What are the needs of investors when hiring support for Growth Companies/M&A work?

Mike Hicks, Catalysis Ltd.

22^nd October 2021

There are too few quality suppliers with an interest in the provision of management support to Private Equity during buyout and M&A work, argued Mike Hicks in a presentation of Private Equity and the need for support services which deliver real value.  However, there is increasing pressure on investors and chief execs who are becoming increasingly aware of the importance of this support.   Private Equity has the resources to bring a professional approach to transformation but it needs more advocacy from suppliers to bring about radical change: the real competitors are currently investors who try to navigate the complexities of transforming businesses without support.

Following a career in Eastern Europe at EBRD and then at Creditanstalt, Mike Hicks left to take a Doctorate, funded by helping friends raise money from and sell businesses to Private Equity.  After a spell as head of management assessment at Grant Thornton, he created Catalysis 11 years ago, working on strategy, team and organisation issues with top teams and investors.

What is Private Equity?

• It is a route to raise funding as an alternative to debt financing.
• In 2000 there were 100 PE companies whereas now there are about 500, and these are the higher profile ones that we are aware of
• The level of activity in 2021 is double that of 2018
• 20% of UK market capitalisation is now owned by PE.
• Most PE work is focused on early stage and growth companies which are far more receptive to the structure of PE financing than corporates.

Private Equity tends not to operate as integrated entities.  The reality is that Private Equity operates as a collection of Individuals who can be working with a PE house but this is not reflected in conversations which are individual.

Catalysis networks, observes and scouts for opportunities, and is then engaged by appropriate senior PE people when negotiations start.  Senior people have portfolio roles and some PE organisations have value creation teams, which includes assessment work and talent sourcing staff some of whom tend to be ex-headhunters and related commercial people.

There is a difference between PE organisations: some simply like to do deals and others prefer to additionally get involved in the operational side.

By 2021 activity in PE investment had doubled from 2018.  This has led to frenetic activity, leading to shortages of professional support services, e.g. accountants, with the skills necessary to undertake this work.  In 2021 Catalysis has worked on 90 projects.

Compared to the 1990s it is harder now to make money in PE.  A feature of the current environment is that debt easier to raise, to the extent that backing management teams coming out of the corporate world has made it possible to make huge returns on investments.

Background to Private Equity

The 1990s was dominated by leverage, economic growth, multiple arbitrage, backing corporate MBOs.  In 2021 the emphasis is more on improving business models, honing strategy, building teams and organisations, backing entrepreneurial scale ups, but it is harder for services to make money.

Why are there opportunities?

Catalysis conducted an evaluation of organisations in which it has been involved and, following analysis by questionnaire, net scores of 25% or less indicate that businesses are underperforming.    It is estimated that management teams in areas covered are operating at below ideal levels of effectiveness in 29 of the 76 areas analysed.  These can cover areas such as

• Top team
• Strategy execution
• Organisational Framework
• Organisational effectiveness
• Scalability
• People Management

Investors used to work more by themselves.  In the 90s, they were more entrepreneurial.  Now they tend to be better qualified but have narrower experience, having gone through the route of corporate finance and into investment.  The result has been a decrease in competence in dealing with messy human issues.  Investors for the most part don’t have the expertise in running businesses, so one of the most gratifying reasons for working in this area is that management teams and investors recognise that they are underperforming in some areas and are grateful for the external support which firms like Catalysis can offer.

A big structural trend with the need to improve approach. Practice has evolved over the last 15 years but is still far from fully developed.  Mike undertook some research in mid 2000s on the state of mid market Private Equity looking at

Starting conditions/Due Diligence: levers of change and value.  Strategic factors, human factors

Levers of change and value.  Strategic levers, human levers

The conclusion of this research (see detailed slide) was that human expertise was lagging significantly behind strategic, and that post deal levers of “change and value” were less developed than at Starting Conditions.  This reinforced the evidence of the opportunities to add value to these deals.

Competition for involvement is more intense.  Prices are also higher.  Businesses are entrepreneurial, but they are still lacking in structures and processes.  Not only is there a need to build proper strategies, but there is also an imperative to improve processes in the more subjective area of managing talent and getting people in place in these dynamic and fast moving environments.   There is a need for structural improvements in process and we need to get better at it.

In contrast to the financial and legal sectors, where businesses prefer to have at least two or three advisors, there is a lot of loyalty in the PE sector: in 16 years of involvement as an advisor, there has not yet been a need to pitch for work.  PE tends to remain with one or two advisors unless serious problems arise.   Once relationships are established, they tend to become quite productive.

The world of HR support in PE and buyout sectors is much smaller than one might expect.  While the big buyout support area is dominated by large organisations such as YSC, the mid-market has a number of players, with catalysis as one of the major operators with 10 staff.

Why is there a credibility gap between investors and managing people and why can this be so tricky to manage?

At the back of this problem is the question of recognition of the issue and the matter of “ownership”, which can largely be determined by the mix of senior directors and their collective attitude.  Board investors have the ear of the Chairman, CEO and Finance Director, but the “value creating” operating partners can be two or even three layers removed from the investors.   Two things need to be addressed:

• Who is really the client?
• Is there a trend towards homogeneity, or is one party all powerful?

What is the client perceiving as the value, and is there a proper understanding of where the value is being created and delivered? For example, psychometrics can provide some kind of HR solution for some decision makers, but they fail to understand the need for professional interpretation and application.  To others, it is the “magic” part of the due diligence process which is some kind of “Voodoo”, without recognising its scientific basis.  In short, it therefore becomes the “expendable” part of the budget which can be easily sidelined and substituted by, e.g. establishment of Sales structures.   There are practical problems which make the sale of management support services a challenge:

• Both under and over-estimating the effectiveness of people interventions are both signs of a lack of familiarity on the part of the PE partner
• Fear of confrontation and lack of wording can make management work hard to sell. Investors may understand the benefits but there is a fear that psychological services support will risk driving a wedge between members of senior teams
• Chronic busy-ness of deal work can lead to forgetfulness
• Even 20 years in, the habit of paying properly for this kind of work is patchy
• Consequently, the main “competition” is not to use any external management help and just muddle through

The problems on the supplier side can be just as challenging:

• “Methodological inflexibility” can alienate clients and lower expectations.  For example, a client may ask for what seems to be a reasonable request but for the psychologist may be outside his professional area but not his competence.
• Outputs are less measurable and more difficult to align with company criteria, despite psychology being a science
• Psychology is riddled with interesting components but these aren’t always presented in the form of useful solutions.
• A low base line in terms of value means fee rates are low compared to other more financially measurable service providers

In conclusion, a key thread through the work is managing change in rapidly evolving environments, and translating strategic priorities into actions producing successful outcomes.  There are opportunities for business psychologists: the challenge is identifying the problem and what can reasonably be achieved, communicating the concept of value in terms of the different elements of the service, and navigating the dynamic of the personal relationships between members of the senior team.

Mike Hicks is happy to continue this conversation with interested ABP members and suggests that members get in contact.  mike@catalysis-advisory.com  07779 619088