2011 Managing Portfolio Investments Survey

8/6/2019 2011 Managing Portfolio Investments Survey

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Managing PortolioInvestments Survey

Maximizing value inan evolving market

Experience the power o being understood.

SM

2011


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Foreword 3

Executive summary 5

Survey ndings 7

Focus is power 7

Costly surprises to consider beore striking a deal 10

Holding and growing 13

Optimizing your exit 16

Contributors 21

Table o contents


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This report summarizes telephone interviews with 75 managing

directors, principals and vice presidents who lead private equity

groups investing in the middle-market.

As the domestic market continues to emerge rom the recession,

many o the responses reect past-year deals made in a

less-than-optimal environmentone in which high-quality

companies open to private equity acquisition continued to sit on

the sidelines, waiting or the economic tide to turn in order to be

rewarded with a better price.

Now in an improving economy, prospective buyers are swarming

quality sellers. Private equity groups have capital that is ready ordeployment and are exploring exit strategies or their portolio

companies. For many, the investment horizon or generating

avorable returns is narrowing. For owners o niche-leading

companies, whether private equity-owned or rst-time sellers,

there is now a window o opportunity or a liquidity event at

attractive valuations. McGladrey proessionals expect to see

more activity and major deals in the coming year.

This report was issued in June 2011, in an environment where

middle-market deal activity began to stabilize. While deal

volumes last quarter were down, dollar volumes were up, even

in a mixed environment as some sectors continued to improve

their health.

It is a highly competitive environment or private equity rms,

as quality sellers with a good business model, high sustainable

margins and a strong backlog are commanding interest rom

many suitors. In this environment, it is essential or those

looking to proceed cautiously out o the recession to have strong

relationships when it comes to the deal-making process and

sourcing channels.

Along with commentary rom our private equity specialists,the report that ollows explores trends in private equity

specialization, costly surprises to weigh pre-deal, the rise o due

diligence, evolving hold-and-grow strategies, and actors to

consider in optimizing an exit.

We hope these ndings will help you evaluate your business

practices and provide useul inormation or uture decision

making. Please contact us should you have any questions,

and as always, we welcome your input.

Foreword

In the spring o 2011 McGladrey teamed with mergermarket to conduct an

independent, third-party survey o private equity group senior executives.

This survey reects our desire to provide our clients and riends in the private

equity community with valuable inormation on how your peers are responding

to an improving economy, and ofer insight into the trends impacting your business

in the coming year.

Donald A. Lipari

National Executive Director, Private Equity Services

RSM McGladrey

[email protected]

212.372.1235

Hector J. Cuellar

President

McGladrey Capital Markets

[email protected]

714.327.8636


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Executive summary

Focus is power

Last years McGladrey report on portolio management

showed the tail-end o a narrow add-on acquisition strategythat populated the post-crash downturn. Private equity

groups are turning the corner and opening their checkbooks,

as acquisition operations will be largely centered on platorm

rather than add-on acquisitions. Sixty percent o respondents

reported that they would be spending more than hal their

acquisition time in 2011-12 ocusing on platorm acquisitions.

Amid a more competitive bid environment, buyers appear

to be considering industry specialization as a way to set

themselves apart rom other would-be buyers, with nearly

a third o respondents describing their private equity groupsas generalists, but saying they intend to narrow their ocus

on specic sectors.

Costly surprises to consider beore striking a deal

Advisors are also being hired to work in a once-viewed

unnecessary areapre-letter o intent (LOI) due diligence.

With increased competition on the buy-side, exclusivity time

has been cut short, i not eliminated, and private equity

practitioners are beginning to see the benet in adding the

help o third-party expertise even beore signing an LOI.

An indication that IT may be underestimated in the deal-

making process, respondents stated that management

reporting limitations incurred the greatest surprise costs

post-investment (47 percent), ollowed closely by unoreseen

capital expenditures (44 percent)both areas ultimately tie

back to inormation systems.

Holding and growing

When private equity groups are able to put their stamp on

a portolio company, they tend to be hands-on. Fund managersmost requently make changes to nancial reporting,

management and human resources, while simultaneously

ocusing on expansion, acquiring bolt-ons and introducing

new products and services.

In measuring their own impact, respondents eel they

requently increase top-line growth when theyre highly

involved in increasing operational eciency, and optimizing

pricing strategy and organizational structure.

