As we start 2023, the economic outlook is cloudy with much talk of a recession.  While this story unfolds, it is likely to put downward pressure on the volume of portfolio company exits, at least into the first half of 2023.  This situation sets the stage for what could be better conditions for an exit later in 2023 or 2024 and beyond.  By taking several actions now, PE firms and their portfolio companies can take advantage of this time and improve their positioning for a higher valuation and successful exit.

Start with the end and work backwards

PE firms need to help position a portfolio company for sale to the next buyer and, even to ones beyond that buyer, by creating valuable options that support a robust valuation.  To accomplish this, a private equity owner may need to prepare to sell a portfolio company to both a strategic acquirer and a financial buyer.  Strategic acquirers can afford a higher price due to the opportunity to realize synergies with the portfolio company, but they have specific acquisition criteria, and it takes planning and effort to align with their needs.

As a first step, PE firms can identify a broad range of potential strategic acquirers and assess potential strategic fit.  Focus should be on identifying synergy opportunities in such areas as customers, end markets, products, services, and geographic overlap.  To create optionality, the portfolio company may need to invest resources towards potential synergy areas, which will take time and effort to realize benefits and begin to build the business case for a strategic acquirer.

Take the example of an industrial equipment rental company. As part of its exit planning, the PE owner and the company began to identify non-traditional, strategic acquirers to broaden its options and support a successful sale. The team assessed forty acquirers across eleven industry segments considering strategic criteria (e.g., demonstrated interest in rental, customer fit, complementary products, geographic fit) as well as financial criteria (e.g., financial capacity, capital intensity of current business).  Ten non-traditional, strategic acquirers were then prioritized into three different tiers to achieve the highest return on time spent cultivating relationships.  As a result, ownership successfully sold the company to a strategic buyer at a high valuation.

If the portfolio company is more likely to appeal to a financial buyer, then other factors may be more of the focus, such as expanding participation into adjacent markets, completing add-on acquisitions to gain scale or expanding geographically.  This path can also help to create valuable options for the longer-term, which an immediate financial buyer can build upon and further improve the position of the business for a later sale to a strategic acquirer.

Sharpen focus on customer segments

With a clearer view on potential acquirer paths, PE firms and management teams can determine which customers it should focus on and adjust how it serves them.  In a downturn scenario, not all end markets are impacted equally.  Digging into customer segments and end markets can identify which areas are better off, and within these, which customers should be targeted for growth.  Adjustments can then be made to sales resource deployment, field service support levels, and post-sales support that reflect the near-term sales and margin opportunity.  Such adjustments will help portfolio companies to better manage customer profitability and control costs.

A good example is that of a regional third-party logistics company.  Its private equity owner was looking to sell the business but first needed the company to improve the trajectory of its sales and margins.  A commercial review led it to re-consider its growth and go-to-market strategy to focus on several end markets and customer segments where there was significant demand.  The company invested in and re-deployed sales and marketing people and resources to support the near-term opportunity.  The company improved its growth trajectory over the next 9 months and the PE owner sold the company a few months later at a high valuation.

Calibrate pricing and stop margin leaks

With inflation slowing and a likely recession, the ability to pass on broad-based price increases will diminish, forcing companies to re-examine their pricing approaches.  Not all customers are worth the same to a business, so the level of discounts, rebates, service, and support are all areas to look for excessive giveaways and margin leakage.  PE-backed companies can prepare for this environment by:

  • Ensuring their pricing approach has clear governance, policies, and processes to guide salespeople with customer negotiations
  • Improving communications with customers on the rationale for price levels and the value the company provides
  • Tightening up transaction level pricing to ensure net pricing and contribution margins for customers are acceptable
  • Tracking pricing changes at a product, service, and customer level to gauge the impacts of changes and adjusting as needed

Consider the example of a PE-owned industrial wire rope manufacturer. The company was struggling to find growth within a mature market and needed to grow revenue ahead of an exit. Transaction-level analyses uncovered pricing variability driven by the company’s decentralized, inconsistent approach.  Customer level analysis uncovered additional pricing opportunities as excessive discounts were given to less valuable customers.  As a result of these actions, the Company saw meaningful, near-term bottom line improvement and its sales team adopted a more strategic pricing mindset.

Adjust the product and service offering

Many PE-backed companies have grown with add-on acquisitions, resulting in larger product and service offering portfolios that may need adjustment.  Analysis of product and service offering profitability often yields opportunities to rationalize underperforming offerings or re-price them.  And, with rationalization actions, there are typically operational costs savings.

A helpful example is that of a packaging products business that was being prepared for sale.  To improve margins, the company analyzed its product portfolio, which had grown over the years with several acquisitions.  Management found opportunities to eliminate low and unprofitable products, and re-priced numerous products.  The product eliminations also led to cost savings in operations.  Overall, EBITDA margins improved significantly over the next 9 months which helped position the business for sale.

Not all adjustments need to be focused on scaling back.  The PE owner of a facilities services company worked with management to find new opportunities for growth as it began internal discussions about a potential sale later in the year.  The company leveraged its customer relationships and service capabilities to add several new service offerings.  It took a targeted approach to marketing its new services, which provided management time to refine the offerings and generate early wins.  These efforts paid off as clear evidence of the company’s new service offering success boosted its sale price to a new PE firm that planned to help management scale this part of the business.

Execute aggressively

Implementation plans that support an exit process are necessary, but they are not worth much to a prospective buyer.   More valuable are actual results and supporting evidence that back up a PE firm’s asking price.  To accelerate results from exit readiness efforts, PE firms and their management teams can take several actions:

  • Make sure goals and targets are reasonable. If they are too much of a stretch, they will not be believable, and it will be tough to get people to sign up.
  • Form the right cross-functional teams. It is common to have exit readiness projects that cut across not only sales and marketing functions, but customer service, finance, IT, operations, supply chain, etc.  This set up will prevent needless delays and re-starts.
  • Balance the load. The timing and sequence of projects will be important to make sure sufficient progress is achieved and avoid overloading management.
  • Actively manage the projects. Track and report, resolve issues, stay on top of initiatives, and adjust as needed – these are important aspects of successful execution.
  • Document as you go. The next buyer will require convincing evidence the actions taken are resulting in positive, meaningful results.

This year may be challenging for many businesses, but there are always opportunities to improve the positioning of a PE-backed company.  Getting started early will be critical to being ready for when the timing is right.