When a private equity firm invests in a portfolio company, they often perform technical due diligence to assess risks, identify opportunities, and determine potential value creation avenues. However, as investments span over several years, it becomes crucial to monitor the ongoing performance of these companies to maximize their exit multiple potential.
This blog will explore 6 key benefits of conducting mid-term or periodic health checks on portfolio companies. Additionally, we will explore the role of technical due diligence providers in delivering this service and what stakeholders can expect from their involvement. By understanding the benefits of health checks and the support provided by technical due diligence providers, private equity firms can ensure effective monitoring and enhance the long-term success of their portfolio companies.
1. Performance Evaluation
A mid-term health check provides an opportunity to evaluate the overall performance of portfolio companies. It helps assess whether the companies are on track to achieve their strategic goals and financial targets. By thoroughly evaluating financial statements, operational metrics, and competitive landscape, private equity firms can gain insights into each company's performance relative to its initial projections and industry benchmarks. This evaluation allows them to identify strengths and weaknesses, address performance gaps, and take corrective actions to improve overall performance.
2. Risk Identification and Mitigation
A mid-term health check identifies and mitigates potential risks that may have emerged or evolved since the initial investment. It helps uncover operational, financial, regulatory, or market-related risks that could impact the portfolio companies' performance and profitability. By proactively identifying risks, strategies can be developed to mitigate or manage them effectively. This risk mitigation approach helps protect the investment and optimize returns by addressing potential obstacles that could negatively impact the companies' financial stability and growth prospects.
3. Strategic Alignment
Conducting a mid-term health check allows private equity firms to reassess the strategic alignment of portfolio companies. Market dynamics and business landscapes can evolve rapidly, requiring companies to adapt their strategies to stay competitive. By evaluating the portfolio companies' strategic positioning, market fit, and growth potential, private equity firms can ensure that the companies are aligned with current market trends and customer demands. This assessment helps identify strategic opportunities for expansion, product diversification, or market penetration. Adjusting the strategic direction based on the mid-term health check results can enhance the portfolio companies' competitiveness, value proposition, and long-term growth prospects.
4. Identifying New Value Creation Opportunities
A mid-term health check uncovers potential value-creation opportunities within portfolio companies. It helps identify operational efficiencies, cost optimization initiatives, and revenue enhancement strategies that can drive financial performance and increase the companies' value. By conducting a detailed analysis of processes, systems, and organizational structures, private equity firms can uncover areas where improvements can be made to optimize operations, reduce costs, enhance productivity, and capture additional market share. Implementing value-creation initiatives based on the mid-term health check findings can positively impact the companies' financial performance and overall valuation.
5. Optimizing The Exit Value
Conducting a mid-term health check allows private equity firms to optimize the exit value of a portfolio company by identifying and prioritizing value drivers, mitigating risks, optimizing financial performance, enhancing strategic positioning, and demonstrating growth potential. By proactively improving the company's value proposition, private equity firms can maximize the exit valuation and generate superior returns for their investors.
6. Investor Communication and Transparency
Conducting a mid-term health check demonstrates transparency and accountability to the private equity firm's investors. It provides an opportunity to communicate the progress and performance of portfolio companies, highlighting achievements, challenges, and the actions being taken to address them. Transparent communication builds trust and confidence among investors, reinforcing the firm's commitment to monitor and manage their investments actively. It also allows for open dialogue and collaboration with investors on potential strategies to optimize portfolio company performance, leading to better decision-making and stakeholder support.
What To Expect From A Technical Due Diligence Provider
When conducting a mid-term or periodic health check, a technical due diligence provider can compare the company’s performance with historical data from the initial investment period (e.g., from a technical due diligence report). The health check can compare current and historical benchmarks to understand the portfolio company's progress. It can also outline any new risks or improvement opportunities that can enhance the exit value of the business.
At RingStone, we recognize the significance of value creation in maximizing the potential of portfolio companies. Our health checks predominantly focus on re-assessing maturity and identifying value-creation opportunities that can be employed before exit. So you get a sense-check on current health and insights into how portfolio companies' health can be improved.
RingStone’s value creation assessment process revolves around three key-value creation levers. By carefully analyzing these levers, we develop a backlog that emphasizes value and cost considerations. The objective is to provide actionable insights that inform the value creation plan, enabling portfolio companies to make well-informed decisions and drive optimal results.
Revenue Growth Potential
A key focus at RingStone lies in creating customer value by identifying new features or services that enhance product stickiness. Additionally, we emphasize value creation through the expansion into new markets and the growth of existing market share. This approach ensures that every item on the backlog, whether it pertains to software architecture, IT infrastructure setup, process optimization, or team structure, is evaluated based on its impact on revenue growth enablers.
For example, suppose a backlog item involves enhancing the software architecture. In that case, we assess its potential to improve scalability, performance, or user experience, contributing to increased customer satisfaction and revenue growth. Similarly, if the item relates to IT infrastructure setup, we evaluate its impact on improving system reliability, security, or scalability, which can lead to enhanced customer trust and business expansion opportunities.
Regardless of the area addressed in the backlog, process optimization, or team structure adjustments, each line item is carefully measured against its potential to drive revenue growth enablers. This approach ensures that our value creation efforts are directly aligned with the overarching goal of maximizing the success and profitability of portfolio companies.
Margin and EBITDA Potential
To drive improved margins and EBITDA potential, the second value creation lever at RingStone focuses on efficiency, productivity, and the ability to achieve more with fewer resources. This lever centers around creating higher-quality products and services while quantifying the value of accelerated time to revenue.
