As the coronavirus crisis continues to rage across the globe, private equity investors are being forced to think more carefully about managing their existing portfolios amid a volatile dealmaking market. AltAssets spoke to Eaton Partners’ Peter Martenson about the proactive portfolio management and the tools available to GPs.
What’s your best advice for GPs?
My best advice for GPs is to be proactive in their approach to portfolio management.
For simplicity, there is the single-asset recapitalization. It’s not uncommon for fund managers to have a single asset in their portfolio that they want to keep around for another three to five years, with the expectation that it will have a high growth rate. We expect to see more of single-asset recaps as it lets the GPs manage that company further into the future and extract more value.
For the GPs who may be even more aggressive, there is the multi-asset recapitalization. This is where the GP has multiple portfolio companies in either one fund, or multiple funds, that they would like to hold onto for another three to five years. The GP rolls those assets into a new special purpose vehicle while giving current LPs the option to stay in and roll forward or get their capital out. Many times these companies not only have great organic growth rate, but have potential for M&A, so there’s usually an opportunity to put more investment dollars into it the companies.
Beyond single and multi-asset recaps, the GP can also leverage high quality companies by inserting a preferred instrument into the recapitalization that provides the ability for GPs to get capital back early to their LPs on a high-quality portfolio and increase the return profile of that portfolio.
The final interesting thing we’re seeing GPs do with these special purpose vehicles is roll them into longer-dated funds. In many cases there are some very high-quality companies that have good growth rates, low volatility and a strong return profile. We’re seeing some GPs roll those into vehicles that can last more than ten years. It is not quite evergreen, but they look like permanent capital vehicles that they can then utilise for a recap or build a restructuring around.
Are there any portfolio management tools that GPs should be implementing?
I think the single and multi-asset recap will be the most relevant portfolio management tools for GPs. When these recaps are combined with longer dated fund terms, they are best suited for a broad swath of general partners, which is good for limited partners too. You often hear LPs say they want to hold on to good assets for longer, so that’s what they want their GPs to do, if possible. However, GPs do need to put portfolio companies into a vehicle that can extend beyond the classic five-year investment period and 10-year hold type of vehicles that are currently in play. By combining longer term permanent capital vehicles with interim liquidity provision via a programmatic recapitalizion provision, it is a win-win for both GP and for LPs.
When is the best time to implement and use proactive portfolio management by GPs?
The key is early and often. We’re encouraging people to do what the forward-leaning GPs are already doing—start early and to think about it often. We’re seeing this happen, and sometimes it is even as early as the three-to-five year point in the life of a fund and/or portfolio company. GPs who are proactive utilize these tools to provide liquidity before their next fundraise.
In many cases, after the five-year point of an investment period, the high quality companies that are growing typically need more investment capital to grow, typically due to much larger M&A requirements or due to bringing on additional accretive companies.
GPs can also be proactive in their legal documents by addressing terms regarding portfolio management. This gives a heads up to LPs that this GP is thinking forward about portfolio management and planning ahead in an appropriate manner.
What are the benefits GPs get from being more proactive with their portfolios?
First, LPs really appreciate proactive portfolio management, and GPs get the accretive benefit in the additional interaction with their LPs, especially now that it’s an even more competitive environment for relationships and investment dollars from LPs. While it’s not always as measurable, we’ve certainly heard LPs say, “I like that GP because he’s thinking about his portfolio and acting on it.”
Secondly, it allows a GP to do what the stock market tells you to do. If you have a company that’s doing well, hold on to it for a long time. It allows the GP to hold on to a high performing company and provide internal liquidity, while pushing a winner forward. It also allows GPs to have another bite of the proverbial apple in carry and management fee, which is something that is a positive.
How should proactive portfolio management be viewed in context of the broader “operational value add” that fund managers provide to their portfolio and underlying portfolio companies?
My view is that proactive portfolio management by GPs is the next step in the process of GPs adding operation value to their investments. Whenever LPs look at GPs now, they’re always asking the question of what operational value add did the GP provide to portfolio companies that were purchased in the past funds. GPs will typically say they brought in operating partners from industry or similar things. Our view is that this proactive management at the portfolio company investment level is the next area for GPs to focus on, and quite frankly I think LPs and groups like the ILPA will actively encourage GPs to focus on it, because at the moment portfolios are kind of languishing. GPs are very good at sourcing transactions, underwriting them, closing on them, financing them, and then adding that intense operational value for the first 18 to 36 months. After that it’s like the company is on its own. The GP has built out a portfolio of 10 to 12 portfolio companies, but then let them run while they move on to the next fundraise. We’re seeing the pool of assets isn’t being quite as managed in the last one as it should be. So our view is GPs need to take it upon themselves to really think about this type of portfolio management of what companies are performing well and should they utilize a single or multi-asset recap as a portfolio management tool.
This is an area where GPs will really focus on next because you can squeeze out stronger IRRs and total value multiples. It also provides more interaction with LPs and dialogue, therefore giving a good investor relationship venue as a GP. They can talk with their LPs and show them how they’re maximising value at this point in between fundraisers. I wouldn’t say it is the last bastion of focus, but it certainly is an untapped area of value creation for GPs and LPs that I think will be a focus for the next five to ten years.
With competition as tough as ever, do you think that using these different tools can set a GP apart from other players in the market?
Absolutely. You’re extracting a higher IRR and multiple out of these portfolio companies and by default, you will look better as a GP to LPs. It also allows those market forward-leading GPs to have more substantial dialogue with LPs and show how they’re really maximising that value. We’re seeing the truly forward leaning and aggressive GPs are the ones who are really quietly doing this and as it becomes a bit more out there, more GPs will recognise how you can really continue to maximise value.
Who are the GPs that best embody the pursuit and implementation of proactive portfolio management?
It’s usually the GPs who are most in touch with LPs and listening to them. They’re in dialogue and hear them saying, “Tell me about your assets that look really good. I’d like to hold that for a longer time.” Additionally, the GPs have good performing portfolio companies that they are comfortable rolling forward into a single or multi-asset recap, and putting preferred underneath the portfolio and/or putting the portfolio companies into these longer dated funds.
GPs who might not be as savvy regarding proactive portfolio management view the portfolio management dialogue as an adversarial relationship with LPs, when really it really should be viewed as a cooperative, accretive relationship opportunity.
Is there anything you would like to add on this topic of portfolio management tools?
I think we hit it already, but I’ll just reiterate it. The biggest message I would just say is that for smart, forward leaning, aggressive and high performing GPs, this is really something for them to embrace, because it’s only upside. There’s no downside here that we’re aware of really and LPs love it. You get to interact with LPs more, you get a higher return on your portfolio companies and a higher performance fee. So, I would encourage high performing GPs and those that aspire to be high performing GPs, to really think about it, embrace it, call us or another service provider and figure out how to do this. Eventually, someone at a GP might have this role of active portfolio management of companies in the next five to ten years, because the biggest thing we’re seeing is people just don’t really know what to do once they buy these companies and have them running well.
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