The private equity effect

Al Melchiorre

Al Melchiorre, MelCap Partners

The notion that private equity firms buy companies to slash costs and strip them down to their core is fading, but still persists, says Al Melchiorre, founder and president at MelCap Partners LLC.

“Change for change sake isn’t something a private equity firm is looking to do,” Melchiorre says. “They are looking to add value. It could be IT, manufacturing capabilities, production capacity and product quality. There are so many different aspects of a business where a PE firm is going to say, ‘Alright, how do we add value to help this company transition to the next level?’”

MC Sign CEO Tim Eippert agrees.

Tim Eippert

Tim Eippert, MC Group

“Every single time I tell somebody I’m owned by private equity, their first reaction is they clench and go, ‘Oh,’” Eippert told Smart Business Dealmakers last year. “The news media makes private equity sound bad.

“My experience has been different,” says Eippert, who has sold his company to private equity three times, always keeping a piece of the business. “Every single experience I’ve had with private equity in middle-market America is exactly the opposite of the perception of big bad private equity.

“The last thing they want to do is come in and start causing problems and upset the apple cart. It will put their investment at risk.”

This week, Smart Business Dealmakers takes a look at how private equity investments are just the fuel companies need to drive growth.

Fueling growth

The Association for Corporate Growth has been tracking the impact of private equity on the middle market. Working with researchers from the University of Wisconsin, it’s found that over a 20-year period, PE-backed companies grow sales a 3.6 times the rate of other businesses.

The figures don’t surprise Blue Point Capital’s Jim Marra.

Jim Marra

Jim Marra, Blue Point Capital Partners

“There’s really only one reason why a PE firm owns a portfolio company,” says Marra, director of business development at Blue Point. “That’s to build value at an accelerated rate with the goal of selling that company for a lot more money than what was paid for it.”

Private equity deals are ideal for business owners looking for some liquidity or looking to take their business to the next level, Melchiorre says. “They may have outstripped their ability to borrow from a bank and private equity can help support or facilitate additional growth.

“That growth many times can be through add-on strategic acquisitions,” he explains. “We’ve had clients where we helped them do their first private equity deal and they are 10 times the size they were when we did the first deal.”

Marra agrees. “We focus on businesses that have an ability to grow, that aren’t overly cyclical and that already have some critical mass,” he says. “So there’s some self-selection effect in (the ACG data), but I know from our experience at Blue Point that the typical result of our ownership of a company for five years or so is that it is a substantially larger, more valuable business and employs more people when we are finished owning it.”

With the relatively high valuations that PE firms are placing on middle-market businesses —driven by the huge amount of committed capital managed by PE firms — many business owners across the country have generated significant wealth by selling all or part of their business to PE firms, Marra says.

Another local PE success story is Matt Kaulig, founder of LeafFilter Gutter Protection.

Matt Kaulig

Matt Kaulig, LeafFilter Gutter Protection

“We chose Gridiron Capital to be our private equity company in selling my business,” Kaulig told Smart Business Dealmakers last year. “We sold it for more than a nine-figure deal, and even since then, we’ve more than doubled our business. It’s been a year and a half and we’ve more than doubled the value of the company.”

Local impact

It’s been well-documented that there’s more than $1 trillion in global private equity ready to be invested. Northeast Ohio has its own pot of PE gold, with $6.7 billion in dry powder, Melchiorre says.

That $6.7 billion could conservatively be leveraged to nearly $20 billion in buying power, he says. “That tells me there is still plenty of dry powder to invest to support M&A activity.”

Between September 2017 and September 2018, there were 57 private equity deals in the Cleveland area, Melchiorre reports. During this same time period, however, strategic buyers closed 222 transactions.

With so much local capital ready to be invested, why aren’t more PE deals getting done in Cleveland?

“I think this is a reflection of the amount of cash that strategic buyers have on their balance sheets, which needs to be deployed in order to enhance shareholder value,” Melchiorre says.

“Cleveland has a pretty robust M&A community via private equity, investment bankers, lawyers, accountants and insurance,” he adds. “It’s all supporting M&A activity. But just because private equity funds may be headquartered here or investment banking firms are here, that doesn’t mean all your deals and investments are in Northeast Ohio.”

