Many U.S. government agencies and private contractors use “Red Teams” to identify weaknesses in a nation or organization. The teams, named for their origin in the former Soviet Union, use their highly refined skill sets to approach the problem or scenario from angles to which the organization itself may be blind.
Private equity firms do essentially the same thing, using a set of tools and skills to ferret out issues. Only their actions go beyond identification; they extend to mitigation of the weakness, resolution of the challenge and ultimately boosting the value of the business for investors.
Employing their fiscal and human resources, private equity firms invest in companies to stabilize their health and increase their value, often bringing substantial returns for investors. Equity firms use their expertise and financing to fuel future growth.
While many have historically opted for cost-cutting and expansion, today’s private equity investment firms look at ways to re-engineer aspects of the business to improve results. The engineering actions fall into three main areas, and often involve a combination of them: governance, operational and financial engineering.
Governance engineering involves ensuring the overall management and oversight for the entity meets its needs and growth requirements going forward. The investment firm can train, augment or even replace the current management team to ensure that it is skilled and able to accomplish the desired results. For entrepreneurial or family-run companies, that may mean providing help in establishing the professional structure and governance required to satisfy external shareholders as the company grows.
A good private equity firm can assemble a strong, highly motivated executive team for a company. They realize that owners typically wear too many hats or are too busy soliciting new business and lack time to devote to strategic planning and expanding operations. Accordingly, the private equity firm may feel the need to add C-suite expertise or advisers adept at growing businesses to the management team.
Top firms do not stop at the executive team; they may also opt to nurture internal talent or recruit people with skills and expertise that are missing in the company. When a company is acquired wholly or partly by a private equity firm, one of the biggest fears for current personnel is job loss. When seeking how to streamline the talent in an organization, a private equity company will look for low-performing employees or areas that do not fit their vision of the firm’s future. However, strong performers need not fear; they may be offered retention bonuses, better performance incentives and greater autonomy than they previously had to encourage them to stay.
Operational engineering involves developing operating expertise, product lines and production means to add value for investors. Like the “red teams,” the equity firm’s teams strive to spot deficiencies in the company’s commercial operations or unrealized opportunities that can be tapped into.
- Changing the products or differentiating them – Companies may not have recognized additional ways to use a best-selling product or brand name or become hesitant to drop a beloved but no longer viable product line. Additionally, the re-engineering of operations may provide an opportunity to give a product a new life or new angle to promote, such as an environmental aspect or ingredient.
- Changing the process – While many companies claim to have a culture of continuous improvement, having a fresh set of eyes examining all aspects of the production and distribution process is helpful. For example, they may find untapped capacity in equipment to capitalize on or inefficiencies in the supply chain process that need to be remedied.
- Changing the technology – Technology is one area that companies of all sizes can typically improve on. The need for rows of servers may be fulfilled in the cloud. Systems that do not integrate information smoothly and require additional steps by staff could be superseded. Outdated and expensive-to-maintain proprietary software may need replacing with something widely used and readily updatable. These all require a cash infusion, which the equity deal is in place to facilitate, but could reduce costs and staff time, thereby recouping the investment.
A typical part of private equity efforts to foster growth, financial engineering works by creating strong monetary incentives and pressure to pay off debts, cut costs and improve profits. Here are two common financial techniques:
- Changing capital expenditures – Private equity firms strive to provide a meaningful return on capital for investors in a relatively short time period. Growing the business often requires changing the capital structure and putting more debt on the books. Ideally, cash flow improvements from cost cutting, product and process advances and other initiatives pay down the debt and eventually add value for investors. Changing expenditures may also involve funding more profitable product lines or market expansion. Private equity firms often reallocate capital investments from a slowly growing area to lines or markets that will grow revenues faster.
- Changing routine expenditures and negotiating with suppliers – Cost cutting is part of most methods used by private equity firms because they are carefully looking for ways to streamline operations by removing unprofitable areas and shutting down internal money pits. Additionally, they look to decrease costs by changing to lower-cost suppliers and renegotiating deals with existing ones.
Not all private equity firms will use the same strategy in a particular situation. Some have a standard approach, while others carefully tailor it to the company. Business owners want to make sure their potential equity partner listens carefully to what the needs and possibilities are before jumping to conclusions. The goal is to partner with someone who will help the firm identify problems and unexploited potential.
HJR Global can help you in this area. We can help you put into action a process for eliminating those problems and taking advantage of the potential using every tool available to you. Get in touch with our team at HJR Global for more information.
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