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Private Equity in the US: A Pivot to Value Creation

By Holly Croxton,

Private equity continues to grapple with the slowdown in deal activity that took root in 2022. This activity slowdown is largely attributed to ongoing macroeconomic headwinds, challenging debt markets and continuing global geopolitical uncertainty. The impact on deal-making has been significant, with deal volumes sinking to a four-year low. Private equity deal volumes dropped 63% from the same period last year to $293.5 billion. In the US, deal volumes have more than halved to $162.5 billion from 2022.

In this climate of relative deal scarcity—compared to the historic highs of 2021—a disparity still exists between buyer and seller expectations on asset valuations. This divergence is expected to remain for some time, further exacerbating the lack of deals as long as buyers and sellers stick to their guns. 

Innovative Deployment

Firms across the globe have amassed large dry powder reserves, with one estimate suggesting as much as $3.7 trillion was waiting to be deployed. However, amidst the current challenging backdrop, private equity firms are not standing still—far from it. Firms are deploying dry powder in various innovative ways: investing in sectors with market tailwinds, carve-out transactions and take-private deals, private debt financing, creative capital deployment and value creation through business reorientation and reinvention. 

In this era of deal slowdown, value creation has emerged as a pivotal strategy for firms in the US who are starting to experience the problems the UK and Europe have been facing for the last year. US Private equity firms are now focusing their attention on boosting operational performance and strategic positioning of their portfolio companies to increase their value. This shift toward value creation will redefine the private equity landscape for the rest of 2023 and beyond. 

The Necessity of Reinvention for Private Equity in the US

In the current environment, value creation is a primary growth driver for portfolio companies, as stubbornly high valuations have significantly altered the landscape for portfolio growth. This pivot has resulted in more emphasis on value-driving changes, including digital transformation, talent acquisition and management and the implementation of ESG initiatives. Not only do these changes drive up value in the short and medium term, but they also position portfolio companies for sustainable long-term development. 

With fewer acquisition targets available at a reasonable valuation, private equity firms must grapple with narrow error margins. As a result, a growing number of firms are integrating value creation into the due diligence process to ensure target assets align with growth plans and a clear roadmap for future value creation.

Driving Value through Digital Transformation

Today, digital transformation is a crucial value creation lever in the private equity world. In the US private equity market context, digital transformation initiatives are driven by several key trends, including advanced analytics, artificial intelligence, cloud-based solutions and cybersecurity. 

A survey of 100 mid-market private equity firms revealed that digital is becoming a key aspect of the private equity playbook. Half of the respondents signalled that they always include digital value creation as part of their investment strategy. However, less than half of GP respondents said that their firms did not have a standard definition of ‘digital’ across their organisation, which suggests there is still significant work to do.

Private equity firms increasingly leverage digital technologies to improve operational efficiency and uncover potential growth opportunities. However, it is important to note that digital transformation is far from a one-size-fits-all process—it demands a tailored approach that closely aligns with the requirements, capabilities and objectives of individual portfolio companies. But several digital technologies are taking the industry by storm, including advanced analytics, AI and cloud solutions.

  • Advanced analytics and AI

US firms are increasingly focusing their efforts on advanced analytics and AI, recognising them as vital elements of a successful digital transformation strategy. From May 2022 to May 2023, the US and Canada had the highest number of AI and machine learning-related transactions, with 147 deals worth $5.05 billion

Private equity firms are leveraging advanced analytics and AI in several ways. First, advanced analytics and AI allow portfolio companies to streamline operations to improve overall efficiency. But that’s not all—advanced analytics and AI is also enhancing the customer experience through the implementation of AI chatbots and machine learning algorithms that provide customers with personalised recommendations and boost sales in the process.

  • Cloud solutions

US private equity firms also increasingly embrace cloud solutions to create value in their portfolio companies. Organisations that invest in cloud solutions reap significant benefits. For example, a recent survey found that nearly half of the companies surveyed reported measurable value from cloud solutions, including improved productivity and profitability. 

Cloud solutions offer businesses across all sectors scalability, flexibility and cost-effectiveness, making them an attractive option for portfolio companies focusing on operations optimisation. Additionally, cloud solutions give firms access to real-time insights and analytics, allowing them to make data-driven decisions which affect operational performance and profitability. 

Talent Acquisition and Management

In the US, the ability to attract, retain and develop top talent within portfolio companies has become a crucial success factor in 2023. Private equity firms increasingly recognise the importance of having the right people in their portfolio company teams, especially as unfavourable macroeconomic conditions persist. Having the ‘right’ people has the power to make or break an investment—after all, they drive company strategy. Attracting suitable leaders, retaining valuable employees, and optimising company culture are essential components of successful firms. 