Optimizing your exitThird-party specialists are receiving increasing attention rom

private equity groups. Outsourced due diligence expertise is

approaching standard practice ater post-closing surprises

took their toll on portolio revenues. A likely tie-in to a third

o respondents hiring third parties to perorm sell-side due

diligence more requently than ve years ago.

With the increasing popularity o IPOs as an exit strategy,

the majority o respondents agree the time required to make a

company IPO-ready is long, with 55 percent reporting that they

begin preparing within 18-24 months beore the intended IPO.

Private equity strategies and the dealmaking process are in

a redening phase as many rms make adjustments based on

the lessons theyve learned since the nancial crisis. A small

ew have barely adjusted their approach, but the overall

market is clearly changing.

Ater a ew quiet seasons, nancial buyers returned to the market amidst improving

valuations, better access to capital and pressure to deploy dry powder. Current deal

activity resembles 2006 rather than 2008 with less consolidation and more actual deal

closing, but some processes have changed or private equity groups as they hope to

avoid the errors that caused widespread losses just a ew years ago.


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Asked to describe their investment strategy, nearly a third

o respondents described their private equity groups as

generalists, but said they intend to narrow their ocus on

specic sectors. And more than hal o respondents plan to

spend 25 percent or less o their time on add-on acquisitions,

a shit rom McGladreys 2010 report, in which respondents

split their ocus between platorm and add-on acquisitions.

Investment strategy

McGladrey believes the desire or industry specialization makes

sense, as that specialization can be used to create operational

eciencies. Those eciencies are the hardest to come by, but

are the most valuable ways to improve growth. And when a

private equity group targets a company, that specialization can

help them stand out rom the crowd o buyers and be a true

diferentiator. When a rm decides to specialize, it leads to much

easier alignment between the private equity management team

and a portolio companys operating partnersboth groups are

more likely to have an easier time understanding one another,

and one anothers operations.

Which o the ollowing best reects your

investment strategy?

Moreover, buyers who have spent time pinpointing key sectors

and subsectors oten come out ahead when sellers investmen

bankers create a buyers list or an auction process. Current and

prior investment history plays a key role in determining which

groups have experience in a sector and will be able to quickly

understand the target companies business.

Trend data generated by mergermarket supports the ndings

o this research. During the last 12 months in the United States

the industrials and chemicals sector was most active in buyout

volume.

These companies will continue to be attractive acquisition targets

or private equity groups in the coming year. That industry was

surveyed as part o our Spring 2011 Manuacturing & Distribution

Monitor, which indicated that 90 percent o manuacturing

respondents are very or somewhat optimistic about their

companys prospects or overall growth over the next 12 months.

Steve Menaker, East Region Manuacturing Practice Leader,

RSM McGladrey

US Private Equity Buyout Volume

(Last 12 months)

We are generalistsand invest in manydiferent sectors

We are generalists,but intend tonarrow our ocuson specic sectors

We are sectorspecic and will

remain that wayWe are sectorspecic, but willexpand into othersectors

49%

33%

14%

4%

Industrials andChemicals

Business Services

TMT

Consumer

Healthcare

Financial Services

Energy/Mining/Utilities

Leisure

Construction

Transport

Real Estate

Agriculture

Deense

10%

8%

6%

4%3%2%

1% 1%


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Healthcare and technology, media and telecommunications

(TMT) trailed closely with 15 percent and 10 percent o all

buyouts, respectively. The healthcare and manuacturing sectors

also continue to sustain high levels o activity, which the 2010

McGladrey survey anticipated.

Platorm vs. add-on

In specic interview commentary, many respondents said they

intend to expand and indicated the majority o their platorm

acquisitions will target the manuacturing, industrials and

healthcare sectors. In contrast, add-on ocused rms will target

technology companies.

Business services (18 percent) and consumer (13 percent) are

also popular sectors with private equity investors. Indeed, the

largest buyout o 2010 was the $5.2 billion acquisition o Del

Monte Foods Co. by a consortium o private equity investors

led by KKR.

A number o consumer products companies, in particular non-

durables, are more recession-proo. Investors have been drawn

to the sector or this stability, as well as or good values and thepotential upside these companies oer in a recovering economy.

