To Thrive PE Houses Need To Shift From Being Deal Shops To Value Creation Masters
Discover the blueprint for successful and sustainable Value Creation in Private Equity
The private equity landscape has fundamentally transformed. Gone are the days when financial engineering and cost-cutting alone can deliver superior returns.
In today's competitive market, with high valuations and abundant dry powder, PE firms must master the art of genuine Value Creation to thrive.
McKinsey's analysis of 120 PE firms reveals that those with dedicated Value Creation teams achieved IRR five percentage points above their peers – a stark reminder that Value Creation is no longer optional but essential.
The Fit to Lead Value Creation Toolkit consists of 7 Core Levers and 6 Foundational Enablers, forming a comprehensive framework for transforming good businesses into great ones.
The 7 Core Value Creation Levers: The Path to Success
At the heart of effective Value Creation are 7 Core Levers that can significantly enhance a company’s performance and, ultimately, its exit value. Each lever plays a crucial role, and when used in combination, it creates a powerful toolkit for driving value.
Buying Smartly – The Foundation: As Charlie Munger wisely noted, “A great business at a fair price is superior to a fair business at a fair price.” Smart buying involves thorough qualitative and quantitative due diligence, and Value Creation planning should start during the due diligence phase.
Revenue Growth – The Queen: If buying smartly is the foundation, revenue growth is the queen of value creation. Growth is like oil for an engine, everything flows with less friction. Revenue growth accounts for 62% of value increase, according to Duff & Phelps and INSEAD research. Six primary drivers fuel revenue growth:
Customer Retention and Growth – keep your current customers and sell more to them
Market Penetration – sell existing products or services to new customers in current markets
Market Expansion – sell existing products or services to new customers in new markets
Product Expansion – sell new products or services to new and existing customers
Price Optimisation – sell your new and existing products or services for more money
Sales Team and Marketing Optimisation – improve sales team effectiveness and maximise the impact of marketing efforts
Margin Expansion – The Unsung Hero: Often underappreciated, margin expansion differentiates top-performing funds. It’s not merely about cost-cutting but smart resource allocation and operational efficiency. The focus should be on “good costs” that align with long-term strategy while eliminating wasteful spending.
Buy-and-Build – The Growth Accelerator: Add-ons accounted for 55% of European PE transactions in 2023, making this strategy increasingly prominent. BCG research shows that buy-and-build deals outperform standalone PE deals by 8.5%, primarily through multiple expansion.
Capital Efficiency: The Cash Flow Catalyst: Moving beyond simple cost reduction, capital efficiency encompasses working capital optimisation, smart CAPEX allocation, and creating a culture of financial discipline. Modern PE firms use advanced analytics to track Return on Invested Capital (ROIC) and Economic Value Added (EVA), ensuring alignment with Value Creation goals.
Multiple Expansion – The Valuation Virtuoso: The “secret sauce” operates through market-driven and investor-driven expansion. Success requires building great businesses, de-risking operations, sector repositioning, growing recurring revenue, and developing compelling growth narratives.
Exit Maximisation – The Grand Finale: The grand finale begins with the end in mind, requiring careful orchestration of all Value Creation efforts. Success demands early planning, demonstrable operational improvements, and a clear roadmap for future Value Creation.
The 6 Value Creation Enablers: The Underlying Support System
While the 7 Core Value Creation levers form the backbone of PE strategy, it’s the 6 Foundational Enablers that truly set the stage for exceptional returns. These enablers are the hidden engines that power sustainable growth and differentiate top-performing firms from the rest.
Strategic Agility & Defensibility – The Competitive Compass: Strategy must be at the core of Value Creation. Frameworks like Hamilton Helmer’s 7 Powers and Roger Martin’s Playing to Win help build sustainable competitive advantages.
Winning Leadership/Team/Culture – The Human Engine: Human capital is the top predictor of investment success. The “CEO alpha” is crucial, with 94% of PE firms believing portfolio company leadership contributes an average of 53% to investment returns.
Digital Transformation – The Tech Revolution Accelerator: No longer optional, digital transformation can drive revenue growth, enhance customer experience, enable business model reinvention, and improve operational efficiency. The advent of AI is prompting PE firms to reevaluate their technological strategies.
Leveraging Business Intelligence & Data – The Insight Alchemist: Modern PE firms use advanced analytics and data-driven insights to make better decisions, optimise operations, and identify Value Creation opportunities.
Beyond Profit – The Stakeholder Symphony: This “Beyond Profit” approach considers the interests of all stakeholders – employees, customers, communities, and the environment – alongside those of investors. Far from being a constraint, this holistic view is emerging as a powerful enabler of Value Creation in PE-backed businesses. It’s not just about doing good; it’s about doing well by doing good.
Value Creation Execution – The Master Orchestrator: The master orchestrator that transforms strategies into results through early planning, clear goal-setting, and rigorous performance management.
The Interconnected Nature of Value Creation
Understanding the interconnectivity of these levers and enablers is crucial. A business is a complex, adaptive system where changes in one area influence others.
For example, A digital transformation initiative might improve operational efficiency, enhance the customer experience, attract tech-savvy talent, and provide rich data for better decision-making.
The Continuous Complex Journey of Value Creation
Value Creation is not a one-time effort but a continuous journey. The business environment is constantly changing, and what worked yesterday may not work tomorrow.
Value Creation in PE: The Art of Turning Good into Great
The future belongs to what might be called ‘Positive Equity‘ – an approach combining traditional PE strengths with enhanced capabilities for hands-on Value Creation and a broader stakeholder perspective. Success requires mastering all levers and enablers while understanding their interconnections.
For PE professionals and portfolio company CEOs, the message is clear: Value Creation must be embedded in your DNA. It’s no longer enough to be good at deal-making; you must excel at transforming businesses. The most successful firms will be those that can orchestrate all elements of the Fit to Lead Value Creation Toolkit, creating sustainable value while making a positive impact.
The canvas awaits those ready to master this new paradigm of Value Creation. In an increasingly competitive landscape, the difference between good and great lies in your ability to execute this comprehensive approach to Value Creation.