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Next in private equity: Strategic industry trends in 2024
How PE firms and their portfolio companies can succeed with their value creation plans
Trends helping portfolio companies find renewed growth in 2024
This past year was defined by many portfolio companies struggling to achieve growth and having difficulty creating value beyond their original entry multiples. Many factors are responsible. Rising interest rates, for example, are forcing an increase in the cost of capital. And, executives not being fit for purpose has caused an increase in management turnover (both CEO1 and CFO2 turnover rates have recently exceeded 10%). Portfolio companies (portcos) finding their way to growth have gone back to basics, with a renewed focus on fundamentals and careful cash management.
Pivotal trends in 2024 fall into five major categories:
Portfolio companies are turning to digital transformation with a subsector focus to achieve their value creation goals, despite liquidity pressures
Liquid cash is the fuel that powers a value creation plan. But companies are having trouble managing their operational demands to find the liquidity to fund change. For example, companies are now having to deal with a 22% rise in interest costs on their debt compared with a year prior — and this can be much higher depending on industry3. We have seen companies succeed in finding their way to growth by putting resources into a digital transformation approach that centers on speed to value and a granular subsector lens. Companies have chosen this approach for two main reasons. First, using subsector knowledge gives portcos an opportunity to focus their strategy on proven levers that have worked for others in their industry. Second, tech transformation has radically changed in the past few years and implementing a system now can be done in months or even weeks rather than years — and at a much lower cost.
So, what does this look like in practice? Imagine a PE firm building a platform of veterinary clinics. They find early success in the initial setup phase but their growth opportunities often stagnate as consumer spending flatlines. This company could find a path to improvement using cloud-based predictive analytics, based on market-available data, to better understand customer lifetime value and to improve revenue growth per clinic visit. A generative AI implementation could power the entire client experience within the four walls of the clinic, providing better customer engagement, answers and solutions that weren’t possible before. And a simple refreshable dashboard could provide actionable insights into customer behavior that was previously cost-restrictive.
This is just one example in one industry, but portcos across any industry can find their growth opportunities quickly using this combination of a subsector-focused strategy and investment in the right technologies.
1 “The US Experiences Higher C-suite Turnover Rates in 2022,” PR Newswire, March 30, 2023, accessed via Factiva, November 15, 2023.
2 Jennifer Williams-Alvarez, “Companies Broaden CFOs' Responsibilities to Retain Them In Strong Job Market,” The Wall Street Journal, July 4, 2022, accessed via Factiva, November 15, 2023.
3 “US companies scramble to cut costs, pay down debt as interest rates surge”, The Straits Times, June 15, 2023, accessed via Factiva, November 15, 2023.
Leading PE firms are innovating new approaches in the diligence phase of the investment cycle to make deals work in this market
PE firms often find their portcos make it past the initial value creation phase but then have less liquidity than they originally expected to execute on the final stages of a plan toward an exit. Or maybe they can’t find the capital they need to make an unexpected transformation to adjust to changes in the market.
We’ve seen portfolio companies find their path forward by taking atypical approaches to the deal cycle. For example, partnering with established corporations can prove to be a fruitful alternative to the traditional exit path. These companies may need access to a certain product line, a niche market they are having trouble breaking into, or a brand name. Portcos, in turn, are looking for funding for transformation or a possible exit path. Whether through an investment, bridge loan or a joint venture, leaders in this space will pursue these kinds of deals, with some exploring partnerships earlier in the diligence or pre-diligence phase.
Leaders make tax part of their strategy at every point in the investment cycle, considering every location worldwide, and part of cost savings and liquidity in operations
Whether you’re considering major digital transformation, working on a value creation target, implementing a data strategy, or expanding operations multinationally, tax is a crucial strategy component that you need to consider from the start. You may be surprised which business issues, like liquidity, can get a boost from better tax planning and strategy.
For example, beginning a process of portfolio company tax optimization can start a portco down the road to either better liquidity or better post-tax return on investment (ROI.) Oftentimes after a deal is executed, PE firms can let their portcos operate as usual. This approach may cause them to miss out on certain tax opportunities such as rethinking which jurisdictions their debt is held, taking advantage of the incentives and credits available to them, or changing the company structure to pay less liquid cash. Sometimes the fundamentals are the difference between finding the cash internally to fund a value creation plan or having to seek outside credit.
How can executives create a successful tax strategy in 2024?
Tax Leaders
Confirm you understand all Pillar Two impacts to your portfolio companies. Some private companies, regardless of size, may have certain compliance requirements if they are part of a multinational structure. Additionally, leaders can meet these impacts while keeping their focus on their tax operations and tax technology enablement.
CFOs
Understand how the portfolio company tax profile/footprint impacts the entire PE firms’ value chain. Confirm that you’re appropriately considering tax in modeling and that the company is structured and operating as efficiently as possible to manage cash tax for itself and the owners.
PE firms continue to approach deals with focus on sustainability to create value
Over the past year, discussion in the sustainability world has centered around the overflow of regulation either proposed or enacted. Be it the new California legislation or the EU’s CSRD, the change in regulation will not slow down. CSRD has to be implemented by certain companies within the next few years and the SEC’s climate rules are now out. However, this has not stopped PE funds from making sustainability a driver for value creation or a focus of discussion at every part of the investment cycle.
The regulatory environment does increase PE firms’ and their portcos’ focus on the midterm perspective. PE firms want to make sure their portcos are equipped for any future sustainability challenges. Leaders can find innovative solutions to these issues, such as grouping ESG requirements together with the goal of one set of disclosures that satisfies all regulatory requirements.
How can executives create a successful sustainability strategy in 2024?
C-suite
Building a successful sustainability strategy is a cross-functional effort for the entire C-suite. The CEO provides the vision and tone at the top. The CFO finds the share of the wallet and focuses on reporting. The CTO provides the data and environmental, social and governance (ESG) architecture that support the group and business lines’ need for more reliable and useful real-time information. And, the Chief Sustainability Officer organizes the execution of the sustainability strategy while trying to consistently assess the big picture.
CHRO
Successful deal transactions have a specific focus on diversity, equity and inclusion (DEI) and the CHRO supports DEI functions across the organization.
Successful firms make trust a differentiating factor in creating value
Trust has an enormous impact on the ability of any entity to do business, from customer loyalty and buying decisions, employee retention, to the relationships between private equity firms and portfolio companies. Investors expect it. Employees want it. And all it takes is one poor decision to erode a firm’s or portco’s trustworthiness. Given the direction of both the market and regulation, we expect firms to start making their trustworthiness a value creation center.
For example, look at all the sustainability data investors want. A firm may be looking at multiple data sets from each of their portcos, and having to determine individually the accuracy, completeness, and general reliability of the information they are combing through. And presenting any of the wrong information can turn investors, employees and regulators against them. It isn’t just a technology or infrastructure issue. Firms who will win in this space should build trust down through the fund to the portco level, making it the foundation of every action, and share the same vision and goals.
How can executives foster trust in 2024?
CEO
Thread the needle between the trustworthiness built over time and the need to create value from the company. Successful leaders will be upfront with their employees and inclusive as they make the journey through a value creation plan.
CFO
Foster an environment that focuses on the reliability of data. It will only increase in importance across any organization. From meeting regulatory requirements to having the information you need to create value, everyone across the structure will look to the CFO for the answer.
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