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Buying That Business – Negative Surprises

The backbone of surprise is fusing speed with secrecy.

When working to close a deal, there are so many moving parts.  Some parts move faster than others, as the desire to check off a box is strong to move onto the next aspect of a company deserving of validation or scrutiny.

In our operational diligence work, we often find our private equity clients come to us because they have been negatively surprised one too many times.  They go through their traditional due diligence checklists, work through the Quality of Earnings and, because of that report, address any visible operational issues.  During this process, however, the actual constraints are influencing operations and what is really bubbling beneath the surface often fails to show up until after close. 

Operational improvements are largely ignored because they are often considered pedestrian.  Labor is often a small percentage of sales.  Why care about that?  The equipment works, the people are there.  Are operational improvements really going to have a positive impact?  The company is growing, their customers are happy, they are profitable.  Given these positive signs in the financials and customer satisfaction, are there really any risks?

Yes!

Despite going into a deal with eyes wide open, you will always be limited to what people want to show you, and the speed of dealmaking is often paired with secrecy on the sell-side.  Maybe intentional secrecy, or maybe just undiscovered challenges because the owners may not even be aware, the right questions were not asked, or the speed of the deal masked those challenges.  As a result, the negative surprises could be numerous:

  • The estimate of capacity in operations was grossly overstated or understated
  • There are key people who are not capable of achieving the plan, or there are impediments to the growth of the management team
  • Operations is not making use of the information system that’s available
  • A key piece of equipment is on its last leg and needs replacement
  • Vulnerability to key talent or operators leaving the company post-close 
  • Volatility in the supply chain or reliance on a key supplier
  • The company is reliant on tribal knowledge and/or lacking standard work and process documentation
  • The current management team is fully committed to an ineffective approach to running the business

Negative surprises don’t happen if we can provide insight.

The ProAction group provides DeepViewä Operational Diligence to bring industry leading transparency and clarity around:

  • Business interruption risk (including supply chain)
  • Undisclosed CAPEX requirements
  • Undisclosed investment required to maintain current performance levels
  • Management isn’t prepared to lead the company to realize the investment thesis
  • The company is static and not prepared to act as a platform
  • Evaluation of operational systems to support the investment thesis
  • Real-time insight to the industry’s market and its customers
  • Data generation and validation where data may not be available

Our operational diligences highlight potential negative surprises and provide post-close value creation strategies, with suggested implementation plans, management guidance, and interim leadership as needed.  We bring the plan to eliminate, manage or mitigate the risk.

We help you to say yes to the deal, with your eyes open.

Beyond our valued pre-close operational diligence work, we also serve as an important relationship bridge between the seller and the buyer.  We engage sellers with genuine appreciation for a company’s history and a desire to understand why the company operates the way it does.  We acknowledge the good and plan for where the gains are to be claimed.  We eliminate the ability for secrets to exist, as we are taking the time to truly understand operationally what is going on. All this helps our PE clients and management teams in a smooth transition post-close.  

You are not ready to close your next deal without this…

BEYOND EXCEL SPREADSHEETS

Quality of Earnings Report Should be Paired with Operations Diligence

The importance of a Quality of Earnings (QoE) report cannot be overstated.  They are ubiquitous.  The report is a key tool in understanding the health of a business, but it is not the only tool.  Beyond the clarity a QoE delivers on the buy-side, it can also provide sellers with a third-party’s view of potential areas for concern – areas that can be targeted to maximize the company’s future market value. 

The QoE report contents are the same regardless of who requests it (or should be!), and that information provides a full picture of the business financials with key insights into aspects of the company’s operations… or does it?

Operations Diligence – It’s not Sexy, but the ROI is

Foreseeing future negative surprises and understanding the true hidden value within an organization’s operations are essential to protecting and unlocking future profits.  Sounds simple, however it’s not sexy work and is best done by functional experts who are deeply versed in the questions to ask and things to look for.  When dealing with operations planning, it’s important to understand WHY something is done the way it is before plans are made to improve it.  It’s important to dive deep into the operations and identify future negative surprises, quantify ops challenges, and qualify whether the challenge is worth solving.  Furthermore, it’s important to identify and quantify hidden value worth claiming – before a single employee is added or piece of equipment or machinery is purchased. 

Enhancing EBITDA through operational improvements, albeit not sexy, is not only a proven way to increase ROI, but is also a critical cash flow lever in today’s environment of lofty purchase price multiples.

The Check you Write and the Check you Get:

Buy-Side

Beyond the third-party expertise of a thorough operational review by industry veterans, our process involves great, collaborative communication with both the buyers AND the sellers (and their associated service providers and investment bankers).  We are often viewed as a relationship bridge, helpful to both sides of the deal.  Buyers will sense that we seek a practical understanding and appreciation for all they have achieved with their current operations.  We’re a fan of entrepreneurs, and our passion and enthusiasm for understanding their processes are genuine.  We work to document the “as-is” and seek to claim the “could be” in operational value.   As a result of our work, buyers will have confidence in the check they write, and knowing the potential cost to generating the results they wish to achieve.

