by: Kay Francoeur
Over 80% of ECA’s clients are PE or PE-backed, and so we have an intimate understanding about how , they’re often seeking candidates with experience in “Value Creation.” Value Creation is now a ubiquitous term. We all have at least a vague sense of what it means, but rarely do we have nuanced discussions about this concept and how it’s applied.
It’s helpful for both PE clients and potential candidates applying to portfolio ops roles that touch value creation to examine some common definitions of this concept – less in pursuit of pinpointing some Ur-meaning of the term, and more so towards creating a shared language for articulating: 1) how a specific firm is framing their approach to inorganic growth and, from the candidate’s perspective, 2) how your experience dovetails (or does not) with a firm’s preferred internal take on value creation.
Why is there no clear definition of such a common term in PE? While there is consensus that PE firms do contribute to value creation, there is a lack of understanding around how this process unfolds. As Krysta and Kanbach (2022) write, part of the issue is that over the past 30 years, the PE space has become much more crowded. In the early 1990s, PE funds managed around $100Bn USD; by 2019, this number had risen to $2.4 trillion AUM.
PE firms once used to rely on financial leverage as their main tool for boosting the rate of return on portcos. But as this space has expanded, PE firms have had to employ other means of creating real operational value beyond financial engineering, for example through add-on acquisitions within “buy-and-build” strategies.
Existing research on value creation hasn’t yet caught up to this shift. Earlier studies of value creation often used the lens of “agency theory,” which focuses on how PE firms maximize efficiency by decreasing misalignment between shareholders and management – through actions like taking the company private and optimizing organization through pulling various governance and performance management levers.
Krysta and Kanbach argue that while the role of PE firms as “inefficiency cutters” remains crucial, given the broader shift to operational improvements and add-on acquisitions as drivers of value, the pivotal roles PE firms play as “growth enablers” and “strategic revitalizers” deserve more attention. The concept of “resource theory” focuses on the PE holding period as a time of dynamic change that exploits market operations and catalyzes growth by developing a company’s available resources and driving it toward new market segments.
Krysta and Kanbach offer a helpful framework for value creation, consisting of three main areas:
- Inputs – divided into Efficiency and Growth – meaning the contributions the PE firm makes to portfolio companies.
- Outcomes – increased performance and improved results from the PE firm’s inputs.
- Context factors – internal and external circumstances that impact the PE firm and portfolio companies, such as buyout factors, PE firm characteristics (e.g. industry specialization), portco characteristics, and global events and trends (e.g. Brexit, Covid, ESG).
Biesinger et al (2020) provide further framing of value creation plans as consisting of one or more key “action items.” These authors reviewed 1580 emerging-markets deals by 171 PE funds raised between 1992 and 2017, identifying 23 distinct action items grouped into five strategies:
- Operational improvements (84% of sample deals)
- Top-line growth (74%)
- Governance engineering (48%)
- Financial engineering (35%)
- Cash management (14%)
Studies like these are valuable for building comprehensive contemporary understandings of value creation – but to return to the question with which I began, why does defining our terms matter for our PE clients and for candidates looking for portfolio ops positions?
As Rajesh Sennik of KPMG writes, as PE deal volumes, values, and returns have increased over recent years, there has been sharper focus on the value creation process as a tool for PE firms to maximize value from investments. With the significant shift in emphasis from avoiding risk to “creating value,” value creation thinking occurs much earlier in deals-making and value creation specialists are increasingly influential given the central role they play in this process.
If value creation is, as Sennik suggests, the next frontier of PE and increasingly the main determinant of whether a transaction will succeed, identifying key themes and factors that define value creation plans seems like an important early step to ensure that the plan is comprehensive and exploring the full range of value levers possible from the outset before growth opportunities become more limited.
For candidates looking to land in-demand roles as value creation specialists, precise understandings of value creation are likewise beneficial – both for framing their own experience to target the specific position they desire, but also for evaluating the underlying investment thesis of a PE firm they might join. Job interviews are supposed to be about ensuring a good fit on both sides. Candidates might wish to hold up a firm’s value creation plan against their own understanding of the concept, and ask themselves whether they think enough levers are being pulled in the right places. What can the candidate offer that the firm currently needs in order to drive future success across the portfolio?
Kay Francoeur is a Project Manager at ECA Partners. She can be reached at [email protected]