Working Capital: A Vital Value Lever for Private Equity Firms

The private equity industry has matured, but it now faces new challenges in a world that is rapidly changing, and firms need to explore new levers of value.

Working capital optimization is relevant for private equity firms, as it is a key enabler for value creation, releasing cash, expanding through investment, or conducting acquisitions without incurring further indebtedness. It is generally one of the first tasks private equity firms should perform in order to release cash, amortize debt, and improve financial ratios from their portfolio companies.

To maintain company growth, treasury departments are under pressure to provide efficient solutions to achieve working capital objectives. Assessing potential levels of cash available in portfolio companies becomes crucial for private equity firms.

Often, management believes that working capital is only a financial issue, when, in reality, it is also an operational issue driven by multiple interconnected processes. This is why technology should not be separated from financing when talking about working capital (e-invoicing, supply chain finance platforms, etc.). 

By implementing a cohesive working capital strategy within the portfolio companies, benefits of balance sheet improvement can be obtained. 

There are several ways to optimize a company’s working capital position:

Account Receivables 

The sale of a portfolio of receivables without recourse and monetizing illiquid assets, while accelerating the cash conversion cycle and improving days sales outstanding (DSO) in one step to improve working capital posture. Receivables finance and trade-receivables securitizations are financial products that support such objectives. Generally, these solutions do not consume the company’s banking lines and are especially useful for non-investment grade companies that will be able to raise funds at a rate lower than its existing cost of capital. 

Accelerating the billing cycle, optimizing or outsourcing of the collection process, and dispute management are other strategies to consider. 

Accounts Payables 

Matching days payables outstanding (DPO) to industry-acceptable vendor payment terms, supplier terms by category, accounts payable centralizing and tech-based supply chain financing programs that link the parties in a transaction, lower costs, and improve efficiency are paramount. 

A corporate can achieve extension of payment terms with its suppliers by: 

1. Using the company’s power of negotiation; imposing longer payment terms. The issue with this solution is that this strains the commercial relationship with the suppliers and risks losing partnerships.
2. Establishing a supply chain finance program in which the company extends the payment terms with their suppliers and offers the possibility of early payment at a competitive price (where the funder will be bearing buyer’s payment risk). This solution is important for small-to-medium business suppliers who have difficulty accessing traditional forms of finance. At the same time, the company’s supplier relationship will strengthen. 

Supply chain finance programs may also enable companies to improve their profit and loss through rebates and dynamic discount structures. Such programs can also work as a payment-risk-mitigation tool for suppliers, as the funder will bear such risk once the early payment has been requested.

Supporting CSR Initiatives

Private equity firms also need to embrace the concern for environmental and social governance and diversity, equity, and inclusion issues. 

As younger generations enter the workforce, we will see a push towards corporate social responsibility. Companies are recognizing the need to remove unjust barriers to participation in the global economy. There is a greater focus on the idea that businesses must do better with respect to improving the diversity of their workforces and making all voices heard. 

Many wonder why working capital management is so important when the market has plenty of liquidity at attractive prices. Companies with the right working capital structure are better prepared for an economic downturn where liquidity is scarce and expensive. Finding ways to support supplier resilience is essential to maintain a healthy supply chain ecosystem and increase the capacity of all companies involved. All of which ultimately leads to better ROI and expansion and growth.