Operating expertise has emerged as a key value creation lever for middle market private equity firms in recent years.
The field has broadened over the past decade, encompassing a range of roles from C-level operating executives to experts focused on a single value creation lever such as pricing or e-commerce.
An operationally focused approach to investing is well suited to the middle market, especially for firms with a deal sourcing strategy that focuses on distressed businesses or assisting with succession challenges. Many middle market businesses have capability gaps; there simply aren’t enough resources to build their suite of operating capabilities to the same level as a larger company. Often led by a founder with deep expertise in their core industry, they can struggle with a narrow perspective on the business. This is an area where a savvy private equity investor can accelerate value creation by serving as a sounding board for management, funding investment in required capabilities, and providing broader perspective on the firm’s environment.
A seasoned operating executive can also guide middle market leadership teams towards tapping into trusted and established solutions for common challenges, accelerating their growth. For example, there are many widely vetted and accepted options for building an e-commerce portal. Most businesses don’t need to fund creating custom software, especially for a market test. The same applies to manufacturing and service operations. Best practices can be quickly passed around the business, leveraging established industry insights. There is frequently little value in re-inventing these capabilities for a small business.
Lincolnshire Management’s Operating Talent Strategy
One firm which has made a heavy investment in recruiting and cultivating operational talent is Lincolnshire Management. Operational expertise has been a key part of the firm’s investing approach since the early 90’s: their current chief executive office, TJ Mahoney, spent his early years with the firm focused on driving value creation at their portfolio companies. Lincolnshire takes a generalist approach to middle market private equity investing, examining between 700 and 1000 deals per year across a wide range of industries.
Lincolnshire Management generally has between two and four operating professionals on their staff. These executives serve multiple purposes, ranging from assisting with deal assessment to serving as strategic advisors for their portfolio companies. Drawn from the ranks of former C-level executives, these leaders have the stature to serve as an effective sounding board for portfolio company CEO’s.
Lincolnshire’s president Michael Lyons commented on the critical role these operating executives play in transforming the firm’s relationship with their portfolio teams:
“A key challenge in building a constructive relationship with your portfolio companies is that you want to connect with the business beyond merely being a capital provider. This is where having experienced C-level operating talent on your team can pay dividends. They are able to have a peer-to-peer chat with a portfolio company’s leaders as a fellow executive and help open their eyes to new opportunities.”
This talent model also provides Lincolnshire with immediate bench strength in the event a portfolio company gets in trouble. As former C-level executives themselves, the operating professionals are able to immediately jump in and assume an interim management role, bridging the gap until a longer term CEO or COO can be recruited. The fact the operating executive is already a known quantity within the Lincolnshire team and familiar with the deal helps them rally support behind a troubled portfolio team: they’re uniquely positioned to champion appropriate values, improve transparency, and rebuild trust. These engagements can also provide a platform to accelerate change within the portfolio company.
Michael expounded on the latter, the need to connect effectively with the management team to help facilitate change within your portfolio companies:
“While our operating executives can serve as an interim manager, they are intended as change agents. We won’t buy a business unless a strong management team is in place. We never presume we know more about an industry than the people who have run that business for years. But we firmly believe that there is a happy medium where you’re providing portfolio company executives with perspective outside their core industry, sharing best practices and insights to spur new thinking. Our operating professionals have the credibility to help open people’s eyes, because they’ve experienced the highs and lows of actually running a business instead of buying one. That connection can be invaluable.”
Operating Talent as a Strategic Investment
Lincolnshire is highly selective in recruiting operating professionals. While the focus of the role may be on operational matters, they are full-fledged members of the Lincolnshire Management investing team. Operating professionals are frequently pulled into due diligence efforts, drawing on their expertise in a particular business. They are also engaged in post-acquisition value creation, tapping into their experience to guide the portfolio company’s team towards high value opportunities.
The firm hires senior level leaders with broad experience for these roles, often with a background in manufacturing and services. These are generalist roles, spanning multiple industries and value creation strategies. Lincolnshire supplements this with investments in specialized talent for channel and product specific initiatives, using consultants and traditional operating roles (portfolio companies) to engage niche experts. The challenge with hiring niche experts is the needs of the firm will evolve over time; this staffing model allows Lincolnshire to periodically refocus their broader team as their portfolio evolves.
The Payoff: Superior Value Creation
The Lincolnshire example offers an interesting case study on the impact of strong operational talent. Lincolnshire is a veteran firm, which has been in operation since 1986. Investing in operational expertise has been a key tenant of the firm since the early 90’s. Their results are a matter of public record.
So does it work? What do their performance statistics indicate about operational expertise?
In 2012 a business school professor (Oliver Gottschlag, HEC Paris) teamed up with Dow Jones to study the long term results of private equity firms, focusing on highly active firms (raised two funds, over $500 MM capital). The relevant private equity firms were ranked based on long term performance.
Lincolnshire Management ranked fifth in this survey – proof that this model delivers superior returns.
Lincolnshire Management: Investing in operational expertise
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