Written by Key Metrics for Finance Leaders and Private Equity Sponsors
Congrats, you’ve been taken private for a healthy premium. Things will be a little different now for your growing company. In a private equity-sponsored company, the CFO must vigilantly monitor various key metrics to ensure financial health and operational efficiency. These metrics are crucial for both the company’s management and the private equity firm that holds a stake. The CFO’s role is pivotal in balancing the interests of the company’s operational goals and the private equity firm’s objectives of maximizing returns and managing risk.
We delve into the essential metrics a CFO should monitor, the importance of debt and cash levels, EBITDA, and the key priorities for both the private equity firm and the portfolio company. Additionally, we will explore recent examples of successful companies that have gone through the private equity process and the application of zero-based budgeting.
We also discuss how the PE firm looks at things so you get a different perspective.
Key Metrics to Monitor
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization):
Importance: EBITDA serves as a measure of a company’s operational profitability and is used to compare performance across companies and industries by eliminating the effects of financing and accounting decisions.
Monitoring: Regularly track EBITDA to gauge operational efficiency and profitability. Adjust strategies to maintain or improve EBITDA margins.
Example: In 2020, Silver Lake Partners invested in Airbnb, helping the company navigate the pandemic’s financial impact. Through operational efficiency improvements and strategic planning, Airbnb improved its EBITDA, leading to a successful IPO in December 2020.
2. Debt Levels:
Importance: Debt management is critical, especially in leveraged buyouts (LBOs) where high levels of debt are utilized to finance the acquisition.
Monitoring: Keep a close eye on total outstanding debt, changes in debt levels, debt covenants, and refinancing opportunities. Ensure compliance with debt agreements and maintain a healthy debt-to-equity ratio.
Example: After Blackstone acquired Ancestry.com in 2020, the company managed its debt effectively while continuing to expand its subscription base and enhance its product offerings.
3. Cash Flow:
Importance: Positive cash flow ensures the company can meet its operational expenses, service debt, and invest in growth opportunities.
Monitoring: Track operating cash flow, free cash flow, and the cash conversion cycle. Forecast cash flows to manage liquidity effectively and plan for future investments or debt repayments.
Example: Hellman & Friedman’s acquisition of Splunk in 2021 focused on improving cash flow management, enabling the company to invest in growth initiatives while maintaining financial stability.
4. Revenue Growth:
Importance: Sustainable revenue growth is a key driver of company valuation and attractiveness to investors.
Monitoring: Analyze year-over-year (YoY) and quarter-over-quarter (QoQ) revenue growth. Segment revenue by product lines or geographies to identify growth drivers and laggards.
Example: Thoma Bravo’s acquisition of cybersecurity firm Proofpoint in 2021 emphasized expanding revenue through product innovation and strategic acquisitions, resulting in substantial revenue growth.
5. Profit Margins:
Importance: Gross and net profit margins provide insight into cost management and overall profitability.
Monitoring: Regularly assess gross profit margins (revenue minus cost of goods sold) and net profit margins (net income divided by revenue). Identify areas for cost optimization to improve margins.
Example: Vista Equity Partners’ investment in Duck Creek Technologies in 2020 led to enhanced profit margins through streamlined operations and cost management, culminating in a successful IPO later that year.
6. Leverage Ratios:
Importance: Leverage ratios, such as debt-to-equity and interest coverage ratios, indicate the level of financial risk associated with the company’s capital structure.
Monitoring: Maintain a balance between leveraging debt for growth and ensuring the company can comfortably meet its debt obligations.
Example: Advent International’s acquisition of McAfee’s enterprise business in 2021 highlighted the importance of maintaining healthy leverage ratios while focusing on growth and profitability.
Private Equity Firm’s Key Metrics
Maximizing Returns for Limited Partners:
Importance: The primary goal of a private equity firm is to deliver high returns to its limited partners (LPs).
Monitoring: Evaluate potential returns using metrics like internal rate of return (IRR) and return multiples. Conduct sensitivity analyses to assess how changes in key assumptions impact returns.
Example: Insight Partners’ investment in Monday.com paid off significantly with the company’s IPO in 2021, delivering strong returns for limited partners through strategic growth and value creation.
2. Managing Risk:
Importance: Risk management is crucial to protect the investment and ensure stable returns.
