Our webinar, Understanding Private Equity M&A, was designed to help entrepreneurs understand how private equity deals are structured and what private equity firms are really looking for. A video and transcript are available below.
Our speakers included Cheryl Moss, director at Friend Skoler & Co., and Grant Marks, principal at The Riverside Company. Cheryl has over 15 years of experience in private equity investing and serves on the board of directors of Hex Performance and Urban Skin Rx. Grant has over 12 years of experience in private equity and is responsible for platform and add on sourcing, thesis development, relationship management, and more at The Riverside Co. The Riverside Co. is one of the leading private equity firms in the lower middle market, and has partnered with over 120 consumer products brands.
Sally Anne Hughes: Tell us more about your firms and the companies that you invest in.
Cheryl Moss: Friend Skoler is a boutique private equity firm. We invest in the smaller end of the lower middle market, and on a select basis we squeak into venture land and invest in venture and growth-stage companies. We have a flexible investment mandate and lean on the founder and operator background of my partners Alex Friend and Steve Skoler. They began their careers as owner-operators of middle-market companies, and after 10 years of leading companies day-to-day and going through transactions with those companies they decided to move to the other side of the table. We’re an independent sponsor, which means we invest in companies on a deal-by-deal basis. We’re not investing out of a big pool of capital that we need to deploy over a period of time. We look for interesting investment opportunities and then raise the capital and structure the deal around that particular transaction. This affords us a lot of flexibility around the kinds of companies that we can invest in and how we structure equity deals. We look to invest in companies that generally have over $10M in revenue, may or may not be EBITDA-positive, and we can invest control or minority growth capital. While our website says that we’re generalists, we do a lot in consumer. 90% of my time is spent focused on consumer brands.
We look to invest in companies that generally have over $10M in revenue, may or may not be EBITDA-positive, and we can invest control or minority growth capital.
Grant Marks: Riverside, for contrast, is global in scale. We are a committed capital fund that manages about $13B of capital across nine fund families providing a whole host of different structures and solutions to business owners looking for everything from a controlled buyout to non-control equity to debt across various stages. Despite our size and the assets we manage, we have grown by staying true to lower middle-market investing. We partner with business owners, who are between break-even profitability up to about $30M EBITDA. We remain committed to the entrepreneurial end of the market, and to partnering with individuals who need access to capital, strategic guidance, and operational expertise. We are generalists as a firm but consumer brands is one of our largest specializations.
We partner with business owners, who are between break-even profitability up to about $30M EBITDA. We remain committed to the entrepreneurial end of the market, and to partnering with individuals who need access to capital, strategic guidance, and operational expertise.
Sally Anne: To the extent that there’s ever a “typical” private equity deal – for a majority acquisition that you might do on the smaller side of the middle market – can you discuss how a deal might get structured?
Grant: No two deals are alike. Typically, our controlled buyout strategy is predicated on investing in a controlling equity stake, which means we acquire north of 50% of the common equity in the business. We typically look for seller participation in some form, which means the seller will take the proceeds from the sale of the business and roll a portion of those proceeds alongside us into the deal under our hold period and ownership. Usually we hold anywhere from 60% to 80% of the common equity of the business. Sellers’ participation usually sits in the same security so that we are perfectly aligned. We look for that participation because we think it means the seller is has bought in to the future of the business. At this stage of the market the seller and entrepreneur are usually critical to operations, culture, vision, and driving the future growth of the business, so we want to be well-aligned with those individuals. Private equity is built on using some form of debt to be able to generate a return, so we usually fund some portion of the purchase price of the business with a modest amount of debt. That is a piece of the overall transaction structure.
Cheryl: We start with a blank sheet of paper and focus on what’s best for the company. Sometimes the structure that Grant described doesn’t fit the mold for a particular deal. That doesn’t mean that it’s not appropriate for an equity investor, it just calls for a slightly different structure. I’d also echo Grant’s comments about seller rollover. There are some cases where we wouldn’t do a deal unless the seller rolls over into a significant stake because the seller is that critical to the business. It’s also nuanced by the specifics of the company, the seller’s goals, and the transaction itself.
Sally Anne: How does your approach to an add on acquisition differ from a platform acquisition?
Grant: Typically, it means that we can be a bit more flexible. A seller’s willingness to potentially participate in a management role or an equity role within the platform that we own can be an indicator in the belief of the business and the growth behind the business. Having said that, there are circumstances with addons where maybe we already have an existing infrastructure and maybe we don’t need another C-suite exec, or we already have a CFO and we don’t need a second financial executive, where maybe selling a 100% stake makes more sense to us and the seller. Nothing fits into one box, I would say, the thing that everybody should take away from this conversation is that 1) sellers have more ability to dictate terms than they even appreciate and 2) not all PE firms are created equal. So you can have a buyer that might have more strict or rigid approaches to certain components that we’re talking about today, and others that are more flexible and might fit your needs more appropriately. There are ways that you can figure out a deal that works for you.
