By: Heidi Pozzo
You want to work for Private Equity? It’s tough to get your foot in the door for the first time. It is different than working under other ownership structures because the bar is typically much higher on the timing and the quantum of results expected.
So, how can you stand out? I regularly speak with folks in and around the Private Equity space and find a consistent theme. People who have been in and around the space that are successful, they get it. What is the “it”? The people who get it understand the three P’s that must be there to succeed – People, Pace, Performance.
People – it is that intangible element in the organization that can give you insight as to how well things are running. That buzz that you feel when you walk into a room. Chances are, if you feel that buzz, the people are clicking and so is the performance of the company. Harnessing that energy takes three people focused elements:
- Attracting and retaining the right people throughout the organization
- A culture for success.
Leaders are the rudder in the organization. They set the tone and strategy. They get people excited about being part of the organization, performing their best, learning and growing and delivering outstanding goods or services to the customer. Having the right leadership in place starts moving the organization in the right direction.
Strong leaders know how to attract and retain the right people. The right people can lift the organization to new heights. The wrong people can drag it down. With the right people in place, problems get fixed and the organization moves forward. It seems natural when you see it working well. But it takes a lot of work to get and keep the right people on the bus.
The culture of an organization is critically important in keeping people moving toward the goals of the organization. It impacts how people get their work done, how quickly, how they feel when doing it and the experience your customers have when interacting with the organization. It is the glue that holds the organization together.
I’ve heard some describe this as rebuilding a 747 in mid flight. It can also be called a sense of urgency. However you describe it, having the right pace means getting a lot done quickly. The hold time for a portfolio company is typically between 3-5 years, but can vary based on a variety of factors. Whatever the investment thesis is for the company, whether growth, restructuring, combination, etc. the time frame to execute is short. Especially when considering that nothing goes perfectly.
There are likely to be changes in the market conditions, the ability to obtain capital, customer needs, etc. Additionally, to exit with an acceptable valuation, there needs to be a solid track record of earnings – that means more than 6 months. So, the major changes that generate higher EBITDA in the business should happen within the first year of ownership by the private equity so that the earnings are solidly in place toward the end of the second year.
When you think about the timeline, the first six to twelve months may involve changes in the leadership team and alignment/clarification of the strategy based on the investment thesis. This means that with greater understanding of the company and the leadership team in place, clarity is gained on the drivers that will increase the bottom line.
By the second year, improvements in the business should be evident. This means that you can demonstrate increased output, price increases that are independent of market change, reduced costs that are based on efficiencies, etc. These changes are made by the company and independent of what is going on in the market and demonstrate management is in control of the business. By the third and fourth year, the earnings stream should approach or be at the levels necessary to achieve the desired exit value.
When thinking about the pace, the bar should be set high to establish the pace in the organization.
Why did I put performance last in this article, as it is typically the first thing people look at to tell if a company is doing well? The right people create the right focus and the appropriate pace. These are necessary elements to get outstanding performance. To judge performance, the following key indicators are critical:
- EBITDA (Earnings before interest, tax, depreciation and amortization)
- Return on Capital
Cash is king. It is easy to understand and drives every business. And yet in many businesses, a quick poll of key leaders reveals that most don’t know how much cash the business has on a regular basis. It is critical to understand what is driving cash and the profitability of each product. Knowing where the cash comes from is one of the biggest indicators of whether the business is healthy. At the end of the day, it doesn’t matter how much of anything else you have. If you don’t have cash, you are out of business.
Many companies focus on generating net income. The problem is, it is subject to accruals and other non-cash items. It is also impacted by debt structure, tax structure, etc. So while net income is interesting, it does not allow for comparison to other companies and is not an indicator of how much cash is being generated by the business.
EBITDA is a better way to look at the earnings of the business for all the reasons net income is not. EBITDA is the volume times the margin. By thinking about it this way, you focus on margin by product and how much of each product is being sold. EBITDA also gives you a directional view of how much cash the business is generating before being invested in capital, working capital, debt and interest.
With that in mind, cash gets tied up in the business in a variety of manners including working capital, capital, debt, and equity. There are a number of measures for looking at returns on capital, invested capital, equity, etc. The point of looking at these measures is to understand how much the business is returning based on the level of investment being made. Every dollar put into the business should be working hard and generating a return.
Performance is the scorecard. You either get the results or you don’t. Great companies figure out a way to make money in good times and bad, so focusing on the right things that really move the dial is critical. With the right people and pace, performance is very achievable.
Copyright © Heidi Pozzo.
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Heidi Pozzo is a strategy and performance improvement consultant. She has helped transform businesses by connecting the people in the company to the strategy, resulting in significant increases in earnings and business value. To find out more about her services,
or call 360-355-7862.