Best of LinkedIn: Private Equity: Value Creation CW 36/ 37

00:00:00: provided by Thomas Allgaier and Frennus, based on the most relevant LinkedIn posts about private equity.

00:00:05: Value creation in calendar weeks thirty six and thirty seven.

00:00:09: Frenness supports P backed manufacturers with a market intelligence needed to unlock revenue from idle production capacity.

00:00:15: you can find more info.

00:00:16: description

00:00:17: imagine like needing to grow your business by twelve percent every single year.

00:00:22: wow Just to break even on expectations.

00:00:25: exactly

00:00:26: like completely rewiring your margins and operations.

00:00:29: just a tread water On the exact same returns you used to get for a five percent growth rate.

00:00:33: I mean that is just a brutal reality For private equity backed companies right now, so today we were taking you straight into The boardroom.

00:00:40: We're doing it deep.

00:00:41: dive Into the top Private Equity insights And you know if value creation trends currently dominating LinkedIn.

00:00:48: Because the era of the private equity easy button, where you could just lever up a company with cheap debt.

00:00:54: Wait for the market to rise and sell it for massive game.

00:00:56: that's completely dead?

00:00:57: Oh totally dead!

00:00:59: And we're going explore fallout from death across three core themes today.

00:01:04: First look at the macro shift forcing this huge operational reckoning

00:01:08: Right The Death Of The Multiple Expansion

00:01:10: Exactly.

00:01:11: Then get into intense like almost unprecedented strain this is placing on portfolio company leadership, because well somebody actually has to execute some possible math.

00:01:22: Yeah that talent piece is huge.

00:01:23: right now it

00:01:24: really does.

00:01:25: and finally we're doing a reality check on AI in private equity.

00:01:29: you know moving past all the buzzwords and looking at what actually drives real EBITDA.

00:01:35: So let's start with that macro shift, because the fundamental mechanics of how these firms make money have just completely shattered.

00:01:42: Right

00:01:43: David Harmeier actually highlighted some really fascinating data from Apollo's Torsten Slocke.

00:01:47: That puts this perfectly into perspective.

00:01:49: Oh

00:01:49: I saw that!

00:01:50: The data on multiple expansion right?

00:01:52: Yeah

00:01:52: so before the Federal Reserve started hiking rates Multiple Expansion accounted for like roughly forty percent of private equity value creation.

00:02:01: Forty

00:02:01: percent?!

00:02:01: I mean thats almost half the values coming to market going up

00:02:04: Exactly, which meant you didn't necessarily have to be this brilliant operational wizard.

00:02:09: You just had to buy at a decent price apply your leverage and rely on the broader market multiples expanding over time to bail out your whole thesis.

00:02:18: But today that forty percent contribution it's collapsed down to eight percent.

00:02:23: It is massive drop.

00:02:24: That thirty two percent gap represents monumental loss of passive value.

00:02:30: So when multiple expansion just vanishes like that and financing costs double, the value actually has to be built on the factory floor.

00:02:37: Right in the supply chain and the pricing models.

00:02:40: you cannot rely on financial engineering to hit a hurdle rate anymore.

00:02:44: it doesn't work.

00:02:45: And y'know The Hurtle Rate Itself Has Become Incredibly Daunting.

00:02:48: Marcella Grassietti shared an insight from Bain's Mildew Report That Frames This Just Perfectly.

00:02:54: He Said Twelve is

00:02:57: the new five.

00:02:57: Think about the operational mechanics behind that phrase for a second,

00:03:01: it's heavy!

00:03:01: It really is... A deal that required a pretty modest five percent annual EBITDA growth decade ago now demands a twelve-percent annual growth rate to deliver that exact same.

00:03:13: two and half times return over a standard five year hold.

00:03:16: Wow.

00:03:17: so put into real operational terms Bane noted that the required margin expansion has to jump from twenty percent, to twenty seven point six percent.

00:03:26: Yeah almost twenty eight percent

00:03:27: right and going from a twenty percent margin to nearly twenty-eight percent.

00:03:31: I mean thats not matter of just trimming corporate overhead or like optimizing marketing budget.