Efficiency and productivity enhancements are measured by analyzing processes, workflows, and resource allocation to identify areas for improvement. By streamlining operations and eliminating inefficiencies, companies can optimize their output and achieve more with less. This not only boosts productivity but also reduces costs and improves margins.
The ability to bring products and services to market earlier is a key component of value creation. Doing so allows companies to gather valuable customer feedback, make necessary pivots, and minimize wasteful investments. Companies can maximize revenue potential and capture market share more effectively by rapidly iterating and responding to market needs.
Cost optimization is another critical aspect of this lever. Companies can optimize their cost structures and enhance margins by identifying improved tools, processes, or organizational design opportunities. This may involve implementing more efficient technologies, automating manual processes, or reorganizing teams for better resource allocation.
For example, optimizing the software development process by adopting agile methodologies and DevOps practices can improve efficiency, reduce time to market, and enhance the quality of products. Investing in tools that automate repetitive tasks can free up resources and enable teams to focus on higher-value activities. Restructuring the organization to align with strategic objectives and eliminate redundant roles can drive cost savings and improve profitability.
By emphasizing efficiency, productivity, time to market, and cost optimization, RingStone helps portfolio companies enhance their margins and EBITDA potential. These value-creation initiatives drive improved financial performance and position companies for sustainable growth and profitability.
Exit Multiple Potential
Improving the exit multiple potential is a crucial objective at RingStone, recognizing the challenges associated with planning for exit multiple expansions in advance and navigating market shifts. Technology is pivotal in establishing brand positioning and building trust, enhancing the exit potential.
At RingStone, our assessments and diligence processes track the value-add derived from technology initiatives. This includes attracting, hiring, and retaining top talent, contributing to the company's human capital, and strengthening its competitive advantage. Additionally, reducing compliance and security gaps through technology implementation enhances operational robustness and minimizes risks, thereby increasing the company's attractiveness to potential acquirers.
Customer satisfaction excellence is another aspect that technology enables. Companies can build strong customer relationships and loyalty by leveraging technology solutions to enhance customer experience, streamline processes, and provide personalized offerings. This contributes to revenue growth and enhances the company's reputation and exit potential.
Furthermore, the ability of technology to be flexible and adaptable in accommodating market pivots serves as insurance against market shifts. In a dynamic business environment, companies need the agility to quickly adapt their strategies and offerings to changing market conditions. Technology infrastructure and systems that can readily support such pivoting enhance the company's resilience and exit multiple potentials.
For example, implementing scalable cloud infrastructure allows companies to efficiently handle increasing demand and adapt to changing customer needs. Advanced analytics and data-driven insights enable companies to identify market trends, make informed decisions, and seize growth opportunities. Embracing digital transformation and emerging technologies positions companies as forward-thinking and future-ready, which can significantly enhance their exit prospects.
By leveraging technology to attract talent, address compliance and security, prioritize customer satisfaction, and enable market pivoting, RingStone empowers portfolio companies to strengthen their exit multiple potential. These technology-driven value-add initiatives position companies for successful exits and maximize returns for the company and its investors.
In summary, conducting a mid-term health check on portfolio companies is a valuable practice to establish whether they are on track to deliver the expected returns, optimize costs and potentially enhance overall performance. By evaluating the company's operations, identifying potential issues, and providing guidance towards the proper outcomes, companies can effectively address cost optimization and improve the exit multiple potential for the private equity investors.
The first key benefit of performing a health check is the ability to identify issues and areas of improvement within portfolio companies. By assessing various aspects such as financial performance, operational efficiency, and resource utilization, it’s possible to gain insights into potential cost-saving opportunities. This allows companies to proactively address any inefficiencies or bottlenecks, leading to improved cost optimization and enhanced profitability.
The second benefit lies in the identification of high-spend areas. Through the health check process, it’s possible to review the company's expenditures, including operational costs, vendor contracts, and technology investments. By identifying areas of excessive spending or opportunities for cost reduction, companies can develop strategies to optimize expenses, improve financial performance, and maximize shareholder value.
Another key benefit is to help portfolio companies achieve appropriate outcomes. For example, implementing efficient processes, leveraging technology solutions, or adopting lean methodologies to drive cost savings and operational excellence.
Overall, performing a health check empowers private equity firms to manage and optimize costs within their portfolio companies actively. Private equity firms contribute to their portfolio companies' financial success and long-term growth by addressing issues, identifying high-spend areas, and providing guidance. The result is improved operational efficiency, enhanced profitability, and increased value creation, benefiting private equity firms and their investors.
About the Author
Jon White is an experienced technology leader with over 34 years of international experience in the software industry, having worked in the UK, Malaysia, Bulgaria, and Estonia. He holds a BSc (Hons) in Systems Design. He led the Skype for Windows development teams for many years (with 280 million monthly connected users), playing a pivotal role in the team's transition to Agile.
Jon has held multiple leadership positions throughout his career across various sectors, including loyalty management, internet telecoms (Skype), IT service management, real estate, and banking/financial services.
Jon is recognized for his expertise in agile software development, particularly helping organizations transform to agile ways of working (esp. Scrum), and is a specialist in technical due diligence. He is also an experienced mentor, coach, and onboarding specialist.
Over the last few years, he has completed over a hundred due diligence and assessment projects for clients, including private equity, portfolio companies, and technology companies, spanning multiple sectors. Contact Jon at email@example.com.