Growth Framework: A tool for analysing growth opportunities in financial and strategic investments

Imperial College Business School
Imperial College London
Growth Framework: A tool for analysing growth opportunities in financial and strategic
investments
Pengiran Izam Ryan
CID: 00889857
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A report submitted in partial fulfilment of the requirements for the MBA degree and the
Diploma of Imperial College London
September 2014

II
ABSTRACT
Not all types of growth have the same impact on a company’s valuation. Some forms of
growth are “accretive” and add to a company’s valuation, while some growths are
“deletive” and subtract from a company’s valuation. We set out to better understand this
division and analyse some of the historical perspectives behind the finance profession’s
fascination for growth.
We then selected a panel of investment professionals who specialise in investment
appraisal and conducted a series of interviews to gauge current practices. We sought to
find out what is the current practice used by analysts to discriminate between
“accretive” or “deletive” growth.
We contend that, as the rate of technological change has accelerated, more and more
industries once thought to be stable and mature are being disrupted by business model
innovation, advances in information technology and changing social norms. While the
nature of competitive advantage has become increasingly elusive, the practice of pre-
investment due diligence has not always kept up and. From these interviews, we
learned that some acquirers view this key stage in the M&A cycle as being a
compliance “box ticking” exercise and don’t focus on the areas in an acquisition which
can create the most value.
This compliance focused approach to due diligence and evaluating investment
opportunities focuses on a historical analysis of an investment’s financial (through
Financial Due Diligence, or “FDD”) and legal red flags, but leaves out prospective
strategic analysis (through Commercial Due Diligence, or “CDD”). In practice this FDD
analysis is directed at a Target company’s Earnings Before Interest Tax, Depreciation
and Amortisation (“EBITDA”) and identifying “normalisation” adjustments to EBITDA.
However, when we derived a financial valuation model, we saw that EBITDA is just one
piece of the bigger valuation puzzle. Return on Invested Capital (“ROIC”), and projected
Growth (“g”) have a “multiplier” effect on EBITDA. We present mathematically how it is
the balance between ROIC, g and the discount rate (“WACC”) is conceptually similar to
valuation multiples (“Multiple”) used to understand pricing.
Given the direct (and potentially exponential) connection between Enterprise Value
(“EV”) and Multiples, shouldn’t M&A due diligence focus on the Multiple, which is the

III
key driver of valuation? It has a multiplicative effect after all, and getting comfortable
with the Multiplier can have a more significant impact on overall M&A deal economics
than in understanding the normalisation adjustments to EBITDA.
We prove that mathematically, these two value drivers have different relative
importance depending on the WACC used. We suggest that the key driver of M&A deal
economics is therefore this balance between ROIC and g.
Because of the importance of this balance, we hypothesise a “Growth Framework” to
help analysts pick apart and analyse a company’s growth prospects. We drew
inspiration for this “Growth Framework” from qualitative factors identified in
contemporary business management literature.
We then used the Growth Framework to analyse the performance of Private Equity
exits. We wanted to analyse Private Equity exits at both the individual transaction level
and also at the aggregate fund level, and so we used two main sources of data – the
Bureau Van Dyke Zephyr database of individual historical M&A transactions and the
CalPERS annual survey of aggregate fund performance. We used a database of
Private Equity Fund exits because these Funds are largely held out to be experts at
analysing and capturing value in M&A situations and therefore should be an excellent
sample to illustrate the Framework’s predictive power.
To gain further analysis and insight in to value “deletive” businesses, we also applied
the Growth Framework to a case study of a failed startup. We selected the case of
Bartap, a VC-backed payment services startup specialising in the Food & Beverage
segment. This additional step validated the predictive power of the Growth Framework
to highlight the risk of a value destroying investment.
We then concluded by revising the Growth Framework, based on our insights with
applying the Growth Framework to live cases from the three sets of data above –
individual M&A transactions, aggregate level fund performance and the unique case of
a failed startup.
This refined, theoretically robust and quantitatively tested framework is presented as a
tool to help analysts discriminate between different types of growth, to defend and
appraise their evaluation of deal economics. We hope to avoid the risk of overpaying for
a weak asset and to maximise their chances of underpaying for a strong asset.

IV
ACKNOWLEDGEMENTS
I would not be able to individually thank all of the awesome people who have helped me
along the way given this one short page. And so, I’d like to thank everyone who has
helped me come this far – each and every one of you has been key in this journey.
My deepest gratitude go to my parents and my siblings for being there for me during
this tough year in London. Their wisdom, patience and loving support have seen me
through this experience.
I would like to thank my supervisor Professor Andreas Angelopoulos for his guidance
and continuous support. I am grateful to have been given the opportunity to gain from
your experience.
I am thankful to my MBA cohort for their inputs into my professional development over
this year and to the professionals who have agreed to participate in this work. You have
all shared your insights and your time with me, I will not forget your kindness and hope
to one day return the favour.
And special thanks go to my close friends, confidants, the Javanese coffee plantations
who fuelled my nights of frantic writing and the Anjuna record label for publishing the
soundtrack to this piece of work. My greatest learning during this year has been that it is
those who stand by you during your lowest times and when you have the most to lose
who are truly those who love you for who you are.
Thank you all!

V
NOTATION
ABBREVIATIONS,
SYMBOLS AND TERMINOLOGY USED
DEFINITION
AIE Apollo Investment Europe I, Ltd.
BHAG Big Hairy Audacious Goal, see Collins &
Porras (1994).
CalPERS The California Public Employees’
Retirement System
CDD Commercial Due Diligence, the practice
of analysing prospective strategic data in
pre-investment analysis
DCF Discounted Cash Flow, a capital
appraisal technique where future cash
flows are discounted to reflect the time
value of money
EBITDA Earnings Before Interest Tax
Depreciation and Amortisation
EV Enterprise Value, the sum of the
valuation of all the claims on a
company’s equities and debts
FCF Free Cash Flow, cash flows generated by
the core operations after capital
expenditures
FDD Financial Due Diligence, the practice of
analysing historical financial data in pre-
investment analysis
g Growth, the rate at which NOPLAT or
FCF grows each year
IR Investment Rate, the portion of profits
that are reinvested in the business
IRR Internal Rate of Return, a tool for capital
appraisal that accounts for the time value
of money

VI
ABBREVIATIONS,
SYMBOLS AND TERMINOLOGY USED
DEFINITION
NOPLAT Net Operating Profits, less Adjusted
Taxes
Represents after-tax profits of the core
operations
NPV Net Present Value
Target Company that is selected by an acquirer
for an investment
WACC Weighted Average Cost of Capital,
investors’ expected rate of return from
investing in the company

VII
CONTENTS
ABSTRACT ...................................................................................................................II
ACKNOWLEDGEMENTS............................................................................................ IV
NOTATION................................................................................................................... V
1 Intro – a historical perspective on our growth obsession.........................................1
1.1 Definitions........................................................................................................1
1.2 The LBO boom of the `80s...............................................................................2
1.3 The shareholder value movement of the `90s..................................................4
1.4 The Millennium and similarities over these three waves ..................................5
2 Practices in the PE, VC and M&A deal environments .............................................7
2.1 Private equity (“PE”) ........................................................................................7
2.2 Venture capital (“VC”)......................................................................................8
2.3 Mergers and Acquisitions (“M&A”) ...................................................................9
2.4 Implications ...................................................................................................11
2.5 Using a valuation model to analyse practice..................................................12
3 Crafting a growth framework.................................................................................13
3.1 Built to Last....................................................................................................13
3.2 Good to Great................................................................................................16
3.3 Is the company Playing to win? .....................................................................17
3.4 Crafting a growth framework..........................................................................19
4 Applying the framework ........................................................................................22
4.1 Individual M&A Transactions .........................................................................22
4.1.1 Limitation with the dataset ......................................................................22
4.1.2 Top 5 performers – “Leaders”.................................................................22
4.1.3 Deal 1 – GI Partners sells PC Helps support to Baird Capital Partners...23
4.1.4 Deal 2 – GI Partners sells Plum Healthcare to Bay Bridge Capital..........23

VIII
4.1.5 Deal 3 – Summit Partners backs Welltec MBO.......................................24
4.1.6 Deal 4 – Atlantic Street Capital exits its investment in Fleetgistics..........24
4.1.7 Deal 5 – The Riverside Company exits United Central Industrial Supply
Company..............................................................................................................24
4.1.8 Conclusion..............................................................................................25
4.2 CalPERS Annual survey of aggregate fund performance ..............................25
4.2.1 Bottom 5 performers – “Laggards”..........................................................26
4.2.2 Fund 1 – American River Ventures I.......................................................26
4.2.3 Fund 2 – NGEN II...................................................................................27
4.2.4 Fund 3 – Exxel Capital Partners V..........................................................27
4.2.5 Fund 4 – Carlyle/Riverstone Renew Energy Infrast ................................28
4.2.6 Fund 5 – AP Investment Europe, Ltd. 1..................................................28
4.2.7 Conclusion..............................................................................................30
4.3 A special case of a failed startup - BarTap.....................................................31
4.3.1 Introducing the case ...............................................................................31
4.3.2 Applying the framework ..........................................................................32
4.4 Conclusions from applying the Framework to live cases................................33
5 Conclusions & Implications for practice.................................................................34
5.1 Future studies................................................................................................34
5.2 Business agility..............................................................................................34
5.3 Revised Growth Framework ..........................................................................35
Bibliography....................................................................................................................i
6 Appendix 1 – Primary research performed............................................................. vi
7 Appendix 2 – Manipulating financial equations ..................................................... vii
7.1 Deriving a valuation model............................................................................. vii
7.2 Equivalence of Value Drivers to the Multiple................................................... ix
7.3 Sensitivity of Valuation to ROIC and g ............................................................ ix

