Renewing a Focus on Value Creation Planning to Meet IRR Expectations
In private equity and life, no one can accurately predict what will happen tomorrow, let alone in five years. This unfortunate reality is causing headaches for some PE sponsors that, right about now, expected to be exiting out of investments and delivering returns for investors.
The turbulent economy of recent times has shifted markets and slowed both dealmaking and exit opportunities to a crawl. An absence of buyers is forcing sponsors to extend hold periods well past original expectations. Five-year plans have become six- and seven-year ones. Even with optimism that economic conditions are improving, there is no real timetable for a return to the frenzy that characterized deal activity a few years earlier.
Unless additional value creation activities are identified, extended hold periods threaten rates of return and, for sponsors, heighten the challenges of raising money for the next fund. Each month that goes by without an increase in EBITDA commensurate with the current hold period leads to a decrease in IRR. As the hold period extends, it can become more and more challenging to identify value creation opportunities.
It was a much different environment when these investments were made and deals originally consummated. The strength of the markets and favorable economic indicators, like low interest rates, meant that many sponsors were able to rely on financial engineering or buy-and-hold strategies to generate returns. Value creation was a less formalized and operationalized process than it has since become.
In most cases, plans were created with the anticipation that exit would happen within five or six years. Over that course of time, most if not all the value creating levers would likely have been pulled. Companies would be acquired, merged, and integrated. Synergies would be leveraged across the portfolio.
So, what happens when the sponsor approaches the anticipated finish line only to find the goalposts have been moved? How can additional value be found in a company when all the so-called typical blunt instruments would have already been deployed and exhausted?
An additional wave of value creation planning can identify any number of untapped or out-of-the-box initiatives that could lead to new growth, such as:
- Utilizing data to predict customer purchasing behavior
- Raising prices on existing products and services
- Introducing new products
- Testing the waters on international expansion
- Driving new product and feature introductions outside of the core focus of the company
These value creation opportunities often require additional time and attention to execute and increased monitoring of results. But they will provide the muscle, yield the tools, and generate the results that can be leveraged and deployed during future acquisitions.
Today, value creation is much more ingrained as a recognized requirement for generating returns. With greater frequency, PE firms are assembling teams of operating partners and ensuring that value creation planning is a standard operating procedure the moment the deal is signed.
Most sponsors think about value creation at the beginning of a hold period. But even in year five, initiating an entirely new value creation planning exercise can find new ways to squeeze additional drops of potential value from a portfolio company and help reduce the negative impact of a delayed exit.
An operationalized and strategic approach can help identify new value creating opportunities, even several years into the investment. Utilizing modern value creation planning tools can keep teams focused, organized, and on task no matter how long the hold period extends, ultimately helping restore IRR to a more acceptable, and maybe even a more desirable, number once the inevitable exit occurs.
Maestro is the value creation platform designed exclusively for the Private Equity industry. Founded by its parent company Accordion, the PE-focused financial consulting and technology firm, and backed by S&P Global Market Intelligence, Maestro helps PE sponsors modernize their operations and maximize value creation in private equity–backed companies through enhanced portfolio management and increased collaboration with all stakeholders. The Maestro platform serves as an essential solution for the private equity industry – from diligence to exit.
Accordion is a private equity-focused financial and technology consulting firm. Rooted in a heritage of serving the office of the CFO, Accordion works at the intersection of sponsors and management teams to maximize value. The firm’s services span the entire CFO function – including operational and technical accounting, strategic financial planning and analysis, CFO-related technology, transaction execution, interim leadership, and turnaround & restructuring solutions. Across all of Accordion’s services, clients are supported by deep expertise in data & analytics, CFO-specific technology and finance-led transformations. Accordion is headquartered in New York with eleven offices around the globe. Learn more at accordion.com.