Sell-Side

We work with sellers to provide support and objective assessments that identify and quantify the impact of implementing operational improvements, which will provide exponential value in the selling process.  We provide a fresh perspective and fine-tuning of operational processes, documentation to expedite the operational diligence process, and a dry run, in anticipation of tough questions that may occur during negotiations.  As a result, we help sellers reveal the value that’s hidden in their business and increase the potential to receive checks with extra zeros on the end.

The ProAction Group, and its Operational Diligence, provides a proven process for achieving exponential value for companies in a wide range of industries and sectors, including manufacturing, distribution, and business services.

We invite you to reach out to our team anytime to start a conversation about the benefits an Operational Diligence can bring to your company, as well as any related services we may provide, to help buyers buy and sellers sell.

ProAction’s 2022 December Digest

  • The end of the year brings time for reflection and openness for doing things differently in the new year. Do you have a portfolio company (Portco) that is underperforming and needs help determining the problems and solutions to get earnings back on track?
  • At the ProAction Group we bring the Action. We provide momentum, process, and tools to impact results with our industry leading experts who will work with your existing team to guide companies through operational improvements.
  • Check out the Conferences we will be attending. Hope to see you there.
  • There are no surprises in the deal when we provide “The Knowing” through a DeepView Diligence.

This is Alarming, but not entirely unexpected…

Morgan Stanley reported Monday that jaw-dropping inventory levels are a key risk to retailers, and there is a 19% discrepancy between inventory levels and sales growth.  Additionally, according to Descartes, which aggregates U.S. Custom data, reports that US imports sank in September and posted the steepest drop since 2020 lockdowns.

The headlines are daunting. 

We can chalk this up to skidding demand amid a lot of inventory.  The reverse bullwhip effect that many predicted back in May.   

Companies with high consumer exposure have slashed their ordering — even though this time of year tends to be when retailers are beefing up their warehouses ahead of the holiday season.

According to the Morgan Stanley Shipper Survey, in which some 100 corporations regularly share their transportation needs and macro expectations, net ordering levels have reached the lowest point in the survey’s 12-year history. Ordering levels are down 40% year over year. Net inventory levels are also unusually high.

The report offered guidance, “Faced with a glut of inventory, companies will need to decide whether they want to accept high costs to continue holding inventory, destroy inventory, keep prices high and take a hit on the number of units sold, or slash prices to stimulate demand. We believe many will turn to aggressive discounting to solve their inventory problem which is likely to spark a ‘race to the bottom’ as companies attempt to cut prices faster than peers and move out as much inventory as possible. This dynamic will weigh heavily on margins and fuel the earnings slowdown.

How do you maintain, but ideally grow EBITDA in this challenging environment – make the operations more efficient? That’s where we can help. 

Our team at The ProAction Group works with organizations to identify operational performance improvement processes that get an immediate 22-40% performance gain without adding a single employee or piece of equipment.

We will be honest.  This is a lot of work, and it will require some meaningful changes on your part.  If this truly is a problem worth solving, let’s talk.

Recession Proof Your Portfolio Companies

We’ve got some key insights and questions to ask at your next leadership meeting

Former Chicago Cubs Coach, Joe Maddon famously told his Cubbies “Try Not To Suck” as a light-hearted way to inspire action.  Simple and direct.  His leadership ended the 100-year Cubs World Series drought.

Economists are still dancing around the issue, but the reality is we are likely headed into a recession.  As businesses survived the worst of the pandemic, the murder hornets, civil unrest, supply chain issues and sky-high energy prices – now comes the recession.

What does history tell us?  As you lead a portfolio of companies, “trying not to suck,” is a low bar.  You’ve got pressure to make sure the results are there for a winning exit. 

In their 2010 HBR article “Roaring Out of Recession,” the researchers found that during the recessions of 1980, 1990, and 2000, 17% of the 4,700 public companies they studied fared particularly badly: They went bankrupt, went private, or were acquired. But just as striking, 9% of the companies didn’t simply recover in the three years after a recession—they flourished, outperforming competitors by at least 10% in sales and profits growth.

A more recent analysis by Bain using data from the Great Recession reinforced that finding. The top 10% of companies in Bain’s analysis saw their earnings climb steadily throughout the period and continue to rise afterward. A third study, by McKinsey, found similar results.

The difference maker was preparation and execution. Among the companies that stagnated in the aftermath of the Great Recession, “few made contingency plans or thought through alternative scenarios,” according to the Bain report. “When the downturn hit, they switched to survival mode, making deep cuts and reacting defensively.”   Many of the companies that merely limp through a recession are slower to recover and never really catch up.

How should you guide your portfolio companies in advance of a recession and what moves should it make when one hits?  We’ve got some great tips and questions to challenge your leadership team:

OPERATIONAL EFFICIENCY IS A GAME OF INCHES

Companies that are even marginally better than their competition can steal market share in good times AND in bad times.  As we face recessionary pressure, it’s good to challenge your leadership team with two key questions:

How will we maintain a consistent flow of supply with tight labor markets and a volatile supply chain?