Cristin Singer, Food & Beverage Practice Leader, RSM McGladrey

Sixty percent o respondents reported that they would be

spending more than hal their acquisition time in 2011-12

ocusing on platorm acquisitions, compared with 18 percent

o respondents who said the majority o their acquisition ocus

would be on add-ons.

The divide is unsurprising. Coming out o a recession, now is

the time to buy better-perorming companies, compared tothe heavy recession period, when add-ons were likely seen

as a better t or a saer strategy.

In the improved economy, capital is readily available, and

private equity groups can deploy more o that cash through

platorms acquisitions. From the activity we are seeing with our

private equity clients, this redeployment o capital has begun

and we consider it a positive sign or uture economic conditions.

Perorming companies in the middle market continue to be

a stabilizing orce in our economy.

Bob Jensen, Great Lakes Region Private Equity Services Practice

Leader, RSM McGladrey

What percentage o your acquisition time will be ocused

on platorm acquisitions or add-ons to existing platorms

in 2011-12?

Platform acquisitions

Add-ons

None

Under 10%

Between 10%and 25%

Between 25%and 50%

Between 50%and 75%

Between 75%and 100%

21%

37%

23%

4%6%

9%

None

Under 10%

Between 10%and 25%

Between 25%and 50%

Between 50%and 75%

Between 75%and 100%

41%

22%

13%

5% 1%

18%


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Firms in the survey also viewed ewer consolidation-ocused

buyouts, where cost cutting and synergies were at the

oreront o the acquisition plan, as a sign o a more expansive

market. One respondent commented, Platorm acquisitions

have been giving us consistent growth potential with stable

incomes. Private equity seems to be moving away rom the

abundant consolidation o recent years. A poor economic

environment leads to consolidation through add-ons, said

another respondent, relating increased portolio expansion

to a positive economic climate.

These results are consistent with what our proessionals are

seeing. Private equity groups are eeling pressure to deploy

capital. Financing is readily available or higher multiples.

The perect storm may be gathering, leading many private

equity groups to believe now is a better time to do a bigger

acquisition.


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The middle-market is the largest area o investment or private

equity groups, and 48 percent o middle-market companies

are private equity-owned according to U.S. Census data. As

activity continues to heat up, the unique challenges and

opportunities that accompany those potential portolio

companies cannot be overlooked.

Now that a quality sellers market has arrived and the overall

M&A marketplace has shited toward a competitive bid

environment, the trend toward conducting more intensive due

diligence prior to executing a letter o intent (LOI) will likelycontinue in the coming year. Accompanying the continued rise

o due diligence in U.S. private equity deals, respondents said

a record 22 percent o the due diligence they perorm beore

signing an LOI is now external.

Third-party due diligence expertise is an increasingly

important part in the standard private equity buyout process.

While some rms preer to keep their due diligence activities

in-house (one survey respondent said conducting the work

afords the private equity group the opportunity to get to

know management better), a growing number are seeing

benets in seeking external expertise, particularly since the

2008 crash when pre-LOI due diligence was rare.

It remains a potential battleground or quality platorm

companies and private equity rms are in a renzy to gain

position with sellers, making it a potentially dangerous time to

be a buyer. Strategic buyers have cash and are back in the game

aggressively pursuing synergistic acquisitions.

Hector J. Cuellar, President, McGladrey Capital Markets

And the simple act is that while some larger private equityrms may have the resources to conduct due diligence,

many smaller groups lack such internal resources. One und

manager respondent said, Using a third party or legal and

technical diligence is essential. The importance o seeking

outside expertise has been spotlighted by many rms ater

the nancial crisis.

What percentage o the due diligence that you perorm

beore you sign an LOI is internal or external?

The shit in the market to avor sellers, and the increased

competition rom strategic and private equity buyers, has had

several proound eects on the deal process and due diligence.

Exclusivity time is shorter and sometimes not granted, which

makes it essential to understand due diligence best practices.

Joe Kinslow, Transaction Advisory Services Director,

RSM McGladrey

What was the most costly surprise youve experienced

ater investment?

(select top three)

External

Internal

78%

22%

Percentage o respondents

47.2%

44.4%

41.7%

40.3%

36.1%

33.3%

13.9%

8.3%

0% 10% 20% 30% 40% 50%

Inadequate IT systems

State and local taxnoncompliance liability

Management capabilitylimitations

Improper accountingmethods

Customer retentionand concentration

Unforeseen workingcapital requirements

Unforeseen capitalexpenditure needs

Management reportinglimitations

Costly surprises to consider beore striking a deal


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In examining the deal-making process, respondents reported

that management reporting limitations incurred the greatest

surprise costs post-investment. Especially in cases in which

external advisors were not brought in earlier, or when a

company is rst-time sold, it is common or reporting xes to be

one o the undamental things tackled ater a new acquisition.

