Managing through the J-curve
At Credo Partners we take pride in our investment philosophy “Scaling up businesses”. This aims to transform small/medium-sized companies to rapidly growing institutions where EBIT-results sustainably out-paces top line growth by instituting a scalable platform and business model to take these companies beyond the scope and capabilities of typical owner-led companies. While this sounds easy in retrospective celebratory speeches, the reality of the matter is that from an owner’s perspective, scaling up successful smaller businesses requires a dedicated and profound approach with a replicable methodology that permeates all aspects of governance. This is true for all phases of the investment, but particularly relevant for the first few years of the holding period to ensure control through the typical “J-curve development” experienced when transforming high-potential companies to high-growth cases. The “J-curve challenge” represents the purgatory of events that smaller companies typically face 1-2 years into their transformation journey from a “know it all founder-led model” to a “scalable institution model”; ie the first 1-2 years in the holding period when investments into new competencies and leadership for longer term growth have been undertaken, but before these added costs have resulted in revenue growth and margin expansion.
A typical J-curved transformation path is exemplified in the above figure, although the actual shape of this curve will vary greatly from case to case. This is the time that distinguishes good operators from bad ones, and experienced investors with a proven methodology from others. Embarking on such a transformation journey requires a carefully thought through and executed plan for ensuring control through the J-curve. In addition to clarity on key risks and strategic choices, this includes sufficient financial capital to fund the journey, high quality leadership and human resources to execute, and a set of well-defined leading indicators/KPIs to proactively navigate and adjust speed and course through the journey. Well executed, such transformations for scalability and growth are very attractive for value creation.
Scaling up businesses is the hallmark of Credo’s core competence, which we apply with a mono-focal approach to our investments and value creation: We partner with investors and founders to transform small and mid-sized companies into scalable and sustainable companies. This investment focus is distinct, and holds the potential for high value creation on the back of careful planning and executing for control through the transformation phase. However, to be successful and in control though the journey, a proven methodology, governance model, and execution need to be the pillars of such transformations. Therefore, Credo Partners applies a staged, three-steps model for managing through the J-curve when transforming companies for longer term growth and value creation:
1. Design for transformation success up front
The prerequisites for success are defined at entry of a new investment. Credo typically partners with founders or family owners who have succeeded with developing their businesses thus far. However, typically they have under-invested in competencies and resources, and taken on a non-delegative leadership style. Thus, to realize their growth potentials, such businesses face a transformation journey to be scalable and grow beyond the capacity of the founder or dominant owner.
At time of entry, Credo Partners is adamant at ensuring the necessary platform for future success:
Structure transformation journeys as partnerships with Credo as a small majority owner with control, while ensuring that key people (typically founder/owner/CEO) retain a large minority stake in the company (ideally 51-49%) to ensure aligned incentives for future ambitions and goals. In addition, we ensure an attractive management incentive program (MIP) as basis for recruiting future top management, Board members and other potential select key people that are instrumental for achieving future success.
Spend sufficient time with founder/owner/CEO to build joint ambitions for the next ownership era; and, dig into what it takes to achieve this ambition and document this in a short and crisp document outlining “Strategic guidelines” for the company going forward.
Conduct Commercial DD ourselves: To prepare for a transformation journey, Commercial DD is far too important to be outsourced to outside advisors. This is the opportunity for us to get truly under the skin of the company, and start crafting hypotheses for strategic development, organizational development, cultural strengths and weaknesses, required BoD composition, and prioritized actions to build business going forward;
Prudent valuation: Reflect missing costs and under-investments in the valuation. Good investment returns are easily spoilt from lack of realism in assessing what is required for a successful transformation for further growth in the company.
2. Use momentum of transaction
Once ownership change has happened, Credo leverages the momentum brought about by the transaction as stakeholders expect new energy and changes to be conducted in the company:
We get pivotal people on board as quickly as possible (but not everyone at the same time). If a new CEO is on the horizon: Recruit early to ensure the CEO gets a good opportunity to shape the team. Equally important for us is carefully composing and recruiting the BoD, with a view on ensuring deep industry insights and highly relevant experience around the table for the top management team to draw on through the ownership era;
We ensure “one frame of mind” permeates everyone, and spend quality time crystalizing objectives and plans to ensure distributed ownership and shared ambitions throughout the organization. Such up-front time investments are prerequisites for installing a value-based culture built on performance ethics, shared values, and team identity, and represent invaluable intangible equity for the rest of the ownership era.
We stay close with the bank to ensure that our plans and ambitions are well aligned with financial frames for the transformation journey. In this, we seek to set realistic progress expectations, and ensure sufficient back-up plans and resources so that there will be room to re-group to maneuver through all critical phases of the transformation, well knowing that not all parts of a plan always come to fruition as anticipated.
3. Execute for sustained control
With these preparations in place, Credo is prepared to navigate with control through the typical J-curve development embedded in most transformations for building sustainable growth businesses. In this early execution phase (typically first 2 years of Holding period), we pay particular attention to complementing top management by taking on the following execution-reinforcing roles:
Ensuring a bifocal focus on progress and performance; ie, being very close to short term KPI-performance and corrective actions, while maintaining and reinforcing long term ambitions and goals. This bifocal approach reinforces the links between current performance and progress with the ambitions for the company; thus, ensuring continued alignment and shared responsibility for strategy, progress and results;
Prioritizing, focus, and prioritizing again: Coming successfully through the J-curve requires a univocal focus on execution and progress. Resources are scarce, and pressures on management on the downward side of the J-curve are high both in number of hours worked and mentally. This is the time for tough prioritizations: Only necessary “must do’s” should get attention. From our experience, this is when management is most in need of both close support and follow up. From the inside of the pressure cooker, sufficiently stringent prioritization is tough, and we find ourselves in this phase frequently spending much of our time with supporting top management to prioritize only a very few but essential tasks, while ridding them from all other “nice to do tasks”;
Providing confidence and support to top management, while keeping very close to operations. Credo provides management with a clear mandate to take on responsibility and accountability for effective execution. To control inherent risks, Credo in this phase remains extraordinary close with top management and operations. While we focus on coaching and enabling, we are also sufficiently close to gauge individual performance, and identify potential required rectifying actions if progress falls behind and before it goes off track.