Building Value Through Carve-Outs, Operational Transformation and AI

In this episode of The Private Equity Podcast, Alex Rawlings speaks with Russ Roenick, Co-Founder and Managing Partner at Transom Capital, about building a differentiated middle-market investment strategy around carve-outs, special situations and operational complexity.

Russ explains how launching Transom shortly before the global financial crisis shaped the firm’s highly hands-on approach. He outlines how Transom identifies businesses with strong underlying industry potential but significant operational challenges, then applies a disciplined value-creation model to improve performance.

The discussion covers Transom’s six core operational transformations: salesforce effectiveness, new product innovation, digital transformation, supply-chain improvement, cost reduction, and talent and culture.

Russ also shares how the firm structures its operations team, why former portfolio-company CEOs and CFOs can become highly effective operating partners, and how Transom is deploying AI across back-office and commercial functions.

Key Takeaways

• Why operational and situational complexity can create attractive entry points.
• How Transom approaches carve-outs as an opportunity rather than simply additional risk.
• The importance of building repeatable operational capabilities instead of attempting every possible transformation.
• Why operating teams should be involved from underwriting through execution.
• How supply-chain improvements have generated substantial gross-margin expansion.
• Where AI is currently delivering value across accounts payable, receivables, customer service, forecasting and sales.
• Why portfolio companies need internal AI champions to drive adoption.
• How leaders can stay informed without overpowering portfolio-company management teams.

Timestamps

00:00 Introduction to Russ Roenick and Transom Capital
00:30 Moving from McKinsey into Private Equity
01:26 Transom’s value-oriented investment strategy
01:55 Distressed investing versus operational value investing
03:16 Using operational and situational complexity
04:14 Carve-outs, lender situations and tail-end funds
05:14 Launching Transom during the global financial crisis
07:04 The importance of adapting while maintaining investment discipline
08:29 Why Transom specialised in carve-outs and special situations
10:58 Why many firms view carve-outs as excessive risk
12:54 Transom’s six operational transformation strategies
13:23 Salesforce transformation
14:17 New product innovation
14:45 Digital transformation and AI implementation
15:15 Supply-chain and gross-margin improvement
16:13 Cost reduction, talent and culture
17:37 Structuring the portfolio operations team
18:05 Recruiting former portfolio-company CEOs and CFOs
19:59 Transom’s approach to AI adoption
20:57 Applying AI across back-office functions
21:49 Creating internal AI champions
22:48 Common AI use cases across the portfolio
24:10 How Russ stays informed
25:31 Leadership, decision-making and knowing when to step back
25:57 How to contact Russ

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Transcript

00:00

Welcome back to the Raw Selection Private Equity Podcast. Joining us today is Russ Roenick, co-founder and managing partner at Transom Capital, a middle-market private equity firm focused on carve-outs and special situations. We’re going to dive into that today, but also into how these guys are using AI in their portfolio companies and what they’re using as a value-creation strategy. Let’s dive in.

Russ, share with us a brief insight into you, please.

00:30

Well, I started this business almost 20 years ago. I started a private equity business, yet I had never done private equity before jumping in headfirst. So, a little bit of a unique background, I guess.

I was at McKinsey & Company before I started Transom back in 2008, and I was working on private equity-oriented projects on behalf of much, much larger private equity firms at the time, working on their due diligence and working on

00:57

portfolio challenges that they had and the like. But I partnered together with my partner, and way back when, he had some direct private equity experience. But for me, it was all in, learning by doing right from the get-go.

And so, here we are almost 20 years later. I guess it worked, to some extent.

01:26

For us, we’ve always been very value-centric, very value-oriented. Maybe that comes from not really knowing necessarily what we were doing and wanting to keep things as close to the vest as we possibly could. But that franchise and that strategy have actually done us very, very well over the years.

So, we are a middle-market, value-oriented buyout investor.

01:55

I tend to talk about the landscape for value buyouts as sub-segmenting into three general strategies.

You have a strategy that’s very oriented around distress, meaning companies that are facing some existential threat, insolvent or facing insolvency. That’s not what we do.

