Stout’s Rudi Moreno on Value Creation During Long Hold Periods

Holding periods for private equity buyouts are growing longer, and the longer hold times are changing the way firms approach value creation. Rudi Moreno, managing director in the transaction advisory group at global advisory firm Stout, joins Middle Market Growth Conversations to discuss whether extended holding periods are here for the long haul, how the trend is shaping growth initiatives and more.

Middle Market Growth: Welcome to the Middle Market Growth Conversations podcast, I’m Katie Maloney. Last year, holding periods for private equity buyout funds averaged seven years, their longest in two decades. Here with me to discuss how this trend toward longer hold times requires a different approach to value creation is my guest, Rudi Moreno, managing director of the transaction advisory group within Stout, a global advisory firm with an array of practices, including investment banking, valuation and transaction advisory. Rudi, welcome to the podcast.

Rudi Moreno: Thanks for having me, Katie.

MMG: So let’s start by talking about what’s behind these longer hold periods that we’re seeing in the market. What’s prompting private equity firms to hold onto their assets longer, and is this a trend you expect to see continue for the foreseeable future?

RM: I think there’s primarily two factors that we’re seeing that are influencing the longer holding periods. First and foremost, we’re in a higher interest rate environment. I think a lot of people were expecting that that would begin to reverse sometime this year. With all the recent news we heard from the Fed, it looks like it’s going to take longer than maybe initially a lot of us expected. So that is one of the things: Higher interest just makes it harder to get the deals done, to get the financing, etc. The second one, somewhat related to that, is the uncertainty around the direction of the economy. There were talks about potentially a recession coming due to the higher interest rates, [but] we were all kind of hopeful that there would be much more of a soft landing still to be seen. I think the combination of those two things really became a drag in the dealmaking environment over the last I’d say 12 to 18 months.

Now the reason that’s had an impact is that it’s just been hard to get deals done, both from the perspective of agreeing to valuation and what’s a fair valuation, giving the uncertainty, and the second one really is because firms have a little bit more time, it’s been hard to get through the diligence process. When we were in the heyday of the dealmaking environment in the 2021, 2022 period, a lot of companies were really willing to I wouldn’t say forgo diligence but take a little bit lighter approach because there was such competition to get deals done. Now we’re in an environment where that’s not the case and we’re seeing a lot of the companies actually being a lot more careful about diligence, not willing to overlook these items. And that’s definitely thrown gum in the works here and makes the deal go a little bit slower.

Now I will say that there is still record amounts of dry powder so at some point, this is going to have to turn. The private equity firms are going to have to deploy that capital. It’s really more a question of what’s the right timing. So right now, realistically, I think we’re all hoping that by later this year, we’ll begin to see a turnaround in terms of the deal environment, but it might flow later into 2025 as well. So we’re all anxious to find out exactly when that will be.

MMG: And in instances where a portfolio company is held for a longer period of time, what projects and initiatives are you seeing being prioritized and do those look different at all from what you might see during a more standard hold period?

RM: One thing we’re seeing a lot is actually bolt-on acquisition. One thing that I think is really interesting is, in terms of the number of deals, we’re still seeing a large number of deals. They just tend to be smaller in terms of size. When you’re looking at deal value, deal value has gone down, but in terms of the number of deals, I don’t know if it’s actually gone down as dramatically as the value of deals. So companies are finding that by doing bolt-on acquisitions, they’re able to continue to realize growth through those acquisitions. Not only that, but also by rapidly integrating them, they’re getting some efficiencies. So once again, it plays to the core of continue with the growth, driving efficiencies, driving that value. So bolt-on acquisitions are definitely something that we’ve been seeing a lot of.

On the operations side, because there are these longer hold periods, we’re seeing an increased drive towards adopting technology and making investments that are a little bit longer term in nature. You hear a lot about AI and that’s the cool and sexy thing, but there’s even more basic automation, automating manual processes, finding ways to squeeze out inefficiencies given that they’re going to have to be holding to these companies for a longer period of time.

MMG: I want to go back to your comment about bolt-on acquisitions. I was curious whether a longer hold period influences how a private equity firm thinks about organic versus inorganic growth and where they place their focus. Can you say more about that?

RM: I think, once again, they will always look at both. I don’t think they try to be exclusive one towards the other. Essentially, I think they will continue to look at both inorganic and organic growth. Now, one thing I will say is that because we do have longer holding periods, the sponsors are looking at a longer-term window in terms of being able to implement things that maybe if you’re going to have only a two to three year period might not be feasible. So investments in technology, things that you might not see the results on if you’re only thinking about a two to three year investment horizon, why would you make the investment if the returns weren’t going to be demonstrated right? If you’re looking a little bit longer, it makes more sense to invest in technology, to invest in things like AI. And I think that’ll actually help companies think a little bit more long term. So those are a couple of specific examples, but by and large, I think having a longer holding period just gives them a broader horizon when considering investments.

