What Private Equity Firms Do and How?
What do private equity firms really do?
Is it all about cutting costs and increasing profits?
Well, not really. There’s a lot more private equity firms can do to improve the value of their portfolio companies.
In this article, we’ll discuss how exactly private equity firms pick up underperforming businesses when they’re falling, and how they increase the value of these companies and take them to an unimaginable level.
Hint: PE firms help their portfolio companies way beyond financing.
How? Let’s find out.
1. Boosting Value for Company Owners by Operational Performance Improvement
This is one of the most prioritized strategies private equity firms use to increase the value of portfolio companies. Operational efficiency is a very broad term and can include measures like factory relocation, purchasing cost reduction, pricing, supply chain optimization, etc. For example, if a private equity firm wants to reduce procurement costs for an industrial company, they can create a detailed strategy to achieve this. This may include tasks like negotiating with the suppliers, forecasting and managing the demand of materials beforehand.
Even a measly 10% reduction in procurement costs increases a portfolio company’s overall profit substantially. Another example could include improving the internal team’s efficiency. They do this by creating new processes and employing the right person who can lead the team and make them as productive as possible. Something we’ll discuss in detail later in this article.
But one thing is certain: Sometimes, just by brainstorming and improving business operations, portfolio companies could reduce costs, increase revenue, and help the team reach a peak performance level.
2. Making the Company’s Financial Position Strong Through Deleveraging
If you don’t know what deleveraging is, you should understand the meaning of the word ‘leverage’, which means debt, in this case. Now, the word ‘deleveraging’ should be self-explanatory. A company that is financially weak might struggle to increase its value. That’s just the way it is. A lot of times, portfolio companies take huge debts to fund their growth. However, things don’t always work out as planned and a company’s debt to earnings ratio might increase drastically.
This is when private equity firms can step in and handle, or rather ‘balance’ the debt to earnings or debt to capital ratio. They do this by either reducing debt or increasing earnings. Debts can be reduced by selling assets, shutting down underperforming outlets, or downsizing. Whereas the other side (or the better side) of the ratio can be balanced by raising capital or increasing earnings. It might be really difficult for an underperforming portfolio company to do this by itself. However, with the guidance and leadership of private equity firms, a perfect debt to earnings ratio can be achieved.
3. Leading the Existing Team and Hiring New Talent
Spending months strategizing the perfect business model or buying the latest equipment to increase production is of no use if the portfolio company doesn’t have the right people. In fact, the lack of talent is one of the leading reasons behind failure in business. Successful private equity firms know this, and they find the best human resources from every nook and cranny of the world. Along with training and upskilling the existing staff, private equity firms also expand their talent pool by hiring interim managers, freelance consultants, and even full-time workers.
4. Embracing Digital Transformation to Enhance Value for Customers
Whether a company’s value has increased or not is ultimately decided by the customers. In fact, a very common reason why most businesses fail is not having enough customers. A study conducted by Microsoft found that 50% of customers will choose a competitor’s brand if they offer a better service. So, there’s no way around this - portfolio companies have to provide value to customers consistently before and after the purchase. There are many ways to make a company’s products, services, and purchase experience more valuable. However, we’re going to discuss digital transformation for now because it’s often underestimated.
Digital transformation basically involves using technology to improve or modify a company’s operational processes, culture, and value creation. For example, several shoe companies now allow online shoppers to customize their shoes completely. Buyers can now choose from dozens of different colors, add patterns, and get custom text printed on the shoes.
Private equity firms hire freelance consultants who can help them with incorporating digital transformation in their portfolio companies. Digital transformation requires new ideas and fresh perspectives, something that freelance consultants offer their clients routinely. It’s likely that the internal team might not have the time or the expertise to explore and strategize new advancements in the company. That’s why, in this case, hiring freelance consultants could be good, and probably the only option.
Boosting a company’s value doesn’t just involve the company as an entity, but it also includes its staff and customers. Private equity firms improve a company’s value by keeping the broader picture in mind. No doubt, operational efficiency and financial engineering are key to improving a portfolio company’s value.
However, hiring the right personnel, such as interim managers and freelance consultants is equally important - as is providing massive value to the customers through flawless customer service and advanced products/services. And that’s how PE firms offer more than just financial investment to boost the value of their portfolio companies.