Swedish private equity firms have demonstrated a historical success in the buyout industry. However, current trends in the industry such as institutional changes, phenomenon of capital overhang and an influx of new entrants have intensified competition among buyout firms.
To maintain the expected high gains, private equity firms must actively create values for their portfolio companies. The purpose of this study is to describe and analyze how private equity firms with a hands-on approach add value to the companies under management.
A literature review on value-creation by private equity firms was conducted. The valuecreation methods were classified by the authors under the four themes: governance engineering, financial engineering, operational engineering, and strategic redirections. In order to collect the empirical data, the authors chose an inductive approach, used semi-structured interviews with representatives from five private equity firms.
The results show that the studied firms undertake to a large extent similar actions when it comes to corporate governance and financial engineering. With governance engineering, the firms attempt to strengthen the portfolio companies’ governance system through proper due diligence, the appointment of a competent and independent board of directors, an appropriate and deep management incentive program, establishment of a close relationship with management, and periodic management reports.
The key to efficient governance is to give the portfolio firms 100% focus on operational and strategic issues in the board meetings. All but one firm use significant debt to lever the buyouts as it is evident that the pressure of debt repayment incentivizes management to better handle scarce capital.
Operational engineering and strategic redirection are the two themes in which the firms mainly distinguish themselves. Operational engineering largely concerns running operation more efficiently through a combination of cost-cuttings (divestment of non-profitable product and customer, outsourcing, centralizing purchases) and higher revenue growth (finding new markets, providing more after-sale service, extending product range). Strategic redirection incorporates the focus on core competences, making strategic decisions about investments, divestments, and add-on acquisitions.
There have been differences in actions taken by the studied firms. Factors that could affect the behavior of private equity firms are the type of companies acquired, the firm size, their perception of risk and reward regarding a particular action, as well as years of experiences in the industry. There is no common timeframe for actions taken by the studied firms. Nevertheless, all firms emphasize the importance of implementing fundamental changes in the early years of the investments.
Source: Jönköping University
Author: Bengtsson, Patrik | Nagel, Ron | Nguyen, An