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Private Equity Secrets to Value Creation

Private Equity Strategies for Driving Growth and Increasing Value

Money growing in jar

Private Equity Secrets to Value Creation


Private equity firms have long been known for their ability to create value in the companies they invest in. They will often more than triple the value of companies they buy within three to five years. After working with private equity firms for over thirty years, we have come to understand their approach to enhancing value after their investment or acquisition. Their secrets to value enhancement are often low hanging fruit that can be acted on by management and the business owner.


This article explores the strategies used by private equity firms to increase the value of the businesses they own. The elements of the strategy include:

  • Increasing revenue by expanding the sales team.

  • Bolstering the strength of the management team.

  • Increasing profit margins through investments in capital expenditures and other strategic initiatives.

  • Implementing an analytical approach to decision making.

The secrets to private equity value creation aren’t so secret, and if they are embraced by business owners prior to the sale of their company these secrets will help them realize higher valuations for the companies they have spent a lifetime building.


Driving Revenue Growth Through Sales Team Expansion

Private equity firms may explore and pursue growth opportunities through a variety of methods including product or service line expansion, vertical and horizontal acquisitions, and many other methods. But the first initiative they almost always undertake after acquiring a company is to start with an examination of the existing sales team to determine if the team in place is adequate to take advantage of the existing market opportunity. At most of our clients we will see a sales team that is too small, and is too reliant on the CEO or business owner. When this is the case, private equity firms will quickly move to expand the sales team and further penetrate the existing markets. In growing the team, they focus on hiring the right talent, providing comprehensive training and development, establishing effective sales processes and workflows, and continually seeking ways to optimize their sales team's efforts. Growing the sale team takes some effort but is critically important to creating value.


Increasing the Strength of Management Teams

While growing the sales team is important, if a company is going to profitably grow while meeting their customer’s needs, they will need to have strong people in place at every level of management. Private equity firms often work with the CEOs of companies they have bought to identify weaknesses in the team and recruit the right talent to improve the management team. The areas of focus by private equity firms are typically in the areas of sales, operations, and finance and accounting. Having strong leadership in each of these areas allows the CEO the flexibility to spend time on developing and implementing strategy rather than crisis management that often takes over when there isn’t an adequate management team in place. Private equity firms will also focus on providing training and mentorship to existing members of the management team and helping them to develop the skills and knowledge needed to effectively lead the business. While increasing the strength of the management team might increase operating expenses at the company, it will almost always result in improvements in profitability and company valuation over time.


Improving Profit Margins Through Capex and Other Strategic Expenditures

While private equity firms have a reputation for being relentless cost cutters who cut personnel and costs throughout an organization, we have only seen this with multi-billion-dollar acquisitions that make the front page of the Wall Street Journal. In sharp contrast to those front-page deals, we find that private equity firms investing in lower middle market companies are likely to encourage spending to grow the team or improve gross profit margins or EBITDA (earnings before interest, taxes, depreciation, and amortization). One example of this was a company that invested $5 million to purchase additional manufacturing equipment to both improve output as well as to generate a 7% improvement in the company’s gross profit margin. Another example is a company that invested $300,000 on a market study identifying how large the market opportunity for their products was and where their sales team should focus their efforts. The company’s CEO was very suspect of the investment at the outset, but later stated that it turned out to be one of the best investments he had ever made in his business. Private equity firms have a strong belief in the old adage "sometimes you have to spend money to make money." They don’t do it blindly, stupidly, or without an end in mind, but they will sacrifice short-term profitability or cash flow for long-term value creation.


Creating an Analytical Decision Making Culture

Private equity firms realize that effective decision making is a critical part of value creation at the companies they own. To support effective decision making, they encourage their portfolio companies to create a data-driven decision-making culture that relies on data collection and analytics to help make decisions. For example, if a management team wants to open a new branch in Tulsa, Oklahoma, they will need to show the data and analysis to support that decision. Likewise, if management want to expand the company’s manufacturing capabilities in Madison, Wisconsin, the data and analysis will need to support that decision. By creating a culture where data-driven decision-making is the norm, the company is encouraging critical thinking and intellectual curiosity that leads to better decision making and helps everybody work smarter.


Some companies collect data and analyze everything. Others still want an analytical approach to decision making, but they significantly simplify the decision making by focusing on a single metric. One key metric that private equity firms often focus on is EBITDA, which is a measure of a company's profitability that is the key factor used in determining company valuation. Increasing EBITDA becomes the gate through which all significant decisions must eventually pass. In board meetings we have attended we have seen board members apply simplified analytical decision making by responding to management proposals with the question, “how that is going to increase long-term EBITDA?” This creates an easy lens through which management can evaluate many of their important decisions.


Secrets to Private Equity Concluding Thoughts

Private equity firms have long been known for their ability to create value in the companies in which they invest. By focusing on the four key areas we have outlined above, these firms are able to drive growth and increase profitability, leading to significant value increases at the companies they own.


The secrets to private equity value creation aren’t so secret and are not exclusively available to private equity firms. They are sound strategies that should be considered by every business owner. Implementation of these strategies by business owners will allow them to significantly increase the value of their company prior to its sale.


If you would like to explore these value enhancing strategies and others prior to the sale of your company, please call one of the professionals at Waypoint Private Capital.

 

About Waypoint Private Capital

We are an investment banking firm that provides lower middle-market clients the quality of

investment banking services typically available only to large companies. Waypoint helps privately-held business owners sell and buy companies, raise equity and debt capital for growth and recapitalization, and plan for a successful exit from their business.


To learn more visit waypointprivatecapital.com or call us at 608.515.3354 or 918.633.2647 and speak with a Waypoint Private Capital expert.

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