Created Value Attribution:

Assessing How Value is Created

in Private Equity Investments
B Y P. J . V I SC I O A N D G EO RG E PU S H N E R , PH D.
 Created Value Attribution

In response to the increasing need for investors to ascertain how value is created in private equity
investments and ultimately identify General Partners (“GPs”) that create sustainable value-add and
“build better businesses,” Duff & Phelps has developed a conceptual and analytical framework to
measure and attribute created value to its sources. While the framework was created for the analysis
of private equity investments, it is suitable for analyzing value creation for many asset classes and
strategies including activist investing and public companies. The Duff & Phelps Created Value
Attribution (“CVA”) Framework builds on industry convention by drilling down to fundamental
market, industry, and company specific value change factors, including organic and acquired, and
then quantitatively maps created value to four fundamental sources: Industry/Sector, Capital Markets
(“Beta”), Deleveraging, and Unique (“Alpha”).

Introduction The key to our Framework is to isolate unique company specific

returns by quantitatively attributing value creation to numerous
How a General Partner creates value has become increasingly measurable factors.We present the full technical detail of the
important as Limited Partners have grown more sophisticated and Framework here in order to demonstrate why the company
demanding. To provide real insight into how value is created, the specific factors that are isolated are meaningful indications of
attribution of value needs to go beyond the industry convention unique value creation that suggest the ability to create alpha on
of analyzing changes in EBITDA (earnings before interest, taxes, the part of GPs. In our presentation of the technical details, we
depreciation and amortization), multiples, and net debt. utilize an illustrative example based on an actual case study.

Investments with strong returns are sometimes just the result of

timing and market movements, and sometimes weak investment
Background
returns hide value creationor preservation in a difficult
Private Equity net returns have been and will continue to remain
environment. In order to distinguish those portfolio companies
the single most important criteria in evaluating fund performance,
(and their GPs) that have truly excelled, it is necessary to
whether for manager selection, for subsequent fund investments,
isolate or separate value creation that comes from industry, capital
or for ongoing monitoring with respect to existing commitments.
market, and deleveraging factors from unique company specific
However, the attribution of these returns, i.e., how the returns are
efforts and accomplishments. By isolating unique value creation
created, is becoming more and more important to investors.
across multiple portfolio investments, the Duff & Phelps Created
Value Attribution (“CVA”) Framework (the “Framework”) can There are several reasons for the new focus on created value
reveal patterns of value creation that ultimately help in identifying attribution. One is value for fees. If returns are created through
GPs that can repeatedly build better businesses and create value selection, execution and leverage, one may argue that such
through operational and/or strategic value-add. returns are replicable, to a large extent, through synthetic
portfolios utilizing underlying liquid securities, which can be
Our experience has identified three critical analytical steps
done at costs significantly less than fees typically paid to
for analyzing value creation:
private equity managers.
1. Deconstruction of the apparent value change drivers (i.e.,
The new focus on value creation also reflects the evolution of
changes in EBITDA, multiple, and net debt) into their primary
the private equity industry. In the early days of private equity,
components: changes in revenue, margin, cost of capital,
excess returns were often, if not almost entirely, achieved
growth profile, as well as a number of capital structure and through market inefficiencies. Over the last several decades,
balance sheet items; as the number of private equity investors has increased and
2. Integration of portfolio company performance benchmarking their corresponding levels of expertise and sophistication have
analysis to separate the impacts of industry and company- matured, opportunities for hefty returns based on capitalizing
specific value change drivers; and on market inefficiencies have all but disappeared. While deal
sourcing and access to debt financing will continue to be
3. Analysis of value change driver impacts stemming from
essential, it is unlikely proprietary deals and financial engineering
add-on acquisitions. will be the major drivers of excess returns in the future.

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 Created Value Attribution

Excess returns are now expected to be driven primarily through

strategic and operational expertise and the leadership provided
Industry convention
by the GP. Whether through the operating partner, senior advisor, For many investee companies with sustainable operations,
or other operations-focused models, a large and increasing the private equity industry has historically assessed pricing
number of private equity firms are bringing operational expertise and valuation in terms of a multiple of EBITDA. Based on
to influence their portfolio companies. In addition to operational an informal survey, it appears that the industry’s approach to
value-add, private equity firms may also increase the value of a attributing created value has employed a similar approach.
portfolio company through strategic value-add, often taking the The industry convention in attributing value creation (or, perhaps,
form of add-on acquisitions and integration of the acquired destruction), is to attribute changes in value to the change in
businesses with the platform portfolio company. EBITDA, change in the EBITDA multiple, and change in net debt.

Additionally, investment returns and impacts have taken on

new meaning as environmental, social and governance (“ESG”)
aspects of investing have become increasingly important to
investors. The basic thrust of ESG as it relates to value creation
is that LPs are looking to general partners (GPs) to “build better
businesses,” including sustainable and environmentally friendly
operational improvements and initiatives.
ESG considerations address both the notions of sustainability as
well as contributing to the development of the global economy.
European investors have been at the forefront of the ESG
movement. While few if any U.S.-based investors have any
explicit ESG directives, a growing number of U.S.-based
institutional investors (e.g., pension funds, endowments, and
foundations) are including ESG factors in their investment
allocation calculus.