IX
7.4 Sensitivity of Valuation to the Economic Spread............................................. xi
7.5 Value creation and multiples.......................................................................... xii
8 Appendix 3 – Financial Model..................................................................................i
9 Appendix 4 – Value creation by type of growth ........................................................i
10 Appendix 5 – Bureau van Dyke Zephyr database................................................ ii

X
Figure 1 Business Model framework adapted from Finklestein et al (2006)....................8
Figure 2 Evolution of strategic M&A over time, as discussed with one of our
interviewees.................................................................................................................10
Figure 3 Summary of findings from interviews .............................................................11
Figure 4 Modified Ansoff growth matrix, excerpted from Deloitte (2014) ......................15
Figure 5 Three key pillars of companies making the leap from good to great, excerpted
from Collins (2001). .....................................................................................................16
Figure 6 Five cascading strategic choices, excerpted from Lafley & Martin (2013). .....18
Figure 7 A Growth Framework.....................................................................................20
Figure 8 Analysis of Zephyr database of M&A deals....................................................22
Figure 9 Summary of top 5 deals.................................................................................25
Figure 10 Summary of Bottom 5 performers deals.......................................................26
Figure 11 Summary of Bottom 5 performing Funds......................................................30
Figure 12 Applying the Growth Framework to the Flowtab case ..................................32
Figure 13 A Revised Growth Framework, adding the core pillar of “Agility”..................35
Figure 14 Sensitivity table of valuation model ................................................................x
Figure 15 Moving horizontally across the matrix ............................................................x
Figure 16 Versus moving diagonally across the matrix ................................................. xi
Figure 17 High ROIC companies achieving high growth ............................................... xi
Figure 18 Value created by different types of growth, data extracted from Koller (2010)
....................................................................................................................................xiii

1 INTRO – A HISTORICAL PERSPECTIVE ON OUR GROWTH OBSESSION
1.1 DEFINITIONS
Kaplan & Stromberg (2008) give a succinct definition of private equity investments and
contrast this to venture capital investments:
‘In a leveraged buyout, a company is acquired by a specialized
investment firm using a relatively small portion of equity and a relatively
large portion of outside debt financing. The leveraged buyout investment
firms today refer to themselves (and are generally referred to) as private
equity firms. In a typical leveraged buyout transaction, the private equity
firm buys majority control of an existing or mature firm. This is distinct
from venture capital (VC) firms that typically invest in young or emerging
companies, and typically do not obtain majority control.’
(p. 2)
But what exactly are investors looking for in LBO’s, as compared with VC investments?
Jensen (1986) describes a desirable LBO candidate as having ‘stable business
histories and substantial free cash flow’ (p. 6), while Marson & Clark (2004)
characterise VC investors as looking for companies with growth potential, hoping to
invest in significant global players.
I would further add that the core of what it means to be a successful PE or VC investor
is the ability to select a portfolio of investments, acquire them at an affordable cost,
groom them and then to divest them with a price that achieves sufficient capital gain to
compensate the PE or VC fund for the additional risk undertaken for investing in these
risky assets. This “risk premium” is analysed in empirical studies by Idzorek (2007).
Although portfolio management is key to successfully investing in the PE/VC asset
class, I would argue that this is best done at the individual investor level and not at the
PE/VC fund level. Building on the work of Idzorek 2007), in Ryan (2014), I give the case
that investors can enhance their investment returns through asset allocation across
asset classes by including PE/VC investments in the investment universe.

2
So although portfolio management and the ability to judiciously allocate capital is key to
PE/VC investing, I would argue that, more importantly, the ability to discriminate
between low growth and high growth investments is a core competence of PE/VC
investors. Rosenbaum et al (2009) support this line of reasoning – and highlight that
LBOs ‘generate returns through debt repayments and growth in enterprise value’ (p.
173).
Since debt repayments fall due in line with debt repayment schedules, the remaining
levers for generating returns are through growth in enterprise value, which can be
achieved through either increasing profitability or the EV multiple used to value the
business. Growth then – is very much on the minds of the PE and VC investor.
I would contend that the business world is obsessed with growth. But what is the root of
this obsession? And is it healthy? Could there be a time or a place where that growth is
destructive? Let’s start by understanding how we got to this place, before bringing in
expert insights and first hand experience from the field.
1.2 THE LBO BOOM OF THE `80S
Sudarsanam (2010) recounts a historical overview of M&A activity since the 1890s, and
he observes that M&A occurs in peaks of activity followed by troughs of relative quiet.
This “wave pattern” has been partly explained by structural changes within disrupted
industries causing players to pursue a consolidation strategy.
And there is some support for this “wave pattern” within the work of development
economists Schumpeter (1961) and Perez (2002). They theorise that, in the absence of
innovation, our economies tend to stagnate and slow down to a stationary steady state.
They suggest that it is entrepreneurs, inventors and innovators who push economies
out of this steady state equilibrium, in a cyclic fashion in “Kondratiev waves”, so named
after the Russian economist Nikolai Kondratiev who proposed the theory.
The troughs in the M&A wave cycle that we observe could therefore be partly explained
by a lull in the Kondratiev wave, and peaks where industries go through a period of
consolidation coincide with increased innovation and entrepreneurship. One might
further say that this acceleration and deceleration relates to not just technological
change, but also to the credit cycle.

3
This aligns with the boom and bust cycle leading up to what is termed by Sudarsanam
(2010) as the fourth wave of M&A during the 1980s. This cycle was characterised by
the increasing popularity of hostile tender offers, bust-up takeovers, leveraged buyouts
(LBOs) and a more permissive anti-trust environment.
This particular boom in the 1980’s was also partly fuelled by the availability of cheap
credit in the form of the junk bonds phenomenon. Bruck (1989) gives us an inside
account in to the inner workings of Drexel Burnham Lambert and of Michael Milken’s
rise to fame, where he created innovative debt financing instruments that opened up
credit access to a whole new segment of corporates that had difficulty accessing credit
markets in the past. These junk bonds eventually led to the downfall of Drexel, and
Bruck (1989) gives us a cautionary tale about the risks of obsession with growth.
This boom also drew a lot of attention from academia and the finance profession.
Jensen (1989) even predicted that PE funds would become the dominant corporate
organisational form. He argued the strongly aligned incentive structures resulted in
active managerial involvement in portfolio companies which leads to the minimisation of
“agency costs” and the development of lean fund structures that efficiently and
effectively allocate capital across their portfolios.
Jensen (1989) hypothesised that this alignment, and therefore this minimisation of
agency costs that, in the long run, would give PE funds a long run advantage over the
slow and lumbering public corporation conglomerates. Conglomerates typically took
longer to make key decisions (as corporates has dispersed shareholder structures),
higher costs of equity (as corporates employed lower levels of leverage) and this
resulted in weak standards of corporate governance (as corporates suffered high
agency costs).
I would therefore summarise that historically, the fascination in LBOs in the `80s were
driven by:
• An alignment of long-run economic super cycles in the `80s. The level of
economic and technological development came to a head and, combined with
an unprecedented increase in availability of debt financing in the junk bonds
phenomenon, set the scene and created a set of enabling environmental factors
for the explosion in LBO activity.

4
• Growing academic literature and professional experience that validated the use
of the LBO structure.
Following the experience in the `80s, we now turn to the rise of the “shareholder value”
movement.
1.3 THE SHAREHOLDER VALUE MOVEMENT OF THE `90S
While the `80s were fuelled by the emergence of PE firms, the popularity of the LBO
and availability of cheap debt financing, the M&A wave in the `90s is described by
Holmstrom & Kaplan (2001) as being much less hostile and employing lower leverage
than the M&A wave of the `80s. The `90s are characterised by a greater focus on
creating shareholder value and a return of the management theory of the resource-
based view of competitive strategy.
Holmstrom & Kaplan (2001) write about the popularity of companies setting explicit
goals of maximizing shareholder value. This went hand-in-hand with the practice of
linking executive pay to measures of Economic Value Added (“EVA™”). Biddle et al
(1999) analyse the usefulness of EVA™ as a method to align executive incentives with
the overarching goals of maximising shareholder value and found evidence that firms
which align management incentives to EVA™ and Economic Profit measures tend to
outperform those that didn’t have the same alignment.
Based on this study by Biddle et al (1999), I suggest that the resurgence of resource-
based view of competitive strategy, fuelled by the widespread adoption of the
“shareholder wealth maximisation” mantra and Economic Profit measurement
mechanisms (i.e. EVA™ and similar systems) resulted in corporate executives focusing
their efforts on wealth maximisation to the extent that the PE funds’ long run advantage
hypothesised by Jensen (1989) was gradually eroded.
Sudarsanam (2010) attributes the expansion of corporates through M&A activity in the
`90s to increased globalisation, new supranational trading blocks and the restructuring
and consolidation of industries. As in the `80s, these environmental factors encouraged
and enabled economic activity and therefore a new wave of M&A.
Theoretically, unrelated diversification by conglomerates results in the “conglomerate
discount”, and as shown by Graham et al (2002), this is how conglomerates destroy
value. However, I would contend that in some cases focusing on shareholder wealth

