How Mid-Market Portfolio Companies Create Value in an Uncertain Environment
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April 10, 2024
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Private equity portfolio companies in Spain (like all Spanish businesses) have been experiencing a challenging environment for years, marked by the increasing costs of capital, raw materials, energy and labour. In this demanding business landscape, mid-market portfolio companies often face additional challenges such as low levels of professionalisation, a lack of capabilities within their teams and overexposure to the local market — all against a backdrop of pervasive economic uncertainty.
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In response to this economic pressure and sustained, widespread uncertainty — the dreaded “permacrisis” — private equity firms are increasingly recognising the need for deeper partnerships and opting for a more hands-on approach that prioritises long-term success. Firms that excel in this environment adopt a dual strategy: close collaboration with their portfolio companies, with an absolute focus on value generation, and adaptation of their internal operating model to provide effective support to their companies.
Focus on Value Generation
For 2024, private equity prioritises improving the profitability of portfolio companies through inorganic growth and operational optimisation. This approach becomes even more relevant given the complicated environment for divestments and high valuations, which remain the sector’s primary risks.
Inorganic growth endures as a fundamental pillar of value generation. In fact, around 55% of transactions conducted in Europe during 2023 by private equity funds were add-ons, compared to 25% buyouts or leveraged buyouts — the highest figure in the past 10 years. Executing buy and build strategies requires significant effort, however, and more than half of these transactions did not achieve the expected results. Supporting portfolio companies in developing the internal capabilities to support transaction and integration thus becomes particularly relevant for private equity firms, as a way to effectively build inorganic growth platforms and sustainably manage cultural change.
Yet improving profitability can be addressed in a variety of ways. Private equity teams typically encourage actions that have an impact on expected investment timelines: increased selling prices and/or the reduction of third-party and personnel costs, often accompanied by improvements in operational efficiency, inventories and commercial terms to optimise the cash cycle. In any case, for portfolio companies, installing highly professional management and experienced supporting teams is crucial to ensure success in implementation.
Adapting the Operating Model
Traditionally, monitoring and supporting the firm’s portfolio companies was the responsibility of an investment team. To increase the focus on post-deal value generation, however, today we see an evolution, with private equity firms transforming their operating model to provide direct support to portfolio companies.
This novel approach — close involvement in portfolio company operations — has materialised through various support schemes. Operating partners may serve as experts (often internal) who work cooperatively with portfolio company management teams to identify and implement operational improvements. In parallel, senior advisors can provide specialised functional or sector-specific advice to address a range of challenges.
Complementing this support, external advisors can provide additional knowledge and skills to solve complex problems and confront the portfolio company’s shortcomings. Finally, some private equity firms choose a model that coordinates or even centralises certain activities, which can facilitate management and capture efficiencies in multiple portfolio companies simultaneously.
In a demanding landscape where uncertainty persists, especially in the mid-market segment, portfolio companies that receive direct support from private equity firms will be positioned to drive value capture, whether inorganically or by improving operations. Private equity teams therefore must be prepared to evolve, equipping themselves with the capabilities and resources to provide the necessary support to their portfolio companies.
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Published
April 10, 2024
Key Contacts
Managing Director, Co-Leader of Spain Business Transformation
Managing Director, Co-Leader of Spain Business Transformation