Reading 1.6 Flashcards
How do VALUE CREATION PLANS differ?
Deal Type, ownership, growth strategy and geographic focus
What is a key driver of investor returns (more than strategy selection)
Value creation plans and how strategies are combined
Value creation plans are ESPECIALLY more important that strategy selection for investor returns in what type of deals?
Growth, Buyout and Secondary Deals
Successful execution of Value Creation Plans is dependent on
Resource constraint, Economies of Specialization, Diminishing Returns
VCP
Value creation plan
Top 5 VCP strategies in order of popularity (% of sample)
- Operational improvements (84%)
- Top-line growth
(in 74% of sample VCPs) - Governance engineering
(in 48% of sample VCPs) - Financial engineering
(in 35% of sample VCPs) - Cash management
(in 14% of sample VCPs)
A VCP often incorporates multiple strategies (____% in the sample). PE firms tend to choose from a concentrated set of favorite combinations. In this dataset, the average VCP spans ___ strategies.
1) 82%
2) 2.5
The ____ most popular strategy combinations account for ___% of the sample VCPs.
____ of the top ____ involve operational improvements and / or top-line growth.
1) 10
2) 80
3) 8
4) 10
The three most popular combinations involve both operational improvements and top-line growth; with no other strategy (___%), combined with governance engineering (___%) or with governance and financial engineering (___ %).
1) 18
2) 15
3) 11
What does the rise in popularity of the top 5 most popular VCP represent?
That PE Firms have become more hands on
Use of growth strategies in deals doubled (from 1992-1996 to 2012-2017), popularity of ______ tripled, popularity of_____ nearly quadrupled, and even popularity of _____ (the least popular strategy) more than doubled.
The already widespread operational improvement strategies also experienced further increase (____%) in popularity.
1) governance engineering
2) financial engineering
3) cash management
4) 5
5 types of deals and their description
- Early-stage deals (19% of sample deals) - Involve traditional venture capital deals, involving startups, pre-revenue companies, and pre-profit companies.
- Growth deals (59% of sample) - Typically involve external financing (but not outright acquisition) of companies with growing sales and profits.
- Buyouts (13% of sample - Typically involve acquisition (or at least majority control) of mature companies with fairly stable cash flows (eg., division of a large firm or a publicly listed company).
- Secondaries (6% of sample - Involve one PE firm acquiring the portfolio company of another
PE firm, and are more common in growth equity or buyouts than in early-stage companies. - Turnarounds (2% of sample) - Focus on underperforming or struggling companies.
In which deals are PE FIRMS more Hands on (implement VCPs more frequently)
- Involve buyouts (more so than early-stage deals).
- Are majority owners.
- Pursue inorganic growth (vs. organic growth).
- Invest in multiple countries (i.e., manage regional rather than country-focused funds
VCP strategies differ across deal types: while ____ are popular across all deal types, the frequency of implementation of top-line growth, governance engineering, and financial engineering varies significantly.
1) operational improvements
_____ and ______ become more popular as deal maturity increases, with ___/____ engineering strategies pursued in ___%/___% of buyout, ___%/___% of growth, and ___% /____% of early-stage deals, respectively.
1) Top-line growth
2) governance engineering
3) top line and gov
4) 88, 62
5) 77, 47
6) 56, 39
____ and ____ exhibit considerably stronger focus on financial engineering than the other strategies.
Secondaries, while generally similar to ____, pursue financial engineering less frequently.
This suggests that _____ and ____ are less important (have diminishing marginal returns) since buyout targets are sold to new PE investors.
1) Buyouts & turnarounds
2) buyouts
3) optimizing capital structure
4) incentive systems
Turnaround deals’ dominant strategy (___%) is _____, with the least focus on ____ (53%) and _____ (41%). This frequency of implementation of _____ is similar to that in early-stage deals (39%).
1) 59
2) financial engineering
3) top-line growth
4) governance engineering
5) governance engineering
_____ does not vary significantly in popularity across deal types.
Cash management
PE firms pursue growth, governance engineering, and financial engineering in ___% /___%, ___% /___% and __% /__% of their minority-/ majority-owned deals, respectively.
1) 72 , 78
2) 45, 56
3) 31, 43
The frequency of ____ and ____ does not vary significantly with ownership level.
1) operational improvement
2) cash management targeting
Examples of
1) organic growth
2) inorganic growth
1) increasing sales of existing/new products
2) acquiring other companies
Slightly more than ___ of sample deals are managed by single country funds and rest managed by “regional” funds that invest in multiple countries.
Half
____ funds pursue top-line growth and governance engineering strategies significantly more than ____ funds, often because they ________ of managers and board members.
