Instead of Hating Private Equity, Learn from Them
Listen, we get it. Private equity (“PE”) feels like the Big Bad Guy.
A lot of entrepreneurs feel this way, and frankly, for some valid reasons. In the exit side of our business, we talk a lot with our clients about why there is so much skepticism and resentment toward PE, and when it’s warranted and when it’s not.
But let’s say you’re not ready to exit, you’re ready to grow and evolve.
In that case, private equity has a playbook that you can, and should, learn from.
And for purposes of this discussion, we are not talking about the megafunds, or even the middle market private equity funds … Instead, we are focused on the lower middle market private equity groups that focus on acquiring businesses that have never had institutional investors like private equity. Larger funds often utilize complex financial engineering strategies to make money for their investors.
Whereas lower middle market funds employ strategies that are grounded in reality – strategies you, as a small to medium-sized business owner, can implement. So let’s jump into them.
Understanding The Lower Middle Market Playbook As A Small Business Owner
Disciplined Profit Driven Decision Making
PE relies on accurate monthly financial data as the key decision-making factor when it comes to any strategic decision in the organization. Be it a new hire, a new piece of equipment, opening a new location, investing in a software customization, initiating a strategic partnership, or any other strategic opportunity, the prospective return drives the decision. Every choice is evaluated against the metric of the future profit of the company.
Unlock your company's financial potential without the hefty price tag of a full-time CFO.
In many owner/operator-owned businesses (referred to as “closely held” in the PE world), we see decision-making often driven by the owner’s intuition, rather than hard data. While this intuitive-based decision-making got you here, it can limit your ability to evolve.
Investing in the Right Talent
During due diligence, even before they complete the purchase of a new business, PE firms start making plans to bring new talent into the company. They have learned the age-old lesson that people are the key to business performance. You can have a great product, amazing technology, the best processes, etc., but without the right people, you are going nowhere. The win here is hiring senior leaders who can go toe-to-toe with the owner. It’s a cliche at this point, but the best leaders hire people who are smarter and better than they are at what they do.
If you’re the most talented person at everything at your company and nobody is your equal, your company’s potential is capped.
Developing a Repeatable Sales Strategy (That Doesn’t Revolve Around You)
Private equity firms in the lower middle market are obsessed with growth opportunities, so they often rewrite the sales playbook for companies they acquire. They want to understand what drives a successful sales process, and they will invest in finding new customers, end markets, geographies, etc. A clear example of this is a business that employs a digital marketing strategy, where returns on marketing investment dollars can be easily observed. If you’re familiar with that world, you will know terms like CPC, TACoS, and RoAS, which stand for Cost per Click, Total Advertising Cost of Sales, and Return on Ad Spend. PE loves to put money behind these proven sales processes.
Most entrepreneurs are the Chief Revenue Officer (CRO) for the company, whether you have the title or not. To you, it’s intuitive, whereas PE firms are happy to push the boundaries on marketing spend in ways that might make you uncomfortable. Your educated guess is not a scalable strategy if it relies on your continued efforts to keep the business from languishing.
Related Read: 3 Types of Revenue You Need To Understand as a Business Owner
Using Acquisitions to Grow Your Business
Perhaps the most well-known strategy of private equity is what’s called the “roll-up”. You buy a bunch of similar companies, put them together, and then sell them off to a larger investor. This can be done sloppily or strategically.
In my own experience, I’ve observed these firms focus on adding two companies together on a spreadsheet rather than really trying to assess operational and cultural fit. That said, when done strategically, this is a game-changer and is available to entrepreneurs too.
Yes, you have to pay to acquire a business. But it’s much easier to grow something that is already established than to start something new from scratch. Ask yourself, if you’re the founder, what’s harder: 0 to 1, or 1 to 10?
If you’re like most (including me), 0 to 1 is the hardest. So if you’ve got an idea, why not go buy someone who is doing it rather than starting from scratch?
Most self-made business owners shy away from this strategy because it’s potentially expensive, and they’re uninitiated, which can be intimidating. While these things may be true, when viewed through the private equity lens, those are just obstacles that we call opportunities. If the return on investment is there, we can work out the other details.
Related Read: Have You Outgrown Your Advisers?
Using Other People’s Money to Grow Your Business
Finally, and interestingly, an important strategy utilized by private equity firms is other people’s money.
In particular, these firms utilize third-party debt from banks or other non-bank lending institutions when making investments. This enables the business to do more without requiring any more owner’s equity to be contributed. Most people have an aversion to debt, but this type of borrowing is what we call “productive” debt. If you’re looking to expand your operations or purchase a company, you can utilize a third-party lender to fund the investment partially or completely, allowing you to keep more of your savings elsewhere. This also has the side effect of focusing the business on servicing the monthly mandatory debt payments, providing discipline that might not otherwise be there.
We’ve worked alongside many debt-free, closely held businesses. This isn’t a bad thing per se. But are you holding back from making investments that could easily be financed with productive debt? With the right guidance, this can provide powerful leverage.
Related Read: 5 Signs Your Business Needs a Fractional CFO - ASAP
Conclusion
The private equity playbook is not a secret; it’s available for all to read. If you’re a business owner, you don’t need to join up with private equity to implement its strategies. Ultimately, it’s your company and your goals. But if you want to see your company get better and bigger, consider how these strategies might help you grow your business.
These might sound daunting, but they are doable!
In fact, this is exactly the kind of strategic advising we do with clients day in and day out at Doescher Group. If you’d like to talk through your options for you and your company as you look to evolve your business, we’re here to help.
