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The most successful PE firms spearhead such business transformations all the time. In the process, they create exceptional returns for their investors.

How exceptional?

Rather, it lies in the rigor of the managerial discipline they exert on their businesses. Despite the widespread assumption that the stock market forces managers to concentrate on increasing the value of their companies, many executives of public companies lack a clear focus on maximizing economic returns.

Their attention is divided between immediate quarterly financial targets and vaguely defined long-term missions and strategies, and they are forced to juggle a variety of goals and measurements while coping with contending stakeholders and other bureaucratic distractions. In stark contrast, the top private-equity firms focus all their energies on accelerating the growth of the value of their businesses through the relentless pursuit of just one or two key strategic initiatives.

They narrow their sights to widen their profits. By adopting these disciplines, executives at public companies should be able to reap significantly greater returns from their own business units. The best investment theses are extraordinarily simple; they lay out in a few words the fundamental changes needed to transform a company.

The thesis is then used to guide every action the company takes. In the short term, they strive to hit their financial targets for the next quarter, even if it means making decisions that run counter to the overall interests of their companies.

In contrast, PE firms manage their businesses to the intermediate term—three to five years—about the time they typically hold an investment before selling.

This time frame removes the often counterproductive focus on quarterly numbers yet still creates urgency to transform the business quickly. Consider what happened when, in , Texas Pacific Group acquired Paradyne, a struggling, unprofitable telecommunications equipment arm of Lucent Technologies.

Paradyne had endured for years as a relatively neglected division of a very large conglomerate. TPG quickly set expectations of a turnaround and exit within five years. Both of the new companies have flourished under purposeful new ownership and management and fresh, urgent direction.

Look at the simple investment thesis that Berkshire Partners developed when it invested in Crown Castle International Corporation in The founders of Crown Castle had hit upon a lucrative business model: They would purchase a cellular telephone transmission tower from one telecommunications company and then lease space on it to other service providers in the area.

Lacking the cash for expansion, however, the founders were stuck in a single metropolitan market, Houston. To date, Crown Castle has successfully rolled out this model across the United States, the United Kingdom, and Australia, generating a tenfold return on investment for Berkshire.

Over the years, Wesley-Jessen had ascended to a leadership position in specialty contact lenses primarily colored lenses and toric lenses used to correct astigmatism , but in the early s, it lost its way.

How employees get screwed in private equity deals

Looking to expand into bigger markets, it began to neglect its key customer base, the optometrists who wrote lens prescriptions. It let overhead grow to dangerous levels. And it overexpanded into unprofitable segments, particularly standard contact lenses. Wesley-Jessen simply lacked the scale to turn a profit in that market.

By , those missteps had reduced the company to an operating loss and a perilous cash position. When Bain Capital acquired Wesley-Jessen, it brought in a new management team to pursue a back-to-basics investment thesis: Return the company to its core business. This required drastic action.

The company stopped serving unprofitable customers such as high-volume retail optometry chains. It cut spending on advertising, promotion, and other outside services and eliminated many positions, including several levels of management in manufacturing. At the same time, it expanded its product range within the specialty segment and made selective acquisitions to bolster its leadership position in the core market. The investment thesis proved a resounding success. On the strength of its turnaround, Wesley-Jessen completed a successful initial public offering in , creating a fold return on equity in less than two years.

Yes, imposing a stronger strategic focus usually entails aggressive pruning of the existing business, but creating a path to strong growth is what produces the big returns on investment. Far from stripping assets to boost short-term returns, PE firms actually tend to overinvest in businesses during the first six months of their ownership.

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In the wake of the article, enthusiasm for expanded business metrics burgeoned, with many large companies dramatically increasing the number of measures they tracked. The top PE firms, however, have steadfastly resisted measurement mania.

Everything else was secondary. The top PE firms have steadfastly resisted measurement mania.

PE firms have some general preferences about the measures they track. They watch cash more closely than earnings, knowing that cash remains a true barometer of financial performance, while earnings can be manipulated.

And they prefer to calculate return on invested capital, which indicates actual returns on the money put into a business, rather than fuzzier measures like return on accounting capital employed or return on sales.

However, managers in PE firms are careful to avoid imposing one set of measures across their entire portfolios, preferring to tailor measures to each business they hold.

Wine making is very asset intensive, requiring large inventories of cellared wine, not to mention extensive vineyards, so ROA and EVA would necessarily appear very low. By those measures, the company was actually doing quite well.

This limited the amount of equity that TPG had to put into the company and maximized the return on invested capital and return on equity. In the wake of the changes, Beringer thrived, achieving a ninefold return on the initial investment within five years.