1) regional
2) single country
3) consolidate companies across countries and and utilize wider networks
Operational improvement Strategy action items (7)
1) Buy/ upgrade assets (most used in initial VCPs)
2) Sell assets
3) Divest/spin off companies
4) Improve IT systems
5) Reduce costs (most used in revised VCPs)
6) Improve distribution or logistics
7) Improve organizational structure
Top line growth Strategy action items (7)
- Target market share
- Pursue add-on acquisitions
- Change mix of products/ services
- Pursue international expansion
- Change pricing strategy
- Improve marketing and promotion
- Improve quality
Governance Engineering Strategy action items (3)
- Change CEO, CFO, and other management
- Change board/ shareholder structure
- Improve corporate governance
Financial engineering Strategy action items (2)
- Optimize capital structure
- Improve incentive systems
Cash management Strategy action items (2)
- Improve receivables/ payables
- Improve inventory management
PE firms typically aim to implement ___ actions items. The average VCP in the sample includes ___ action items. The three most popular planned action items are:
The least frequent action item is (__%).
1) 2-5
2) 4.5
- Buying new or upgrading existing physical assets (66% of deals).
- Changing the mix of products and/ or services (37%).
- Pursuing add-on acquisitions [i.e., M&A deals] (33%).
improving inventory management 4%
Most VCPs are ____ to the deal
Unique
Most popular combination of VCP action items is
Asset purchases & Planned optimization of portfolio companies’ capital structure
VCP Action items depend on deal types:
• ___ typically focus on optimizing capital structure, pursuing inorganic growth, changing the mix of products or services, and replacing senior or middle management.
• ____ and ____ focus primarily on capital expenditures and pursue other action items opportunistically.
1) Buyouts
2) Early-stage and growth deals
How does resource constraint impact the likelihood that an ACTION ITEM FROM VCPs is achieved?
The less action items the higher probability that they are completed
Operating partners - definition and responsibility
Team of experts that help portfolio companies with implementation
When are action items of a VCP more likely to be achieved?
• Longer holding periods (i.e., the longer the deal is in a PE firm’s portfolio).
• Larger size (possibly due to increased focus on these deals)
• Majority ownership.
- More focused strategies with fewer action items
Focus on _____ has a negative effect on the likelihood of achievement; i.e., it reduces the chance that an action item is successfully implemented.
inorganic growth
How does economies of specialization impact VCP implementation
When a company has experience implementing action items => they are more likely to be implemented in other deals
Fund fixed effects explain more of the ____ achievement than other variables
Deal level
PE FIRM fixed effects explain the largest and second largest fraction of variation of the _______ achievement and ____ achievement
Action item
Strategy
What does a U shaped relationship between detail level in a VCP and successful implementation signal?
Details for a VCP are beneficial up to a certain point after which they become counter productive
Vintage year
Year when first round of investment capital is delivered to the company
Fund focus is important for successful implementation, as funds’ VCP achievement rates improve when their portfolio deals are more ____ in size and when they focus on ____ deal types.
______, on the other hand, does not seem to matter.
1) homogeneous
2) fewer
3) Sector specialization
_______ is the only fund strategy that significantly affects successful implementation: funds with predominantly _____ positions are more successful at implementing their VCPs.
Why is it so?
1) Minority ownership
2) minority
3) Possible explanation for this may be that funds with minority positions involve less ambitious, thus more achievable goals.
Vintage-year effects are significant, underscoring the importance of the _____ in successful VCP implementation and thus the role of ____ in VCP implementation.
At the PE firm-level, successful implementation also correlates significantly with _____ and ____
macro environment
luck
fund focus
minority ownership.
Plan revisions
Introduction of a new action item after holding period’s first year
What percentage of sample deals experience plan revisions?
What is the most common action item (% of deals)
Other common elements
77%
Cost reduction 31%
Capital structure optimization and CEO change
What is key for achieving high returns for investors?
Why is that?
Successful Implementation of Strategies.
Because it is more important to see ex post (achieved) than ex ante (planned) strategy
Is there a certain strategy that is most associated with higher/lower returns?
Or is there a certain number of strategies best to implement?
Or on what do returns depend on?
1) no
2) no, broad and focused strategies work
3) how the strategies are combined
When is successful implementation of action items of the VCP more effective and less effective in delivering good returns?
Why?
1) most - growth, buyout and secondary deals
2) least - early stage deals because risks are more idiosyncratic
MOIC and what does it measure?
Multiple on Invested Capital => returns on invested capital (with multiples more than 1 indicating profitable investment)
____out of the planned (ex-ante) 32 strategy combinations have predictive power for PMEs: ___ predict higher than average returns and ___ predict lower than average returns.
What are they?
1) four
2) two and two
- The highest returns (PMEs) are predicted by VCPs that plan to combine top-line growth, governance engineering, and financial engineering.
- The lowest returns (PMEs) are predicted by VCPs combining operational improvements and governance engineering
Why strategic reporting is unlikely to be an issue for PE?
1) quarterly reporting
2) monitoring by the EBRD
What company level changes positively correlate with investor returns
Increase in Sales, EBITDA, Employment and Capital Intensity
What changes are not associated with higher returns?
Governance Engineering, Financial Engineering, Cash Management
Most popular action items in a VCP
• Buying/upgrading assets
- Changing product/ service mix
• Pursuing M&A deals
