After more than a decade of private equity investing with business owners as partners, I’ve learned that the relationship can seem like a marriage. This is especially true in situations where things don’t go as planned.
For the business owner/private equity marriage to withstand challenging circumstances and generate value for both parties upon conclusion (a “liquidity event”), it is important that partners embrace the following attributes:
- Mutual trust and transparency.
- Shared vision.
- Willingness of each partner to put the best interests of the partnership ahead of personal ego.
- Determination and commitment to make it work.
Mutual trust and transparency
Trust is the cornerstone of all successful relationships. Without it, one can never know for sure where he or she stands. Trust should be built and tested during the courtship phase of the partnership prior to closing the deal and consummating the business owner/private equity marriage.
Key questions requiring answers include: Does my prospective partner always do what they say they will do? Do they exaggerate? Do they tell only part of the story? Are discussions about the business always clouded by sales talk or spin? Are verbal commitments taken seriously?
If each of these questions can be resolved, the focus is then transparency.
Both partners should be comfortable sharing both positive and negative developments. The due diligence period provides ample opportunity for both sides of the partnership to test this attribute.
It is critical that the business owner and private equity investor share a consistent vision for the marriage. This shared vision should influence strategic planning, resource allocation and the incentives built into the deal structure. The realities of the business should be taken into account, with both partners challenging each other as to the achievability of projections given the business environment, the company’s competitive position and overall potential.
Each party should share the SWOT analyses they have conducted from their vantage points and their base case return expectations. For example, the private equity investor likely has a required time-based return hurdle. Similarly, the business owner will have a target exit value. Both need to be in sync.
Willingness to put personal ego aside
Most entrepreneurs believe they are capable and smart, and it can be difficult to acknowledge mistakes. The same applies to private equity professionals who often view their academic credentials and resumes on par with “real world” operational expertise.
Each needs to separate their personal egos from what is best for the company and the partnership. The business owner must be willing to add to the senior leadership team, and even in the most extreme case, allow a more qualified individual to lead the company, if that is what is best for the business.
Likewise, the private equity professional must be willing to acknowledge their limitations and bring in a more experienced member of the firm or qualified consultant, if challenges warrant additional insight.
Determination and commitment to make it work
Unplanned negative events can put a business on its heels. Much like a marriage, determination and commitment are required to drive the partnership through these tough times.
If they have a strong marriage, the partners’ vow of “in sickness and in health, ’til liquidity event do we part” can ultimately pay off.
Craig Dupper is managing partner at Solis Capital Partners, a private equity firm in Newport Beach, Calif., focused exclusively on lower middle-market companies. For more information, visit www.soliscapital.com.
The old term “putting lipstick on a pig” refers to prettying up a mediocre asset right before you want to sell it. Prior to marketing, the seller makes changes that cause things to look better than they really are under the surface. There is little difference between a cheap paint job on a used car to hide rust or new carpet in a house to cover cracks in the foundation and short-term cosmetic changes at a company justified as “preparing for sale.”
Here are four key mistakes business owners often make when trying to prepare their companies for sale:
? Shallow bench: Sellers often hold off hiring personnel in key management positions such as senior vice president of sales, controller and manager of procurement. They do this to minimize administrative costs in hopes of increasing sale value. Most buyers will evaluate the leadership team and make purchase price adjustments to account for those vacant positions.
The leadership team (both the C-suite and upper management) is a critical value-driver for buyers of businesses. As such, business owners should always maintain the strongest, most complete team whether the business is for sale or intends to remain independent.
? As-is, where-is: Often, sellers neglect making necessary investments in machinery, facilities or IT systems to preserve cash and/or pad the bottom line. Any sophisticated purchaser of your business will take into account the need to remedy inappropriately deferred capital expenditures and a buyer’s perception of these deferred costs could be greater than those if the business had been maintained all along.
Well-run, growing businesses require ongoing investment. Machinery wears out, IT systems require updating and facilities need refurbishment. While every capital expenditure should be highly scrutinized based on cost and overall contribution to efficiency, deferring critical investment in hopes of increasing sale value is a mistake.
? Pump-up the balance sheet: Another mistake sellers make is in the area of working capital. Balance sheet cash can be increased by more aggressively collecting receivables and extending payables in ways that are inconsistent with historical practices.
To detect this, buyers of businesses often include a “working capital adjustment” in their purchase consideration. If the company has been pulling cash out by collecting accounts receivable and/or extending payables, there will likely be a negative working capital adjustment.
