Success factors that can open up further value creation potential for SMEs, even in challenging markets
Introduction
The term “value creation” is used when a company experiences an increase in value due to operational improvements.
SMEs are a company segment which, due to its structural nature, offers above-average value creation potential; operational improvements usually have a disproportionately high effect on value creation. The reasons for this are often to be found in the management, organization and processes of medium-sized companies, and the frequent lack of know-how / knowledge and/or resources to implement measures to tackle operational improvement. Accordingly, the positive impact of implementing these measures, for example by increasing the number of specialised team members, invest in the IT infrastructure and optimise financial structures, is considerable. It is however crucial that such activities are viewed as medium-term investments and not as a short-term increase in the cost base, as some measures will take time to implement and contribute.
How can a financial co-owners create value?
In the competition for attractive SMEs – which are often taken over directly by the founders/entrepreneurs – the “value add” of a new majority shareholder is more important than ever as a decisive success factor; because these new co-owners must be able to demonstrate transparently to the existing shareholders, especially if they remain on board (through re-investment), why they will generate the added value as majority shareholders in future. The tools available to them for this are not new. However, it can be observed that investors are increasingly integrating an ever-greater variety of these known value creation levers into their future value creation plans. There is no “one-size-fits-all” approach, as each activity must be individually tailored to the sector, the SME and the prevailing market environment. Nevertheless, factors can be identified that increase the likelihood of successful implementation of the value creation strategy from a (financial) co-owners’ perspective.
Based on above, I take the opportunity to elaborate on four of these factors in more detail:
1. Specialization in selected (sub)sectors
In the USA, there has been a trend towards investors specializing in specific sectors for many years. In Europe, on the other hand, many investors have long worked primarily with a generalist approach. However, the trend towards specialization is also becoming increasingly prevalent here. Even if individual investors do not commit to just one sector, they are carefully considering the sub-sectors in which they have been particularly successful to date and are increasingly focusing on these for future investments. The advantage of specialization is obvious: investors can use their previous successes to argue very credibly that they have the experience and expertise to achieve sustainable increases in business value. Specialization also makes it easier to assess the quality of companies and markets in which they operate. This also increases the likelihood of successful implementation of value enhancement plans.
2. More intensive use of operational resources
A growing number of investors employ operational experts who work closely with SMEs to develop value creation plans and then support their implementation.
These can be former executives at management level, for example, who then support management as mentors, as senior advisors or step in as interim CEO/CFO. Many investors also rely on functional experts: HR specialists, digitalization or go-to-market experts who provide SMEs with targeted advice on specialist issues and their implementation. The advantage over external consultants lies in their availability, the solution-oriented approach to operational implementation and their incentives: the long-term engagement over the entire value creation period ensures equal interests between the co-owners – investors and management – as well as the employees.
3. Stronger focus on M&A
Many investors are increasingly looking for ways to use their initial “platform” investment to make company acquisitions. Such “add-ons” are not a new phenomenon per se, but investors are now going on the offensive much earlier and with more emphasis. In some cases, they are already working with specialist service providers prior to a transaction or setting up internal teams to provide portfolio companies with greater support in M&A transactions. They are pushing this area for two main reasons. Firstly, to achieve economies of scale more quickly by tapping into products, regions or knowledge and to achieve better diversification. Secondly, these acquisitions can be made at lower company valuations and result in a corresponding increase in value at (consolidated) group level because the group becomes larger and more diversified as a result – or in short, 1+1 equals more than 2.
4. Concentration on resilient industries
In the years of low interest rates and growing economic output, value growth could be achieved in almost all industries and sectors within the planned holding period of a majority shareholder. However, in the current market environment, which makes exits more difficult, more resilient business models are coming back into focus. The trend is towards investing in companies with controllable value creation potential and support from long-term megatrends, where a potential medium-term sale is not at risk. In contrast to this, there is currently a certain reluctance to invest in companies active in very cyclical, energy-intensive or capital-intensive sectors; however, this does not preclude that such sectors can be interesting if there is a clear and well-defined value enhancing strategy!
It goes without saying, that the opportunity to increase value is not “only” limited to shareholding structures which include long-term oriented financial co-owners but can also be implemented for the active development of a 100% family-owned SME to achieve the same value expansion with support of appropriate external support, and if required, without opening the shareholder base on a short-term basis. Swiss Private Equity Partners will be happy to discuss the topic in more detail at any time.