Ways private equity firms can genuinely add value
… continued from The role of the chairman in private equity-backed companies …
As previously highlighted, private equity returns continue to outstrip quoted shares and it is certain that operational improvement in portfolio companies is a key component of value creation. Of our sample, 63% had been involved with a private equity-backed business which was subsequently sold and, of these, 77% had been sold for a profit.
According to the survey, the most important contributors to the value uplift were operational improvements and sales growth. Leverage and growth through acquisitions were much less important; highlighting perhaps the reality of the more difficult funding climate.
Approximately 40% of the respondents credited private equity with contributing more than a quarter of the value uplift achieved on exit. This is a clear indication that private equity is capable of generating a significant amount of value.
For the rest of respondents who estimated the value uplift at 25% or less, this still represents material incremental value which contributes to private equity’s ability to outperform public markets.
Private equity’s contribution to value uplift
Where private equity made a significant contribution to the value uplift, it was said to be through the following means, in rank order:
1. Provided capital to grow business
2. Optimised business plan
3. Removed constraints on management 4. Brought in operational expertise
5. Other (including dealing with banks).
The finding that the majority of our sample ascribed a moderate figure to private equity’s contribution to value uplift may surprise private equity executives – but not management. In their eyes, private equity backers are viewed as enablers; meaning that their ability to contribute value is focused on areas such as providing access to capital and bringing a greater focus to achieving an exit.
Management, and for that matter non- executive chairmen, tend to believe that real value creation comes from growing the business and improving profitability – and this is down to the executive team. However, respondents acknowledged that in some cases, private equity directors are able to make much greater contributions – in the range of 30–50% of the uplift in value.
We should point out that respondents’ views on the contribution private equity firms make to value uplift were estimates and not usually based on detailed analysis.
Ways to add more value
- Giving access to the firm’s network of contacts.
- Making sure acquisitions/projects make an acceptable ROI.
- Identifying acquisitions.
- Focusing attention on cash flow management.
- Optimising the balance sheet through re-leveraging.
- Accelerating process of good financial reporting/governance standards.
- Grooming company for sale, finding potential buyers, structuring the sale.
According to Robert Ohrenstein, KPMG Global Head of Private Equity in the UK:
It is difficult to quantify private equity’s role as enabler – especially in ‘soft’ areas like making sure the right management team is in place and supporting it to achieve the business plan. However, most respondents recognised that private equity made a real contribution to the business and many ascribed a significant proportion of the value uplift to their input.
Even at levels of 5–25%of the uplift, we suspect that most limited partners would be happy if their private equity managers contributed incremental value over public markets at these sorts of levels.”
Questioning private equity’s input
According to a Partner in the Packaging sector:
If a firm has chosen a good management team and is able to manage them well, are the good results down to management or the PE house? Hard to determine, but I’d put the figure more at 30%.”
This survey has produced a lot of useful feedback on the ways that private equity executives add value and interact with portfolio companies. The findings are especially credible, given the number and quality of the respondents who took part in the research and their willingness to give insiders’ views on what really goes on in private equity-backed businesses. The positive feedback relating to private equity’s added value in the entry, financing and exit phases should be no surprise to those within the industry.
However, the feedback on the contribution made by private equity houses to businesses under their ownership was more mixed. While many respondents were happy to give private equity firms significant credit for the value they bring to their investments, it would be fair to say that a small number questioned the quality of private equity’s input and the effectiveness of how they work with management.
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