5
maximisation and aligning business operations through economic profit-based
approaches can lead to value creation. McTaggart & Langford (2011) give a detailed
analysis of how scale, diversification capabilities management across the portfolio and
portfolio management can result in conglomerates earning a “conglomerate premium”.
Despite the detractors to economic profit based approaches, this evidence shows that
economic profit based measures are useful in managing diversified conglomerates as a
way to align incentives with the overarching goal of shareholder wealth maximisation.
I would therefore summarise that historically, the M&A wave of the `90s was driven by:
• A resurgence in the resource based view of competitive strategy and an
increase in focus on maximising shareholder wealth.
• A return of the multinational conglomerate as a dominant corporate vehicle and
a body of corporate finance literature around Economic Profit performance
measures that empowered a new generation of middle management in
multinational corporations to justify corporate-level strategic decisions with a
goal of shareholder wealth maximisation.
• Globalisation and deregulation – Two powerful enabling set of environmental
factors that fanned the fires of economic growth.
If the `90s marked the return of the corporate conglomerate as the dominant corporate
vehicle, then the Millennium became the wave of the financial investors.
1.4 THE MILLENNIUM AND SIMILARITIES OVER THESE THREE WAVES
While the `80s were fuelled by the emergence of PE firms, the popularity of the LBO
and availability of cheap debt financing, the M&A wave in the new Millennium is
described by Sudarsanam (2010) as being driven by financial investors (p. 21):
• Firstly, PE funds took advantage of the ready availability of cheap credit to
launch new investments.
• Secondly, hedge funds started adopting aggressive takeover strategies, in some
cases attacking prospective acquirers.
• Thirdly, shareholder activism became more prevalent as large mutual funds,
hedge funds and other financial investors started to throw their weight around.

6
How the wave of M&A activity in the new Millennium will play out still remains to be
seen, and this picture has been made more complicated with issues such as the
European banking crisis and the impact the quantitative easing will have on investors
and economies of the world.
One common thread that spans across these three waves is the focus on growth. In the
`80s, this growth was realised through LBO’s and the rise of the PE fund. In the `90s,
conglomerates exploited the trend of globalisation in the name of shareholder wealth
maximisation. In the new Millennium, financial investors focused on growth through new
financial strategies and by clamouring for better corporate governance.
As we have seen, Growth is therefore key on the investor’s agenda, and has been for
the past several decades over several waves of M&A activity. How useful or beneficial
this growth obsession has been to the finance profession as a whole, or to society in
general, is a discussion that is beyond the scope of this paper but is considered in
depth by Shiller (2005).
We now turn our attention to current practice in investment appraisal, and how it
focuses on growth.

7
2 PRACTICES IN THE PE, VC AND M&A DEAL ENVIRONMENTS
To better understand how investment professionals currently evaluate growth
opportunities in investments, we conducted a series of interviews (see Appendix 1 for
details) with experienced investment professionals. We summarise the findings from the
interviews below.
2.1 PRIVATE EQUITY (“PE”)
Interviewees were consistent in emphasising:
• The importance of negotiating good deals – strategically viable, business sound
and economically favourable deal terms.
• That the hard work in investment appraisal in the due diligence of evaluating
target investments is only the starting point. Value is generated in PE through
excellence in operating the portfolio companies.
• There is limited use in engaging deal professionals to conduct aspects of the
due diligence unless they bring a unique capability to the deal team. This could
be in terms of unique skills, industry sector or professional specialist knowledge
or simply bandwidth in being able to add additional human capacity to the deal
team to cover sufficient ground during tight M&A timelines. Interviewees cited
that legal due diligence is the main work stream where outside lawyers are
brought in and that occasionally consultants are brought in to conduct financial
due diligence (“FDD”) and commercial due diligence (“CDD”).
• In applying a resource based view of the organisation, due diligence must cover
the spectrum of business issues, across both the “hard” and “soft” domains. In
other words – an LBO is a financial transaction to acquire unique resources to
develop a sustained competitive advantage, as described in Barney (1991).
Regarding this delineation of “hard” and “soft” domains, Finklestein et al (2006) give us
a business model framework with which to work on (see Figure 1 below). This
framework discriminates between the soft “socio-system” that covers the strength of the
team, the corporate culture and management capabilities, versus a hard “techno-
system” that covers the financial resources, the value chain and business processes.
One interesting point that interviewees raised was that when differentiating between the
“hard” and “soft” domains, it is that much easier to implement hard “techno-systems”

8
because most of the time these simply require a financial investment. For example, a
new acquirer may upgrade a Target’s ERP and financial management systems.
Figure 1 Business Model framework adapted from Finklestein et al (2006)
Our interviewees emphasised that culture is something that can’t be bought overnight,
or improved overnight. Therefore, the usefulness of quantitative analysis of financial
resources and performance in a pre-investment due diligence can be quite limited if it is
focusing on the hard “techno-system” but doesn’t take into account the supporting soft
“socio-system”.
Our interviewees also suggested that financial due diligence, as it is practiced today
has limited use in a rapidly changing environment because FDD tends to be the study
of historical financial performance and the hard “techno-system”. Because of the waves
of technological innovation (as Schumpeter (1961) and Perez (2002) would highlight)
are increasingly disrupting industries through digital transformation, the financial history
is becoming less of a strong predictor of future commercial success. Therefore, there is
greater urgency to perform adequate CDD and to take on a more strategic approach to
pre-investment due diligence to analyse of the supporting soft “socio-system”.
2.2 VENTURE CAPITAL (“VC”)
Our interviewees shared that VC investing is very different to PE investing in that VCs
sometimes invest in pre-revenue companies that may not have built strong track

9
records or have significant trading history with which to conduct due diligence on. Pre-
investment due diligence therefore focuses on developing a belief in the “story” or the
investment thesis.
This requires understanding an investment’s market dynamics, the underlying
technology capabilities and credibility of management’s ability to deliver on future
growth. This kind of qualitative analysis is very hard to master through an academic
setting and comes from years of experience in practical application.
In fact, the art of venture investing was described as one of our interviewees as being
an “apprenticeship” business, with knowledge being transmitted directly from master to
disciple in informal coaching classes. This is also supported by Wilson (2010) who says
that ‘Venture capital is best learned in an apprenticeship model’.
One might say that VC investing is predominantly focused on the soft “socio-system” as
described by Finklestein et al (2006). This preference for the soft “socio-system” was
reflected in our interviews when a respondent even mentioned that Discounted Cash
Flow (DCF) and Net Present Value (NPV) financial modelling in the context of VC
investment is not very relevant. However, one respondent did explain that the art of
valuation in VC investments could also be understood as buying call options on future
investment rounds, the relative attractiveness of which depends on the strength of the
VC investor’s conviction in the business model.
2.3 MERGERS AND ACQUISITIONS (“M&A”)
Our interviewees were consistent in pointing out that although corporate acquirers and
strategic investors approach the discipline of M&A similarly to how financial investors, in
some ways they are very different than financial investors.
Where they are similar might be in applying a resources-based view of strategy and the
M&A targets that they acquire. As Barney (1991) highlights, M&A could be viewed a
tactic to acquire resources that are valuable, rare, inimitable and non-substitutable. A
corporation could therefore create a sustainable competitive advantage through
synergies between these unique resources and the existing portfolio of resources.
However, one key aspect in which they differ is in a tactical view of M&A, for example,
when applying a game theory perspective. One might view M&A and competition as a
form of a sequential game, and that some acquisitions can be made as a pre-emptive

10
measure in order to take a Target out of play. One of our interviewees cited the
example of Google’s acquisition of Waze, was to “keep Facebook, Apple or Nokia from
acquiring them”, which is also a sentiment echoed by industry analysts in Cohan
(2013).
Perhaps in this way, it could also be possible to view strategic M&A activity by
corporates through the lens of real options theory. In the same way that VC investing is
a form of buying a call option in startups, corporates engaged in M&A activity as a way
to acquire call options in new, innovative and disruptive businesses. Having the option
to later increase their stake, corporates therefore enhance optionality in their business
strategies.
One keen insight that one of our interviewees raised was that as time has progressed,
that the rate of industrial change, disruption and innovation has increased significantly.
Historically, conducting FDD was seen as being of paramount “must-do” importance,
with CDD as being seen as only being optional in M&A deal making.
Figure 2 Evolution of strategic M&A over time, as discussed with one of our interviewees
I suggest that this is because in the past, confirming that a target is operating as
“Business As Usual” was the key red flag test in M&A. But the technological revolution
and digitisation of industries has disrupted many industries. In a way, the forces of
creative destruction identified by Schumpeter (1961) and Perez (2002) have meant that

11
looking forward to prospective strategic analysis and CDD has become more important
because it is harder to predict the future by analysing the past as in FDD.
One interviewee also suggested that some corporates practice a “compliance focused”
approach to due diligence. This is where investors focus on only FDD and legal due
diligence, the minimum required to get past corporate compliance and to get a deal
approved. This could be risky as it doesn’t consider the forward-looking focus that
comes from prospective strategic analysis.
2.4 IMPLICATIONS
Deal types Key Observation
Private Equity Because it’s harder to acquire soft “socio-
system” capabilities, PE pre-investment
due diligence takes a strategic approach
and focuses on the commercial forward-
looking aspects of a deal.
Venture Capital Because of the lack of trading history in
typical VC investments, pre-investment
due diligence focuses almost exclusively
on analysing the soft “socio-system”
capabilities and analysing a business
through real option theory.
Mergers & Acquisitions Predominantly a resources based view is
taken, or a game theory perspective. As
industries have been subject to disruption
however and greater uncertainty, the role
of historical financial analysis has been
reduced and more emphasis has been
placed on prospective strategic analysis.
Figure 3 Summary of findings from interviews
One common thread that we could draw across the three deal types and the interviews
conducted was that successful deals use the right blend of pre-investment due
diligence across different domains: commercial, legal and financial.