There is a direct correlation between high caliber management

and good inormation. Private equity groups want good

inormation, and usually make getting good inormation a

priority, as that is a core part o their management approach.

Typically, sponsor-owned companies that have already been

sold once and have moved away rom their ounder will have

better systems and inormation, and thus less costly surprises

on average. For a rst-time sold company, there is a lack o

transaction accounting experience, and the early days as a

portolio company are oten characterized by the need or

care and eeding by private equity groups. This is necessary

not only in terms o reporting, but to ensure the platorms

have consistent reporting across portolio companies and or

associated implications, be it regular and routine issuance o

K1s, or gaining an understanding o business issues, such as

inventory turn, in a timely ashion.

A lot o these costly surprise actors ultimately tie back to

inormation systems. I equate categories like management

reporting limitations and unexpected capital expenditure needs

back to IT. Our experience has seen a marked increase in the

number o rms including IT in their diligence process; these

responses underline the reasons more rms need to do so as soon

in the process as possible.

Jane Shaer, Technology Consultant, RSM McGladrey

Eighty-ve percent o survey respondents said they have

adjusted the purchase price in at least one transaction. And o

those respondents, nearly hal reported one in every our deals

required an adjustment.

I anything, in the context o a market in which the importance

o due diligence is rising, it was surprising to see that 15 percent

o survey respondents said they had not encountered

the need to adjust purchase price. Usually, adjustment

mechanisms are built into acquisition contracts. One possible

explanation is that some respondents may make concessions

outside o purchase price.

Over the past year, what percentage o deals required

an adjustment to the purchase price?

Fair or unair, the view occasionally taken by investment banks

is that when there is a purchase price adjustment, somethinghas gone wrong. The end result is an occasional concession

on other terms. Whatever the vehicle, the key is identiying

a problem and getting value or identiying that problem.

Hal the surveyed population had 25 percent or more retraded

a signicant adjustment to the purchase price. The expectation

is the months ahead will see more retrading than what occurred

during the look-back period surveyed.

The companies that have come to market to sell over the past

year were generally not as clean, not as high quality, and were

accompanied by more issues. Its not surprising that once privateequity groups got in there, they ound issues and started the

retrading exercise.

Milton Marcotte, National Managing Director-Transaction

Advisory Services, RSM McGladrey

None

Under 10%

Between 10%and 25%

Between 25%and 50%

Between 50%and 75%

Between 75%and 100%

32%

25%

9%

11% 15%

8%


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How oten do each o the ollowing issues play a role

in purchase price adjustment?

Respondents said the primary issue or purchase price

adjustment is inaccurate EBITDA calculations, with working

capital needs and pro-orma adjustments similarly signicant.

Many respondents admit that an adjustment, albeit not always

signicant, is made or each o their transactions.

Considering EBITDA multiples, adjustments have a signicant

impact on returns. The value is in identiying the adjustment,

lowering the purchase price, and receiving a better return in the

end. Also, the number o surprises post-closing will be reduced.

Bill Spizman, Managing Director-Transaction Advisory Services,

RSM McGladrey

Private equity groups should be sure to take caution; a targets

ailure to comply with state and local tax ling requirements

can oten lead to signicant tax exposure requiring escrows,

indemnications and purchase price adjustments.

In your experience, how valuable are each o the ollowing

advisory areas during the typical transaction process?

(where 1=limited/no value and 5=immense value)

Legal advisory is seen as the most valuable advisory position

in the typical transaction process, with nancial, operational

and tax advisory closely behind. Environmental due diligence

is important or sector-specic situations, according to

respondents, especially in the manuacturing sector, where

environmental regulatory issues are more prominent.

Whether dealing with regulatory and contract issues, or when

providing a tax-efcient structure, obtaining the correct legal

and tax advice is critical to any transaction.