00:03:37: no

00:03:37: you are talking about fundamentally tearing down rebuilding how business functions

00:03:42: which completely explains why the timeline for value creation has so violently shifted forward.

00:03:47: Like George Gillespie has pointed out that fifty-eight percent of PE firms are now investing heavily in value creation and year one

00:03:54: Wow over half

00:03:56: Yeah, And just a year ago That number was only twenty nine percent.

00:03:59: I mean that is A massive behavioral shift For entire industry In Just twelve months.

00:04:03: Well, the cost of capital is just too high to weight right.

00:04:06: Plus...the average hold period stretching out nearly seven years.

00:04:10: in this exit environment

00:04:11: Right you can't flip it into three.

00:04:13: more.

00:04:13: Exactly If you buy a platform and wait until year-three finally rollout your one hundred day operational plan The debt servicing has already eaten all your margin error.

00:04:23: So if top court sponsors are treating their original deal thesis as just baseline They're starting heavy operational demolition on Day

00:04:31: One Day one,

00:04:33: but I actually have to push back a little on this whole approach.

00:04:36: Okay go for it

00:04:37: because when sponsors panic about hitting at twelve percent growth hurdle their default instinct is usually just screened growth At the C-suite.

00:04:46: well

00:04:47: For sure always

00:04:48: they want new markets New product lines aggressive acquisitions.

00:04:51: But like if your core business has fundamental flaws and its Just bleeding cash pushing for aggressive top line expansion feels a bit like doing cosmetic surgery on a patient who is actively bleeding out in the emergency room.

00:05:05: Oh man, that analogy perfectly captures the trap so many boards fall into and it's a trap that Brea Page specifically warned about in one of the posts.

00:05:15: What did she say?

00:05:16: Well, she works heavily with consumer brands and she notes that sponsors are completely addicted to the growth narrative because you know it looks fantastic in a quarterly LP update.

00:05:26: Right look at this shiny new market we entered!

00:05:28: Exactly

00:05:29: launching a new market is exciting but the unsexy grueling work of plugging existing leaks...that's what actually protects the baseline value

00:05:45: is learning how to stop losing.

00:05:47: I love that, Stop Losing First!

00:05:49: Right before a board starts demanding all these new revenue streams they need ask what is actively destroying value right now?

00:05:55: Like

00:05:55: Toxic Managers?

00:05:56: Exactly are there toxic middle managers running off your top tier engineers?

00:06:00: Are you bleeding capital into low return legacy marketing channels?

00:06:04: You had to kill the leaks first.

00:06:06: Pouring expansion Capital Into A Poorly Optimized Operation Is Literally Just Pouring Water In To A Leaky Bucket.

00:06:12: But Here's The Catch.

00:06:14: Fixing those leaks and driving that twelve percent mandate requires a very, very specific type of human capital.

00:06:21: Right?

00:06:21: Which brings us to our second theme.

00:06:23: Yes!

00:06:24: The intense almost breaking point strain on portfolio company leadership because the traditional talent model in private equity is just fracturing under this pressure.

00:06:40: completely recontextualizes the risk of taking a C-suite role in this industry right now.

00:06:45: It's

00:06:45: a scary stat, it

00:06:46: is nearly seventy percent Of PE backed CEOs are replaced during the average hold period.

00:06:52: Seventy percent I mean.

00:06:53: when you see a failure rate that high The instinct is to just blame a talent pool.

00:06:57: Right boards will say oh there Just aren't enough good operators out There.

00:07:00: yeah But my cave argues it as a structural defect not a talent defect.

00:07:04: he actually calls private equity A contradiction factory

00:07:06: A contradiction factory.

00:07:07: That is so accurate!

00:07:09: Right,

00:07:09: just think about the cognitive dissonance in the mandates these boards hand down to a new CEO.

00:07:14: it reads like a hostage note

00:07:16: Yeah they demand that you move at lightning speed but absolutely do not disrupt The Founder's delicate culture.

00:07:23: Exactly or You know They want you to aggressively upgrade the talent pool But you must strictly adhere To the legacy budget.

