As investors, our focus is on companies in the lower middle market. This typically means companies with annual revenue between $15 million and $75 million. As such, our strategy for value creation is different from investors who focus on larger companies. Those investors, typically, include financial engineering as a significant part of their value creation strategy.
We, by contrast, base our value-creation strategy on three elements: leadership development, enterprise improvement and growth. If we accomplish the first two, growth usually results. Even if it doesn’t, such as during the recent recession, significant value can still be created.
Good leaders make good companies. It is not required that our leaders have a long track record of success. We can support them in accomplishing that. What is required is that the leaders possess the personality traits and capabilities that are required to realize the vision of the company. For example, if the success of a company hinges on continually developing creative, new products, then the leader of that company must possess a personality and leadership style that fosters ideation and creativity. By contrast, such a leader likely would not be effective if they needed to streamline manufacturing processes. Good leadership is paramount.
Be sure you have the right team in place. Do a critical and honest analysis of your senior leadership relative to the company’s needs, and adjust accordingly. If you are the owner and at the center of most activities, this may mean firing yourself.
One of the elements we look for in an investment is the ability to evolve the enterprise. If accomplished, this also will create value without the need for growth. However, when coupled with growth, the value creation is multiplied. Enterprise evolution, typically, is accomplished by harvesting one or more of the following:
Strategic planning. For us, the strategic plan is the cornerstone of enterprise improvement. It is not a just a budget. It sets the management team’s vision.
Sales and marketing. This is an area that often can be improved. In our experience, a majority of lower middle-market companies have not invested sufficiently in this area.
Systems. Often there is an opportunity to evolve an enterprise by improving or replacing systems, including accounting, ERP, oversight, reporting and accountability.
Asset utilization and balance sheet. In lower middle-market companies, there almost always is the ability to improve and create value through better asset utilization and balance sheet focus. This may include using a return on investment framework for capital budgeting, as well as basic items such as improving accounts receivable, accounts payable and inventory turns through focus and technology.
Professional support and other external resources. Most business owners and senior leaders build a relationship of trust with their service providers. When making an investment, we appreciate and respect those relationships. We often find a level of complacency. Often, the mere introduction of a competitive scenario will yield better service at the same or even reduced cost. This is most often true with auditors, senior lenders and insurance and benefit providers. Providing services should not be an evergreen annuity for the service provider.
If you are able to accomplish some or all of the leadership development and enterprise improvement initiatives described in this article, you will create value irrespective of business cycles. Even better, you are likely to also create growth.
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 email@example.com.