And then there’s the preponderance of value firms that really focus on

02:22

buying heavy industrial businesses and running a lean transformation, usually businesses that have some sort of large factory footprint. You’re buying these businesses at a value, meaning a low multiple, because, candidly, they’re not in the most attractive underlying industries.

And so, you can buy them cheaply, you can harvest cash flows, and you can sell assets along the way. It’s a tried-and-true strategy. It works really well. It’s just a little bit of a different flavour of value investing than what we practise here.

For us,

02:51

we are very focused on buying businesses on the front end at a value, meaning a mid-single-digit multiple of EBITDA. But we’re buying those businesses in underlying industries that trade somewhere generally in the range of eight to 12 times. That’s our focus.

The magic comes in trying to take that eight-to-12-times multiple end point

03:16

which is really tied to the industries that we focus on. We focus on high-multiple industries like tech hardware and specialty distribution and the like.

We’ve got to find a way to cram that multiple down into our mid-single-digit starting point. The way that we go after that is by leveraging two forms of complexity: operational complexity and situational complexity.

Operational complexity means we’re not buying A-plus

03:45

assets at entry. We’re buying B-minus-quality businesses, often businesses that need some form of operational sophistication or operational edge that we can bring to the table.

We have six specific operational transformations that we zero in on and really focus on when we do that.

Then we think about situational complexity. We can’t compete in a broad, auction-style process with 250 other private equity firms because the best price will always win.

04:14

What that means is that we’re focused on three or four ways in which we enter transactions that all have some degree of complexity around the entry point, including carve-outs, which I know we’re going to talk more about here.

Often, we work with lenders and help them with their overleveraged or somewhat troubled assets.

Another robust area for us lately has been working with tail-end funds, meaning private equity firms that ultimately

04:44

have chosen not to raise their next fund or are struggling to raise their next fund. They need to drive some sort of DPI and liquidity back to their LPs.

That’s how we’ve done it.

As I was saying, when I started this business, I had not done private equity directly before. I had that classic top-down operational and strategic approach

05:14

to the way that we went after things.

We started the business in 2008. We started in early 2008, the world was great, and things were easy. Money was growing on trees. By September 2008, the world was on fire. We were in the GFC, and everything felt like it was melting around us.

What that really forced was a totally different model for engaging.

05:43

As I said earlier, we needed to learn by doing. So, we flipped the engagement model on its head and went very bottom-up. We got inside the portfolio companies every single day and worked the problem.

For me, some of the most valuable experience I had came from running a couple of those businesses as CEO in the early days. I got direct, line-level operating experience.

06:08

All of that essentially rolled up into some success in the early days, when success was hard to find, especially in that era.

We felt that if the business model could get us through those troubled waters and was good enough to succeed, it should work even better once the ground underneath our feet was much more stable, which is obviously what it has been for the last 15 or so years.

06:35

In a nutshell, that’s us. That’s why we have a very tactical style of engagement inside our businesses, working alongside the leadership teams that run those companies on a day-to-day basis to effectively run the business efficiently and put one foot in front of the other, while at the same time running what can be a pretty dramatic operational transformation to radically improve performance, double EBITDA, if not more, and ultimately expand the multiple.

Thank you for that.

07:04

What’s one mistake that you see private equity firms making with their portfolio companies, and what would you suggest to correct it?

I think one of the things that has been the most successful for us over the years is changing with the times, not changing the model by which we invest, meaning it’s a very rigid model through which we work through the problems

07:33

or the opportunities inside a business, and it’s very bottom-up.

Our entry-multiple window and our exit-multiple window are rigid. The transformations we take a business through are rigid. We know what we’re good at, and we try to stick to that.

But we try to change and be creative in terms of where we can find value, because the access points for opportunities change. The market changes, and where you can

08:01

hunt and peck for value can change.