12
Interestingly – several interviewees mentioned the impact of disruptive innovation, as
written by Christensen (2013). In a way, the shifting wave patterns identified by
Schumpeter (1961) and Perez (2002) has been the fuel that has accelerated disruptive
innovation. Because the future is becoming increasingly uncertain and harder to predict
based on historical performance, work done to analyse the past such as FDD is being
thought of as more of a compliance exercise and less of a true source of value creation.
We observed that there isn’t a central unifying theory of “how to” conduct strategic and
commercial due diligence, and that in practice, professionals are very pragmatic about
the management concepts and theories that they use. We therefore conclude that
developing some kind of conceptual framework could be useful to the practice of pre-
investment due diligence.
2.5 USING A VALUATION MODEL TO ANALYSE PRACTICE
While the professional practice of FDD, as described by BDO (2014) focuses on
analysing historical financial data and assessing “the Earnings Before Interest, Taxes,
Depreciation and Amortisation (“EBITDA”) used for pricing purposes”, I would suggest
that the practice of FDD and the focus on EBITDA normalisation adjustments for pricing
purposes is focusing on but a small part of the bigger picture.
Through our primary fieldwork and interviews we have discussed first hand with
investment professionals, how over time, the importance of CDD and prospective
strategic analysis has increased in line with increased business environment
uncertainty (see Figure 2).
We have shown in Appendix 2 – Manipulating financial equations how a valuation
model can be analysed and how the valuation Multiple is very closely linked to ROIC, g
and WACC. Although this Appendix provides some insight in to how we could start to
discriminate between different types of growth, we felt that there could be room to build
further on these concepts of Economic Spread by applying corporate strategy
development techniques and strategic marketing frameworks. In the following section
we review the strategic management literature for further insights.

13
3 CRAFTING A GROWTH FRAMEWORK
Understanding the corporate finance theory of what underlies a highly valued business
tells us that the key to crafting a strategy to maximise shareholder wealth is in
understanding the interplay between ROIC, g and WACC. What the financial theory
doesn’t tell us however, is how to go about managing for that improved profitability or
what to look out for during pre-investment due diligence. What should we look for
before we invest? The answer lies outside of the finance literature.
3.1 BUILT TO LAST
Collins & Porras (1994) in their landmark study analysed the business results of
hundreds of companies, before whittling down to a set of 18 visionary companies,
together with 18 comparison “laggard” companies for each of the visionaries. The
authors then analysed the cultures of each of these companies and identified key
turning points in their corporate timelines.
In a way – over a 6 year research period, the authors did a deep dive on what
Finklestein et al (2006) would have termed as the interaction between soft “socio-
system” and the hard “techno-system” of the 36 companies. Some of the themes
identified included:
• The importance of having a clear, consistent strategy – a “Big Hairy Audacious
Goal” and a corporate culture that is almost “cult-like”. Schein (1984) would
have concurred with the importance of these two factors in strengthening a
corporate culture – i.e. having a homogeneous and stable core “cult” group that
held several intense shared experiences together. Schein (2010) might have
also pointed out that the “Big Hairy Audacious Goals” (“BHAGs”) could be seen
as representing a type of cultural artefact that further strengthens the corporate
culture.
• The authors introduce the concept of having a culture and leadership ethos that
outlives the management team – they refer to it as “time telling vs. clock
building”. Rather than having a single source of the culture (in their example,
just one person who can tell the time) but instead build an infrastructure that
reinforces that culture and transmits it (in their example, building a clock that can
tell others the time as well). Horowitz (2014) enforces this in his leadership

14
manual by advocating continuous employee training and on-boarding. In a way,
Horowitz (2014) suggests that this training is like “clock building”, and this would
be how leaders can architect a system that perpetuates the culture of a firm,
long after the original founders are gone.
• This then leads in to the concept of having “Home Grown Management”. Part of
maintaining a strong culture is having a core team that has built significant
experience in working together and have cultured a shared belief system.
Resisting the temptation to hire senior leadership from outside just means that
future leaders are drawn from within the company and who have built that track
record of building shared experiences with management teams.
• The authors touch directly on the importance of growth by describing the need
to “Preserve the Core / Stimulate Progress”. This is an unusual dual-personality
of strategy in that the core ideology of the firm must remain the same, but
competencies, strategies and goals evolve over time. The authors give the
example of Boeing in the 1950s that ventured into building commercial airlines,
outside of their core of military aircraft and thus beating rival Douglas Aircrafts in
this new market.
One way to understand what Collins & Porras (1994) describe as “Preserve the Core /
Stimulate Progress” is with an Ansoff Matrix, as described in Ansoff (1957). This matrix
has been extended in Deloitte (2014) and the result is presented below:

15
Customers/Markets
New to the
world
Identify new uses or users Create new
markets
New to you Extend to new
markets,
segments
Expand the
value chain
Change the
basis of
competition
Existing Retain,
acquire
customers,
optimize
pricing,
improve
existing
products and
services
Extend
products and
services
Existing New to you New to the
world
Products / Business models
Legend:
Core Adjacent New
Figure 4 Modified Ansoff growth matrix, excerpted from Deloitte (2014)
I would therefore conclude that the role of senior leaders is to architect a cultural and
strategic fit for the companies they lead. There must exist a clear and consistent overall
goal of the organisation (the “BHAG”) and a channel by which organisational culture is
reinforced to existing managers and introduced to new managers. It is up to senior
leaders to look ahead of the curve and be sensitive to changes in the environment, to
help companies position themselves to preserve the core business but stimulate
progress. This modified Ansoff matrix could be used to analyse a portfolio of growth,
allocating resources across core business and new business.

16
This analysis has been a good starting point for helping us understand what makes
companies great. But this analysis has started with leading companies that have
already achieved greatness. To understand how companies built greatness in the first
place, we now turn to Collins (2001).
3.2 GOOD TO GREAT
In a follow-up to Collins & Porras (1994), Collins (2001) and a team of researchers
analysed 11 companies that achieved breakthrough business performance following a
key transition point. In a similar methodology to the earlier study, Collins (2001) pairs
each of the 11 successful companies that achieved this transition to greatness, with
companies that failed to make the same quantum leap.
Figure 5 Three key pillars of companies making the leap from good to great, excerpted from Collins (2001).
Some of the themes covered include:
• Disciplined people. The Good-to-great companies each had modest and
resolute leaders who exemplified good stewardship. Their focus was on building
up their companies to be better than the companies they inherited, for future
generations by setting up their successors for success. The good-to-great
leaders also had a people-centric approach to strategy – they focused on getting
the best team possible on board and then supporting them in their strategic
decisions and operational responsibilities.

17
• Disciplined thoughts. Another differentiator of the Good-to-great companies was
their willingness to face the hard facts of their strategic situations. Through
dialogue and debate, these companies showed humility and let their
environments teach them about what strategies were feasible. The Good-to-
great companies also turned this analytical courage inwards too, what Collins
(2001) referred to as their “hedgehog concept”, meaning their one singular
vision of the business that could help clarify strategy by understanding: what the
company was excellent at, what passions drove the companies, and what
economic engines drove growth.
• Disciplined action. Good-to-great companies built cultures with a bias for action.
Employees were self-disciplined, free and empowered but also had a framework
of discipline. And within this framework, the Good-to-great companies thought
differently about the use of technology, as compared to their peer comparisons.
They looked at technology as an accelerator of existing momentum that was
driven by the singular vision of the business – not a creator of momentum.
One key over-arching concept from Collins (2001) was the importance of architecting
an institutional system. In the same way that the earlier study by Collins & Porras
(1994) emphasised on the importance of building a culture that would survive the
departure of its founders, Collins (2001) emphasised the importance of creating a
“Flywheel” – or a self-perpetuating system that reinforce on existing managers and
introduce new managers to the organisational culture.
These two studies, in Collins & Porras (1994) and in Collins (2001), have, through their
rigorous approach, given us quantitative analysis of exemplar companies. They have
done a deep dive on qualitative factors such as culture and leadership and provided us
rich material with which to build a framework to understand highly performing
companies. But although we have a framework to understand what the internal
structure of a highly performing company might look like – we do not yet understand
what a winning strategy might look like. For that, we turn to Lafley & Martin (2013) for
their insight on strategy development.
3.3 IS THE COMPANY PLAYING TO WIN?
Where Collins & Parras (1994) identified “BHAG” as being a kind of a rallying call, a
clarifying vision and mission statement behind which the whole organisation could get

