NextWave Private Equity

Jon Shames, Senior Partner and Leader of the EY Geostrategic Business Group, joins Winna Brown to explore why PE must embed geostrategy in both deal lifecycle and organizational culture to recognize unique opportunities and drive investment decisions.

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The geopolitical landscape is shaped by four disruptive forces: globalization, technology, demographics and the environment. Private equity firms need geostrategy to manage a shifting political environment with the objective of finding opportunity amid geopolitical risk. It is necessary to develop a culture in which these considerations are explored, resourced and incorporated into all steps of deal flow, ESG and LP relationships.

A geostrategy is a powerful way for private equity firms to differentiate themselves and win in the market. Some PE funds have a more sophisticated and proactive approach to geostrategy while others are more reactive and ad-hoc: whatever the chosen approach, there is ample room for PE to further embed geostrategy into investment committee decisions.

Geopolitics shouldn't just be about risk and worrying about the downside: it should be about driving the investment strategy from a proactive, informed perspective that yields unique opportunities that may not have otherwise been considered. It's also about making sure a deal makes sense given the complexity of risk in the current geopolitical and broader ESG environment.

A successful geostrategic framework should follow:

• Scan: establish and maintain the ability to identify, monitor and assess political risk.
• Focus: evaluate the impact on key performance indicators, mapping the political environment to the company footprint.
• Act: develop a portfolio of robust geopolitical risk management instruments and build a growth-oriented geostrategy.

Five key geostrategic practices PE executives can adopt:

• Political risk is here to stay and is increasingly more complex.
• Firms need to refine their philosophical and organizational perspective.
• PE firms must embed geostrategy into every stage of the deal lifecycle from origination to exit.
• Consider developing a geostrategic center of excellence (COE) that empowers executives to move beyond risk identification to opportunity assessment.
• Geostrategy is more than a "check the box" compliance exercise: it should be integral to a firm's investment decision process, incorporated into ESG and culturally valued.

Sean Epstein, Senior Vice President and Global Head of SAP Private Equity & Mergers and Acquisition Programs, and Marc Noë, a Managing Director in the EY Digital practice, join Winna Brown to discuss how customer experience is driving digital transformation in private equity.

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"Digital" drives enhanced experiences for customers. And while many people talk about digital in terms of technologies, the most important (and difficult) aspect of digital is adopting new ways of working in areas such as product orientation, design thinking and customer experience.

Finding the right technology fit across the PE portfolio can be daunting, but the pandemic is inspiring PE firms to question the more fundamental processes of buying, making and selling:

• How can digital help us identify synergies in procurement across the portfolio so we can leverage our aggregate buying power to drive cost reductions?
• How can digital help us reimagine our sourcing and manufacturing so we can continue making products with fewer workers?
• How can digital better connect us with the experiences, desires and needs of our customers in a post-pandemic shopping environment?
• What are my peers doing that is driving superior performance and which digital technologies, investments and best practices will help me get there?

Experience-led transformation impacts PE-backed companies from three key perspectives:

• Customer: customer experience and feedback changes business fundamentals and KPIs by informing how a company innovates, develops, markets and sells its products.
• Employee: employee experience and feedback surfaces valuable business learnings about what is working and not working "on the ground."
• Firm: scalable customer and employee feedback loops and the resulting KPIs serve as an ongoing barometer throughout the business lifecycle that is especially illuminative and relevant during due diligence.

Top tips for PE-backed companies that want to enhance their customer experience include:

• Rather than ask, "what do we need to do to digitalize our business?" ask, "what do we need to do to make us easier to do business with?"
• Launch and learn, speed is of the essence. You may fail but you will learn from the experience.
• CIOs need a seat at the table alongside all the other business leaders.
• It's hard to attract and retain top talent, so don't "sleep" on your talent.

Andres Saenz, EY Global Private Equity Leader, shares his observations regarding the evolution of private equity and the role it will play in a post-COVID world.

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The initial impact of COVID-19 on the private equity complex echoed what was seen in businesses across all sectors, with workplace safety, remote ways of working, investor and employee communication, liquidity and supply chain being top of mind to triage. In addition, deal markets (with the exception of credit funds) practically shut down overnight.

PE firms are well-positioned for an economic downturn and have been preparing for this type of event in recent years. With over US$750b in dry powder in what is now a favorable buyer's market, PE is looking to be as active as possible, as soon as possible.

A few impediments to deals have included the inability to travel, a lack of available financing, and valuation disconnect between buyers and sellers in pricing assets. Despite these challenges, firms have become creative around investments in public equities as well as credit opportunities. Barring a resurgence of COVID-19, we anticipate buyers and sellers to converge sooner on valuations and in addition to pursuing opportunities in corporate carve-outs.

PE-backed companies have a real advantage in this volatile environment: not only do funds have greater access to capital, they also have a mix of operating resources, expertise and advisor relationships ready to deploy across the portfolio.

