Buyout firms' use of management consultants is increasing, as private deals become more expensive and buyout firms have to justify paying premiums.
Although these consultants long have worked with buyout players, their role is changing, as principals of the management consulting firms realize there is more money to be made on the deal origination side of a buyout.
To that end, some management consultants and buyout firms have established solid, but informal, ties with strategic consultants choosing to be compensated with equity. Formal relationships have been formed in other instances, with management consultants and buyout firms using their strengths to raise money and fund deals.
The continuing health and growth of the buyout business is driving the trend of increased involvement of management consultants in the buyout business, according to Wayne Cooper, president of Kennedy Information, which tracks the activity of consulting firms.
". . . The business is getting bigger and the stakes are higher," Mr. Cooper said from his Fitzwilliam, N.H., office. "It's an insurance policy to bring a consultant in during the due diligence process in an attempt to leave no stone unturned."
The other reason is money.
"They (the consultants) went to school with the buyout people, and the buyout guys are making so much money," Mr. Cooper said.
The trend has strengthened during the past six months, notes Jay Lucas, managing director of management consultant Lucas Group Inc. He expects to see more relationships between consultants and financial buyers come to fruition in the next two to three years.
"The deal environment is so much more competitive and fund sizes have increased such that everyone is looking for an edge," said Mr. Lucas, whose New London, N.H.-based firm has worked with buyout funds for seven years.
First Atlantic Capital Ltd., a New York-based buyout firm, is staffed with ex-McKinsey & Co. consultants, including Chairman and President Roberto Buaron. McKinsey is the world's largest management consultant.
Other ex-McKinsey consultants at First Atlantic include Managing Director Joseph Haviv, a 12-year McKinsey veteran, and in a part-time position, Charles Shaw, a 20-year-plus McKinsey employee who is in the process of retiring from the consulting firm.
First Atlantic doesn't have a formal relationship with McKinsey, preferring to use it and other management consultants for specific deals, Mr. Buaron said.
"My theory is that at this point, with prices of acquisitions being quite high, it's essential to find a way to add value to achieve a high rate of return," Mr. Buaron said. "Our approach to adding value is to get involved with a company and improve operations and strategy and make add-on acquisitions.
"I can't think of people more qualified than consultants who have been doing that for years."
Management consultants that work with First Atlantic are compensated with a combination of fees and a "special arrangement" Mr. Buaron declined to describe.
Mr. Lucas said Lucas Group is compensated with equity. The firm has worked with Nassau Capital LLC, Clayton Dubilier & Rice Inc., McCown DeLeeuw & Co., Jupiter Partners LP, Chase Capital Partners and DLJ Merchant Banking Partners.
"There are two aspects of working with a private equity firm that a consultant needs to master: economics and the style of work," said Mr. Lucas.
"Deal firms don't like to pay fees on a busted deal or prior to the completion of a transaction," he said.
"It's also important to put something at risk. Our culture is to put our fees at risk to align interests.
"We (buyer and consultant) are both trying to increase value."
Principals from Boston-based management consultant The Parthenon Group and buyout firm Summit Partners formed Parthenon Capital Inc., which closed a $250 million middle-market buyout fund in June.
Parthenon Group, on its own, previously had invested more than $70 million in three buyout deals and 31 minority investments in the past five years.
Questor Partners Fund LP's core strategy leverages off its relationship with turnaround specialist Jay Alix & Associates, said Robert Shields, managing director and chief operating officer of Questor Partners.
Jay Alix heads Questor Partners and the turnaround firm. The firm is brought into a company and assumes management decision-making responsibilities rather than working as a consultant or adviser to management, said Mr. Shields.
"The whole thesis of our buyout fund was to focus on noncore business units, underperforming companies and distressed companies," Mr. Shields said of the fund, which dates to 1995. "That is the same focus that Jay Alix & Associates has in its strategic management and turnaround business.
"The investor's purpose in putting money into our buyout fund was to concentrate in this sector that would leverage off the expertise of Jay Alix & Associates," said Mr. Shields.
"In appropriate situations, we would work very closely with Jay Alix & Associates to enhance profitability."
Five partners of strategic consultant Monitor Co. Inc. recently joined with partners from The Clipper Group to form Monitor Clipper Partners, an independent buyout company based in Cambridge, Mass.
"The reason that both (firms) decided to do this is the ex-Clipper guys realized Investment 101 won't work anymore," said Monitor Clipper Managing Director Mark Thomas. "You need some type of edge.
"There is too much capital chasing deals. Sellers of deals are smarter nowadays."
Although Monitor Clipper Partners is separate from and independent of the firms from which the partners came, they will receive consulting assistance from Monitor Co., which also committed $35 million to Monitor Clipper's first fund, the $625 million Monitor Clipper Investment Fund.
The $2.5 billion Boston City Retirement System committed $10 million, said Donna Mueller, the fund's executive director. A spokesman for Boeing Co. said its pension fund also committed to the partnership, but he declined to disclose the amount.
Other tax-exempt investors that reportedly committed to the fund are the Ralston Purina Co. pension fund, St. Louis, and the Menlo Park, Calif.-based Stanford University endowment.
The buyout firm will focus on three themes:
* Industries that are undergoing fundamental change;
* Complex industries with multiple product variations and distribution channels; and
* Industries in which there is convergence of formerly disparate operations or technologies.
"Monitor Co. will make available to us this type of expertise on an as-needed basis, as long as there is no conflict," Mr. Thomas said.
The issue of conflict of interests has become more prominent as strategic management consultants have altered the traditional fee-for-service relationship they enjoyed with the buyout funds.
"Traditionally, management consultants considered one of their values to be the ability to be independent and deliver bad news," Mr. Cooper said. "When you become an owner, it is sometimes harder to do."
Mr. Cooper cites an example of a consulting firm that has an equity stake in one company and advises other companies in the same industry in which its company participates.
The same conflict could exist in a simple fee-for-service arrangement, but many consulting firms have developed walls between project teams, Mr. Cooper said.
"If you are a part owner, it raises potential conflict of interests or the perception of conflict of interests," he said.
Monitor Co.'s policy is to ask clients if there is a problem, Mr. Thomas said. "Tie goes to the client," if there is, he said.
"Personally, my job is to have a foot on both sides of the fence. I am the guy who is supposed to watch for conflicts.
"You need to have a guy senior enough in both organizations to make sure the policy is adhered to."
