5 key value creation strategies for Private Equity
5 key value creation strategies for Private Equity
Private equity fundraising has shrunk by nearly a third since 2021. Firms are having to operate in a more complex and changing environment, and this is creating fundraising challenges. The virtuous circle of investing at a fair price and exiting with decent returns used to ensure investor confidence for future funding rounds. Now, this cycle is starting to show signs of stress - is it becoming more vicious than virtuous? And what can be done to remedy this?
Value Creation trends and challenges
- S&P Global reported that 'dry powder' remains at a record level of $2.515 trillion. This excess of funds has been chasing a limited pool of quality assets, leading to inflated valuations.
- Increased market volatility both domestically and internationally means valuations and business predictability are far more difficult to nail down.
- There is increasing focus on international investment to drive growth as funds look further afield for investment opportunities.
- Advancements in technology are opening up opportunities to challenge traditional operating models and drive increased productivity but require careful investment to ensure a return at exit.
All of this points towards investors being more cautious in backing new funds unless there is a strong track record of exits with strong returns. Only the PE firms that have invested wisely and can show they have enhanced the value of their portfolio will attract future investment. At the same time, there is a bottleneck in exits, with hold periods extending to some of the longest in recent memory.
If assets are likely to remain in portfolio for longer, there is an opportunity for more fundamental performance improvement. It is critical that PE firms double down on value creation strategies to maximise their return on investment and accelerate their ability to crystallise returns for their investors.
5 ways to maximise and sustain value for portfolio companies
1) Broaden and deepen value creation planning
Hitting top line growth, although still important, will not differentiate in this market. Longer hold periods mean that there is the opportunity for PE houses to mine value further down the P&L in core operations and back-office processes of their portfolio companies.
Driving sustainable efficiency and boosting margins while maintaining scalability will be the key differentiators. PE houses will need to rigorously prioritise initiatives that maximise measurable EBITDA and cash generation at an acceptable level of risk to the business. They also need to begin value creation programmes as early as possible while maintaining 'business as usual'. This requires a true understanding of the specific environment and the level of change that an organisation can absorb. In our experience, businesses are often over-optimistic about their performance improvement assumptions and timelines, which, in reality, are often constrained by data quality issues and resource availability. Having an experienced third party to support and validate your management plans adds rigour and credibility, and data driven insights will accelerate decision-making and improve measurability.
2) How can AI strengthen Value Creation?
AI offers the promise of providing greater insights and increased efficiency. In some industries, it can be transformative. However, the costs associated with AI, especially for a business that has limited experience, can be significant and potentially risky. Understanding the capabilities of AI as a tool within a broader operating model environment, and its interaction with people and processes is fundamental to achieving success. Many PE-backed businesses still need to work on the core foundation of strong data - harnessing and understanding data in itself will drive significant improvements. Overlaying this with in-house capability and appropriate governance and accountability will ensure AI enablement switches from being a cost to a value multiplier.
3) Be proactive in tackling risks
Business leaders have seen some of the most volatile conditions in recent years, and it’s now imperative to have a proactive approach to risk. PE portfolio companies with an agile governance structure will be the winners and applying approaches like horizon scanning and risk-based scenario-planning will deliver clear advantages. Recent market volatility underlines the need to have the right processes and tools to triage risks and effectively manage and mitigate them. Make sure any tools used are pragmatic and do not become an industry in themselves but engage your key stakeholders effectively and efficiently. Depending on your situation, this can range from simple spreadsheets through to enterprise risk management tools.
4) Deliver in full on your Integration Business Case
According to most studies, between 70% and 90% of integrations fail to deliver on their promise. Some of the main drivers of this range from unrealistic business cases through to cultural differences and everything in between. Developing a realistic full potential plan of opportunities and delivering against it is critical. Establishing practical targets is important, but these targets need to be supported with the right team, resources and funding to achieve success. If any one of those elements is missing, value will be lost. The days of aggregating businesses while conducting ‘light touch’ integrations are over.
5) Look further afield
Identifying untapped or undervalued investments requires a wider net and greater international expertise to acquire and build businesses. Geographic expansion has its complexities but can deliver significant untapped value for investors if managed correctly. It requires local understanding and the ability to establish an operating model that works across jurisdictions while addressing other elements including tax, supply chains, regulatory, corporate and employment law.
What can firms do now?
The current environment for Private Equity means that Value Creation plans need to be deeper and wider to deliver competitive advantage. There is no silver bullet, rather a portfolio of levers that can be pulled. There is value in complexity if managed correctly – but the ability to course-correct effectively and efficiently as things change will increasingly become a key market differentiator.
Get expert value creation support
Our global network of Value Creation experts can deliver tangible benefits, whether your growth is organic or inorganic. We are experienced specialists supporting deals of all sizes, and work with you to optimise operations, deliver measurable value, and maximise sustainable profitability.
Our capabilities in operating models, cash optimisation and profit delivery are equally relevant outside the deal environment to improve performance and drive competitive advantage for portfolio companies. We specialise in mid-market and Private Equity, working with your senior teams to deliver value and manage risk in accelerated timelines.
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