18
behind and support, we haven’t yet seen a way in which we can differentiate between
“good” strategy and “bad strategy”.
Figure 6 Five cascading strategic choices, excerpted from Lafley & Martin (2013).
Lafley & Martin (2013) share their “Where to play, how to win” strategic framework that
is made up of five cascading strategic choices. When answered, the results reinforce
one another and build up to create a strategy. These five questions are:
• What is the winning aspiration? In a way this aspiration could be seen as being
the BHAG that is described in Collins & Parras (1994). The authors share how
this framework was applied when crafting strategy at Procter & Gamble (P&G) –
for their launch of the Oil of Olay product range the BHAG was to become a
leading skin care brand.
• Where will we play? With the overall BHAG in mind, strategists should then turn
to understanding their market segments. In the P&G case, Oil of Olay stayed
with mass market retailers rather than prestige stores, but P&G changed the
brand positioning to become a “masstige” higher end than existing mass market
products but not yet quite a prestige product.
• How will we win? Key is having a clear value proposition that attracts customers
in the chosen markets in a way that builds a competitive advantage. For P&G,
this was to use price as a signal of quality to the mass market segment and
which allowed P&G to increase the brand equity. Kapferer (2012) gives us a

19
good framework to understand how this could be done – that brands are made
up of ‘living systems made up of three poles: products, name and concept’ (p.
9). Repositioning Oil of Olay in the “masstige” segment changed each of the
three poles and served to create that competitive advantage through strategic
management of the brand that lead to a perceived product differentiation in
consumers’ minds.
• What capabilities must be in place? This links back to the resource based view
of strategy, particularly around what Leonard-Barton (1992) would term core
capabilities, we can think of capabilities to be ‘core if they differentiate a
company strategically’ (p. 111). Thus, common capabilities that are
maintenance oriented can’t be considered core. Given the heavily brand-reliant
this strategy in the P&G case of Oil of Olay, it was P&G’s core capability at
brand building that was key to the success of this strategy.
• What management systems are required? In the business model framework in
Figure 1 from Finklestein et al (2006), this would correspond to the business
processes, the customer management systems and the value chain. In the Oil of
Olay case it was the ability to leverage on P&G’s distribution systems.
My key take away from this body of work is the importance of crafting a coherent
strategy that aligns all the way from the key purpose, the raison d’etre of an
organisation through to the strategic choices of markets to compete in, differentiation
strategy, value proposition, core capabilities and managerial systems of control. In a
way, this echoes very much the concept of the “coherence premium” that Leinwand &
Mainardi (2010) write about, where they recommend that corporate strategy is crafted in
a way such that the different components of a business model reinforce one another.
3.4 CRAFTING A GROWTH FRAMEWORK
From the above literature, we can identify some common and consistent themes which
we can weave in to a new framework and with which we can apply some learnings from
the corporate finance literature.

20
Figure 7 A Growth Framework
In this Growth Framework – we present the supporting pillars going vertically on the
diagram, and we emphasise the need for coherence across the pillars going
horizontally across.
All of the literature reviewed highlighted the importance of having an overarching Vision.
This is termed a “BHAG” by some writers, this is the wider strategic goal of the
organisation. This should be crafted with an attention to what currently works for the
company, and the economic reality of the industry.
Supporting this Vision are the two pillars of Strategy & Operations and Culture. This is
very analogous to the Business Model framework adapted from Finklestein et al (2006)
that we adapted in Figure 1, where we differentiate between the hard “Techno-system”
and the soft “Socio-system” of an organisation.
We then arranged the next layer from Financial, Operational, Strategic, Teams and
Leadership in what we considered to be the order from the hard “Techno-system” to
more gradually soft “Socio-system” factors.
This last layer consists of what we consider to be the most pertinent indicators of a
company with strong growth potential:

21
• Economic spread. Financially, there can’t be a feasible business case where the
company’s ROIC is less than the WACC and there is a negative Economic
Spread. Koller et al (2010A) suggest that a low ROIC in a mature business is
indicative of a flawed business model or an unattractive industry structure
(p.20).
• Systems alignment. As Leinwand & Mainardi (2010) write about the “coherence
premium”, here we mean that the series of cascading strategic choices
undertaken by management reinforce one another and are coherently aligned
within one another. Another dimension to consider is also across the
organisation – so systems should be aligned not just within one business unit of
an organisation, but coherently aligned across different organisational levels.
• Where to play / How to play. A clear strategy that is made up of these five
cascading strategic choices described by Lafley & Martin (2013) makes up the
key of what a strategy is.
• Self-sustaining culture. Collins & Porras (1994) and Collins (2001) both imply
that a core differentiator of successful companies are those that can sustainably
imprint their culture on existing management and new team members in a
consistent method.
• Discipline. Collins (2001) highlight the importance of a leader who exemplifies
good stewardship – they are leaders who manage their companies for the long
run. I would contend that this discipline also extends to a disciplined approach to
future visioning – that leaders apply a disciplined thought process in sketching
out the growth portfolio of their companies, in the way that Deloitte (2014)
extended the Ansoff growth matrix in Figure 9.
These make up the key components of what we see as being core to what drives
growth in companies. In the following section we attempt to apply this framework to real
world cases of financial investors.

22
4 APPLYING THE FRAMEWORK
With this growth framework in hand, we tried to analyse the performance of PE exits at
both the transactional level and the fund level. We also tested the predictive power of
the framework by analysing the case of a failed startup.
4.1 INDIVIDUAL M&A TRANSACTIONS
We obtained access to the Bureau Van Dyke Zephyr database of individual historical
M&A transactions and used the filtering criteria to analyse the IRR of PE fund exits.
4.1.1 Limitation with the dataset
Immediately we came across a key limitation in the dataset: that PE fund performance
tends to be quite opaque and the reporting on transaction level details are vague. The
database that we used did not report full details of all PE exits because the data set did
not include any negative IRR deals. When scanning through the dataset we noted that
hardly any of the deals listed in the database had data on IRR achieved in the exit. Of
the 22,882 buyouts that were extracted from the entire database, only 120 had IRR
data on deals that were marked as “completed” or “assume completed”.
Because of this limitation, and the limited nature of this study, we only used the dataset
to analyse the top 3 performers in this dataset, and used other data sets to analyse
performance of “laggards”. Had we access to better, more complete cross-sectional
data, we would have adopted a different approach here.
4.1.2 Top 5 performers – “Leaders”
Analysis of Zephyr database of M&A deals
Ref # Acquirer Target IRR
1 1601400688 BAIRD PRIVATE EQUITY PC HELPS SUPPORT LLC 500.0%
2 1601428337 BAY BRIDGE CAPITAL PLUM HEALTHCARE GROUP LLC300.0%
3 561632 MBO Team WELLTEC A/S 182.0%
4 1601170962 HARBOUR GROUP LTD FLEETGISTICS HOLDINGS 156.0%
5 439903 AMERICAN SECURITIES LLC UNITED CENTRAL INDUSTRIAL 153.0%
Min 153.0%
Mean 258.2%
Max 500.0%
Source: Bureau Van Dyke Zephyr Database
Figure 8 Analysis of Zephyr database of M&A deals

23
The analysis of the deals below was performed using the details provided in the Zephyr
database.
4.1.3 Deal 1 – GI Partners sells PC Helps support to Baird Capital Partners
In this deal, GI Partners oversaw the growth of PC Helps, a leading desktop and mobile
software application support services company. Over the 7 years of ownership, GI
Partners invested in improving profitability through seeking organic growth (i.e.
according to our Growth Framework, increasing the “Economic Spread” through
synergistic growth) and market expansion (“Discipline” in preserving the Core but still
stimulating progress).
In applying our Growth Framework we can see that some of the leading indicators in
our Framework were present in this deal as reported by PR Newswire (2012A) – except
that in this deal we saw an outsider CEO being employed by the team.
4.1.4 Deal 2 – GI Partners sells Plum Healthcare to Bay Bridge Capital
In this deal, GI Partners oversaw the growth of Plum Healthcare, a nursing facilities,
home health and hospice services provider with a strong reputation for clinical care.
Over the 6 years of ownership, GI Partners invested in improving profitability through
increasing clinical quality and staff levels which resulted in industry leading patient
outcomes results and occupancy rates while improving the mix of medically complex
residents (i.e. according to our Growth Framework, thereby increasing the “Economic
Spread” through “Systems alignment”).
Plum Healthcare also diversified into adjacent markets and expanded geographically
and into different product offerings (“Discipline” in preserving the Core but stimulating
progress).
Perhaps most outstanding was the focus reported by PR Newswire (2012B) saying that
‘The unique human touch Plum brings to a healthcare services business has made it a
rewarding investment.’ I would suggest that this implies the “BHAG” of the business as
being improving patient’s lives through a unique human touch approach to healthcare
(“Vision”). Applying our Growth framework here confirmed that the leading indicators.

