Why management due diligence (MDD) needed to evolve into team and organisation strategy - and beyond
We suggested recently that private equity investors are involved in building ‘value machines’ built from four components: partnership; governance; expectations; team & organisation strategy. That has implications for people like Catalysis who work with investors, CEOs and Chairs designing management and organisational solutions for growth companies. Let’s have a look at where things started, where they have reached now, and where they may lead.
Where MDD started
The language used above would have sounded weird thirty years ago. When I was introduced to investing through EVCA (now called Invest Europe tag: www.linkedin.com/company/invest-europe/) back in 1994, our course notes (now lost in an archive box) advised us to find companies displaying a list of desirable features beginning with the letter M. Market was one, Moderate valuation may have been another. Not surprisingly, Management was definitely there, in the sense of a solid team with relevant experience whom we could confidently back. Since most deals were MBOs in those days, there was an expectation that (i) most teams should already be well established in their skills and, (ii), we would screen out teams which didn’t look up to scratch. There was little sense we would be responsible for sorting out weak teams except in extremis.
In that context, it isn’t surprising that when management due diligence emerged as a significant activity in the early 2000s, it focused on checking whether the personality, motivations and experience of management teams were backable or not. There might be some developmental suggestions, but MDD was mostly a descriptive activity leading to a punchline related to risk and success probabilities.
Where we have arrived
Twenty years later, however, and much has changed. Mid-market investors who paid low entry multiples, deployed plenty of debt, grew earnings due to mostly benign economic conditions, and backed experienced teams, now pay higher multiples, use less debt, are faced with a more volatile environment, and largely back entrepreneurs. That has lowered overall returns, increased risk and forced the investment process (pre-and post-deal) to become more rigorous. Moreover, management teams expect investors to be value-adding partners not just light-touch backers. Consequently, investors have necessarily become preoccupied with value creation – and the creation of ‘value machines’ to make that possible.
Twenty years later, however, and much has changed. Mid-market investors who paid low entry multiples, deployed plenty of debt, grew earnings due to mostly benign economic conditions, and backed experienced teams, now pay higher multiples, use less debt, are faced with a more volatile environment, and largely back entrepreneurs. That has lowered overall returns, increased risk and forced the investment process (pre-and post-deal) to become more rigorous. Moreover, management teams expect investors to be value-adding partners not just light-touch backers. Consequently, investors have necessarily become preoccupied with value creation – and the creation of ‘value machines’ to make that possible.
The implications for people advising investors on management issues are multiple:
The scope of our work had to expand from a dominant focus on the top few people to, now, encompass team and organisational effectiveness.
The purpose of the work has moved from mostly assessing the status quo to helping map out what roadmap for improvement.
Although reports remain important outputs, the emphasis on other forms of advice and feedback has grown with more ad hoc discussion along the way.
Whereas old MDD definitely served investor clients, the work is now expected to create substantive value for management (and NEDs) whom we increasingly consider as equal clients.
Meeting those requirements has created more complexity which, in turn, has created a greater need for better tools, data, processes – as well as project leads who can cope with those as well as work as trusted advisers at board level.
The Catalysis label for that is ‘team & organisation strategy’, reflecting the wider and more dynamic nature of the offering.
Beyond team & organisational strategy
However, even that label has its limits as clients expect useful input on other components of their value machines: the investor/management partnership; board and governance arrangements; and strategic objectives and financial expectations. Consider each of those in turn:
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There are several ways in which we now contribute to the construction of the investor/management relationship:
• Investors ask more explicitly whether teams are seeking a genuine partnership with them, and our recommendations more often comment on how to create alignment.
• CEOs are more likely to ask for informal insight into the style of the investors and how the post-deal interactions might work.
• The style of our work is seen by managers as a reflection of the culture of the investors.
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We are also drawn more into this area:
• Investors and CEOs have increasingly sought guidance on what sort of Chair or other NEDs might best fit the requirements of the growth strategy.
• We often talk through options for who from the executive team should participate in the Topco board.
• Occasionally, we have been asked to advise on which individual investor might be best suited to handle (usually trickier) board roles.
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This is a key area where value creation and value enablement intersect, because:
• Strategic initiatives are just wishes unless tested for executability via team and organisation.
• The speed of progress in executing growth plans can be seriously constrained by business model complexity, market/competitive conditions and the overall level of challenge in the various types of change anticipated by value creation plans.
• Figuring out the inter-dependencies between strategic options and team/organisation options needs debate and iteration which we are typically part of.
These shifts feel structural rather than temporary, and new pressures on investors may lead to additional areas where input is required. Meanwhile, though, there is plenty for investors and providers to digest and get better at.
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