When an investment has been done the work with developing the company starts. This process is pivotal in increasing the value of the portfolio company. Operating and industrial improvements in the portfolio companies are today absolutely necessary in order to achieve lasting value creation in the portfolio companies. The strategies deployed to reach these targets differ, but there are several basic strategies that are commonly used although every investment case has its unique merits.
The corporate governance model
Fundamental to the entire process of creating value in the portfolio companies is the corporate governance model applied by private equity. This means a very active ownership which primarily is done via the portfolio company board of directors but also through informal contacts directly between the owners and company management. This results in swift decision-making and small, flexible and empowered boards willing to take risks in a way that is otherwise rarely seen. Since management is expected to invest in the company on the same terms as the other owners there is also a strong alignment of interest between owners, board and management.
This implies expanding the company quickly by acquiring competitors or companies with similar or complementary products, technologies or market presence. It is often a question of increasing market share to achieve economies of scale and drive internal efficiencies. For more mature business it is often a way of participating in or even leading an ongoing consolidation of a fragmented industry.
There is often great potential in opening new markets for the portfolio company’s products. For the growth company it may imply market entry for the first time which means getting the commercialisation of an invention of new technology going. New markets may mean new geographies but also new customer groups previously not targeted. This requires capital for market investments but also experience and knowledge about this kind of expansion and what it means for the company.
With private equity a broadening of the product offering is often on the agenda and that may mean new products in existing categories or applying a technology to new product categories or uses.
Better margins and efficiency
With private equity ownership a process starts by aiming at increasing efficiency and profitability. The process concerns all levels in the company with bench-marking and best-practice often used methods. The ambition is typically to become “best-in-class” in categories such as production, customer relations and service.
The cost structure can also be overhauled and could entail shifting simpler production to low-cost countries or making necessary investments in order to improve productivity at home.
One way to boost growth and add value to a company is through investment. It may relate to new production facilities, marketing investments or product development. Private equity ownership is often sought when the companies cannot muster these investments on their own.
When the private equity fund together with the management in the portfolio company has carried out the strategies and plans identified at the time of the investment it may be time to start planning for the exit, which means letting a new owner take over and continue developing the company. Private equity funds normally own portfolio companies for periods of between three and 10 years. At an exit a structured process is common which often involves an auction process.
A trade sale is when the portfolio company is sold to an industrial buyer. A secondary sale occurs when the company is sold to another private equity fund which can continue to develop the company. Today it is not unusual for one private equity fund to sell to another private equity fund which may have a different geographical scope and larger financial resources necessary to help the company through its next development phase. In this manner a company can be financed by private equity for an extended period of time. With an IPO, the private equity firm often stays on as a substantial owner for a period of time.