The "Value Bridge," which attributes change in value to changes in EBITDA, multiples, and net debt, is fundamentally flawed. It is often misleading for those who seek to identify operational and/or strategic value-add. Moreover, it does not quantify or identify alpha.
In addressing these flaws, we have developed The Kroll Created Value Attribution Framework (the “Framework”). The Framework builds on the traditional Value Bridge by 1) taking into account the factors that underlie the changes in EBITDA, the multiple, and net debt 2) assessing organic (i.e., created) value change vs. transactional (i.e., purchased) value change and 3) taking into account portfolio company vs. respective industry performance. The resulting value change drivers are quantified and also mapped to four fundamental sources: industry/sector, capital markets (beta), deleveraging, and unique (alpha).
In this update to our original 2014 whitepaper, we present the full conceptual details of the Framework, utilizing an illustrative example based on an actual case study. We also provide, based on our more than 90 studies to date, statistical evidence as to the inefficacy of the traditional Value Bridge as well as other observations on value creation in private equity that may very well have implications for both private equity GP’s and LP’s.