Private Equity Portfolio Value Creation: What Comes After Cost Cutting?
Renegotiating procurement terms. Removing duplicated work. Improving unprofitable customer relationships. Profitability improvements are an important management priority in private equity portfolio companies.
As these initiatives progress, a further question emerges:
“What will generate this company’s next stage of growth?”
The next task is to connect the profit and capacity released by cost improvements with customer value and growth capabilities. That requires choices about business development, capital allocation and the management structure needed for execution.
The ingredients for growth may already be in the business
Growth often brings to mind entering new markets or making acquisitions. Yet a portfolio company’s existing technologies, customer access, service network, data and operational expertise may also provide opportunities.
For example, knowledge accumulated through equipment maintenance might support a service that improves customer uptime. A software developer’s industry expertise could provide the basis for a recurring service addressing a specific operational problem.
These are illustrative possibilities. Before committing capital, management must test customer willingness to pay, the capabilities required for delivery, and whether the investment and payback period are commercially viable.
Alongside “What assets do we have?”, ask “Whose problem can we solve with those assets?”
Four decisions that make a growth plan executable
1. Make the growth hypothesis specific to customers
Statements such as “grow through AI” or “move up the value chain” do not provide enough direction for daily decisions.
Specify the target customer, the problem, the offering, the price, the sales approach and the delivery model. Expanding an existing customer relationship and acquiring a new customer may require different capabilities and timelines.
2. Decide how to allocate resources between financial priorities and growth
Cash generated by improvements has several potential uses, including debt repayment, maintaining existing assets and investing in growth. Financial constraints and business risks should inform the sequence and scale of investment.
Growth initiatives do not all need to begin at once. Separate the stages of testing willingness to pay, establishing delivery capabilities and scaling the business. Make further commitments as evidence develops.
3. Give accountable executives the authority to execute
An executive cannot deliver growth simply by being assigned a financial target. The executive also needs the ability to influence sales, development, staffing and budgets.
Clarify decision rights among the fund, board, CEO and business leaders. For issues spanning functions, establish a decision-making forum and deadline, as well as responsibilities for coordination.
4. Distinguish a temporary improvement from a durable capability
Management should be able to explain why profit improved and why that improvement can continue.
Depending on the initiative, examine new customer acquisition, renewals, gross margins, repeatability of sales, delivery quality and dependence on particular individuals. Consider whether the operation can continue when its leader changes.
Enterprise Redefinition tests the coherence of the growth plan
VURA’s Enterprise Redefinition approach connects five dimensions of the enterprise:
Purpose: What value will the portfolio company create, and for whom?
Business: Which revenue model will turn that value into a viable business?
Organization: What capabilities and decision-making processes will execution require?
Capital: Where should funding, talent and technology be allocated?
Leadership: Who sets direction and remains accountable for results?
For example, a company may pursue recurring revenue while continuing to evaluate salespeople primarily on the initial sale. Strategy and behavior then diverge. Incentives and delivery capabilities need to reflect the new model.
VURA places emphasis on resolving these inconsistencies so that growth hypotheses influence actual management decisions.
Preserve evidence of growth for exit preparation
A future buyer will need to understand the growth proposition and the evidence behind it.
Why did revenue increase? What supports contract renewal? What does customer acquisition cost? Which staffing or capacity constraints accompany expansion?
Building this information into management processes makes the assumptions behind future plans easier to explain.
Enterprise value and valuation multiples also depend on market conditions, business risks and transaction terms. Management can improve earnings quality and execution capabilities, then build evidence supporting those improvements.
Consider the portfolio company’s next source of growth
Start by discussing three questions with the management team:
Once current improvement initiatives mature, where will the next source of gross profit come from?
Do the people responsible for execution have the authority and resources they need?
What evidence will demonstrate repeatable growth to the next management team or buyer?
VURA participates in management to execute business, organizational and technology transformation. Explore VURA’s approach for global private equity funds.
To discuss a portfolio company’s growth priorities and execution structure, contact VURA.
Naoki Kadowaki — Founder & CEO, VURA Capital Innovation Holdings Inc.
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