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.

Yet, the ongoing dilemma lies in achieving optimal returns on these investments. In this intricate financial landscape, the importance of delivering robust financial performance not only at the private equity (PE) firm level but also at the portfolio company (PC) level cannot be overstated. One often underestimated, yet significantly influential domain in this pursuit, is treasury and risk management.

Amongst the hustle and bustle of strategic mergers & acquisitions and operational enhancements, the treasury function silently shapes financial performance and value creation. Across the PE investment lifecycle, treasury's role in portfolio companies is pivotal. In this article, we explore how treasury's meticulous handling of cash management, working capital management and cash flow forecasting enhances portfolio company financial performance. Welcome to a world where treasury isn't just a function - it's a game-changer.

Treasury's impact on financial performance and value creation

The strategic role of treasury in a PE setting is visible throughout the PE investment lifecycle, i.e. at the acquisition stage, the value creation stage and in the run up towards an exit. In this context, a well-performing treasury function will deliver optimal cash management, working capital management, cash flow modelling and financial risk management solutions amongst other deliverables.

Cash & working capital management

Cash management improves company performance via enhanced cash visibility & liquidity management. Moreover, cash management ensures that the PC unlocks sufficient liquidity to fund growth initiatives. This may include expanding product lines, entering new markets, or acquiring complementary businesses. Without effective cash management, the company may face liquidity constraints that hinder its ability to pursue these opportunities. Moreover, optimizing cash management structures helps a firm manage its financial resources more effectively, reduce costs, and make better use of available cash. Here, a PE firm can assist a portfolio company by leveraging its network and expertise to renegotiate banking agreements and establish more favourable terms for credit facilities. Additionally, they can improve cash management services.

Furthermore, efficient working capital management is crucial for a company's financial stability, profitability, and ability to pursue growth opportunities. By minimizing Days Sales Outstanding (DSO) and optimizing Days Payable Outstanding (DPO), the cash conversion cycle (CCC) is shortened. Moreover, by using factoring, a PC can accelerate cash inflows which in turn provides the opportunity for an even shorter CCC by reducing the time it takes to convert A/R into cash. A shorter CCC is favourable because it signifies that a company can free up cash more quickly for improving operational efficiency in different areas of the business and to meet other financial obligations promptly. Moreover, working capital is optimized with the use of inventory financing solutions which allows a PC to access immediate cash by using its inventory as collateral. Consequently, instead of having capital tied up in unsold inventory the company can free up funds for more strategic purposes and enhanced liquidity.

Cash flow modelling and forecasting

Cash flow forecasting (CFF) is vital in various themes relevant to PE-owned companies. One benefit of having a well-functioning CFF, is that it offers transparency into the financial health of the PC and future cash flow expectations. This transparency is invaluable for both internal decision-making and external stakeholders. Moreover, it ensures that the company maintains sufficient liquidity to cover operational expenses, debt obligations and unforeseen contingencies, contributing to financial stability and uncovering the true cash drivers. In essence, a strong CFF process is the PC's financial compass, guiding it toward better financial decisions.

Risky business?

From a PE firm point of view, financial risks can be divided into event driven- and ongoing financial risks. The latter is a result of operations, and generally accepted to be present. Therefore, PE firms usually don’t go out of their way hedging this risk with complicated financial instruments. The former is a result of engaging in situational activities such as cross-border acquisitions. Usually, steps are taken to mitigate this risk. Two main sources of risks faced by the PE firm and their PC’s are:

Exchange rate risk
When engaging in cross-border acquisitions, exchange rate risk poses a significant risk, with acquisition cost and future cash flows denominated in foreign currencies. Treasurers collaborate closely with the CFO and senior management to craft and implement currency risk hedging strategies. Deal contingent hedging, for instance, locks in an exchange rate upfront, mitigating potential adverse currency movements during acquisitions. This enhances financial predictability and shields against uncertainties arising from unfavourable exchange rate fluctuations.

Interest rate risk
In our current challenging economic climate, treasurers proactively manage the company's exposure to interest rate fluctuations. Utilizing financial instruments such as interest rate swaps, caps, or forward rate agreements, they hedge against rising rates, thereby controlling borrowing costs and reducing interest rate-related financial volatility. Treasurers also collaborate with financial institutions and advisors to structure debt in ways that minimize the impact of rising interest rates. This may include negotiating fixed-rate debt or flexible covenants to bolster financial adaptability in a shifting rate environment. Staying vigilant in treasury operations allows for swift responses to both exchange rate volatility and surging interest rates.

Treasury value ‘unlocked’

Clearly, treasury plays a pivotal role in unlocking value by directly influencing financial performance and strategic outcomes. Through improved cash management, working capital optimization, and precise cash flow forecasting, treasury ensures that the PC maintains the necessary liquidity to fund growth initiatives, enter new markets, and make strategic acquisitions. Moreover, by proactively mitigating financial risks related to currency exchange and interest rates, treasury safeguards the PC's financial stability and enhances predictability. This strategic alignment between treasury functions and the overarching goals of the PE firm results in improved operational efficiency, sustainable growth, and ultimately, the creation of substantial long-term value.

Conclusion

As we conclude our journey through the crucial role of treasury in the private equity realm, one undeniable truth emerges: treasury is the heartbeat of value creation. This article explained how treasury's handling of cash management, working capital management, and cash flow forecasting empowers portfolio companies. These actions drive liquidity, operational efficiency and secure financial stability. In essence, treasury isn't merely a backstage function; it's the driving force behind PE triumphs. In the world of PE, treasury isn't just a key player; it's the catalyst for success.

This article marks the first of a series of articles about treasury in PE-owned companies. Following articles will zoom in more on the critical tasks laid out for treasury in a PE-setting. We will thoroughly discuss topics like post-merger treasury integration, cash flow modelling, digital transformation as a catalyst for growth and aligning treasury strategies with ESG goals.

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