We’re not rigid around saying that we’ve just got to do corporate carve-outs, or that we have to buy everything we can from tail-end funds. We try to be as creative as we can on the front end of our opportunities, both in where we find them and how we ultimately structure them, in order to have a constant source of deal flow and the right type of opportunities that

08:29

fit the business model that we’ve created.

Nothing is simple in any business, I’d say, but certainly through a private equity lens. You guys have developed a specialism around carve-outs and special situations, which, from my perspective, require more attention from an executive-search lens and, no doubt, from a private equity perspective.

Why the decision to go into something outside of a traditional, let’s say “normal,” business, although I don’t know whether that phrase can be used?

09:00

Yeah, well, look, I think it all comes back to the beginning of the story for my partner, myself and the people we surrounded ourselves with.

I think we all have that deep operational perspective that we brought to the business from the early days. We’ve really narrowed that down over time because you can’t be all things to all opportunities. We’re not perfect.

09:30

We’re not experts at every form of operational transformation that exists under the sun. There are six things that we do, and we try to do them exceedingly well.

We feel pretty confident in identifying those opportunities, as well as identifying solutions that we can execute with a high degree of confidence and certainty.

I think where we came from influences where we are

09:59

to a large extent. I think that’s why we decided to go down this road.

At the beginning, it’s not as though we knew we were going to do a lot of corporate carve-outs or buy a lot of businesses from lenders. We just knew that we liked value. We wanted to dig in, be hands-on and have that operational lens. That drove everything.

Ultimately, to my earlier point about being creative and flexible around where we find those opportunities,

10:28

that’s how it happened. Those characteristics tend to lend themselves to doing carve-outs and the other forms of transaction that we talked about earlier.

Sorry to interrupt. Just a quick mention of our longstanding partnership with Grata.

As you will probably know, the private equity scene is constantly evolving, and deal flow is moving towards proprietary and data-driven processes. Grata provides you with data and information on over seven million private companies.

10:58

So, if you’re looking to improve your proprietary deal flow, improve your data access and reach, reach out to Grata today.

Now, back to the podcast.

What is it that you believe companies get wrong from a carve-outs and special-situations perspective that you guys have approached differently?

I think the vast majority of private equity firms hear “carve-out” and immediately translate that into

11:27

excess risk. I think that is accurate if you don’t have the experience or haven’t built a team that knows how to perform the carve-out and dig in operationally.

I think it all boils down to the people you surround yourself with at the firm and the expertise they carry and bring to the table.

That is probably why the

11:57

vast majority of firms hear “carve-out” and say, “That’s too heavy a lift. It’s not what we do.”

I think they’re probably right. You’ve really got to have the personnel to back up the strategy, and it takes a long time to build that base of personnel you can trust.

You have to be rigid, and you have to

12:25

be really good at certain things, such as running a PMO, a project management office, because there are a lot of moving pieces going on at the same time.

If you don’t have that DNA, or you don’t have people who really know how to do it and have done it time and time again, I think it is scary and it does create more risk.

For us, we see it as an opportunity, not a risk. But I think that’s probably why you don’t see many firms gravitating in the same direction that we have.

12:54

Makes sense. You spoke about the value-creation work that you’ve done. Your website references the OUR Method, which I liked.

Walk us through how you’re helping your portfolio companies by driving value creation, operational improvement and capabilities.

Yeah, so we really focus on six things, six specific types of operational transformation. That’s

13:23

the North Star: following those.

We have a large operations team, the largest team we have here at the firm. They work with the portfolio companies and their leadership teams every single day to prosecute some set of the six operational transformations on our menu.

The six, really quickly: salesforce transformation. We buy a lot of businesses with a large field-selling staff. Often, there are

13:52

varying degrees of performance, from the best salesperson down to the worst salesperson. We have tactics and strategies to help, at the very minimum, take those low performers and bring them up to the overall industry or company average. You’re going to grow sales as a function of that.

New product innovation is another big one. My background, even before I was at

14:17

McKinsey, was as a product developer at Microsoft. This is something I really championed and brought to the table in the early days, and it has become a big lever for us.

