Michael Beauregard, Senior Partner, Huron Capital Partners07.20.15
As a business owner, you’ve probably heard about private equity firms looking to invest in middle market companies like yours. And just because most have capital to invest doesn’t mean they are all the same. In fact, one crucial point of differentiation is what these firms do after the check is written and their money is invested with you. In other words, what specific growth strategies have they identified and how are they planning to pull the oars with you? Not only is this plan to create value important to the private equity firm looking to make a return for its limited partner investors, it is equally important for business owners who are planning to reinvest or “roll” a portion of the proceeds from a sale of their company to be in lock-step agreement with the strategy and its execution.
This article will introduce three fundamental levers of value creation that go beyond a private equity firm’s initial equity investment: operational, financial, and strategic. It will also discuss specific levers within each category that can be pulled to help accelerate earnings and create value for you, your management team, and your private equity partner.
An operationally-focused investment approach is perhaps the most important tool of value creation that a private equity firm can offer. Operational levers can include: increasing throughput amount by addressing manufacturing bottlenecks, improving supply chain management, adding additional manufacturing capacity, building or improving upon a quality control system, recruiting talent from the private equity firm’s network, and installing or updating IT systems that track and monitor key performance indicators.
For example, Huron Capital partnered with the management team of an engineered plastic film manufacturer located in the Midwest. Prior to Huron’s investment, the company was at 80% capacity and needed a facility expansion in order to accommodate growth. Huron, in partnership with management, made funds available to add two new manufacturing lines and optimized existing lines, increasing capacity by more than 12 million pounds or 37%. In addition, Huron and management identified meaningful cost savings related to scrap by institutionalizing a continuous improvement program for scrap reduction and funded the implementation of a new ERP system, which should enhance margins, production efficiencies, and financial processes across the company’s two facilities.
In an effort to enhance profitability through traditional routes like manufacturing efficiency improvements, it is not uncommon for a business owner to overlook the meaningful impact of financial levers. These may include working capital management, alternative debt financing, the sale and lease back of fixed assets, capital investment or divestment, and management of the fixed/variable cost structure. It may also include additional focus on recurring, non-project oriented revenue streams to reduce cyclicality or seasonality.
For example, Huron Capital partnered with a designer and importer of fashion casual and athletic socks sold principally through specialty footwear retailers and sporting goods stores. Prior to Huron’s involvement, the company factored its receivables through a third party. While factoring is useful for companies that need immediate cash from the sale of a receivable to meet current obligations, it can be quite pricey and restricts the company from using those assets to secure other more traditional financing. Part of Huron’s investment in the company went to retire over $2.5 million of factoring debt, which allowed the company to take back ownership of its receivable assets and retain a full margin from product sales. Huron’s investment also helped the company secure a $10 million revolving line of credit from a commercial bank with over $4 million of liquidity for near term working capital needs. Further, Huron was able to negotiate favorable terms on behalf of the company due to a long term relationship it has with that particular bank, having closed several other financings with it in recent years.
Strategic levers can be extremely powerful and transformative, yet are often de-prioritized by business owners. This is certainly not surprising, as an owner’s plate tends to be full managing critical day to day operations, and additional resources are often unavailable to tackle vital strategic questions. Strategic levers may include: expanding existing customer relationships and/or acquiring new ones, extending a company’s geographic footprint, adding new products and services, building a formal sales team and business development process, training new managers, and executing synergistic add-on acquisition opportunities.
For example, Huron Capital and management led the recapitalization of a fire protection engineering services firm headquartered on the East Coast. Prior to Huron’s investment, the company had 18 locations and had grown by opening new offices (15) and through acquisition (3). With Huron’s involvement, the company has opened or acquired 32 offices through eight separate transactions, growing the business to 50 offices worldwide. In addition to arranging the capital necessary to affect these acquisitions and office openings, Huron formalized a rigorous strategic planning process to define and allocate resources toward top acquisition and geographic priorities. Huron also provided intellectual capital by identifying several new members for the board of directors. One of those members is a seasoned industry veteran who helped management identify and implement specific workflow process improvements and increase the company’s business development activity resulting in a solid platform for future acquisitions.
