The formula to help your firm manage this year

It’s January 2016 as we think about this scenario for your firm: By January 2019, you have grown your firm’s valuation three and one half times its current valuation. How could you do this is just three years? One possibility is to use private equity disciplines.

The purpose of this article is to give you the ammunition to decide if you want to take on private equity disciplines before being approached by a private equity firm to sell to them or maintain your ownership and grow your firm yourself. I will paraphrase from a great little book “Lessons From Private Equity Any Company Can Use” by Orit Gadiesh and Hugh MacArthur in addition to relaying my experience.

funds buy existing businesses, apply hard-nosed disciplines and usually after three to five years sell the company for sometimes a huge capital gain. For example Onyx funds bought Canada’s Husky Injection Molding Systems for $900 million in 1998 and two and a half years later sold the firm for $2.5 billion.

The private equity industry has been booming for the last 10 to 15 years. Warren Buffett’s Berkshire Hathaway, Bain Capital (Mitt Romney’s former firm) and the Carlyle Group are some of the well-known names. Google “list of private equity funds,” and you fill find hundreds listed and this. And guess who is owned by a private equity firm? Chrysler, Ducati motorcycles, Tiffany, Gucci, Neiman Marcus, Hertz, Hilton Hotels, Metro- Goldwyn-Mayer, Toys ‘R’ Us, to name a few. It is estimated all private equity firms invested globally $1 trillion to buy firms from just 2005-08. With the growth of the number of private equity firms awash with capital, nearly all established firms could be targets.

When a private equity firm acquires an existing firm, this is usually a win-win for the private equity firm and the owner of the business who gets to cash out. Usually they can still serve in their firms, but this is not ironclad. Some private equity firms are ruthless in slashing costs and people, selling real estate, moving production offshore, etc. to try to increase the valuation of the firm very quickly for a “flip” – a quick sale within three to five years to another entity. This kind of PE firm has been described as “nasty” and heavily criticized over the last few years. In addition if your firm is a family business, it can be dismantled by this kind of private equity firm. Another kind of private equity is described as having “patient money.” These private equity firms partner with the management teams to work together to build the valuation of the firm over longer periods of time. While they can be very tough on the management teams, there is a sense of “shared destiny” to build the valuation of the firm.

So what is the “formula” that private equity firms use to grow the valuation of the firms they have purchased and now help to manage?

1. Define the full potential of your company – The target is large increases in equity value. Getting there requires strategic due diligence and the pursuit of a few core initiatives. This step can be daunting though. Say you have a good business that operates only in Shreveport and you do not like to travel. But what if the full potential of your business lies in it being national in scope? You need to change or hire someone who likes to travel.

2. Develop a blueprint for change – The blueprint details how to turn a handful of initiatives into results, choreographing actions from start to a finish line. Key here is private equity firms do not confuse effort with results. Results are all that matter.

3. Accelerate performance – This step entails molding the organization to the blueprint, implementing a rigorous program and monitoring a few key metrics. Key here is if you think something will take two years to do, the private equity firm will demand a one year or less cycle time.

4. Harness the talent – This discipline requires creating the right incentives for managers to think and act like owners, and assembling a decisive and efficient board. Key here is employing incentive compensation that only pays out if targeted increases in firm valuation are achieved.

5. Make equity sweat – The challenge is to embrace Leveraged Buyout economics (this means using more debt in your capital structure). This stage calls for managing working capital aggressively and disciplining capital expenditures. Key here is adding assets only if they will contribute to profitable growth firm valuation. A misstep of faulty investment can mean the CEO’s job.

6. Foster a results-oriented mindset – This means making private equity disciplines part of a company’s culture and creating a repeatable formula for achieving results. Key here is once milestones have been achieved, the private equity firm sets higher milestones.

Is your firm ready to take on private equity disciplines, ahead of being approached by a private equity firm? Or would you desire to sell your firm to a private equity group and cash out? Or is the way you’re running your firm now just fine?

Bill Bigler is Director of MBA Programs and associate professor of strategy at LSU Shreveport. He spent 25 years in the strategy consulting industry before returning to academia full time at LSUS. He is involved with several global professional strategy organizations and can be reached at bbigler@lsus.edu or www.billbigler.com.