  • Strategic talent acquisition

Private equity firms are becoming more strategic in their approach to portfolio company talent management. However, finding the ‘right’ talent is challenging, especially as dozens of private equity and financial services firms compete to attract high-value employees. 

To overcome this challenge, private equity firms in the US and beyond are becoming more strategic about their recruitment process. They set clear diversity, equity and inclusion (DEI) goals, implement diverse candidate sourcing strategies, and review and improve hiring processes to attract top talent. 

  • Developing effective leaders

Author Seth Godin said that “leadership is the art of giving people a platform for spreading ideas that work.” In the private equity world, this sentiment rings particularly true. Those at the helm of portfolio companies are not just figureheads—they are the catalysts that drive innovation and growth.

In the context of the US private equity market, the vital role of leadership in portfolio companies is unique and demanding. Portfolio company leaders are tasked with driving performance, managing operational and cultural change and navigating the unique challenges of the private equity space. Firms seek CEOs who can think without adhering strictly to hierarchical structures, have a comprehensive understanding of financial metrics and have exceptional team-building and nurturing skills.

  • Managing performance and retaining talent

US firms have come to recognise the power of cultivating a culture of leadership that extends beyond the C-suite. This culture of leadership is vital for effectively managing performance and retaining talent, two key aspects that contribute to the overall success of portfolio companies.

Performance management within US private equity companies is increasingly data-driven, involving setting clear performance expectations, tracking progress and giving feedback to facilitate continuous improvement. Not only does this process enable managers to detect potential issues, but it also allows for the identification of high performers within firms. 

Private equity firms are creating more positive work environments to increase employee retention. When private markets took a hit in 2022, firms had to focus more attention on retaining employees within their portfolio companies. A report by Private Equity Wire revealed that 60 per cent of private equity CFOs were struggling to recruit millennial and Gen Z employees, with 82 per cent of the respondents reporting issues with employee retention. The push to attract the best talent has led to significant firm remodelling. Firms are bringing on experienced talent managers to recruit and onboard new employees and advise on culture, training and benefits in an effort to increase retention.

Environmental, Social and Governance Initiatives

Another key value creation driver in the US this year is environmental, social and governance (ESG) initiatives. Private equity firms have recognised that ESG factors are not only related to effective risk management but to creating new value within their portfolio companies. Driven by investor demand and regulatory changes, ESG has shifted from a ‘nice-to-have’ differentiator to a non-negotiable requirement. 

In 2022, the Securities and Exchange Commission (SEC) proposed rule changes that would require firms to make climate-related disclosures, effectively elevating the importance of ESG reporting to the same level as financial reporting. The proposal has implications for private equity firms and their portfolio companies, requiring them to assess ESG factors at all stages of the investment lifecycle. This process involves preparing for high-quality and high-volume ESG data as well as having a clear understanding of portfolio companies’ current commitments, methodologies and processes for measuring ESG factors. 

  • ESG as a Value Driver

Private equity firms are now viewing ESG factors as key value creation drivers. This shift is a result of a growing recognition that ESG considerations are not only about risk management and compliance but can lead to new value creation opportunities for portfolio companies. 

ESG considerations are being integrated into the due diligence process, with firms evaluating potential investments through an ESG lens. This includes identifying where ESG initiatives can provide operational improvements, cost-savings and revenue growth, such as through energy efficiency schemes, employee engagement drives and supply chain improvements. 

In the current macroeconomic environment, many firms are now focusing on creating value within their portfolio rather than putting energy and resources into portfolio expansion. Firms are implementing ESG initiatives to drive operational improvements, cost-savings and create value during longer hold periods. These initiatives vary by firm, but some of the most common include implementing energy-efficient technologies and renewable energy, DEI and health and safety initiatives and extensive ethics, risk management and compliance programs. 

Final Thoughts: Navigating Choppy Waters in US Private Equity

At Palladium, we have amassed extensive experience in managing challenging macroeconomic conditions for UK and European firms. The US private equity market is now encountering similar choppy waters to that which has been seen across the EU for 12 months or so, and as such we are well-positioned to assist firms with portfolio companies spanning a wide range of industries. Our experience and expertise allow us to do more much than simply help you weather the current storm. We can help you pivot toward value creation during these challenging times, as there are always opportunities to create new value, be it through digital transformation, talent management or ESG initiatives.

Contact the Palladium team today to learn more about how we can help your firm pivot to value creation during these challenging times.

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