Private equity firms are known for improving underperforming companies. But how do they accomplish this? Let’s look at how private equity firms operate and the three principal ways they benefit companies.
Private equity firms look for underperforming companies with noteworthy potential. Sometimes the present leadership is incapable of maximizing the company’s strengths. At other times, there may not be enough capital available for the company’s growth. In either case, private equity firms acquire the companies, improve them, and then sell them at a profit.
1. Streamlines the Company
Private equity firms are focused on eliminating redundancy in a company’s hierarchy and operations. Firms want to operate the acquired companies with as little oversight as necessary to accomplish the task. Inevitably, over time, companies create positions that serve a limited function. Often the position remains long after its responsibilities could be absorbed by another department.
Private equity firms look for that sort of duplication and erase it. The result is a cut to the payroll as well as a reduction of bureaucracy. The fewer levels of management there are between the firm and the workers, the quicker changes can be implemented. It’s not unusual when a private equity firm takes a public company private for the firm to remove mundane positions.
2. Gives the Company Motivation and a Goal
The very nature of private equity firms is rooted in change. Firms buy companies with the express purpose of selling them. So before a firm enters into a deal for ownership, it already has an exit strategy in place for making a sale.
Once a private equity firm acquires a company, a clock begins ticking. That clock indicates how many years the firm has before it has to liquidate the funds that it used to purchase the company. By law, the fund must come to an end. That means that everyone at the private equity firm is aware that goals must be reached as soon as possible.
That sense of urgency tends to permeate the entire company. Private equity leadership knows it must turn the new company around fast. The company must show a healthy profit in order to attract potential buyers. In turn, the sale has to be enough to justify the faith of the firm’s investors.
The staff of the acquired company is also motivated to cut costs and innovate to help boost the company’s bottom line. Predictably, as the company improves, workers become more engaged in the continued success of the company.
It’s standard practice for private equity firms to link the success of the acquired company to financial incentives for executives. This motivational tool can propel executives running the company to perform well past their usual standards.
3. Prepares the Company For the Future
Companies become better positioned for the future. For example, the elimination of unnecessary managerial positions makes the company more nimble when additional changes are needed.
Several years of belt-tightening can also help a company realize where it was wasting money. The experience of using a private equity firm may help company leaders become better stewards of their assets.