According to Harvard Business Review, a private equity (PE) firms’ major differentiator to their LPs is their ability to quickly identify, create and execute value creation opportunities, starting with due diligence. During diligence, identifying synergies at new platform companies or add-on acquisitions is essential to a portfolio company’s ultimate exit value success. With less financial flexibility now due to higher interest rates, PE firms have greater LP and lender pressure to identify and execute synergies to support value creation. Poor synergy assessment and roadmap development for revenue, operational and labor synergies can:
- Lead to gaps in pre or post- LOI go or no-go decision-making
- Result in poorly designed integration and value creation plan(s) that miss key synergy levers
- Impact future fundraising or lending relationships due to non-top quartile IRR results
Key Revenue Synergy Levers
Revenue and underlying product capabilities are usually the primary deal thesis driver for PE firms. Historically, revenue synergy assessment and planning have been minimal with PE firms using high-level industry revenue comps to build the investment case. This strategy is becoming less effective as most industry revenue comps face their first down market since the 2008 Financial Crisis. Identifying and mapping synergies requires a thoughtful approach that evaluates and prioritizes opportunities by:
- Assessing sales, marketing, and GTM maturity focusing on strategy, personnel capability, and market penetration
- Analyzing the sales, marketing and product strategies, and existing customer relationships to identify cross-sell, particularly for current and planned future add-ons
- Reviewing product roadmap gaps within new platforms and add-ons
- Analyzing current pricing strategies
Key Labor Synergy Levers
Labor synergies have historically been an easy synergy lever for PE firms. This has become more complex to implement in this ESG era for PE firms as firms have to consider the societal impact of layoffs and potential LP concerns (particularly state and union pension funds). In addition, PE firms are factoring customer quality and satisfaction in their HR diligence. Many PE firms have been assessing labor synergies through two key methods: 1) automating and reducing manual tasks through technologies (ERP and AI/ML); 2) process and operating model improvements to avoid additional hiring needs as portcos acquire add-ons. Identifying and mapping labor synergies are now typically done in diligence by:
- Identifying and leveraging shared services opportunities, particularly for platform companies that will experience many add-on deals
- Identifying duplicated or ineffective functions or processes that require a new operating model to scale future acquisitions
- Analyzing business functions for lower labor and real estate cost strategies (nearshoring, offshoring)
- Identifying potential automation opportunities leveraging AI/ML and ERP to reduce future headcount growth
Key Operational Synergy Levers
Historically, operational synergies have traditionally been the easiest synergy lever with SG&A optimization being the top lever in the PE firm synergy playbook. However, operational synergies have been more sophisticated with LP pressure to execute and demonstrate a PE firm’s value creation capabilities beyond “low-hanging fruit” like SG&A. PE firms are increasingly focused on operational synergies in areas like cost of goods/sales inputs and IT that require industry-specific knowledge and functional expertise. This trend has driven PE firms to bring on more specialized operating partners. However, at most PE firms, these individuals only have bandwidth to assess one or two major issues across their 5 to 10 diligences going on simultaneously. Identifying and mapping operational synergies are typically done in by:
- Benchmarking all operational costs (e.g., IT, supply chain, SG&A, input costs) during diligence
- Conducting a deep dive on the two to three operational red flags (e.g., IT, product scalability, manufacturing, raw materials)
- Assessing commercial and operational excellence capabilities and programs
- Identifying how digital transformation can enable margin improvement
Synergy Roadmap
Over the past decade, PE investors largely relied on portfolio company revenue growth and multiple expansion to drive their value creation playbook, while seeing the third IRR component —profit margin growth through synergies—become an afterthought. By identifying synergies at a more granular level during diligence, PE firms can quickly support a portco’s margin improvement plan post-close. Lastly, building a detailed synergy roadmap that a portco’s management can easily implement over the 3-to-7-year hold period can avoid PE firm and LP disappointment due to poor portco performance.
How MorganFranklin Can Help
If your organization is struggling with identifying and implementing synergies within your PE firm or portco and wants to improve the overall performance, then having a trusted partner with significant PE synergy experience is essential. MorganFranklin’s Private Equity professionals, which includes former COO, CFOs and CROs, work with companies to design and implement synergies that drive value to the portco and PE firm.
