kurt salmon-the finance function as value-driver-m.mercusot-m.leon
Dsi papers series 1 paper 4 - nov 09
1. Diligence Services International
The Shire, Chalk Road, Ifold, West Sussex, RH14 0UA, UK
DRAFT
FOUNDER DIRECTORS’ PAPERS
SERIES 1 – VALUE AND RISK; THEIR ASSESSMENT AND MANAGEMENT
PAPER 4 – BALANCING VALUE, PACE AND RISK (2):
THE INTERPLAY OF VALUE, PACE AND RISK
This is the last in a series of four brief papers which explores the assessment and
management of operational value and risk in mid-market acquisitions. The paper will
discuss:
A value maximising framework and;
Based on another DSI model which represents our practical approach to
balancing value, pace and risk - consider in turn the interplay of:
o Value with pace,
o Value with risk, and
o Pace with risk.
You are cordially invited to contribute your comments on the subject matter of our
papers or thoughts and suggestions for future papers on operational aspects of
mid-market M&A.
In Paper 3 of this series we discussed the sources of value and risk, example
improvement areas, and implementation issues. We concluded that understanding how
the sources of value and risk are accessed in a timely fashion, in the context of the
investment objectives, is often harder than identifying them. This Paper 4 seeks to
illuminate these accessibility and timeliness aspects of managing operational value and
risk in mid-market acquisitions.
Value maximising framework
The following ‘Value maximising framework’ is intended to summarise the key drivers of
and constraints to the release of business value to give context to the balancing of value,
pace and risk. By way of explanation of the model: the free cash flow of a business,
which of course needs to exceed its cost of capital before shareholder value-added
becomes positive, can be seen as held in balance by opposing influences. These are
constraints, which tend to limit business performance, and operational value drivers,
which tend to improve it; the principal ones are indicated in the framework.
It is our long and repeated experience that viewing and addressing both constraints and
drivers should be done on a balanced, pan-functional basis or improvement progress will
be distinctly sub-optimal. This is increasingly the case as successful exits more often
involve the need to make substantial positive impact upon the functioning of operations,
rapidly, in order to increase the value of the acquired asset. This has led us to evolve an
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4. about the latter than the former. Nevertheless, we are often asked for our view on the
ability of the management team from the operations perspective, and frequently there
are gaps in the capability of the team that have already been identified and need to be
filled through the time consuming and inherently risky business of recruitment. Not being
realistic about what the management team can achieve within the time before exit is a
common source of disappointment, which can be reduced by assessment and planning.
As to the broader organisational capability and capacity, this is sometimes assumed to
be adequate on the basis that senior management is there partly to ensure that it is.
However, putting these in place is usually another task, additive to and competing with
the various improvement initiatives being heaped on their plate during an already very
demanding period. There are of course multiple facets to the broader organisational
competence - falling into the general and interacting categories of people, processes
and systems - some of which are much less apparent than others and well worth
understanding early-on.
Once an understanding of the value potential opportunities and management and
organisational resources is available, it becomes feasible to design an appropriate
improvement programme structure. In practice this is a reiterative process and benefits
from input and feedback from various involved parties. Assessing the expected timing of
financial and organisational impacts resulting from key improvement initiatives is an
important aspect of the reiteration process leading to a viable programme of operational
performance improvement. Using this approach, collapsing the overall elapsed time
required by optimising parallel activity without creating overload can also be achieved.
Value – risk
The key risks of proposed value-releasing improvements will often have presented
themselves, in part at least, during the review process thus far. However a more
comprehensive assessment of risks and plans for their mitigation and management will
be required. Also the levels of tolerance and sensitivity, in terms of both risks and
financial outcomes, implied by the proposed initiatives should be well understood up-
front.
In planning operational improvement and controlling the value-risk aspects, the
programme length, costs, benefits, other financial impacts, risks, sensitivity and
tolerances are all clearly inter-related. Primarily for this reason we have devised a high-
level financial impact tool which can be used to scenario-model the financial outcomes of
proposed operational changes, typically over a 3-year timeframe, and bridge the
operational and financial perspectives. Although the modelling is carried out at a high
level, the tool is supported by shorter-term plans and cost/benefit, risk and sensitivity
analyses that involve a method of working through proposed changes in significant detail
where appropriate and beneficial.
In financial terms, the tool models at a high-level the delta financial impact of key
operational changes on the base metrics of a given year, as an adjunct to diligence and
restructuring planning. It is based on a limited set of key opening financial metrics as
available and considers the impact of proposed operational changes upon them. It does
not forecast the resultant metrics as at the end of each year in the planning timeframe
but the model output can be converted to populate the ‘operational lines’ in a corporate
finance or similar model. The tool simplifies, makes clearer to the mind, promotes
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