Private Equity Firms Get Creative About Value Generation

As market conditions worsen, it’s hard for PE firms to achieve successful outcomes if they focus on nothing but chasing new deals.

Illustration by II (Ismail Ferdous/Bloomberg)

Illustration by II

(Ismail Ferdous/Bloomberg)

When it comes to value creation, private equity firms are steering away from the old norm as dealmaking slows down from its 2021 peak.

These firms are increasingly focused on working with operating partners and leveraging economies of scale to drive up profit, according to Jeremy Swan, managing principal at the tax and advisory firm CohnReznick. He said that instead of laying off employees — a common tactic to improve earnings — PE firms are exploring various strategies to adapt to the new macroeconomic environment.

“Headcount reduction is still part of the strategy, but that’s such a small piece of it,” Swan told Institutional Investor in an interview. “The labor market is really difficult. Hiring and firing people is more challenging in this market than it has ever been.”

Private equity firms can increase revenues without reducing headcount. A middle market PE firm that CohnReznick works with bought an industrial services business in the U.S., which then made five acquisitions. The PE firm helped the company integrate the acquisitions by combining the same operating departments overseeing finance, technology, and human resources. The PE firm also optimized the companies’ supply chain, improved sourcing and procurement, and implemented an inventory management system.

“As of today, the consolidated company has improved cash flow by over 20 percent,” Swan said, adding that headcount actually increased, rather than decreased, after the PE firm purchased the industrial service company.

Since the 1990s, some private equity firms have been hiring accomplished executives who have expertise in auditing, general management, human resources, or other operational functions. While the investment team focuses on finding the best deals, the operating partners work directly with the management team.

“Today, [PE firms] are really building out that operating partner structure — we see this as an increasing trend,” Swan said. “More often than not, they work with the investment team all the way through the due-diligence process and the whole period [during which they’re] prepping the company for exit.”

“Chasing new deals and focusing on value creation go hand in hand, particularly in a more challenging market from a growth perspective,” Swan concluded. “The investment process, operating process, and value creation process — it’s hard to do one without the other to get to a successful outcome.”