Sally Anne: Cheryl, you’re on the board of two of your portfolio companies. How involved are you in the day-to-day operations of the business once the acquisition has taken place?
Cheryl: Our approach is to be a strategic partner and resource to the founders, management teams, and companies that we’re invested in. For us, that means more than meeting at quarterly board meetings, even when things are going perfectly well. We’re still in at least weekly contact with the leaders of the companies that we’re invested in. That’s sort of the intention going in. Given that we do focus on much earlier-stage, in some cases resources-strapped companies, our involvement sometimes becomes much more than that. On one end of the spectrum, we’re at quarterly board meetings, we’re checking in, everything’s fine, we’re here to help you structure an equity compensation plan for the management team, we’re here to help you through budgeting, we’re here to help you through negotiations with the key customer, those are the strategic kind of things. On the other end of the spectrum, for example, many years ago we were investors in a tire repair accessory business. Very sadly in the last year of our ownership period, the CEO passed away. My partner, Alex Friend, stepped in as CEO of that business during the last year of our ownership period.
Grant: Because we invest at an earlier stage, a lot of the businesses we partner with are lacking financial controls, they need support in getting set up in terms of budgeting, thinking through building out a sales team, thinking out a pricing strategy. We are equipped with a lot of operating resources that we can lend to our portfolio companies. We have a staff of over 60 operating partner resources who have functional expertise where they can be of value for entrepreneurs. Going back to the theme of the day, it does depend, because some businesses are well-equipped in terms of their infrastructure, their management team, their strategy, their approach to be able to continue growing at a 30% clip every year, and don’t need as much of our time and resources. The way we generally think is “eyes in, fingers out”, unless we’re needed, and when we’re needed, we’re happy to help provide guidance in either direct operational capacities, or strategic capacities.
Cheryl: Typically, our investments need additional firepower across a variety of functions. It’s just a function of the stage that we’re all investing at. One thing is to look at how often that firm invests in a first-time funded company versus the other private equity firms out there that generally buy from another private equity firm. That’s a very different situation versus investing largely in founder management and owned/led companies. At this stage of the game, in terms of size/scale/growth, and never having had institutional capital there’s certain areas that often require a heavier lift.
Sally Anne: Both of your firms do minority or growth equity investments as well. Anything so far that is different when you are looking at a minority acquisition?
Cheryl: In general, we’re structure-agnostic. If we find a really interesting, growing business that checks the boxes for an investment opportunity in every way, whether it’s control or non-control, we will consider the best way to structure the transaction and work from there. So the first gating item is whether we’re interested or not. I think if it’s a minority deal, we’re paying more attention to the founders, the management team, because presumably we have less control over who is driving the ship. We pay much more attention to our partnership with those individuals, and I think we also pay attention to the role that our capital is playing in the deal. Typically, where we’re investing in minority, it’s for a growth round, so it’s important for us to understand what our capital will get the company.
Grant: We usually invest in different types of securities that give us some of those preferences in terms of what happens when the business is sold, etc. The management team and the seller is such a critical component. When we’re not in a control position we spend far more time performing diligence on the people – maybe even more than on the control strategy. Spending time getting to know the entrepreneur, learning more about what makes them tick, understanding their vision for the business, how they plan on executing it, what role we’ll play as typically board participants and helping figure out certain growth initiatives. At the end of the day, we’re really putting ourselves in the position of entrusting you, the seller, with the future of our investment, so we spend a lot of time – more than just a dinner – getting to know the people side of the business.
Sally Anne: From an initial screen, what are you looking for, and what catches your attention? What are you looking for as you do more analysis on a deal?
Cheryl: The number one is always growth. We are high-growth investors. We’re typically not looking at your 5% top line grower. We’re looking at companies that have the potential to go through transformational growth during our investment period. That’s always #1. I can’t tell you the number of times I see a really nice company that would be a great deal, but it just doesn’t have the growth legs to meet the standard we’re looking for. There are plenty of equity investors that look for slow, steady, mid-single digit growth companies, so again it’s really all about looking for the right investor for you. We look look for defensible, unique positioning, and brands that are the leader in their niche. We also look for companies that are capital efficient, companies that have attractive profit margins. We’re thinking about the exit before we invest in the company, so we are also looking for companies that, when the company reaches where we think it will reach during our investment horizon, will also be attractive to a broad array of next-tier buyers, so that we have an attractive exit opportunity. Then there’s the people side of it, of course. All our diligence work, deal analysis, really tends to revolve around those dimensions.
Sally Anne: Grant, I want to ask you about valuation. Do you have a methodology at Riverside in terms of how you put a number on the companies that you’re looking at?