Figure 1: Private Equity Industry Convention for Attributing Created Value

EBITDA Multiple Net Debt

Created Value = + +
Impact Impact Impact

This approach quantifies the impact of the change in each number of GPs and limited partners (LPs) we believe that the
of these variables while holding each of the other two factors significant majority of firms in the industry utilize this
constant. While we have identified a few firms that perform convention.
more sophisticated analyses, based on our discussion with a

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 Created Value Attribution

Figure 2: Illustrative Example of Conventional Attribution Analysis

Investment Date: June 30, 2007 Total Change in Investment Value Initial
Valuation Date: June 30, 2011 $185
2,500

2000 $679
$(768)

$262 $1869
$1,684
($ in millions)

1,500

1,000

500

Initial Investment Value EBITDA Impacts Multiple Impact Net Debt Impact Investment Value as of
(USD) the Analysis Date
(USD)

In order to focus in on the changes in value and not to have the changes obscured by the starting and
ending values, the changes in value can also be presented using a tornado diagram, as shown below.

Figure 3: Same Example of Conventional Attribution Analysis Using

a Tornado Diagram
Change in Investment Value
ValueTEV at June 30, 2007: $4,000

$0

EBITDA Impacts $679

Multiple Impact ($756)

Total Change in
($77)
Total Enterprise
Value
TEV at June 30, 2011: $3,923

Net Debt Impact

$262

Total Change in $185

Investment Value

Investment Value at Acquisition: $1,684

Investment Value at Valuation Date: $1,869

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 Created Value Attribution

Analyzing these factors can be useful in assessing what is An increase in the multiple can reflect higher market and/or
apparently1 driving changes in value from one time period to company expectations, or reduced trailing performance.2
another. In fact this conventional analysis should be an essential Similarly, a lower multiple can reflect good or bad news,
tool in assessing how and why a fair value estimate has changed for instance, as market expectations decline or as trailing
from the prior period and thus serves as a reasonableness check performance improves. In addition to macro factors beyond
for fair value estimates for unrealized investments. While such the control or influence of the GP or the portfolio company
analysis of the above three drivers of value change is useful in management team, a decline in the multiple could result from
identifying, from a mathematical perspective, components of declining growth prospects or from a successful execution of
value change, these value drivers alone do not provide much a growth strategy implemented at acquisition, in addition to
insight as to how value is being created. other potential causes. Without detail and context, changes
in the multiple provide very little, if any, insight into how value
In the example above, the change in EBITDA provides a positive is created and whether the factors are industry or sector driven,
contribution to value change, while significant negative impact company specific, related to changing capital market
from the change in multiple more than offset it, resulting in a slight rates of return, or some combination thereof.
decline in enterprise value. Further, the decline in net debt
provides a positive contribution to value change, resulting in Similarly, changes in net debt can reflect positive and negative
an overall increase in the reported fair value. But each of these cash flows from operations, but historical cash flows can also be
factors may or may not actually reflect value creation, as obscured by financial engineering or the financing of acquisitions.
explained below.
We concluded that the current industry convention of looking
Increases in EBITDA, for example, would suggest a positive result, simply at changes in EBITDA, the multiple and net debt to assess
as this increase is typically viewed as representing an improvement and attribute value creation is inadequate to effectively identify
in the operations of a business. However, if EBITDA increases evidence of operational or strategic value-add that results from
solely as a result of an acquisition, the increase in value was not GP competencies and leadership.
created, but rather purchased. In fact there could be, at least in
theory, situations where increases in EBITDA are a detriment to
value as a result of the buyer paying too much (e.g., for overstated The Duff & Phelps created value
expectations and synergies). Changes in EBITDA may point to
where and how value change takes place, but do not necessarily
attribution framework
Responding to the need to better assess how value is
directly provide any insight into how value was created.
created, Duff & Phelps has developed a more robust
With respect to multiple expansion, increases in value that attribution framework, based on discussions with clients
are manifest through an increase in the multiple are typically and others in the GP and LP communities as well as our own
viewed as value creation driven by market, industry or other experience and core competencies in the valuation of private
macro factors and thus may be viewed with at least some level equity portfolio companies. While we concluded that the
of skepticism by investors with respect to assertions of GP conventional approachto value attribution was inadequate,
value-add. Ascertaining any insight into the value creation we also determined that it was a logical and practical starting
process based on movement of the valuation multiple is point, given the familiarity that GPs and LPs have with it and
difficult as multiples increase and decrease for reasons that as well its alignment with the multiple-based approach to
may be positive, negative, or neither. Additionally, changes in valuation that has been a staple of the private equity industry.
multiples may be related or unrelated to the subject company.
The Duff & Phelps Framework builds on the conventional approach
Multiple expansion in the context of a broad bull market, for
and is comprised of three essential components:
example, is often not seen as justifying the 2% and 20% fee
structure and illiquidity associated with private equity 1. Primary deconstruction (of the components of the
investment. Multiples can change due to movement in the conventional analysis);
numerator (level of risk and/or expected growth) and/or the 2. Integration of portfolio-company-level performance
denominator (cash flow or earnings), and therefore can reflect benchmarking; and
both changes in expectations and past performance. 3. Isolation and segregation of acquisition-related
transaction impacts.