MMG: Another thing we hear about a lot is the lack of high-quality assets in the market in recent years. That’s coupled with an inward shift by sponsors as they focus more on their existing portfolio rather than investing in brand new platforms, which you alluded to earlier, or even postponing selling if they don’t feel that the timing is right for an exit. I’m curious how the pressure from LPs fits into this equation, Rudi. Are they pushing sponsors to offload stakes or influencing their decisions in other ways?

RM: I think LPs will always be pushing to try to get the cash in [sooner] rather than later, so I think there will be that continued push to basically have the distributions. On the one hand, I think that they’re realistic. They understand that you don’t want to force an exit if the market isn’t ready or if this specific situation surrounding the company they’re taking a look at is not ready to go to market yet. On the other hand, I think taking into account the fact that you want to make sure you get the best exit possible, I think a lot of them are willing to be patient.

That said, I think where the pressure is coming from is when you look at some of the sponsors raising new funds. If they’re not able to show a history of distributions, when you’re coming back asking for additional funds for the next fund you’re looking to raise, they do want to hold off a little bit and say, hey, look, first I need you to prove to me that you can actually successfully exit before I’m going to fund the next round. So once again, I don’t think they’re going to push for distributions immediately, [but] it might actually affect their willingness to invest in the next round, at least until they see some results.

Another thing I’ll add is when you look at it, if you go back to the 2019 to 2021 period, there was a substantial amount of fundraising and that was the period of time when we’d expect to see a lot of those funds begin to provide some distributions. And because that’s not happening, you have a lot more capital that’s still tied up. So there’s a little bit of a timing issue. But right now I think until they get a little bit more certainty in terms of the ability to capitalize and to bring the cash out and to realize those exits, I think there’s going to be a little bit of hesitancy in terms of additional fundraising.

One quick thing to add to that is, [in an article I read earlier today], one of the statistics I saw that was interesting was that when you look at fundraising in Q1 of this year versus Q4 of last year, it was down about 28% which is pretty substantial. Some of the things I talked about are probably some of the reasons you’re seeing that decrease in fundraising.

MMG: Rudi, you’ve described value creation as mostly keeping value from leaving a company. To that end, what are some of the strategies that can help prevent value deterioration?

RM: One of the things we tell companies—when you buy the company, there’s a deal thesis, there’s a rationale for why you think this is a good investment, and the first thing you want to make sure of is that you have that kind of joint vision with the management team around what the strategic intent of the business is. What are their inspirations, what kind of markets they want to play in, how do they expect to win? And then making sure they have all of the capabilities necessary to meet that, and if they don’t have them, making sure that they’re building those up. So first and foremost, making sure that you have [clarity] on that hypothesis and how you’re going to get there.

That said, at the same time, you also want to make sure that when you do these acquisitions, you understand what they have today and make sure you’re not taking actions to basically destroy the existing value. There might be value in certain technologies, the way they do business. So as you’re looking for efficiencies or potentially to integrate them into another business, you do need to be careful that you’re not destroying the things that create value for the business itself.

One example of that was a company that we worked with that had done an acquisition. They bought a company in an adjacent space, but their thesis going in was, “Hey, we’re just going to integrate this and bring them into our processes and our systems,” without really realizing that there were some unique things about the business that should have been preserved. And unfortunately, they weren’t preserved. So they weren’t getting the growth they expected and ultimately, they divested. So once again, while it’s important to have a vision as to where you want to go, I think it’s equally important to understand what value the business has to begin with and make sure you’re not taking actions that would negatively impact the ability to retain those capabilities.

MMG: One asset that I know is valuable in a lot of transactions from a buyer standpoint is the talent that they’re acquiring with the business. So I wondered if you can talk, Rudi, about how a talent focus and strategy might look different during a longer holding period.

RM: I think everyone’s very clear that talent is one of the key things that you’re acquiring when you’re doing these transactions. So with a longer holding period, one thing that’s interesting is a lot of people who are coming into these businesses or might be brought in if the existing management team isn’t retained is that clearly the win for them is to get that exit and the benefits that come with it. So as the exits are getting delayed, we need to think about ways to keep the talent motivated, either by putting in place other packages or finding ways that they can be compensated for continuing to grow and for holding on for a longer period.

With a longer holding period, one thing that’s interesting is a lot of people who are coming into these businesses or might be brought in if the existing management team isn’t retained is that clearly the win for them is to get that exit and the benefits that come with it.

The other thing I’d add is that if there are situations where there might be a longer holding period, you might want to take that into account when you’re thinking about who’s going to run the business. There are individuals who are more motivated by that longer term growth and thinking about “how am I going to build this business over the next four to six years” versus those individuals who are more motivated by going in, doing a quick turnaround, getting the exit, getting the cash and moving on to the next one. To a certain degree, it might be a little unpredictable when you’re getting into the deal, but to the degree that if the longer holding period is something we believe [will] stay, I think it’s important to take into account even when you’re considering who would be the right person for management positions.