00:07:30: Oh and my favorite professionalize every system yet somehow maintain the chaotic entrepreneurial magic that made the company attractive in the first place.

00:07:40: It's literally an impossible equation, you're setting up executives to fail because the board itself hasn't reconciled what trade-offs they are actually willing to make.

00:07:51: and this train trickles directly down into the CFO too.

00:07:54: especially Mark Janssen broke down what operating partners are actually screening for when they back-channel a CFO candidate today.

00:08:01: And it's not what he used to be?

00:08:02: Not at all, They're not looking for a balance sheet historian like having a shiny big four pedigree and knowing gap that is just table stakes now.

00:08:10: So What do they screening for?

00:08:11: What Jansson terms crisis velocity Crisis

00:08:14: Velocity?

00:08:15: I Like That.

00:08:16: Yeah.

00:08:16: consider the mechanics of severe downside scenario.

00:08:20: Let's say revenue drops fifteen percent in a single quarter.

00:08:23: Does the CFO freeze and wait for the monthly close to figure out what happened?

00:08:28: Right, just stare at the spreadsheet...

00:08:29: Exactly!

00:08:30: Or do they possess the operational grit actionable, tiered cost reduction scenarios ready for the board by Monday morning.

00:08:44: Wow!

00:08:44: And even further do they have their backbone to look an aggressive founder in the eye and kill a pet project because it threatens a debt covenant?

00:08:52: That level of wartime operational grit is rare which probably what makes IFIC Carp's data points so fascinating.

00:08:58: Sixty-four percent new CFO appointments are going into first timers...

00:09:02: Which seems completely counterintuitive.

00:09:04: right if The job is harder than ever.

00:09:05: Why hire rookies?

00:09:07: Well, because the veterans might actually have the wrong muscle memory.

00:09:10: Oh that makes sense.

00:09:11: Yeah.

00:09:12: For a Deckard being a PECFO meant managing cheap debt and riding the multiple expansion wave.

00:09:18: Sponsors want operators who aren't anchored to the easy days.

00:09:22: But I mean...the expectations placed on these first timers are just brutal.

00:09:26: How

00:09:26: so?!

00:09:27: Well, eighty-seven percent of them Are expected to explicitly drive the value creation plan Not just report on it and nearly sixty percent inherit a finance function so broken that they have to completely rebuild the ERP in reporting infrastructure before it can even begin strategic work.

00:09:44: That shift toward raw operational capability over traditional pedigree is really echoed by James O'Dowd too, he observed BCG, Bain carries significantly less weight for senior operating roles today.

00:09:59: Oh really?

00:09:59: Yeah!

00:10:00: Sponsors are finally realizing that advising on twenty different transformations is fundamentally different from owning one.

00:10:05: Well

00:10:05: yeah Powerpoint is easy.

00:10:06: Exactly they want leaders who have actually run a P&L sat through a disastrous quarter own the outcome and stayed long enough to see if their corrective actions Actually worked in The Real

00:10:15: World.

00:10:16: But you know here Is where I find A massive disconnect In the sponsor playbook.

00:10:20: What's That

00:10:21: If private equity firms are supposedly hunting for these battle-scarred, contrarian operators who know how to make the tough calls.

00:10:29: Why do boards still heavily optimize for boardroom consensus?

00:10:33: Oh

00:10:33: that's a great point!

00:10:34: Right in my experience.

00:10:35: The second an operator actually pushes back on a flawed thesis and a board meeting... ...the GP gets incredibly nervous.

00:10:42: Are they actually ready for the friction they claim to want?

00:10:46: That is the ultimate paradox Consensus feels safe in the board room But Francisco Lara argues that the most effective executive teams optimize for healthy friction.

00:10:56: Healthy Friction?

00:10:56: Yeah, if you have a board meeting where everyone just nods and agrees but the CFO and Chief Revenue Officer leave their room with entirely different interpretations of this strategy The entire organization will feel that misalignment...

00:11:09: The friction doesn't disappear.

00:11:10: It moves from the boardroom down to middle management layer Where it completely paralyzes company

00:11:15: Precisely.

