Understanding alternatives

Active management in private equity

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Challenging market conditions create opportunities for those private equity managers which take a more active operational approach to portfolio company management and value creation. In the current climate, these strategies have the potential for higher investment returns says Lorna Robertson, Head of Funds.

Current macro-economic pressures, fuelled by geo-political uncertainty, are bearing down hard from all directions right now, squeezing balance sheets, putting trading under strain and throwing up obstacles to sustainable growth. The combination of rising interest rates, soaring inflation, supply chain disruption, labour shortages and increasing regulation across the board is potentially damaging to any business, but small and mid-sized enterprises (SMEs) most of all.

Currently, favourable bank lending terms to help ease the impact on stretched balance sheets are becoming increasingly hard to come by, especially from traditional capital providers and SMEs, by virtue of their size, are beneath the radar of the large-cap private equity buyout funds.

Against these headwinds, growth companies with strong fundamentals but short-term challenges, are likely to benefit from more than just capital alone if they are to get to their next stage of maturity. The welcome addition of practical, hands-on support from experienced and expert specialist ‘operational’ private equity managers can enable a company to make a transformational growth step which incumbent management had failed to achieve, or for a company to regain its mojo after a sustained period of suppressed performance.  

Very broadly, we can categorise the opportunities focused on by active private equity managers as either growth or turnaround and while the issues investee companies in either category are facing will be different, some of the solutions deployed are likely to be similar.

Investing for growth

Companies requiring growth equity are typically strong and dynamic businesses that are still maturing and are EBITDA-positive but are not yet sizeable enough for the big-ticket sizes of the traditional private equity fund managers. This is a role for specialist growth managers with the requisite skill set and global footprint to help to grow the business to its full potential.

They may be leaders in their field who need a leg-up to create scale through organic growth or the pursuit of an active acquisition strategy. Transformation and growth are typically achieved by a combination of factors, professionalising the management team, digitising their operations, honing their expansion strategy, or internationalisation, helping them to scale up and break into new markets.

Investing in turnarounds

Businesses needing turnaround support have significant – even existential - challenges to surmount. However, with the right support, advice and targeted actions they can be lifted onto a safe and sustainable pathway or be transformed from only being marginally profitable to being put firmly on an upward trajectory of success.

Such ‘sleeves rolled up’ approaches taken might range from strengthening the management team or repositioning the business, to restructuring the entire operation, or carving out and selling off unprofitable or non-core parts of the business.

What these issues and solutions have in common across both growth and turnaround investing is that they are both highly complex, specific and business-critical and the job of a dedicated, experienced investment professional. Therefore, the choice of fund manager is crucial. They need to have the experience and the toolkit to enable portfolio businesses to conquer difficulties or capitalise on their potential and come out on top.

Achieving these goals often requires pragmatic operational guidance and a proactive, involved approach from fund managers with operators embedded in the company on a regular basis, as well as a financial injection to make it happen. As a result, these managers often run with concentrated portfolios – this increases concentration and therefore risk but outsized, often rapid, returns are possible.

What are the ingredients for success?

In order to be consistently successful in this space, fund managers need to have a big enough footprint to be leaders in their particular segment of the market, while being small enough to have direct involvement with the people they work with.

They should have a long and demonstrable track record of delivering success across cycles, as this should stand them in good stead to weather current volatility and continue to perform highly, whatever lies ahead. A long-established network within their market will secure proprietary transactions sourced at attractive entry prices and they need to be able to build strong relationships with the teams they back as well as with their own investors: being seen as trusted responsible partners who can help businesses accomplish their aims and work together through challenging situations.

This is particularly important when it comes to investing in family-run businesses, which often have succession issues and require a delicate approach due to the overlapping professional and personal relationships which exist and where the business strategy/management could benefit from external rationalisation.

We believe in backing leading specialists in such strategies who have a deep understanding of the respective niches (if any) in which they operate, for example by sector (e.g. industrial) or by region.

Having this ‘edge’ is vital for sourcing the best investment opportunities and for delivering the best results, because these are not straightforward slam-dunk deals: they require managers who have the remedy for problems or the recipe for success.

Why are hands-on strategies attractive to private equity investors?

As investors increasingly look to diversify sources of risk and returns by including alternative investment asset classes like private equity in their portfolios, they are on the lookout for investments that will outperform public markets.

From an investor perspective, there is the potential for very attractive returns from investing in both growth and turnaround strategies. We see private equity buyout strategies target an average return multiple of 2.0x capital invested. For growth and turnaround, this increases to 2.5x-3.0x and beyond.

There is also plenty of demand from companies who are struggling with today’s uncertain and, in many sectors, challenging market dynamics. This means private equity firms can choose the best opportunities. There’s also less competition in the lower-mid market for deals, where opportunities like this tend to exist. There is also more room for a geographic focus with specialists in these strategies existing here in the UK and in Europe in the DACH or Southern Europe for example. These specialists operate in markets with less competition which means more attractive pricing than in, for example, areas of the large cap market where competition has forced prices up. Attractive pricing can support the potential for higher returns.

Investors may wish to select a range of private equity strategies, and managers, to diversify their exposure across the asset class. Accordingly, for our clients we have previously arranged access to a number of fundraisings with leading fund managers in this space, notably Opera Small Cap Value Fund I and Endless LLP’s Enact III fund. The Connection Capital Funds Team have more funds of this type in the pipeline.


Today’s challenging climate is tough on businesses and investors alike, and this current environment is likely to continue for some time. But for fund managers with the know-how and the willingness to tackle the issues head-on that are holding businesses back and take bold yet constructive decisions, there could be a silver lining here.

Many successful companies need support but are overlooked by the bigger private equity players, and investors are looking for good opportunities. In this relationship-driven part of the sector, fund managers who can marry the two, steering investee businesses through difficult conditions or finding that sweet spot for growth, should be well-placed to make a virtue out of necessity.

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