Small / Middle Market Private Equity Investments and Spend Management

Earlier in the week, I had the chance to attend a gathering that my wife's consulting firm, Aptium Global, hosted for small and middle market private equity firms and bankers in Chicago at the University Club. The event, also attended by fellow blogger Michael Lamoureux -- who happened to be in town visiting -- discussed ten ways that investors can drive EBITDA improvement in their portfolio companies. Lisa Reisman started the discussion and was joined by two fellow speakers. The first was Mark Pruitt of the Energy Resources Center of the University of Illinois, a non-profit consultancy focused on energy cost reduction strategies. The second was Ara Surenian, a middle market lean and operational expert, who serves as President of Cadent Resources. Each presented real-world examples of cost reduction and EBITDA improvement in small and middle market organizations.

I'll leave the case study write-up and analysis to Michael -- and I'll link to them when he posts on his blog -- but what struck me most from the interactions I had during this event as well as other recent discussions with financial types is how private equity firms are getting more operationally oriented -- or at the least, working with advisors, consultants and operators who are. And this type of thinking is going down to the lower middle-market as well (even for firms with investments in companies with as little as $10 million in revenue).

In fact, even for a company at this level, it's sometimes possible to have a huge EBITDA impact merely by targeting a handful of category sourcing or lean initiatives, increasing valuations by as much as 1.5x-3x depending on given industry multiples. Even though many investors are not lean or direct materials sourcing experts, they get it. And they’re increasingly bringing in operational experts -- often ahead of new sales and marketing staff -- to help create new value.

Another interesting learning from this small to middle market segment is that within manufacturing, especially, direct materials cost reduction efforts -- either sourcing or inventory based, or both -- can have a disproportionate impact on overall profitability because so much of COGs and working capital is typically tied up in only a handful of categories. This is in contrast to larger organizations that typically have much more fragmented spend, even on the direct materials side, because they're producing a greater number of SKUs, part categories, and / or finished products. In addition, indirect and services sourcing in small and middle market manufacturing is often a much shorter cost reduction lever to pull than it is in larger companies. This is because overhead is typically a lower percentage of overall spend than it is in larger organizatons.

Jason Busch

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