As a business owner, choosing the right private equity partner is crucial to ensuring meaningful value creation. You should select an investment partner with a common partnership philosophy who will bring more than just an “equity check” to the relationship. This is especially true if you are planning to reinvest a portion of your ownership from the sale of the company and share in the potential for future upside. If the company is successful at identifying and pulling one or more of the operational, financial, or strategic levers in collaboration with a private equity partner, management and the board of directors, you could be poised to realize significantly more value than your original sale proceeds. Put another way, why settle for just one or two bites of the proverbial apple when you can enjoy the whole thing?
This article will introduce three fundamental levers of value creation that go beyond a private equity firm’s initial equity investment: operational, financial, and strategic. It will also discuss specific levers within each category that can be pulled to help accelerate earnings and create value for you, your management team, and your private equity partner.
An operationally-focused investment approach is perhaps the most important tool of value creation that a private equity firm can offer. Operational levers can include: increasing throughput amount by addressing manufacturing bottlenecks, improving supply chain management, adding additional manufacturing capacity, building or improving upon a quality control system, recruiting talent from the private equity firm’s network, and installing or updating IT systems that track and monitor key performance indicators.
For example, Huron Capital partnered with the management team of an engineered plastic film manufacturer located in the Midwest. Prior to Huron’s investment, the company was at 80% capacity and needed a facility expansion in order to accommodate growth. Huron, in partnership with management, made funds available to add two new manufacturing lines and optimized existing lines, increasing capacity by more than 12 million pounds or 37%. In addition, Huron and management identified meaningful cost savings related to scrap by institutionalizing a continuous improvement program for scrap reduction and funded the implementation of a new ERP system, which should enhance margins, production efficiencies, and financial processes across the company’s two facilities.
In an effort to enhance profitability through traditional routes like manufacturing efficiency improvements, it is not uncommon for a business owner to overlook the meaningful impact of financial levers. These may include working capital management, alternative debt financing, the sale and lease back of fixed assets, capital investment or divestment, and management of the fixed/variable cost structure. It may also include additional focus on recurring, non-project oriented revenue streams to reduce cyclicality or seasonality.
For example, Huron Capital partnered with a designer and importer of fashion casual and athletic socks sold principally through specialty footwear retailers and sporting goods stores. Prior to Huron’s involvement, the company factored its receivables through a third party. While factoring is useful for companies that need immediate cash from the sale of a receivable to meet current obligations, it can be quite pricey and restricts the company from using those assets to secure other more traditional financing. Part of Huron’s investment in the company went to retire over $2.5 million of factoring debt, which allowed the company to take back ownership of its receivable assets and retain a full margin from product sales. Huron’s investment also helped the company secure a $10 million revolving line of credit from a commercial bank with over $4 million of liquidity for near term working capital needs. Further, Huron was able to negotiate favorable terms on behalf of the company due to a long term relationship it has with that particular bank, having closed several other financings with it in recent years.
Strategic levers can be extremely powerful and transformative, yet are often de-prioritized by business owners. This is certainly not surprising, as an owner’s plate tends to be full managing critical day to day operations, and additional resources are often unavailable to tackle vital strategic questions. Strategic levers may include: expanding existing customer relationships and/or acquiring new ones, extending a company’s geographic footprint, adding new products and services, building a formal sales team and business development process, training new managers, and executing synergistic add-on acquisition opportunities.
For example, Huron Capital and management led the recapitalization of a fire protection engineering services firm headquartered on the East Coast. Prior to Huron’s investment, the company had 18 locations and had grown by opening new offices (15) and through acquisition (3). With Huron’s involvement, the company has opened or acquired 32 offices through eight separate transactions, growing the business to 50 offices worldwide. In addition to arranging the capital necessary to affect these acquisitions and office openings, Huron formalized a rigorous strategic planning process to define and allocate resources toward top acquisition and geographic priorities. Huron also provided intellectual capital by identifying several new members for the board of directors. One of those members is a seasoned industry veteran who helped management identify and implement specific workflow process improvements and increase the company’s business development activity resulting in a solid platform for future acquisitions.
As a business owner, choosing the right private equity partner is crucial to ensuring meaningful value creation. You should select an investment partner with a common partnership philosophy who will bring more than just an “equity check” to the relationship. This is especially true if you are planning to reinvest a portion of your ownership from the sale of the company and share in the potential for future upside. If the company is successful at identifying and pulling one or more of the operational, financial, or strategic levers in collaboration with a private equity partner, management and the board of directors, you could be poised to realize significantly more value than your original sale proceeds. Put another way, why settle for just one or two bites of the proverbial apple when you can enjoy the whole thing?
