PRIVATE EQUITY | ACCELERATE
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PRIVATE EQUITY | ACCELERATE
ACCELERATING VALUE GROWTH
ON PAGE 3 WE OUTLINED 8 TOOLS THAT PE INVESTORS DO TO GROWTHE VALUE OF THEIR INVESTMENT. BUT WHAT DO THEY MEAN TO YOU?
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INCENTIVISATION
LEVERAGE
M&A
OPERATIONAL IMPROVEMENTS
NEWMARKET ENTRY
R&D AND DIGITAL TRANSFORMATION
RISK MANAGEMENT
INVESTMENT IN MANAGEMENT
This is a potentially difficult area as people can feel vulnerable and egos can get in the way. However, it stands to reason that all shareholders benefit from a complete, rounded and effective leadership team: prospects are improved, innovation is enhanced, plans are better, and better executed, and the business can become both more strategic and sensitive to new opportunities all at the same time. Sometimes it is obvious: there is no CFO (Chief Financial Officer), but other times it is more difficult to see - should the business have a CTO (Chief Technical Officer) for instance? Other times it could be more painful as there is a weak link or dissonance in the team. Consulting help is available: but often teams already know. Having said that, beware of the PE houses with the rolodex of great people who can be ‘parachuted’ in: each addition to the team needs to be considered carefully avoiding the misty-eye of celebrity.
Similar to adding value through a buy-and-build programme, operational Improvements are strongly sought by PE investors. If margin can be tweaked up through reorganisation or the investment in slicker processes for instance, or risks can be diluted by reducing fixed costs or working capital can be managed more efficiently making the business more cash generative, all shareholders will benefit. Often operational improvements are incremental and subtle, but they can be profound, for instance outsourcing manufacturing in its entirety or switching a business model to being on-line. There is an enormous array of help available in this area these days and you will be surprised how far you can go if you are open minded and prepared to put in the work.
Contrary to what people might think, PE is interested in the longer term prospects of a business. They know that the visibility of further future growth will help eventual buyers pay more. Therefore, investors are constantly looking to evaluate potential returns from new product development, process automation, tech-enablement as well as the conditions and processes that are needed to build more innovation into an investee company from ideation to execution. It is probably not silly to say that all businesses should be spending some time looking at how they can embrace the opportunities that the internet, digital analytics, digital marketing, digital communication and clever software can provide. No business model is immune.
Using debt lowers the cost of capital. Lowering the cost of capital helps all shareholders make a bigger return. However, this must be balanced with the risk of adding third party debt to an investment structure: ‘cheaper’ debt brings covenants that become disproportionately painful in underperformance. Management teams should also be mindful of the split between ordinary shares and preference shares/loan note instruments. If not ‘pari passu’ management teams might be more incentivised but also carry greater risk which could challenge alignment.
The overall area of risk management affords a massive array of value enhancement opportunities. Having said that, it is an area that is often overlooked as teams strive for more glorious achievements (see above!). Simple activities like running through the details of the due diligence from the investment and talking to the providers can remind investor and management alike of areas that can be tightened and improved: where warranties and indemnities were sought, could work be undertaken to dial entry risks out when it comes to exit? Also, can customer dependency be worked on; and how can revenues be made more ‘sticky’, that reduces risk? There may be tactical and strategic work streams to ultimately improve the quality of earnings, the diversity of revenue, address bandwidth issues etc.
‘Buy & build’ is becoming more prevalent as a value growth tool. There is a great attraction to ‘following your money’ if you are a PE investor. This means putting more funding behind a proven management team in a sector or setting that is already well known. This reduces the perceived risk. Equally, there is the allure of synergies, reducing the average entry multiple (if bolt-on or add- on acquisitions can be purchased at a lower multiple that the original investment), new market entry and a simple premium for scale all of which will provide shareholders with the benefits of potential multiple arbitrage (where the exit multiple is higher than the entry multiple).
PE houses seek to disproportionately incentivise key people to deliver growth in the equity value of an investee company. This is managed through the investment structure (how much and what type of leverage there is) and the all- important Sweet Equity and the terms attaching to it. These include the notorious ‘Leaver Provisions’. As well as Sweet Equity, key people can also benefit from bonuses and option schemes. Senior management must ensure that each member of the team has clear objectives which, when aggregated, support the overall goals. Getting this right is essential as it drives alignment throughout the senior team.
Teaming up with PE brings two things in abundance (if you have picked the right PE house). Firstly, the power and wherewithal to invest; and secondly, experience. All business plans should look at newmarket entry on top of doing more of the same. This can be adjacent products or services, new territories or new customer areas or sectors. Each needs to be evaluated against the cost of capital, expertise, management bandwidth and timeframe. The classic strategy for UK businesses is to open up in the US or to the US marketplace. This can be extremely lucrative when it goes right but care and planning is required especially in respect of the human capital that is needed: it is often the difficulty of finding the right leadership or team in the US that hampers success. Your PE investor should be able to fund such activities and provide guidance from their own investing experience.
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