Companies are generally pretty good at understanding their customers. They’re pretty good at understanding how to translate those customer needs into features and benefits, products, product-line extensions and services alike, but they’re universally bad at getting those things to market quickly enough to

14:45

capture the opportunity, or the full extent of the opportunity. We can help them collapse the critical path and get there faster.

Digital transformation is the third.

Historically, when we thought about digital transformation, it involved looking at a dysfunctional ERP system or commerce platform, ripping it out and dropping in something state-of-the-art that was cheaper, more effective and moved the company in the right direction. We still do a lot of that.

But now we spend probably

15:15

75%, if not 80%, of our time, when we’re thinking about digital transformation, implementing AI.

We start with the back office, getting AI implemented throughout all the functions there. Now, we’re pushing it into the front office and looking at analysing the sales funnel, forecasting and the like to try to drive top-line performance.

The fourth area, the area that, of all the things we do, I think we’re probably best at, is supply chain.

We have about

15:46

650 basis points of gross-margin expansion across our realised assets. In some cases, we have companies where we’ve improved gross margin by over 2,000 basis points.

We love supply chain. We love digging into supply chain and all the sub-strategies that you can attack. They’re usually fairly mutually exclusive, so you can hit one, then move to the next and the next.

We’re talking about things like running an RFQ process, a value-engineering process or

16:13

a lean transformation. You can pursue each of these things in sequence to really ladder up the gross margin.

The fifth area is straightforward cost reduction. You’re identifying all the discretionary spend within SG&A, squeezing it out and trying to do that relatively quickly, within 90 to 120 days.

The last area we focus on is talent and culture.

Often, we buy businesses that

16:41

are B-minus quality. Maybe there are one or two executives who are standing in the way of transformation and higher performance. They’re not adapting to the times, or whatever you want to call it.

We work with the company to identify leaders who are more appropriate for that business. We have a proprietary process that uses not only the typical

17:08

qualitative interview process, but also a lot of quantitative data to increase our hit rate and bring in the right executives for the job.

Those are the six things that we pursue. That’s the OUR Method, to your point, that we really focus on.

There are many other things we could theoretically focus on to create value, but we steer away from them because they’re not within the core skill set of the team.

Exactly. So, you mentioned your value-creation setup within the firm.

17:37

It’s a big discussion point around how people and firms are structuring that at the moment.

We’ve seen larger businesses predominantly bring in people like yourself, ex-McKinsey-type people, as operating partners, or whatever job titles they’re using.

In the lower-middle market, they typically work with an ex-operator, someone proven who has done it before, to come into that role.

Then there’s some contention around specialists versus generalists, whether it’s a specialist CFO or a specialist AI person.

What are you doing at Transom that’s

18:05

driving value creation, and how are you structuring that?

What we try to do, as I mentioned, is build this large operations team.

The way we’ve built it is by bringing the best CEOs and CFOs from our exited portfolio companies over to Transom. We’re trying to convert them to the dark side, right?

We’ve worked with them through a full investment lifecycle and had a great win with them.

18:34

They know us, and we know them intimately. We’ve probably worked together for three to five years in pursuit of transforming that business.

We’ve got a lot of operating history together, and we can effectively bring them on board here at Transom to oversee their own portfolio of assets. It’s fairly seamless.

That has been our methodology for building out this function and team.

19:01

They’re all members of the management company, and they sit side by side with our M&A team, our business-development team and the people who work on our platform.

We’re not using a third-party model with arm’s-length operating executives, as most firms do. These are people who are actively working on new investments. They have an equal voice and an equal say in consummating a new investment opportunity alongside everybody else here at the firm.

19:31

I think that’s a pretty significant point of differentiation for our business model and how we execute it.

Again, we have our operations team involved from day zero. They’re effectively the ones identifying all the available transformations, sizing their impact and determining how long they will take to execute.

When we underwrite something, there is a high degree of reliability between what we expect to happen during underwriting and what actually comes to pass post-closing.

19:59

Okay. You referenced digital transformation as being part of it. We couldn’t go through a podcast without talking about AI, of course.

