Best of LinkedIn: Private Equity: Value Creation CW 42/ 43

00:00:00: Provided by Thomas Allgaier and Freenas, based on the most relevant LinkedIn posts about private equity value creation in calendar weeks thirty-eight and thirty nine.

00:00:09: Freenas supports PE backed manufacturers with the market intelligence needed to unlock revenue from idle production capacity.

00:00:14: you can find more info in the description.

00:00:16: And welcome.

00:00:18: Today we are laying out a really specific mission for ya.

00:00:22: We're doing deep dive into that top private equity value creation trends that are just circulating all over LinkedIn right now.

00:00:29: Exactly, we want to impact what's actually happening out there because honestly the macro landscape of private equity has fundamentally changed.

00:00:37: Oh it really has.

00:00:39: I mean We've got a fascinating stack of sources for you today spanning everything from well The harsh new realities at the deal market To massive leadership bottlenecks.

00:00:49: Yeah and were even getting into hard truth about AI in Private Equity which i know everyone wants.

00:00:55: No fluff today, just smart focused trends.

00:00:58: So let's just jump right into it.

00:00:59: I want to start with this overarching theme of the new math of private equity because It explains exactly why the pressure on operations is so intense Right now.

00:01:09: Yeah The math is what drives everything else.

00:01:12: Brian DeLuce shared a really great insight.

00:01:15: He basically pointed out that the era of cheap capital and you know financial engineering Is completely over.

00:01:20: yeah its gone.

00:01:22: Think about Barwing costs used to be sitting around six or seven percent, right?

00:01:26: With like fifty-percent leverage.

00:01:27: Which is crazy the thing about

00:01:28: now!

00:01:29: It is.

00:01:30: and in that environment you could literally just hit a five per cent annual EBIT dog growth And you'd produce it two and half times MOIC

00:01:37: Two and a half times multiple on invested capital Just for growing five percent

00:01:42: Exactly.

00:01:43: but now barwing cost are what eight to ten percent?

00:01:47: easily.

00:01:47: yeah Yeah You have way lower leverage.

00:01:50: So to hit that exact same return profile, you don't need five percent anymore.

00:01:54: You need ten to twelve percent EBITDA growth

00:01:58: which is a totally different ballgame

00:01:59: right?

00:02:00: It's like um it's like we used to be sailing with this massive tailwind of cheap debt and now the wind has just completely died And we actually have to row the boat

00:02:09: We have to execute.

00:02:10: yeah I totally agree With that analogy and Christopher J Conti Actually backed us up was some pretty wild data.

00:02:17: Oh, what did he find?

00:02:19: So he noted that take privates are seeing median equity checks hit a ten-year high.

00:02:25: They're sitting at seven and half times evened up.

00:02:28: Wow!

00:02:29: A ten year high Right

00:02:31: Meanwhile buyout multiples have actually drifted down to about ten point two X. so you're putting more equity in getting lower multiples out

00:02:42: Which just squeezes the margins Even tighter

00:02:45: Exactly.

00:02:47: And Borgia Del Omo weighed in on this too.

00:02:49: He noted that because of all these, the lower middle market is becoming an absolute sweet spot.

00:02:55: Makes sense!

00:02:56: Better entry points down there?

00:02:57: Yeah

00:02:57: better entry points and honestly way more room for actual operational transformation.

00:03:02: like you said rowing a boat not just financial engineering.

00:03:05: But wait if we're talking about rowing the boat We have to talk how long were rowing four?

00:03:10: Because McKay pointed out massive consequence Of new math

00:03:14: The whole periods

00:03:15: Yes, longer-holding periods.

00:03:17: He noted that eight hundred and sixty billion dollars of US buyout assets are just sitting in companies that have been held for seven years or longer.

00:03:24: Eight

00:03:25: hundred and sixteen billion?

00:03:27: That's...that's insane!

00:03:29: So okay I've a question then.

00:03:31: if hold periods are literally stretching out to seven or eight years doesn't change how we measure success?

00:03:38: Oh absolutely

00:03:39: Like.

00:03:39: it can't be about the exit multiple anymore right?

00:03:41: Exactly It fundamentally changes day today.

00:03:45: Working capital is basically the whole game now.

00:03:47: How so?

00:03:48: Well, think about it Before.

00:03:51: you could just let a fifty-two day DSO slide.

00:03:53: You know days sales outstanding...you'd ignore because you knew that exit would wash out in three years.

