When thinking about the idea of selling their business over to a private equity firm, private company owners may be nervous given the negative stories they may have heard about what happens to companies, legacies, people, and jobs when a professional investor becomes the owner. One of the reasons that so much change is heaped upon private companies when they are owned by professional investors is that professional investors have one singular goal and focus: to get the highest return on their invested capital in the shortest period of time possible. This singular focus eliminates any noise and drives their decisions.
Private company owners do things differently because they often have broader goals and objectives, including personal preferences and a longer time horizon. Some examples include how they decide which investments to make in the community, how they compensate their employees, or how much they budget for the holiday party.
A private company owner has the independence to operate their company however they want. Sometimes, however, there can be a downside when too little emphasis is given to performance and the company exists to support the lifestyle of the owner. It is the owner’s prerogative to do this, but it often leads to long-term value destruction in the business. And given that the private company is often the single biggest asset of the owner, it can have negative long-term consequences for their personal wealth.
There are valuable lessons to be learned about how professional investors approach decision-making without necessarily taking it to the same extreme. Below is a checklist of items that professional investors focus on that private owners can benefit from considering in order to create long-term value in their businesses.
- Elimination of Bias – Being unafraid to step back and take a hard, unbiased look at the company and its performance usually uncovers areas of significant improvement. Things should never be done the same way just because they’ve been done that way in the past.
- Strategy – An increased focus on strategy and competitive position occupies a lot of attention for professional investors. Many private companies never really get to the strategy discussion and may believe that their annual operating plan is a strategy. It is not.
- Execution and Accountability – An increased focus on executing and holding people accountable can lead to a dramatic improvement in results. Professional investors often have significant incentive packages for managers to align their compensation with the company’s goals.
- Governance and Board – Utilizing a board of directors or advisors can create a lot of long-term value for a company. Professional investors use boards as a source of brainpower as well as a way to hold the manager accountable for performance.
- Capital Allocation – Capital allocation is the process of deciding what to do with profits. Many private companies do not intentionally focus on this. Instead, they often make bad investment decisions because they don’t have processes to determine whether there is a proper return on investment on things such as new equipment purchases.
- Key Metrics and Financial Performance – Many private companies do not have a proper way to determine whether their performance is creating value or destroying value, and most don’t measure it at all. Focusing on Return on Invested Capital and how that compares to the company’s cost of capital is a basic way to determine whether the company’s value is improving. What does not get measured does not get managed.
Private owners don’t have to operate fully like professional investors. However, there are things you can learn from them and apply to your company to drive long-term value for the owners.
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