Nick Gruidl, Managing Director - Mergers & Acquisitions

Tax Practice, RSM McGladrey

Bearing in mind the costly surprises encountered post-deal

many o which tie back to IT expenditures the low ranking

awarded to IT suggests a possible disconnect in deemed

value. Private equity groups should consider whether they areperorming enough diligence in the area, and ensure they scope

accordingly to ensure they allow IT to add value and insight to

the process.

Percentage o time

0% 10% 20% 30% 40% 50% 60% 70% 80%

IT Systems requiringsignicant investment

State and local taxnoncompliance issues

Revenue recognition not inconformance with GAAP

Non-recurring revenue

Pro-forma adjustments

Working capital needs

Inaccurate EBITDA 73.4%

71.4%

70.0%

60.8%

58.6%

55.8%

52.8%

Degree o value

1 1.5 2 2.5 3 3.5 4 4.5

HR

IT

Environmental

Tax

Operational

Financial

Legal 4.14

4.05

3.9

3.7

3.16

2.96

2.88


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Delving deeper into the relationship o private equity rms

in the hold-and-grow stage with their portolio companies,

respondents were asked to identiy the areas in which their

involvement had the greatest impact on creating top-line

growth.

The responses ound that general partners most requently

believe that taking a hands-on approach adds the greatest

value, especially when they get involved in increasing

operational eciency and optimizing pricing strategies.

How oten does direct involvement by a und executive in

each o the ollowing areas lead to top-line growth?

That increasing operational eciency tops the list is no

surprise, as that is a primary driver behind maximizing value.

The rise o the operating unction is a distinctive trend in

private equity. Whether bringing on board operating partners

or working with external advisors who have the appropriate

operational and industry experience, private equity rms with

these expert resources can dramatically improve their portolio

companies perormance.

While comparatively ranking as a lower area o ocus,

increasing sales orce efectiveness and providing industry

sector expertise, should not be discounted. Industry expertise

in particular is noteworthy, since some o the most valuable

ways to create operational eciencies oten begin with a deep

understanding o the business and the market. The same

is true o optimizing pricing strategy.

As a previous question ound, nearly hal o all private equity

groups said they were either sector specic (14 percent), or were

generalists planning to narrow their sector ocus (33 percent).

Asked about the particular areas most likely to be afected

by change throughout the investment liecycle o a portolio

company, nancial reporting and controls is rated the most

requently targeted area, ollowed closely by management

efectiveness and compensation structure and design.

These days, it is rare or a rm to simply buy a company and

not make numerous changes to enhance the organization.

How requently do you make changes to the ollowing

areas o your portolio company?

Respondents noted that although specic changes vary rom

company to company, consistency is maintained with respect

to certain areas. One respondent said system tweaks can

oten be implemented at portolio companies that otherwise

need to make ew changes to improve perormance. Another

segment o respondents revealed a tendency to requently

change compensation structure while rarely changing IT

systems or product designs/service processes; requency in

other areas difered rom respondent to respondent.

That compensation structures are oten modied is another

key takeaway.

Percentage o time

67% 69% 71% 73% 75% 77%

Providing industry

sector expertise

Increasing sales forceeectiveness

Guiding go-to-marketstrategies

Optimizing organizationalstructure

Optimizing pricing strategy

Increasing operationaleciency

76.8%

73.2%

71.6%

71.0%

71.0%

70.6%

Percentage o time

0% 10% 20% 30% 40% 50% 60% 70% 80%

New product design/service process

IT systems

Business model innovation

Resource utilization

Cost eciencies

Compensation structureand design

Management eectiveness

Financial reportingand controls

76.4%

76.8%

78.4%

74.2%

67.6%

65.2%

60.8%

60.6%

Holding and growing


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In particular, rst-time sold, owner-managed companies oten

do not have a compensation structure in place that is truly aligned

with value creation. Private equity groups put that alignment in,

which is why respondents cite changes around compensation

structure as happening so requently. That can be correlated to how

oten a portolio companys personnel is changedprivate equity

groups may not make a ton o people changes, but the end result is

enhanced management eectiveness.

Milton Marcotte, National Managing Director-Transaction

Advisory Services, RSM McGladrey

When asked about strategies or optimizing perormance

and reducing costs, only implementing consistent, automated

reporting and insurance coverage and brokerage are

reported to be used over 60 percent o the time. The relatively

lower scores in other areas suggest a lesser sense o urgency

in regard to cost-cutting strategy. This marks a contrast to

the 2010 report, where consolidating costs among portolio

companies in a wide variety o areas was a key ocus.