00:03:59: Right!

00:04:00: Just pass this problem to next guy.

00:04:02: Yeah

00:04:02: But now every single dollar trapped into receivables Is dollars.

00:04:06: you are paying ten percent or more to borrow for seven years.

00:04:11: Oh wow That compounding interest will eat your life.

00:04:14: It destroys your returns.

00:04:15: You cannot ignore the balance sheet anymore.

00:04:18: So, okay leverage won't save day.

00:04:21: The exit is taking years longer Which means firms have to rely almost entirely on their value creation plans.

00:04:26: Their VCPs

00:04:28: Right...the master plan.

00:04:30: But

00:04:30: according to sources we're looking at These plans are completely failing contact with reality.

00:04:36: They really are.

00:04:37: they look great paper but

00:04:39: ...but don't work in practice.

00:04:41: George

00:04:41: DeLoreas introduced a really core problem here.

00:04:43: He said most VCPs are written for the investment committee, not the actual company.

00:04:49: That makes so much sense.

00:04:50: It's just spreadsheet exercise.

00:04:52: Exactly The deal team needs math to work.

00:04:54: So they just slap an EBITDA target onto this founder-led business

00:05:00: A business that probably doesn't even have basic reporting yet

00:05:03: Exactly Business with literally zero pricing discipline.

00:05:06: And then they act shocked when completely missed their targets by year two.

00:05:10: And then by year three, they're suddenly in an quote-unquote extended hold.

00:05:14: Right and well Alex Eck pointed out another huge issue with this.

00:05:18: he noted that seventy two percent of PE firms say operational improvement is their top lever right now

00:05:24: which sounds great but

00:05:25: But They don't have the people to do it.

00:05:27: The operating partners are stretched so thin.

00:05:30: Eck noted That many of them Are covering five or more portfolio companies at the same time.

00:05:35: Five?

00:05:36: You can't actively transform five businesses At once.

00:05:39: It's impossible.

00:05:41: Which is why I love Scott Peters' solution to this.

00:05:43: Oh yeah, his post was brilliant.

00:05:45: Basically he said you have to stop trying to do twenty-five things at once.

00:05:49: Yes

00:05:50: Focus.

00:05:51: He shared this incredible example.

00:05:54: He took over a business that had thirty five major documented problems Thirty-five.

00:05:59: Most PE firms would spin up thirty-five separate work streams for that

00:06:03: Exactly And everyone would burn out in the month.

00:06:06: But Peters narrowed it down to just three work streams, Just Three.

00:06:10: What were they?

00:06:11: Restore profitability Re-engineer processes and align sales.

00:06:16: that's It.

00:06:17: he ignored the other thirty two fires.

00:06:19: Wow That takes a lot of discipline.

00:06:22: it does.

00:06:23: but The results Customer satisfaction jumped from forty seven percent To ninety Two percent.

00:06:28: no way yeah.

00:06:30: And Sales Increased by Forty Million Dollars in Just Year One.

00:06:33: Forty million Just

00:06:35: from narrowing the focus.

00:06:36: That is actually real quick.

00:06:38: before we move on to The Next Point, if you are finding these kinds of insights useful for your own firm.

00:06:43: make sure To hit subscribe On this deep dive so You don't miss future additions.

00:06:47: Definitely do that because um...the Insights just keep coming like This blind spot that Nicholas Vandenstein highlighted.

00:06:54: Oh!

00:06:54: The survey he shared?

00:06:55: That was wild Right.

00:06:57: So PE execs were asked to rank their value creation levers.

00:07:01: Operations gets eighty percent Pricing gets seventy-five percent.

00:07:04: Makes sense,

00:07:05: but talent in HR only nine percent.

00:07:08: it was second to last

00:07:09: Nine percent yeah.

00:07:11: But then in the exact same survey fifty three percent of those execs say poor Implementation is the main reason their initiatives fail.

00:07:18: so wait We are hyper focusing on the math or hyper focusing On the operations.

00:07:23: what we're completely ignoring?

00:07:24: The actual people who have to execute the plan

00:07:27: exactly the human element Is totally broken.

00:07:29: Which brings us perfectly to the next theme, The Leadership Dilemma.

00:07:32: Because if the VCP is failing it's usually because of wrong.

00:07:35: people are sitting in seats.

00:07:36: Yeah... Usually the CEO seat!

00:07:38: To be honest.

00:07:39: Right And Lauren Cohen shared a stat on this that just blew my mind.

