Seven Value Creation Lessons from Private Equity

Private equity firms enjoy a number of advantages when it comes to building high-growth businesses and they can implement the following strategies to build a value creation regimen.

First, for continuous investment from partners, private equity firms must focus on value creation that extends beyond simple financial engineering and cost-cutting. PE firms focus on investing in core operations to reduce extraneous costs, and carefully choose, and exit, companies based on the available potential to create value. 

The next strategy is to understand the importance of cash. PE firms typically finance 60 to 80% of an acquisition with debt, creating a sense of urgency to generate cash. To improve cash flow, firms tightly manage receivables/payables, reduce inventories, and scrutinize discretionary expenses. To preserve cash, they invest only in opportunities that contribute significant value and delay the other options. 

Third is to operate as though time is money. PE firms must be proactive and deliberate in their actions during the first few months of ownership of portfolio companies. 

The fourth tip is to apply a long-term lens. The best PE firms not only cut costs but also invest in the highest-potential ideas for creating core value in their portfolio companies. These decisions come only after rigorous analysis and thoughtful debate. 

Another key suggestion is to work with the right team. PE partners understand that strong, effective leadership is critical to their investment’s success. A third of portfolio company CEOs exit in the first 100 days and two-thirds are replaced during the first four years. To put the right CEO and management team in place, PE firms may draw on their own in-house experts or external network.

Sixth is to link pay with performance. Companies can foster a high-performance culture by strengthening individual performance measures and incentives to align them with value creation. They must first reform the performance review process so it distinguishes and rewards talent.

Finally, firms must set clear, optimistic goals in critical areas and tie them directly to compensation. Long-term aspirations should drive specific initiatives with explicit objectives, and, in turn, the financial implications of these initiations should drive annual plans and budgets.

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