Shortly after the movie “Saving Private Ryan” was released, I spoke with a World War II veteran who was one of the first soldiers to jump out of a landing craft to storm the beaches of Normandy. He said the movie was the most accurate depiction of that glorious and horrific event that he had ever seen. He was one of the lucky ones.
The beaches of Normandy are a good analogy to today’s post-recession landscape of buyout investors and operating companies: Many are dead, many more are severely injured, and a few are strong and thriving. What factors make the difference? The first and most important of these is debt. When used appropriately, debt can be a very cost-effective source of capital for growth. When used excessively, debt can put a company at risk of loss and cause a tremendous shift of resources and time away from your main focus — value creation.
The problem with debt is that lenders cycle greatly in their willingness to lend. At times like today, underwriting is very strict, and except for the most ideal borrowers, debt is very hard to get. Typical leverage today is around 2 to 2.5 times earnings before interest, taxes, depreciation and amortization (EBITDA). By contrast, at times like those from 2003 through 2007, debt is abundant and aggressive. Typical leverage during that period was around 3.5 to 4 times EBITDA, and often got as high as 6 or 7 times.
Lesson 1 from the recession: Don’t overlever
Even if lenders are willing to lend, only borrow to the extent the company can cover under conservative projections. If debt alone cannot meet the company’s capital needs, then look at bringing in equity. We often say, “It’s better to own half a watermelon than a whole grape.”
Lesson 2 from the recession: Run your company during boom times as if times were lean.
We have heard many leaders bemoaning that their companies would be far more successful if they had run them during the boom period as they are running them now. Without question, success can bring complacency. However, the best leaders we know resist this tendency. Their companies’ cultures foster continuous improvement and cost-reduction regardless of great performance.
Similarly, the advice we often give entrepreneurial and family business owners is, “Run your company as if you are preparing to sell it in three years.” This means eliminating underperforming employees (which can be difficult, even when done with great care and consideration, but is critical), and building cost-cutting and improvement initiatives. These efforts will grow EBITDA and result in a more successful, resilient and valuable company.
