How Private Equity Firms Create Value in Uncertain Times

By Bridget Walsh, Jon Morris, Paul Pan, Luke Pais

Private equity (PE) firms thrive on their ability to acquire and build great businesses even in challenging times. They are skilled at creating rapid value and adapting their plans as circumstances change. They have always had a differentiated approach that gives them an edge, and their interventionist nature is key to getting returns in a competitive market.

Given the significant ongoing shifts in the macroeconomic environment, what are PE firms doing differently now? And what can corporate leaders learn from the way these firms are adapting?

Any value-creation strategy put in place as the world came out of the pandemic may be based on assumptions that no longer apply. Inflation has returned to levels not seen in developed economies for decades, supply chains have been shaken, debt has become far more expensive, and the global economy is suffering.

This means exit valuations can be harder to achieve and typical holding periods are lengthening. Achieving the desired multiples on exit has typically become more challenging, not least because affordable talent is scarce and new technologies — notably artificial intelligence (AI) — are driving waves of disruption across the business landscape.

Given this uncertainty, PE funds are doing what they do best — adapting fast to changing times. The five critical areas that PE owned companies are looking to transform are cash and liquidity, cost, talent, technology, and sustainability.

1. Cash management is more sophisticated.

Maximizing the cash available to the business has always been critical to the way PE operates, as cash is much more valuable to a highly leveraged business than it is to a public company. PE portfolio companies are getting much more sophisticated about how they unlock trapped cash across all their operations and territories.

Liquidity is becoming a much higher priority. Many PE portfolio companies are examining their balance sheets critically, using better tools to forecast their cash needs, and establishing sophisticated cash repatriation and pooling systems so they can maximize centralized liquidity and manage working capital, and their use of funds even better.

2. Costs are under the microscope.

Cost management is critical to PE-owned businesses, and their approach to it has changed recently. Funds are now making targeted investments to upgrade the finance functions to transform their cost-management capabilities in their portfolio companies.

New priorities include generating the data insights to inform more granular decision-making about costs and putting more robust governance controls on spending and investment decisions and reporting.

PE funds are also working hard to create operating structures that can drive operating leverage as their portfolio businesses grow. Several funds have recruited operating partners with specific finance function responsibilities to drive this effort forward.

3. Revolutionizing talent management can amplify value creation. 

Often, talent management means equipping people—in finance or tech, for example—with the tools and support they need in order to perform better. And funds are taking a much more granular perspective on talent when they make an acquisition, asking what skills people have, how these skills can be improved, and how they might be pooled or moved to benefit other companies in the portfolio, such as by creating specialist cross-company teams to prepare for the risk of cyberattacks.

4. AI is dominating the technology agenda. 

At a time when companies are under financial pressure, there’s less appetite for large digital transformations; funds are focusing on ways to get more value from the technology they already have.

The rise of AI is leading many private equity leaders to revisit their technology priorities. AI’s potential impact has become more prominent in due diligence over the past year. Funds are asking questions: How might AI disrupt a business, its operating model, and its balance sheet? Where will AI create opportunities, and where might it be a threat? PE funds are asking more questions about how AI might lower barriers to entry, either allowing competitors into a market or creating opportunities for the business to enter adjacent markets and segments.

Alongside the strategic thinking, funds are doing a lot of work to prepare their businesses for AI, such as by generating or gathering the kind of data that effective AI requires. AI is also driving greater value on sale due to a rerating or an increased multiple.

5. ESG is a catalyst of value creation.

Improving a portfolio company’s environmental, social, and governance (ESG) performance is often an integral part of the value-creation strategy. If a business can’t satisfy ESG reporting requirements, some initial public offering (IPO) routes will be closed when it comes time to exit.

Another reason funds are more likely to stick with a progressive ESG approach is that the investment they’ve received often comes with ESG commitments attached. While ESG’s contributions to an investment shouldn’t be overestimated, PE funds are more likely to see ESG as a source of value rather than a risk issue.

Relentless focus on value creation

What can we learn from the way PE companies are responding to today’s climate?

While some funds are holding companies longer, that doesn’t mean they are slowing the pace of value creation.

PE has always had an interventionist approach and a relentless focus on what matters most. In these uncertain times, firms are innovating their approach to value creation and portfolio transformation. This enables firms to optimize performance during extended hold periods, while still hitting their interim performance targets and building in agility for optionality and speed on exit when an opportunity arises.

All these approaches to devising value-creation strategies can translate to the corporate world as business leaders look to learn from the PE companies that are doing it best.

Learn more about how our private equity value creation team can help your organisation