A great deal of work goes in to completing a new private equity backed acquisition. The PE sponsor will conduct extensive diligence, build multiple case financial models and ratify it all in a purchase agreement. At the heart of the transaction is an investment thesis, which identifies how shareholder value will be created over the sponsor's 5 - 7 year ownership period. The investment thesis relies on four primary levers to create incremental shareholder value. The objective is to create new value and then let the exit price reflect that value. Typically, the outcome is a plan, which is a key part of your Investment Committee decision as well as a blueprint for the CEO and the management team.
1. Revenue growth of the existing business model. Greater revenues lead to greater EBITDA which leads to greater value, assuming the same entry/exit multiples. Examples include:
• Improve sales productivity with current direct and indirect channels
• Introduce new products and services
• Implement value based pricing strategies by market segment
• Add new functionality to current products and services
• Enter new geographic markets
• Accretive M&A; achieve operating scale with targeted tuck ins
This lever is an area in which the PE sponsor has a high level of awareness but a low level of expertise. Typically, the revenue growth plan is the domain of the CEO and the management team.
2. Profit Improvement of the existing business model. Focus on improving the efficiency of the existing business model by increasing gross margins or decreasing SG&A as a percentage of revenue. Both deliver greater EBITDA as a percentage of sales. Examples include:
• Value engineering products to lower COGS
• Integrate and optimize prior M&A
• Rationalize on/off shore development centers
• Streamline your procurement, vendors and supply chain
• Identify and decrease the inefficiencies in G&A
• Adopt cultural changes and operational disciplines around execution
In contrast to revenue growth, this lever is an area in which the PE sponsor has both a high level of awareness and a high level of expertise. The nature of private equity provides insights for cutting operating costs, particularly those related to G&A.
3. Transform the business model, Focus on building a new business model that results in an exit multiple that is better than your entry multiple. Examples include:
• Add recurring revenue to a transactional sales model
• Convert perpetual license software to a SaaS model
• Expand your geographic footprint; local to regional to regional to international
• Identify and capitalize on the 7-year secular trend or industry evolution
• Make better strategic decisions; win big and fail fast
• Improve market shares or growth relative to the market
• Transformational M&A; acquire the change
This lever is the most difficult to implement; business transformations are fraught with risk. If the sponor's investment thesis requires transforming the asset they have likely acquired the business at a discount or as a carve out.
4. Improve free cash flows. Examples include:
• Improve working capital measures
• Reduce capital expenditures, sweat the assets
• Re-structure debt to lower interest payments
• Reduce the impact of re-structuring costs and one-timers
• Convert Capex items to Opex items
• Convert up front investments to marginal expenditures; partner with suppliers
This lever reflects a core expertise of most PE firms. Because the resulting capital structure likely includes debt, the sponsor is hyper focused on predicting and managing cash to service debt and avoid capital calls.
