Private equity & the downturn: 5 rules for a high-inflationary environment

Between the recession and a drop in M&A activity during the first half of 2022, dealmakers may be left wondering what their next move is. One thing is certain: The cost of lending for private equity firms will increase as the Federal Reserve continues its war on inflation with a series of rate hikes. And as credit markets become tighter, the days of easy financing for large acquisitions will come to a close. 

Dealmakers may have to go after smaller, add-on acquisitions to shore up the platform companies they used to enter a sector, target struggling competitors with a strong foothold in those markets—or both. Whatever growth strategy they end up pursuing, private equity firms looking to stay resilient in a downturn will want to keep these five strategies top of mind. 

1. Build an aggressive deal strategy in adjacent markets

Picture the M&A landscape post-recession, and plan for the fact that consumer behavior will change. Successful firms will position their portcos to take advantage of whatever catalyst eventually brings us out of an economic slump. 

How do you accomplish this? Broaden your list of targets to include companies in adjacent markets to “catch” potential market catalysts in closely related sectors. Diversification close to core businesses often holds the potential for higher margins and better net returns—a bold, if high-reward, move in a bear market. 

Dealmakers should also go on the offensive in their hunt for prospects. Lean on front-line employees, such as sales team members, to identify potential targets. Those staffers often have a deep understanding of why transactions fall flat, which businesses your portcos are competing with, and when a target may accept an acquisition offer—even if it’s not explicitly for sale.

2. Craft an investment thesis that accounts for slower growth

If your firm isn’t in the habit of putting together a clear and concise investment thesis—or even crafting one in the first place—now is the time to start. An investment thesis will not only help your firm lay out the value you expect to receive from an acquisition but also allow you to evaluate fixed costs and pinpoint operational value levers. These factors carry greater importance when capital is tight and rolling up your competitors holds greater risk. 

An ideal thesis outlines realistic objectives that take into account the slower growth of a downturn—and may be geared toward protecting profitability.. It also provides a roadmap to employees—both in leadership ranks and those further down the ladder––for how to integrate the new business into an existing platform. 

3. Get laser-focused on integration activities that drive value

When it comes to integrating a new acquisition, it’s easy to get overwhelmed by the hundreds of small things firm leaders can choose to integrate between two companies that, when taken together, don’t create value. Many firms working multiple acquisitions at the same time can get bogged down in the integration process, resulting in integration fatigue and unnecessary spending.  

This can be accomplished by building out a 100-day plan as well as a shift from an IMO (Integration Management Office) to a VMO (Value Management Office) to focus on the areas that drive the most value in the short term. 

A few value drivers to track during integration are:

Cross-selling Opportunities 

Start with what is immediately at your disposal––products and services that both your platform company and the acquisition offer. Ideally, you have acquired a company close to your core business that provides complementary offerings, which can present unique, profitable cross-selling opportunities. 

Cost Takeout and Reduction 

Businesses will need to land on an optimized structure that not only drives innovation but reduces operating costs. Don’t get distracted by pinching every penny––look for the quarters. Big cost sinks tend to come from duplicative processes such as multiple, redundant tech platforms or tech stacks servicing similar products or features.  

Product Development Strategy

Leverage data and analytics to understand your acquired customer base as well as industry trends and buying behaviors to drive new customer acquisition and find new ways to deliver adjacent products and services that will complement your existing offerings. Being a holistic, one-stop-shop in a fragmented industry can drive explosive growth, as it has recently in the e-commerce industry.  

To work fast, private equity firms need to realign their priorities. When integrating in a recession, it’s better to define what “done” looks like from the outset, accomplish those goals with as much agility as possible, and let go of achieving perfect assimilation. 

4. Retain high performers—even if they’re more expensive

Consolidation will result in redundancy among roles. To make smart staffing decisions during a reduction in force (RIF), it’s important to identify employees who are driving revenue growth and retain them—even if they are expensive to keep on. Retaining key talent will enable faster ramp-up to maximum productivity, and if your company needs to pivot, those employees can more easily be reskilled or cross-trained to align with the new direction. 

Identify your culture drivers – building a strong culture will foster productivity and retention, propelling a company to move faster and farther. Culture is essential in consolidations – the integration of people in an acquisition is as important as the processes and technology.  

And, don’t forget––as soon as a recession ends, and more job opportunities become available, those high performers essential to your company’s operations may well leave. Firm leaders should maintain a strong company culture and stay proactive in their retention efforts, and consider the costs of recruiting, onboarding, and training new hires in their RIF strategy.  

5. Restructure and consolidate platform operating models to be more digital 

Restructuring a business during consolidation is a great opportunity to prioritize cross-functional collaboration—especially if an acquired company has multiple teams working in silos. Adopting a digital operating model can instead help companies form agile, multidisciplinary, and product-oriented teams that design and build fluid experiences. Expanding these digital capabilities can even help your firm identify cross-selling opportunities and maximize revenue from them.  

Adopting a digital operating model can also streamline the creation of a combined data set to bring greater visibility to the company’s (and the acquired company’s) performance. By tracking a standard set of metrics and KPIs—customer data, employee data, operational data––a company can improve its internal operations, and ensure they are meeting the goals outlined in their investment thesis.  

Despite major headwinds and a downturn of unknown magnitude, private equity firms should see this moment as an opportunity to go on the offensive with their current investments. With the economy in recession, there is no better time to evaluate your firm’s inorganic growth strategy by taking these tactics into consideration.