What to Expect If Permanent Equity Buys Your Business
Here’s a thing that happened…
We went under Letter of Intent (LOI) to buy a business and took a few members of our team to get to know the people we’d be working with. We brought in lunch for the executive team and struck up a conversation. But, there was something “off.” So finally, we tried to level set.
“Are you all worried about something specific?” we asked. After a beat, someone answered.
“Are we relocating to Columbia, Missouri?”
We buy businesses with the aim of preserving traits that attracted us to them in the first place. In fact, our first operating principle is “Do no harm.” No business needs know-it-alls who have only just gotten to know it suggesting radical changes based on unrelated experience. Just recall Ron Johnson’s tenure at JC Penney.
So no, an investment from Permanent Equity doesn’t require anyone to move to Columbia, Missouri. (Not that you shouldn’t — PSA alert — want to move to CoMO with its high quality of life and low cost of living.)
Having said that, there are inevitable post-close changes that are natural byproducts of bringing on a significant new partner. The relevant questions are “How?” and “To what end?”
What Changes and Why
Here’s another true story…
The day after we partnered with a business, the CEO (who remained in place and from whom we bought our stake) called us up to share a problem with a longtime customer. After describing the issue (which had to do with spending a few extra dollars to deliver on that customer’s expectations), he asked what he should do.
Our response was simple: Do what you would have done two days ago.
Now, we appreciated the phone call — communication is one of the biggest things that does change post-close — but it’s not our style to tell leadership teams how to run the business. That’s because we pursue businesses that are operationally excellent i.e., they do the thing they do to make money really well. Where we try to add value is around the periphery — what we call the “business of business.”
The “business of business” is where the change occurs. It’s not us coaching one of our construction firms to change the gauge of steel they’re using, or tinkering with the matchmaking process at Selective Search, or suggesting we’d know a better way to distribute airplane parts.
While we’re always available to help brainstorm through a problem, our post-close focus is always on improving the parts of the business that “taste like chicken.” It doesn’t matter if you’re building swimming pools or recruiting for the military, some parts of business are the same. How to find customers. How to sell customers. How to identify and implement relevant technology. How to make sure employees are provided for and that the business is properly protected against risk. Lastly, how the company is governed, how data is gathered and reported, and how financials are created.
Optimizing Together
Here’s one post-close guarantee we can make: We’re going to spend a lot of time together, and that’s a good thing. There will likely be weekly (if not more frequent) phone calls, monthly site visits, quarterly deep dives, and annual strategy and forecast reviews (which are a lot more fun than they sound). We want to know what’s working and what’s not. In fact, we want to learn all about what’s not working because those are likely to be the greatest opportunities to work together to grow. That’s why we always ask for the bad news, or challenges first, and why it’s disastrous to try to hide them.
The purpose of all of this communication is not to fault-find or micromanage, but to get to know the business from an owner’s and leadership team’s perspective inside and out, and most importantly to be helpful. We want to help where we have some insight or expertise, and otherwise leave our leadership teams to do their jobs and live a good life.
Here are some examples…
Marketing: We acquired a business recently that didn’t have a website let alone a Google AdWords budget, yet the company was operating below capacity and stuck on ways to generate further demand. The operator acknowledged the lack of online presence, citing past bad vendor experiences, costs, and ever-extending timelines. Using internal resources we had a website up within a week and began generating new leads.
Optimizing marketing funnels is a major focus for us. Who doesn’t want more demand?
Finance: We encounter many small businesses that are wary of using financing, including operating lines of credit. Typically this fear is healthy. These are owners who have been through downturns and seen friends and competitors wiped out by debt. Further, they find it difficult to work with banks (who doesn’t?) due to the cost, long contracts, legalese, and confusing covenants.
But banks exist for a reason and it can be nearly impossible in industries such as construction, where costs are borne upfront and payments received long after, to grow without financing smoothing out the time between when invoices are issued and paid. That’s where we like to work with management to understand a company’s balance sheet and discover where something like a line of credit might make sense. We can help negotiate in order to reduce fees, get competitive rates, and lighten up on the covenants so everyone feels great about having access to financing.
People: Is there a hire you’ve always wanted to make but never found the fit or thought you had the budget? In many small businesses, everyone does everything. Ask yourself: Are there things I’m doing that someone with more training could do better? Are there things I’m doing that keep me from doing the things where I add the most value? You could be in need of a chief operating officer, or controller, or some other essential executive. We like to help to identify these gaps and then work with you to help fill them — either with candidates you know or others from The Orbit, our proprietary pool of talent.
And for all key roles in the company, we want to make sure there is redundancy, a replacement in place in case you, or any other senior leaders, have to leave the business. Leadership is everything and creating redundancy is the best way to make sure a business can survive for the long-term, and we have a long time horizon.
How Decisions Get Made
Too many cooks in the kitchen is never helpful. Is something your decision or is it ours? Do you need sign-off or is it your call?
While we would like to say we are perfect at this, we can’t and aren’t. No one is. Every organization has some role confusion and ambiguous chains of authority. One framework we’ve been tinkering with recently is the DACI Model, where clear roles are assigned based on the type of decision that needs to be made. Here’s an example of how that might work after we partner with a business:
What should be clear is that the operator is left to drive the majority of the operating decisions, with Permanent Equity approving or participating alongside the most important decisions. Frameworks like this are always going to be a work-in-progress, with people and roles perpetually evolving. But we’ll work on it with you and seek to get it right.
Where The Money Goes and Why
Healthy businesses, the type we get involved with, generate cash from operations. As that cash is generated, here’s how we think about what to do with it.
The first thing we want to look for are high-probability, high-return opportunities to reinvest back into the business. Oftentimes these projects are small and obvious. Perhaps it’s buying some new equipment that will improve our product quality, or staffing up to take advantage of continued growth. These types of reinvestments are table stakes for maintaining the company’s trajectory.
The next categories of reinvestment are expansion projects. This could be investing in research and development to create a new technology, or opening up a new office to expand geographically. Sometimes it’s bringing on a new team to build an adjacent line of business, or doing a small acquisition. These decisions are strategic and are aimed at growing the business significantly.
Regardless of the type of reinvestment, the decision-making process is identical. We want to do our best to estimate the range of potential outcomes from the decision, then try to understand probabilities. We then force rank these opportunities and see how much risk we want to take. The higher the probability and higher the expected return, the more likely we are to green light the project. We live in the real world, so the math is important, but obviously far from precise. Yet, the conversations generated by such exercises are priceless and lead to dramatically improved decisions.
After we’ve poured resources over the projects we feel best about, there’s usually money left over. And since there’s rarely debt used in our portfolio, we can make distributions. The first priority is to make sure all the partners can pay their taxes and all distributions are done pro rata. Said differently, we’re not fans of multiple share classes that split up the fruits disproportionately. We like partners who all eat from the same table.
Once reinvestments have been made and taxes paid, we can make distributions of profits. Our investors are outrageously patient, hence our functionally permanent time horizon, but they like to share in the on-going profits of the business, as any family would. If you roll forward equity, which we highly encourage most sellers to do, you’ll also share pro rata as this profit distributions are made.
What Doesn’t Change
If that is all that changes we hope it’s evident that most of the day-to-day does not. We want the same great people doing the same great work and delighting the same, and eventually some additional, customers. We want to help put in foundations for growth and potentially explore new markets and additional capabilities, but the thing that will be growing will be the same core business. We will augment the team, but the team will stay in place.
And no, no one needs to move to Columbia. But, you’re always welcome to visit.
Want to start a conversation?
