- Works with GPs to value firms for succession planning
- Future funds, eventual performance of investments taken into account
- Incentive compensation for younger partners a popular option
With more PE firms facing the challenge of transferring power from aging founders to partners in their prime, the question of how to value management companies is coming to the fore. CFA Jordan Barnett has been working with GPs since 2008, almost as long as he’s been with Murray Devine. The firm was doing mostly fair-value-accounting work when he joined; then the financial crisis hit and “our portfolio-valuation group took off,” Barnett said.
When “the market stopped functioning, third-party appraisals became more important,” he recalled. “We were able to build some pretty strong relationships coming out of that.” That includes with the alternative-finance providers that arose in the aftermath of the crash to become big players in the middle market.
Murray Devine helps BDCs and private debt funds value loans and equity stakes to comply with disclosure requirements or as part of restructuring processes. And Barnett’s team also works with PE firms to understand the value of their businesses for tax planning, minority-interest purchases or succession planning.
As firms become larger, raising more and richer funds, founders have a decision to make, Barnett said: “Are we growing something here that we want to go on into perpetuity, or are we just building something that’s centered around a partner and ends with a partner?”
If founders want their firm to go on, valuation is essential to planning. As GPs think through various arrangements, they have to consider questions without straightforward answers. For example, if a firm’s time horizon is much longer than the lifespan of its current funds, how do prospective vehicles affect its valuation?
Or how much is unrealized carried interest worth? Compared with management fees, carry is much more subjective, Barnett said: “The value of the carry is contingent on the performance of the investment companies, and they have to hit certain targets.” Since no investment is guaranteed to succeed, “you need to consider a large range of possible outcomes” when calculating the value of carry.
Barnett said the process of cashing out older partners and investing the next generation can be a complicated negotiation. For founders who have built firms from the ground up, “there’s this kind of illusion of control. There’s a tendency to overvalue, and a tendency for the younger partners to undervalue.” A natural push-pull dynamic can develop between buyer and seller. “They all bring these emotional biases to the table when you go through succession planning.”
Frequently, younger partners don’t get straight ownership: incentive compensation is also very popular. The questions then become “what are the hurdles [and] how aggressive are they before you start investing and participating in the economics as an equity holder?”
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