Position Your Portfolio to Thrive, Not Just Survive
How investors can help companies navigate through these turbulent times
By Elise Chowdhry, April 10, 2020
Originally published by Middle Market Growth – www.middlemarketgrowth.org
As our founding father George Washington once said, “the harder the conflict, the greater the triumph.” Without question, the middle-market private equity world faces an unprecedented challenge. In S&P Global’s annual private equity outlook survey published on March 12, PE professionals cited economic uncertainty as one of the greatest risk factors to portfolio companies in 2020. This pandemic has unquestionably compounded that risk. The future of portfolio companies will depend on what investors do now and in the coming weeks and months. Triumph depends on it.
We are in the early innings of this virus and its aftermath, which will almost certainly include a recession. Thus far, COVID-19 has created a struggle for some companies and a fight for survival for others. Investors I’ve spoken with over the past two weeks have said this virus will be the “nail in the coffin” for one or more of their portfolio companies.
As highlighted in a recent MMG article, investors have been in close, even daily, dialogue with their management teams. At a time like this, it will be critical to keep up the more intense communication for the foreseeable future.
This is not the time to “wait and see.” Recent predictions of how this virus may spread suggest we could be looking at many more months of restricted activity and then another wave in the fall. If you haven’t begun intense dialogues with your management teams, now is the time to assess the landscape, refine the strategy, plan and execute. Broad implementation of best practices has never been more critical.
Be sure to address the following at each of your companies:
Assessment: Understanding Risks and Opportunities
As an investor, work in partnership with the CEO to assess the factors critical to its future, including: liquidity, people, strategic partnerships, cybersecurity, supply chain, community outreach and acquisition opportunities.
IF YOU HAVEN’T BEGUN INTENSE DIALOGUES WITH YOUR MANAGEMENT TEAMS, NOW IS THE TIME TO ASSESS THE LANDSCAPE, REFINE THE STRATEGY, PLAN AND EXECUTE. BROAD IMPLEMENTATION OF BEST PRACTICES HAS NEVER BEEN MORE CRITICAL.
Liquidity: As always, cash is king. By now, companies generally have tapped into available credit lines to shore up the balance sheet. Many have already laid off or furloughed workers. An ongoing question for the CEO remains: How should precious dollars be prioritized?
People: The importance of worker safety is on par with the need for liquidity. One resource for how to protect employees not working remotely is the Centers for Disease Control and Prevention’s guidelines on workplace safety.
Once you conclude that the company is viable, ask yourself: Are the CEO and the rest of the senior leadership team truly up to this monumental task?
In my consulting practice, I assess leaders using a tool that predicts an individual’s “Dark Side”—behavior that shows up under stress and pressure. Watch for leaders that appear to be pulling back from leading under the weight of this crisis.
Investors should also evaluate the bench strength of the rest of the leadership team. Every leader on the team has a critical role to play. Questions to ask yourself and the CEO include: Is the CFO strategic enough to navigate through the financial and cash flow challenges? Is there enough human resources horsepower to juggle ordinary responsibility, COVID-19 headcount changes, workplace safety, the Families First Coronavirus Response Act and other legislative, regulatory and guideline changes?
Probe how well the leadership team works together by spending time (virtually) with individual leaders. Teams that lack trust tend to operate in silos, which is problematic when things are going relatively well and can lead to real trouble under extreme stress.
Strategic partnerships: With the flood of changes in federal and state laws, rules and guidance, your companies will need strong partnerships with bankers, lawyers and accountants. Does the company have the right partners or are there changes that need to be made? If so, the sooner the better.
Cybersecurity: S&P’s survey found that only 7% of investors were concerned with cyberrisk at portfolio companies. Aside from liquidity and people, cybersecurity now presents a huge risk as employees work from home and attend virtual meetings. The increased popularity of Zoom has already drawn bad actors, and more criminal behavior is expected. Does the company understand its increased cybersecurity risk and has it taken steps to address it?
Supply chain: As the crisis unfolds and more states order residents to stay home, supply disruptions are inevitable. Does the company have alternate suppliers for mission critical products or offerings? If not, how can you as an investor potentially help? An ongoing question to the CEO: What is the financial health of the key suppliers?
Community outreach: Can the company repurpose manufacturing to help support the fight against COVID? If not, what else can be done to help the community in which it operates?
Acquisition and business opportunities:: As the crisis unfolds, there will be opportunities for strategic acquisitions for those with capital resources. Can the company identify the target wish list now in anticipation? Weakened competitors may not be able to serve customer needs. What will the company need to do to yield those business opportunities?
Leaders must be intentional in setting the course and devising a path forward.
Strategy: Based on the assessment, investors can help the company determine goals for the next three, six and 12 months around talent, supply chain, customer relationships, operations, product and service offerings, and financial position and liquidity.
Planning: When designing the revised strategy, investors can assist companies in developing SMART goals—specific, measurable, achievable, relevant and time-bound—with objectives, metrics and accountability. As I discussed in a previous MMG article, the crisis brings the risk of being very busy but not productive.
Plans should include the development of multiple scenario cash flow forecasts—expect the best and plan for the worst. Calibrate and recalibrate as the situation warrants.
Operating in this “new normal” environment requires laser-focused blocking and tackling.
THE CURRENT ENVIRONMENT PRESENTS AN OPPORTUNITY FOR COMPANIES TO BUILD A STRONGER FOUNDATION FOR THE FUTURE.
The CEO, CFO, HR and IT roles are arguably the most critical positions during this pandemic. If the bandwidth isn’t there, urge your CEOs to outsource or secure third-party assistance from consultants that specialize in the middle market as soon as possible.
Investors should help companies determine what costs should be cut, including 2020 capital expenditures, without impairing the business. They should remind leaders to communicate continually with internal and external stakeholders, to maintain intense focus on cash and working capital, and to keep an eye out for new risks to the business as the crisis unfolds.
Also, be sure to caution companies to be mindful of company values as they react to the pandemic. As one PE investor suggested to me recently, current actions or inactions can bring reputational risk once the crisis passes, indicating that “it is time to true up to your values.” Investors, including MiddleGround and KKR, have done just that in support of employees at portfolio companies.
Implementing Best Practices
The current environment presents an opportunity for companies to build a stronger foundation for the future.
Investors can help portfolio companies shore up performance management and high-potential programs so that leaders can identify (and groom) the next level of management, as well as those who should be coached or terminated.
Private equity owners should set up a portfolio company portal on the firm’s website, akin to investor portals, to provide critical information. They should establish regular videoconference calls with CEOs and CFOs to foster the sharing of best practices.
Investors should encourage their CEOs to review company benefits offerings and consider more robust mental health offerings. This will support employees whose stress levels are rising due to this crisis and address the needs of the upcoming and future workforce.
As New York Governor Andrew Cuomo said in a recent press conference, “This is not a sprint, it’s a marathon.” Initial reactions have understandably been reactive, but now is the time to be proactive. Firms that approach the impact of COVID-19 with both the short term and future in mind will not just survive but thrive as the economy emerges from this crisis.