A panel of GPs and advisers recently sat down with Real Deals to discuss how private equity goes about transforming the infrastructure portfolio companies require to support rapid expansion and growth, and what operational changes firms focus on in the drive to create value through to exit.

At the table:

Olof Faxander, Nordic Capital

Diego Prada, Metric Capital Partners

Selina Benavente, ADP

Katie Beck, August Equity

James Markham, Graphite Capital

Martin Calderbank, Agilitas Private Equity

Ben Hollowood, AnaCap Financial Partners

Tom Leader, Caledonia Private Capital

Michele Gray, ADP

Mark Turner, Livingbridge

Clive Austin, Mobeus Equity Partners

Andrew Hartley, Corsair Capital

Ben Slatter, Rutland Partners

Ian Wallis, MML Capital Partners

Moderator: Nicholas Neveling

How closely do financial sponsors diligence the systems and processes of target companies pre-deal and is there any concern on the private equity side when a portfolio company is using IT, finance and HR systems that are unfamiliar to the sponsor?

Katie Beck: The size of the businesses we invest in means that the systems and processes are fairly basic. If we are not familiar with a system, it is not typically something that is of particular concern, because over the course of our investment we are looking to improve business infrastructure and make changes.

From day one there will be a focus on the core financial processes and controls, but the main question for us is at what point we can start to make bigger changes. A lot of what we do has a buy-and-build element to it, so a business can triple in size within a year to 18 months. The aim is to map out that growth and have an awareness as to when changes to processes are required to support the business as it expands. If you make too much change on day one, without the people in place to support it, you can run into difficulties.

Clive Austin: Our approach at Mobeus will be very similar, although there will be certain instances where the focus on systems will be to the fore. One specific example is a business that we bought from ADP. It was a carve-out and the business was not a standalone entity at that point, so we did a lot of work to understand how reliant the company was on its parent for its infrastructure, and how the system separation exercise would work.

Aside from those particular situations, systems and processes will be something all firms look at, although it won’t always be at the top of the agenda. There is the recognition, however, that if you drive improvement to systems you gain efficiency, but you also make assets more saleable.

Ian Wallis: To be honest, the system part is quite marginal for us. We are not particularly concerned about what system people are using. The systems question only comes into focus if there is something else driving it. Is the management information timely and are the KPIs the right ones to drive the value of the asset? If that information is not coming through, that is what leads to a closer interrogation of systems and processes.

James Markham: Our engagement flexes to match the needs of the businesses we back. Some of the businesses we back will be well set up already, but there will be others where there hasn’t been the same focus on IT and business infrastructure. As Ian has already mentioned, the first indicator of whether investment in systems is required is the quality and timeliness of management information.

Ben Slatter: From our point of view systems are all about control of the business and reducing risk. It is about understanding how systems produce the right information. The business we back will often have a lot of data, and the systems they have in place will churn out huge amounts of information. But what the systems often won’t do is pull out the data that provides useful information to act on - information that can tell you which activities are unprofitable and which activities produce the margin. It is all about harnessing data to make useful change. 

Changing an ERP is a huge step, and there is often a lot you can do around existing systems, and that comes down to people and accountability.

There are of course situations where you will take that big step and rollout an ERP. I understand you are working through that process with a company now Ben?

Slatter: Yes, we have invested in a business that is turning over around £40m but is using processes and systems set up for company doing £15m. It has outgrown itself. It is still using green screen technology, so there is a good opportunity to add value by investing in a new system.

That said, we haven’t started out with the ERP. There were other things we needed to address first around procurement and supply chain, because if you don’t get those things right they can cause problems that cascade through the business. There is no point in putting an ERP system in place if the business isn’t on a stable footing.

Michele Gray: Which parts of the ERP will you implement first? Will you do it step by step, or will it be a big bang implementation?

Slatter: So we have already introduced a new warehousing system, and we have done a lot of work there that will feed into the ERP rollout. We are still working on the project and finalising the details of the rollout.

Mark Turner: I think the toughest thing is figuring out the timing of an intervention and deciding what you want to do and the order in which you want to do it. It all comes down to control, and it is up to each house to define what that means for their deals. If you don’t have that control you can mess things up in the early months. The first thing is to make sure that you have that core group at the centre of the business, and then augment that group as required. For us, and I imagine for many people at the table, one of the key people we will bring in will be a really good FD. Once the management team is where you want it to be, then you can start looking at things like systems and make change, but at a pace that doesn’t crash what is already in place.

