For private equity teams focused on the lower middle market (LMM), the best playbook is simple in concept, and it's repeatable for professionals with the ability to execute:

Step 1 - Buy a small platform-like company (<$10MM EBITDA) with in a fragmented industry that has roll-up potential at a low valuation (<8X EBITDA) through an inefficient sale process (partly due to the company's size and scale).

Step 2 - Scale and improve the business via:

• professionalizing management,
• implementing best practices - both finance and operational,
• then, ramping up M&A and organic growth to create a larger, more stable company.

Step 3 - Sell the larger company (>$20MM EBITDA) to another PE firm through an efficient process, marketed to the middle-market segment, which has more capital and leverage available (i.e., increased multiples and valuations).

The key, often-overlooked portion of Step 2 (scaling and improving the business) is getting out of the gate efficiently. This typically involves adding an outside professional for four to six months, either as Interim CFO or as a Project Management Office (PMO) resource. While this approach may appear to be an expensive, one-time cost, appointing an experienced Interim CFO (or PMO/Operational PE Partner) for a brief period can transform a founder-led business into a private equity platform. 

This approach will make the business ready for the acquired growth that is part of the value-creation blueprint. The evolution involves:

• Creating and implementing the valuation-creation blueprint – setting up a PMO, mapping out work streams, assigning accountability and monitoring 
• Creating KPIs – getting management tools and access to the key metrics
• Automating lender reporting – automating and understanding requirements
• Automating financial analysis, not simply printing the Income Statement from the ERP
• Making cash to accrual accounting adjustments – understanding entrepreneurs have different motivations versus PE firms
• Creating a standardized M&A implementation road map
• Understanding operational inefficiencies
• Conducting an analysis of procurement strategies and opportunities
• Confirming the right talent is in the right seats
• Ensuring audit readiness

A former colleague once said, “The professional you need today is not the professional you need six months from now.”  That advice is most applicable in LMM at the acquisition date when a founder-led business is bought by institutional capital for the first time. 

Being the first institutional owner of a company has significant upside opportunity if done correctly, but an unsophisticated back office is the reason many LMM companies have more risk and are sold at lower multiples.

Setting the business up for success allows for a stable platform to grow compared to stacking acquisitions onto an unstable platform. Additionally, it prevents frustration from growing between the founder and the PE firm and provides guardrails so that the private equity team is not blindsided when challenges pop up.