This Q&A originally appeared in PitchBook's Q2 2022 US PE Breakdown.
On average West Monroe supports more than 600 private equity transactions every year, performing buyside operational, technology, and market diligence. This experience, combined with our multidisciplinary approach which looks at each situation through the lenses of industry, operational, and technology expertise helps dealmakers plan for and manage the complexities of mergers, acquisitions, and divestitures.
Keith is a partner in West Monroe’s Mergers & Acquisitions practice, leading the firm’s carve-out and merger integration offering. Under his guidance, clients see an average of 30% reduction in timeline and cost for their divestitures. Keith has led teams on more than 300 private equity and corporate carve-out transactions, and he uses that knowledge to quickly identify issues and opportunities, estimate standalone costs, and negotiate favorable TSAs—resulting in millions of dollars in value creation.
Brad is a partner in West Monroe’s Mergers & Acquisitions practice, leading the firm’s extensive capabilities in post-merger integration. Brad specializes in highly complex deals involving multiple buyers, rapid add-on investments, hostile takeovers, multi-company mergers, and carveouts-to-integrations. A trusted advisor to many private equity firms and strategic buyers, he has led more than 500 M&A transactions in the last decade.
Brad Haller: As the outlook darkens for the remainder of the year, private equity firms have been taking a more conservative approach. They’ll spend more time working with their portfolio companies to make sure they’re as recession ready as possible versus devoting most of their time to identifying new investment opportunities. We aren’t seeing companies going into layoff mode yet—aside from some very high-growth tech companies that haven’t reached sustainable profitability. But overall, the priority is on the businesses where they’ve already put capital to work.
Keith Campbell: Deal-making is starting to slow for the summer, but our clients are divided on whether that will pick back up in the fall given the recession outlook. Good assets are not likely to go to market if valuations are depressed, IPOs are on ice, and the historically high-growth tech sector sees headwinds.
Brad Haller: We are seeing capital markets evolving rapidly. Lenders are also being more conservative about what businesses they’re willing to fund and those companies’ equity-to-debt ratios.
Keith Campbell: Operating partners have been spending a lot of time on labor challenges. That includes replacing portfolio company management teams, either in founder transitions or in recruitment for the next phase of growth. Private equity firms are also looking at building technology and other back-office capabilities in-house, or leveraging outsourcing, either offshore or nearshore. There are some creative strategies where private equity clients are considering forming offshore arms to provide services that their portfolio companies can tap into.
Brad Haller: Private equity firms have been raising bigger funds, and they’re having to scale their own teams so they can work across these broader portfolios.
We’re also seeing the evolution of portfolio operations teams at larger funds. They are closer to consulting organizations that work across the portfolio on both strategic priorities as well as at times tactical needs, as opposed to traditional operating partners who spend most of their time coaching executive teams.
Keith Campbell: Some private equity clients are building small, in-house analytics teams that support due diligence, to gain an edge in the bid by identifying trends. Once they buy the company, that data can drive value for the firm. The concept of a digital operating partner is now becoming more and more prevalent.
Brad Haller: As operating teams scale up, they generally prefer advisors that can bring more breadth of expertise and offer multiple capabilities. Instead of looking for best of breed, operating partners are searching for the Swiss Army knives of the advisor landscape. For example, West Monroe can provide due diligence work and then improve a portfolio company’s data capabilities or revenue operations. As our clients spend more time doing triage on their portfolios to guard against potential recession impacts, data will assume even greater importance. Their portfolios are larger, and the ability to ingest and analyze data in an efficient way across 30 or 50 companies can you give greater confidence around the health of those businesses.
Brad Haller: A lot of demand is chasing limited supply, creating a very competitive process.
Some of this is a holdover from COVID-19. While business travel has resumed, most diligence is still happening via Zoom and in virtual data rooms. That works to sellers’ advantage because they can meet with more parties. Some clients are having all their advisors work together to solve a joint mandate, which can lead to greater focus and productivity within a tight timeframe.
Further out, new technology is being built to allow private equity professionals to do their jobs more efficiently using tools like optical character recognition (OCR) to review documents for keywords. It's digitizing elements of the diligence process so they can focus on the questions necessary for them move forward in the deal.
Keith Campbell: Things that historically would have happened during normal diligence windows are now occurring even before companies are up for sale. Private equity firms are deciding what areas of the market they want to invest in, closing in on the winning companies and building relationships with management teams. So, when those companies come up for sale, firms know the business, and can just focus on key questions instead of starting from scratch.
Some deal aspects are shifting into post-close. Things you can fix about a company—replacing management, operational improvements – areas that PE firms have proven they can execute post-close and don’t really impact valuation.
Keith Campbell: There has been a push to use publicly available data because dealmakers’ access is constrained. That includes data on jobs, labor spend, looking at employee sentiment or purchase data. You could show up at a meeting with the HR leader at the target company, and already understand key metrics such as attrition and sentiment from sources such as via LinkedIn.
For cyber due diligence, we can scan the dark web, and tell companies whether they have critical infrastructure up for sale that they don't know about. With access to a retail business’s internal data, we can use machine learning to identify opportunities for revenue growth, reallocating marketing span, and customer lifetime value —key metrics that help us figure out how we can drive company growth or profitability.
Keith Campbell: The private equity industry is catching up on digitization. Startups and software companies are helping private equity firms turn their playbook into a collaboration tool with real-time (as opposed to quarterly) access to portfolio company data and key performance indicators (KPIs). That helps deal teams track progress on value creation initiatives and equity value goals, and drives collaboration on initiatives to help portfolio companies achieve those KPIs.
This transition comes as valuations and multiples climb. Private equity firms need to underwrite EBITDA improvements through portfolio value creation to justify paying these kinds of premiums.
Software platforms, such as Mosaic.pe, are also digitizing the leveraged buyout (LBO) model to reduce the effort and improve the modeling process, and more importantly understand why investments are successful. You can quickly model how changing an assumption would impact enterprise value. Over time, you can introduce machine learning as you gather a greater sample size and better data.
Brad Haller: Many of these trends are based on a healthy economy and competitive private markets—whether it’s doing more with less on due diligence or businesses working hard to drive value for a return because of a high cost of acquisition. If the economic situation devolves rapidly, dealmakers’ attention would have to shift from future investments to existing investments. That would affect the transaction market.
As the clouds gather, one thing that’s not being discussed is whether the move by some tech companies to cut their way to profitability is shortsighted. By slashing labor expenses, those companies could be missing out on a chance to retain or grow revenue—for example, by using customer success teams to upsell additional services or using support teams to retain existing customers by providing better training on tools or improving the user experience.
Keith Campbell: Private equity firms know how to finance and lead companies in times of distress, but I think they will jump at the opportunity to get some steals (i.e. companies in bankruptcy and non-core assets). If a recession happens, public companies will have to prune their assets and divest for cash. Who do they divest to? Private equity.