Driving Private Equity Value Creation Through Credit Solutions

Driving Private Equity Value Creation Through Credit Solutions
Trade

05 of 11

This insight is part 05 of 11 in this Collection.

October 19, 2023 24 mins

Driving Private Equity Value Creation Through Credit Solutions

Driving Private Equity Value Creation Through Credit Solutions

The strategic use of credit solutions (credit insurance, political risk insurance and surety) can enhance liquidity, improve transaction returns, facilitate capital-efficient deal closures, and support long-term value creation.

Key Takeaways
  1. Credit solutions can drive value creation objectives for private equity and support working capital optimization.
  2. Different stakeholders at portfolio companies including Corporate Treasury, Sales and Business Development and Procurement can benefit from leveraging credit solutions.
  3. Credit solutions can meet a range of strategic objectives across the private equity investment lifecycle from due diligence and pre-close, during the first 100 days and ownership stage, and at exit.

The current macroeconomic challenges has led many to forecast a prolonged slowdown in private equity deal volumes and question whether the return levels of previous years can be sustained. Despite these challenges, it is an opportune time for private equity firms to deepen their focus on value creation through operational improvement and reduce emphasis on financial engineering to generate value.

A key pillar of an operational improvement strategy is working capital optimization which can create liquidity and release short-term cash, as well as enable access to off-balance sheet financing and support de-levering.

The benefits of a sound working capital strategy are well documented. One of the most regularly cited studies on working capital and firm performance concludes that ‘firms that converge to an optimal level of working capital improve their stock performance and operating performance’1.

A lesser emphasized finding of the study is that freed up working capital was most often redeployed to fund investment in revenue growth.

In other words, besides the liquidity and financing benefits, working capital optimization initiatives often have second-order effects such as boosting sales growth, which can support the private equity firm’s value creation objectives.

In fact, the strategic use of credit insurance solutions should be incorporated into the value creation playbook not only to capture upfront liquidity advantages, but also for additional benefits that can actively support value generation such as market expansion, procurement efficiency, and debt reduction.

Whilst credit solutions can meet a range of strategic objectives across the investment life cycle (see schematic at the end of the article), the post-acquisition role of credit solutions to drive private equity value creation through working capital initiatives is the focus of this article.

The strategic use of credit solutions (credit insurance, political risk insurance and surety) can enhance liquidity, improve transaction returns, facilitate capital-efficient deal closures, and support long-term value creation.

  • Corporate Treasury
    • Raise Off Balance Sheet Financing
    • Leverage the Trade Finance Market
    • Create New Source of Funding
    • Preserve Existing Sources of Funding
  • Sales Management and Strategy

    • Valuable Sales Tool to Drive Growth
    • Support Market Expansion
    • Access to Credit Risk Data and Analytics

  • Procurement and Supply Chain

    • Build Supply Chain Resilience
    • Leverage the Credit Value Chain

Corporate Treasury

1. Raise Off Balance Sheet Financing

During the first 100 days, a common workstream for the treasury function is to review, consolidate and optimize existing sources of working capital bank lines. It can also be an opportunity to explore off-balance sheet financing structures (subject to local accounting treatment) that can improve debt metrics, create financial flexibility and prevent potential covenant breaches, while still maintaining access to the same level of financing lines.

The use of portfolio trade credit insurance to enable off-balance financing is a commonly used strategy by sophisticated corporates and one that can be replicated by portfolio companies of all sizes. For relevant industries, operating leases can be considered as they qualify for off-balance sheet treatment in certain jurisdictions, and credit solutions can play a key role in credit-enhancing such leasing structures.

2. Leverage the Trade Finance Market

Portfolio companies can turbocharge growth through trade financing solutions that are designed to support sales and revenue momentum. By looking beyond vanilla receivables financing, companies can evaluate the relevance of distributor finance or warehouse/ inventory finance and understand whether it can support their business models and deliver growth. Some of these solutions can also enhance the inventory component of the cash conversion cycle which is often overlooked.

Credit insurers have deep experience with a variety of trade financing structures and can partner with lenders resulting in cost competitive and bespoke trade financing solutions.

