Using Private Equity Firms To Improve Operations

Aug. 30, 2006
A new breed of buyer is helping middle-market manufacturers reduce costs and grow their business through lean initiatives and foreign sourcing.

Many middle-market manufacturers are stuck in an operating rut. They lack the financial resources, in-house management skills or even the energy to identify and initiate changes that can help them reduce overhead, establish an offshore strategy or grow the business. To take the company to the next level, owners often look for a buyer with the means and motivation to make the necessary adjustments.

One alternative that has emerged in recent years is a new breed of private equity firm that specializes in building business value through operating improvements and growth initiatives. Instead of simply purchasing a company and relying on financial engineering to generate returns, these firms work in tandem with company management to enhance the business. Actions may range from plant and equipment upgrades to new product development, channel expansion and process improvements that will shorten lead times.

For selling owners, this helps provide assurance that the company that represents their life's work will not only survive but thrive.

For employees and managers, it helps ensure a solid future, provides the ability to influence the direction of the business, and generally allows them to share in the company's success through an incentive-based compensation program that allows key staff to purchase or earn equity in the company. When the private equity firm sells the business five to seven years later, the employees also reap the financial benefits.

Building A Better Joystick

Elk Grove Village, Ill.-based Happ Controls is a poster child for this approach to business improvement. Founded in Frank Happ's garage in 1986, the company rapidly grew to become the leading U.S. manufacturer and distributor of parts and accessories for coin-operated amusement games, slot and video gaming and vending machines.

By 2004, however, Happ was looking for ways to execute the next phase of its game plan. Its manufacturing facility was in need of an overhaul, and its efforts to go global were barely scratching the surface with just $2 million in annual sales from a small UK operation.

Frank Happ and his son Tom decided to sell a majority stake in the company to Pfingsten Partners, taking advantage of the private equity firm's checkbook as well as Pfingsten's staff of hands-on operating professionals.The Happs retained significant minority ownership in the business, and Pfingsten rolled up its sleeves and got to work.

First, Pfingsten managers helped Happ replace an existing Henry Ford-style production line with a cellular arrangement allowing individual products to be assembled by teams. Happ simultaneously installed new workstations, better lighting and seating, new lockers and a new cafeteria.

Next, with Pfingsten's guidance and capital, Happ acquired Netherland-based Suzo International, its leading European counterpart. The deal created a global company with 400 employees serving customers in 80 countries and doubled Happ's annual sales to about $150 million virtually overnight. The company has since made four more add-on acquisitions.

Equally significant, Pfingsten has assisted Happ in identifying cost savings opportunities for the company's 30,000 SKUs by leveraging offshore factory relationships put into place by Suzo as well as Pfingsten's office in Hong Kong. In the first year alone, Happ's China sourcing activities saved the company upwards of $1 million.

Working As A Team

To achieve these kinds of results, the buyer typically functions like a partner/coach rather than handing down decisions from on high. Cross-functional teams consisting of senior management, middle management and team leaders are created to identify critical business problems, brainstorm solutions, put them into practice, and carry the ball forward. The goal is to build a better business that can sustain itself even after the private equity firm is out of the picture.

In addition, employees are trained in the principles of team-based continuous improvement and incentivized to give them a personal interest in business outcomes.

At kitchen and cabinet bath manufacturer Norcraft Companies, for example, this strategy resulted several years ago in nearly $10 million in annual savings through a combination of reduced warranty claims, improved logistics and workforce restructuring. It also dramatically reduced lead times for cabinet delivery and led to the addition of semi-custom cabinetry to the company's stock line.

This new operationally focused model is still the exception rather than the rule in the private equity world. "You need to look for firms that have multiple operating people on staff and get them in there months before a deal closes so they know what they need to do to improve a company," says Lewis E. Gasorek, president of Listowel Incorporated, a private investment firm based in New York. "A lot of firms say they do it, but most only have a figurehead who may not actually get his hands dirty."

But partnering with a buyer that has operating expertise can pay off in better business practices, lower overhead, business expansion, better employee morale, and a variety of other benefits. If you've poured your heart and soul into your business, you want to see it succeed even if you're no longer in the driver's seat. The good news is that there are buyers out there who are dedicated to the same goal.

Thomas S. Bagley is the founder and senior managing director of Pfingsten Partners, a Deerfield, Il.-based private equity firm that invests in middle market manufacturing, distribution and specialty media companies with the goal of strengthening each platform business through operational and strategic improvements. He can be reached at [email protected].

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