Markham: Often we have to hold management back, slow things down and make sure that any plans to roll-out a new systems are worked through step-by-step. There is no point in putting the best system in place if the right people and the right culture are not already in place. When you have the buy-in from the management team, which is the single biggest risk factor facing any change, then you can bring in the expert to due diligence the existing systems, advise on options and project manage any changes.

I wanted to move on to discuss how the discussion so far relates to buy-and-build? Rapid buy-and-build has become an essential growth strategy in the private equity toolbox. When executing a build-up is it important to have cross-platform uniformity with respect to systems and processes?

Ben Hollowood: We recently sold Heidelpay, a German payments company with an ecommerce focus, to KKR. Our original investment thesis was based on organic growth through exposure to the growth in ecommerce in Germany and the shift from cash to card. The company was 100 per cent founder owned and had built a proprietary system, so we were also looking at the professionalisation of the systems and processes to make sure they worked.

Between signing and closing there was a six month wait as Heidelpay is a regulated business, and during that time we found a transformational deal that doubled the size of the business. From that point on we were following a dual-track investment strategy of organic growth and buy-and-build in parallel. That was a big shift in investment thesis.

The business plan was about capturing scale in the marketplace before exit. As a general rule you want to move a business onto a single unified platform to make sure processes are streamlined and that the data works. Heidelpay, however, was moving quickly to do deals because we didn’t want to miss opportunities. We did seven acquisitions over 18 months. The integration of companies can take longer than the rate of acquisitions when you are doing a build-up.

The key for us was to make sure the Heidelpay team could do the buy-and-build internally. On the first deal for Heidelpay our M&A team did the deal, but part of my role as the operating partner for the business was to build the internal teams the business needed to do bolt-ons. That started with the hire of a CFO and the team was built up from there.

The priorities were to make sure that the team on the ground was the best it could be with clarity around team responsibilities. We formed separate integration and M&A teams, with separate mandates and responsibilities.

Austin: How did it feel at the time to go through that? Seven acquisitions in 18 months is a very demanding programme.

Hollowood: It was exciting, challenging and stressful. The first acquisition was the largest, so the most demanding one came early. The other six were smaller, but we never did those in parallel and there was always a handoff from the person doing the deal to the person doing the integration. What you want to avoid is the same person signing off SPAs one day, working on an integration the next.

Wallis: Ben raised a very interesting point earlier. The ambition is always to move everything onto a common platform, but when there are deal opportunities out there to support a buy-and-build programme, I don’t think private equity firms are going to hold off buying because there is still integration work to be done. I look back at some of the buy-and-builds we have done, and we have ended up selling before we had a chance to do the integration.

Hollowood: That is a very fair point. You won’t find many situations where an opportunity is passed up because you haven’t integrated the last one. That said, there are situations where that integration is integral to the investment case. We backed a trust management company called First Names, for example, where there was a huge focus on creating an M&A infrastructure with all the teams and processes in place to target, buy and demonstrably deliver integration. That went to value on exit.

Olof, Nordic Capital has executed a number of very successful and extensive build-and-build strategies over the years. How do you approach it and how do you keep control of the programme and monitor integration when the pace of expansion is so fast?

Olof Faxander: We have done a lot of buy-and-build, and on each occasion the approach differs depending on the industry and the situation. Our investment in veterinary business Anicura, for example, involved more than 150 bolt-ons and the business grew fourfold through the hold period. Vets train and study for the same amount of time as medical doctors, but on average are paid less. They pursue their careers because they are passionate about working with animals. So this was a lighter touch integration and the focus was on giving these independent practitioners the flexibility to take time away from their practices without losing revenue while they aren’t working.

Our investment in care home Alloheim, however, follows a very different approach to bolt-ons. The business has a detailed model for how it runs care homes and it knows exactly what levels of staffing and purchasing costs it requires to run a care home. So if it is looking at a bolt-on target, it can rapidly map out how the target runs and what it needs to run within the Alloheim model in the future. It can thus reach a buying decision quickly and execute an integration into its model within as little as a month.

Tom Leader: That is very interesting. We had a care home business that was recently exited called Choice Care. It was providing care for learning disabilities and mental health. We could never get comfortable with the acquisition model. We found that sellers were very aware of the benefits that scale could bring to the buyer and priced their businesses accordingly.