00:07:44: That turnover one?

00:07:45: She noted that sixty-five percent of PE firms experience ceo turnover during the hold period and It usually happens right around year two

00:07:52: which Is when the unrealistic VCP starts falling apart.

00:07:55: Exactly.

00:07:56: The IC plan hits the founder led reality, the numbers miss and the CEO gets the boot.

00:08:01: So what's the fix?

00:08:03: Camille Federer actually had some really strong advice on this.

00:08:06: She said PE firms need to fundamentally change how they hire leaders.

00:08:09: Okay How

00:08:11: Well.

00:08:11: They Need To Stop Screening For A History Of Two Plus Exits.

00:08:14: Wait Really

00:08:15: But an exit track record is like the ultimate PE resume.

00:08:19: It used be.

00:08:20: but she points out that exits are super rarely.

00:08:22: you can't rely On That Anymore.

00:08:24: Instead You need to screen for judgment.

00:08:27: Judgment, meaning what exactly?

00:08:29: Meaning the ability to pivot when a plan breaks because as we just discussed The plant is definitely gonna break

00:08:35: right.

00:08:36: you need someone who won't Just blindly follow the spreadsheet off of cliff.

00:08:40: Exactly

00:08:41: Because if you just hire a mercenary To hit a number it gets ugly.

00:08:44: Anthony Gorman shared this wild cautionary tale about exactly that.

00:08:48: Oh the cost-clearing CEO.

00:08:50: That story was rough.

00:08:52: It was

00:08:53: so.

00:08:53: they bring in this new ceo And in three months, he grows EBITDA by twenty two percent.

00:08:58: The board must have been thrown a party right?

00:09:00: Twenty-two percent and a quarter.

00:09:03: but here's how we actually did it.

00:09:05: He executed this insanely destructive cost clearing playbook

00:09:09: just slashing everything

00:09:11: Everything!

00:09:12: He fired the senior client directors to save cash...he froze all support hiring..He even cancelled a major client conference

00:09:20: Just totally starving the business to pump the margins.

00:09:22: Yes

00:09:23: And nine months later, six million pounds in recurring revenue just walked out the door.

00:09:27: The clients all left.

00:09:29: Wow Six million.

00:09:30: It's like it's like stripping the copper wire Out of the walls Of your own house to sell it Like sure?

00:09:36: It looks like you made money today But the House is completely destroyed.

00:09:40: That's a perfect analogy.

00:09:42: The House Is Unlivable.

00:09:43: So how do operating teams actually prevent this?

00:09:46: How Do You Make Sure You Have The Right Leader For The Right Moment?

00:09:50: Well Mark Jansen laid out A Great Framework for This Especially when it comes to finance leadership.

00:09:55: He says you really have to diagnose the actual stage of the company.

00:09:59: Okay,

00:09:59: his quote was don't hire an architect to swing a hammer.

00:10:03: I love that.

00:10:05: What does that look like in practice?

00:10:06: Well say You Have A Company That Takes Twenty Days To Close The Books And The Financial Data Is Just Absolute Garbage.

00:10:14: Which is Most Lower Middle Market Companies?

00:10:16: Exactly In that situation, you do not need a heavy-hitting strategic CFO.

00:10:21: They will just get frustrated.

00:10:22: You need a tactical controller someone who can get the weeds and swing a hammer

00:10:26: Right.

00:10:27: Fixed the plumbing before you design The Fountain Exactly!

00:10:30: You only need That Strategic CFO when your prepping for an exit.

00:10:34: or maybe doing like four add on acquisitions?

00:10:37: That makes total sense.

00:10:38: So we've got VCPs failing Operating partners stretched thin CEOs turning over.

00:10:44: It's no wonder everyone is looking For A Magic Bullet

00:10:47: Which brings us to the elephant in the room, artificial intelligence.

00:10:51: Yes everyone wants solve these massive capacity problems with AI but reading through this post there is a huge gap between the hype and actual EBITDA.

00:11:02: Oh

00:11:02: massive!

00:11:03: The reality check has hitting

00:11:05: hard.

00:11:05: Nilesh Tucker brought it up.

00:11:07: he pointed out that buyers in due diligence will rigorously test your AI savings.

00:11:12: They don't just take you word for it anymore.

00:11:13: No If your AI doesn't definitively move an EBITDA line on the spreadsheet, Buyer's assigns zero value to it.

