PE firms are back in investment mode and sharpening their focus on value creation

Julie Neal is a Director and Tom Acfield is Strategy Director at Vendigital. They recently shared their insights with Alpha Week.

An upturn in private equity investing seems to be underway, with more firms demonstrating a willingness to deploy capital. However, with multiples constrained and exits continuing their slow recovery, managers are sharpening their focus on value creation.

Analysts reported a significant uptick in private equity deal activity in the final quarter of 2023, signalling renewed buoyancy and increased confidence about investing in businesses with growth potential. Much of the investment capital is currently being directed to businesses in distress, where working capital is depleted, which is making it harder for the business to pursue growth opportunities.

The increased confidence among private equity managers is largely due to more realistic value expectations among private companies, which means realising gains is that bit more achievable. However private equity managers also recognise that there is a real opportunity to optimise investment value through value creation.

One important way to create value is to focus on establishing a clear ESG strategy and delivery plan, which can make portfolio companies stand out in their chosen markets. Private equity managers can add value by supporting the development of compelling ESG credentials and driving improvements across the business. For example, understanding the link between carbon and cost is vital and can uncover opportunities to reduce cost by investing sustainably.

As well as using ESG as a critical valuation lever, private equity managers appreciate the importance of cost understanding to unlock value-driving potential. For example, an in-depth understanding of the cost of a specific product or service can flag opportunities for small changes that will deliver significant value, as well as potential sustainability gains, over time. A professional and robust approach to data capture and analysis, combined with AI powered cost modelling tools, can help to drive operational efficiency and reduce cost. If a portfolio company has multiple divisions, there could also be an opportunity to realise value through consolidation, for example, by centralising back-office functions and improving operational efficiency.

Historically, private equity managers would have often expected to increase the multiple on their investment portfolio. However, in today’s market they realise that gains are more likely to come from cost reduction or other value-driving initiatives, and it is important to act quickly. With their depth of sector-based knowledge, private equity managers and their advisory teams are ideally placed to add value through benchmarking. For example, knowing how much a company in a given sector should be investing in IT support services or paying senior-level employees could help to optimise their cost base without increasing risk or impacting the portfolio company’s employer brand.

With fewer portfolio companies pursuing IPOs in the current macro-economic climate, private equity managers are more likely to be looking to exit through a strategic sale to a trade buyer or a secondary buyout. In some cases, a ‘buy and build’ acquisition strategy could help to boost the portfolio company’s valuation significantly prior to exit. However, at a time when distressed sales are prevalent, private equity managers must adopt robust due diligence at every stage of the deal process. They should also stay close to the management team in the first 100 days following the acquisition to smooth the integration process and galvanise the business from the top down.

With interest rates in the UK set to fall steadily this year and so much dry powder still available, the current upturn in private equity investment is expected to continue. Private equity firms that have taken steps to strengthen their value creation expertise and embraced AI and data analytics to improve their strategic decision-making will be best placed to optimise value at the point of exit.