So instead of buy-and-build we went down the organic route of building new facilities on greenfield sites. There was an exceptionally good return on capital, with lower risk because there wasn’t the risk of integration.

Martin, we have heard how complex an integration can be, and the risks of buy-and-build execution. Is that execution of integration the creator of value, or can a buy-and-build add value if there isn’t full integration at the time of exit? 

Martin Calderbank: The first thing I should say is that although most of our portfolio companies have made bolt-on acquisitions, I am something of a build-up sceptic.

In the future I think private equity firms should show that they are the best and most logical backer of a company. They will have to understand the sector and be able to support the specific transformations a company undertakes. Yet a lot of the logic of many build-ups is premised on financial engineering, and if a bolt-on is only done to arbitrage the gap in multiple between a larger asset and a smaller one then I don’t think you can say you are creating sustainable value.

The organic route should always be the first option and a bolt-on only makes sense if its offers a quicker route to value creation than what can be done organically. If a bolt-on is done only to expand a platform, with no real thought on integration, then it is unlikely to be a good bolt-on.

Leader: Acquisitions are tricky and all too often they underperform expectations. Going in with your eyes open is critical. When the investment thesis is built around finding cost synergies and moving a target onto an acquirer’s platform it is difficult. Full integration is painful, and we are suspicious of buying assets that have grown aggressively following a buy-and-build. It looks glossy but dig deeper and nothing is stitched together.

So, how do you differentiate between a bolt-on done for the right reasons and one that isn’t?

Calderbank: Let me put forward our investment in Recover Nordic, which has done more than 20 bolt-ons, as an example. This is a fire and flood damage control business, similar in some ways to a fire brigade. There is a natural consolidation around Recover as it is the market leader. The focus for the business’s clients is not price, but response time and quality of work. If you build up local scale, you drive up quality and lower response time. There is a clear benchmark to measure whether a bolt-on supports those two priorities. If not, then it is not worth doing.

And that comes back to the process of integration. If a bolt-on is organic, integration is more effective because the new asset can plug into systems relatively easily and will see benefit from the added value being part of a bigger group. When a bolt-on is done as part of a financial strategy, the pathway to integration is less clear.

Finally, on the question of support for management, it is easy for private equity to say it will identify and negotiate all the deals. But it doesn’t help management to just leave them to get on with the integration. That is the challenging bit and it is the integration that makes the whole larger than the sum of its parts.

Markham: Throwing a bunch of assets together is not value creating. But private equity feeds itself, and there is always a buyer out there. The level of integration is not always factored in by buyers when paying high multiples.

Andrew Hartley: This question of integration is particularly relevant for SMEs that are going through this journey and expanding rapidly via acquisition. They can find themselves living in a state of ambiguity and uncertainty. Does the management team have the capacity to deal with the change and can the sponsor afford to to put the resources in place at that particular time, because there is an impact on the bottom line. This is where operating partners can help companies, providing an external resource at a temporary cost that enables the company to build and develop from there.

Ultimately, companies going through a buy-and-build journey will be sold, with or without integration, and the question then is what next? If there is an integration then that can fall to the next firm up. We have seen this with our investment in an Italian insurance software company called RGI. It has grown quickly, now has €30m of Ebitda, and has built up an infrastructure that includes heads for technology, revenue and acquisitions, all specifically brought in to support the company’s expansion.

The fact is that private equity is a giant ecosystem, and there is the next firm up that will buy a platform and integrate it. Whatever level you are at in that ecosystem, your role is to deliver your part of the chain. Firms are not going to stop building up companies and working to grow market share. The integration, if it hasn’t happened, can be something for the next buyer to go for.

Diego Prada: That is how we have approached one investment in our portfolio. We have backed a Polish self-storage business that has been incredibly successful and we have observed how it does things, and how to do self storage wrong and right. It is a very clear, replicable business model. We acknowledge that we are not buy-and-build and integration experts, but we have supported an acquisition strategy across Europe, identifying targets and helping the business to execute the deals. The strategy is to share best practice across the group before selling the platform to the next buyer who will look at the integration. We see this as where we can add value, before passing the company on. It is about being realistic about what you can add, before handing over to a buyer who can do the pieces where we have less expertise.

Gray: A theme that keeps coming through in the conversation is how it is people who determine the success of a build-up or systems overhaul. How do you identify the people and skills to handle all the deals and transformation that will be thrown at them?

