In the high-stakes world of private equity, where the pressure to deliver exceptional returns is relentless, the playbook is evolving. Gone are the days when financial engineering—relying heavily on leveraged buyouts and cost-cutting—was the silver bullet for value creation. Today, the narrative is shifting toward a more sustainable, operationally driven approach, with treasury and finance optimization emerging as pivotal levers in this transformation.  

In this article, we blend fictional examples, use cases and other real-world examples to vividly illustrate key concepts and drive our points home.  

The Disconnect Between Promised and Delivered Operational Value 

Limited Partners (LPs) are becoming more discerning in their investment decisions, increasingly demanding more than just financial returns. They expect General Partners (GPs) to deliver on promises of operational improvements that go beyond mere financial engineering. However, there is often a significant disconnect between the operational value creation promised by GPs and the reality, which frequently relies too heavily on short-term financial tactics. 

A report by McKinsey highlights that while 60% of GPs claim to focus on operational improvements, only 40% of LPs feel that these efforts significantly impact portfolio performance. This gap between intention and execution underscores the need for GPs to align their value creation strategies with LP expectations. LPs are particularly focused on consistent investment strategies, strong management teams, and robust operational processes that drive sustainable growth. They view genuine operational value creation as the cornerstone of a repeatable and sustainable investment strategy, offering reassurance that future fund generations will perform consistently. 

Treasury: The Unsung Hero of Value Creation 

Treasury functions, once seen as mere back-office operations, are increasingly recognized as crucial drivers of value in private equity. These functions—ranging from cash management to financial risk mitigation—are the lifeblood of any portfolio company.  

The evolution of treasury functions, now known as Treasury 4.x, has transformed them into pivotal drivers of value. These modernized treasury roles—encompassing advanced cash management and risk mitigation—now align financial operations with broader strategic goals, leveraging technology and data analytics to optimize performance. 

Yet, many firms struggleto appreciate just how much inefficiencies in these areas can erode value. Poor liquidity management, fragmented cash operations, and outdated financial processes can strangle a company's ability to invest in growth and hamstring its potential to capitalize on market opportunities. 

Consider the example of a mid-sized European manufacturing firm acquired by a private equity investor. Initially, the focus was solely on scaling revenue by entering new markets. However, it soon became apparent that fragmented treasury operations were hemorrhaging resources, particularly due to decentralized cash management systems across multiple jurisdictions.  

By centralizing these operations into a single source of truth, like a treasury management system (TMS), the company was able to cut down on redundant processes, improve visibility and central control on cash, reduce external borrowing cost and cash related operational costs by 20%. This freed up capital that was then reinvested into R&D and expansion efforts, positioning the firm to seize new growth opportunities with agility. 

Cash Flow Forecasting: The Financial Crystal Ball 

In the realm of private equity, where every dollar counts, cash flow forecasting is not just a routine exercise—it’s a strategic imperative. Accurate cash flow forecasting provides a clear window into a company's financial future, offering transparency that is invaluable for both internal decision-makers and external stakeholders, especially Limited Partners (LPs) who demand rigorous insights into their investments. 

Take, for example, a mid-market technology firm backed by private equity, poised to launch a groundbreaking product. Initially, the firm’s cash flow forecasts were rudimentary, lacking the sophistication needed to anticipate the working capital needs for the product launch phase. As a result, the company nearly ran into a liquidity crisis that could have delayed the launch.  

By overhauling its cash flow forecasting processes and incorporating scenario analysis, the company was able to better anticipate cash needs, secure bridge financing, and ensure a successful product rollout, which ultimately boosted investor confidence. 

Navigating Financial Risks in a Volatile World 

In today’s unpredictable economic landscape, managing financial risks such as currency fluctuations and interest rate spikes is more critical than ever. As private equity firms increasingly engage in cross-border acquisitions, the exposure to foreign exchange risk has become a significant concern. Similarly, the current high-interest-rate environment complicates debt management, adding layers of complexity to financial operations. 

Consider a global consumer goods company within a private equity portfolio, operating in regions with volatile currencies like Brazil or South Africa. Without a robust FX hedging strategy, the company was previously exposed to unpredictable swings in cash flows due to exchange rate fluctuations, which affected its ability to meet debt obligations denominated in foreign currencies.  

By implementing a comprehensive FX hedging strategy, including the use of natural hedges, the firm was able to lock in favorable exchange rates, stabilize its cash flows, and protect its margins. This not only ensured financial stability but also allowed the company to reinvest profits into expanding its footprint in emerging markets. 

Treasury in M&A: A Crucial Integration Component 

Treasury management is often the linchpin in the success or failure of mergers and acquisitions (M&A). The ability to seamlessly integrate treasury operations is essential for realizing the synergies promised by a merger. Failure to do so can lead to significant financial inefficiencies, eroding the anticipated value. 

A cautionary tale can be seen in General Electric’s acquisition of Alstom Power, where unforeseen integration challenges led to substantial restructuring costs. The treasury teams faced difficulties in aligning the cash management systems and integrating different financial cultures, which delayed synergies realization and led to missed financial targets.  

Conversely, in another M&A scenario involving the merger of two mid-sized logistics firms, a pre-emptive focus on treasury integration—such as harmonizing cash pooling arrangements and consolidating banking relationships—enabled the new entity to achieve cost synergies ahead of schedule, saving millions in operational expenses and improving free cash flow. 

