Three things that should stick with every business leader Featured

8:01pm EDT April 30, 2011
Dan Lubeck, founder and managing director, Solis Capital Partners Dan Lubeck, founder and managing director, Solis Capital Partners

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.

Lesson 3 from the recession: If you follow lessons 1 and 2, recessions can create great opportunities for growth and value creation.

Recessions eliminate the weak and reward the survivors. The weak generally are overlevered and are spending their time and significant dollars appeasing their debt holders. The strong, by contrast, are appropriately capitalized and well run. They are poised to bring in more work and to acquire other companies.

There are many companies, including our portfolio companies, which have thrived during the recession. These companies are growing revenue and EBITDA and are taking market share. They are accomplishing this both organically, often picking up business from failing competitors, as well as through acquisition. Those acquisitions often are of struggling competitors at very advantageous valuations.

Follow these lessons, and your company will be positioned to thrive through down cycles, and to dominate once the market turns positive.

Dan Lubeck is founder and managing director of Solis Capital Partners (www.soliscapital.com), a private equity firm headquartered in Newport Beach, Calif. Solis focuses on disciplined investment in lower-middle-market companies. Lubeck was a transactional attorney and has lectured at prominent universities and business schools around the world. Reach him at dan@soliscapital.com.