Private Equity Firms – How Are You Going to Close the Gap on Returns?

Private equity firms are finding themselves in a tight spot in 2017 as LP’s return expectations intersect with market realities. LPs expect returns in the 20+% range, which can be generated through revenue growth, margin improvement or multiple expansion. Using the S&P 500 as a proxy for revenue performance suggests the majority of the return will have to come from other avenues. In 2016, revenue growth for the S&P was 5.88%. As for 2017, Y/Y revenue quarterly growth for Q1 barely registered at 0.34%.

So, how do you solve for this disparity? How do you close a 15+% gap in returns in today’s market when revenue growth is moderate at best?

Historically, private equity firms have turned to operational improvements or financial engineering (or both). The challenge today is the low-hanging fruit of operational improvements is gone. There’s a shortage of management talent capable of generating the operating results needed to achieve positive ROI, and traditional financial engineering tactics are commonplace. While these tactics were once a differentiator, they’re now normal operating procedure. Furthermore, leverage multiples are high and interest rates are set to rise.

One strategy for private equity firms to generate higher returns is to leverage the supply chains of their portfolio companies. Initiated within the portfolio company, a supply chain finance program provides an off-balance sheet way to tap into working capital without adding debt to the balance sheet. The cash freed up from supply chain finance can be used to deliver, invest in growth initiatives or pay a dividend. It’s also a valuable financing tool for M&A transactions.

“How do I know if our portfolio companies are a good candidate for supply chain finance?”

It’s a common question as more private equity firms explore these strategies as viable alternatives for improving access to capital. Here are some questions to consider:

• Are you leverage constrained and need off-balance sheet funding? Supply chain finance is an ideal way to increase liquidity without adding debt to the balance sheet.
• Do your portfolio companies have a diversified supply base? Supply chain finance is ideally suited for companies with numerous suppliers.
• Wait – isn’t supply chain finance only available to large cap companies? No, advances in fintech platforms and alternative funding sources have expanded the reach of supply chain finance to include both large cap and mid cap companies.

To close the gap on returns, today’s private equity firms need to turn an innovative eye to working capital optimization within their portfolio companies. Leveraging the supply chain for higher returns can be a game-changer while providing a much-needed competitive edge – especially in a turbulent global market.