Streamlined Treasury and Finance: Driving Strategic Value and Returns in Private Equity 

 Streamlined treasury and finance operations are crucial for maximizing value in private equity. These enhancements go beyond cost savings, improving a company's agility and resilience by ensuring financial resources are available precisely when needed. This empowers portfolio companies to seize growth opportunities while driving cost savings and better resource utilization through operational efficiency. Optimizing cash management and liquidity also enables companies to better navigate market volatility, reducing risks such as poor cash flow forecasting. 

Enhanced transparency and real-time data visibility lead to more informed decision-making, aligning with long-term value creation strategies. This not only strengthens investor confidence but also prepares companies for successful exits by making them more attractive to potential buyers. Improved free cash flow directly boosts the money-on-money multiple, enhancing financial outcomes for private equity investors. 

Conclusion 

In today’s private equity landscape, the strategic importance of treasury and finance optimization is undeniable. The era of relying solely on financial engineering is over. A comprehensive approach that includes robust treasury management and operational efficiency is now essential for driving sustainable growth and maximizing value. By addressing treasury inefficiencies, private equity firms can unlock significant value, ensuring portfolio companies have the financial health to thrive. This approach meets the rising expectations of Limited Partners, setting the stage for long-term success and profitable exits. 

If you're interested in delving deeper into the benefits of strategic treasury management for private equity firms, you can contact Job Wolters.

The evolving economic landscape has placed a spotlight on the critical role of treasury in value creation. Our latest roundtable, themed ‘Treasury’s Role in Value Creation,’ delved into the challenges and strategies private equity firms must navigate to enhance financial performance and prepare for successful exits. This event gathered industry leaders to discuss the expectations from treasury functions, the integration of post-merger processes, and the use of innovative technologies to drive growth. Read more as we explore the insights and key takeaways from this engaging and timely discussion, offering a roadmap for treasurers to elevate their impact within portfolio companies.

Roundtable theme: Treasury’s Role in Value Creation 

The roundtable’s theme, ‘Treasury’s Role in Value Creation,’ was chosen to address the pressing economic and operational challenges that resulted in longer holding periods and slowed exits in 2023. In this context, private equity firms are increasingly focusing on growth and optimization strategies to drive long-term financial performance improvements, positioning their portfolio companies for successful exits once deal markets rebound. Key questions explored included: What is expected from the treasury function? How can treasurers navigate priorities and challenges to deliver productivity, financial performance, and value-added analysis to their company and PE sponsor? How can successful treasury post-merger integration be achieved in a buy & build scenario? And how should one prepare for an exit? 

Key Insights and Strategic Directions 

One of the significant discussion points was the value of cash management as a directly measurable lever of value creation. The panel emphasized the importance of focusing on free cash flow, EBITDA, and debt levels, which form the backbone of a successful investment. These metrics are crucial during due diligence, as they are scrutinized by Limited Partners (LPs). The consensus advocated for a focus on organic growth and business transformation over multiple expansions, which can signal stability and long-term value to LPs, and therefore add significant value to PE firms. 

Moreover, it was discussed that, LPs intensely evaluate the financial models of portfolio companies, focusing on recurring revenue, Capex, margins, and debt levels. These factors often determine the soundness of an investment. The robustness of financial operations and the sophistication of the technologies employed are crucial in investment decisions, underscoring the important role of treasury in due diligence. 

Enhancing ‘Buy and Build’ Strategies 

Effective cash management was highlighted as a key factor influencing the success of ‘buy and build’ strategies, which involve acquiring companies and then integrating and growing them to enhance value. Effective cash management ensures the necessary liquidity and financial oversight during the integration and growth phases. An attendee noted that firms often "buy but forget to build." Quantifying the impact of effective treasury management is essential to addressing this gap. 

A way of realizing operational improvements is through increased automation. Despite some pushback from PE firms on automating treasury functions, there are instances where sponsors are willing to invest in technologies to support the treasury function. For instance, an attendee mentioned receiving a sponsor’s support to invest in technology that will improve cash flow forecasting. Additionally, the approach to value creation at the portfolio company level depends on the sponsor's type and level of commitment. 

The use of Artificial Intelligence (AI) in search of value creation was also discussed. Notably, various tangible use cases for AI in Treasury are envisaged. One example highlighted was ASML’s use of AI for forecasting optimization. Even though the large chip-manufacturer is not PE-owned, ASML’s use of AI for forecasting optimization served as a prime example in the discussion. In 2023, ASML implemented an AI-powered material intake forecast model to enhance the effectiveness and efficiency of its purchase FX hedging program¹. This sharpened focus on FX risk management is a visible trend across private market firms. Deploying more sophisticated tools to increase FX hedging effectiveness at the PE fund or portfolio company level is an area worth exploring. 

Looking Ahead 

We reflect on a successful inaugural edition of the Private Equity Roundtable. We learned that effective cash management is crucial for value creation, focusing on free cash flow, EBITDA, and debt levels to ensure liquidity and financial oversight, particularly in ‘buy and build’ strategies. Moreover, automation and technology investments in treasury functions, such as improved cash flow forecasting, are essential for operational improvements and enhancing value creation in portfolio companies. After the event, participants shared that the event added significant value to their roles as treasurers of PE-owned companies. The positive feedback energizes us to organize similar sessions in other countries. 

Is your company about to be or already owned by private equity? We can share our experiences regarding the added complexities of being a treasurer for a PE-owned company. For further information, you can reach out to Pieter Kraak.