The Triumph of Revenue Engineering over Financial Engineering

The Triumph of Revenue Engineering over Financial Engineering

Private Equity is Adding Revenue Operations To Their Value Creation Toolbelt

The ability to sustainably grow future revenues is now essential to generating a return on capital in a marketplace where rising interest rates, inflation, and competition for deals take the teeth out of financial leverage, engineering, and multiple arbitrage.

With record levels of undeployed capital ($3.7 Trillion globally), elevated interest rates, and a sustained slump in mergers, acquisitions and IPOs – Private Equity (PE) investors must contend with paying larger multiples for assets, at higher borrowing costs, and fewer short term liquidity options. These dynamics have intensified the operating pressure on PE investors to generate greater profits and future cash flow from the investments they make.

In response, PE firms are looking beyond their traditional profit levers of add-ons, financial management, financial leverage, and operational cost control and beefing up their operations and systems for driving organic revenue growth. They are working directly with the sales, marketing, customer success and operations leaders within their portfolio companies to drive more scalable, profitable and consistent growth. They’re finding 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.  

“Instead of pulling all the levers—leverage, multiple expansion, inorganic growth—PE suddenly found itself with one lever to pull,” according to Stephen Brennan, head of private wealth solutions at Hamilton Lane. The lever Brennan is referring to is organic growth. “There’s a flight to high-quality companies that will be able to grow organically despite a challenging environment,” adds Brennan. As evidence, growth equity deals that use operating leverage and expansion capital to accelerate and scale fast growing companies have grown to historic highs to represent over one in five deals, according to the Pitchbook Q32023 PE Breakdown

“The top tech buyout funds like Vista Equity Partners, Thoma Bravo, and Insights Partners have become relentless in their programmatic efforts to build organically and apply operational best practices to enhance organic growth via ongoing technology, go-to-market initiatives and product improvements across the organization,” according to investment banker Ben Howe, CEO of AGC Partners.  For example, more and more PE firms have implemented commercial Operating Partner roles to drive revenue growth across their portfolio companies. The most progressive growth equity firms like Vista Equity Partners have built teams of over 100 operating partners and subject matter experts in sales, marketing, revenue operations and customer success to provide strategic counsel and hands-on support to portfolio companies to find ways to generate more scalable and consistent growth. Others like Insights Partners, sponsor forums and conferences where sales, marketing, and customer success and operations leaders from across their portfolio companies can share best practices.

Within the portfolio companies – commercial leaders are actively reconfiguring, optimizing and upgrading their commercial models to unlock more growth from their markets, customers, channels and growth assets. For example, over 85% of B2B organizations are reconfiguring the way they lead their revenue teams, align the operations that support them, the composition of their commercial tech stacks, and the roles, assignments, incentives and priorities of their customer facing employees, according to the book Revenue Operations.

This makes good business sense because organic revenue growth – the increase in a company’s sales over time – is the primary basis for creating business value.  The more sustainable and scalable revenue growth is, the more valuable a business becomes.  In fact the ability to grow revenues organically has created more firm value than all efforts to reduce costs, expand earnings multiples, and improve free cash flow combined according to an analysis of total shareholder return over a twenty year span.

This relationship between revenue growth and return can be seen in the high valuations awarded to businesses that can deliver predictable, scalable, and profitable growth. For example, the marketplace values firms with hyper growth (e.g. annual growth over 25%) and predictable revenues (e.g. Net Annual Recurring Revenues of over 100%) disproportionately. That is why the top 15 public SaaS business commands Revenue and EBIDTA Multiples that are more than twice that of the average SaaS business according to an analysis by AGC Partners

Another factor is the bar for the quality of revenue growth (e.g. the Rule of 40) required to IPO or exit at a high multiple has increased. This puts even greater pressure on PE funds to provide more active support to their portfolio companies to help them achieve sufficient investment performance.

“There is a flight to quality – with more PE dry powder than ever before (increased demand), and very few gold standard companies coming to the market (limited supply),” reports Ben Howe, the author of the AGC Partners Fall Tech Capital Markets Update. “There is a much higher bar for 2023 and 2024 IPO hopefuls, which leaves the current herd of 809 technology sector unicorns on the outside looking in,” he adds. “Many do not have the performance metrics that would meet today’s IPO standard.”

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. The challenge for both investors and operators is that growing a business in 2023 is complex, data-driven, capital intensive, and interdisciplinary. This makes it difficult to compare one commercial model to another and apply benchmarks and best practices from other businesses that can improve results.

For example, an analysis of the top 150 global public SaaS companies by AGC Partners found that while the best SaaS companies spend roughly the same amount on Sales and Marketing (about a third of revenues) –  they get very different revenue outcomes in terms of revenue growth, revenue retention, and company value. For example, revenue growth across the 150 SaaS firms in the AGC SaaS index varied sixfold (between 4% and 35% CAGR). Company value as a multiple of those revenues varied eightfold (between 1.6x and 13.3x revenues).