24
4.1.5 Deal 3 – Summit Partners backs Welltec MBO
In this deal, Zephyr (2014A) reports that a PE fund, the Riverside Company, exited its
investment in Welltec A/S at a 182 IRR and 9.9 times gross cash on cash return when
the management team and another fund, Summit Partners, bought them out.
Terms were not disclosed except for the above high level information on financial
returns.
4.1.6 Deal 4 – Atlantic Street Capital exits its investment in Fleetgistics
PR Newswire (2010A) reports that Atlantic Street Capital, a specialist investor in
distressed and deep value companies, sold its stake in Fleetgistics to Habour Group,
yielding a return of 7.7x to their $10.4m equity investment and an IRR of 156%.
Atlantic adopted a roll-up strategy, which is as described in Koller (2010A), is a
consolidation strategy to right-size and build a business up to an appropriate level of
scale. Bolting on additional three acquisitions to Fleetgistics, Atlantic Street built up a
national player with superior economies of scale (i.e. according to our Growth
Framework, thereby increasing the “Economic Spread” through revenue and cost
synergies).
Atlantic also paid significant attention to operations by investing in back office support
infrastructure (achieving “Systems alignment”) and in driving a strong teaming culture
(building a “Self-sustaining culture”).
4.1.7 Deal 5 – The Riverside Company exits United Central Industrial Supply Company
Zephy (2014B) reports that Riverside Company sold its stake in United Central
Industrial Supply Company to American Securities Capital Partners, yielding a gross
IRR of 153%.
Terms were not disclosed except for the above high level information on financial
returns.

25
4.1.8 Conclusion
Elements of a
Vision?
Elements of
strong Strategy &
Operations?
Elements of a
strong Culture?
Deal 1 Some Yes – strong
Financial and
Strategic elements
Yes – strong
Discipline
Deal 2 Yes Yes Yes – strong
Discipline
Deal 3 No data, terms not disclosed
Deal 4 Some Yes Yes
Deal 5 No data, terms not disclosed
Figure 9 Summary of top 5 deals
Across the 5 deals analysed above, we were able to test our Growth Framework and
were able to see the predictive power of some of the Framework. Lack of available
terms and data on the deals prevented in-depth analysis, but in the main we were able
to see that in LBO deals, there are usually very clear financial and strategic elements in
the deals consummated, and that there is some evidence of strong Cultures,
particularly the Discipline to do good deals and craft strategy with strong economic
discipline.
We will now proceed to testing the Framework against aggregate fund performance and
observe if the Framework can be applied to low performance businesses to predict their
outcome.
4.2 CALPERS ANNUAL SURVEY OF AGGREGATE FUND PERFORMANCE
The California Public Employees’ Retirement System (“CalPERS”) manages pension
and health fund benefits for Californian civil servants. CalPERS manages the second
largest pension fund in the US and according to Barber (2006), has been recognised as
a leader in institutional activism. We would therefore expect CalPERS to maintain
strong financial discipline over the General Partners managing its private equity
investments.

26
4.2.1 Bottom 5 performers – “Laggards”
CalPERS PE Program Fund Performance Review
Fund description
(figures in US$'000)
Vintage
year Capital
Cash
In
Cash
Out RV Net IRR Multiple
American River Ventures I, LP 1 2001 15,000 15,000 135 135 (61.9)% -
NGEN II, LP 2005 15,000 14,536 918 1,194 (61.6)% 0.1
Exxel Capital Partners V, L.P. 1 1998 75,000 81,861 4,742 4,874 (33.5)% 0.1
Carlyle/Riverstone Renew Energy Infrast 2006 60,000 59,618 5,443 15,410 (23.7)% 0.3
AP Investment Europe, Ltd. 1 2007 75,887 75,050 34,601 34,601 (21.2)% 0.5
Min 15,000 14,536 135 135 (61.9)% -
Mean 48,177 49,213 9,168 11,243 (40.4)% 0.2
Max 75,887 81,861 34,601 34,601 (21.2)% 0.5
Notes: (1) RV = Residual Value
Source: CalPERS (2014)
Figure 10 Summary of Bottom 5 performers deals
We extracted the above data on the bottom 5 performers from the CalPERS (2014)
analysis of PE fund investments. The total population has 292 funds, in which CalPERS
has invested US$45.5B and achieved an average IRR of 68%. We selected these
bottom 5 performers (after excluding recent vintage funds which had a “not meaningful”
footnote assigned to their IRR statistic) and did a deep dive in to the characteristics of
the funds.
4.2.2 Fund 1 – American River Ventures I
O’Brien (2006) in her role as fund CFO describes American River as:
‘an early stage, high technology venture capital firm … We typically
invest $1m to start and up to $7m total in any one startup company. The
companys management team is kept very focused on at least three
things: meeting product and revenue milestones, keeping to a tight
budget, and working on their next round of financing.’
Using the venture capital fund database at CrunchBase, we analysed some of the
recent investments of American River Ventures I and found that the fund hasn’t made
any investments for the past 4 years, with the majority of its investments in very
bespoke and specialist component technologies and R&D driven businesses. American
River Ventures has co-invested with Intel Capital, perhaps this is because one of their
co-founders, Harry Laswell, previously worked at Intel Capital.
Reviewing their website (at http://www.arventures.com) leads to a broken and poorly
maintained corporate site. It is not immediately apparent what the fund’s strategy to
realise value from its portfolio holdings. Perhaps the key problem with American River

27
Ventures is the fact that there is only a 2-man team managing the portfolio. Based on
the fund documents and Bloomberg data that we could observe, there only seems to be
the 2 co-founders involved in the day-to-day business, together with their CFO. In this
way we might say that the fund hasn’t established a strong Team (i.e. according to our
Growth Framework, there is no “Self-sustaining culture” in that new professionals who
join the team can’t absorb a winning team culture”) or a strong Leadership (i.e. there is
no “Discipline” with which to pursue new portfolio investments).
4.2.3 Fund 2 – NGEN II
Siemens (2005) describe the NGEN II fund, run by NGEN Partners as focusing on
cleantech through its understanding of materials science. This includes the areas of
clean and sustainable technology, such as pollution abatement, water, air, and
alternative energy.
Perhaps the key problem with NGEN II has been that the sector of renewable energy is
currently over-invested by VC money at the moment, and that securing good deals with
strong economics is a challenge. Aghion et al (2009) concur with this and add that it is
questionable if ‘Greentech will prove to be a lasting investment interest for VCs, and
suggests that the current investment boom may be an unsustainable bubble.’ (i.e.
according to our Growth Framework, the “Economic Spread” is just not sustainable in
this fund’s portfolio companies.)
4.2.4 Fund 3 – Exxel Capital Partners V
This fund from 1998 was launched by the PE professional Juan Navarro who Goodman
(2001) is said to have been described by some as the “Henry R Kravis of South
America”.
Perhaps the key problem with Exxel Capital Partners V was timing – the fund invested
in Argentina just before a currency devaluation in 2001, which according to Rossa
(2008) forced resulted in their banks taking possession of some of these portfolio
companies owned by the fund.
This could be a great example where, despite having strong leadership in the form of
Juan Navarro (i.e. according to our Growth Framework, the “Leadership” component is
strongly represented), the funds were blighted by bad financial performance and
position of their portfolio companies (i.e. the “Economic Spread” was weak). This

28
highlights the importance of coherence across both the hard aspects of “Strategy &
Operations” and the soft intangible aspects of “Culture”.
4.2.5 Fund 4 – Carlyle/Riverstone Renew Energy Infrast
Despite Carlyle and Riverstone having excellent track records in the PE world, this
outlier fund is their joint venture renewable energy infrastructure fund. CalPERS also
invests in other Carlyle/Riverstone funds with different vintages from 2005 up to 2012,
and those funds each have a positive IRR and have generated significant value for
CalPERS in both cash distributions and the funds’ Residual Value that have all been in
excess of the cash subscriptions by CalPERS in to these funds.
In fact, the follow-on fund, the “Riverstone/Carlyle Renew & Alt Energy II” fund with a
2008 vintage was capitalised at US$300m and has to date generated an 8% IRR for
CalPERS. However, not all appears rosy for the Riverstone/Carlyle JV – as mentioned
above regarding Fund 2 – investing in clean tech is seen by some as being in a
“bubble” (i.e . in our Growth Framework, the “Economic Spread” isn’t very strong).
Wayne (2009) also points to a deeper, systemic problem with Riverstone and reports to
us about the alleged bribery and kickbacks being paid by Riverstone to close
investments from state pension funds. Mr Cuomo, the New York Attorney General is
reported in Wayne (2009) as having said that ‘Riverstone was a partner of Carlyle and
most of the objectionable activities were by Riverstone.‘ Having leaders who stand for
their principles is key, as the standard-bearers of the organisation they should lead with
strong principles and ethics (i.e. we might say that the “Self sustaining culture” here was
a toxic culture!).
4.2.6 Fund 5 – AP Investment Europe, Ltd. 1
As in above with Fund 4 – AP Investment Europe (“AIE”) is a sub-fund of a more
successful franchise – in this case it is Apollo Global Management, a PE house founded
by former Drexel Burnham Lambert banker, Leon Black.
In Apollo Global Management (2012), management explains that this fund was
‘managed from inception through to April 2009 by a portfolio manager who is no longer
associated or affiliated with Apollo or AIE I’ and that it ‘experienced significant losses’.
The fund further explains that AIE was ‘designed to invest in subordinated credit,
employing the use of leverage in these investments.’

