Gone are the days of short hold periods and hands-off portfolio operations management. Economic headwinds, the cost of capital, reduced multiples, geo-politics and a host of other factors has private equity (PE) and their portfolio companies searching for value creation opportunities in pursuit of alpha.
Alpha, often associated with excess returns beyond market benchmarks, takes on a new dimension in the context of PE as an imperative for creating additional value. In today's competitive environment, the ability to unlock alpha is instrumental in the success and sustainability of PE investments and their portfolio companies.
At its core, alpha in the realm of PE is about generating value that transcends market movements. The current need for PE and their portfolio companies to create additional value is more pressing than ever, given the challenges posed by economic uncertainties, technological disruptions, and evolving consumer preferences. To harness alpha successfully, PE firms are adopting innovative strategies, embracing operational excellence, and fostering a culture of continuous improvement within their portfolio companies.
In her recent Pitchbook article, PE firms need to double down on adding value, Marie Kemplay says that as PE firms look to “squeeze more operational value out of assets, [t]here is very little new under the sun—much of what it takes is common sense and a dusting off of old tactics.” While true in the sense that generating alpha lies in operational efficiency and taking a proactive approach not only mitigates risks but positions the company for sustained success in the long term, there are additional avenues to explore.
The concept of alpha underscores the centrality of people in value creation – something we refer to as People Alpha. It may be one of the last bastions of untapped value creation opportunity. Savvy investors recognize that a strong leadership team and well cared-for employees are catalysts for success.
The emerging role of Human Capital or Talent Operating Partner and the growing demand for sophisticated partners to support their imperatives is direct evidence of this change in viewpoint. By attracting, developing, and retaining top-tier talent, portfolio companies can cultivate a culture of innovation and grit. This people-centric approach not only enhances organizational capabilities but also fosters a dynamic and adaptive environment essential for creating sustained alpha.
Adopting a pre-deal-to-exit approach to human capital is the surest route to People Alpha. We conduct exhaustive diligence on finance, operations and commercial capabilities. Generate value creation plans (VCPs) for accounts receivable improvements and implementation of new sales technologies. More and more we are assessing leadership talent, which is crucial for success. Yet, we’ve left people operations (human resources), culture, and the day-to-day experiences of the employees who keep it all running out of the value creation equation. When you open this door, you unleash potential.
Once, during diligence, we asked a team of middle managers what would make them and their employees more productive. Of the 50 people we interviewed, all but one said, “better wi-fi bandwidth”. After digging deeper, we learned that employees had to leave their workstations and drive 10 miles to Panera for enough bandwidth to stream their required video learning content – at a cost of 5 hours of productivity per person, per training course.
We convinced the leadership team to install signal boosters on the day of closing, saving the facility $364,000 in annual lost productivity for less than $500 in equipment and labor. As a bonus, the employees expressed gratitude for their new leadership team who invited their voices and valued their input. Subsequent employee engagement surveys showed increased levels of trust and confidence in the leadership team and decreased intent-to-leave the organization. Both measures correlate significantly to metrics such as human capital return-on-investment (HC ROI), human capital value add (HCVA) and human capital return-on-culture (HC ROC).
The pursuit of alpha in the context of private equity has evolved into a multifaceted strategy focused on creating additional value. Operational excellence, ESG considerations, technology integration, and strategic leadership are all crucial elements in unlocking alpha and ensuring the long-term success of PE investments and their portfolio companies.
“PE firms should remain focused on the long game if they are going to succeed in the current environment, while avoiding the temptation to chase shortcuts. A renewed focus on the meat and potatoes of value creation should be central to their approach,” says Kemplay.
As the landscape continues to evolve, the ability to innovate and adapt will be the hallmark of those who truly understand and harness the power of alpha in the world of private equity. Ninety percent of the S&P500 market value in 2020 was comprised of intangible assets, including intellectual capital – People Alpha drives this market.
If you’d like to learn more about People Alpha and how we create can value for your organization, please reach out to us. We'd love to talk to you!
If you're interested in learning more about measuring the value of people in business, People Economics: Defining and Measuring the True Value of Human Capital is a terrific resource.