1. We use the word “apparently” as this conventional analysis suggests areas of value creation and destruction but may obscure actual value creation and
destruction as explained in the following paragraphs.

2. Company specific reasons leading to an increase in the multiple could stem from many factors, such as an increase in expected growth stemming from new
market initiatives or poor recent performance (but with the expectation of recovery).

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 Created Value Attribution

After drilling down to fundamental market, industry, and company the change in the cost of capital (i.e., required market rates
specific factors, including both organic and acquired growth, we of return at the enterprise level) and the changes in market
then map the ensuing value change drivers to four fundamental expectations relative to past performance, or what we refer
sources: Industry/Sector, Capital Markets (“Beta”), Deleveraging, to as “growth profile.” The term “growth profile” refers to
and Unique (“Alpha”). the overall expectations of growth, in terms of the rate, extent,
and timing of expected cash flows that is reflected in the
valuation multiple.3
Primary deconstruction
Primary deconstruction involves disaggregating the value Net Debt:
change impact of each of the factors of the conventional approach
In addition to the pay down of debt and/or a build-up of cash,
(EBITDA, multiples, and net debt) into their
the change in “net debt” may also reflect changes in a number
primary constituents.
of balance sheet and capital structure items that are often not
separately identified. These include dilution resulting from
EBITDA: management equity plan related stock and option issuance as
The impact of the change in EBITDA is deconstructed into well as other transactions. Other potential items in the category
the component attributable to the change in revenue and the include the capital structure effects of platform acquisitions and
component attributable to the change in margin. This first level divestitures, dividends, and capital infusions.
of deconstruction of the change in EBITDA can add some
Primary deconstruction results in identifying and measuring
clearly meaningful information. Specifically identified is value
the impacts of at least five separate value creation drivers:
creation attributable to top line revenue growth versus that
attributable to improved profitability. Likewise, decreases 1. Change in Revenue;
in value may be quantified and attributed to revenue and/or
2. Change in Margin;
profitability declines, and changes in value can also represent
a mix of positive and negative changes in revenue and margin. 3. Change in Cost of Capital;

4. Change in Growth Profile; and

Multiples: 5. Change in Capital Structure and Balance Sheet Items
Similarly, the value change impact resulting from a change
in the multiple can be deconstructed into the impact from The breakout into these factors is diagrammed below:

Figure 4: Primary Deconstruction

Net Debt
EBITDA Multiple Balance Sheet /
Capital Structure Impacts

Cost of Growth Share Add-On

Revenue Margin Leverage Dividends
Capital Profile Dilusion Investments

After applying Primary Deconstruction to our previously introduced followed by a relatively modest contribution from capital
illustrative example (see below), more detail emerges. In this structure/balance sheet impacts (of which the change in net debt
example, the most significant positive contributing factor to is one factor – a more detailed discussion follows below). All other
value change is the impact attributable to the change in margin, value change drivers contribute negatively to value change.

3. The change in multiples can be calculated either on an industry or company specific basis. We believe that it is important to calculate and understand the change
in multiples both ways, as explained in the next section which discusses the integration industry benchmarking. As a result, we also ultimately calculate growth
profile on both an industry and company specific basis.

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 Created Value Attribution

Figure 5: Illustrative Example: Attribution Analysis Based on Primary Deconstruction

Change in Investment Value
ValueTEV at June 30, 2007: $4,000
Value Driver
($ millions) $0

Total Revenue Based Impacts ($237)

Total Margin Related Impacts $916

Change in Cost of Capital ($428)

Change in Growth Profile ($328)

Total Change in ($77)

Total Enterprise Value
TEV at June 30, 2011: $3,923
Total Balance Sheet and
$262
Capital Structure Impacts

Total Change in
$185
Investment Value

Investment Value at Acquisition: $1,684

Investment Value at Valuation Date: $1,869

In assessing the potential contributions, if any, to value Value creation driven by enhanced profitability at the enterprise
creation (or destruction) attributable to GP actions and level in excess of that achieved from the overall industry level
decisions, it is then logical to examine the portion of the indicates, all else being equal, outperformance that could
specific impacts above driven by industry/sector factors provide evidence of GP value-add (i.e., resulting from GP-driven
versus the portion that is company specific. initiatives). This value creation attributable to GP actions would
not be available through making a benchmark or industry-based
In the case of our illustrative example, one of the primary questions
investment comprised of a basket of public securities
to ask and answer is “How much of the margin improvement
representative of the industry (e.g., an industry ETF).
can be explained by industry/sector trends and how much is
specific to the portfolio company?” The next step or component The integration of performance benchmarking into the analysis of
of the Duff & Phelps CVA analysis below therefore provides a value created, results in further deconstruction and in a finer level
standardized framework with which to answer this question. of detail, providing visibility into a number of industry, sector and
company specific value change drivers. Specifically:
Integration of portfolio- 1. The change in revenue is deconstructed into (a) the
company–level performance change in market size and (b) the change in market share;