Faxander: It is a good question, and it comes down to the business you back in the first place. You want to identify the player in the market with the processes and ways of working that make the business scalable. 

You are also looking at the management team and planning how to supplement the team as the business grows in advance. It is very unlikely that the composition of a management team at the start of a build up will be the same as when the company is ten times bigger.

It is likely that through the journey you will need to add management capacity.

So how do firms think about integration through the hold period? Is there ambition to integrate and does that go to value? Or is integration for the next buyer?

Beck: What you want to avoid is building up a platform at pace, with no infrastructure to support the growth, and then hope you can sell it without anyone noticing. There will be windows where you can get away with it, but you do not want to miss the window and land up stuck just as everything starts to creak.

That doesn’t mean that a full integration will have to be complete at exit, but it is important to be proactive. We have a dental platform, for example, and we had the right team with the right skills to do the M&A and integration in place from day one. That team needs to be in place so that business can carry executing its strategy into the future without our involvement. That is the capability that we will be selling and that is what a buyer will be acquiring.

Hollowood: That point on the team is so important. It is less about whether acquisitions are or aren’t fully integrated and more about having the team in place within the business to do that.

Turner: For us we want full integration on exit. If you get to exit and all you are selling is acquired profits then you are going to get found out if you can’t grow that business organically.

If there is no clear growth proposition and you can’t explain why you are acquiring assets in addition to synergies then I don’t see that as an investment strategy in itself. 

As Ben and Katie have said, if acquisitions are part of the strategy then the resources to deliver on that have to sit within the company. We way help on the first one, but after that the company needs to be able to do deals independently.

Hartley: I am not convinced that the buy-and-builds have been found out. Many sponsors have done buy-and-build, have sold the assets, moved on and done very well. It is not an unsuccessful strategy.

Hollowood: I think there will come a point in the cycle where multiples will be discounted for platforms that are not fully integrated. Right now, however, the market is not differentiating between integrated and unintegrated.

Austin: It does depend on where you are investing and at what level. In our market we are backing businesses with some degree of customer and supplier concentration. There is a real case in these scenarios for diversification as it does at value. We do strive for full integration as a result of that, because integration is what achieves true diversification.

Wallis: I think there are layers of integration. We recently sold CH&Co, which had done four acquisitions. The exit opened up before we were able to complete the integration, but this was still a very strong business. Although it was still operating across different systems, there was a robust, cohesive management structure in place. We had a good CFO and the finance function that reported into the CFO and was producing timely, accurate information even though it was running different systems.

Would we love to have a common platform in place every time? Yes. Is the first thing to work on. No.

Michele and Selina, you will work across a number of deals with a number of sponsors on putting new systems and technology in place. Are there any mistakes or issues that consistently crop up, and have you formulated any views of best practice for implementation and integration projects?

Gray: When a company embarks on systems or people change it is important to understand what it is getting into and understand what will deliver the first benefit and the first opportunity to derisk. A company, for example, my decide that it wants to build a shared service centre, but that can be the worst thing to do if the company doesn’t have the platform to actually implement it. It may look good on paper, but the people piece is what is really crucial and where there is a trip up. You have to factor in things like resistance to change and how you will support people through the process. The people there at the beginning of a project may not be there at the end, and when new people step in to pick up a project they can come in with different ideas on how to make it work.

Another trip is change fatigue. A roll-out can take between 18 months and two years to complete. That is a long haul and sustaining the effort and interest is not easy.

You can do the logistics and cash flows and all the theoretical stuff, but when it comes to making it happen there has to be willingness within the business to make it happen.

Selina Benavente: The number one item is always the buy in of the executive team. It has to come from the top down, because when you implement a new system it is disruptive and people do have to change the way they work. The leadership has to be there to show that the initial disruption will make things easier for everyone in the long run.

We can add the most value when we can really get into the nitty gritty of portfolio companies and how they operate. What systems do they have and if they are about to embark on a buy-and-build are the systems in place to support that? How do you set up in a new country, for example, when you are unfamiliar with regulation and business culture? Do you have the infrastructure to deliver that? Do you have visibility across the whole business as it grows?

The closer you look at the details, the more value you can add. You can find profit leaks in time systems used by manufacturers, for example. It really does come down to keeping an eye on the details and working with a leadership team to keep everything on track.