Reecting back on the costly surprises that accompany new

acquisitions, it is apparent that private equity groups aremaking a air number o changes in a variety o areas, and

perhaps are surprised about how many o those changes they

have to make.

How oten do you implement the ollowing strategies

to optimize perormance and reduce costs across all

your portolio companies?

Improved nancial perormance o portolio companies can

come either rom cutting costs or increasing revenues. While

there appears to be less emphasis on cost cutting, engaging

in growth initiatives such as geographic expansion, the

acquisition o add-ons to grow the business, and development

o new products and services are in the cards or 2011 and

beyond, according to respondents.

Engaging in growth changesactivities such as expanding

into oreign markets and/or increasing research and

development investmenteven hal or more o the time, ascited in the respondent answers, can have a very meaningul

impact when it comes to a portolio companys uture outlook

The end result o those activities gets to the heart o the

private equity model.

Many acquired companies are somewhat or signicantly

undermanaged. To an owner managing a company, growth

may be airly important, but within the context o the private

equity group environment, growth becomes extremely

important. The diference between an owner satised to

manage and maintain as opposed to a private equity group

that is adding an emphasis on growth is a major shit. The

business model is built around proessional managers who

understand how smart resource investments can transorm

a portolio company.

How oten do you implement the ollowing changes

to your portolio companies?

Percentage o time

0% 10% 20% 30% 40% 50% 60% 70% 80%

IT server consolidation

Outsourcing networkmanagement

Network/carrier selectionand consolidation

Strategic sourcing/procurement

Consolidation ofservice providers

Insurance coverage

and brokerage

Implementing consistent,automated reporting

59.0%

67.8%

71.6%

58.6%

58.4%

51.4%

49.4% 0% 10% 20% 30% 40% 50% 60% 70% 80%

Increase R&D expenditures

Expand into foreign markets

Divest non-core assets

Introduce new products/services

Acquire add-on acquisitions

Expand into new domesticmarkets

67.6%

69.4%

70%

56.6%

55.6%

53.0%

Percentage o time


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The careul management o private equity investments,

coupled with the industry expertise and business acumen o

senior executives, allows private equity rms to add value to

portolio companies. Respondents revealed a clear tendency

among middle-market private equity rms to retain their key

management, particularly the CEO.

We always try to retain the key management and work

with the existing team, commented one respondent.

Many respondents echoed that sentiment. Explaining his

rms thorough target identication, one und manager didadd he will consider the probability/necessity o changing

management when it is needed to improve the business.

The overall results or likely retention o top executives

trended higher than anticipated, particularly in the case o the

CEO. The assumption might be that the chie executive is the

roadblock to implementing change in an ecient manner,

and the person most responsible or having sub-optimized

the company making it ripe or acquisition by a private equity

group. Thus, such a high proclivity to retain the chie executive

is very surprising. One explanation may be that deals wherein

the CEO is retained or an agreed-upon amount o transition

time is not reected in the responses.

How oten do you retain key management executives

ater an acquisition?

Percentage o time

66% 68% 70% 72% 74% 76% 78% 80% 82% 84% 86%

Controller

VP Human Rescources

VP Operations

CFO

VP Sales

CEO 84.2%

78.2%

74.2%

74.0%

72.6%

71.8%


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Optimizing your exit

As management teams prepare to exit, and weigh sales to a

strategic buyer or an IPO exit, the team can expect to spend

long days acing dicult decisions, many or the rst time.

Companies need to have a credible nancial team in place to

weigh all the organizations options. The rst step o the process

begins with determining whether a company is actually ready

to go public, and taking a hard look at the nancial numbers.

As the economy has turned in the past year, market conditions

have ollowed suit, witnessing a signicant increase in the

volume o deals in 2010 and through the rst hal o 2011.

Sell-side due diligence is also becoming more prevalent, both

or buyers seeking reassurance, and or sellers who want to do

everything possible to optimize their exit price.

U.S. Private Equity Exits

Volume Value USD (m)

2006 703 128,617

2007 737 152,032

2008 441 81,097

2009 324 37,969

2010 560 110,862

H1 2011* 184 22,982

source: mergermarket.com * H1 2011 as o 5/23/2011

There is a large inventory o portolio companies ready to be

sold. Private equity exits have increased signicantly over the

last ew months and we expect this trend to continue.