Grant: We have different ways that we can approach investing that have different thresholds for return. On the buyout side, in general, and this is a comment maybe of all private equity, we’re looking to return 2-3 times our initial invested capital back to our LPs at the end of the day. That’s just the way that private equity works. If we invest a dollar, we return two in the next 5-10 years back to our investors, they will be very happy, and we will be able to eventually raise more money. We are looking for ways that we can generate that return in five years. What does the business need to look like five years from now to reach our target? What do we have to do in terms of delivering on growth? Most of the way that we price deals is based on a multiple of EBITDA – a multiple of your profits. That modelling exercise looks at a whole bunch of financial metrics, but it also takes into account what other businesses in this category trade for in terms of multiple. We’re all doing this whole math equation how the next buyer will value our company. Ultimately, we want to deliver a business to the next buyer that is measurably more unique than when we bought it.
A quick example: when we invested in Tate’s, which is a cookie business that is now a national brand owned by a big strategic investor. What we initially invested in was really a regional brand in the premium cookie category that served a regional market in the Northeast really well. It had a hero product in its chocolate chip cookie that people really, really loved, and it sold really well. We wanted to be able to grow it into a national business that sold in multiple different channels that had more than just one SKU that was an outperformer and had the ability to improve the production capacity of that business so that we could ultimately grow more with the market. The question wasn’t just how to work our way back into the math, but how to tangibly bring this business from a wonderful company to a big national business. That was the value that we saw in Tate’s.
Sally Anne: How long did you hold Tate’s?
Grant: It was four and a half years. It was a really good success story. We grew EBITDA over 180%.
Cheryl: That’s the exciting part about what we do, in terms of investing in this part of the market. It’s not financial engineering, solely, it really is helping companies get to that next level and providing them with the support and resources to do that. Some companies can do it on their own, and we all hear about those stories, but sometimes companies need more capital and support in other areas. What Grant just described with Tate’s, they transformed the brand and the business into something that is significantly different and bigger than what it was before. They didn’t just invest and make it bigger; the business is much broader in scope – they made it a regional brand, now it’s a national brand with much more coverage.
Grant: I’ll just add that it was built on the vision of Kathleen, the founder of Tate’s. Her risk tolerance level for making some of the investments that would have been required to grow that quickly in that period was limited. Selling down her stake allowed her to get behind a riskier profile and share in the upside alongside us.
Christopher Hupp: What are some of the typical mistakes that you see entrepreneurs make when selling their business to private equity?
Cheryl: Not being prepared. You have to prepare your company for diligence and auditing inside and out. You have to have the resources to operate your business while you are going through due diligence. What comes out of that process of really being prepared is having a good handle on how your company will perform through the process. Without an ability to perform in a reasonably predictable manner during that period, it can derail the process and blow up your deal. It impacts how the investor views the business and the performance of the business, and it reflects on the management team as well. People are such a huge piece of the calculus that we as investors all go through. The other thing I would say is have realistic expectations. Those expectations can really be guided by smart advisors. Have realistic expectations around timeframe, around valuation, around structure, around how it’s going to go, so that you don’t go in and feel blindsided if it goes in a different direction.
Grant: One of the biggest mistakes is deciding today that your business will sell tomorrow. That’s not typically a successful approach. You have to give yourself enough time to prepare yourself, the business, all of the data we’re going to request, etc. It’s not fun, but that’s what due diligence is, so hiring the right advisors is important.
Additionally, management meetings for us are an opportunity to learn more about the people side of the business and understand what your strategy is and what you’re thinking about for the future of the business. There are things that we’ve heard in management meetings that made us think maybe this is not the right partner for us. We think about what’s appropriate for the future of the business and we think about what’s going to make the company successful in our hold period. We take it pretty seriously.
Christopher Hupp: Why would a seller consider selling his business to a PE versus a strategic buyer?
Cheryl: Selling to a PE firm gives you the opportunity to get what we call the second bite of the apple. If things play out the way that you and your PE partner want, the second bite of your apple should be significantly larger than any money you’re taking out today. If you’re bullish on the future value of your company and the growth story that you’re presumably telling potential investors and buyers, and you want to buy into that and be part of that, selling to a PE firm is the right option for you. Typically, those opportunities to participate in the future growth of the business once you transact, they’re typically not available when you sell to a strategic.
About Hughes Klaiber
Hughes Klaiber is a mergers and acquisitions advisory firm based in New York City. We help clients turn a desire to exit their business into a successful sale that meets their personal and financial goals. We focus on working with brands who are too small to receive personalized attention from large investment banks, but need the professional advice and guidance to navigate a complicated financial transaction. If you are considering a sale of your business, please give us a call. We would be happy to share our insight into the current M&A market, learn more about your business, and discuss how we may be able to assist you. Contact us here.