Hold leaders accountable with a metrics-based plan
Editor’s note: This is one of three stories in a series on how PE firms can build value immediately after an acquisition. In addition to this article on optimizing operations, see our stories on finance modernization and human capital management.
For private equity leaders and their portfolio companies, value creation via operational improvements has taken on outsized importance.
PE leaders have substantial cash on hand that needs to be invested to deliver returns. At the same time, higher interest rates and a more challenging M&A market relative to prior years have made it more difficult to drive value creation through multiple expansion.
To continue to drive value creation in the current environment, PE leaders are increasingly focusing on operational improvements they can implement with their portfolio companies. It’s a process that begins in earnest from the moment of the deal’s inception.
And it starts with a metrics-based plan that holds the portfolio company leadership responsible for results.
“You must establish clear accountability for the results of a transaction.”
“You must establish clear accountability for the results of a transaction and generate a decision-support framework to achieve planned outcomes,” said Grant Thornton Transaction Advisory Principal Scott McGurl. “Whether it’s a standalone company being added into a portfolio, or a platform roll-up, you need to make sure there’s a clear understanding of the objectives and the strategy to generate returns over a planned horizon. What are we going to accomplish based on that strategy? How much value will we build? And when?”
Satisfactory exit values have been more difficult for PE firms to achieve over the past year. U.S. PE deal value declined by 29.5% percent in 2023 compared with the previous year, according to PitchBook data, reaching its lowest yearly mark since 2020’s pandemic-induced slump.
To build value successfully, portfolio companies and private equity firms need to establish key performance indicators, track progress toward the deal thesis in real time, identify opportunities to adapt, and further create value for investors. If the KPI trends being tracked don’t show measured progress, McGurl said the dashboard should be lighting up like a Christmas tree, alerting leadership that changes need to be made.
“If you’re in an investment for three, four or five years, the focus on value creation is intense.”
Grant Thornton Growth Advisory Principal Jonathan Eaton said the short timeline of a PE acquisition increases the urgency of monitoring and improving these indicators.
"If you’re in an investment for three, four or five years, the focus on value creation is intense,” Eaton said. “In the beginning, look at the operating model and the supply chain. Where are there threats? Where are there risks? And where are there opportunities to drive operational improvements?”
Consider your value drivers
Good things happen in PE portfolios when leadership maintains a laser focus on the four key value drivers — revenue growth, operating margin, asset efficiency and working capital.
Long before a deal is complete, a basic understanding of these value drivers is essential for creating the improvement that will lead to a higher enterprise value a few years down the road.
“Look at the target and ask, ‘What am I getting out of this?’” McGurl said. “Am I getting intellectual property that I can use to differentiate in the market? Am I getting a new territory where I can go after new customer segments? What am I getting out of it, and how do I leverage that with my existing platform or portfolio?”
Levers you can adjust to improve the performance of these value drivers include:
- Cost to serve
- Unit pricing
- Customer lifetime value
- General and administrative expense
- New product revenue percentage
- Cost of goods sold
- Equipment effectiveness
- Customer churn and retention rate
- Asset efficiency
- Weighted average cost of capital
- Cash conversion cycle
- Workforce productivity
- Employee engagement index
Where even some mature PE firms sometimes fall short is in regular monitoring of the progress of those indicators.
Tactics for turning red to green
Fortunately, there’s a lot that can be done to turn the dashboard indicators from red to green. After an acquisition, the firm or portfolio company can make changes in the following areas to deliver progress:
Supply chain: Some portfolio companies use common suppliers across their multiple portfolio companies. Anytime there’s an acquisition, the extra volume presents opportunities to request additional material from a supplier that can result in a negotiated discount across the portfolio.
Products and services: An acquisition should be followed by an immediate analysis of which products and services are profitable and which are a drag on the business. The growth of supply chain cost to serve since the start of the COVID-19 pandemic requires a renewed consideration of SKU rationalization that may not have been undertaken by the acquired company prior to the transaction.
Markets and geographies: Which locations and markets are producing the best results? Are there some locations that should be targeted for more growth? Is it time to pull back from other geographies?
Inventory: The high cost of capital makes inventory an asset on the balance sheet that’s often highly leveraged. If you’re paying a high rate of interest on an inventory asset, it had better be something that’s absolutely necessary and can be sold at a profit.
Property, plant and equipment: Is equipment properly maintained? Could new equipment result in better production? It’s important to know what to invest in these physical assets.
Customer segmentation: Consider customer segments, marketing tactics, order fulfillment logic and service-level commitments. Find the right balance between serving the right customers optimally and serving other customers effectively in a way that’s most profitable for the acquired company.
Dynamic pricing: Consider the adoption of algorithm-based dynamic pricing schemes to analyze market trends, consumer behaviors and other relevant data to optimize margins across product categories and customer segments.
Operational risk management: Some of the less mature companies that are purchased by PE firms may have an underdeveloped understanding of operational risk, particularly related to their suppliers or third parties. PE leaders can assist in developing a more robust enterprise risk management program that successfully identifies and mitigates the correct risks.
This focused, relentless pursuit of value creation is extremely important in the current economic conditions. When interest rates were low and capital was plentiful, it was easier for PE firms to sell for higher multiples than it is now. This difficulty achieving optimum deal value was reflected in a median annual PE company hold time of 6.4 years in 2023 that was longer than any hold time charted since at least 2007, according to PitchBook data.
Despite the high cost of capital, there are still opportunities for PE firms to profit handsomely if they are very successful at driving value creation through operational improvements. Metrics are a key to driving this value creation. PE firms need to put a performance scorecard in place at the portfolio company level that clearly defines and measures the KPIs that are necessary for growth. Cash conversion cycles, workforce metrics and customer trends all need to be measured and monitored constantly to turn the strategy into reality.
PE firms and portfolio companies that don’t already have those scorecards may look to third parties for the metrics that should be included, as they will differ depending on a company’s industry, maturity and other factors.
“It’s really important to have a near real-time view of progress and opportunities for value creation,” Eaton said. “Monitoring progress and adjusting your activities based on well-constructed scorecards will help you deliver on your strategies.”
Contacts:
Scott McGurl
Principal, Transaction Advisory Services
Grant Thornton Advisors LLC
Scott has worked in industry and management consulting environments for over 25 years supporting clients define and achieve their business transformation objectives.
Tampa, Florida
Industries
- Life sciences
- Healthcare
- Manufacturing, Transportation & Distribution
- Technology, media & telecommunications
- Retail & consumer brands
Service Experience
- Advisory
- Human Capital Services
- Transaction advisory
Jonathan Eaton
Principal, Growth Advisory Services
Grant Thornton Advisors LLC
Jonathan is best most recognized for his ability to help clients define their supply chain strategy in response to changing market conditions and other disruptive forces and subsequently helping
Charlotte, North Carolina
Industries
- Manufacturing, Transportation & Distribution
- Technology, media & telecommunications
- Energy
- Retail & consumer brands
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