29
Based on the publicly available data on this fund, we might conclude that here was a
misalignment between the fund’s financial strategy (i.e. in our Growth Framework, the
“Economic Spread” isn’t very strong) and the market that it operates in. There could
also have been in misalignments in other parts of the business model, for example from
an Operational stand point, the previous portfolio manager may have exceeded his
investment authorisations or undertaken excessive financial risks within the vehicle.

30
4.2.7 Conclusion
Elements of a
Vision?
Elements of
strong Strategy &
Operations?
Elements of a
strong Culture?
Fund 1 Yes – fund is
focused on
milestones,
budgets and
successful
financing rounds
No – public website is poorly maintained
and the Team and Leadership seem to
be lacking.
Fund 2 Yes – NGEN
Partners have a
clear vision
No – Economic
Spread doesn’t
seem sufficient in
cleantech
investing.
No data
Fund 3 Yes – investing in a
booming Argentina
No – Argentina
went through a
currency
devaluation soon
after
Some elements in
Leadership in the
form of Juan
Navarro.
Fund 4 Yes – Riverstone
and Carlyle have
clear visions for the
fund
As above in Fund 2
– Economic Spread
questionable in
cleantech investing
No – risk of a
“Toxic” culture
Fund 5 Yes – Apollo has a
clear vision for
realising value
Potentially there may have been
misalignments between aspects of the
business model
Figure 11 Summary of Bottom 5 performing Funds
One thing that is especially outstanding is that – despite having clear strategic visions
these 5 funds were still the worst performing of their comparison peer set. In other
words – having a good strategic vision isn’t useful if you don’t have a strong supporting
“Strategy & Operations” or “Culture” to support that vision. This confirms one of the
aspects of our Growth Framework.

31
One theme that is consistent with the interviews we conducted is the importance of
systems alignment, and of coherence across the whole hard “techno-system” and soft
“socio-system” of the business.
4.3 A SPECIAL CASE OF A FAILED STARTUP - BARTAP
Wilhelm (2013) introduce an example of a company that received venture capital
funding, but which quickly failed. Flowtab (2013) have published their lessons learned
and a detailed timeline of events for their failed startup.
4.3.1 Introducing the case
Wilhelm (2013) and Flowtab (2013) introduce the facts of the case for us as below.
In 2011, two founders, Mike Townsend and Kyle Hill, developed a mobile payment app
that was designed to be used in bars to order and pay for drinks. It required bars to run
an iPad behind the bar, in order to receive customer drinks orders and to record the
payments. However, when the app first launched on the AppStore, there were no bars
that had the necessary infrastructure for users to interact with!
One key learning that the founders discovered was that they could not partner with
point of sale system integrator companies – Flowtab was a competitive threat to these
companies. The startup needed to build its own sales team to push the product, but
instead at this juncture chose to file for patent protection instead. This absorbed a lot of
management time without a commensurate return on investment.
Flowtab continued burning cash and management time without a clear strategy. They
executed a failed product version launch party, tried to audition for new investor money
on a reality TV show and they hired a call centre in the Philippines to cold-call bars to
sign them up to the Flowtab system. All of these absorbed resources that Flowtab
couldn’t afford to waste.
Flowtab signed a distribution deal with eCommerce company DexOne, but this involved
more cash investment to expand to new cities and markets while Flowtab was still cash
flow negative. This pointed out to the founders that the actual business model of the
Flowtab service was flawed – it required expensive iPads behind the bar, customers
wouldn’t pay an extra US$1 to order drinks through their mobiles and the business was
still at negative ROIC. No matter how much revenue growth they generated, all of that
new growth would still be deletive growth.

32
4.3.2 Applying the framework
Framework suggests? Present in case?
Vision Is there a BHAG that
unifies the company and
rallies the troops?
Unclear what the Vision is.
Economic spread Is there a compelling
business model? Is ROIC
> WACC?
Founders wasted
resources on low non-
strategic matters instead
of building the business.
This resulted in a bad
ROIC.
Systems alignment Are management systems
aligned with the Vision?
Weak systems didn’t
support the business
Where to play / How to
play
Is there a clear strategy
made up of the key five
cascading questions?
No strategic clarity.
Self sustaining culture Is there a strong teaming
culture in place?
The two founders and the
CTO didn’t build a lasting
business with a self
sustaining team.
Discipline Do leaders exemplify good
stewardship? Do they
have the courage to
preserve the core and
stimulate progress?
Founders didn’t have a
good vision of what made
economic sense and that
meant they couldn’t build a
lasting business.
Figure 12 Applying the Growth Framework to the Flowtab case
Finally, after trying to make the old business model work and getting to the stage of
having to raise US$300k, the founders decided to pivot the business model and,
instead of charging users a fee to order drinks, they would go for an advertisement-
supported business model. This pivot eventually failed and the company was wound up.
Based on the analysis of the Flowtab case – I would suggest that the Growth
Framework is a good tool for predicting failure in VC investments as well.

33
4.4 CONCLUSIONS FROM APPLYING THE FRAMEWORK TO LIVE CASES
We were not surprised that the Top 5 performing PE / LBO deals all had strong financial
and strategic reasoning. What was interesting was that the Bottom 5 performing PE
funds and the case of the failed startup both exhibited strong Vision statements, but
lacked the organisational management and cultural strength to deliver on those vision
statements.
One problem that we have with our research methodology is the existence of a
“survivorship bias”. As described by Brown et al (1992) this is a phenomenon where
financial performance for a cohort is calculated based on only the successful members,
excluding the performance of the failures because they didn’t “survive” to the end of the
time series. This is also covered in Kahneman (2011) by what he terms as the
‘availability bias’ – we are making judgements on the applicability of the Growth
Framework based on the available successes that we have examined.
To address this we have tried to also look at the negative cases – for where failures
have occurred and to see if the framework can predict the failure. One common theme
that can we draw from all three case studies (the Top 5 M&A deals, the Bottom 5
Funds, the case of a failed startup) is that having the courage and foresight to adjust
the strategy, to course correct and to pivot the business model is key to success.
Fleetgistics (Deal #4 examined) had the case of a financial investor coming in to a
business and overhauling the business model. Exxel Capital Partners (Fund #3
examined) had the case of a superstar private equity deal maker who lost significant
capital when he over-concentrated his portfolio in a single country – Argentina – without
diversifying his country risk. Had Juan Navarro course corrected earlier on, things may
have turned out differently. And in the case of Flowtab, the founders realised too late
that their business model didn’t make economic sense, and they gave up before they
could profitably pivot their business.
We examine the topic of business agility and the importance of course correcting in the
following section.

34
5 CONCLUSIONS & IMPLICATIONS FOR PRACTICE
5.1 FUTURE STUDIES
There are two main areas we have identified for further research in this area:
Firstly, we were limited by the availability of robust data. Using only secondary data and
desktop research for the second half of this report may have limited the breadth that we
could have gone in to. It is the author’s hope that this Growth Framework could be built
on and further improved in future work, perhaps by working with data from a financial
investor’s own portfolio, or by working with a cross-section of different financial
investors.
Secondly, one area for further work may be to condense the Flowtab (2013) data in to a
case study that is appropriate for analysing entrepreneurship and innovation
management, or as a case study for what VC investors may want to look out for when
conducting due diligence on potential Targets.
5.2 BUSINESS AGILITY
Business agility and organisational learning are topics that have recently surged in
popularity in the business management literature.
Brown (2009) argues the case for greater use of “design thinking” in organisations, as a
way to inspire innovation and encourage organisational learning. Building on this trend,
Ries (2011) exhorts entrepreneurs to adopt a “Build-Measure-Learn” cycle. One might
say that had the Flowtab team adopted design thinking and the “Build-Measure-Learn”
cycle, they might have had an opportunity to course correct and to adjust their business
model profitably.
Taylor & LaBarre (2006) present case studies of visionary “maverick” business leaders
and analyse their successful traits – discovering that great leaders are insatiable
learners. McGrath (2013) extend this further and say that great organisations are led by
leaders and managers who prioritise learning and who rapidly acquire and exploit new
competitive advantages ahead of their competition with active innovation portfolio
management.

35
Finally, in their most recent study, Collins & Hansen (2011) analyse the behaviours of
agile companies who have succeeded through uncertain times. One key trait that they
found was that these companies exhibited ambition and consistency in pursuing those
ambitions. But the key in leading agile businesses is the ability to strategically analyse
their situations and to respond effectively. I would add that it is also important to have
the ability to see the required strategic shift through to its end and to effectively
operationalise that strategy.
5.3 REVISED GROWTH FRAMEWORK
Taking in to account the need for agility in mind, we conclude this report with a revised
growth framework.
Figure 13 A Revised Growth Framework, adding the core pillar of “Agility”
We revised the framework after testing it against actual cases and found that one of the
great predictors of success was an attitude of “Agility”. This presents itself in an attitude
of organisational learning, and is best observed in a company’s use of a portfolio
approach to learning.
In the same way that Ries (2011) exhorts managers to adopt a “Build-Measure-Learn”
cycle, we also suggest that this cycle of constant learning is a key leading indicator of a

36
company’s ability to find profitable growth and to consistently increase their economic
spread over time.
In conclusion, I would say that the forces of economic disruption and innovation
identified in Schumpeter (1961), Perez (2002) and Christensen (2013) have forced
changes on the different manufacturing, services and public sectors. Over time, these
have also affected the practice of M&A, of PE and VC investing. This revised Growth
Framework is offered as a handy heuristic for investors and managers in differentiating
between additive and deletive growth in these times of increased disruption.

