Ever since I got involved with Private Equity operators and their many times straightforward, simple and obvious finds for value creation, I wondered why management couldn’t find the same paths to success prior to change of ownership. Taking financial engineering aside, which is arguably a major value creator, what is most astonishing is how many companies’ core operation performance improves under PE. While there is no definite answer, the seed of the truth lies somewhere in the following areas:
The oldest and biggest value creation argument has been – “while we back management we are quick to bring in the best talent”. Recruiting great performers does not sound like rocket science to me. Why can’t a company upgrade their managers and functional specialist before PE shows up?
Performance and Rewards
The outsize rewards of meeting and exceeding EBITDA targets are a major lever. This may be one of the most important. Many companies I met had a hard time with their incentive models both on the upside and the downside. Without PE owners managers would rather keep a narrow band of rewards between top players and bottom performers than create a competitive workplace. Over time the underperformers stick around and the top athletes leave for a workplace that better rewards them for delivering twice as much. If you think you have meritocracy try this test: if your top sales guys deliver 2x the expected do they get 2x of the bonus? How about your CFO or CPO? How about delivering half? Is that half or none of the bonus pool? I rest my case.
Knowing What Works
Having been involved in performance benchmarking for a decade now, I’m convinced that the average company is woefully unaware of where they stand against their peers in most but a few functional areas. Benchmarking becomes a tool to justify a pet project to the board vs. a way to discover and fix weaknesses and exploit strength. PE brings this discipline to bear.
This is huge. I spent the early years of my career in projects like ‘improvement portfolio optimization’, which was a way for a company to rationalize and prioritize hundreds and sometimes thousands of initiatives. Most projects remained on the books and I believe the average large corporation still has hundreds of competing and parallel programs, most with massive negative impact on the business in distraction, wasted resources or simply sunk cost. PE has an unparalleled ability to cut down the chaos and focus the business on very projects with quantifiable results. And executive compensation tied to the results.
Initiative du jour is so true it is a cliche in most companies. Beyond the question of focus above, the cash flow pressure of debt paybacks many times create a culture of thrift, attention to real business cases and results. My former boss at a public company had this approach even without PE: whatever the project needs in terms of resources – give them half. Mostly the projects will still come in on time, delivering the results and not wasting too much time and resources in navel gazing.
The key point here is this: almost all operational tools PE deploys are available to management teams. If they had the focus, discipline and right talent they would be able to reap similar returns to PE firms without surrendering most of the rewards.