Q&A: Giving credit where credit is due

Valuing portfolio companies is hard enough work as it is, so why recommend GPs go beyond the traditional metrics in attributing created value? 

Viscio: One of the major points of regularly valuing portfolio companies is to update investors on the performance of the portfolio. But why not show them more? If able to drill down deep enough into a company’s financial performance, GPs can better identify where their value-add strategies had actually produced results. A bird’s eye view look doesn’t necessarily do that. 

PJ Viscio

And as we all know LPs are becoming increasingly more sophisticated in their GP selection process. As part of that they want to clearly separate managers who were in the right place at the right time, or one hit wonders, from those with actual value creation capabilities. A robust value attribution exercise can allow that separation to happen. 

So how is it done?

Our approach is to first take the total change in value (typically from the inception of the investment until the present or the date of realisation) and attribute this total change into various factors or components. We then dissect those figures, in quantified amounts, to specific drivers – each of which may or may not have been subject to the GP’s actual control or influence. Maybe for instance a growing economy was responsible for some of the company’s growth, which the GP shouldn’t be able to take credit for. 

To be clear, as of now GPs typically perform attribution analyses by looking at changes in EBITDA, valuation multiple, and leverage. But additional effort can produce much more useful detail: further steps can be taken to deconstruct common high level metrics to include factors like revenue growth, margin changes, changes in cost of capital, change in growth profile, and specific balance sheet and capital structure impacts.  

The next step is to compare how the portfolio company did against industry benchmarks. This provides a much higher level of transparency to better substantiate evidence of operational value-add and/or GP leadership. Additional visibility can be derived by assessing the impact from specific initiatives (like marketing, cost reduction, etc.) as well as taking into account impacts of acquisitions in order to isolate organic changes in value and attribute those to specific drivers.

Theoretically speaking, could this level of analysis be able to identify which particular deal members deserve credit for value-add contributions?  

This was not our original intention, but as we’ve spoken to more GPs and LPs, it’s clear that this potential use is something in which the market has an interest. 

We would imagine some less than stellar GPs not being open to this level of review. What has the market reaction been?

GPs have been generally very receptive, particularly founders, investor relations professionals and chief financial officers.  Fund raising has become more competitive and top GPs are always interested in market trends that will impact their businesses in the future.   

We have heard from a number of GPs that they believe that more transparency to LPs provides a competitive edge. A rigorous detail attribution study enhances transparency into the value creation process. We believe this allows the GP to better tell their story of what they did to create value.