As we saw two weeks ago in the Urbana Varro post: Private Equity Backed Companies Versus Comparable Publicly Traded Companies, Herb Engert’s study (”Private Equity’s Value Creation Secrets”) showed that companies backed by private equity firms outperform their publicly-traded competitors 2-to-1, earning around twice the EBITDA growth. His article goes on to talk about the process used by private equity firms and why they have such a positive effect on the companies they invest in, beginning with “PE firms focus relentlessly on value creation throughout the entire investment life cycle, even before their initial investment is made.” Private equity firms investigate many options before deciding which to invest in, spending time studying the company. Before purchasing, they also go through a process called due diligence, an intense analysis before the final paperwork is signed that provides extra insights into how the company is working while comparing their claims to the reality of the different aspects of the company. The time and money spent on due diligence provides so much information that it has become common in Europe for private equity firms to purchase from other private equity firms to take advantage of the previous firm’s due diligence paperwork.
After investigation, private equity firms will “develop a road map that details key activities; highlights expected results; assigns responsibilities; identifies key milestones; and develops key metrics and dashboards for tracking performance.” In addition to serving as a plan for action, it offers opportunities for the firm to earn the respect of the stakeholders and plan out long-term investments.
Once this road map is complete, private equity firms develop value-creation frameworks. They consist of things such as: “developing plans to address strategic requirements[;] determining, prioritizing and implementing key value drivers[; and] establishing key enablers (i.e., people, processes and systems) to make a permanent shift in performance.”
The firm then continues in and works on enhancing revenue – organically, through additional strategic acquisitions, exploring market trends, exploring growth regions, and evaluating its sales approach (among others). Improving margins comes next, reducing non-value-added processes and optimizing high-value-added processes. “These measures can take time, and PE firms typically make short-term investments to achieve longer-term objectives.”
The last two phases include creating capital efficiency and performance management. An example of capital efficiency includes “carefully track inventory throughout the supply chain to reduce disconnects between sales, manufacturing and supply chain.”
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