Article.

Not Your Grandfather’s Value Creation

Today, maximum value creation means looking beyond EBITDA.

M&A continues to explode. In the first quarter of 2021, M&A activity skyrocketed 94 percent from Q1 of the previous year, reaching a staggering $1.3 trillion in value. And Q2 showed no signs of slowing down.

Yet, as Ernst & Young notes in a recent report, “Traditional value creation levers such as financial engineering, cost optimization and revenue growth may reach a ceiling and prove to be insufficient. Focusing on new value creation and digital transformation will therefore be key to deriving new value and achieving profitability targets.” (1)

To efficiently drive value today, companies must look beyond earnings before interest, taxes, depreciation, and amortization (EBITDA). If a company looks at increasing value through an investor lens, the focus is on hitting specific revenue growth or EBITDA metrics. From an M&A perspective, the focus is on similar math-driven targets.

Yet, this one-dimensional formula, says a new INSEAD Business School whitepaper “offers an easily applied methodology and a complete picture of the value created for investors ... but no insight into company specific value creation.” (2)

The whitepaper also points out that EBITDA delivers “no insight into the sources of changing operating performance,” yet “half of the value created via margin change is directly attributable to operating improvements. The ability … to consistently add value through operational improvement has become a key driver of investment returns and fundraising success ...” (2)

That means a deep dive into operations. An experienced operator has a deeper understanding of what really drives value. For an operator, value is about more than numbers, it’s about the strategy and tactics you need to utilize to achieve those numbers. It’s about deeply understanding and defining the market, products, processes and talent. And that’s invaluable.

A recent, insightful McKinsey & Company (3) report points to four key strategies as critical to modern value creation. Let’s take them one by one.

1.
“Creating early trust-based relationships with the asset’s management... In our experience, rapid decision making and execution are closely linked to the level of trust among key stakeholders in an organization. Therefore, creating strong, trust-based relationships is critical for successful value creation. This trust is typically achieved when investors become considerably more involved and learn all that they can about their potential new assets.”

The model has changed. If you’re growing a business, you want a partner with experience not just in M&A and investing, but also in operations. You need an operator.

An operator should never look at you and say, “Hey, the plan we gave you isn’t working.” They are trusted advisors, guiding you through the entire process, from initial strategy all the way through execution to exit.

2.
“To create real value, high-performing firms must essentially become more entrepreneurial—that is, they need to take initiative, shape strategy, be willing to assume risks with the promise of bigger rewards...”

For maximum effectiveness, an operator/partner should have skin in the game—employing a model where compensation is aligned to success. The success of our business model hinges on our teams’  proven track record of value creation. Experience, expertise and IP should drive strategy, execution, flexibility, and confidence in results. In this scenario, the more value you create, the better everyone does. Now your partner is uniquely invested.

3. “Establishing a comprehensive and granular operational plan that leads toward the targeted exit...real transformation happens only when a leadership team embraces the idea of comprehensive change in how the business operates—tackling all the factors that create value for an organization, including top line, bottom line, capital expenditures, and working capital, as well as the business model and the overall strategy.”

Value creation should start with assessment—a deep dive that involves significant research on your company, the market landscape, and the overarching opportunity. This repeatable methodology should be configurable based on company/stage and drive a level of discipline and structure to identify the best possible growth options and the level of execution/capital risk. 

4.
“While investment professionals need to be equipped with deep financial acumen, a focus on value creation also requires a more diverse set of operational and change-management skills.”

When operators are involved, you historically see an out-sized return. So why doesn’t everyone use them? Because most funds can't afford to hire a team with the required depth of experience. To have proven, experienced operators across your key business functions means a very expensive bench.

At Orchid Black, the deep experience and insights of our team of former CEOs, CROs, CMOs, strategy execs, board chairs and board members are a force multiplier in executing impactful change that will drive growth.

How do you achieve maximum value creation? Do you have an experienced team leveraging collective business intellect and data from across your company? Our operators do just that, clearing a path to alignment, healthy growth and results-driven success.

 

Sources

1 How can Financial Sponsors Shape Tomorrow’s Value Creation?, Ernst & Young

2 Value Creation 2.0, INSEAD and Duff & Phelps

3 From Pure Investor to Entrepreneurial Owner, McKinsey & Company

About the Author

Jim Barnish is a strategic change leader with over 15 years of leadership experience in global and integrated operations, M&A, and strategic go-to-market planning. Drawing on deep operational and investment experience at startup and scale-up businesses, he’s created and curated a collection of proven, data-driven processes and methodologies to help companies build scalable and fundable solutions—accelerating organic growth.

Jim can be reached at: jb@orchid.black.