1.6 Value Creation in PE Flashcards
What does VCP stand for and mean?
Value creation plan. The strategy for PE firm to unlock superior returns by monetizing their industry and operational expertise (e.g. cost cutting, productivity improvements, operational change, leverage).
Highly skilled employees at a PE firm are known as _____
Operating partners
What are 5 categories of action items in a VCP?
1. OI
2. TLG
3. GE
4. FE
5. CM
- Operational improvements (reduce costs or improve assets)
- Top line growth (sales)
- Governance engineering (changing mgmt team/processes - this is 3x more popular now than 20 years ago). The strategy of changing the CEO, CFO, or senior managers is equally deployed.
- Financial engineering - optimising cap structure. Adjusting leverage or refinancing current obligations. But there is a balance between reducing taxes paid (through higher interest expenses) and the firm’s weighted average cost of capital and not too increase interest cost too much risking bankruptcy. Changing the firm’s capital structure (i.e., adding debt) is used more frequently than imposing incentive-based compensation
- Cash management - focuses on reducing working capital needs. Such as through reducing credit extended to customers (i.e. receivables outstanding), increasing credit provided by suppliers, and improving inventory management (the latter is used less than the 2 former).
Examples of operational improvements included in a VCP
- reducing costs
- buying/upgrading assets
- employee related (size of employee base, wage structures, labour productivity, and capital intensity)
- buying or selling firm assets or divisions/ restructuring business units
What is top line growth and how (in VCP):
Aims to increase sales. Such as through increasing market share, changing product or service mix, pursuing international expansion (or new markets more broadly), changing the pricing or marketing strategy, improving product quality, and adjusting margins.
What are the most commonly used action items in the VCP?
Operational improvement and top line growth are the most commonly employed. Financial engineering and cash management are the least used although they are still viable approaches
The use of VCPs varies based onwhat four things?
1. DT
2. FO
3. GS
4. GF
- deal type
- fund ownership
- growth strategy
- geographic focus
Deal types can be split into 5 categories:
1. ES
2. G
3. B
4. S
5. T
- early stage - traditional venture capital deals
- growth - involve external financing, not acquisition, of firms with high sales or profit growth
- buyout - acquisition (full or partial) of a mature company with stable cash flows
- secondaries - one PE firm buys a deal from another PE firm
- focus on struggling or underperforming companies
Popularity of VCP action items by deal type?
1. OI
2. TLG
3. GE
4. FE
5. CM
- op improvement - buying or upgrading firm assets and reducing costs are the most common VCPs across all deal types
- top line growth - changing the product or service mix popular across all, for turnarounds, pursuing international expansion is also popular. Growth, buyout, and secondaries may focus on add-on acquisitions, while early-stage deals most commonly improve marketing efforts.
- governance engineering - all deal types pursue changing CEO and other managers. for early stage, changing the CFO may be a less popular option than for the other deal types, and instead more likely to change the board’s structure
- financial engineering - optimising cap structure is the most popular across deal types
- cash management - improving the management of receivables and payablesis the most popular action item across all deal types
Fund ownership categories in a PE deal (2)
Fund ownership in a PE deal can be either a majority stake or a minority stake
Popularity of VCP action items by fund ownership type?
1. OI
2. TLG
3. GE
4. FE
5. CM
- OI - both maj and min stakes focus on buying or upgrading assets, reducing costs, and improving IT systems. Buying/upgrading assets is by far the most important.
- TLG - both maj and min focus on changing the product or service mix, pursuing add-on acquisitions, and improving marketing efforts. Changing product or service mix is most important activity.
- GE - both min and maj stakes focus on replacing management with less emphasis on attempting to replace the CEO and CFO.
- FE - both focus on optimizing capital structure
- CM - both focus on improving the management of receivables and payables
Two types of growth strategy for a PE deal?
The growth strategy for a PE deal can be either organic (i.e., focus on internal growth drivers) or inorganic (i.e., acquisitions).
Popularity of VCP action items by growth strategy?
1. OI
2. TLG
3. GE
4. FE
5. CM
- OI - Both organic and inorganic growth strategies focus on buying or upgrading assets and reducing costs. The emphasis is on buying or upgrading assets.
- TLG - for inorganic, the focus is pursuing add-on acquisitions - this is not pursued at all by the organic type. Shared strategies are changing the product or service mix, improving marketing efforts, and pursuing international expansion (in that order).
- GE - both focus replacing management with less emphasis on attempting to replace the CEO and CFO
- FE - both focus on optimizing capital structure
- CM - both focus on improving the management of receivables and payables
Popularity of VCP action items by geographic focus (single country or regional)?
1. OI
2. TLG
3. GE
4. FE
5. CM
- OI - Both single country and regional strategies focus on buying or upgrading assets and reducing costs. The emphasis is on buying or upgrading assets.
- TLG - both focus on changing the product or service mix, pursuing add-on acquisitions, and improving marketing efforts
- GE - both single country and regional strategies focus on replacing management
- FE - both focus on optimizing capital structure
- CM - both focus on improving the management of receivables and payables
Popularity of VCP action items by deal type:
- early stage - OI (80%), TLG (56%), GE (39%), FE (29%), CM (5%) - smallest focus on CM than any deal type.
- growth - OI (85%), TLG (77%), GE (47%), FE (32%), CM (15%)
- buyout - OI (82%), TLG (88%), GE (62%), FE (54%), CM (18%) - stand out due to high FE focus relative to other deal types
- secondaries - OI (85%), TLG (72%), GE (56%), FE (32%), CM (13%)
- turnaround - OI (88%), TLG (53%), GE (41%), FE (56%), CM (14%) - OI very important, as is financial and gov engineering