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Private Equity

How to Create Value in Lower Middle Market Bolt-On Acquisitions


Corporations represent a complicated amalgamation of many components: people, process, products, and stakeholders. This complexity is particularly acute in the lower middle market space, as successful companies are often stretching the capacities of their infrastructure and management resources. Creating value in lower middle market companies involves many layers of decision-making — both daily and longer-term.

Successfully navigating this landscape is more art than science, and requires private equity managers to utilize a flexible approach. In many cases the leadership of lower middle market companies are single entrepreneurs or families, rather than the more developed corporate executive suite typical of a larger company.

Toeing the Line

Part of the conundrum in lower middle market private equity is navigating the line between “strategic improvement” and “destabilizing revolutionary change” at the right time.

Let’s consider a fast-growing B2B services company with multiple national offices. When we consider structuring the accounting department for optimizing cash flow management, we encounter multiple questions. For example, where should the gatekeeper of Accounts Receivable and Accounts Payable be located? Does it make sense to have a single location processing all invoices, streamlining the process, and eliminating redundancies, or should local offices manage their own customers’ receivables and lean on their local relationships with customers and vendors? A similar matter emerges with managing company information systems, where again we debate the metrics of centralization versus developing competency at each office.

In the meantime, another aspect of the problem: the management team may perform best with the way things were done in the past. In these cases, it’s important to consider the repercussions on strategy and culture – in addition to the bottom line – that changing the company structure could bring about. Depending on the situation, it may or may not be worth the disruption.

Balancing Bolt-On Best Practices  

This conundrum becomes even more complicated when platform companies do bolt-on transactions with the aid and capital of private equity sponsors. Best practices call for the acquired company’s legacy system and procedures to be upgraded to match the platform company’s. In this situation, “destabilizing revolutionary change” may fit the bill in order to ensure a successful integration. Successful private equity firms can employ a few tactics to implement these changes:

  • Plan ahead.

A 100-day plan is always a good start in private equity bolt-on acquisitions. A plan with categorized action items, detailed implementation strategy, and necessary steps to achieve them should always be prepared in the early deal process. Some of the key features of a good plan (per each action item) include: involved organizations and responsible leaders, achievable milestone dates, clear goals or visible impact (e.g., economic, organizational), and follow-up protocol for multiple-step items. It is important to let the management of the platform company and the acquired company communicate from an early stage to create a reliable and realistic plan, rather than something last-minute and over-ambitious.

  • Implement a people-based solution.

The lower middle market necessitates nuance and flexibility in the action plan, whether related to management issues such as personal ego and management style, succession matters, divisions between family members, and estate planning, or to business issues such as customer concentration, lower economies of scale, unsophisticated IT solutions, unique payment terms, and others relevant ones in small business. Many companies have typically been run by family members, who are talented, smart, and successful leaders but may not have formal business education. Moreover, post-close changes may require support from multiple organizational layers. Therefore, creating a proper incentive plan matters. Consider setting the management team’s bonus and awards not just on earnings but also on qualitative criteria such as team success and well-executed transition plans.  Finding a right balance between different criteria is also  critical.

Working with the right partner makes all the difference in the lower middle market.  Good private equity managers have learned, sometimes the hard way, the best way to solve problems from their previous investments. The best way to find a great private equity partner is to look at their portfolio companies. Track their performance to date; talk to a management team member of a current or former portfolio company; search for related information in middle market M&A and private equity communities. Great private equity managers know that building a great, lasting enterprise is not always easy, but they are nevertheless excited by the challenge.

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