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Looking Private Equity Groups in the Mirror
In tough times, adopt the PEG philosophy.
It’s more than buy low and sell high.
Fast Focus
- Firms that take a page from the private equity playbook can come out winners.
- Set performance goals, engage the best talent, put your foot on the gas, and reward results.
- It’s a blueprint, more than a resolution, for success in 2009 and beyond.
2009. New year. Newly elected leaders. New challenges to a stressed economy. What all this means for agency leaders—indeed, for any forward-looking businessperson operating in this changeable environment—is that you must be open to a new mindset if you’re going to thrive, or even just survive, in this new economic atmosphere.
If you think you saw a lot of change during the election season—accompanied by the financial meltdown and unprecedented government actions—just wait until the fur starts flying with a new administration. Economists are debating how long “Great Depression II, The Sequel” will be showing on all screens at our national multiplex. Even if you call it “just” a recession, it seems destined for a long run—and not by popular demand.
Well, maybe you’ve read a bit too much about all this, looking at the doom and gloom of our situation and wringing hands over what got us here. True visionaries like us (he says immodestly) are already looking well ahead into a future where there still will be companies winning and losing, where there still will be agencies serving up great products to their markets and being well compensated for their efforts. They will be growing their businesses as high-performing firms always have done.
So let’s turn away from the politics and market pressures and focus on something positive we can do to put our companies into the winning column. Let’s turn toward time-tested methods that have accomplished this goal. I want to talk about lessons from private equity firms that we can implement in the agency model.
I know some readers are wondering why we would focus on private equity groups (PEGs), which were once the talk of the insurance industry, with billions of dollars invested and billions more waiting. Where are they now, now that the markets have gone south and the credit crisis has deepened? Well, they’re probably still looking for smart investments and doing the most with the cards they’re holding in their hands because the good private equity firms, just like the savvy firms in any industry, are making their decisions and managing their assets to maximize shareholder value.
As I discuss PEG strategies, I’m sure many CEOs will say they already follow the management philosophy being described. Again, though, I’ll challenge readers to really evaluate what I’m saying and see if it doesn’t encourage you to think imaginatively and consider what different approaches you can take to managing your business to increase shareholder value.
Finally, before I go into detail on the practices of PEG firms, let me disclose that I own a private equity firm. It is not big and it does not make headline news, but what it does do is follow the philosophy below to maximize shareholder value. So as you read this, please know that my perspective is not just that of a consultant who has studied these practices, but of someone who has implemented them and tested them in running his own profitable business.
BEYOND BUYING LOW
Even for people who’ve never had dealings with PEGs, their stories are familiar to us from the financial news: They buy low, focus on growing the company, and then go public or sell to someone else. Pure financial engineering. Well, that’s somewhat of an old model. Nowadays, most PEGs are managed similarly to public companies, with a single stated goal: to improve shareholder value. They do that in whatever ways make good business sense.
There are many growth strategies employed by PEGs that will be familiar to readers and may even seem quite obvious. However, my experience in dealing with hundreds of agencies is that most agency owners and CEOs do not follow such time-tested strategies.
The main reason, I believe, is because strategic growth requires discipline and change. Put those two words on the white board to begin 2009: discipline and change.
Most people don’t like change. Some fear it; some just don’t have the energy. And many agency owners (although they would not admit this) would rather have a lifestyle firm than a firm that is truly a top performer. Which one, do you think, requires more discipline to own and operate?
Nobody will ever be able to convince me that the number one responsibility of an agency owner is anything but making the business more valuable. So we’ve come to the fundamental difference between a PEG and the typical agency: PEGs operate their companies to generate exceptional results, which ultimately translates into superior financial returns to the PEG and its investors.
LESSONS YOU CAN USE
To take a look at various strategies, I want to refer to a must-read book by Bain chairman Orit Gadiesh and partner Hugh MacArthur, Lessons From Private Equity Any Company Can Use, (Harvard Business School Press, “Memo to the CEO” series, February 2008). Their strategies can be summarized as follows:
- Define the full potential.
- Develop the blueprint.
- Accelerate performance.
- Harness the talent.
- Make sweat equity.
- Foster a results-oriented mindset.
These ideas sound simple, but they are unquestionably hard to implement.
Define the full potential. This seems to me to be the most difficult task, but also the core of a successful PEG strategy. The key is to understanding how your agency can differentiate itself from other firms, what your competitive advantage is, and—most important—what key attributes can create significant shareholder value. Once you can truly define a vision of your agency three to five years down the road that answers those questions, you’ll be on the road to maximizing value.
I know, many of you will say you do this already, but I will argue that you don’t. Why? Because most agencies will settle for OK performance—10% in revenue, 20% margins—that does not call for any radical change from current processes. But a PEG doesn’t look at a company this way. PEGs perform a detailed analysis of the market, competitors, regulatory and legal environments, and other factors to determine an overarching goal for performance. Most importantly, they get management and firm leaders to buy into the goal and see it as realistic if executed with excellence.
How do PEGs achieve their overarching goal? The first step is to identify a few initiatives, no more than five or 10, that will get you there and challenge the business-as-usual philosophy with three core components:
- Incremental changes or execution that will make the firm’s current activities more profitable;
- Out-of-the-box thinking that will require changes to some or all of current operations and processes that will have an impact on future success; and
- Shifting resources away from those activities that do not represent the future of the company.
Develop the blueprint. If you’ve been successful in defining your full potential, the next step becomes easier. It consists of taking the initiatives that can accelerate growth and making them happen. Use a blueprint to map out the strategic and tactical operating plan that details how you will implement your initiatives over the next three to five years. You may call this strategic planning, but again I would argue that most agencies, if they plan at all, plan for the next 12 months, not the next three to five years.