Strong businesses have consistent working capital and cash-conversion cycles, and temporarily changing best practices can irreversibly impact vendor and customer relationships. Maintaining consistency will preserve these relationships and be rewarded in the purchase multiple offered by a discerning buyer.
? Run on a shoestring: Some sellers try to operate their businesses with the bare minimum of liquidity in order to increase perceived working capital. This is more difficult to identify, since there is a fine line between capital efficiency and too little operating cushion.
Buyers will again employ a working capital test and closely evaluate the historical monthly fluctuations in receivables and payables. If there are certain months where larger fluctuations necessitate an operating cushion, this will be factored into the purchase value.
Once lost, liquidity can be difficult to regain. It is better to always operate the business leanly but with enough liquidity to provide cushion for seasonal working capital variances and to support ongoing growth.
While the decision to sell your business requires a new perspective, it doesn’t necessitate changes in fundamental operating principles. Making short-term cosmetic changes in an attempt to “prepare the company for sale” will ultimately be visible to the buyer, can create lasting customer and vendor challenges, and won’t be rewarded in increased sale value.
Focus on fundamental operating principles and maximize the value of your business — no lipstick required.
Craig Dupper is managing partner at Solis Capital Partners (www.soliscapital.com), a private equity firm in Newport Beach, Calif., focused exclusively on lower-middle-market companies.
During the life cycle of any business, there are successes and missed opportunities. Even the most accomplished business leaders tell me that while they were ultimately successful, they committed missteps along the way. Often, they attribute these missed opportunities to inattention or “blind spots” that, when looking back, should have been obvious. Why is the seemingly obvious often missed?
Successful business leaders tend to be confident, independent thinkers. This independence can lead to insulation, with an overreliance on an individual or small cadre of the management team.
Other members of the team, or individuals deeper in the organization chart, are heard but not necessarily listened to. At best, they are heard through a filter of preconceptions held by the senior leader or inner circle, thereby limiting the value of the input. At worst, they are completely ignored.
While few have perfect vision, business leaders can limit their blind spots. An outside perspective from experienced resources can provide informed foresight in advance of making critical strategic decisions. Better decisions increase management effectiveness and drive results. How can you gain this invaluable outside perspective? There are several alternatives we have found to be effective, alone or in combination, including:
- Thoughtfully constructing a company advisory board
- Participating in a reputable business forum
- Engaging a qualified consultant
- Obtaining an investor partner
Public companies always have a formal board of directors with regulated fiduciary obligations. Private company boards of directors tend to be much less formal, with wide variances in effectiveness and impact, depending on the particular company.
In both cases, the formal statutory board is typically dominated by insiders. We have found the establishment of an advisory board consisting of just key company leadership and several outside individuals to be effective in providing needed external perspective.
These individuals can have specific industry or functional expertise, such as sales or operations. Their input is typically independent of management’s internal preconceptions.
Multiple business forums exist that can provide peer-to-peer external perspectives, providing business leaders a sounding board for strategic decision-making.
Solis and its portfolio leaders are members of the Young Presidents’ Organization (www.ypo.org), Sage Executive Group
(www.sageexecutivegroup.com), and Vistage (www.vistage.com), among others. For a business forum to be effective, it must provide a confidential format in which senior leaders can feel comfortable candidly sharing and receiving insight.
Many senior leaders roll their eyes when we suggest hiring a consultant to assist in providing external perspective. We agree that consultant relationships, inappropriately qualified and structured, can be ineffective.
Hence, it is critical to thoroughly vet a potential consultant and clearly define expectations. Create objective criteria against which to measure the success of the relationship and design compensation accordingly. By tying compensation to clear deliverables, you’ll limit the chances of a consultant relationship becoming the negative stereotype.
The most transformative way to gain an outside perspective is to bring in an equity investor partner. If the investment relationship is correctly structured, the partnering can be a powerful source of external knowledge and experience. Professional investors bring experience across many companies, often in different industries. This often surfaces insight that business leaders didn’t know they didn’t know.
Obtaining an investor partner doesn’t have to mean ceding control of your business. For example, there are financial firms that take minority equity stakes in private businesses — albeit typically with “ratchet provisions” that increase ownership if the company underperforms — and our firm has pioneered a true 50-50 partnership structure. When selecting a potential investor partner, key factors to keep in mind are the experience an investor partner brings, your level of comfort with the partner and the chemistry between the two parties.
An outside perspective can help business leaders make better decisions and produce superior results. See what you’ve been missing.
Craig Dupper is the managing partner at Solis Capital Partners (www.soliscapital.com), a private equity firm in Newport Beach, Calif., focused exclusively on lower middle-market companies.