Over the last five years, Facilitator Capital Fund has looked at more than 400 potential transactions, made investments in 12 companies and seen more than its fair share of business opportunities, both good and bad. The fund invests in smaller middle-market companies, with $10 to $50 million in revenue, close to our home base in Wisconsin.
The companies in its portfolio have a history of operating successfully in niche markets, and their management teams always have a meaningful equity stake that can be realized over its investment horizon of five to 10 years.
So, what does a venture capitalist look for in a potential clientω
What makes a successful investment is first and foremost the knowledge, skills and abilities of the chief executive officer of the firm we are investing in. His or her leadership sets the stage to develop a qualified management team dedicated to developing a culture of continuous improvement and superior returns on invested capital.
Extraordinary accomplishments in a short period of time are required to achieve such returns. To help achieve that goal, our CEOs report to a good outside board of directors and are charged with growing their companies to a dominant position in their niche markets.
How do we measure a company’s performanceω
Let’s remember that the overall goal for a venture capital firm is to generate a return to its investors. A common framework for measuring value creation is economic value added (EVA).
EVA is the performance measure most directly linked to the creation of shareholder wealth over time and is an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that we, as investors, could get by investing in other assets or securities of comparable risk.
That can be 7% for secured bank debt, 18% for mezzanine capital or 25% for equity capital. Positive growth in cash flow and value beyond the cost of capital is what creates incremental shareholder value.
The four cornerstones
To achieve value, our management teams use a framework that has proven useful to evaluate the potential value creation. The four main components include:
— Human resource development
— Profitable customer growth
— Operational excellence
— Information for decision making.
The key driver in generating value is having the right people in the right position. Without the right people, execution of the right strategies or tactics just won’t happen. Leadership with a continuous learning mindset is crucial to grow and develop the management team in terms of market and industry knowledge, technical expertise, product development, leadership skills, mentoring and practical business insight.
That development also typically includes a critical evaluation of team members, clearly defined goals and objectives and the execution of a personal development plan.
Ask yourself the following questions: What has your team learned lately that is new or innovative in order to make the company betterω Are you setting goals and objectives driven by a performance-based/performance-reward systemω
The process of identifying why customers buy from you, what your market niche is and how you can develop additional business with your most profitable customers is an important driver of increased value.
Do you know which customers are your most profitableω Why they buy from youω And how you can find more just like themω
If you are not continuously identifying the needs of your customers and serving them, you will see the top line dwindle. Also, if you don’t really understand your costs and individual customer profitability, your business may be masking unprofitable customer relationships that should be terminated, and future growth may not be targeted to the right customers or markets.
Just how good are your operationsω Just being average doesn’t cut it in a worldwide economy and competitive marketplace. The gap in operational efficiencies continues to grow between best-in-class companies and average companies.
Does your company have a process in place (Six-Sigma, lean manufacturing, process mapping with identified process improvements etc.) that will continuously create improvements in your supply chain, whether it be in manufacturing, direct contact with customers (front office), administration (back office) or distribution channelsω
The days of monthly financial statements and making decisions solely out of the rear-view mirror are over. Supporting the decisions that need to be made on a day-to-day basis requires good information for decision making. That concept goes well beyond financial information to include key performance indicators measured daily or weekly that show the results of actions (i.e. on time shipments, quality measures, new orders received etc.) that will have a positive effect on future results.
To keep a business nimble and responsive to the marketplace, you must spot problems early on and undertake immediate, well-informed actions. Ask yourself, "Do I have the right operational, sales, financial, customer and market information required to manage the business and make decisions on a timely basisω"
Last but not least, the company culture is critical to the success or failure of the leadership team. The strategy must be meaningful and well-understood by all employees.
Simply having a high-level strategic plan without specific actions, responsibilities, expectations and timing developed by management and team members responsible for getting them done, leads to a document that is put on the shelf and not executed by the organization on a daily basis.
Leadership by the CEO determines success or failure for private equity investments. If the CEO effectively leads the process that develops strategy based on the four cornerstones and drives timely execution across the organization, investors will achieve EVA and superior returns on invested capital.
Dave Bauer is a principal and the chief financial officer at Facilitator Capital Fund, Milwaukee. Facilitator Capital is a $130 million later-stage venture capital fund investing in manufacturing, distribution and consumer products industries, and it is geographically focused in Wisconsin and the upper Midwest. For more information, contact Bauer at 414-967-7008.