That means other factors beyond effort and investment are impacting and confounding the ability of managers to improve the quality of their revenue generation. Achieving the type of consistent, profitable and scalable growth markets are demanding is a complex, interdisciplinary, technology enabled sport where the team that connects the most dots wins. Factors like teamwork, information sharing, the return on commercial assets, and the alignment of people, process and operations play a much bigger role in the growth formula than most managers realize. Revenue Operations is a systems-based approach to aligning the complex set of  commercial systems, operations, and processes that support the revenue cycle in your business to accelerate growth and maximize company value.  PE firms are increasingly embracing Revenue Operations because it has the potential to generate more growth and value with existing resources and assets.  As evidence, there are seven ways any B2B organization can unlock more growth potential and improve financial performance by using the principles of Revenue Operations to engineer more revenue growth from their businesses.

1. Automating and optimizing the lead-to-cash cycle. 1 to 5% of EBITDA flows unnoticed out of companies due to 11 points of failure in the product to cash cycle, according to an analysis by the Revenue Enablement Institute. Automating and optimizing the lead-to-cash cycle can grow revenues by 5%, reduce cost to sell by 5%, improve forecast accuracy by 34%, reduce billing errors and disputes on orders by 35%, and shrink the time it takes to collect cash by over 10% according to research by Salesforce.
2. Optimizing Selling and Resource Allocation Tuning your commercial architecture –the design of your sales force and they key incentives, quotas, and roles, coverage and engagement rules within in – to take better advantage of digital technology can double the speed, engagement and performance of your front line sellers, according to research in the book Revenue Operations. A properly designed and optimized commercial architecture can contribute five or more points of profit contribution to the bottom line because selling systems can generate vastly different outcomes in terms of rapid revenue growth and better profit contributions without adding resources and costs based on how variables like channel mix, customer treatment types, coverage ratios, selling effort, and product emphasis are set up. For example, a Pharmaceutical company was able to drive $25 million in marginal sales contribution – an 8% increase – by changing the size, deployment, and product emphasis of their sales force, according to research conducted by Professor Leonard Lodish of Wharton.
3. Improve The Economics Of Field Selling – Moving to a more digital, data-driven, distributed and diverse (“4D”) sales model can improve sales productivity over 50% with cost reductions of 10% compared with traditional field sales.
4. Better Managing The Rep Recruiting, Ramp And Retention Process – A 5% increase in sales rep attrition can increase selling costs 4-6% and reduce total revenue attainment by 2-3% overall. Ten points of salesforce attrition can wipe out revenue plans and margins if nobody picks up the slack by increasing the cost of sales by over 20% and revenue attainment by  8% according to an analysis by the Revenue Enablement Institute.
5. Improving Pricing Structure, Governance, Precision –  More disciplined and optimized pricing can expand margins by 3-10% with existing resources and improve earnings multiples with limited investment according to analysis by Wharton Business School. Data-driven pricing can yield even greater profit margin expansion by enabling pricing personalization and innovation.
6. Consolidating, Simplifying and Optimizing the Commercial Tech Stack – 94% of B2B sales organizations are actively consolidating and simplifying their commercial technology portfolio as these investments start to exceed over $10,000 per sales rep on an annual basis.Measuring, optimizing and connecting the commercial tech stack to simplify the seller workflow and augment seller value can yield a 50% improvement in performance and return on assets according to the Tuning the Growth Engine report.
7. Valuing, Managing And Monetizing Commercial Assets. A large and often ignored factor confounding the ability of managers to assess and manage growth is that the commercial assets that generate growth are hard to measure, manage, and report because they are largely regarded as “intangibles”  – just like R&D, “process know how”, and brand equity – by accountants. So they don’t show up on any balance sheet or management report. The financial reality is that most of the value of a modern business is in the form of intangible growth assets like customer relationship equity, brand preference, data and insights, process know-how, and digital channel infrastructure. A number of commercial and academic research studies have documented that, when properly measured and accounted for, these intangible assets represent in excess of 80% of the value of a business. The ability of revenue teams to deploy these assets to grow future revenues and profits by building customer preference, conversion, loyalty, and usage while commanding price premiums are the primary drivers of firm value.

Revenue Operations provides a framework to get investors and executives to focus in on the core drivers of future growth in ways that improve their visibility into their ability to hit revenue targets and quantify the untapped growth potential of their business assets.  RevOps also helps create new value by identifying  the root causes of poor or inconsistent revenue growth results, and objectively measuring that performance on a normalized and “apples-to-apples” basis.“The best method for developing – and executing – the optimal revenue operations playbook is to benchmark current practices and compare performance to peer best- in-class,” says Steven Busby, a Managing Director of the Revenue Enablement Institute who piloted and engineered a successful exit of his business in 2020.  “The resulting gaps can be prioritized by revenue impact and feasibility to ensure revenue operations efforts are focused on the right areas – and teams can get aligned on those areas. This benchmark approach works at all stages of the revenue operations lifecycle, whether companies are launching initial efforts or looking to master the discipline after several years.”