As PE navigates through COVID-19 and prepares for a momentous shift, a few trends will accelerate, including:

• Investing up and down the capital stack
• Defining digital transformation and enablement
• Refining their value proposition to attract incoming talent
• Hiring talent with the right skill sets
• Elevation of D&I and a broader focus on social responsibility
• Widening the aperture and representation of stakeholders
• Pivoting strategy towards long-term value

Tim Dutterer, EY-Parthenon Head of Private Equity, and Greg Schooley, EY US Value Creation Leader, discuss how COVID-19 is transforming operating models across the PE portfolio and beyond.

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After the economy recovered from the Great Financial Crisis of 2008, economic activity and growth were steady and predictable. As a result, private equity-owned companies optimized their operating models for efficiency, anticipating the next economic cycle would a more modest recession. No one, publicly traded corporates or PE-owned companies, was prepared for the sudden and complete secession of economic activity caused by COVID.

However, PE investors reacted very quickly, understanding the severity of the crisis and mobilizing to increase liquidity across the portfolio. While a few sectors were spared from the sudden economic collapse, a wide spectrum of both impacts and actions can be observed across the vast majority of the US economy.

We believe that the COVID-induced economic collapse will greatly accelerate several ongoing trends:

• Global supply chains will fragment as companies look for more resiliency
• Continued reconsideration of extent of reliance on China compared to lower-cost and lower-profile countries
• Automation will be more widely deployed in a range of activities and sub-functions
• Back-office functions will be increasingly outsourced
• The value of office real estate will diminish due to large-scale adoption of remote ways of working
• Assessing the impact "black swan" events will become the norm in scenario planning

Jeff Schlosser, EY US Supply Chain Transaction Leader and Jay Camillo, EY Americas Operating Model Effectiveness Leader, explain why a post-pandemic supply chain will prioritize resilience over efficiency.

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• COVID-19 has forced companies across all industries and geographies to pivot towards a "new normal" related to their supply chains.
• Supply and demand plans became irrelevant practically overnight as companies reprioritized to serve critical needs
• Lean, linear supply chains are losing favor to parallel structures that allow executives to pivot production in response to demand shocks
• Traditional levers of consolidation and rationalization will lose popularity and efficiencies will have to be found elsewhere amid rising costs and condensed margins
• Companies are modelling future scenarios to plan for catastrophic events
• Regulation is widely anticipated to be a global response to the pandemic, as companies will be increasingly scrutinized (and rewarded) for supply chain resiliency

In order to forge a sensible path to this new world, tax teams will need to work closely with business and operations teams and ensure tax efficient measures are considered including evaluating the challenges and opportunities inherent in this pivot from lean to agile.

• Near term: for liquidity and tax liability management, internal reviews of legal contracts and government agreements to find opportunities for flexibility and efficiency
• Medium term: as companies pivot, external evaluation of new incentives as tax authorities seek to help companies cope
• Long term: as companies move to resiliency, shifts of manufacturing require close evaluation of exit liabilities, IP development and use will require careful review, and indirect tax consequences in the excise, customs and VAT area will require management

Nick Boaro and Sven Braun of the EY Transaction Advisory Services and Working Capital Group explain why freeing cash from working capital can allow PE to prolong sustainability, realize value sooner and invest earlier.

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Four reasons why a PE-backed company would want to optimize cash flow now include:

1. Up to 7% of sales can be unlocked and released quickly.
2. Unlocking cash is the cheapest source of liquidity.
3. Companies with optionality are in a stronger position to reinvest for growth.
4. A successful outcome in one portfolio company can inspire other portfolio companies to take the same journey.

Working capital is the cash a company has tied up in assets less the cash it holds as a liability; a financial metric that represents the amount of day-to-day operating liquidity available to a business. Freeing cash from working capital is the cheapest source of additional liquidity often unlocked to pay down debt, fund day-to-day operation or fund strategic initiatives.

Today, private equity funds and their portfolio companies are able to unlock on average 5%-7% of revenue in cash flow improvement within 3-6 months of completing 8-12 week operational improvement programs. A company that optimizes working capital increases liquidity, improves predictability of cash flow and increases visibility in all areas of cash.

Because of COVID-19, many PE funds are laser focused on forecasting and releasing cash to prolong sustainability, realize value sooner and invest earlier. PE funds are asking for liquidity forecasts from across the portfolio to measure exposure, identify opportunities and quickly accelerate cash flow for as many companies as possible. Where corporations have complex hierarchical structures that force them to move slower with more measured outcomes, PE is able to act more quickly.

Having a "cash culture" is important for any company, especially now. After all, cash is the cheapest source of liquidity a business can generate, and it provides critical funding in either a downturn or growth period. Healthy cash flow is a positive indicator of a company's preparation for an economic downturn; however, it isn't too late for companies to improve cash flow, so they have greater optionality when opportunities arise.

Jennifer Shearer and Alexander Ludwig Reiter of the EY International Tax & Transaction Services group help PE funds and portfolio companies understand and manage the tax implications of recent coronavirus stimulus packages.