00:11:20: It is just a list of SaaS tools you're paying for Right.

00:11:23: And Asif Rahman made brilliant point about why its so hard to move that EBITTA line.

00:11:28: He said plainly Productivity does not equal EBITJA.

00:11:33: Wait unpack that first.

00:11:33: second!

00:11:34: if You are more productive shouldn't make more money?

00:11:37: You'd think So.

00:11:39: But Think About A System.

00:11:40: Say AI makes your engineers four times faster.

00:11:43: Okay So we build four times as much software?

00:11:46: Right.

00:11:47: But your sales team, they can't suddenly sell four-times as much product.

00:11:51: The bottleneck just moved.

00:11:53: Oh I see.

00:11:54: And it gets worse because now you have all this extra product out there and that just crashes the customer support queue.

00:11:59: oh wow so you didn't actually make any more money.

00:12:01: You just created a massive headache for customer service.

00:12:04: Exactly Productivity in one silo does not equal firm white even though

00:12:09: There's an even bigger financial danger here too.

00:12:12: Chandan Mahajan pointed out that renting AI actually compounds your costs in a terrifying way.

00:12:17: Oh, the token cost?

00:12:18: Yeah!

00:12:19: Right.

00:12:19: if a portfolio company has a one million dollar annual bill for renting AI tools and they get valued at a fifteen X exit multiple

00:12:27: That reduces the enterprise value by fifteen million dollars at Exit.

00:12:30: Yes Fifteen million dollars just wiped-out because you rented the tech instead of owning it.

00:12:36: Mahajin says PE firms need to actually own their AI capabilities not pay by the token.

00:12:42: But then you hit the real roadblock, The Absolute Fundamental Roadblock.

00:12:46: Jake Seymour highlighted a quote from Brookfield's CEO that just sums this up perfectly.

00:12:51: Oh!

00:12:51: This was hilarious

00:12:52: Right

00:12:53: And sad?

00:12:54: Right.

00:12:55: The CEO said that PE firms are out there buying businesses with billion dollars in revenue and two hundred fifty million in EBITDA.

00:13:02: Massive companies

00:13:03: Massive...and they're barely using Microsoft Excel properly.

00:13:08: Just zero digital infrastructure.

00:13:10: No ERP system, no CRM.

00:13:13: just broken spreadsheets.

00:13:14: Which means all this?

00:13:15: talk about you know deploying advanced AI agents.

00:13:18: It's fantasy.

00:13:20: it's total fantasy.

00:13:21: AI is a massive lever.

00:13:22: sure We know PE firms are surging their AI roles by like five X right now.

00:13:28: But you cannot build advanced AI on the foundation of broken spreadsheet.

00:13:32: You

00:13:33: can't.

00:13:34: The operations have to catch up with ambition.

00:13:37: They do.

00:13:38: And you know, we've talked a lot about the struggles today but I want to leave you with one final totally fascinating thought from The Sources.

00:13:46: that shows what happens when private equity actually gets this stuff right.

00:13:50: Oh yeah...the BCG report?

00:13:52: Right

00:13:53: Jay Ruckelsimer highlighted this data showing that private companies are actually cutting their carbon emissions way faster than public companies

00:14:01: Which feels backwards!

00:14:02: You could

00:14:02: think

00:14:03: Public companies without all of they're ESG mandates would be leading the charge.

00:14:06: Exactly.

00:14:07: But Scope One emissions drop four point one percent of private companies versus just point nine percent at public peers.

00:14:13: That's a huge difference.

00:14:15: Why is that happening?

00:14:16: Because public companies treat it like PR Private equity sponsors treated, Like A math problem.

00:14:21: they align the operational performance with actual financial incentives.

00:14:26: precisely If a PE operating partner sees that cutting factory power consumption will increase EBITDA.

00:14:32: They don't form a committee.

00:14:36: It just proves that when private equity gets back to its roots, enforcing true operational accountability they can drive incredible systemic change.

00:14:43: Whether it's in EBITDA or sustainability?

00:14:46: Its all execution!

00:14:48: Exactly Well...that is a perfect place to wrap up todays deep dive.

00:14:52: If you enjoyed this episode new episodes drop every two weeks.

00:14:56: Also check out our other editions on PE fundraising PE exit strategies venture capital M&A and strategy & consulting.

00:15:04: Thanks so much for listening, everyone.

00:15:06: Make sure you subscribe and we'll catch ya on the next one!

00:15:09: See you next time.