How private equity can supercharge a company's innovation

PE firms specialize in exactly the kind of questioning and fruitful evaluation that can turn a company around


Innovation is critical to the continued success of a company, yet it can be difficult for businesses to avoid slipping back into stagnancy despite the best intentions. Delivering the same performance levels, failing to create substantial value and rehashing what one has accomplished before is all too common for many teams.

When that occurs, opportunities for growth and strengthening a brand can be missed. It is vitally important to understand just how innovation happens – and how to generate more of it.

Why good companies stall

One reason momentum breaks down is that small companies are not able to invest enough time, money or other resources into innovation. Typically, that's because they are remaining in 24/7 firefighting mode. That robs them of the resources necessary to think through innovative ideas.

Even when leaders are oriented toward ongoing improvement, small companies are too often focused on modest changes: Good quality, lower price and better service. There's nothing wrong with those factors, but concentrating on only those fundamentals means one can miss the bigger picture of what's going on in an industry. This idea was captured well in Michael Gerber's book The E Myth, in which he explained how owners could get so caught up in working in a business that they would fail to spend enough time working on that business.

There are other reasons that good companies don't innovate. Perhaps they have no external resource in the form of outside advisors to help push them. Perhaps things are working well enough at the moment, so there's a resistance to fix something that isn't broken. Or maybe existing businesses are incentivized to optimize around proven, successful efforts and not new, risky ventures.

Which doesn't mean that all small companies fail to innovate. To the contrary, a great deal of innovation does come from unique small and medium businesses. The biggest tech giants today – Facebook, Microsoft, Google and Amazon – were those upstart companies not all that long ago. When it comes to the state of innovation today, look no further than this quote:

"Uber, the world's largest taxi company, owns no vehicles. Facebook, the world's most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world's largest accommodation provider, owns no real estate."

— Tom Goodwin, SVP at Havas Media

In fact, Amazon's monumental success serves as a great example of how many small companies can fail to innovate at the right juncture. Consider the massive disruption that has happened in the book industry: Independent bookstores largely missed the migration to Amazon, and book manufacturers missed the migration to smaller printing. Amazon missed none of it and wound up with almost unimaginable growth – far beyond merely selling books.

The many benefits of private equity

Fortunately, for many companies small and large, there is a solution to the problem of limited innovation: Private equity (PE) firms. PE firms have consistently grown their portfolio companies faster than publicly traded companies or family-owned businesses. Here are some key characteristics of PE that help businesses grow faster:

Deep reflection: PE firms will carefully evaluate a company and its business domain before they invest in the company. Evaluation by a PE firm presents a rare chance to get that degree of external scrutiny while delivering a critical assessment about what's good with the company – and areas that need work. As a result, PE firms start off in their ownership with a comprehensive understanding and deep reflection on the strengths and weaknesses of any business model.

Focus on value creation: PE firms are universally focused on one metric: Equity value creation. This singular unit of measurement drives innovation because PE firms will readjust a company's business model to ensure that equity value creation does occur. PE firms will not survive if their portfolio companies are not creating value through innovation.

Good governance: Many PE firms encourage engagement by independent directors and operating partners via monthly board calls, as well as quarterly in-person board meetings. Regular touchpoints like these create opportunities for productive introspection and robust dedication to innovation.

How to keep the innovation fires burning

Let's take a look at three basic steps you can take to re-evaluate your current approaches to innovation:

Never stop questioning

To stay innovative, company leaders need to consistently ask themselves questions such as "What are the biggest changes occurring in my industry?" Today's rapidly changing business world requires a constant vigilance toward the business landscape and the new products and services cropping up on it. Raising questions should be one of your top rules as a forward-thinking leader.

Shine the spotlight on your own company

Successful leaders must then also ask themselves how these changes in the ecosystem will affect their companies directly – and what to do about it. If a competitor launches a new product, will that encroach on market share? Is there a way to vie successfully in that same product space by bringing new value to that niche?

Be the change.

It's not just simply monitoring. Successful leaders will be able to shape the changes within their industries. But to do that, they must be informed and ready to react to new technological enhancements or other disruptions to how things had previously been done.

Although these seem like simple guidelines, carrying them out amid the chaos of day-to-day operations at any business is not easy. Enlist all the help you can get. PE firms can be a great choice for many businesses because they specialize in exactly the kind of questioning and fruitful evaluation that can turn a company around. Those leaders who choose wisely are likely to enjoy a bright and innovative company future.

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