Selling your company? Why not do what a Private Equity firm would do?June 21, 2018
There are more than a thousand private equity (“PE”) firms that buy middle market companies, then make mostly straightforward and predictable changes, and sell the companies again for double or more what they paid initially.
If a PE firm buys a company, what do they do? What are these straightforward and predictable changes? And can a business owner make those changes him/herself?
Let’s start with the last question: can a business owner do it himself?
The answer is yes, but outside help is needed. And while the changes needed may be straightforward and predictable, I did not say they are easy. But why would they be? Doubling the value of the company in three to five years is not likely to be easy. As a result, the business owner has to ask how much he/she cares about taking the valuation from, for example, $20 million to $40 million. If the extra $20 million is not that big a deal to the owner, or it is not enough to justify the time and effort, then by all means gift that value creation opportunity to financial buyers – people who did nothing to create the company and build it up over decades.
Assuming the owner does want to retain the extra $20 million for himself and his family, why is outside help needed to make that happen? The answer falls into two parts:
1. Change is challenging. Even where the changes needed to effect significant value creation are known to the owner, change is always challenging. An organization and the people in it (including the owner/CEO) get set in their ways. Knowing what to do and actually doing it are two different things. Part of what you get from Stanton Associates is a tough fitness trainer. We work with management to build detailed executable plans with monthly goals and objectives by department, together with a performance management system that holds everyone accountable for delivering results on time and on budget. It is also a lot easier for outside consultants to be analytical and dispassionate about what needs to be done. We are not encumbered with company traditions or long-term relationships. But unlike a PE firm buyer that can be ruthless after an acquisition, we will work with the business owner to effect acceptable changes.
2. Experience matters. Also, knowing what to do and doing it well are different again. While the changes required may be known to the CEO conceptually (e.g., from what has been learned at YPO or Vistage meetings – or just general business reading) doing it for the first time requires a lot of trial and error. Successful business owners are invariably clever and resourceful. But while they have been focused on their own company and industry for decades, Stanton Associates has worked with dozens of companies on executing improvements. We are not more clever than company management, we have just seen the movie before – and that makes a huge difference.
Which takes us to the first question: what are the straightforward and predictable changes a PE firm would make if they buy the company? While every company is unique and the specific answers are going to vary, simply put the changes needed will improve every area of the company. It may well be that some of the company’s functions are already excellent; however, just as a chain is only as strong as its weakest link, a material deficiency in any part of the company will drag down the whole enterprise.
Accordingly, the changes may include implementing the following or, if they are already in place, increasing the effectiveness:
- Documented business plan and financial model
- Monthly goals and objectives by department
- Performance management system to hold everyone accountable
- Compensation system that rewards performing according to the plan (and “negatively rewards” those who do not)
- Accurate sales forecasts
- Accurate cash flow forecasts
- Accurate and timely historical financial statements
- ROI based decision-making
- Sales organization has the tools, processes, training and supporting infrastructure to ensure that growth targets can be hit
- Marketing serves a strategic role, while effectively delivering market awareness, demand creation and tools are available to support the sales process
- Product costs (direct variable costs) are known at the SKU level so that a reliable break-even analysis exists to drive product strategy and inform product pricing and allow gross margin expansion
- The interests of the shareholders, management, and all employees are aligned to ensure the whole company is executing the value creation plan with discipline, determination, and a sense of urgency.
As you can see, I have not listed the potential for improvements in products or service, quality, and on-time delivery. Or the potential to grow into adjacent market segments or expand to other territories (either via direct sales or via distributors/resellers) or use core competencies to launch new product lines. These may also all be attractive and achievable opportunities. But first start with the basics to the extent they are not already at an A level.
When the value creation plan has been successfully implemented the company can then be sold at the much higher price to the category of buyer that the PE firm would sell to.
There’s also another attractive alternative. After driving significant value creation, business owners may choose to do a dividend recap. In a dividend recap, business owners pay themselves a dividend approximately equal to the extra value that has been created, and they continue to own the company.
I’d love to hear what you think about this issue. Please let me know in the comments section below.
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About Stanton Associates
Stanton Associates is passionate about helping business owners unlock the value in their companies and keep it for themselves. We are different from most exit planners. Like others we help prepare the company for sale and guide business owners through the process. What sets us apart is our ability to drive significant value creation. It is our mission to ensure that business owners don’t allow to be stolen what is rightfully theirs. Members of the Stanton Associates team have been the CEO, CFO, COO, CMO and Head of Sales at many mid-market companies. We know what it takes to drive value creation prior to an exit.