benchmarking analysis 2. The change in margin is deconstructed into (c) the

change in industry margin and (d) the change in the
While attribution based on primary deconstruction provides
company specific margin, incremental to the change
significantly more detail than the conventional framework,
in the industry margin (indicative of outperformance/
it may still be insufficient to provide insight as to whether there
underperformance relative to the industry benchmark);
is significant value-add, operational and/or strategic, that may
have stemmed from GP actions. As in our illustrative example, 3. Change in growth profile is deconstructed in (e) the
suppose that a significant level of value creation is attributed industry growth profile change and (f) the change in
to increased margins. Is the increase in margin being driven the incremental (i.e., relative to the industry benchmark)
primarily at the industry level (e.g., is it resulting from an company specific growth profile; and
industry or secular trend or from an industry cycle) or at
4. The change in the cost of capital can be deconstructed in
the enterprise level relative to the industry as a whole?
(g) the industry cost of capital change and (h) the change
in the incremental company specific cost of capital.

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 Created Value Attribution

Figure 6: Primary Deconstruction and Integration of Performance Benchmarking

EBITDA Multiple

Cost of Growth
Revenue Margin
Capital Profile

Incremental Industry Incremental Industry Incremental

Market Market Industry
Company Specific Cost of Company Specific Growth Company Specific
Size Share Margin Margin
Capital Cost of Capital
Profile Growth Profile

Revenue Impacts resulting in a lower cost of capital. The Duff & Phelps Framework
We first examine the revenue growth rate exhibited by the addresses this by deconstructing the change in the cost of capital
portfolio company relative to that of an industry benchmark.4 to arrive at an industry change in the cost of capital and the change
This analysis separates the created value due to the change in attributable to the portfolio company on an incremental basis.
market size from the created value due to the change in market
The change in the cost of capital can be deconstructed in
share. In most cases one would consider the change in market
(g) the industry cost of capital change and (h) the change
size to be the result of macro factors, as opposed to enterprise-
in the incremental company specific cost of capital.
level factors. In contrast, the change in market share speaks to
performance of the enterprise.

Margin Impacts
Determining industry benchmarks
A critical component of the integration of performance
Similarly, the change in margin can be separated into the change in
benchmarking is the determination of the industry benchmark,
industry margin and the change in the portfolio company’s margin
and there is no simple one-size-fits-all method to benchmark
relative to that of the industry (i.e., the incremental company-
industry performance. Sometimes a single proxy or group of
specific change in margin).
publicly traded competitors is used for benchmarking but this
Growth Profile Impacts approach often suffers from “pure-play” and size issues, and may
therefore present a very limited or distorted view of the industry.
Just as the change in the portfolio company’s growth profile can
Additionally, a single proxy is not necessarily representative
be derived from the change in the company’s implied valuation
of the industry as a whole. It is generally preferable to create
multiple, the change in the industry’s growth profile can be
a comparable company group, as is used to determine fair
ascertained from the change in the industry benchmark multiple
value using a market approach. In the valuation process, the
(e.g., weighted average multiple of comparable companies). This
comparable company group is utilized to benchmark value
analysis allows the impact from the change in growth profile to be
based on historical and expected performance while normalizing
deconstructed into the change in industry growth profile and the
exposure to comparable risk and opportunity. Within the Framework,
change in the incremental company-specific growth profile.
a comparable company group can be used as a proxy for the
industry or that part of the industry in which the portfolio
Cost of Capital Impacts
company operates in order to assess relative performance.
Cost of capital impacts can also be separated into industry In order to reflect the contribution of all of the comparables to
and company specific components. GPs often maintain that industry performance, a weighted average of the performance
as a portfolio company grows and/or becomes more diversified of the comparable companies is utilized rather than relying on a
in its product and customers, the portfolio company’s cost of
median or mean figure. A weighted comparable company group
capital decreases relative to what it otherwise would have been.
can also be thought of as a readily investible alternative to the
In cases like these it may be appropriate to give credit to the GP for
portfolio company and thus represents an investable measure of
value created as a result of lowering the riskiness of the business,
industry performance. The comparable group therefore

4. Note that the industry benchmark (explained further below) is a portfolio company benchmark of firms operating in the same industry. It is not a benchmark of
private equity performance or returns

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 Created Value Attribution

provides a real view of the opportunity cost of investing in Adjustment factors, to reflect degree of product/service relevancy
the portfolio company rather than an “industry index” of as well as geographic relevancy, are applied to each individual
public comparable companies. While it can be outright company within the benchmark. The adjusted results are then
challenging to identify a group of public comparable companies, weighted based on relative contribution. While this approach
particularly for niche portfolio companies, a market comparable may be less transparent in terms of the companies included in
group represents, in theory, a readily investible alternative to the the composite (necessary in order to keep the private company
specific portfolio company, reflecting industry risk and return data confidential), it can provide a more complete and refined
profiles, and thus serves as a logical benchmark of performance. view of industry performance.

We have also developed and utilized proprietary industry Returning to our illustrative example, the integration of
composites (“Duff & Phelps Industry Composites”), which performance benchmarking reveals significant additional detail into
expand on the comparable company groups, in order to provide the value creation process.
a more complete view of industry performance for benchmarking.
This approach takes comparable public company benchmarks
and combines them with private company performance data.

