Five ways private equity firms quickly realise transformational value

13 December 2021 8 min. read
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The number of merger and acquisitions deals by private equity firms has fallen during the pandemic – but the total estimated deal value has exploded. If they are to maximise their returns, it is more crucial than ever that investors create transformational value as early as possible; and experts from Alvarez & Marsal have provided five key tips to help them do just that.

A combination of low interest rates, ongoing pandemic support from governments, and an overflow of capital chasing few quality assets have seen company prices soar over the last two years. This has left private equity houses under increasing pressure to deliver tangible returns to their investors – especially as the average value creation programme implemented by new private equity owners has shortened in length. Formerly, according to research from Alvarez & Marsal (A&M), these programmes lasted between five and seven years; but now this has fallen to a three-to-five year window.

In 2021, the estimated total value of mergers and acquisitions (M&A) deals involving private equity is forecast for €548.7 billion, having risen steeply from €423.6 billion in 2020. According to Steffen Kroner Managing Director, A&M Private Equity Performance Improvement, this means private equity firms, management teams at portfolio companies and their advisors “need to be working seamlessly together to find ways to drive value creation from the start of closing or even immediately after signing the deal.”

Private equity deal activity

Kroner went on, “One senior private equity operations partner shared that: ‘You see a good investment in its first year of ownership when the value creation programs take off. If you run into issues in year one, chances are high that the transformation will run into more challenges down the line.’ This is consistent with our findings that management teams as well as private equity sponsors and advisors tend to initiate the value creation programs right out of the gates, in a structured but also quick and vigorous way.”

But how can private equity firms ensure they hit the ground running in such a way? A&M surveyed a total of 65 C-level executives within private equity firms or from companies owned by private equity firms in Germany, France and the UK, in a bid to distil the industry’s best practices. This eventually led the researchers to make five important recommendations.

Begin in the first 100 days

A&M’s survey found that value creation programmes are is mainly rolled out during the first few months of ownership, when there’s a basic understanding of the portfolio company’s business processes. However, the majority of firms do this relatively cautiously, with 46% using the first 100 days to mitigate business continuity risks, and plan for value creation, which begins after six months. On average only 22% – and an even lower 16% of UK firms – launch their first value creation activities immediately, before extending the scope of project into full after 100 days. The researchers believe this provides an opportunity for many private equity firms to boost their performance by being bolder, sooner.

The researchers noted, “Our experience shows that early alignment with management teams, active listening to the specifics of the situation and jointly presenting the plan are essential steps for sustainable change management. The switch in ownership creates a window of opportunity to also break with incumbent business conduct, practices and behaviours that are not beneficial for the future path of a transformation. The longer the period stretches out before change happens, the harder it is to get the organisation moving.”

Collaborate with internal staff

As company management has the expertise regarding the strong points of the business, and understand its daily running. However, they also have a day job to run, so will not be able to solely focus on change programmes. However, it is important not to alienate existing management by bringing in external expertise without running it by them. The final decision about bringing in a consulting partner to support them therefore involves management most of the time. In 46% of the time, management alone make the call to bring in expertise, or do so in conjunction with the PE firm. In contrast, just 9% of respondents say the PE firm makes the decision on their own.

Expectations Towards Consulting Partners

Highlighting the boost contracted experts can give to internal managers, the researchers stated, “External consulting partners play a key a role in helping PE firms execute these transformations. [However] a management team co-selecting a consultant ensures that the team is in charge and accountable. Otherwise, management may not engage fully in the pursuit of a joint project goal and change may not be effectively implemented.”

Bring in a consultant

Relatedly, 86% of surveyed investors indicated they often or occasionally suggest management works in partnership with consultants to launch value creation programmes swiftly. Most commonly, these consultants are deployed in a strategic role, providing guidance and direction for the mid-term company roadmap for 26% of respondents. In the case of UK respondents, however, they consultants were more commonly used in an analytic capacity; examining performance and identifying future opportunity in a specific area of performance. Either way, the independent perspective consultants can bring is vital to delivering transformational value quickly.

Based on A&M’s own 20-years of experience working with private equity-backed transformations in portfolio companies across Europe, the researchers said, “A joint decision on bringing in an external partner to execute a VCP helps the success tremendously by forging ownership and accountability with management… They understand the importance of speed of execution to prioritise the key areas of improvement that will impact EBITDA and ensure sustainable cash generation. Free from any legacy baggage, they also bring in objectivity, specific expertise and experience that may not be available in-house, allowing sponsors to optimize resources and allocate them where a high return on money invested can occur.”

Monitor constantly

When a private equity firm first purchases an entity, it needs to quickly make itself aware of areas of high and low performance to determine what needs to change – as well as to understand positive or negative impacts its changes will have. Measure twice, cut once, as engineers would say. However, even though urgency with value creation programmes is increasingly important, most private equity firms currently only measure KPIs on a monthly basis. A global average of 80% – or once again, an even larger 92% of UK respondents – fulfil this bare minimum. A comprehensive set of levers reported regularly linked to a baseline forecast would improve performance notably, though.

When value creation outcomes are not delivered as expected

On this basis, the analysts recommended, “Based on our experience, A&M views short interval monitoring as key to achieve results quickly. A transformation office needs to drive and track progress. Weekly or bi-weekly monitoring is recommended over monthly reporting in situations where performance is below plan or when it requires a quick turnaround time to get results delivery back on track.”

Patience is a virtue

When this monitoring suggests things are off track, private equity firms are still relatively patient – and remain committed to working collaboratively with existing management. According to A&M, 0% of private equity respondents said they would replace managers immediately when expected targets were off track. The majority only wait so long though; and 71% said if results do not change in two quarters, then proverbial heads will roll. This may be counterproductive, though, as it dismisses talent with an important understanding of the business very quickly. Leading firms, by comparison, look to embed operational capability from the private equity firm, supporting and challenging management to boost performance.

A&M’s researchers concluded, “We take an active partnership approach with management of portfolio companies. Supporting leadership teams with the delivery plan is our key focus to show joint progress and produce results. We aim to build sustainable programs for transformational value creation that last way past our departure.”