How will we tighten the belt during a slow period while optimizing our ability to serve customers and protect employees?

THE NEED FOR SPEED

Speed of execution is extremely important for business momentum.  The plan to achieve numbers cannot be with big cuts or to pause initiatives due to recessionary fears.  Our advice – proceed with caution and reframe initiatives as an investment with a clear ROI for each initiative.

The sooner a portfolio company can find and mine hidden value, the higher the ROI once it is ready for a sale.  Some challenging questions to pose:

As an organization, do we have self-paced obstacles that slow our pace down to needed improvements or identifying opportunities to create value?

Where can we gain scalability and speed?

In addition to budgeting operational improvements into the budget, can we also allocate “excess availability” within working capital lines of credit to ensure improvements can continue to happen if things get tight during the recession (if cash flow in the ordinary course of business is a problem)?

QUESTION DATA WITH FEEL

Coach Maddon told his players there is a healthy tension and balance between art and science, between data and winning strategy.  Sometimes as a leader you must go with your gut and instincts (while also evaluating data and performance). 

As a PE firm with multiple portfolio companies, perhaps 1 or 2 of the companies are hitting grand slams consistently.  Maybe a few companies are always striking out.  Perhaps a few of your companies are hitting singles and doubles, but you feel the potential is there.  We would recommend focusing operational improvements on companies hitting singles and doubles – turn those into triples and home runs.  These companies demonstrating positive performance (but still not quite there) could benefit from focus.

PHONE A FRIEND

Do you have one company in your portfolio that is already challenging your patience, mental capacity, and time? 

Do you want to get ahead of impending situations before they go from bad to worse? 

At The ProAction Group we do three things:

1. Conduct a Pre-Close Operational Diligence

  • Like a QofE, but with a focus on Operations
  • Quantify “how much more will you make when you run it right?”

2. Implement

  • Drive initiatives to increase EBITDA and to improve your position in the market.
  • Guide your management team to scalability.
  • Get rid of the pain.

3. Revitalize Stale or Stagnate Portfolio Companies

  • Do you have one portfolio company that requires more thought and effort than all the others combined?

Call us today so we can help you ensure your portfolio companies come out of the recession with winning returns.  There is no time to waste!

PROACTION PROVEN PROCESS

Discovering hidden value and opportunity within an organization is important to unlocking future profits and increase the speed of realizing the investment thesis – of achieving the desired future state. 

Plan, Aim, Fire (Never take down a fence until you know why it was erected!) 

We support organizations as they identify those opportunities, and then quantify the impact of implementing these improvements considering the effective path for execution. For an aggressive and expert realization.  Download our ProAction Proven Process to learn more, and then let us know how we can help!

We have something to share with you…

The ProAction Group is focused on sharing our thought leadership to help organizations improve their operational efficiency and ultimately their bottom line.  In that spirit, we are pleased to provide you with a digital edition of Insider 94, The Midwest Business Journal for entrepreneurs, tailored to the business owner (https://www.insider94.com).  The publication offers relevant, current, and unbiased advice covering issues we all encounter as entrepreneurs and individuals.  We are also featured contributors!

What Your Business and Speed Skaters Have in Common and Why You Need to Up Your Ante With a Good Coach

Timothy Van MieghemThe ProAction Group

The Olympic games are nothing short of inspiring.  The backstories, the challenges and the opportunities for glory all come together on the world’s stage for these athletes. 

I find speed skating especially incredible and relatable to my line of work.  Speed skating is a racing sport with the primary aim to complete each circuit in the fastest time possible. To win a race, the athletes must adopt a particular set of techniques including balance and positioning – and then add speed. 

The technique, process, and analysis to reach this level of magic is analogous to preparing an organization to win at the profit game (which is my Olympic sport). 

Let me explain.

The road to operational excellence requires balance and positioning of a different kind.  All organizations race for results to earn gold for investors by increasing the internal rate of return, meet loan covenants or personal gain.  As in speed skating, organizations must find the right balance and positioning of whatever the opportunity for improvement is.  If you can identify it, it can be quantified.  Once it is quantified, we can plan for it.   Once an organization has identified and quantified the opportunity for improvement – then speed comes into the equation.  How fast and for how long?

At The ProAction Group we call this the ProActive Profit Process — and we’re excellent coaches.  We can help identify and quantify what needs to improve, and then tell you how fast you’ll need to go to achieve success sooner.  Like any great coach, we’ll work the formula with a proven process that lands you on the winner’s podium in your industry’s competitive landscape (and it won’t take four years to prove it).  We’ll map out the implementation at the agreed speed to assure you that you’re covering the distance between where your organization is now and where it needs to go.  Beyond implementation, we’ll be there to institutionalize changes for sustained results.

Balance and positioning at a high rate of speed is challenging for any organization, however with a good coach, with a proven track-record to guide the way, makes the difference.  Let us help.