Figure 7: Illustrative Example: Attribution Analysis Based on Primary

Deconstruction and Integration of Performance Benchmarking
Value Driver Investment Value at Acquisition Date:
($ millions) $1,684

Estimated Δ Market Size $181

Δ Market Share $(419)

Total Revenue Based Impact $(237)

Operating Leverage Impact $(76)

Δ Industry Margin (Incremental to Operating Leverage) $263
Company Specific Change (Incremental to Industry, Operating Leverage Delta) $729
Total Margin Based Impact $916

Δ Cost of Capital $(428)

Δ Industry Growth Profile $(615)
Incremental Δ in Company Growth Profile (Residual) $287

Total Growth Profile/Cost of Capital $(756)

Δ Total Enterprise Value $(77)

Net Debt Reduction $339

Owenership Dilution $(77)
Total Balance Sheet Impact $262

Δ Investment Value (Assuming 100%) Equity) $185

Investment Value at Analysis Date:

$1,869

In this example, the negative contribution to value stemming Based on a real life case study, the margin improvement
from the loss of revenue was essentially driven by the loss of outperformance in this illustrative example was the result of
market share, partially offset by an increase in market size. The a number of GP-led initiatives, including those relating to cost
company had fewer customers as of the analysis date than it savings and changes in customer and product mix. In fact, the
did as of the date the investment was made. While the change company terminated relationships with unprofitable customers,
in the industry margin provided a positive contribution to value, which reduced market share but which was more than made
incremental company-specific margin improvement drove the up for by the value created through improved profitability.
majority of overall value creation and more than offset the
value eroded from the loss of market share.

9
 Created Value Attribution

Purchased vs. created value Segregating the impact of acquisitions can be difficult, but
the Framework addresses this “bought” vs. “built” EBITDA
As mentioned above, generally EBITDA increases are seen question through a similar approach to the attribution
as a positive. But a question arises as to how much of the methodology described above. It utilizes an algorithm that
increase is organic in nature (i.e., created) and how much identifies, for each material acquisition, how much revenue,
was obtained through acquisitions. If a follow-on acquisition margin and growth were acquired. Utilizing the portfolio company’s
is purchased at fair value, there is no real value created at valuation metrics as of the date of the add-on acquisition as
the time of acquisition. But as the follow-on acquisition is benchmarks, the initial value impacts for each acquisition can be
integrated onto the platform and revenue, margin, and other identified and segregated. Any subsequent or post-acquisition
synergies are obtained, there is potential for significant value growth of the combined entity is then represented in the
creation to occur. In order to measure this value creation, it is Framework as true organic value creation. We label this total
necessary to pull out what was actually acquired at the time organic company-specific value creation as:
of the follow-on acquisition, as well as how much additional
capital was required to complete the transaction. • Revenue Change Alpha
• Margin Change Alpha
• Growth Profile Change Alpha

Figure 8: Full Framework with Primary Deconstruction, Benchmarking,

and Isolation and Segregation of Acquisition Related Impacts

EBITDA Multiple

Revenue Margin Cost Growth

of Capital Profile

Incremental Incremental
Industry Growth
Market Size Market Share Industry Margin Company Specific Company Specific
Profile
Margin Growth Profile

Growth
Acquired Revenue Revenue Acquired Margin Acquired Profile Change
Change Alpha Margin Change Alpha Growth Profile Alpha

Note: Cost of capital impacts can also be segregated into industry, acquisition, and alpha impacts

As an example, consider value created under “arbitrage” While this may not necessarily appear intuitive, without
strategies. A GP may seek to acquire targets with a lower representing lower margin of the acquired business as an
margin than the platform company and then, through any offset, the lower margin would obscure, at least in part, any
number of initiatives, seek to bring the margins of the actual organic change in margin and would therefore serve
acquired businesses more in line with that of the platform to understate or even hide any real improvement in margin.
company. Value may not be created at the time of each Without separating the acquisition impacts it might appear that
follow-on acquisition, but it is created if the margins move there is weak or even negative margin growth, but if we fully
toward that of the platform company. reflect the lower margins of the added business the true value
creation can be revealed.
For the acquisition of a business with a margin less than that of
the platform, though the revenue would be reflected as positive Once the value change impacts attributable to acquisitions
value purchased, the margin impact would reflect an offset to are quantified, then the true amounts of organic value change
purchased value within the Framework. or created value can be determined.

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 Created Value Attribution

It is also important to re-emphasize that within the As seen in Figure 9, the separation of acquisition impacts reveals
Framework, value created through successful acquisitions an even more granular level of detail. The value created from
(e.g., post-acquisition growth, realization of synergies, or other margin improvement outperformance, for example, is more
increases in the value of the combined entity after acquisition) pronounced because the acquisition of a lower margin business
is considered organic value change (i.e., created value). had obscured some of the margin improvement. Similar
refinement of the other estimates of company specific value
Returning to our illustrative example, the full Framework creation can be observed, including a lower revenue change
with acquisition impacts reveals additional detail into the alpha, relative to the previous company specific revenue value
value creation process. change, and a higher growth profile change alpha relative to the
company specific growth profile change.