Gina Hintz, Co-Head o Private Equity Coverage Team,


The volume o private equity exits declined in response to

deteriorating economic conditions rom 2007 to 2009, but

witnessed a comeback in 2010. Many private equity groups

held onto investments or longer than usual in anticipation

o improved market conditions, nancing and valuations.

Another actor in the uptick o exits: proposed changes to

carried interest tax policy, which threaten to change the way

the private equity industry is taxed on income.

Whether private equity will gain time to plan and execute

exits in a revitalized economy, or be hastened by new tax

policy, respondents highlighted several issues to consider

in optimizing value. According to one und manager,

Unreported accrual awareness is the main issue.

When exiting an investment, how important are each

o the ollowing issues?

(where 1 = unimportant and 5 = extremely

important)

Much o the work in the planning stages o a transaction is

ocused on the quality o earnings. Companies need to get

to a point where they have produced three years o quality

nancials that are comparative when looked at year to year.

While the equation to get there may be simple, it comes

down to having the right team in placethe experience and

credibility o a companys nancial management team is what

will most directly impact the quality o earnings.

Unquestionably, private equity groups need to develop the

right exit process to optimize value. The downturn in thedomestic market continues to dictate the necessity or sell-side

due diligence, which has long been a more prevalent practice

in Europe.

Degree o importance

1 2 3 4 5

Valuing intangibles

Unreported accrual awareness

Identication and treatmentof non-recurring items

Tax liability accuracy

Revenue recognition accuracy

Quality of earnings levels

3.75

3.77

4.42

3.66

3.42

3.09


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With the depressed economy, the number o exits has been

suppressed in recent years. Because the market is coming

back, sellers want to make sure they receive optimal value.

Third-party experts can help eliminate anything the market

may attempt to use to discount the price.

One nuance is that right now, some o the companies that are

selling have gone through difculties. Those companies have a

story they need to bring credibility to through a sell-side diligence

exercise. Because o non-normal activity in the marketplace that

typically accompanies a major recession, many companies haveweathered a number o issues, be it downsizing, restructuring,

loss o accounts, big A/R write-os. They need to credibly show

that their business is sound in order to maximize value.

Scott Vanlandingham, East Region Financial Advisory Services


Do you perorm outside (third-party) sell-side

diligence more requently now than ve years ago?

One-third o respondents perorm sell-side due diligence more

requently now than ve years ago. Bringing in outside expertsto help prepare a company or an exit can allow management

to ocus more time on running the business, while helping

optimize EBITDA and exit price, according to respondents

commentary.

One managing director summarized the trend by stating that:

Third-party sell-side due diligence greatly helps in addressing

and clearing up issues with technical, HR, nance and others

that arise during the course o investment, thus helping

in understanding the right value or the deal and eventual

success o the deal.

The upswing in sell-side due diligence is not surprising and

corresponds to the other major shit in the market: more

buy-side scrutiny on the deals.

The uptick o sell-side due diligence can be largely attributed

to the intensication o buyer due diligence, which is a direct

outgrowth o economic conditions. Buyers typically have to put

more o their own capital into deals nowadays, so they not only

are acing potentially lower returns, but greater risk that an

overlooked problem at an acquisition candidate could blow up in

their aces.

Bill Spizman, Managing Director-Transaction Advisory Services,

RSM McGladrey

IPOs

On the IPO ront, while the market is a key driver o IPO

decisions, it is not alone. Structure and timing in going publicare key, and become complicated in liquidating ater the IPO

is raised, one und manager said. Respondents also pointed

to poor current market conditions and stronger competition

rom strategic buyers.

Market conditions are a relatively sae place to lay the blame

or dismissing an IPO, but cost was a surprisingly prominent

reason to dismiss an IPO as an exit strategy. Presumably,

the value o an IPO will dwar the cost. The reality is that i a

company is struggling to remain SOX compliant, or lacks good

internal controls, chances are it will never be in a position to

seriously consider an IPO.

Giving up control may be part o the perceived cost in pursuing

an IPO, and that a strategic buyer may sometimes present a

better option. Alternatively, a company may decide the IPO

is not large enough when weighed against the surrender o

control. There may also be a need to upgrade the talent o a

companys team. Prior to reaching the IPO, a company should

Yes, much morerequently

Yes, somewhatmore requently

No change

No, less requently

No, much lessrequently

65%

1%1% 14%

19%


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18

have both a CEO and CFO in place with experience leading an

IPO, as well as an SEC reporting person and a solid legal team,

whether internal or a third-party provider.