Those types of arrangements typically give managers a stake in the parent company, not the individual unit. But there are ways for public companies to structure compensation as PE firms do.

For instance, management bonuses tied directly to the performance of the individual unit, not the entire company, can be increased as a proportion of overall compensation, with an offsetting decrease in cash compensation.

Work the Balance Sheet PE firms rely heavily on debt financing. But PE firms also make equity work harder; they look at their balance sheets not as static indicators of performance but as dynamic tools for growth.

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The most sophisticated firms have, for example, created new ways to convert traditionally fixed assets into sources of financing. Consider the story of Punch Taverns Group. Thanks to the stable and predictable nature of pub revenues, Punch was able to isolate the rents it earned on real estate an important source of cash flow to the company and package them as real-estate investment securities that could be sold to investors.

In combination with a focused investment thesis—tailoring pub products and prices to local markets—the innovative use of the balance sheet enabled TPG to restore growth to a business that for years had posted flat to declining sales. PE firms also work the balance sheet by aggressively managing the physical capital in a business. Consider how the U. They realized that the key to making profits lay in selling directly to customers and focusing only on regional markets where they could achieve market share leadership.

Dominant market share in a locale provided scale economies for local call centers and pools of alarm technicians and installers. Selling through independent contractors or promotional marketing channels, by contrast, drained profits.

Sorting the Plums from the Lemons Types of due diligence that private equity firms conduct Market due diligence in private equity All financial statements matter in private equity.

PDF Private Equity Secrets Revealed - 2nd Edition Free Books

How to calculate capex from financial statements The free cash flow capex conundrum Working Capital Series: Introduction Working Capital Series: References and calculations Working Capital Series: Drivers Working Capital Series: Cash-positive and cash-negative profiles Working Capital Series: Valuation Working Capital Series: What to do at settlement?

Working Capital Series: Measuring and monitoring Working Capital Series: Improvements and one-off cash wins Working Capital Series: Preparing for sale Confidentiality during market due diligence 8. Making Sense of What to Pay The silence of snow and investee valuation methods The earnings multiple valuation method Quick and dirty, yet conservative, valuation in these crazy times Comparing a trade deal with a private equity deal I'll take your privates and give you my publics Pre-money versus post-money valuations An apples vs apples comparison of earnings Should I consider EBITDA or EBIT?

Does enterprise value include working capital? What happens to EV when you issue more equity? Drivers of valuation multiples Negative equity, but positive cash flow Negative equity: Donning an Important Hat Fundamental themes of private equity value creation Obvious value-add for private equiteers I just made an investment, what do I do now? An ounce of entrepreneurial blood A lean mean entrepreneurial machine Entrepreneur-in-residence EQ: Entrepreneurial Quotient The customer value proposition Making something of this downturn: Porter's 5 Forces Porter's 5 Forces: Risk management is temporal for private equity The competitor without a face: The Art of Getting In Private equity deal strategies Channels for private equity deal origination The pros and cons of intermediation As difficult as it may be, it pays to be nice to bankers The many drivers of a private equity investment Opportunities abound, but what about the existing portfolio?

Minimum stake a private equiteer will take in a business A preference for partial sales Low-hanging deal fruit ain't what it used to be A word on private equity and franchises Private equity deal killers The aftershock of hard negotiations The economics of bolt-on acquisitions Methods for private equity firms to exit investments Exiting founders, unaligned interests Is a recapitalization a compelling exit strategy?

How to get the best price when selling a business Tips for an entrepreneur to investigate private equity options Stay clear of single-owner private equity firms Equity returns for debt risk Natural selection or naturally speculation? Private equity returns are misleading Private equity returns are misleading - Part II It's all about investing in the best management team Clip-on acquisitions in private equity The puzzle of private equity Private equity: The superficiality of most due diligence A sure-fire way to get private equiteers talking nonsense The perversity of secondary buyouts Venture capitalists stymie innovation Stop deceiving your limited partners!Name plates must be brought to every class: participation points will be lost if name plates are not displayed.

And it overexpanded into unprofitable segments, particularly standard contact lenses. The team also brought in new managers from outside when necessary. Most corporate staffers at PE firms are deal makers and financiers, people who play core roles across an entire portfolio. Having one high-level contact streamlines the relationship and avoids distractions.

Everything else was secondary. Should it be broken up? It was a fun and challenging job, involving tons of international travel and I met some amazing people along the way. A one page response to each set of case questions should be posted on Blackboard prior to classes when the case is to be discussed.