• Private equity firms’ ability to control companies enables them to enact change and create value during their hold period
• Sophisticated operating resources can create the ability to grow earnings by institutionalizing processes, innovating, expanding products as well as geographically and rationalizing costs
• Increasing the quality of a company by diversifying and stabilizing sources of revenue can lead to multiple expansion
• Thoughtful structuring with regards to leverage de-risks the investment and allows for increased flexibility
Private equity firms are uniquely positioned to create value within their portfolio companies due to their controlling interests in the businesses.
The specific strategy for increasing value varies with each investment, however, the strategies can be categorized into one of three areas: earnings growth, multiple expansion or structuring. Investments have the highest probability of outsized returns when all three of these components work in tandem.
Before diving into each, it is important to understand the building blocks of valuation within private equity. The most common methodology is the multiple approach. When private equity firms buy and sell their portfolio companies they pay a multiple of that company’s earnings, or Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). The market multiple is based on comparable companies in the industry and validated through an auction process conducted by an intermediary. The EBITDA and the valuation multiple equate to an enterprise value; a combination of equity and debt, as shown in the graphic below.
The information contained herein is confidential and the dissemination or distribution to any other person without the prior approval of Fiducient Advisors is strictly prohibited. Information has been obtained from sources believed to be reliable, though not independently verified. Any forecasts are hypothetical and represent future expectations and not actual return volatilities and correlations will differ from forecasts. This report does not represent a specific investment recommendation. The opinions and analysis expressed herein are based on Fiducient Advisor research and professional experience and are expressed as of the date of this report. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Past performance does not indicate future performance and there is risk of loss.