The Private Equity vision of your company

‘Whether it’s broken or not, fix it, make it better. Not just the products, but the entire company if necessary.’ -Bill Saporito

One of the often underestimated key elements of value creation by some private equity (PE) firms for their portfolio companies is the ability, as an outside investor (or any outside advisor), to provide insight from the “outside in”, at least in the first few months after the acquisition. This allows for a review of the business through an objective and dispassionate prism, that is, in a very analytical, fact-based way, that is not hampered by the many cognitive biases of the leadership team that already exist (for example, rationalization of past decisions and related emotional attachment, endowment effect, mental accounting, status quo, or insight, to name just a few).

All companies are in business to create value for their stakeholders. Some companies successfully set the right value creation course and sustain it over time, while others fail. So take a few minutes today to put yourself in the shoes of an outside investor and their ‘outside-in’ perspective of your business: What would you identify that needs to change about the activities your company is currently doing, or how would you create value on top of that? and beyond the way it is currently managed?

1. Changing the budgeting mindset from last year’s default assumption, and readjust the discussion to vigorously challenge every dollar in the annual budget, thus creating a culture of cost management.

Zero-Based Budgeting (ZBB) is a tool often used to seek the most efficient bottom-up cost performance. Provides greater visibility into cost drivers and ranks each activity between “must have” (for example, a legal or regulatory requirement), “necessary to support differentiating capabilities” and “nice to have.” The goal is to eliminate as many “nice to have” expenses as possible, to help identify unproductive activities that can then be reallocated to growth-related activities, for example, marketing, sales, and M&A.

2. Instill a sense of urgency in cash generation capabilities. This starts with tight management of accounts receivable and payable, as well as optimization of inventories, tied to the aforementioned scrutiny of lower-value discretionary expenses, and optimization of high-value expenses. This creates a different corporate mindset: stop managers trying to prove why something is the way it is, and start actively thinking of ways to improve it the way they would if the money came out of their own pocket. This includes a change to “discuss things” instead of “discuss things” and realizing that no expense is too small to be reviewed, as a hundred small changes that save $100,000 each still add up to $10 million.

3. Keep a laser-like focus on long-term value creation. Developing and implementing a strategy that will position the company for long-term growth and profitability involves making sensible decisions: eliminating low-value activities now, to capture near-term cost benefits, while at the same time investing in ideas. with the greatest potential to create core value. This requires taking an objective and dispassionate view to decide what is truly critical to the business, where the potential for growth lies and how to capture it. Deciding what to stop doing is often difficult for most companies. Homonymous cognitive biases, such as endowment, preference for the status quo, or emotional attachment, easily blur what should be an objective and dispassionate assessment (eg, exiting lines of business that will no longer be based on the core strengths of the company and differentiate capabilities to be developed in the future).

4. Don’t underestimate the need for speed. The PE world exhibits a stock bias, as exemplified by the eponymous 100-day program they impose on their portfolio companies during the first few months of ownership. They see this moment as the most critical to make decisions quickly to implement the strategic changes they have identified, to the detriment of consensus building and alignment. While most companies don’t have as much freedom and have to navigate levels of oversight, it’s important to find the right balance between the need to build consensus and align to drive change, and the recognition that not acting fast enough comes with a risk. Opportunity cost: Waiting too long to implement the necessary changes can profoundly affect the future results of the company.

5. Select the right team. Strong and effective leadership teams are so critical to the success of PE companies’ investments that they sometimes invest in a company based on the strength of its managerial talent. Underperformers are quickly replaced: CEOs of a third of portfolio companies leave within the first 100 days. As mentioned in a previous blog article, middle managers are even more critical to the successful execution of a strategy. Talent management is not a frivolous activity: it is imperative to success, and companies often do not put in the effort up front to secure the right team.

6. Select key metrics and set aggressive yet realistic goals. PE firms manage their portfolio companies by developing a select set of key measures, in some areas critical to the success of the acquired company. They then set clear, aggressive targets and track them down relentlessly. Many companies already exhibit some performance tracking through key measures, but this is generally disconnected from long-term value creation. The long-term strategy should drive a set of specific initiatives, with explicit objectives that should then drive the annual plans and budgets, that is, there is a direct operational link between the strategy and the business.

7. Align performance and incentives. PE firms pay modest base salaries to the managers of their portfolio companies, but add highly variable annual bonuses based on individual and company performance, plus a long-term incentive compensation package tied to returns earned from time of departure. As a result, the fortunes of CEOs and their leadership teams are directly related to the performance of their businesses; rising when they succeed, but suffering when they fail to achieve the goals. Bonuses are only paid when a few aggressive but realistic performance targets are achieved, unlike bonuses at most companies, which have become an expected part of overall compensation, regardless of performance. Making a closer link between salary and performance, particularly over the long term (rather than the current year) helps to truly reward star talent and foster a high-performance culture.

PE companies enjoy a number of natural advantages when it comes to building efficient, high-growth businesses, but some of their best practices provide powerful and widely applicable metrics that can be adapted to the realities and constraints of many companies to build a engine for growth. .