‘Whether it’s broken or not, fix it, make it better. Not only the products, but the entire company if necessary ”. – Bill Saporito
One of the key, often underestimated elements of some private equity (PE) value creation for their portfolio companies is the ability, as an outside investor (or any outside adviser), to provide a out-in perspective, at least in the first few months after the acquisition. This allows a review of the business through an objective and dispassionate prism, that is, in a highly analytical, fact-based way that is not hampered by the many cognitive biases of the leadership team that already exist (e.g., the rationalization of past decisions and related emotional attachment, endowment effect, mental accounting, status quo, or inner vision, to name just a few).
All companies are in business to create value for their stakeholders. Some companies successfully set the right course of value creation and maintain 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 they identify that needs to change about the activities your company is currently undertaking, or how would they create more value above and beyond the way it is currently managed?
1. Change the budget mindset from last year’s default assumption, and reestablishing the discussion to vigorously challenge every dollar in the annual budget, thereby building a culture of cost management.
Zero-based budgeting (ZBB) is a tool often used to seek the most efficient bottom-up return on spending. It provides greater visibility into cost drivers and categorizes each activity into “must have” (eg a legal or regulatory requirement), “required to support differentiating capabilities” and “nice to have”. The goal is to eliminate as many “nice” expenses as possible, to help identify unproductive activities that can then be reassigned to growth-related activities, such as marketing, sales, and mergers and acquisitions.
two. Instill a sense of urgency in cash-generating capabilities. This begins with rigorous management of accounts receivable and payable, as well as inventory optimization, linked to the aforementioned scrutiny of lower-value discretionary expenses and optimization of high-value expenses. This creates a different corporate mindset – let managers try to show why something is the way it is and start actively thinking of ways to improve it as they would if money were coming out of their own pockets. This includes a shift to “discuss things” rather than “discuss things” and the realization that no expense is too small to review, as a hundred small changes saving $ 100,000 each add up to $ 10 million.
3. Maintain a laser-like focus on creating long-term value. Developing and implementing a strategy that will position the company for long-term growth and profitability involves making the right decisions: eliminate low-value activities now, to capture short-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 difficult for most companies. Cognitive biases of the same name, such as endowment, preference for the status quo, or emotional attachment, easily blur what an objective and dispassionate assessment should be (for example, stepping out of business lines that will no longer rely on core strengths of the company and the differentiating capacities that will be built in the future).
Four. Don’t underestimate the need for speed. The PE world shows a bias towards action, as exemplified by the eponymous 100-day schedule that they impose on their portfolio companies during the first months of ownership. They consider this to be the most critical moment to quickly make decisions to implement the strategic changes they have identified, to the detriment of consensus building and alignment. Although most companies do not have as much freedom and have to navigate levels of supervision, it is 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 leads to Opportunity cost: Waiting too long to implement the necessary changes can profoundly affect the future results of the company.
5. Select the right equipment. Strong and effective leadership teams are so critical to the success of private equity firms’ investments that they sometimes invest in a company based on the strength of their managerial talent. Low performers are quickly replaced: CEOs of a third of portfolio companies retire within the first 100 days. As mentioned in a previous blog post, middle managers are even more critical to the successful execution of a strategy. Talent management is not a frivolous activity, it is imperative for success, and companies often don’t put the effort up-front to secure the right team.
6. Select key metrics and set aggressive but 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 and aggressive goals and follow them relentlessly. Many companies already show some performance tracking through key measures, but they are generally disconnected from long-term value creation. The long-term strategy must drive a set of specific initiatives, with explicit objectives that must 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 their portfolio company managers, but add highly variable and annual bonuses based on individual and company performance, plus a long-term incentive compensation package tied to earned returns. Upon leaving. As a result, the fortunes of CEOs and their leadership teams are directly related to the performance of their businesses; they skyrocket when they succeed, but suffer when they don’t achieve their goals. Bonuses are only paid when a few aggressive but realistic performance goals are achieved, unlike bonuses in most companies, which have become an expected part of overall compensation regardless of performance. Establishing a closer link between pay and performance, particularly in the long term (rather than the current year) helps to truly reward top talent and stimulate a culture of high performance.
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 tailored to the realities and constraints of many companies to build a growth engine. .