these issues and connecting them with middle-market companies with small internal teams.
This operational support was in addition to financial support since some portfolio companies faced outright financial distress due to abrupt shifts in demand. For example, many service businesses and tourism businesses saw a 90% decline in weekly sales at the nadir of the shutdown. The support of their investors, both financial and advisory, provided a crucial lifeline for corporate survival.
So how do leading private equity firms to approach this challenge in practice?
Be Prepared
One lesson from successful private equity teams during the crisis: it pays to be prepared.
For Lincolnshire Management, a middle-market private equity firm in New York City, the crisis served to reinforce the strengths of its operating approach.
“Private equity investing requires you to plan for and anticipate the unknown,” commented Michael Lyons, Lincolnshire’s president. “You need to factor this into your operating approach. That gives you the flexibility to respond when the situation evolves.”
While you cannot predict a global pandemic, there are steps a well-run business can take to ensure flexibility and solvency. It starts with having a solid strategy: clearly define your operating priorities, identify the required roles and values, and invest the time to align the organization around this vision. There should be a long term value creation plan for the company in place, which ultimately aligns with your goals for the deal. These will serve as a compass in times of crisis.
Moving upwards in the process, this same level of operating discipline can be applied at the fund level. How much you pay for acquisition – and the terms under which you finance it – dictates how much flexibility you have during a crisis. Great investors protect the liquidity of their portfolio companies.
“When the outbreak began, we said, ‘Let’s assume the worst-case scenario, and then make sure we have ample liquidity to get through that.’” Michael commented, “That also ensured that we remained free to pursue opportunities as they arose.”
Protecting liquidity is a team sport. Lincolnshire’s management team strives to ensure their portfolio companies have strong financial reporting processes for cash forecasting, backlogs, and credit quality. These can give you advance warning of major shifts in demand or liquidity issues, providing the management team with an opportunity to respond.
Build Strong Operating Relationships
Lincolnshire Management prizes strong operating teams. Their investment approach is as much about selecting and cultivating the right management teams as it is about picking a high potential business. They’re looking for managers who know how to set priorities, create an effective plan, and stick with it.
Lincolnshire managing director Thomas Callahan shared some perspective on this:
“While we may evaluate at deals from a wide variety of sources, one of the reasons why Lincolnshire invests heavily indirect sourcing deals is because we value having the time to really get to know the firm’s management team. The quality of management can really make or break an opportunity.”
Building on this concept, Michael Lyons pointed to the role of Lincolnshire’s team of operating professionals. Lincolnshire routinely has between two and four operating professionals on the firm’s staff. The goal of this team is to elevate the relationship with their portfolio companies beyond being a provider of capital and the host of a quarterly meeting, serving as Lincolnshire’s ambassadors and change agents.
“We won’t buy a business unless strong management is in place.” Michael commented, “In fact, we’re frequently partnering with them because they’ve worked in that industry for years. We do, however, position our operating advisors to serve as change agents, hiring people with the operating credibility to share new ideas and open people’s eyes to possibilities.”
Never Let a Crisis Go To Waste
Plans give you focus. Relationships give you opportunities. But getting actual adoption requires buy-in. Use this crisis as an opportunity to rally your team and partners around doing the right things.
Many middle-market businesses struggle with policy and process governance, the legacy of their early years as small companies forced to tolerate high levels of employee discretion. During the early years, this could have even facilitated growth: less bureaucracy, faster decisions, happier customers. In the absence of guidance, channel partners and brokers will build programs to their goals instead of yours.
One great example of this is the pricing discipline. As Lincolnshire principal Will Wetzel noted in his article in Industry Week, undisciplined reseller discounting and promotions can whipsaw your supply chain. These aggressive prices can distort your view of demand, prompting your team to make the wrong products at the wrong time. This hurts customer service, working capital utilization, and manufacturing efficiency.
Worse, these behaviors can start to define your role within the marketplace: as a company who will agree to anything and accommodate any request, regardless of its alignment with an actual strategy.
The crisis can provide an opportunity to bring internal and external stakeholders together, explain the cost of not collaborating, and guide the team down a new path. Since the outcome of these changes often addresses a key concern, such as customer service or access to products, the crisis can provide a powerful incentive for people to support the new policies.
Using the Pressure to Reinforce Progress
In a certain sense, none of these three points are new requests of the broader organization. A well run private equity firm should have goals for the portfolio companies, good relationships with management, and effective change leadership strategies. The crisis serves to sharpen the focus.
For well run private equity funds such as Lincolnshire, this provides an opportunity to shine.