Closing The Value Creation Gap In Private Equity

5 Minutes Read

Closing The Value Creation Gap In Private Equity

The landscape of private equity (PE) is undergoing a pivotal transformation. With record levels of undeployed capital ($3.7 Trillion globally), elevated interest rates, and a halt in mergers, acquisitions, and IPOs – PE investors must contend with paying larger multiples for assets, at higher borrowing costs, and fewer short-term liquidity options. Couple this with the reality that getting deals done is becoming increasingly complex. PE firms are holding their assets longer, at an average of 6.6 years—a 14% increase compared to ten years ago (Accenture, 2024). These dynamics have intensified the operating pressure on PE investors to generate greater profits and future cash flow from the investments they make. General Partners (GP’s) now must contend with a growing multitude of headwinds all at once:

  • The level and age of the dry powder in their funds is creating a heavy incentive to get moving. The industry is sitting on a stockpile of undeployed capital, equating to $3.9 trillion in dry powder, the largest share of it ($1.2 trillion) in buyout funds.This slowdown in dealmaking has also increased the average age of that buyout capital; around 26% of it is 4+ years old and aching to be deployed.

  • High interest rates make acquisition “math” harder to pencil in due to the rising cost of capital. When rates go down, multiples of cash flow go up, and vice versa. Because of that, historically low rates for the past decade have provided a tailwind for deals by keeping price multiples growing. However, in the current interest rate environment, that calculus is much harder to make work.

  • The significant surge in the number of firms vying for a limited pool of investment opportunities is creating fierce competition. Sellers are only bringing to market the highest-quality assets, those they are confident will move at a reasonable return. The proliferation of PE entities, coupled with the scarcity of attractive deals, has intensified the battle for assets, making differentiation and strategic value creation more crucial than ever in securing and maximizing investments.

What’s clear is that sitting idle and hoping for conditions to recover is not a viable strategy. The current environment is putting a spotlight on how critical it is to generate operating leverage in a market where tailwinds from multiple expansion have turned into headwinds. While the volatility and the direction of rates are out of your control, you can get better at underwriting value and capturing it through flawless execution. The traditional levers of value creation, primarily financial engineering, are no longer sufficient to meet the escalating expectations. Instead, PE firms must dive deeper into operational improvements and explore new avenues for value creation to stay competitive. The days of “one-and done” interventions are well behind us.

Ushering In a New Era of Value Creation

In response, PE firms must look beyond their traditional financial engineering levers of add-ons, financial management, financial leverage, and operational cost control. Instead, they need to lean into and improve their operations and systems to drive organic revenue growth. The top PE firms are starting to embrace this fact. According to a recent Accenture survey, Leaders recognize that financial engineering is only the first step toward generating value and will account for just 25% of their efforts. They believe the remaining 75% should focus on operational value creation.

To execute this effectively, investors need to work directly with the sales, marketing, customer success and operations leaders within their portfolio companies to drive more scalable, profitable and consistent growth. They must find ways to leverage data, systems, insights and process improvements to unlock more revenue growth from customer relationships, selling channels and markets they already have access to. 

This makes the ability to reliably assess, improve, and maximize a company’s core underlying ability to generate these future cash flows a very important business discipline. It’s also central to creating a modern, data driven value creation plan that is focused on improving results and driving execution. The challenge for both investors and operators is that growing a business in 2024 is complex, data-driven, capital-intensive, and interdisciplinary. Forward looking PE firms can get better at creating value and capturing it by understanding the underlying value levers that generate revenue growth. Doing this systematically, in a data-driven and empirical way requires a standardized proven framework.

Leveraging Quality of Revenue To Accelerate Private Equity Value Creation

As PE investors navigate the complexities of high interest rates, competition for premium assets, and the imperative to deploy capital effectively, a data-driven approach to value creation is indispensable. The Quality of Revenue (QoR) framework offers a lens through which investors can examine the robustness of a company's revenue capabilities—assessing factors such as customer management, sales effectiveness, and the scalability of business models. This holistic analysis provides a strategic roadmap for identifying and implementing operational improvements that drive defensible, lasting growth.

Moreover, in a market environment where quick flips and financial arbitrage are less feasible, the ability to assess and drive organic growth through operational excellence stands out as a key differentiator in a marketplace where raising capital is becoming increasingly competitive. By embedding QoR assessments into their value creation playbook, PE firms can uncover hidden opportunities when conducting diligence of target acquisitions and within their portfolio companies. The primary outcome is to optimize sales processes, enhance customer engagement, and innovate product offerings—all of which contribute to a more resilient and valuable enterprise.

A Holistic Tool Across The Deal Cycle

Opportunities for value creation exist across the entire deal cycle. Knowing when and where to get an assessment of a company’s underlying ability to generate organic value is crucial to building value creation plans that result in crisp execution. This approach equips investment teams with the data and insights needed to make informed strategic decisions, optimize operations, and align investments toward sustainable revenue growth.

Enhancing Due Diligence
The QoR assessment complements traditional diligence methods by providing deeper insights into a company's operational dynamics, often overlooked by Quality of Earnings (QoE) analysis. This helps mitigate risks, ensuring a smoother transition post-acquisition, and establishing a collaborative relationship with the management team from the outset.

Post-Closing: Benchmarking and Diagnostics
Following the deal closure, a detailed QoR assessment aids investors and management in identifying and agreeing on the fundamental challenges facing the business. This consensus facilitates the development of effective action plans, ensuring that the initial period post-acquisition is marked by data-driven and goal-oriented activities.

Portfolio Scan: Addressing Underperformance
For portfolio companies not meeting growth expectations, QoR serves as an essential diagnostic tool, pinpointing the underlying reasons for underperformance. By providing a prioritized action plan, QoR enables management to reallocate resources effectively, align various functions, and streamline the revenue cycle, thereby reinvigorating growth.

Pre-Sale Value Maximization
In the months leading up to a potential sale, conducting a QoR assessment alongside a Quality of Earnings analysis offers an assessment and roadmap for enhancing revenue quality and operational alignment. This preparation not only strengthens the company's growth narrative but also positions it for maximum valuation upon exit.

Leveraging Add-On Acquisitions
A QoR assessment is crucial in evaluating the compatibility and integration potential of add-on acquisitions. This strategic application of QoR helps avoid integration pitfalls and maximizes the synergistic potential of combined entities, fostering a cohesive and growth-oriented organizational culture.

QoR assessments enable a holistic examination of revenue streams, customer engagement strategies, and market positioning, offering actionable insights for strategic enhancements. This approach not only aligns with the demand for operational excellence but also ensures that investments are geared toward long-term growth and resilience. As PE firms strive to navigate the intricacies of today's investment landscape, incorporating QoR into their strategy equips them with the insights needed to drive forward-looking, data-driven value-creation plans.

If you are interested in learning more about the Quality of Revenue Assessment, please feel free to send me an email at and I am happy to provide you with more resources.

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Josh McDonald

Josh is a serial entrepreneur across real estate and technology. He has expertise in helping companies scale their revenue teams, systems, and operations.