Most private equity (PE) firms are interested in organizations that are positioned to scale in a cost-efficient manner. Many firms have a 3-7 year horizon for owning the organization and would then look to monetize their investment.
In order to drive significant value in a short period of time, PE firms seek effective ways to drive top-line and/or bottom-line growth to the organizations they invest in. There are typically 4 methods that PE firms leverage to drive value:
- Financial Leverage – funding the purchase of an asset with borrowed money alongside equity, which increases both the return potential and the risk of the equity
- Multiple Expansion – create a higher multiple of EBITDA than the organization was previously valued due to increased scale or growth
- Revenue growth – expanding the business via increased sales to existing customers and new customers and accessing new markets
- Margin expansion – utilizing operational expertise to increase the rate of profitability a company makes on a sale
The first of the options listed above is undifferentiated and commoditized, while the second is difficult to plan on due to cycles in the capital markets and overall high asset prices in today’s markets. Therefore, today PE Firms disproportionately emphasize revenue growth and operational expertise both to grow their portfolio companies and to differentiate themselves to their limited partners. Examples of this expertise is in the making targeted investments in their sales and marketing organizations, improving compensation models to better align objectives with incentives, strategic pricing optimization, and in leveraging industry expertise and relationships to drive access to new markets and customers. The ultimate leverage that this method is looking to “unlock” is the knowledge of how to efficiently and rapidly scale the business.
"We are looking to expand the scope of our companies’ operations but limit the operational risk while scaling."
Mike Langdon, Managing Director of Frontenac, states, “Our goal is to identify, acquire and build market-leading organizations where we can create value by driving above-market top-line and bottom-line growth. We are looking to expand the scope of our companies’ operations but limit the operational risk while scaling. We focus intently on targeted investments with a demonstrable ROI that will drive outsized results for our portfolio companies.”
Based on this logic, many PE firms are often not in favor of the typical large investments like replacing ERP applications but rather look the smaller, “quick wins” type initiatives. There are several reasons for looking for value gains outside of ERP:
- ERP implementations tend to be very disruptive to the organization and have the company “take their eye off the ball” from the day-to-day operations of running of the company.
- ERP implementations tend to be more costly (both time and dollars) than originally budgeted.
- Because of 1 & 2 above, ERP implementation risk is often high. Compound that with the fact that the reward often does not justify the risk… especially if proper planning, alignment and clear goal establishment has not taken place upfront. Therefore, the true “value” of a different ERP package can be debatable for areas that are typically not core differentiators to the organization and it can be very hard to calculate a quantifiable ROI on an ERP implementation.
With PE firms, there is also a lot of time pressure – they are measured on time as well as return. As such, an ERP initiative that fails to meet the planned time and cost objectives can be very detrimental to the PE’s planned ROI. A project that takes twice as long as it should is a huge opportunity cost. If it elongates the hold period and/or how long it takes before the PE owner can start effecting change, it is a big setback.
Another technology investment that is always a favorite of PE Firms is Artificial Intelligence. The Artificial Intelligence (AI) spectrum can be speculative and take significant time and focus off the organization – all for the same reasons as stated above. However, there are stops along the AI spectrum that are more favorable for PE firms. Process Automation (on the beginning of the AI spectrum) is a perfect investment for PE firms who want to test the waters with AI, but also are looking for their portfolio companies to improve efficiency and position themselves for scale without significant risk or cost.
The Case for RPA – A Low Risk, Quick, High Value Win for the PE Firm and the Company
Robotic Process Automation (RPA) and Intelligent Process Automation (IPA) automates and reduces manual intervention in tasks within a process or processes. For example, RPA can remove the redundancy of duplicate data entry into multiple systems, or remove frequently updated items based on simple logic. Using RPA, processes become more accurate and predictable, and, as a result, free up human intervention for more significant tasks such as analyzing and interpreting data. In addition, the benefits associated with RPA are very easy to quantify thus providing PE firms with a predictable, high value, low risk return for RPA based initiatives.
Overall, RPA enables employees of the invested organizations to scale the business in alignment with the PE firm’s expectations by automating traditional manual, repetitive processes so employees can put their focus on innovation and growth capabilities