00:11:16: Teams that possess the psychological safety to disagree aggressively, debate the mechanics of strategy and really challenge the sponsor in their room.

00:11:25: Those are ones who make faster unified decisions when they leave.

00:11:30: But building a team capable for healthy friction requires intentional organizational design.

00:11:37: James Griffiths pointed out major unforced error sponsors made here.

00:11:42: Let me guess... treating HR as an afterthought?

00:11:44: Exactly!

00:11:45: Treating HR as a post-deal administrative function rather than a strategic risk mitigation team.

00:11:51: By the time HR is finally brought to the table, The one hundred day plan has already locked

00:11:55: right and the leadership's capabilities have been judged entirely on like informal gut feelings.

00:12:01: if talent Is the primary engine for value creation bringing human resources in late actively destroys enterprise value?

00:12:08: Absolutely By the way, if mapping out these operational blind spots and talent traps is useful for your own deal flow or strategy.

00:12:15: make sure you're subscribed to this deep dive so that we don't miss our future additions.

00:12:19: Definitely hit subscribe!

00:12:20: So um... We have a C-suite burning out, macro environment demanding impossible margins And severe shortage of wartime operators.

00:12:29: It's perfect storm.

00:12:30: Yeah

00:12:30: it really is.

00:12:31: No wonder sponsors are turning into artificial intelligence as ultimate magic bullet.

00:12:38: which brings us to our third theme.

00:12:40: Yes, the AI reality check because the sources we extracted reveal a massive often uncomfortable gap between the AI expectations at the fund level and the ground-level execution.

00:12:53: The disconnect is honestly striking.

00:12:55: Marcus Shaddle coauthored a study where they paired fun level partners with their respective portfolio company executives To evaluate their views on AI.

00:13:03: And what did they find?

00:13:04: Well, the partners universally categorize AI as a massive urgent priority like top of list.

00:13:10: Yet when you look at the portfolio CEOs ai almost never appears on their actual balance scorecards Which

00:13:15: completely exposes?

00:13:17: The fundamental flaw in how this is being rolled out.

00:13:19: I mean if an initiative doesn't have a strict quantitative target and a named executive owner.

00:13:24: It's not a strategy it Is merely an aspiration.

00:13:27: Exactly

00:13:28: You just told to CEO they will be fired If they don't hit a twelve percent EBITDA growth target.

00:13:34: They're going to ruthlessly prioritize whatever moves that specific needle.

00:13:38: And right now, AI is often viewed by them as just a cost center with the really ambiguous return horizon and The advice these executives receive is incredibly conflicting too.

00:13:49: Oh for sure

00:13:50: Scott Engler highlighted the whiplash in the market.

00:13:52: You have groups like BCG publishing reports stating that the biggest risk Is underspending?

00:13:57: And falling behind on AI capabilities.

00:14:00: but then on the flip side McKinsey publishes data noting that roughly sixty percent of the cost of complex, agentic AI systems goes to models simply checking and redoing their own work.

00:14:11: Sixty percent?

00:14:12: The compute costs for hallucination management is staggering!

00:14:15: You have AI agents running constant logic loops just to ensure they aren't generating false outputs.

00:14:20: So the competitive edge isn't about deploying the largest budget.

00:14:23: it's about having precise visibility to measure actual compute costs against tangible operational efficiency

00:14:31: which brings up a glaring issue with how AI is being applied to actual workflows.

00:14:36: Yeah, I wanted to ask about this because if a portfolio company has a bloated inefficient ten-step procurement approval chain and they bring in an AI tool just to automate the routing of those approvals They haven't actually fixed the business.

00:14:50: No, not at

00:14:50: all.

00:14:51: they have just engineered a bad process to operate faster.

00:14:54: That

00:14:54: is the exact trap and Anil Kumar provided fantastic framework to dismantle it.

00:14:59: he stays very clearly AI does not inherently create EBITDA.

00:15:04: It doesn't!

00:15:05: No, AI creates capacity.

00:15:07: That distinction changes the entire implementation strategy Completely.

00:15:12: To convert that newly created capacity into actual EBITTA you have to engage in what he calls zero-basing

00:15:18: the work Zero basing the workout.

