Investment firms can support companies with their expertise to grow or by taking over their non-core activities. Today, value creation is much more the focus than mere revenue growth.
EY asks CEOs in Europe every quarter about their top priorities for the next twelve months. This shows a growing enthusiasm for mergers and acquisitions. About 40 percent of business leaders are considering a merger or acquisition. The main considerations are acquiring innovative start-ups, technology, new production capabilities, and expanding into new markets or gaining employees with specific expertise.
Value creation
At the same time, there is an increase in CEOs’ intentions to possibly divest parts of their companies. M&A is not necessarily a growth story of unlimited acquisitions to become bigger. It can also be a story of value creation, which is much more than just revenue growth. A company can accelerate its growth through an acquisition or by focusing on its core activities and divesting non-core activities. The latter also frees up capital for new investments in the rest of the portfolio.
Private equity can play a significant role in this, as can we. As part of financial due diligence, our EY team analyzes historical figures to provide comfort regarding the underlying valuation and cash flow components, which are also consistent with historical reality. This should reassure investors that the assumptions in their valuation model make sense.
Preparation is essential
The importance of due diligence and understanding the fiscal, financial, legal, and commercial aspects in a transaction context has increased significantly in recent years. This is also due to market conditions. Private equity market activity peaked in 2021, followed by a significant decline. In the fight against high inflation, central banks raised historically low interest rates significantly, coupled with geopolitical uncertainty. Bad news for private equity investors who partially finance their acquisitions with borrowed money.
As transactions have become more expensive, impacting investor return expectations, investment firms have become more cautious and are doing their homework in even greater detail than before. As an investor, you need to be comfortable that there is still significant value creation to be realized after the acquisition and that the underlying valuation model is sufficiently robust.
Private equity used to have a negative connotation, but that time is long gone. Now sustainable value creation is at the top of the agenda for private equity fund investment committees. It’s not just about providing additional capital and funds, but rather a collaborative story with entrepreneurs—and that’s a positive development.
