‘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 “outside in”, at least in the first months after the acquisition. This allows for 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. rationalizing 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 they identify as needing to change about the activities your company is currently doing, or how would they create value above and beyond the way it is currently managed?
1. Change the budgeting mindset from last year’s default assumption, and resetting the discussion to vigorously challenge every dollar in the annual budget, thereby creating a culture of cost management.
Zero-Based Budgeting (ZBB) is a tool often used to seek the most efficient bottom-up return on spending. Provides greater visibility into cost drivers and classifies each activity as “must” (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, such as marketing, sales, and M&A.
two. Instill a sense of urgency in cash generation capabilities. This begins with strict management of accounts receivable and payable, as well as inventory optimization, tied to the aforementioned scrutiny of lower-value discretionary spend, and optimization of high-value spend. 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 shift to “discussing things” instead of “discussing things” and realizing that no expense is too small to review, as a hundred small changes saving $100,000 each still 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 sound decisions: eliminate low-value activities now, to capture short-term cost benefits, while at the same time investing in the ideas highest potential to create core value. This requires having an objective and dispassionate view to decide what is really essential for the business, where the growth potential lies and how to capture it. Deciding what to stop doing is often difficult for most companies. Eponymous cognitive biases, such as endowment, preference for the status quo, or emotional attachment, easily blur what an objective and dispassionate assessment should be (for example, exiting lines of business that will no longer leverage the company’s core strengths). company and differentiate the capabilities to be built in the future) .
Four. 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 quickly make decisions 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 layers of oversight, it’s important to strike the right balance between the need to build consensus and align to drive change, and the recognition that not acting fast enough leads to risk. Opportunity cost: Waiting too long to implement the necessary changes can profoundly affect the company’s future results.
5. Select the correct 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 in 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 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 but realistic goals. PE firms manage their portfolio companies by developing a select set of key measures, in a few areas critical to the success of the acquired company. They then set clear and aggressive goals and track them relentlessly. Many companies already exhibit some performance tracking across key measures, but 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 managers at their portfolio companies, but add highly variable annual bonuses based on individual and company performance, plus a long-term incentive compensation package linked to returns earned at the time. time of departure. As a result, the fortunes of CEOs and their leadership teams are directly tied to the performance of their businesses; soaring when they succeed, but suffering when they fail to reach their goals. Bonuses are only paid when a few aggressive but realistic performance targets are met, unlike bonuses at most companies, which have become an expected part of overall compensation, regardless of performance. Establishing a closer link between pay and performance, particularly over the long term (rather than the current year), helps to truly reward star talent and stimulate 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. .