Sully's Stuff

Private Equity Firms Do It For The EBITDA

Jason opines on the growing relevance of Spend Management to companies pursuing mergers and acquisitions on SpendMatters. He's right. Cost reduction drives the achievement of merger synergies, and sourcing and procurement initiatives in the 1st hundred days following a merger can set the tone for a successful transaction.

We have even begun to see acquisitions where the acquired asset's spend management technology and operating model were a key piece of the value proposition. There are even private equity firm's that have set up their own corporate entities to execute strategic sourcing on behalf of their portfolio companies, and to evaluate opportunities as a part of the acquisition's due dilligence.

In 7 years at Ariba Inc. I've had the opportunity to work with several private equity firms. Without question, PE firms do spend management for the EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization. To the PE firm, the ding associated with every downward bid in a reverse auction is the sound of EBITDA going up.

The private nature and concentrated ownership of PE firms does give them some advantages in implementing a sourcing initiative, particularly in the area of commitment. These are not organizations where a lot of people have to "buy-in" to go forward. However, sourcing in the PE firm is not without its challenges:

First, while they are able to make decisions based on an owners right, PE firms are often seen as outside meddlers by their portfolio companies, and not particularly knowledgeable about operating the business, particularly in the early days of an acquisition. This is especially true if the PE hasn't yet installed its own leadership. Brokering this relationship between buyer and bought buyer can be delicate.

Second, when leverage is sought across portfolio companies, these companies often have no direct operating relationship, adding another layer of complexity to the first challenge.

Third, many of the companies purchased by PE firms are "distressed" maybe even coming out of bankruptcy. This results in extra effort being required to build trust with suppliers.

While PE firms have been relatively less interested in more operational procurement, this may change in the future, especially for firms that are more committed to operating their companies rather than repairing and reselling.

posted by Sully @ 6/01/2006