Walk us through what you’re doing with AI, how you’re adopting it within portfolio companies and whether there are any low-hanging opportunities where you’ve rolled this out.

I don’t expect you to give away all your top secrets, but it would be interesting to see how you’re using that from private equity through to the portfolio.

It was probably two years ago that

20:29

we went all-in on AI implementation.

One thing I’ve heard recently is that, even if you don’t know anything about AI today, you’re only six months behind those who know it really well.

My first message is that, if you’re not going there now or you’re not already there, you’re not that far behind, because it’s changing so fast.

Nevertheless, we started to go really deep about two years ago.

20:57

As I mentioned before, we started by focusing on the back-office functions inside the company: accounts receivable, accounts payable and customer service.

We trialled various solutions and made sure the companies piloted them. Once we identified the right specific point solutions for the businesses, we rolled them out throughout the portfolio.

Then, we pivoted the methodology

21:23

towards driving sales- and product-related initiatives that impact revenue.

That’s the methodology in terms of implementation.

We effectively have a chief technology officer here at Transom who oversees the AI implementations inside every company. Usually, there’s a chief information officer or chief technology officer inside each company

21:49

but there’s also an AI champion, who can sometimes be a different person from the CIO or CTO.

That person is responsible for ensuring the execution, getting the team behind it, and making sure user acceptance and everything else are spot-on inside that business.

We try to be the architect and driver of the AI. We help select the right tools for the needs of the business.

22:19

But we place a lot of the ownership on the company to roll it out. If the company doesn’t own it and we’re just forcing it in from the top down, you’re not going to get people on board to the same extent as you would if it were something the company owned and drove organically.

In terms of the actual implementation of AI, part of the problem for many companies is working out where, when, how, what and why.

22:48

At that initial point, when you look across the portfolio companies, is there a common single project? For example, are you using AI specifically to put data into the CRM or something equivalent to that?

In terms of commonalities across the portfolio, there are some really good tools available that are fairly well established for

23:13

managing accounts payable and accounts receivable. I think those are well understood right now.

But when it comes to forecasting, or taking the data from a Salesforce.com installation, pulling it out and running it through an AI engine, we’re still in the process of figuring out what the right tools are.

23:39

Sometimes, the right tool for Company A isn’t the right tool for Company B.

That’s probably where we find ourselves in the journey. Some things are much more standardised, while others are more company-specific, based on the company’s needs, what kind of business it is and how it goes to market.

And what do you read, watch or listen to that you’d recommend others check out?

24:10

I’m not a big consumer of books, but I’m a big consumer of information.

As a kid, I had about seven magazine subscriptions covering all the things I thought were cool, what was happening, video games and this and that.

The equivalent of that now is that I’m on the internet reading all the time.

24:37

I’m on the internet reading all the time. I sit in as many meetings as I can here at the firm and, from time to time, inside the portfolio companies, more as a fly on the wall.

That helps me keep my finger on the pulse of what’s going on out there, both at a macro level and at a more micro level inside our own business.

At the same time, what I can’t do is sit in a bunch of those meetings and

25:06

strong-arm people with my opinion, because people will just go and act on it because Russ is saying it. That’s not the right way to lead and manage an organisation or a set of portfolio companies.

You need to know when to lean in and when to step back. Maybe that’s an art I’m still trying to perfect.

25:31

But, to answer your question directly, I’m much more of a current-news person. I’m trying to synthesise that information into the takeaways I need to become a better leader and help our business continue to grow, rather than reading the latest business book off the shelf.

Okay. If anybody wishes to reach out to you after this podcast, how best can they get in touch?

Shoot me an email.

25:57

It’s my last name, Roenick, R-O-E-N-I-C-K, at TransomCap.com.

Thank you very much for coming on the podcast and sharing insights into the world of carve-outs and special situations, as well as your journey from McKinsey to private equity investing. Thank you.

Of course. I appreciate it, Alex.

And, of course, thank you very much to everybody for tuning in yet again to the Private Equity Podcast. Until next time, keep smashing it.