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COVID-19 stimulus legislation in the US and Europe is designed to ease the strain on businesses with particular focus on small and medium sized companies, keep people employed, increase liquidity and provide access to much-needed capital. Loan programs, cash tax defer programs, tax incentives and compensation for reduced working hours are all being deployed. Key focus areas for private equity are as follows:

Immediate: focus on liquidity and establishing task forces to triage needs across the portfolio.

Short-term: use a coordinated approach to evaluate need and eligibility for assistance. There is a lot of detail and nuance to consider when evaluating these programs, as loans have restrictions and some PE complexes may not qualify depending on how they are structured. Differences in policy adoption across US states and between European countries also adds complexities.

Medium term: take time to understand the fund and portfolio structure in order to determine which measures can be taken without inflicting damage. Debt buybacks present an attractive opportunity but come with important tax considerations.

Longer term: broken supply chains at the portfolio level will need to be fixed. Global sourcing structures will be re-evaluated. The "just-in-time" inventory management strategy will also be re-examined as company seek to protect themselves against future global disruptions. Digitization will drive improvements in sourcing practices and multi-channel distribution. Lastly, a focus on improving "corporate hygiene" by investing in cybersecurity and technology that enables remote ways of working will remain top-of-mind.

Karim Anani, Financial Accounting and Advisory Partner, and Lukas Hoebarth, Strategy & Operations Partner explain how to manage a remote close in today's volatile financial and regulatory environment.

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While there has been a growing trend towards remote (or virtual) close for several years, the need for this capability has not only been accelerated but thrust into an volatile environment. Unforeseen complexity due to macroeconomic uncertainty, regulatory change, remote ways of working, incomplete information, workforce uncertainty and cybersecurity risks threaten vital systems of control that must now pivot to cover the risk mitigation they were designed to provide.

Private Equity CFOs and finance teams are instrumental in connecting the dots throughout the organization and will play a pivotal role as the business partner to the CEO. Analysis of short-term liquidity forecasts, tax implications and business plans will impact investment decisions and expose resource constraints across the private equity portfolio in the weeks and months to come.

In order for CFOs to cultivate successful remote close outcomes, they must focus on:

• Communication: holding regular meetings and establish expectations for communication
• Collaboration: establish and maintain healthy ways of remote working
• Preparation: organize a PMO to map the close calendar, identify exposure and predict/solve for different scenarios
• Motivation: keeping spirits high and nurture positivity

Five complexities will drive additional focus on the upcoming reporting cycle:

1. Delays in the close process due to remote ways of working, personal distraction and impact of available (or unavailable) technology
2. Different/additional analysis will be required to "close the books"
3. Incomplete information from upstream operational activities and suppliers
4. Sensitivity of data in a remote working environment brings cybersecurity and potential vulnerabilities into question
5. The ability to ensure the controls environment is sufficient to ensure accuracy for stakeholder signoff

Mike Lo Parrino, EY Americas FSO Private Equity Leader, explores the evolving role of the private equity CFO.

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In the seven years since EY has conducted the Global Private Equity (PE) survey, private equity CFOs have assumed increasing responsibility for the overall operations of their firms.

They have expanded their oversight beyond the traditional finance functions to include IT system implementation, investor relations and cybersecurity, even as the industry has experienced record growth. Now they are expected to take on an even more strategic role, assisting with the decision-making and deployment of new investment products, location strategy and a changing investor profile, while also keeping a mindful eye on increasing margin pressures.

At the same time, private equity CFOs are also leading the effort to find ways to deploy innovative new technologies, particularly those that leverage next-generation data and robotics. As part of their more strategic mindset, they are also helping to elevate their firms' overall talent profile and interact more frequently with portfolio companies.

The PE CFO's role has evolved over the past seven years in five key ways:

1. The CFO spends more time than ever on asset growth, innovation and talent.
2. CFOs must strike a balance of tactical and technical skills to be effective, strategic leaders for their entire organization
3. Attracting and retaining diverse talent combined with an inclusive culture are top talent management priorities
4. CFOs consider advanced technology solutions to complement new, strategic responsibilities
5. The next generation CFO will leverage data for the benefit of both the private equity firm and portfolio.

To read the full survey, visit ey.com/privateequity.

Andrew Wollaston, Global Private Equity Transactions Leader, and Peter Witte, Global Private Equity Lead Analyst, discuss how PE firms are planning for a potential market correction and the opportunities it might afford.

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While PE-backed companies performed generally well during the GFC, over the last decade, the PE model has evolved in a number of ways that make it even better prepared for future downturns:

• The industry has more capital at its disposal
• PE has diversified in ways that increase its resilience.
• PE firms have expanded their operating capabilities.
• LPs are more sophisticated and have access to better portfolio management tools.
• Perhaps most significantly, PE firms are prepared to deploy more aggressively than during the 2008 recession