Lean process improvement methodologies are crucial when preparing a business for a divestiture. Selling a part or all of the shares of a business always requires the right preparation for due diligence so as to put ‘the house in order’ and develop an appealing offer to private equity firms. Merger and acquisition firms are increasingly making use of lean six sigma techniques during the due diligence process in order to improve the key performance indicators that can make a substantial difference at the time of buying or selling a business. At the same time, more often than ever before, private equity firms are requesting the implementation of a lean transformation prior to the acquisition of a business.
What is Lean?
The lean methodology was developed with the ultimate goal of reducing costs and increasing efficiency by identifying and eliminating activities in a given process (service or manufacturing) that fail to add value and yet consume resources. In the lean terminology, value is defined as ‘what the customer is willing to pay’. As a result, lean is heavily oriented not only toward efficiency and cost reduction but also toward creating value to ensure customer satisfaction.
On the other hand, Six Sigma is a system developed with the goal of controlling variation and making processes more consistent and reliable to ensure the quality of deliverables. The combination of Lean with Six Sigma results in a faster creation of value at the lowest possible cost.
Lean/Continuous Improvement as a Due Diligence Tool for M&A and PE
One of the most important steps that all businesses must take prior to selling or buying all or some of their shares is the due diligence process. Mergers & Acquisition (M&A) companies typically define the due diligence process as an investigation to be conducted on a business prior to its acquisition. Private Equity firms (PE) also understand due diligence as the business transformation they would like to see in an organization prior to investment. Lean Six Sigma methodologies have been of substantial help in this transformation.
The workplace organization tool called ‘5S’ is one of the most basic continuous improvement tools offered by lean. During the due diligence process, this 5S tool can be compared to the staging of a house prior to be listed in the market, delivering a substantial positive visual impact to the eyes of potential buyers.
When it comes to evaluating the operations of a business, there are certain KPIs that should always be present. These KPIs will vary with the type of business to be sold or purchased. Here are some examples of KPIs that are frequently examined:
- Annual revenue
- Employee retention
- Inventory costs
- Margin per product/service
- COGS (cost of goods sold)
- EBITDA (Earnings before interests, taxes, depreciation & amortization)
- OEE (Overall equipment effectiveness)
- Rejection rates (& scrap rates)
And the list is too long to continue. Nevertheless, lean offers a wide range of tools to address and improve each of these KPIs which are crucial to evaluate at the due diligence process. For instance, the application of the pareto principle during a root cause analysis will help to determine the 20% most influential reasons causing inefficiencies such as high turnovers, high rejection rates, or low performance rates per line of products/services, to mention a few. Process improvement tools such as rapid changeover will deliver value while addressing setup times that will positively impact cycle times and overall efficiency. In many cases, up to 80% of the improvements identified in a due diligence process come from a very well detailed process map. This tool will visualize multiple inefficiencies that would otherwise pass unnoticed, such as redundancies, poor flow of materials or information, excessive movement (spaghetti diagrams), etc.
Both M&A and PE firms have observed firsthand the substantial benefits of lean transformation to create value as a crucial step in the due diligence process. This lean preparation is indispensable when buyers want to eliminate any chance of finding skeletons in closets after having closed a deal.
In the particular case of Canadian-based businesses being considered for investment, another important factor to be considered is the type of corporation resulting after the investment. This will play a significant role in the ROI for all R&D efforts performed by the company. For instance, CCPC (Canadian Controlled Private Corporations) are entitled to a maximum of 42.3% return when applying to the SR&ED program (depending on taxable income and other variables), whereas the ROI for other types of corporations drop significantly to 17.98%. We have recently come across a PE firm that was unaware of this situation when they acquired a Canadian-based business. After the acquisition, the type of corporation changed resulting in a drastic drop in the ROI of research and development efforts.
Lean Six Sigma Training & Implementation
At AMSaxum we provide onsite corporate training on lean six sigma/continuous improvement methodologies and help our clients with the implementation of process improvement projects. There are Government grants available in Canada and the USA to cover the cost of corporate training.
In addition to the tangible benefits possible through lean, the research and development efforts required at the due diligence stage (labor, materials and subcontracts), when applicable, could be eligible to be recovered through government funding, such as through the Scientific Research & Experimental Development (SR&ED) program in Canada.
For companies in North America, specifically, there could be applicable grants to aid in upfront costs such as capital investment and employee training. AMSaxum experts in government funding help with the application of these grants and with the preparation of SR&ED claims.
There are additional tools that can aid in improving overall efficiency, such as an RCCA labor tracking solution we offer, which is an application for collecting data or for tracking labor or KPI efficiency.
For more information on continuous improvement and Government funding within the M&A and PE sector call AMSaxum at 905-315-6847 or contact us here.