How can you identify the most important performance indicators for a private equity investment?

2 Align with the value creation plan

The second step is to align the performance indicators with the value creation plan that the PE investor has developed for the portfolio company. This plan outlines the strategic objectives, operational improvements, and financial targets that the PE investor expects to achieve during the holding period. The performance indicators should reflect the progress and outcomes of this plan, and help the PE investor and the management team to track, evaluate, and adjust their actions. For example, if the value creation plan involves expanding into new markets, the performance indicators should include metrics such as market share, customer acquisition, and revenue growth in those markets.

3 Choose relevant and reliable metrics

The third step of the process is to choose relevant and reliable metrics that can capture the performance of the portfolio company in a meaningful and consistent way. These metrics should be aligned with industry standards and best practices, as well as based on accurate and timely data to avoid manipulation or distortion. Popular metrics used by PE investors to measure the performance of their portfolio companies include internal rate of return (IRR), multiple of invested capital (MOIC), earnings before interest, taxes, depreciation, and amortization (EBITDA), EBITDA margin, and revenue growth. IRR is an annualized return earned by the PE investor, taking into account the timing and size of cash flows. MOIC is a ratio of total value to initial capital invested, which is useful for measuring absolute return and value creation. EBITDA is a measure of operating income that excludes financing, taxation, and depreciation, while EBITDA margin is a ratio of EBITDA to revenue expressed as a percentage. Lastly, revenue growth measures the percentage change in revenue over a given period. All these metrics are useful for evaluating profitability and efficiency, as well as cash flow generation, operational efficiency, market demand, customer satisfaction, competitive position, pricing power, and long-term value creation.

4 Customize and adapt as needed

The fourth step is to customize and adapt the performance indicators as needed, depending on the specific characteristics and circumstances of the portfolio company and the PE investment. For example, some PE investors may use additional or alternative metrics, such as net income, free cash flow, return on equity, or customer lifetime value, to capture the financial and strategic performance of their portfolio companies. Some PE investors may also adjust or normalize the metrics, such as EBITDA, to account for non-recurring items, synergies, or differences in accounting policies. Furthermore, some PE investors may change or update the performance indicators over time, as the portfolio company evolves or faces new challenges or opportunities.