Understanding Private Equity Value Creation

Private equity value creation is a foundational concept for fund management. Unlike passive investment forms, private equity (PE) is an active approach to enhancing portfolio company value, utilizing strategic, operational, and financial initiatives over a holding period. Fund managers, institutional investors, and business owners involved in transactions alike need to gain a solid understanding of it.

That’s why we’ve developed this guide, covering the initial levers of value creation, the key metrics utilized to track success, and the approaches global private equity firms take to deliver superior returns. Importantly, we’re exploring elements relevant across the world, rather than being focused on a limited jurisdiction or market.

What Is Private Equity Value Creation?

Simply put, value creation in private equity refers to deliberate and hands-on approaches firms apply to boosting the company or portfolio’s worth in its investment cycle. Typically, PE companies will make strategic management, operational, or capital structure interventions to boost value. This is very different from public market investing or passive capital deployment in which investors have limited or no influence over strategy and operations.

Core Levers of Value Creation

There are 3 fundamental pillars of PE value generation.

• Multiple expansion – This occurs when PE firms acquire a business or asset at a certain valuation multiple and then exit at a higher one. Improved positioning or better market positioning tend to be influencers of success. The potential for success here should also be a consideration when considering selling your business to private equity, too. 
• Revenue growth – This involves focusing on using strategic initiatives to increase top-line sales. Product innovation, market expansion, and sales optimization are common tactics here.
• Margin improvement – This is about making cost reductions and operational efficiency improvements with a goal to boost the overall profitability of a business.

Operational Improvements

There are a handful of common approaches PE firms take to enhance operations within portfolio companies. Firstly, implementing sophisticated professional management structures ensures leadership teams can scale effectively. Technology upgrades also streamline processes and minimize human errors. Overhauling supply chains and procurement protocols to reduce redundancies or leverage more cost-effective partnerships is common, too. Finally, PE firms often assess company operations to identify areas of unnecessary waste and inefficiency, introducing relevant cost controls. 

Strategic Positioning and Market Expansion

Alongside the aforementioned internal improvements, there are ways PE firms can help portfolio companies reposition their brand value, strategically opening up new growth or market expansion potential. Rebranding is a common approach to value proposition positioning, producing engagement that boosts profitability. Developing new products that address emerging market needs or expanding to serve previously untapped international markets present new sources of income. These types of strategies require careful execution, with external private equity consultants often providing investment insights to ensure alignment with industry best practices and global trends.

Financial Engineering and Capital Optimization

Value creation can often be dependent on how effectively PE firms can optimize capital structure. Strategies here can include recapitalizing debt or dividends, as adjustments to either of these components can boost equity returns without requiring extensive operational adjustments. Additionally, restructuring balance sheets in ways that better optimize the debt-to-equity ratios is a fairly typical approach to magnifying the internal rate of return (IRR) while at the same time maintaining a practical level of cash flow for the business.

Talent Management and Governance

Maintaining existing leadership or board structures isn’t always conducive to solid value creation. As a result, PE firms will often make personnel changes. GPs might recruit and install CEOs and other executives with more relevant experience. Alternatively, they might keep existing leaders and introduce incentive structures based on performance. In either case, talent choices will be refined to align management and shareholder interests, ensuring profitable outcomes.

Digital Transformation as a Value Driver

As technology evolves, digital transformation is emerging as a growing focus in value creation. Firms are investing in tools such as automation, artificial intelligence (AI), and enterprise resource planning (ERP) systems with the intention of unlocking cost controls and operational improvements. ERP tools, in particular, provide better visibility of operational data, enabling firms to make more efficient and strategic decisions, while AI chatbots can improve customer experience. Even cloud-based software enhances system scalability.

ESG Integration and Responsible Investment

Solid environmental, social, and governance (ESG) protocols are essential for global PE firms when creating value today. This is because a firm’s relationship to sustainability and ethical practices increasingly impacts brand reputation, alongside customer and employee engagement. Not to mention that ESG oversight helps manage long-term risks related to sustainability and private equity legal issues, among other factors. Indeed, there is a rising prevalence of LPs putting pressure on GPs to prioritize the responsible investment practices that ESG can guide.

Tracking and Measuring Value Creation

To properly quantify value creation, reliable performance tracking and measuring protocols are required. Common metrics here include Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) growth, Return on Investment (ROI), Internal Rate of Return (IRR), and Multiple on Invested Capital (MOIC). Many firms utilize centralized value creation dashboards that provide real-time visibility of metrics for individual investments and across the portfolio. This helps managers make timely adjustments where necessary. Additionally, firms must seek metrics on external factors—such as market trends and economic conditions—to help distinguish market-driven gains from those influenced by operational improvements.

Case Studies in Private Equity Value Creation

So, how do PE value strategies affect outcomes in practice? One good example is a firm acquiring a mid-sized European manufacturer. By applying supply chain optimization and refreshing the go-to-market strategy, the improved efficiencies and engagement can see the firm later exit with a higher multiple due to better EBITDA outcomes. On a cross-border level, a U.S.-based firm may expand into Asia by acquiring a company under PE ownership. As a result, it has the opportunity to increase its customer base, boosting value by engaging previously underpenetrated markets.

Challenges in Implementing Value Creation Plans

While value creation can have positive outcomes, firms can experience challenges. Existing managers in a portfolio company may resist the necessary changes, while misalignment of cultures between firms and businesses can disrupt productivity and staff buy-in. Even market volatility has the potential to derail well-planned growth strategies. These issues are best mitigated during the holding period when firms commit to thorough due diligence to understand their exposure, followed by creating clear transformation plans and open communication with stakeholders.

That said, not all implementation plans succeed and some firms may still experience value erosion due to changing market conditions or operational missteps. Understanding where and why such plans fail empowers firms to improve their approach and arrange relevant contingencies.

The Role of Private Equity Consultants

External advisors play a key role in value creation team activities. Their experience in the field provides insights that contribute to impactful commercial strategy, M&A integration processes, and relevant digital transformation protocols. Typically, a private equity consultant is a specialist that complements PE firms’ existing capabilities and is brought in at stages that best meet the firm’s needs, from leading due diligence in pre-acquisition planning to developing post-deal transformation procedures. Indeed, these third-party advisors can provide expertise-informed objectivity to assist in governance decisions that suit the firm’s goals and jurisdictional needs.

FAQs

What is private equity value creation?

It is the set of strategies private equity firms use to increase the value of portfolio companies during ownership.

How do private equity firms grow portfolio company value?

Financial structuring, operational improvements, strategic growth initiatives, and management enhancements are common approaches.

What are the three core levers of value creation?

Multiple expansion, revenue growth, and margin improvement.

Can value creation be measured objectively?

Yes, through metrics like EBITDA growth, IRR, and ROI compared to initial projections.

What role does technology play in value creation?

Upgrades and digital transformation can streamline operations, optimize data use, and improve customer interfaces.

Why is ESG relevant in private equity value creation?

ESG integration mitigates risk, meets investor expectations, and supports sustainable, long-term value.

References

El Bakkouri, B, et al. (2022). The Role of Chatbots in Enhancing Customer Experience: Literature Review. Science Direct. https://www.sciencedirect.com/science/article/pii/S1877050922006627

Hayes, A. (2024, September 6). EBITDA: Definition, Calculation Formulas, History, and Criticisms. Investopedia. https://www.investopedia.com/terms/e/ebitda.asp

Australian Government. (2024). Use environmental, social and governance (ESG) practices in your business. Business.gov.au. https://business.gov.au/environmental-management/use-environmental-social-and-governance-esg-practices-in-your-business