MMG: Moving on to operations, what are some of the operational efficiencies that firms can tap into as they’re looking to boost value?

RM: It’s always a little bit hard to generalize because there are vast differences depending on the business. It’ll be very different for a manufacturing firm versus a services firm versus a technology-based company. The one common denominator is probably the first thing people to is G&A. There’s always some ways you can find to potentially cut costs in G&A, but make sure that you do that in matters that don’t ultimately affect the client or other key stakeholders. The other thing is that as companies grow, G&A does not grow at the same pace as revenue. So by pushing for growth and keeping the G&M essentially either flat or growing at a much lower pace, that’s one obvious area for operational efficiencies.

Getting to the manufacturing space, there’s obvious things around manufacturing distributions, consolidating sites, locations, all of that. But I think the one thing that people sometimes overlook is leveraging knowledge. If you have an acquisition, if you’re doing a bolt-on, are there things about the way the target was doing business that we can leverage into the business, into the portfolio company? We have to think about these things not only in terms of assets and asset efficiency, but also leveraging knowledge across the business or leveraging best practices.

One last area that comes to mind is streamlining systems and processes. By finding ways to leverage technology, especially with these longer holding periods, it does give you a longer runway in terms of investing in technologies that you might not see payback on immediately. In fact, there might be some increase in costs, but that’ll bring you dividends a year or two years down the road. So automation—a lot of people talk about AI, but there are some much simpler technologies that can get you some efficiencies in the shorter term without maybe being quite as sexy.

MMG: I know one of the areas you focus on at Stout is accounting and advisory. How do you recommend firms use their finance and accounting arms for value creation, given that those areas are not always thought of necessarily as value generators?

RM: Some of this is because we do this work, but I do see that finance and accounting play a very critical role across a whole deal life cycle. To begin with, a lot of things that finance and accounting does touch customers, employees and a lot of key stakeholders. And the more that you can run those processes efficiently, [the more] you can keep those various constituents happy and that can support your growth. The other thing I’d say is that finance is really a key partner to the management team. They are the holders of a lot of information that can give you a better understanding in terms of what products are profitable, which are not, what channels might be more profitable than others.

There’s a lot of information in the financial system that can be mined for better management decisions. While a lot of people focus on finance in terms of, can you actually deliver me the numbers and books and get the lender reporting done?, we ultimately want to get them away from a lot of that work and more focused on the value-add in terms of really supporting the management team around decision-making.

The other thing I’ll add is that in some cases it actually can support the broader growth story. Recently we were hired by a private equity firm to help them update some of their financial processes and a lot of it was really based on making sure that the financial and accounting team was ready to support their future growth. As we got in there, we found that there was a lot of things that the finance team was actually doing in support of the customers and that some of that was actually value added to the customers. So we did give them some recommendations in terms of making the processes more efficient, but we also found that there were things that they could do that were actually valuable to the clients, would increase stickiness, and some of it might actually allow them to request higher margins. It was a really good example of a case where the finance function was not just about producing the numbers, but really part of that customer experience, that customer delivery that could really help generate support, actually differentiating the market by doing things differently than the [customers?]. It would actually give them some capability to differentiate versus other companies in the similar space.

MMG: Before we go, I want to come back to technology. You’ve alluded to that at a couple points in the conversation, and like you said, artificial intelligence is the hot new thing right now. It comes up at every conference; it’s in every industry report that comes across my desk. So in that vein, what are some of the technological or data-based strategies that you recommend to firms that are looking to boost value in an extended hold period?

RM: Generally speaking, AI is one of the various technologies, but there are some simpler technologies that can get you a lot of the benefits of what AI promises but in the shorter term. I think we need to think about technology in terms of a couple of different things. It can help with everything from the early stages of lead generation, understanding the client base, mining your data to see where there might be customers where there are opportunities for cross-selling. But on the other hand, there are also tools to help increase your customer stickiness by providing additional services or enabling technology solutions around whatever product you have. Some of that stuff does vary industry by industry. But the one thing I’ll say is that it’s important to think about technology holistically, both from a back office technology to your operations technology to the technology you deploy from a customer perspective. Ultimately, the things that will generate the most value are things that will ultimately increase the stickiness or ability to deliver the products to the customer.

MMG: So it sounds like a takeaway is not to get blinded by the cool new AI floating around and more about some of the potentially more boring technologies, but that are the right fit for your business.

RM: Exactly. But once again, I’m not going to downplay the fact that AI will be a gamechanger. Some things definitely enable some certain things that weren’t possible before, but I think we just kind of lose the fact that it’s not the only technology out there. There’s a lot of other things available that companies can leverage.

MMG: We’ll wrap it up there, Rudi. Thank you so much for joining me on the podcast.

RM: Thank you for having me, Katie. Appreciate it.

The Middle Market Growth Conversations podcast is produced by the Association for Corporate Growth. To hear more interviews with middle-market influencers, subscribe to the Middle Market Growth Conversations podcast on Apple Podcasts, Spotify and Soundcloud.