Interviews with Maurice Hernandez, Principal at Accel-KKR and Christian Hamilton, Managing Partner at Tenzing
Private equity funding has been a driving force behind deal activity and growth in our sectors in recent years, and despite COVID-19 the private equity capital available is at record levels. Structural change will always create opportunity as well as challenges, and private equity is well placed to help businesses emerge strongly and take advantage of the opportunities.
Feedback from private equity indicates they will continue to deploy funds and back ambitious entrepreneurs through 2020, both through direct investments (‘platform’ investments) and by funding existing portfolio companies in making acquisitions.
We can’t ignore however that COVID-19 and any prolonged downturn will have an impact on the private equity market, whether that’s in deal volumes, the characteristics that private equity look for, or deal structures.
We caught-up with two senior private equity investors to hear their perspectives on how private equity is responding to the current situation. Maurice Hernandez, Principal at Accel-KKR, a leading Silicon Valley-based technology focused private equity firm, and Christian Hamilton, Managing Partner at Tenzing, an independent private equity (PE) investor that invests in high organic growth UK SMEs valued up to £75m.
PE has more capital at its disposal than ever before. According to one study by EY, as of March 2020, PE funds were estimated to hold more than US$1.4 trillion in immediately deployable funds, the so-called “dry powder”. This means PE funds are poised to invest even during this uncertain period and the eventual recovery, and those investments would eventually spur other economic activities such as investments in growth, innovation, strategic alliances, and so on.
Beyond capital, sector-focused PE firms such as Accel-KKR, have expanded their operating capabilities in a meaningful way over the past decade – that deep know-how can be a real aid to management teams when navigating through choppy waters and also to help them make the most of the recovery period.
Specific to us, our firm’s mission is to grow our software companies through various cycles and we are planning to stay the course as we have in past cycles. Short-term investments for growth may be dampened as we head into a potential downturn but our long-term goal remains the same – to position our software companies for long-term growth and support our companies so they are able to maintain and then maximize their growth potential through this cycle.
Operational resources including: Cross-portfolio knowledge sharing including numerous, timely CXO mini-summits and sharing of best practices across our portfolio company management teams. Operational consulting resources through our captive consulting group – Accel-KKR Consulting — to assist with revenue preservation initiatives, cost optimization, customer success, cash flow/working capital management, group cost negotiations with 3rd party vendors.
Financing resources including: lender management (from revolver draw downs, covenant compliance and negotiation of special terms), accessing capital markets and providing additional equity capital through our fund capital as needed.
We have been generally impressed by the speed at which our management teams have come to acknowledge the sudden change and the likely deep and reverberating impact that have been brought on by COVID-19. Once they understood just how serious, widespread and potentially protracted these impacts were, they acted quickly and decisively to protect their company for the long term.
Several other things we were heartened to see:
So many of our portfolio companies showed tremendous empathy towards their customers. And in almost every case, our portfolio companies had something within our means to share with the customer that was timely, valuable and materially impactful e.g., one of our portfolio companies provides sophisticated algorithms to help large companies manage complex supply chains. Right away, the company was able to help customers make adjustments to their predictive models to reflect a world that have never been contemplated before.
Another portfolio company, which has a significant market exposure to the hotel and lodging industry, was able to quickly stand up a voice support service that shuttered hotels could use to answer calls even when they have sent all their staff home.
On the opposite end of the spectrum, one of our portfolio companies provide financial software to US community lending institutions. When the US government announced business lending relief programs (the PPP and soon-to-come MSL programs), the company was able to quickly modify its product to meet the program’s new requirement and release it to its banking customers.
So, whether it’s a product solution, customer support and training, new information or thought leadership, every single one of our portfolio companies has provided their customers with timely solutions, support, expert advice and knowledge sharing with specific implications of COVID-19 on their businesses, all with the goal to help customers navigate this uncertain time and to come out even stronger on the other side.
A strong and united can-do spirit that permeates throughout all our companies: from senior leadership to the rank-and-file, everyone rallied from Day 1 to keep business moving, to serve customers, and to protect the wellbeing of families, co-workers and the company itself. There is a strong sense of focus and direction that is bringing people together towards a common goal. Working virtually has not diminished that feeling of cohesion, and has in fact made work relationships even more authentic, patient and thoughtful. Even at companies that had to make difficult staffing decisions, everyone understood the reasons and appreciated management’s leadership.
As a USD fund, we are able to benefit from currency trends to take a forward leaning stance in European markets. Given our US heritage, we have been able to focus on technology and specifically software investing since our founding 20 years ago. As such, over that period we have been able to develop a very deep and broad set of resources specific to software and tech-enabled services companies that we believe enable them to not only maximize their growth potential but maximize their ability to withstand economic shocks.
We’ve been providing operational support with certain issues which are common across our portfolio companies. For example, we’re providing a central source of information and help with the government support schemes, to avoid having our eight portfolio companies each replicating the work. Another example is the way Glenn Elliott, our Entrepreneur in Residence, has been assisting our portfolio companies with HR-related considerations and providing them with assistance with communications with employees, customers and suppliers.
We’ve also been very struck by how the portfolio companies are pulling together to support each other and share practical help and learnings. This is something we’ve always emphasised and facilitated, and its importance is even more visible now.
Nobody has perfect information at the moment. The important thing is to make decisions quickly, and then to work hard to ensure the board and employees rally behind them. We have found that our portfolio companies’ employees have got behind the decisions of their boards very quickly, and this is in large part down to very high levels of communication and transparency. And that is the second key piece of advice I would give; don’t underestimate the very high levels of communication required at this time, whether that’s to employees, customers or suppliers.
The third piece of advice is to focus on liquidity and cash. A shift in mindset is required, in the short term at least, from a growth focussed CEO to a “battlefield CEO”, where cash and liquidity are king.
Our focus is on market leading businesses with a technology bias and that won’t change. The current crisis is re-enforcing the need for technology and that will continue to drive demand for innovative software solutions. We do however expect the economic environment to become tougher, and that will increase our focus on software that improves operational efficiency and generates genuine measurable ROI.
One key focus for us this year or us will be looking for founders who really want to take advantage of the opportunities being created by the current situation. A downturn can be an amazing time to build a business; to drive sales and marketing, build market share, build product, make acquisitions. We will be very keen to partner with founders who really want to attack their market, and want to have the right ownership structure and capital in place to do so.
We expect most companies to have trading wobbles during this period. The bigger question for us is how will the business trade in a recession? How will its end market be impacted longer term? How do the market position and the fundamentals of the business look longer term? We are investing for 3-4 years not the past few months, and building confidence over how a company will trade over that period is what matters.
Part of that, and particularly important in the current climate, is demonstrating a close relationship between a company and its customers. Are they asking the question what can I do for my customers and how can I serve them better? How often are they in touch with customers? Do they have a good working relationship? What this boils down to is whether a company is listening to its customers and adapting accordingly.
Deal volume will fall. I expect Q2 volumes to be very low, picking up slowly in Q3.
That said, the need for the solutions PE provide certainly won’t disappear. Most founder-operated businesses need some sort of change to their ownership structure at some point; founders want to de-risk or cash out in full, founders want to retire, or certain founders want to leave whilst others want to stay and build.
Our type of PE, lower mid-market, is not about using leverage to generate returns, it’s about providing solutions to founders’ needs. The current crisis and a prolonged downturn might require PE and founders to be more creative about deal structures, but the PE solutions will still be there.