The story of private equity is really two stories. One is about PE firms investing in and enhancing the value of their portfolio companies. The other is about slashing expenses to the bone in the quest for a bottom line that may appeal to certain gullible potential acquirers.

Both are abundantly true stories. While it’s an eminently viable asset class, private equity suffers from an identity crisis caused by frequent missteps.

Dan Fletcher

“You’re not wrong,” says Dan Fletcher, CFO of Host Analytics — which was acquired last January by PE firm Vector Capital — when asked to comment on the darker scenario. “PE developed a reputation for cost-cutting, including unnecessary and misguided layoffs and store closings, through real-world events. There are well-documented stories about it, and I’d never try to shuffle those under the rug.”

The scenario often materializes after a PE firm made some irresponsible or misguided assumptions during M&A due diligence, notes Fletcher.

“Now they’re stuck with an asset that’s not performing to the numbers they underwrote,” he says, “and they start to panic. And what’s the easiest thing to do then? Offload costs to boost EBITDA and the bottom line and hope a buyer will come along, see it as a profitable business, understand that it’s got some topline problems, tuck it into their overall business structure, and make more cost cuts, thinking it will suddenly work.

“But,” he continues, “that’s not the model that I employ.”

Youthful Wisdom

Fletcher, who’s also a vice president at Vector Capital, has packed a lot of relevant experience into the mere 12 years that have transpired since he came out of the University of Missouri, where he earned accounting bachelor’s and master’s degrees.

Career stops have included three years as a capital markets associate at PricewaterhouseCoopers, a year as a manager at Allstate Investments, two years at PE firm Sterling Partners, and four years gaining operational experience at consulting firm Alvarez & Marsal, before joining Vector Capital in July 2018.

“I learned a lot about investing at Allstate and pretty quickly segued into private equity, having discovered that it was the asset class I thought had the greatest potential for long-term returns,” says Fletcher.

“The idea of not just financial engineering but really being able to look someone in the eye and say, ‘We are here to invest and to improve your outlook,’ became a theme in my career. We add strategic and operational advice, cash resources, and expertise” — in M&A, R&D, international expansion, pricing optimization, supply chain management, strategic sourcing, business development, and demand generation.

Also supporting Fletcher’s belief in PE is the fact that it’s private ownership. “When it comes with the right intentions, you can simply get things done that you cannot get done under public ownership,” he says. “It’s total alignment on strategy at the board level and all the way through the business, with everyone reading from the same sheet of music.”

Additionally, Fletcher notes, PE firms often buy distressed companies. “It amounts to saving the business and related jobs with capital and expertise, where others wouldn’t try.”

Down the Middle

Host Analytics provides cloud-based corporate performance and business analytics software. Applications allow financial consolidation, disclosure management, budgeting, forecasting, reporting, and strategic planning.

Fletcher’s mission is recalibrating the business by developing and managing a five-year strategic and operational plan to focus strictly on the middle market. That’s generally defined as companies from $50 million to $2 billion in revenue, although Host has and will consider larger clients on an “exception” basis, he says.

Formerly, he says, Host Analytics had been “chasing up and down the whole ecosystem of potential customers.” Targets included, for example, large companies like Apple and United Airlines, as well as tiny pre-revenue businesses.

In pre-acquisition due diligence, when Vector Capital segmented its customers and sales targets by revenue size, it found that Host Analytics, its software, and its customer service “worked really well” in the middle market. Win rates, customer retention, and customer service were and “sky-high,” according to Fletcher.

“Above $2 billion, it gets complicated,” he says. “It’s spotty — sometimes it works, sometimes it doesn’t. Win rates and retention were lower.”

Complexity also reigned at the low end of the market. “Some businesses of that size make it, and some don’t,” Fletcher notes. “One year they have the cash to invest in the tools, and the next year they’re pulling back. And the leadership changes frequently. The SMB market was a challenge.”

The sharper customer focus involves “a tremendous amount of organization transformation,” he points out. It involves a recalibration of everything from the marketing machine to the product roadmap, and everyone from the executive suite to fairly new employees has to make some kind of shift.

Six Levers

Before building the fiscal 2019 budget, Fletcher sat down with his team to identify what it could do to support the company’s middle market “thesis.” They came up with six levers.

The first order of business was shoring up cash flow. Host historically wasn’t great at collecting its revenue and always paid vendors faster than receivables were coming in. “We had very long and high days sales outstanding and very short and low days payable outstanding,” the CFO says.

Fletcher set a target year-end cash goal and invested in some systems to help automate accounts receivable. But the real game-changer was a new incentive program for the company’s collectors.

Each month, each collector has a target level, a “home run” level, and a “grand slam” level of collections, for which they get bonuses of $200, $300, and $1,000, respectively.

“Now they’re more like salespeople — they have a commission structure offering a real reward if they’re diligent,” Fletcher points out. “It gets them in the game, and it’s about elevating them in the organization and recognizing that what they do bringing in cash is the lifeblood of the business.”

Second, the members of the finance and accounting team were charged with being brand ambassadors. That has multiple components. One is being available to speak with media or participate in webinars. The other is speaking with prospective customers about Host’s product solutions.

“Everyone wants to know how we use our own tool,” Fletcher says. “I told my team that we need to be the best at using Host Analytics’ solution. We need to be at the bleeding edge of what it can be used for.”

The third lever for the finance team is building out an international infrastructure. Before this year, Host Analytics operated only in the United States and India. In 2019, the company has commenced operations in Australia, South Africa, and the United Kingdom. Additional international expansion is on tap for 2020.

The entry to each new country requires a business case; striking agreements with resellers that spell out incentive compensation, geographical boundaries, sales motion, and rules of engagement; implementing systems and making sure the company’s technology stack can handle the expansion; setting up a banking infrastructure; and engaging solution consultants for clients.

Fourth is simply helping the company grow by providing decision support and enablement on various product lines, pricing, and sales incentive compensation.

The fifth is positioning the finance team as value-additive business partners. “If someone comes to us and says it’s not in the budget but they really need to hire another customer service rep, we don’t say no,” says Fletcher. “We say, let’s try to make it work together. We’ll help you build a business case, and if the ROI is there, we’ll make room in the budget.”

Finally, the team is standing ready on the M&A front until it’s “called to duty” to add to Host Analytics’ product suite or add markets through acquisition.

Multiple Masters

Meanwhile, Fletcher reports dually to new Host Analytics CEO Grant Halloran and to an operating partner at Vector Capital.

The arrangement isn’t devoid of sensitivities.

“One of the trickiest pieces of my role is to understand when something needs to be socialized among the executive leadership team before it goes to the board/ownership group,” Fletcher says, “and when I should just be transparent and foster a culture of openness — even just in conversation, for example, expressing concern about a deal that might slip.

“I think I have the right balance now, but it’s incredibly nuanced.”

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One response to “The Two Faces of Private Equity”

  1. Beyond certain media channels that like to demonize PE, I am not aware that it has “developed a reputation for cost-cutting, including unnecessary and misguided layoffs and store closings, through real-world events.” There are generally two reasons why: (1) with over 4,000 PE firms in the US (according to Pitchbook) and with plenty of “dry powder” (approaching $1 trillion) founders who sell their companies to PE firms are in the drivers seat — they can select a firm whose vision and culture are aligned with their own, and (2) it is a little difficult to imagine a PE firm that isn’t creating value — selling an enterprise for more than it paid — will be around long enough to raise another fund and those with reputations of purely cost-cutting are unlikely to attract long term investors.

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