Private equity firms are in a tight spot right now. Firms are struggling to sell portfolio companies at their carried values. IPO windows are largely shut. Strategic buyers are hesitant. To make matters worse, many funds are now pushing up against the end of their 7- to 10-year lifespans. There’s a long line of overvalued, hard-to-sell companies and a lot of impatient limited partners (LPs).
Many PE firms are realizing it’s time to reevaluate their investment strategy and make some fundamental changes. Firms that sit back and wait for the IPO window to reopen or valuations to recover may be waiting a long time.
If PE firms can’t sell for a profit, they need to create profit. This means reevaluating cost structure, systems, and operations across companies in their portfolio. Future investments are going to require better up-front evaluation before buying in the first place.
Here’s what PE firms can do now to cut costs and shift the focus toward driving value, even in a market slump:
Start by reducing costs across portfolio companies. There are a number of strategies here. The first is simple: Make sure the right number of employees are doing the work that needs to be done. Optimizing headcount helps ensure staffing levels are efficient. But don’t attack this hastily. Reducing headcount can be counterproductive if experienced employees who hold critical knowledge are overlooked, remaining staff is overburdened, or the product/service quality suffers as a result.
Consolidate back-office functions like finance, HR, IT, and procurement into a shared services model that multiple companies can take advantage of. Or consider how portfolio companies can combine their purchasing power to negotiate lower prices with suppliers. Improving how work gets done through leaner operations can make processes more efficient and cut down on waste.
In the real world: At Trenegy, we worked with a large energy company on an enterprise-wide cost reduction project with headcount reductions of up to 30% in several departments. We took a value stream analysis approach going through each department with the goal of eliminating waste and redundant work and streamlining processes. This led to operations and administrative functions returning millions annually to the bottom line.
Determine how different portfolio companies can work together to create synergies. This includes identifying opportunities for cross-selling, where one company can sell its products or services to the customers of another company in the portfolio. Standardizing technology and using the same software for CRM or ERP can reduce costs and give investors a more unified view into how all companies are performing. Coordinating sales and marketing efforts through joint go-to-market strategies can boost overall revenue and market presence for companies that have similar target markets or operating models.
In the real world: We helped a company consolidate two of their holdings into one company by aligning sales, operational, and back office functions. They consolidated systems into a single ERP solution to share information and administrative staff. This allowed them to reduce headcount by 15% and improve revenue through customer collaboration.
The old model of buying a company at 8x EBITDA and hoping to sell it for a much higher price isn't working well right now. Private equity firms must shift their focus from just propping up paper valuations to actually improving how much cash their companies generate. Cost savings directly add to a company's bottom line, make it easier to pay off debts, and give the firm more flexibility for future exits, even when the market is tight. Focus on tangible improvements that put more money in the bank.
In the real world: We helped an organization redesign their contracting, bidding, service delivery, and billing processes to reduce DSO from 90+ days to less than 45 days. This improvement gave the investors a rapid cash flow injection to boost returns.
To key to all of this: Treat portfolio companies as operating businesses, not just financial instruments. Exits through IPO are sluggish, and firms that are used to a short investment horizon must now prioritize long term value creation. When buyers aren’t buying, the only way to keep maximizing returns on investments is to drive internal value, not sit back and wait for things to change.
At Trenegy, we help PE firms evaluate cost structure, systems, controls, and operations in light of changing market conditions to drive value and support future growth. To chat more about our work with private equity, email us at info@trenegy.com.
Trenegy is a non-traditional consulting firm based in Houston, Texas.