Everything starts with the vision. It is the cornerstone of any value creation plan.
The vision includes understanding where you want to take the company in terms of its market position, business model, organisational structure and geographical footprint, says Alain Vourch, partner at Charterhouse Capital Partners. “The vision is going to be your compass. If you don’t have that, the risk is huge that you will get distracted along the way, especially in the environment we’re in, and even more so for a buy-and-build strategy that includes many add-on acquisitions.”
Despite its central importance, articulating a vision might be entirely new for a business. “In our experience, some smaller and mid-market companies may not have a clear strategy, or may have outgrown their existing strategy, resulting in a lack of direction and reduced growth prospects,” says Andi Klein, investment advisory professional at Triton, where he is responsible for its Smaller Mid-Cap Fund. The task then for the GP is to work with the management team to create a value-creation blueprint.
While operating partners zoom in on top-line growth and profitability, working capital can often be overlooked.
Filip Debevc, senior manager, Deals at PwC Germany, says: “Working capital due diligence is becoming standard to protect capex and cash management. The focus is moving below EBITDA and top and cost line improvements. However, companies often do not put working capital on the agenda.”
By broadening the scope of pre-deal due diligence to include working capital, investors are in a better place to identify and manage cash flow risks and make capital expenditure decisions once the business has been acquired. “If your business is growing its top line by 10-20 percent per annum, it’s sucking up a lot of cash into debtors,” says Andrew Ferguson, partner at Baird Capital. “[Working capital] is a constant issue that small to mid-size businesses really struggle with as they grow.”
Keeping a close eye on the business’s terms of trade and debtor book are necessary to effectively manage the working capital cycle and to ensure that it does not lengthen, as is monitoring intra-month cycles to guarantee that funding is available to mitigate swings in cashflow. The quality of customer relationships, being clear on contract terms and enforcing them while making it easy for clients to pay, as well as assigning roles and responsibilities within the business around working capital, are key to ensuring invoices are paid on time. Bad habits can be hard to break.
“The devil is in the detail,” says Ferguson. “Make sure you know who, when and where to send your invoice.”
3x… 5x… multiples
Deal multiples hover at historic highs thanks to a seemingly unstoppable flow of capital into private markets, but overpaying for an asset remains a prevailing risk.
That poses a significant threat to value creation and investor return expectations. Whatever price a GP pays today they will have to receive more at exit.
One way to mitigate the risk of overpaying is to expand the scope of due diligence. “The effort put into undertaking due diligence is increasing in order to gain a better understanding of complexity drivers, to argue a value creation story, and to explain high multiples,” says Friederich von Hurter, partner, M&A Integration at PwC Germany.
By identifying internal value drivers and external factors determining the scope for future growth – market conditions, size and the degree of the business’s market penetration – the portfolio team (and its advisors) can contribute to the price assessment. This is not simply to indicate if the asset is too richly valued, but also to give the deal team the confidence to pay more if the growth potential is there, says Dawn Marriott, partner and head of the portfolio team at Hg.
“Value creation and how you build it starts when you consider the deal,” Marriot adds. “Operators apply a real-world lens, and from experience they can say, that’s not a viable value creation plan, it’s too ambitious or, conversely, it’s not ambitious enough. With some intervention and support, maybe the business could go twice as fast.” And that is an opportunity GPs would not want to miss.
Your 100-day plan
Clarity is key when it comes to the 100-day plan, but it should be underpinned by measurement points.
“People have very different approaches regarding the 100-day plan,” says Alain Vourch, partner at Charterhouse Capital Partners. Whether a GP calls it a 100-day, strategic or value creation plan, roadmap or blueprint, or onboarding, it is evident that, “early in the deal you need a clear plan with a set of value drivers that everyone understands, supported by robust action plans and clear milestones”, says Vourch. “That is a key success factor.”
Dawn Marriott, partner and head of the portfolio team at Hg, agrees. “You need a starting point and real clarity around your vision, your strategic goals and financial objectives and timeframes and measurement points along the way. That’s how you engage a large group of people,” she says. “The timeframe depends on complexity. The value creation plan doesn’t start on day one. It starts when you start to consider your investment.”
In devising the plan, “you need to go back to first principles and ask what’s the rationale for the deal and how does that translate to valuable objectives, benefits and synergies and what is the operating model that you need to realise that?” says David Olsson, partner at Beyond the Deal. “You have to have a process that measures and monitors the value you are trying to create, otherwise, it’s just hope.”
And some managers devise a number of plans. The team running the Triton Smaller Mid-Cap Fund develops 365-day and four to five-year plans together with management. This involves a “strategic and operational review to develop and stretch the potential of the business and assess whether we need to draw in additional capabilities and resources to execute the strategy and plan”, says Andi Klein, investment advisory professional at Triton with responsibility for this fund.
Effective budgeting is behind a range of business-critical decisions from resource allocation to funding.
Zero-based budgeting, a method that constructs a budget for every new cycle by reassessing each business division’s needs and costs, has been prevalent in government and non-profit organisations. Now, it has made its way into the private sector. And increasingly, it is a GP’s budgeting technique of choice.
In a nutshell, zero-based budgeting means “building a budget from the ground up using a very granular approach”, says Andrew Ferguson, partner at Baird Capital. “It’s an exercise where private equity can be quite helpful in guiding a business. It gives a more realistic view and holds people to account.”
Putting together a budget as if a business has never had one before rather than tweaking the last cycle’s numbers requires looking with fresh eyes at revenue assumptions, talking to the sales team and clients, reassessing the sales pipeline and re-examining operating, sales and employee costs.
A zero-based approach is more time consuming and labour intensive than budgeting compiled on expected performance, and involves more data collection, paperwork and skill. But the benefits are numerous: a more efficient allocation of resources; greater incentive to find more cost-effective ways of operating; better intra-business communication and alignment with objectives; less possibility of inflated budgets and waste going unnoticed. Critically, this process bestows ownership of budget targets onto the team that provided the figures and holds them accountable for meeting them.