Fundamentals for exit success - Evolving strategies for private equity exit readiness

Fundamentals to prepare for exit success

Depending on the stage of a portfolio company’s holding period, conducting an end-to-end “equity valuation health-check” is crucial before selecting an exit option.

This assessment will validate how investors and their advisors value the company, preceding sell-side diligence activities during the sale process, such as quality of earnings, IT, and commercial financial and operational due diligence. The health check should take place 18- 24 months before an exit to allow time for rectifying potential issues and creating a roadmap for key initiatives to enhance the company’s valuation before the exit process.

The health check covers three primary areas: cost optimization, performance improvement, and revenue growth and margin expansion.

1. Cost optimization

In lower growth environments, private equity firms and portfolio company chief experience officers prioritize identifying and implementing recurring EBITDA improvements. Highspring collaborates with portfolio company management to benchmark the current cost structure against peers, identifying the optimal structure through two distinct avenues:

Internal cost optimization efforts Internal optimizations require an evaluation of a portfolio company’s people, processes, technology and data. Cost improvements in these areas are typically focused on labor, general and administrative expenses, wherein Highspring will often implement a revised operating model as a common internal cost optimization strategy. The goal of a revised operating model is to improve the expense ratio of key business functions like finance, sales and marketing prior to the exit process. Based on Highspring’s internal benchmarks, average savings are typically 10-15%, but can be higher if prior add-ons were not appropriately integrated and optimized.
External cost optimization efforts External optimizations are typically opportunities realized through decreasing external supplier and input costs. Common external cost optimization strategies, such as strategic sourcing and supply chain optimization, were harder to achieve in the high inflationary period of 2021-2023, but the return of a lower inflationary environment has allowed private equity firms to refocus on external cost optimizations. These savings are usually faster to execute compared to internal cost optimization opportunities, with savings averaging 5-10% depending on a portfolio company’s procurement maturity. Highspring has seen a greater exit focus on cloud cost reduction and supply chain optimization given the recent rapid cost increases over the past few years in these two categories.

2. Performance improvement

Performance improvement has become a major topic for private equity firms, with two key drivers emerging: a greater focus on generating improved revenue growth and streamlining existing business processes at portfolio companies that poorly integrated prior add-ons. Assessing these areas and their related pain points significantly impacts overall margins and business performance in today's low-growth environment, with two key areas of performance improvement being the primary focus:

Commercial performance improvement This strategy focuses on improving sales cycle management (e.g., lead to cash, plan to report) and customer management (e.g., optimizing sales/customer tiering). Many of our private equity clients’ CRMs have not been effectively integrated with their ERPs, resulting in issues such as higher day sales outstanding than peers and negatively impacting revenue recognition and cash collections. Additionally, many portfolio companies lack a tiered sales strategy that is properly aligned with current and future customer demand. To address this, portfolio companies must reignite sales growth before an exit by reallocating sales resources by customer tiers and improving CRM-ERP integrations.
Operational and financial performance improvement This strategy revolves around evaluating internal operational processes and system dependencies. Common optimization areas for portfolio companies include streamlining redundant or inconsistent processes (e.g., finance or P2P processes) and systems (e.g., consolidating multiple ERPs into a single ERP or corporate performance management tool). These efforts can be most impactful for portfolio companies that have not yet fully streamlined processes and ERPs from prior acquisitions.

3. Revenue growth and margin expansion

Most investors place a higher valuation on portfolio companies with a sustained history of top-line growth, as this is typically more challenging to achieve than sustained EBITDA growth. Given the uncertain economic environment and significant technology changes like cloud transformation and generative AI/ML, most portfolio companies must focus on refreshing their strategic plan. This process involves a rigorous evaluation of organic and inorganic opportunities including go-to-market strategy, product roadmap and bundling, perceived customer value assessment, and a potential merger and acquisition roadmap. To achieve this, two key revenue and margin expansion strategies are implemented:

Organic growth strategy This involves reviewing a company’s pricing, go-to-market strategy, customer value, and potential whitespace/adjacencies, along with assessing their current product hierarchy. To ensure growth, portfolio companies should benchmark their market share, gross margins and product margins against industry peers to identify potential gaps in their product roadmap.
Inorganic growth strategy To develop an inorganic growth strategy, a portfolio company undertakes a comprehensive cross-functional assessment spanning one year and five years. This assessment aims to identify opportunities given current market share, market positioning, adjacencies and the broader market. The company then leverages this information to explore potential mergers, acquisitions, joint ventures and corporate partnerships that enable it to capitalize on these opportunities.

Equity valuation readiness

A Highspring portfolio company client faced slower growth in their core market but saw significant opportunities in critical adjacencies. By partnering with the portfolio company to execute our equity valuation readiness assessment, an end-to-end review of their potential one and three-year exit valuation was conducted which identified significant gaps in their product roadmap. To address this, we recommended a mix of additional product investments and an add-on acquisition supported by an operational excellence program. This enabled the company to drive commercial (order to cash) and operational performance improvements with a new ERP and CRM, thereby improving enterprise value by 30% within six months.