To Drive Value in a Down Market, Get Back to Basics

As the economy softens and dealmaking slows from its 2021 highs, business leaders who want to create value for their organizations should focus on fundamentals, according to panelists at the opening session of ACG’s virtual Operators’ Summit on Aug. 16.

Kylie Wright-Ford, former CEO of the RepTrak Company, moderated the discussion, titled “Market Update and Drivers in Value Creation,” where panelists cited talent, cash flow preservation and resiliency as critical areas of focus for executives in today’s uncertain market environment.

Shifting Headwinds

After a banner year in 2021 for M&A, private equity deal volume is down, and transaction pricing has stabilized after a steady rise, according to panelist Bob Dunn, managing director at GF Data, a financial data company. Valuation multiples in the middle market slipped to 7.4x in Q2 2022, compared with 7.5x in Q1 and 7.6x at the end of 2021. Still, “quality companies continue to trade at a generous multiple,” he added.

Panelist Jim Murphy, managing director for value creation at private equity firm LLR Partners, noted that his firm had its most active year in 2021, but that transaction activity has since slowed. “We’re digesting what we bought,” he added.

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As other PE investors shift their focus to their own investments, operating partners and leaders of their portfolio companies are pursuing fast-paced growth—a feat that has become more challenging thanks to supply chain disruption, labor turnover, inflation and rising interest rates.

Businesses continue to face those headwinds, yet the hierarchy of hurdles has shifted somewhat. Notably, supply chain disruption presented a serious challenge for businesses in 2021, but “it’s waning now,” said Murphy.

Similarly, there are signs that the impact of the so-called Great Resignation is becoming less acute after a dramatic reshuffling of the workforce in 2021. That year, 40 million Americans resigned from their jobs, according to a Korn Ferry report cited by panelist Kristine Holtz, CEO of Cornerstone Foodservice Group.

Today, rising prices and recession fears might be prompting employees to think twice before leaving their jobs. Murphy has noticed that C-level search processes are taking longer and that people “aren’t picking up the phone” for recruiters. He points to the uncertainty in the market as a reason employees may be staying put—at least for now.

People, Cash, Resilience

While the threat of employee churn may be waning, employers should still continue to prioritize nurturing talent, given its importance for the company’s growth. Holtz described Cornerstone’s approach to human capital as “being flexible, being creative and then being fluid.” That includes understanding the unique drivers pushing people to seek other jobs—“40 million people didn’t all leave for the same reason,” she said—as well as creating flexible work options, and implementing the systems and procedures to onboard people quickly, so that turnover doesn’t impact the business.

On the topic of retention, Murphy advised leaders to make the effort to keep stellar employees: “Make sure they know you love them and that you want them to stay.”

Another growing challenge for leaders comes from rising interest rates and cash flow crunches.

GF Data’s latest figures show the impact of rising interest rates on debt markets. For deals involving middle-market companies, the cost of senior debt increased by a percentage point in Q2 over the previous quarter. The higher cost of capital will make refinancing and tuck-ins more expensive to execute.

An economic downturn could also hurt cash flow, making it especially critical for management teams to focus on their top priorities, as well as to understand the macro environment and its impact on their organizations. Panelists advised leaders to protect their cash flow while ensuring they continue to invest in their people.

Successful companies are successful companies. Those metrics that have always mattered still matter.

Kristine Holtz

Cornerstone Foodservice Group CEO

Hard times underscore the importance of being resilient, something Cornerstone saw firsthand during the pandemic.

The company comprises a family of brands of foodservice equipment, ranging from induction warmers to pizza pans. One of its divisions, which serves hotels, stadiums, cruise lines and casinos, was impacted heavily during the shutdowns in response to COVID-19; meanwhile, another division, which serves the top 20 pizza chains in the country, thrived through the pandemic. The diverse customer base across the organization helped carry the business through the crisis, Holtz noted, and has since led it to think about customer segmentation and product offerings that contribute to the company’s resilience in all market environments.

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Holtz’s company recently added resiliency to its value creation scorecard, which it uses to track metrics like top-line revenue growth, EBITDA and its innovation pipeline, as well as human capital-related measurements.

During a downturn, the fundamentals matter more than ever. For the panelists, those fundamentals include human capital, cash flow, and overall resiliency. Management teams with the right priorities, they agreed, will be positioned well to weather the current economic recession.

“Focusing on day-to-day execution will get you through this. Everything is cyclical,” Holtz said. “Successful companies are successful companies. Those metrics that have always mattered still matter.”