A topic that I hear come up quite a bit is how private equity funds are able to amplify shareholder returns at a strikingly faster pace than public companies. Some folks ask how; others are just fascinated by their ability to drive these returns. Those that think it is because they excessively leverage or inflate company performance for an exorbitant IPO price are missing the critical points that are actually making these companies perform more optimally than public companies. Even with a different political landscape, there are still quite a few ideas that can be applied from private to public companies. Here are some questions you should ask yourself to see if you can create these changes within your organization?
  • Do we have the right capital structure in place? Is there an opportunity to increase our debt-to-equity ratio to help reduce our cost of capital? I am not suggesting that you should raise your levels of debt to the amounts of another company, but it’s likely you can increase it from where you are today.
  • Have we exploited all options for cost reduction? There is always room for improvement, and if you believe you have exhausted all opportunities, it’s time to have an external set of eyes perform an assessment to determine how to lean out or improve further.
  • Can we invest in other areas (e.g., M&A, new products) that would expand our revenues and/or improve our market positioning? Can we divest any non-core businesses? No, I am not suggesting that you just buy any profitable company that exists, but rather perform some due diligence to determine what, or whom, aligns with your plans. For instance, a recent announcement was made that Novartis would pay ~$16B for GlaxoSmithKline’s (GSKs) oncology business, and sell its own vaccine business to GSK for upwards of $7.1B. So, Novartis takes a bit of a hit to their top-line to create better margins and improve position in the consumer healthcare sector. Sounds like a strategic move to me.
  • Do we pay executives and board members for performance and ensure that their compensation is commensurate with the value they bring? Are penalties in place for lack of performance? Think of it this way, why should the company pay someone, including you, for poor performance? An option could be to concentrate rewards to the select few stellar executives instead of a broad, consistent application to all executives. Those who directly impact increased shareholder value receive the benefit. Give board members less monetary compensation and more equity, forcing them to create value to get their return.
  • Is our board focused? Do they have the extensive experience and capabilities needed to drive our strategic vision? Do they have industry expertise, bring unique values to the table and do they have the correct financial incentives keeping them focused? Public companies tend to have larger boards due to the audit, governance and compensation committees. But, aside from independence reasons, why not retain board members who know the business? Or better yet, when faced with issues bring in a senior advisor who is a nonrecurring expense to support overcoming the challenge.
Normalizing this a bit, I go back to operating expenses and managing debt. I personally do not agree with or like that some private equity firms leverage their companies to a point of distress, however I can’t argue that successful firms leverage to enable success while also maintaining a focus on earnings before interest, taxes, depreciation and amortization (EBITDA) to drive higher returns and a potentially quicker exit.
With that, stay tuned for a future blog where I plan to discuss an approach by which you can look into your organization via a lens that considers how some private equity companies measure their operating performance…