For each initiative, you need to define the specific action items required to make it successful. Identify resources, timelines, milestones, metrics and deliverables. When I work with clients to develop a blueprint or work with the companies I own, I make it simple and use tools such as the strategic planning toolkit from Gazelles, which forces the user to outline the details behind the initiative. No sense reinventing the wheel on this process. What is important is to take your leadership team offsite for several days—with an outside facilitator—with the single goal of defining the specific action items needed to implement and execute your initiatives.
Accelerate performance. The next step is to put your foot on the gas pedal. Accelerating performance is simply taking your vision and the blueprint in hand and getting the key employees involved to execute the blueprint. This must be done in a measured way, with accountability standards and rewards set for timely and successful implementation.
What happens in many cases is that companies try to involve all employees when they roll out a key initiative. This is an error because it spreads accountability too thinly. While all employees will definitely be involved in the execution of the blueprint, put your fingers on the key internal talent and external resources needed to make it happen, then set accountability standards. These include defining who “owns” the initiative, key action items, and methods for motivating and rewarding key players. Monthly reporting, at a minimum, is crucial, and it must compare performance to metrics.
This is the key: Executing initiatives is all about monitoring performance against key metrics. PEGs have proven that tracking operational and financial metrics will enable you to make sure that the work delivers exceptional bottom-line results.
One last point about accelerating performance: It must be accompanied by meaningful rewards, which means significant compensation. I’m not talking about a 10% bonus or the annual bonuses that all employees may receive. As a matter of fact, it should not be considered unusual to have bonuses equal to 50% or 100% of a key person’s base compensation. In other cases, results may be tied to ownership. The bottom line is that it is critical to align the interests of key initiative leaders with those of the company.
Harness the talent. A key differentiator for a successful private equity group is its ability to harness talent. Given the relatively short timeframe that PEGs work with, those firms do not give much leeway to leaders who do not deliver on performance. Indeed, they’re quick to replace leaders who fail to deliver.
At most private insurance firms I work with, leaders are afraid to make changes in key positions, even when they know they should. I’m not advocating changing managers at the push of a button for failure to deliver once, but I am saying that you cannot tolerate C players. Nobody likes to fire people, but to maximize shareholder value, you must surround yourselves with A-level talent.
How do you know if you have the right talent or if your recruiting process is bringing you the best people? Look for people who are driven by success, who are willing to sacrifice current reward for a huge upside potential, and who embrace the concepts of change and sacrificing the old for the new. But your A-list leaders must also be team builders and understand that leadership means being at the helm of a machine with many moving parts, which in the agency model are people all advancing toward a common goal.
Your strategy for getting the best people is to create the right incentives, whether money or equity, and to recruit, retain and motivate your best people by getting them to think and act like owners.
One final thought about talent: Most PEGs use a board of directors to help management teams fill in gaps of talent or resources and to hold management accountable. While I do not believe you need to create a board of directors, consider establishing an external advisory board that can bring value-added resources to an agency in such areas as legal, sales, marketing, finance and mergers and acquisitions.
Make sweat equity. The allocation of capital toward a growth plan is one of the most vexing things for most agency owners. How do you make your capital work most effectively? Most owners do not even understand the balance sheet, but this is a key tool. A strong balance sheet is critical for your ability to generate capital for growth. Why? In the PEG world, cash is king and leverage is good. In your world, it will enable you to borrow money for your growth initiatives.
By saying “leverage is good,” I do not mean the 35-to-1 leverage that brought down Lehman Brothers—rather, a conservative leverage ratio that allows you to significantly enhance your returns by using borrowed money. I cringe when an agency owner proudly tells me that his agency has “never borrowed a dime.” What that tells me is that they’ve never taken a chance to go beyond the status quo. To be a truly top firm, and to be able to execute your blueprint for growth, you must get comfortable with some level of debt. Once you determine your debt-level tolerance, you will know how aggressive you can be with growth. This will often require the assistance of financial advisors to help you understand the implications of leverage, but I believe this evaluation is essential to help you rethink your traditional views of debt and use leverage to your advantage.
Foster a results-oriented mindset. To effectively act on your blueprint, you must be results-oriented, as opposed to process-oriented. Anyone who knows me will recognize this mantra because I preach it all the time. For companies I own, it is part of the core culture and value system.
In simple terms, a results-oriented agency sets the goals, metrics and key operational and financial drivers, and then ensures they are met. Whether a hard market or a soft market, the key thing is that results are achieved because one of the core values of the agency is to increase shareholder value. At a very minimum, the concept of value creation is at the heart of everything the firm does.
Unfortunately, many CEOs wrongly think they have fostered this type of environment. It means effectively communicating goals and objectives, getting buy-in from key leadership, demanding accountability, establishing a reward system and—perhaps the most important criterion—having the ability to take corrective action based on performance to ensure that the initiatives are achieved and that the firm’s blueprint becomes a reality.
Effectively using these six strategies, you can bring your firm into the realm of discipline and change that are the hallmarks of successful private equity group firms. Invest in a blueprint that has a three-to-five-year goal, use that roadmap for initiatives that will create the most value for the agency within that time, measure things that matter with effective metrics, find and develop the best people and strategically deploy capital only toward initiatives that support your goal.
This is the formula for success in 2009, and if you want to set a resolution, you’ve got everything you need right here.
Robert Lieblein is a contributing writer and managing partner of Hales & Co.
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