Monitoring: Assess market, operational, liquidity, and compliance risks. Implement strategies to mitigate these risks and regularly review their effectiveness.
Example: The acquisition of Qualtrics by Silver Lake and other investors from SAP in 2021 involved meticulous risk management to ensure the company’s continued success and market leadership.
3. LBO Success Factors:
Importance: Leveraged buyouts are a common strategy for private equity firms, where success is dependent on several factors.
Monitoring: Evaluate the purchase price, financing structure, and cash flow projections. Develop a clear exit strategy and assess potential returns through LBO analysis.
Example: KKR’s leveraged buyout of Cloudera in 2021 demonstrated the successful application of LBO strategies, focusing on cloud data services expansion and profitability.
4. Operational Improvements:
Importance: Enhancing operational efficiency can significantly increase the value of the portfolio company.
Monitoring: Implement and track operational improvements such as cost management, process optimization, and leveraging synergies across the portfolio.
Example: The acquisition of Epicor by Clayton, Dubilier & Rice in 2020 involved significant operational improvements, leading to better performance and value creation.
Zero-Based Budgeting (ZBB)
Definition: Zero-based budgeting is a method of budgeting in which all expenses must be justified for each new period. The process starts from a “zero base,” and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether each budget is higher or lower than the previous one. Here’s our article on
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Importance: ZBB helps companies align their spending with strategic goals by focusing on value and necessity rather than historical spending patterns. This approach can lead to cost savings, increased accountability, and better resource allocation.
Application:
- Implementation: Begin by identifying business units and activities, then develop decision packages. Evaluate and rank these packages based on their contribution to strategic goals.
- Example: Kraft Heinz, under the management of 3G Capital, implemented ZBB to reduce costs significantly. This process helped identify and eliminate unnecessary expenses, leading to improved profitability and better alignment of resources with strategic priorities.
Benefits:
- Cost Management: Provides a rigorous approach to managing costs by ensuring that all expenditures are necessary and justified.
- Resource Allocation: Ensures resources are allocated to activities that provide the highest value and support strategic objectives.
- Accountability: Increases accountability among managers by requiring them to justify their budget requests and demonstrate the value of their expenditures.
Working Together: Key Priorities for Both Parties
1. Growing Revenues While Enhancing Value:
Importance: Both the portfolio company and the private equity firm aim to grow revenues and enhance overall value.
Monitoring: Focus on strategic initiatives that drive revenue growth, such as market expansion, product development, and strategic partnerships. Continuously monitor and improve value creation activities.
Example: The Blackstone Group’s investment in Bumble in 2020 focused on expanding the dating app’s user base and enhancing its product offerings, leading to a successful IPO in 2021.
2. Debt and Cash Management:
Importance: Effective management of debt and cash levels is critical for maintaining financial stability and enabling growth.
Monitoring: Regularly review debt servicing requirements, refinancing options, and cash flow forecasts. Collaborate on strategies for paying down debt and optimizing cash use.
Example: The debt restructuring of J. Crew by Anchorage Capital Group in 2020 aimed to manage high debt levels and stabilize cash flow amidst challenging market conditions.
3. Key Accounting and Finance KPIs:
Importance: Monitoring key performance indicators (KPIs) in accounting and finance ensures transparency and helps in strategic decision-making.
Monitoring: Track KPIs such as budget variance, working capital, burn rate, interest coverage, and return on assets. Use these metrics to identify areas for improvement and make informed financial decisions.
Example: Monitoring key KPIs helped Francisco Partners manage its investment in MyHeritage, focusing on cost management and operational efficiencies.
For a CFO in a private equity-sponsored company, monitoring key metrics is essential for aligning the interests of both the company and the private equity firm. By focusing on EBITDA, debt and cash levels, revenue growth, and other crucial KPIs, the CFO can ensure financial stability and drive value creation.
At the same time, the private equity firm must prioritize maximizing returns for limited partners and managing risk, leveraging LBO success factors and operational improvements to achieve these goals. Through a collaborative and strategic approach, both parties can realize significant growth and enhanced value.
The recent examples of companies like Airbnb, Splunk, and Bumble illustrate the potential for significant value creation through the private equity process. Additionally, the implementation of zero-based budgeting can lead to more efficient resource allocation and cost management, further enhancing the value of the portfolio company.
Let us know what you think.