00:15:19: You

00:15:19: cannot just drop expensive modern intelligence into legacy workflows... ...you have look at ten step procurement chain and ask If we were designing this company from scratch today, knowing what machines can do would this process even exist?

00:15:32: Right.

00:15:33: Because often complex approval chains only exists to catch human errors in the first place.

00:15:38: Exactly!

00:15:38: if machine generates purchase order without error and flags anomalies automatically you don't need seven middle managers signing off on it.

00:15:47: You have to ruthlessly redesign The workflow around AI To actually pull the human cost out of P&L.

00:15:54: But, you know getting that redesign to actually stick in the real world is an absolute nightmare.

00:15:59: Oh

00:16:00: a total nightmare!

00:16:01: William Ekberg shared some insights from SACS-CAP.

00:16:03: that map exactly where this breaks down on paper.

00:16:07: private equity has a massive structural advantage for AI adoption.

00:16:10: they have complete ownership control so they can bypass public market consensus.

00:16:14: right and they have the ticking clock of an exit to force urgency.

00:16:18: but ekberg notes it.

00:16:20: middle management.

00:16:22: It's so true.

00:16:23: Just think about the mechanics of the incentive structure there,

00:16:26: it's totally misaligned.

00:16:28: like a mid-level director of operations is never going to be penalized for running a slow safe legacy procurement cycle.

00:16:34: It or is what they know?

00:16:35: Yeah, I'd say.

00:16:36: but if they champion a radical new AI rollout that redesigns their entire department and that roll out fails are disrupts a quarter They get fired.

00:16:45: The general partners push the initiative from the boardroom, but the implementation stalls out three layers down because the personal risk to reward ratio for middle management does not support innovation.

00:16:57: Which is driving a fascinating evolution in how private equity actually utilizes external consultants.

00:17:04: now

00:17:04: Oh yeah Sam Garg pointed out that traditional two hundred and fifty thousand dollar week consulting playbook under severe threat.

00:17:11: It's about time

00:17:12: Private equity firms no longer have the patience for a twelve-week diagnostic engagement that ends with like, A thick PowerPoint deck telling them what they should do in theory.

00:17:22: They

00:17:22: don't need The Theory anymore!

00:17:23: They need this system actually built and deployed.

00:17:25: And That is exactly What we're seeing With models Like HG's Catalysts.

00:17:29: They are embedding over eighty AI engineers Directly into their portfolio businesses.

00:17:34: Eighty Engineers?

00:17:35: Wow

00:17:36: Yeah...They aren't leaving behind a presentation They Are Leaving Behind Trained Models Running Techstacks and codified capabilities embedded directly into the operation.

00:17:45: Which leaves us with a really critical evolution to consider.

00:17:48: as we wrap up today, The sources make one thing abundantly clear...the macro environment of cheap debt that subsidized mediocre operations

00:17:58: is gone.

00:17:58: Gone completely!

00:17:59: The C-suite is buckling under pressure for twelve percent growth mandates And dropping AI in a broken process doesn't magically create EBITDA without painful structural redesigns.

00:18:11: So where does that leave the traditional sponsor?

00:18:14: Well, it raises a profound question about the future identity of private equity itself.

00:18:18: Okay

00:18:18: I'm listening.

00:18:19: if The ultimate competitive edge is no longer financial engineering or leverage but rather the ability to deeply embed proprietary tech stacks and deploy specialized operating engineers into the guts Of A business right at what point do?

00:18:32: The most successful Private Equity firms stop looking like Wall Street investment funds And start resembling massive highly specialized technology conglomerates that just happen to have a captive capital arm.

00:18:43: Oh, wow!

00:18:44: The winners of the next decade might not be the best financial deal makers but the firms that act as the ultimate tech-enabled operating holding companies.

00:18:52: If you enjoyed this episode new episodes drop every two weeks.

00:18:55: also check out our other editions on PE Fundraising PE Exit Strategies Venture Capital M&A and Strategy & Consulting.

00:19:04: Thank You so much for joining us For This Deep Dive.

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00:19:10: We will catch you Next Time.