Figure 9: Illustrative Example: Attribution Analysis Based on Primary

Deconstruction, Integration of Performance Benchmarking, and Isolation
and Segregation of Acquisition Related Impacts
Value Driver Investment Value at Acquisition Date:
($ millions) $1,684

Estimated Δ Market Size $181

Revenue Impact of Acquisitions $194
Δ Revenue α $(613)

Total Revenue Based Impact $(237)

Operating Leverage Impact $(76)

Δ Industry Margin $263
Margin Impact of Acquistions $(145)
Δ Margin α $874
Total Margin Based Impact $916

Δ Cost of Capital $(428)

Δ Industry Growth Profile $(615)
Growth Profile Impact of Acquisitions $(17)
Δ Growth Profile α $304
Total Growth Profile/Cost of Capital $(756)

Δ Total Enterprise Value $(77)

Acquisition Debt $(32)

Deleveraging $371
Ownership Dilusion $(77)
Dividends $-
Total Balance Sheet Impact $262

Δ Investment Value (Assuming 100%) Equity) $185

Investment Value at Analysis Date:

$1,869

Balance sheet and capital structure In line with what may be expected, the most significant
capital structure/balance sheet impact is that of deleveraging.
impacts (including deleveraging) The Framework quantifies actual deleveraging in contrast to
at this point we have addressed the value change drivers at the just changes in net debt. Deleveraging is a function of cash flow
enterprise (i.e., operations) level. To fully and appropriately generated by the enterprise in the period between measurement
attribute value creation at the investment/security level, changes dates. Other factors in addition to deleveraging that determine
in what is referred to as “change in net debt” in the conventional the amount of net debt include newly issued and/or assumed
attribution framework need to be taken into account. Going from debt related to add-on acquisitions, borrowings related
the conventional framework to the Duff & Phelps Framework, to new capital investments, as well as new debt related
“change in net debt” is deconstructed into a number of changes to dividend/recapitalization transactions. For example, in
in capital structure and balance sheet impacts. a dividend/recapitalization transaction, the newly issued
debt increases the net debt and therefore, re-leveraging
may obscure actual deleveraging.

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 Created Value Attribution

Similarly, the amount of newly added debt used to finance 1. Industry/Sector;

add-on acquisitions is identified and separately considered
2. Capital Markets or “Beta”;
in the Framework so that actual deleveraging can be identified.
Likewise, additional equity investments may result in a decrease 3. Deleveraging; and
in net debt but not in deleveraging and thus also should be 4. Unique or “Alpha”
considered separately. These four categories of value change drivers are what we refer to
as the fundamental sources of value creation.
Is it possible to have deleveraging even when there is no debt?
The answer is yes. Our Framework defines deleveraging as It can also be helpful to present up front the results of this
“organic” net debt reduction resulting from cash flow generated aggregation into fundamental sources, and then to back up this
between the acquisition date and the exit or analysis date. When summary analysis with the full detail. We have presented here the
cash is generated and there is no debt, there is either a cash build full detail first so that the reader can follow the aggregation, but
up, representing a decrease in net debt (which was negative the actual analysis has typically presented first the attribution by
to begin with and then becomes more negative) or a distribution fundamental sources, and then followed by the detailed results
as a dividend to investors and separately accounted for as
discussed above.
Industry/Sector
If additional equity investments are made by new investors, ‘Industry/Sector” value creation is comprised of those value
ownership dilution could result and must be reflected in the change drivers attributable to the performance of the portfolio
analysis. Assuming the investment is made at a price equivalent company industry benchmark. In total, the industry/sector
to fair value, we normally assume there is no value change for category reflects the change in value that would have been
the original investors at the onset as dilution would be offset achieved through investment in the industry benchmark utilized
by the decrease in net debt (e.g. increase in cash).5 After a period (i.e., in the underlying companies comprising the benchmark on
of time during which the value of the enterprise is expected to a weighted-average basis).
increase, the original investors would get a smaller piece of a
larger pie, the difference represented by the quantified amount Should the GP take credit for Industry/Sector value creation?
of dilution stemming from the equity infusion. It may be appropriate to give credit to the GP for some or all of
the industry or sector value creation if the GP has a generalist
Ownership dilution also frequently results from equity provided focus and seeks to identify promising sectors or industries.
to portfolio company management in order to align the interests The Industry/Sector category represents value created by
of management and investors. The cost of incentivizing asset/sector allocation decisions, and if the GP has discretion
management with stock and/or options represents an offset to in making these decisions, they can be credited with value
created value, as the equity-based compensation plan reflects creation. The importance of Industry/Sector value creation
a cost of “building a better business” or value creation. is particularly relevant for generalist funds and managersas
industry selection and ensuing opportunity sourcing and
Fundamental sources of identification are key components of the GP’s value-add

value creation process. GP value-add for industry-focused funds may be

less meaningful, depending on the GP’s ability to define the
figure 9 above illustrates the impact of fifteen value change industry and also how the industry benchmark is defined.
drivers. This detail provides a useful communications and
discussion tool to potentially illustrate and validate GP influences,
particularly where those impacts can be tied to specific initiatives Capital Markets
and core competencies of the GP. Capital Markets, or “Beta,” denotes the change in value stemming
from the change in the required market rate of return at the
Some of these value change drivers are distinct (i.e., capital enterprise level. Beta here represents asset inflation or deflation
markets and deleveraging) while others can be grouped based as the market-based cost of capital for the industry increases or
on their nature (i.e., those that are industry/sector based and decreases. While the GP has at least some control of the timing
the value change “alphas”, which we label as “unique”). In order of investments, the value created or destroyed related to capital
to better understand and appreciate the results of our detailed markets is driven by market conditions independent of any impact
attribution Framework at a higher level but still meaningful way, by the GP once the investment is made.
the various value change drivers are mapped into four categories:

5. It is possible, especially in the venture capital arena, for a new investor to provide stability and recognition to the portfolio company that is more than the sum of
the pre-money value and the new investment. Where appropriate, this can be reflected in the analysis.

12
 Created Value Attribution

Deleveraging Unique
Deleveraging is a very important source of returns. As noted Unique, or “Alpha,” value creation represents the aggregate of the
above, deleveraging is a function of cash flow generation several value change alphas discussed above. Alpha here is thus
during the interim period. Deleveraging is manifest through value creation unique to the three other value creation sources
a reduction in debt, an increase in cash balances, or some above. We believe that a key aspect of this source of value creation
combination thereof. is that it is NOT derived from interim cash flows (i.e., deleveraging)
and is a function of the beginning and ending enterprise values,
The performance of the portfolio company in the interim period and thus addresses the question as to whether a better business
is unequivocally the ultimate determining factor in deleveraging is being built. Alpha here represents value created organically
and can take different paths between the date that created through company-specific factors on an outperformance basis
value is being measured and analyzed. In addition to cash flow and may very well be indicative of the fundamental GP value-add
from operations, excess working capital reductions and other which is operational and/or strategic in nature. The unique or
asset utilization efficiency improvements, as well as the sale of alpha value creation may also (depending on how broadly or
assets (including liquidations), would be expected to contribute narrowly the benchmark industry is defined) reflect the ability
to interim cash flows. of the company and/or GP to identify and target specific industry
segments within a given industry that represent exceptional
Deleveraging is not inherently financial engineering and often
opportunities.
simply represents the build-up of cash or reduction of debt due
to cash from operations. But to the extent financial engineering Returning to our illustrative example, we observe large negative
does create value (e.g., by reducing the company-specific cost impacts from industry and capital market factors and positive
of capital), it may be reflected both in past and future results, and impacts from deleveraging and unique/alpha factors.
could therefore be captured both in Deleveraging and in the Unique
category below.

Figure 10: Illustrative Example: Created Value Attributed to Fundamental Sources

Created Value from Acquisition Date through June 30, 2011

Fair Value = 1.1x Cost

Industry/Sector $(139)

Capital Markets/Beta $(428)

Deleveraging $371

Unique/Alpha $380

$185
Total

Industry/sector and capital market trends had a clear negative Thus when we aggregate the value creation for our example,
effect on value over this period, reducing value by $139 million we see a simple but compelling picture of value creation, as
and $428 million respectively. Other than selecting the initial well as preservation, during a difficult market period. Unlike
timing of the investment and the industry of the portfolio the conventional framework, which showed value creation from
company, the GP had no impact on the change in value related EBITDA growth and value destruction from lower multiples but
to these components. Yet significant value was created through provided no way to provide insight as to how much if any was
both deleveraging ($371 million) and unique company specific related to outperformance or underperformance, the Duff & Phelps
factors ($380 million), which managed to turn the overall Framework does provide a clear indication that value creation was
investment slightly positive over a rather challenging timeframe. far ahead of industry performance and primarily attributable about
equally to deleveraging and initiatives under GP leadership.

