Let's Get Real About Value Creation

What actually works when teaming up with a private equity portfolio company

Hop around to a few random private equity websites. You’re bound to see a fancy-sounding term on or near the home page: “Value creation.”

Spoiler: You probably won’t have to look too hard. The concept has gotten very popular as of late. As a teammate of mine put it this week, “Value creation in private equity is having a moment.” So…why is that?

Well, interest rates are partially to blame. When interest rates are low and debt is cheap, it’s just easier to buy a company. You can borrow more and use less of your own money. Then, with a little bit of cost-discipline and a few surface-level improvements, you can wake up a few years later having created value by simply paying down your debt and nudging your EBITDA up a few points.

But when interest rates go up (like they have recently), this play gets harder to run. Just as higher mortgage rates mean that consumers can “afford less house,” higher interest rates make it harder for PE investors to use debt to finance their transactions. Suddenly, you can’t just financially-engineer your way to success. You have to find a way to make the business you just bought better. Improving a company is a different kind of work than buying a company. Most investors - even the great ones - need a little help to get it right.

And who supplies that help? The operating partner.

The other more enduring reason for value creation’s moment in the sun has to do with how PE funds promote themselves. This is a competitive market, and winning a deal often depends on more than simply offering the highest price. Backable companies and their executives attract many suitors, and investors need a way to differentiate themselves against the other potential check-writers out there. This is a kind of marriage. And just like any potential marriage, we’re drawn to the partner who’s willing to not only commit, but also pitch in.

One way investors broadcast these partnership signals is by talking about how they work with their portfolio. This part of the deal-making process is when investors tout their “value-creation playbook” - a set of standardized processes, templates, and strategies that (in theory) help lead to improved performance, a more valuable business, and a more successful exit. (And, just in case my chief compliance officer is reading this, allow me to double-emphasize the words in theory. The examples and concepts herein are completely hypothetical. This isn’t an advertisement and it’s not investment advice.)

I’m all about helping our portfolio companies. It’s my favorite part of the job. And in an industry that tends to raise the bar on people, I believe lending a hand is the right thing to do.

But I’ve got a few problems with the way the PE value-creation playbook is typically presented, implemented, and talked about.

First, the notion of a “we know best” playbook is pretty condescending. My firm buys businesses from founders. Founders who have been building technical products and serving a specific kind of customer for decades. To think that we can spend a few weeks in diligence and fully grasp the nuances of how the business runs and how it makes money, uncover all the gaps and risks, and then suggest some one-size-fits-all prescriptive transformation that the founder hasn’t considered before that then unlocks millions of dollars of value is the definition of operational arrogance. It’s just not what we do.

Our goal is to help our teams build better companies. And yes, providing outside perspective and a well-meaning push for change is a big part of what I do. And sure, I’ve got the relevant experience to back it up. I’ve worked with a lot of B2B software sales and marketing teams in my day. I understand what a good vs. not-so-good go-to-market motion looks like. But do I have all the answers? Do I have a “just do this” start-to-finish playbook that works in every situation for every company? Do I believe there’s a single, templatized approach to taking a business from where it is today to and through a successful exit?

Sorry folks, I do not.

And, in my humble opinion, you should be wary of anyone who tells you different.

It’s this evolution of value creation in PE - the moment it’s having, the different opinions out there about how to do it well, and the stigma that follows the concept around - that led my fellow partner

Jim Milbery

and I to write down our thoughts and record a “let’s get real” video workshop on the topic this week.

If you’re interested in hearing the insider’s perspective on what it means to add value to a portfolio company, how we see the role of the PE operating team evolving, or just hearing some hot takes on our “it depends” approach to lending a hand inside our portfolio, I think you’ll enjoy it.

We certainly had fun recording it.

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