Unlocking top-line growth The key to improving a portfolio company’s operations is via top- line growth, says KKR Capstone’s Dean Nelson

According to Dean B Nelson, “It’s pretty straightforward to work with a company and get its costs down in the first six months. But if we want this investment that we’re going to hold four, five, six, seven years, to really create a lot of value for our investors, we need to drive top-line growth.”

It seems as though every private equity firm is operationally focused these days.

But separating true operational improvement from window dressing can be difficult, particularly as a growing number of fund managers continue to hype their ability to cut costs and transform portfolio companies. KKR holds a distinct advantage in this regard, as it can point to more than a decade-long operations track record with KKR Capstone, its 60-strong in-house global operations team.

“Our goal is to build the right strategy and work side by side with the team to implement it so that the new processes or tools work long after we’re gone. We succeed when the strategy works and we are able to walk away from it, having created value for our investors,” says Dean Nelson, founder and head of KKR Capstone. “Alignment of interest is not a small point. People at the company know that we have the same interests at hand.”

He continues: “Frankly our model’s a little different. We don’t write slide decks, we don’t try to prove to the ‘nth’ degree how big an opportunity it is – our goal is to work with the management team to get the opportunity up and running.”

The key to defining operational improvement, and overall value for the business, is top-line growth, Nelson says. Operational strategies geared toward the development of stronger revenue streams leave portfolio companies better situated in the long-term.

Most firms focus their operational improvement strategies on cutting costs, a strategy that – though important – usually only provides a one-time bump on the balance sheets. Eliminating costs alone does not position a portfolio company for long- term growth, he says.

“It’s pretty straightforward to work with a company and get its costs down in the first six months. But if we want this investment that we’re going to hold four, five, six, seven years, to really create a lot of value for our investors, we need to drive top-line growth to get the multiple up and keep a good steep improvement in EBITDA,” Nelson says. “And I think that’s unusual for the industry, certainly how people view the industry.”

KKR’s approach to top-line growth begins during the due diligence process, when KKR Capstone executives join the deal and management teams to analyze and determine where a potential portfolio company stands to benefit from the firm’s operational expertise.

Those areas – or “levers” as Nelson likes to call them – generally include a combination of five or six cost-cutting and top-line strategies, he says (the bulk of the firm’s efforts are spent on the top-line strategies).Those levers can include helping a portfolio company negotiate better terms with its supply vendors, improving its pricing functions, creating a new framework for sales staff or targeting areas in which it could expand, but KKR Capstone’s initial involvement generally centres around helping company management find where it has “left money on the table”.“A lot of these private companies, they’re very profitable, and they don’t worry about the cash coming out of the business,” Nelson says. “We never try to put our vendors in a place that’s beyond their comfort zone or beyond what’s appropriate, but we do see a lot of companies that probably aren’t pushing working capital as well as a lot of the best practices companies out there would.”

Another area where private companies stand to benefit is improving their pricing strategies on specific goods or services. KKR Capstone has found that many companies don’t have a pricing function that takes into account their competitors, which can lead to situations in which they lose customers to lower price competitors. It’s also found some companies leave ‘money on the table’ by undercharging.

Freeing up that working capital, and taking into account new sources of revenue, can open the door to expansion, including to emerging markets where macroeconomic growth patterns continue to be more optimistic than those in the US and Europe. Projecting those visions of growth to existing management teams can assuage the anxieties of family owned businesses that may be skeptical of partnering with a private equity firm.

“When working with a family-run business, a founder, or an entrepreneur, it’s like sell- ing a child, it’s something you’ve built,” says Nelson, recalling a recent example where the company was excited by “our vision for growth, and in particular the growth in the number of stores. They wanted to know how we would do that, how we would make sure they had additional resources,” he says.

Crucial was acknowledging that expansion and growth couldn’t come through cost cutting alone, he says. Identifying and executing strategies that a company can use to lower its costs while growing revenues benefit both the company and the private equity firm’s returns in the long run. That’s not window dressing.

Original press release from KKR.