How Private Equity Firms Can Manage Uncertainty With Scenario Modeling
It’s an unusual time in private equity. Many of their portfolio companies face reduced consumption, lower productivity, and supply chain disruption. Many businesses are unprepared. Swift changes are forcing management to rethink operating models.
In contrast, an opportunity exists. Assets with strong fundamentals and low valuations create openings to new markets. Distressed debt urgently needs financing; and digital and automation investments can strengthen resilience and agility. Making the right bold moves could mean leading the recovery.
Pinpoint opportunities
In the face of unprecedented uncertainty, the question is how to quickly evaluate risk, opportunities and competitively allocate capital.
- To understand the marginal impact of changes you need an analytical framework that measures shifts from baseline scenarios. It combines existing trends and unforeseen changes. This requires modeling, not casual empiricism.
- With faster change, predicting the future is more difficult. Scenario modeling can pinpoint potential opportunities so management can start planning today and understand drivers for change – both in their own and parallel markets.
- The right data and digital tools are needed to effectively model scenarios, not just at the overall portfolio level, but to look deeply inside individual portfolio companies – down to specific business units, product and customer categories.
Portfolio companies
During this uncertain time, portfolio companies must focus on operational efficiency to defend revenues and protect working capital. Once the low point has passed, transformation strategies – which were already on the agenda – may be accelerated.
While business strategy is set by the CEO and board, the top-down approach can be out of step with the bottom-up view. For example, last year’s competitors may no longer be the primary threat to future growth. Instead, structural changes, new rising cross-sector challengers, and new consumer behavior may play a bigger role. Modern planning solutions and modeling technology such as Jedox can harmonize these views into cohesive scenarios.
Funds
At the fund level, great uncertainty demands continual strategic and portfolio reviews to manage liquidity, identify assets at risk, and understand growth challenges. Yet many firms still depend on disconnected spreadsheets for complex fund waterfall distribution calculations.
Do you know your portfolio’s weakest link? Portfolio managers and General Partners must adapt quicker to decide whether to divest distressed assets or reallocate capital to acquire rising stars at an earlier stage; or to facilitate M&A with an individual portfolio company for ‘transformation through transaction’.
A modern and flexible EPM solution can provide help in the consolidation of portfolios across multiple investment horizons projecting drivers & assumptions including inflation, rental revenue assumptions financing assumptions and outflows across life of investment.
Investors
Investors thrive on feedback. In the face of uncertainty, investor relations are paramount. Frequent structured communication on performance benchmarks and earning multiples, maintains investor confidence and stability.
For many private equity firms, even when reporting is published through a portal, data preparation can still be onerous and manual. However, when the operational models are streamlined, standardized, and automated, investor reporting becomes another perspective of the same underlying models and scenarios, i.e. one version of the truth. Scenario modeling provides the opportunity for private equity firms to better manage uncertainty, particularly during times of crisis.
This is the last post in our series on the importance of agility in managing uncertainty. Read our previous posts How an EPM Solution Supports Managing Economic Uncertainty and The Importance of Agility in FP&A To Manage Uncertainty.