3. Create New Source of Funding

During the initial post-close period when there may be greater liquidity pressures, portfolio companies with medium-tenor receivables (two to five years) can benefit from a large upfront injection of liquidity by financing those receivables and deploying the cash to fund other value creation projects. Structured credit insurance can play an important role here as it often increases lender risk appetite for medium tenor receivables financings and potentially lowers overall costs.

An incremental benefit is that it also sets up a self-funding mechanism to support other value creation initiatives.

4. Preserve Existing Sources of Funding

In some sectors, the use of bank guarantees is required in the normal course of business, and this can take up a significant portion of financing capacity and collateral.

Surety solutions are a meaningful alternative provider of guarantees with the differentiating benefit that they do not require collateral and are competitively priced. In addition, they do not take up bank financing lines, and preserve a valuable source of funding.

Sales Management and Strategy

1. Valuable Sales Tool to Drive Growth

In a competitive B2B market, sales teams with the option to offer deferred payment terms can gain a critical edge in winning new business and securing existing client relationships. With a funded credit solutions program, portfolio companies can avoid the adverse cash flow impact of deferring their receivables and accelerate their cash conversion cycle by monetizing those receivables.

More importantly, it equips the front-line sales force with a valuable tool to help meet aggressive revenue targets without sacrificing working capital.

2. Support Market Expansion

Entry into new geographies or new customer segments is often a strategic priority for portfolio companies in the value creation journey. The tactical use of credit risk insurance can de-risk market entry by giving confidence to transact with new customers that may be further down the credit spectrum, or ones that are based in new countries.

Conversely, concentration risk on large existing customers can be managed by insuring their receivables to safeguard revenue quality.

3. Access to Credit Risk Data and Analytics

Partnering with credit insurers can allow firms to leverage a deep global pool of credit risk data and analytics. Credit quality ratings on customers can provide valuable insights and be a useful tool in business planning processes.

In fact, credit insurance coverage coupled with advice from insurers can be a critical resource of data for credit control teams and provide decision-making support in managing the receivables book and payment terms. For smaller portfolio companies, it may even allow for a leaner credit control function and deliver longer-term costs savings.

Procurement and Supply Chain

1. Build Supply Chain Resilience

As many firms continue to reconfigure supply chains, the use of supply chain finance and similar payables financing solutions is an opportunity to develop resilience in the supply chain by providing suppliers a valuable source of liquidity. Credit solutions can enable supply chain finance and potentially lower the financing charges that lenders require to offer these programs.

The implementation of these structures often provides an opening for the Procurement function to extend or harmonize payment terms which delivers a working capital boost. It can also lead in a broader review or negotiation of supplier contracts which can create procurement efficiencies for the portfolio company.

2. Leverage the Credit Value Chain

Portfolio companies without a sufficiently high credit rating to anchor their own supplier financing programs can explore opportunities within their credit value chain.

Firms can partner with their credit solutions advisor to directly engage the insurance market and build new credit insurance capacity on their own credit risk. New insurance capacity created through a ‘reverse credit’ exercise can be introduced to key suppliers and potentially enhance future commercial negotiations. This is especially powerful for companies that have recently entered private ownership (i.e. through a private equity purchase) or those that can credibly demonstrate a turnaround story and highlight financial and operational improvements recently achieved.

Companies should also investigate upstream opportunities on the credit value chain such as whether their larger customers have existing payables finance programs and attempt to get onboarded.

Across the various functions of the portfolio company, whether it is corporate treasury, sales, or procurement, credit solutions can be a meaningful tool to optimize working capital and support broader initiatives to deliver sustainable revenue growth and create new operational efficiencies.

With the increased use of credit insurance capital by private equity firms, the use of credit solutions is increasingly an integral part of value creation plans and a critical working capital optimization tool for portfolio companies.

Driving value across the private equity investment lifecycle

Credit solutions can meet a range of strategic objectives across private equity investment lifecycle.

driving-PE-img

1 Aktas, Nihat and Croci, Ettore and Petmezas, Dimitris, “Is Working Capital Management Value-Enhancing? Evidence from Firm Performance and Investments.” Journal of Corporate Finance, 2015.