For companies where an IPO was seriously considered but

dismissed as an exit strategy, which o the ollowing were

the primary reasons why?

For those who choose to go ahead with an IPO, the key issues

do not change. Respondents are most concerned with market

conditions, valuations and cost.

The majority o respondents (55 percent) expect to get a

company IPO ready within 18-24 months, with an additional

35 percent ocusing on the exit 12-18 months ahead. Several

respondents echoed the comment that with the current

requirements, the time required to make a company IPO-ready

is long.

Ninety percent o companies begin investing time and resources

toward IPO readiness between 12 and 24 months beore the

intended IPO. Our experience has been that this may leave them

short on time, since systems are such a critical component o the

process and oten the necessary modications o the systems

and the related business processestake more time to eectively

introduce and become operational with.

Stan Mork, Managing Director-Technology Services,

RSM McGladrey

At what point when considering an IPO as a potential exit

strategy do you begin investing the time and resources to

get the company IPO-ready?

While the length o time to prepare or an IPO doesnt vary

widely rom company to company, the reality is that there are

many companies we work with who believe they are much

closer to IPO than they truly are.

Some clients estimate they are months away rom an IPO but then

require years to le their registration statement. To me, the IPO isgoing to get you a large enough value that its worth the pain.

Scott Vanlandingham, East Region Financial Advisory Services


Percentage o respondents

0% 10% 20% 30% 40% 50% 60% 70%

Other

Lack of corporate preparation tomeet regulatory requirements

Length of time required tocomplete the oering

Strategic buyer wasa better option

Cost

Market conditions/valuation

38.0%

59.2%

63.4%

38.0%

35.2%

4.2%

Greater than 24months

Within 18-24months

Within 12-18months

Within 6 months

35%

6% 4%

55%


21/24


22/24

About mergermarket

mergermarket is an unparalleled, independent mergers &

acquisitions (M&A) proprietary intelligence tool. Unlike any

other service o its kind, mergermarket provides a complete

overview o the M&A market by ofering both a orward-

looking intelligence database and a historical deals database,

achieving real revenues or mergermarket clients.

For more inormation please contact:

Matt Leibman

Publisher, Remark

The Mergermarket Group

Tel: +1 212 686 6305

Email: [email protected]

About Remark

Remark, the events and publications arm o The Mergermarket

Group, ofers a range o publishing, research and events services

that enable clients to enhance their own prole, and to develop

new business opportunities with their target audience.


23/24

21

Contributors

The ollowing individuals contributed to the design

and development o this study.

Ben Brandes

Director, RSM McGladrey

[email protected] | 617.241.1379

Hector J. Cuellar

President, McGladrey Capital Markets


Nick Gruidl

Managing Director - Mergers & Acquisitions Tax practice,

RSM McGladrey


Gina Hintz

Co-Head o Private Equity Coverage Team,



Bob Jensen

Great Lakes Region Private Equity Services Practice Leader,RSM McGladrey


Joe Kinslow

Transaction Advisory Services Director, RSM McGladrey


Don Lipari

National Executive Director o Private Equity Services,

RSM McGladrey


Milton Marcotte

National Managing Director-Transaction Advisory Services,

RSM McGladrey


Steve Menaker

East Region Manuacturing Practice Leader, RSM McGladrey


Stan Mork

Managing Director-Technology Services,

RSM McGladrey


Jane Shafer

Technology Consultant, RSM [email protected] | 319.896.5423

Cristin Singer

National Food & Beverage Practice Leader,

RSM McGladrey


Bill Spizman

Managing Director-Transaction Advisory Services,

RSM McGladrey


Scott Vanlandingham

East Region Financial Advisory Services Leader,

RSM McGladrey



24/24

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McGladrey meets the needs o private equity rms and their portolio companies with integrated transaction advisory, tax,audit, consulting and investment banking services. Clients benet rom a single-point-o-contact service model and teamsthat operate as strategic partners throughout the private equity lie cycle. Our transaction advisory services emphasize

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2011 Managing Portfolio Investments Survey

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Transcript of 2011 Managing Portfolio Investments Survey