Private equity firms are highly focused about the operational enhancement tools that they choose to employ in any given situation.
Experience has shown that attempting to tackle too many areas of improvement at once can stretch management too thinly and produce poor outcomes.
These areas of focus will be identified during due diligence and implementation will be critical to the 100-day plan. Working capital control and the adoption of more sophisticated pricing strategies are typical examples of areas private equity sponsors will choose to focus on early in the life of a deal.
Transformational acquisitions or international expansion, meanwhile, may be identified as key areas of focus for later in the investment cycle, once the business has been optimally positioned for this more radical change.
“Making sure the management team remains focused on key levers of change in a business is critical, and is especially important for smaller companies where resource constraint means if you try to do too much, you run the risk of not delivering on those areas that can really drive value,” says Bryan Turner, independent transformation director.
“Focus is one word that truly captures the power of private equity,” adds Oliver Gardey, head of private equity fund investments at ICG Enterprise Trust. “There is a relentless focus that pervades the private equity model, whether it’s in the diligence process or when managing complex strategic and operational change at portfolio companies.”
Private equity firms can no longer lean on multiple expansion for returns. Slowing economic growth has weakened the potential for relying on multiple arbitrage.
Equally, cost-cutting opportunities have typically already been baked into inflated asset prices or have been captured by a previous private equity owner.
The emphasis has therefore fallen on the ability to relentlessly drive top-line growth through commercial acceleration programmes, which can impact on exit multiples. According to Bain & Co, there is a median return on investment of between 20 and 30 percent when firms focus on commercial acceleration, rather than cutting costs.
Typical growth drivers include: incentivisation programmes to improve sales team behaviour and performance; pricing strategy; marketing initiatives; expansion into new markets and refocusing on the most profitable segments, while moving away from poorly-performing areas.
As Friederich von Hurter, partner, M&A Integration at PwC Germany, points out: “In nearly all cases there is low-hanging fruit. A fresh perspective can identify drivers that management and the owner do not have on their agenda.”
Hiring technical or functional expertise, developing new products and services or revamping the business model are also useful levers. Strategic acquisitions are key and have a potentially transformative effect.
This will often fall to operating partners or specialist portfolio management teams to implement. Such teams have proliferated greatly since the financial crisis. At ECI Partners the commercial team helps companies with bespoke projects ranging from improving the onboarding process for new clients, to identifying acquisition targets that will help them enter new markets, says the firm’s investment director, Duncan Ramsay. “By including our commercial team in a pitch process, we can demonstrate early on to management teams how we can add value to their business.”
Digital transformation remains one of the most potent growth drivers, with meaningful impacts on operational improvement and, ultimately, returns. “The technological changes over the past decade have driven substantial growth in new business models and led to significant value creation, even with relatively weak growth in the major economies,” says Oliver Gardey, head of private equity fund investments at ICG Enterprise Trust.
Despite the value these growth drivers can provide, however, PwC’s recent Creating Value Beyond the Deal: Private Equity survey found only 45 percent of private equity dealmakers realise value through revenue enhancement, compared with 49 percent of deals completed by corporates. Furthermore, while 74 percent of value-creating deals delivered revenue growth, this value lever still received less focus than cost cutting and work on driving working capital efficiency, suggesting a real opportunity for firms that seek to differentiate themselves based on their growth strategies.
Portfolio company leadership, talent development and culture are playing a more important role in driving operational performance and value creation.
At the same time, leadership issues, talent gaps and ineffective management teams can significantly hamper growth and impact returns.
As a result, the majority of private equity firms have now hired heads of talent of some description, who work with the management team to develop a 100-day plan for human capital, alongside the operational and financial plans, and who will help implement these strategies.
Importantly it is not just a question of hiring and firing. Maintaining and building upon a successful company culture is critical. According to PwC’s Creating Value Beyond the Deal: Private Equity survey, 57 percent of dealmakers say cultural issues thwart value creation, while in every deal where value was eroded, more than 10 percent of employees left the company following completion.
“Staff retention, satisfaction and engagement is proving to be an ever more important and difficult challenge,” says Duncan Ramsay, investment director at ECI Partners. “Our experience is there is a strong correlation between the strength of a business’s culture and its success. This understanding led us to create our own people toolkit that portfolio companies can employ with the support of our in-house commercial team.”
Research shows that companies with strong values and a culture employees buy into tend to have happier workers, lower staff turnover and stronger growth. Ramsay offers two examples in ECI’s portfolio. “Moneypenny and B2B price comparison website Bionic have both been feted by The Sunday Times as two of the best companies to work for, precisely due to their strong cultures,” he says. “Perhaps it is no coincidence that these two businesses have also been ranked as two of the UK’s fastest growing.”
Firms typically approach human capital within a company with assessments of the chief executive and senior management, together with structures and decision-making processes, as well as surveys of staff morale. Firms may then invest in executive coaching or consultancy support, or make strategic restructuring or hires.
It is important firms act quickly on top talent. Hesitation, according to Bain & Co, can be a major source of value loss as it often results in unplanned replacements to correct suboptimal performance. However, it is important to also nurture middle management and staff further down the line.
Meanwhile, the open talent economy, in which technology enables firms to connect and work with professionals across borders, is reshaping traditional management strategies. “Firms need to become smarter and rethink their approach to human capital in the open talent economy,” says Charlotte Gregson, managing director at COMATCH, an online marketplace for management consultants and industry experts. “Perhaps surprisingly, the digital economy has made human capital more important. Assembling and deploying the right team to deliver growth and transformation is the new alpha.”
Inventory requires an investment of valuable cash. The faster a business can convert a customer order to a cash payment for goods sold, the better their cashflow and long-term profitability.
Just-in-time inventory management, negotiating reduced supplier lead time, eliminating obsolete inventory, optimising order size and purchasing frequency, and centralising inventory control are all favoured strategies. But inventory reduction must be implemented with care.
“Many understand the working capital benefits, but few understand how carefully this needs to be approached,” says Kent Robinson, operations partner at HKW. “Companies need a ‘shock absorber’ to deal with fluctuations in customer orders, product supply, and all of the variations to normal demand patterns. Because of this, any inventory reduction plan should carefully consider where this shock absorber is going to shift.
“Understanding demand fluctuations back to the source of variability, minimising that and then deploying the appropriate shock absorbers, can be a helpful model to make sure the business keeps performing as customers expect while reducing inventory.”
Joint ventures can represent an efficient means for a company to spread costs and risks, as well as achieve economies of scale.
They can also enable companies to gain access to new technologies or customers and improve speed to market, agility, synergies and diversification without a significant financial outlay.
Private equity firms will often turn to JVs in Asia in particular, given the regulatory constraints in some markets, as well as the dominance of large family businesses and state-owned enterprises that can make acquisitions complex.
These deals are not without their challenges. Legal structuring and personal chemistry can both undermine the strength of the JV, as can a lack of business plan alignment. Joint ventures require strong governance and active management in order to succeed. There should also be a clear exit plan in place from the outset.
Nonetheless, by exploring all the available value levers within the JV, including customers, suppliers, processes, staff, technical expertise and government relations, joint ventures can be a highly effective route to operational performance enhancement and value creation.