The private equity boom of the last decade seems to have slowed down. The cost of capital is rising, while valuations are going down. As a result, riding the wave of increasing market valuations is no longer a given. This is especially true for growth-focused PE firms. Many of them acquired assets at the peak of the market, one to three years ago. Therefore, value creation is once again a hot topic on the PE partner meeting agenda.

Value creation is the art and science of increasing portfolio company value. It focuses on levers such as pricing, digital operational excellence, and post-merger integration. PE firms often help professionalize non-core staff functions, such as finance, legal, and HR. However, becoming actively involved in core value levers as a shareholder comes with tough considerations.

After all, if you trust the management team, why would you want to be involved at all? And if you do want to be involved, how do you organize for success?

As the trusted on-demand portfolio operations team of many Benelux and UK-based private equity firms, we see three typical ways clients organize for value creation. Below are the options, including the pros and cons of each.

‍Option 1: Investment team-led.

In this set-up, investment teams engage in value creation on an ad-hoc basis. This is common for smaller firms.

The investment team helps translate the 100-day plan into concrete KPIs, targets, and progress monitoring templates. However, management remains responsible for execution. Once the plans are ready, the investment team returns to its main focus. This includes sourcing targets, closing deals, and deploying capital for LPs.

Portfolio management then remains limited to tracking progress, flagging potential value creation opportunities to management, holding a board seat, and supporting acquisitions.

If the portfolio company management team reaches out for help, the PE firm has two options. First, the investment team can step in temporarily. Alternatively, it can use its network of buy-and-build advisors, value creation experts, and interim strategy managers.

The benefit of this model is that the PE firm operates in a lean way. As a result, it can allocate management fees effectively and keep a large share of the carried interest pie for those involved. However, there is also a downside. If the focus on closing more deals limits proactivity on value creation within the existing portfolio, untapped value may remain on the table. In the end, this can reduce the size of the pie as a whole.

‍Option 2: ‘Operating guru’.

In this set-up, one dedicated person within the PE firm manages value creation across investment teams and funds. This operating guru is often called an operating partner or operating director. You mostly see this model at mid-sized PE firms focused on mid-cap companies.

The operating partner monitors progress and applies best practices across portfolio companies. In addition, this person ensures that management stays focused on the most important value creation priorities. Usually, the operating partner is a senior generalist with consulting and executive experience at director or partner level. However, he or she does not have a dedicated boots-on-the-ground operations team.

Instead of relying on a dedicated team, the operating partner convinces management of the urgency of specific value creation topics. Then, the operating partner connects management to a network of buy-and-build advisors, topic experts, and interim strategy managers. Management makes the hiring decisions. It also owns the outcome and carries the costs.

The key benefit of this model is that the PE firm empowers portfolio company management with the right focus and talent. As a result, management can realize value creation success without feeling pushed by a top-down agenda. Another benefit is flexibility. The operating partner can allocate the required resources case by case.

These resources are one-off expenses and do not share in the carried interest. The operating partner usually does.

Option 3: ‘Boots on the ground’.

For a large PE fund with many portfolio companies and similar value creation challenges, a dedicated portfolio operations team can make sense. In this set-up, the operating partner or director has a team of experts. These experts work directly inside portfolio companies and drive internal value creation initiatives.

This model has a strong benefit. The same people can identify and implement best practices consistently across portfolio companies. However, it also comes with some challenges.

One important challenge is management buy-in. Bringing in the troops or suits may feel like a sign of distrust. After all, if you trust management, why would you bring in your own resources? Therefore, when you do this, make sure management is fully on board.

Another challenge is sharing the pie. Usually, the operations team gets a stake in the carried interest. So, when you employ a larger team, ask yourself one question. Does each individual create more value than the sum of their carried interest share and base compensation?

Finally, agility matters. Value creation topics are often highly specific and subject to macroeconomic changes. For example, your digital operating expert might be great at ERP migration, but not at online B2B lead generation. Or, if inflation skyrockets, you may need highly specialized pricing skills quickly. However, once prices change and the organization adopts them a few months later, those skills may become redundant.

The key question is whether a team of operations experts on the payroll gives a PE firm enough agility. Can it react quickly to changing and specific value creation priorities?

Final thoughts

Now that value creation is more important than ever, deciding how to make it work is crucial. In our opinion, PE shareholders should take a proactive attitude. At the same time, they should leave ownership with management and stay agile in allocating skills and resources.