New McKinsey research has shown private equity operating groups are playing a vital role in responding to the challenges created by Covid-19.Operating groups are employed by private equity firms to provide strategic direction and support to portfolio companies.
For PE firms, which often own businesses in multiple industries and geographies, the pandemic has meant there are complex decisions to be made, as they strive to safeguard employees, customers, and their companies.
Over April, McKinsey interviewed 12 heads of portfolio company operating groups at leading private equity firms and institutional investors across Asia, Europe, and North America. The picture that emerges is of an industry in rapid response via diverse strategies, varying partly by region.
In Asia, macroeconomic forecasts proved relatively ineffective for decision-making, as initial forecasts were well behind the curve. As such, operating teams have been drawn to more immediate, operational sources of data. Asian private equity executives told McKinsey that they quickly reassessed their mode of interaction with their portfolio companies, feeling that previously this had been unclearly defined.
In North America and Europe, a more common strategy has been to establish a crisis-response team to assess the risk each portfolio company faces. Many operating groups have adopted a ‘red–yellow–green’ triage system to indicate the level of engagement and support each business will need. Acknowledging the primacy of cash in sustaining businesses, firms have also often requested 13 to 26-week cash forecasts from portfolio companies to better manage liquidity.
Jason Phillips, partner at McKinsey, who led the interviews, says: “A common theme in our interviews has been how communication between private equity firms and their portfolio companies is on the rise. Monthly or quarterly check-ins have quickly shifted to weekly — even daily — ones. Firms want access to data fast, so they can respond to emerging issues as swiftly as possible.”
“Operating teams are taking a comprehensive view of the evolving economic environment to help their firms make rapid yet well-informed decisions that can have a dramatic impact on how their portfolios emerge in the recovery — when it arrives.”
New research by McKinsey has also shone a spotlight on the vital role operating groups can have in a downturn. The project focused on how the industry confronted the last economic downturn, searching for hints on what may drive value in this one.
The research found that during the crisis years, firms with portfolio company value-creation teams meaningfully outpaced the others – achieving about 5 full percentage points more in annual internal rate of return (23 per cent) than firms without portfolio-operating groups (18 per cent).
Firms with value-creation teams also saw less disruption in fundraising in the crisis period. This fundraising advantage proved durable, as firms with value-creation teams saw fund size rise by 53 per cent in the post-crisis years, while those without experienced 15 per cent further declines in fund size.
Bryce Klempner, partner at McKinsey and lead author of the report, comments: “The lesson for GPs today is intuitive—PE firms that have a portfolio value-creation team appear to outperform in tough times. The extent of this outperformance is striking, though, as well as the fact that we did not see similar outperformance in periods before and after the last crisis.”