General Disclaimer

Aon is not a law firm or accounting firm and does not provide legal, financial or tax advice. Any commentary provided is based solely on Aon’s experience as insurance practitioners. We recommend that you consult with your own legal, financial and/or insurance advisors on any commentary provided herein. All descriptions, summaries or highlights of coverage described herein are for general informational purposes only and do not amend, alter of modify the actual terms and conditions of any relevant policy. Coverage is governed only by the terms and conditions of such policy. Insurance coverage in any particular case will depend upon the type of policy in effect, the terms, conditions and exclusions in any such policy, and the facts of each unique situation. No representation is made that any specific insurance coverage would apply in the circumstances outlined herein. Please refer to the individual policy forms for specific coverage details. The information contained in this document and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the article or any part of it and can accept no liability for any loss incurred in any way whatsoever by any person who may rely on it.

Terms of Use

The contents herein may not be reproduced, reused, reprinted or redistributed without the expressed written consent of Aon, unless otherwise authorized by Aon. To use information contained herein, please write to our team.

Aon's Better Being Podcast

Our Better Being podcast series, hosted by Aon Chief Wellbeing Officer Rachel Fellowes, explores wellbeing strategies and resilience. This season we cover human sustainability, kindness in the workplace, how to measure wellbeing, managing grief and more.

Cyber Labs

Stay in the loop on today's most pressing cyber security matters.

Cyber Resilience

Our Cyber Resilience collection gives you access to Aon’s latest insights on the evolving landscape of cyber threats and risk mitigation measures. Reach out to our experts to discuss how to make the right decisions to strengthen your organization’s cyber resilience.

Employee Wellbeing

Our Employee Wellbeing collection gives you access to the latest insights from Aon's human capital team. You can also reach out to the team at any time for assistance with your employee wellbeing needs.

Environmental, Social and Governance Insights

Explore Aon's latest environmental social and governance (ESG) insights.

Q4 2023 Global Insurance Market Insights

Our Global Insurance Market Insights highlight insurance market trends across pricing, capacity, underwriting, limits, deductibles and coverages.

Regional Results

How do the top risks on business leaders’ minds differ by region and how can these risks be mitigated? Explore the regional results to learn more.

Human Capital Analytics

Our Human Capital Analytics collection gives you access to the latest insights from Aon's human capital team. Contact us to learn how Aon’s analytics capabilities helps organizations make better workforce decisions.

Insights for HR

Explore our hand-picked insights for human resources professionals.

Workforce

Our Workforce Collection provides access to the latest insights from Aon’s Human Capital team on topics ranging from health and benefits, retirement and talent practices. You can reach out to our team at any time to learn how we can help address emerging workforce challenges.

Mergers and Acquisitions

Our Mergers and Acquisitions (M&A) collection gives you access to the latest insights from Aon's thought leaders to help dealmakers make better decisions. Explore our latest insights and reach out to the team at any time for assistance with transaction challenges and opportunities.

Navigating Volatility

How do businesses navigate their way through new forms of volatility and make decisions that protect and grow their organizations?

Parametric Insurance

Our Parametric Insurance Collection provides ways your organization can benefit from this simple, straightforward and fast-paying risk transfer solution. Reach out to learn how we can help you make better decisions to manage your catastrophe exposures and near-term volatility.

Property Risk Management

Our Property Risk Management collection gives you access to the latest insights from Aon's thought leaders to help organizations make better decisions. Explore our latest insights to learn how your organization can benefit from property risk management.

Technology

Our Technology Collection provides access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities of technology. Reach out to the team to learn how we can help you use technology to make better decisions for the future.

Top 10 Global Risks

Trade, technology, weather and workforce stability are the central forces in today’s risk landscape.

Trade

Our Trade Collection gives you access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities for international business. Reach out to our team to understand how to make better decisions around macro trends and why they matter to businesses.

Weather

With a changing climate, organizations in all sectors will need to protect their people and physical assets, reduce their carbon footprint, and invest in new solutions to thrive. Our Weather Collection provides you with critical insights to be prepared.

Workforce Resilience

Our Workforce Resilience collection gives you access to the latest insights from Aon's Human Capital team. You can reach out to the team at any time for questions about how we can assess gaps and help build a more resilience workforce.

More Like This

View All
View All
Subscribe CTA Banner