13
 Created Value Attribution

Interplay between industry/sector Timeframe of the analysis

and unique value creation It would be expected that, at the very least, a created value
attribution analysis would encompass the time period spanning
Depending on how the industry is defined, there is clearly
the date from the initial investment to that of either the exit (for
interplay between industry and unique value creation. After
realized investments) or a current analysis date (for unrealized
segregating any transaction-related impacts, the sum of the
investments utilizing a contemporaneous estimate of fair value).
portfolio company industry and unique value creation is fixed.
For unrealized investment this may also be performed on a
If the selected benchmark suggests higher industry value creation
periodic (e.g., annual, semi-annual, etc.) basis. Since attributed
than another benchmark, the unique value creation will be
created value is cumulative in nature, the incremental value
correspondingly lower. For example, if the industry is very
changes reflected in the updated attribution analysis (if again
narrowly defined based on the absolute closest comparable
performed since inception) must reflect the interim period.
companies, we are likely to see less unique value creation as the
Alternatively, the update could encompass the period from the
portfolio company makes up more of the industry. And where
prior analysis date to the current analysis date, and adding the
the portfolio company is expanding and taking market share from
results can provide an attribution analysis from inception to
companies in the same and closely related industries, a broader
the current analysis date. Lastly the analysis can be performed
or more complete measure of the industry should properly
over a “discrete” time period, i.e., on a before-and-after basis.
identify more of the subject company growth as unique.
Utilizing this type of time frame lends itself to situation where
There is no “magic bullet” in regards to benchmarking at the certain significant events, such as restructuring, changes in
portfolio company level. Often, as in selecting a market strategy, changes in management team, etc., represents clear
comparable group, developing meaningful benchmarks can lines of demarcation for which how value was created before
be challenging, particularly when it comes to small “niche” vs. how it was created after, and may provide important insights
businesses. It is imperative that the benchmark be clearly defined and additional transparency.
in terms of industry definition. Additionally, use of more than
one benchmark (e.g., narrow vs. broad definition of the relevant
industry), may provide additional insight into value creation.
Aggregating across the
fund or GP
Flexibility in segmentation The CVA results for individual portfolio companies can also be
easily aggregated across a fund, GP, or in other ways. The sample
of the analysis fund presentation below shows that patterns of GP influence
Our analytical Framework is also flexible to the use of other emerge. Just as we saw at the portfolio company level, the
measures or components of value creation. For example, if the summary of fundamental sources separates the impact of
subject company had initiatives to change its customer and industry and capital markets, which are often beyond the GP’s
product mix and has data to track revenue and/or margins by control, from the deleveraging and unique impacts that the GP
customer, we can identify the value impacts of each initiative is quite likely to influence and potentially enhance.
individually, and then identify any residual value creation from
other factors. Our Framework has been used to identify value
from many unique value drivers, including post acquisition
synergies, new product introductions, changes in customer
mix, and marketing programs and initiatives. Given the
limited granularity of most public data, however, it is often
not possible to separate these customized factors into
industry and company specific pieces.

This flexibility in segmentation can also be used to break out

the value creation due to specific ESG initiatives where the data
is available. The impact of energy initiatives on costs and margins,
for example, could be separated from other value creation efforts
or results.

14
 Created Value Attribution

Figure 11: Aggregating CVA Results By Fund

Created Value from Acquisition Date as Reported

Portfolio Co. A Portfolio Co. B Portfolio Co. C Portfolio Co. D Total Fund
Industry/Sector $ (100) $ 88 $ 106 $ (253) $ 198
Capital Market/Beta $ (428) $ (38) $ (54) $ (121) $ (636)
Deleveraging $ 371 $ 52 $ (10) $ (3) $ 410
Unique Alpha $ 380 $ 188 $ 96 $ 58 $ 722
Total Value Creation $ 185 $ 295 $ 138 $ (319) $ 299

As we see above, the aggregate view can show a respective GP’s

relative strength across a portfolio of companies (but in other cases
Conclusion
may show that value creation is not consistent). Created Value Attribution sits in the nexus between GP and LP
interests. GPs need to demonstrate how their proven capabilities
differentiate them in the market. On the other hand, LPs need a
CVA vs. Other transparent framework and methodology to evaluate how returns
are generated. While aggregate returns are, and undoubtedly will
performance analytics continue to be first and foremost for investors, how a GP creates
Created value attribution analysis is complementary to other value is increasingly important. Generation of returns through
performance analytics. Returns are generally foremost to leverage is, for all practical purposes, expected by investors and is
investors, and our value attribution provides insight into how the not viewed as a differentiating factor. In contrast, the creation of
returns are obtained. This can be helpful for both successful and value through building better businesses is a widely recognized
less-than-successful investments. In the former case, our and expected differentiating factor in making capital
Framework can help distinguish between a home run driven allocation decisions.
mostly by macro factors and one driven more by company
specific performance and GP initiatives. Similarly, a weak Attributing value creation with sufficient granularity to support
return or loss can be the product of negative industry and the existence of GP value-add (operational and/or strategic) is not
capital market factors, and company or GP initiative may a simple exercise and needs to go beyond the industry convention
preserve or further destroy value on top of that. Measures such of merely looking at changes in EBITDA, multiples, and net debt.
as an IRR or MOIC may be unrelated to the amounts of unique Created value attribution compliments more traditional private
value created over the investment period, and this is an example of equity fund and investment analytics. It extends the quantitative
why it is useful to examine multiple metrics. aspect of fund manager evaluation by enhancing transparency to
address key issues including:
Unlike an IRR, the CVA results are not time dependent. They show
absolute levels of value creation over the analysis period. And while • Sources of Value Creation:
the CVA results do show whether operational performance was Macro vs. Investment Specific;
above or below industry performance, they do not reveal relative • Impact on Value Creation from Initiatives
investment performance. In order to see the latter investment Driven by GP Leadership; and
performance, we would suggest a PME (public market
• GP Strengths and Weaknesses on the Basis of Industry;
equivalent) analysis, or an analysis of the investment alpha
Geography; Deal Team; regardless of vintage.
created on a leverage adjusted basis.
Properly utilized, Created Value Attribution analysis can be a
Like other metrics and analytical tools, the CVA results require fundamental GP communications tool as well as a fundamental
careful interpretation and should not be viewed in isolation. LP due diligence, selection and monitoring tool.
Together with other metrics and an examination of the efforts
and initiatives of the GP, we believe the CVA results help to
further quantify the investment and fund performance of the
portfolio company and the GP.

15
CONTACTS

PJ Viscio George Pushner, Ph.D

Managing Director Director
+1 212 871 6267 +1 212 871 6285
[email protected] [email protected]

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