Issue 3 - November 2010
In - And Out Of - Control
Private equity funds are becoming more engaged with their portfolio companies. But there’s a fine line between fostering and stifling.
Faced with a sluggish economy that puts pressure on profits and hinders early sales to buyers or public markets, private equity firms often have to keep companies in their portfolios longer than they would ordinarily prefer. But what should happen during these extended holding periods to increase the value of a company? How much assistance can a firm provide without undermining the company’s ultimate independence? And what can a firm do during a prolonged period of ownership to reassure a company’s key audiences — from management and rank-and-file employees to customers and investors — that their efforts continue to strengthen the portfolio company over time?
Taking a less hands-on approach may have been a less risky proposition when the economy was booming and portfolio holdings could be resold quickly and profitably. But these days, most companies are struggling to rebound from the recession, and if a PE fund is not responsive to the needs of a company
on a real-time basis, its future value will be negatively impacted.
At the other extreme, some private equity firms react to hard times by immediately replacing management, slashing costs and assuming complete control of the business. But that, too, brings risks, including damaging employee morale, lowering productivity and slowing the timetable for getting the company in shape to be sold. Rather than being able to exit within four to seven years, the private equity owner might have to stay invested considerably longer, waiting for the new managers to establish the kind of track record that could attract buyers willing to pay a premium price.
Often the approach is to split the difference, not only keeping most or all of current management but also bringing in temporary outside help that can speed the rehabilitation of the company. The idea isn’t to dictate changes but rather to aid in analyzing problems and developing solutions that the managers will embrace. If the ideal balance is struck, the company’s management team will emerge with a record for succeeding despite adverse conditions, and the private equity firm may be able to take its leave on profitable terms — and to build a reputation for turning around troubled businesses, which can help it attract the next round of investors.
Particular success can be achieved when the PE fund and its specialist teams are brought in to work with management to improve particular areas of a company, providing expertise on human resources, information technology, merger integration or underperforming departments.
For example, Wynnchurch Capital, a private equity fund in Rosemont, Ill., recently accomplished a textbook transition, improving a portfolio company by providing management with targeted specialized assistance and developing a framework to drive improvement across the entire organization. In 2007, Wynnchurch acquired two struggling automotive rubber seal manufacturers, GDX Automotive and Metzeler Automotive North America, with the plan to merge the two operations into a newly formed company, Henniges Automotive. The potential efficiencies were substantial, but so were the challenges of combining the two businesses. Wynnchurch had to establish a new management organization, install new management processes and frameworks, dramatically improve operating efficiencies and quality, and replace two incompatible information systems that affected a range of essential functions — from accounting and purchasing to sales and customer relations.
A major attraction of GDX was its strong customer base and product mix, but prior to the acquisition the company suffered from poor quality, inefficient manufacturing and significant operating losses. In some cases as much as 20% of the parts rolling off the production line were flawed and had to be scrapped, and the productivity of certain operations was half of industry averages. Management had to rebuild customer confidence in the business while also completing the integration of the two companies. Since the merger, Henniges has not missed a single launch date and has dramatically improved quality and efficiency. As a result the company has re-established itself as a preeminent global supplier.
Many of GDX’s quality control and efficiency problems, says Wynnchurch partner Terry Theodore, stemmed from old-fashioned organizational structures and work practices. Management had not engaged the workforce to help solve performance issues and instead relied upon an archaic system of management-labor relationships. Changing that system was a priority, and Wynnchurch used the acquisition of GDX and its merger with Metzeler to engage the workforce, including the unions, to solve performance issues. The employees on the plant floor knew what the problems were, and so management provided them with the information, training and authority to solve issues quickly. The labor unions provided a highly constructive conduit to engage the workforce in a dialogue regarding required changes. In exchange for agreeing not to cut wages or health care benefits, the company was able to establish flexible work rules that allowed Henniges to dramatically improve quality, delivery times and efficiencies. One example of these changes involved a union practice known as bumping. Whenever a job opened up, union rules dictated that the employee with the most seniority could take the position. This encouraged workers to shift jobs whenever they wanted a change of routine, which meant that most employees didn’t stay in one place long enough to develop the expertise to optimize performance.