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vi
6 APPENDIX 1 – PRIMARY RESEARCH PERFORMED
We interviewed the following professionals to supplement the literature review and the
data analysis performed. In alphabetical order, they are:
Interviewee Firm / Organisation Perspective
Dato Dr Amin Abdullah,
CFA
Chief Executive Officer at
Al Masah Capital (Asia)
PE and M&A
Edmund Yong Managing Partner,
Accel-X Pte Ltd
VC and M&A
Enrique Garland Analyst at Ariadne Capital VC and M&A
Kjartan Rist Partner at Concentric
Partners
VC
Dr Leonid Shapiro Managing Partner of
Candesic
Commercial due diligence
by corporates and PE
funds
Sam Adlen Head of Business
Innovation at Satellite
Applications Catapult
Investing in high growth
business
To structure the discussion, the interviews were conducted using a standard interview
questionnaire. The open questions listed below were asked, followed by detailed follow-
on questions to investigate areas of interest.
Question
1. What do you look for when evaluating an investment?
2. How do you evaluate growth potential of an investment?
3. Do you analyse the different components of ROIC?
4. What benchmarking analysis do you do?
5. How does your risk assessment factor in to your evaluation?

vii
7 APPENDIX 2 – MANIPULATING FINANCIAL EQUATIONS
Some of the analytic work in this section has been inspired from the work of Raisch &
van Krogh (2007) who gave us an insight in to the nature of growth rates with their
benchmarking study of observed industry growth rates. However, we felt that this
approach of analysing just one of the key value drivers (g) in one dimension (time)
needed to be developed further.
Therefore, to extend on the work of Raisch & van Krogh (2007) and to analytically
understand the interaction of growth (g) and ROIC, in the below we have taken a
standard business valuation model and picked it apart, trying to highlight how theory
could inform the practice of pre investment due diligence.
7.1 DERIVING A VALUATION MODEL
Firstly, we start with a commonly used cash flow perpetuity formula described in
Copeland (1998), using a simplifying assumption that cash flows grow at a steady rate
of g.
Equation 1:
We can refine this further by breaking down the FCF term, by rewriting it in terms of net
operating profits less net investment in operations:
Equation 2:
The rate at which a company can grow without borrowing more money and increasing
leverage is limited by the return on invested capital and the rate of incremental
𝑉𝑎𝑙𝑢𝑒 =
𝐹𝐶𝐹𝑡=1
𝑊𝐴𝐶𝐶 − 𝑔
𝐹𝐶𝐹 = 𝑁𝑂𝑃𝐿𝐴𝑇 − 𝑁𝑒𝑡 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝐹𝐶𝐹 = 𝑁𝑂𝑃𝐿𝐴𝑇 − (𝑁𝑂𝑃𝐿𝐴𝑇 × 𝐼𝑅)
𝐹𝐶𝐹 = 𝑁𝑂𝑃𝐿𝐴𝑇(1 − 𝐼𝑅)

viii
investment. This “Sustainable Growth Rate” can be used to define the Investment Rate
as below.
Equation 3:
Substituting IR from Equation 3 in Equation 2 we get:
Equation 4:
Note that this definition of FCF is generally only useful when ROIC is more than g.
When the assumption of steady state growth is higher than ROIC the resulting FCF is
negative!
And now, substituting Equation 4 in to Equation 1 we get:
Equation 5:
Equation 5 is termed the ‘Tao of corporate finance’ by Koller et al (2010A) because it
connects a company’s valuation with the key value drivers of: g, ROIC and WACC.
Koller et al (2010A) then warn us that although the formula is not used in practice
because it assumes a steady state g and ROIC, nevertheless it is a useful analytic to
understand the key value drivers.
𝑔 = 𝑅𝑂𝐼𝐶 × 𝐼𝑅
𝐼𝑅 =
𝑔
𝑅𝑂𝐼𝐶
𝐹𝐶𝐹 = 𝑁𝑂𝑃𝐿𝐴𝑇 (1 −
𝑔
𝑅𝑂𝐼𝐶
)
𝑉𝑎𝑙𝑢𝑒 =
𝑁𝑂𝑃𝐿𝐴𝑇𝑡=1 (1 −
𝑔
𝑅𝑂𝐼𝐶
)

ix
7.2 EQUIVALENCE OF VALUE DRIVERS TO THE MULTIPLE
Although Equation 5 can be used to understand how a DCF valuation is driven by the
key value drivers of g, ROIC and WACC, its usefulness doesn’t stop there. The
investment community frequently uses multiples to analyse company valuation in the
use of price-to-earnings ratios and enterprise-value-to-EBITDA ratios.
We can demonstrate this equivalence by taking Equation 5 and dividing both sides by
NOPLAT.
Equation 6:
Equation 6 demonstrates how the link between earnings multiples that are frequently
quoted by financial analysts (
𝑉𝑎𝑙𝑢𝑒
𝑁𝑂𝑃𝐿𝐴𝑇𝑡=1
) is actually driven by the underlying expectations
of g, ROIC and WACC.
In other words, a valuation multiple can be viewed as a shorthand method for
communicating the interaction of these three key value drivers to other analysts. Koller
et al (2010A) gives an anecdote of a well known analyst using DCF tools to analyse and
value companies, but using implied multiples as a way to communicate his results.
Therefore, when used in comparative valuations, one might use a higher multiple for
one company than another company to justify higher revenue growth potentials (g), or
better margins (ROIC) or a lower risk profile (WACC).
7.3 SENSITIVITY OF VALUATION TO ROIC AND G
One way in which we can analyse the interaction and balance between ROIC and g is
to use a financial model and sensitivity analysis. We constructed a basic financial model
with some very high level assumptions and Equation 1 to Equation 6 detailed above.
In building this financial model, we took a hypothetical company that had earnings of
£100m, a growth rate (g) of 6% during the forecast period, a Return on Invested Capital
(ROIC) of 25%, a Weighted Average Cost of Capital (WACC) of 9% and therefore, an
𝑉𝑎𝑙𝑢𝑒
𝑁𝑂𝑃𝐿𝐴𝑇𝑡=1
=
(1 −
𝑔
𝑅𝑂𝐼𝐶)

x
implied investment rate (IR) of 24%. This resulted in an NPV of £1,676m after using a
15-year forecast period, with an estimate of growth in the terminal period of 3%.
The sensitivity table we calculated with Excel’s built-in Data Table feature is presented
as Figure 14 below, and the full financial model is presented in Appendix 3 – Financial
Model.
1,676 5% 9% 13% 25%
3% 667 1,111 1,282 1,467
6% (441) 735 1,188 1,676
9% (2,361) - 908 1,889
Growth
(g)
ROIC
Figure 14 Sensitivity table of valuation model
We can make the following observations from this sensitivity table:
Firstly, not all growth creates value. When ROIC is only 9%, we can see that additional
growth is actually deletive. Under a low-growth scenario of 3%, the company is valued
at £1,111m. But under the base case scenario of 6% growth the company is valued at
£735m. This deletive growth happens because ROIC < WACC and this is a core tenet
of corporate finance theory – that value is created only when the incremental ROIC is >
the incremental WACC.
Secondly, the tactics to move the business across the matrix have different strategic
implications. For example, under the base case growth and low ROIC scenario of 6%
growth and 9% ROIC the business is valued at £735m. If management were to maintain
the same growth targets at 6%, but move horizontally across to a higher ROIC target of
13%, the business would theoretically be worth more at £1,188m as shown in Figure 5
below.
1,676 5% 9% 13% 25%
3% 667 1,111 1,282 1,467
6% (441) 735 1,188 1,676
9% (2,361) - 908 1,889
Growth
(g)
ROIC
Figure 15 Moving horizontally across the matrix

xi
However, moving diagonally across the matrix, by taking a lower growth target of 3%
but increased ROIC at 13% would actually result in a higher business valuation of
£1,282m as shown in Figure 6 below.
1,676 5% 9% 13% 25%
3% 667 1,111 1,282 1,467
6% (441) 735 1,188 1,676
9% (2,361) - 908 1,889
Growth
(g)
ROIC
Figure 16 Versus moving diagonally across the matrix
Thirdly, that the greatest increases in value happen for high ROIC companies that
achieve high growth. For example, the high ROIC scenario below of 25% shows that
consistently, in scenarios of increasing growth from 3% to 9% that value is consistently
created.
1,676 5% 9% 13% 25%
3% 667 1,111 1,282 1,467
6% (441) 735 1,188 1,676
9% (2,361) - 908 1,889
Growth
(g)
ROIC
Figure 17 High ROIC companies achieving high growth
7.4 SENSITIVITY OF VALUATION TO THE ECONOMIC SPREAD
The key concept that explains this trends that we observed from Figure 14 to Figure 17
is the concept of economic spread.
Equation 7:
This is a core tenet of corporate finance, and is what Koller et al (2010B) refer to as one
of the four cornerstones of corporate finance:
𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝑆𝑝𝑟𝑒𝑎𝑑 = 𝑅𝑂𝐼𝐶 − 𝑊𝐴𝐶𝐶

Growth Framework: A tool for analysing growth opportunities in financial and strategic investments

Growth Framework: A tool for analysing growth opportunities in financial and strategic investments

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