Local firms and investors can support local deals in more ways than just providing capital, says Jerry Frantz, senior managing partner, entrepreneurial services and investing, at JumpStart Inc.

“Local investors doing mostly deals outside the region are, of course, providing less immediate local impact,” Frantz says. “That said, local investors who make money outside the region still can benefit the local startup community, as the money they make elsewhere increases the available dollars that they can redeploy locally. Also, investors who have participated in deals outside the region can make connections to funders in other regions that they can then bring into local deals.”

Related posts:

Specialization has become the name of the game in private equity investing

M&A adviser urges sellers to take pride in their work building a business

Three things that can help entrepreneurs avoid a bad marriage to private equity

“I know from having started three companies that getting a private equity deal signed may seem like a goal in itself, but that’s short-sighted,” says Tom Knauff, a Chicago-based entrepreneur and CEO of Energy Distribution Partners. When it comes to entrepreneurs and private equity funding, little thought is given to what happens after the deal closes — including whether your PE partner is focused on growing your company or just getting rich off of their fees.

Those fees range from management fees that cover a PE firm’s operating expenses and usually are from 1.5 to 2.0 percent of assets to performance fees that are usually 20 percent of any investment gains recorded by a private equity fund.

And here’s how PE fees can become a major issue: If a company has a unique product and sales momentum, many PE firms will reduce the sales force and essentially milk the brand. The job cuts bolster EBITDA in the short term and provide a rationalization to increase debt. The earnings to pay the debt service aren’t sustainable because the sales team has been gutted. A move like this is an immediate boost that can net an above average return. Longer term, it erodes the portfolio company’s infrastructure and ability to innovate and even threatens its survival. But the PE firm never loses because it collects fees on the refinancing, diverting millions of dollars that could’ve been used to fund real, sustainable growth.

“An entrepreneur’s goal in getting PE should be to use the capital and expertise of the PE firm to innovate in ways that benefit everybody with a stake in the deal,” adds Knauff.

Like Tom Knauff, Deb Schwarz, chief strategy officer and founder of LAC Group, a Los Angeles-based provider of library and knowledge management services, has used PE to help build her company.

“With PE investment, we’ve been able to innovate in terms of investment in infrastructure technology and bolster our leadership team with talented new-hires,” says Schwarz.

According to Schwarz, entrepreneurs will take risks and double-down on moving forward with innovation, a strategic hire or an acquisition if they are convinced the payoff is worth the risk. But, she adds, PE firms are all about the bottom line, specifically valuation and EBITDA; they may not make an investment based on the founder or the CEO’s instinct. What’s often lacking is chemistry between the entrepreneur and PE firm.

Getting private equity that will help you innovate means finding a PE partner who has a passion for your industry and shares your ambition for growth. While searching for funding, remember these three things:

  1. PE firms need you. Right now, there’s a glut of PE money and a shortage of high quality investments. The PE firms are under pressure from their investors to identify companies that have proven leaders, a strong financial track record and a growth plan that would benefit from capital. If you meet these criteria, you’re in a strong position to obtain funding and you should have the confidence to ask the hard questions.
  2. Ask how the PE firm’s partners are compensated. Both parties should have skin in the game. Ideally, the PE firm partners are sharing the risk by being financially vested in the growth of the companies they fund — rather than being compensated primarily by collecting fees. They should make money if you make money.
  3. Find out the PE firm’s average hold period. A PE firm that has indeterminate hold periods will be interested in funding actual growth versus pulling off short-term balance sheet maneuvers. For example, PE firms backed by family offices (instead of large institutional investors) will analyze an investment for how it can preserve and generate wealth over a range of time periods. Family offices are the financial management arm of the ultra-rich. And wealthy families have a centuries-old tradition of investing in companies over the long term. They typically help fund innovation through key hires, capital expenditures and investments in operations, such as sales and marketing. Hold periods can be five- to seven-years and beyond.

No matter which PE firm you sign a deal with, they’re going to bring a perspective on how to grow your company. As the entrepreneur, you have to make sure the PE firm’s agenda and yours align before completing the deal.

Eli Boufis is co-founder of Driehaus Private Equity, LLC, and executive principal of the firm where he oversees the investment strategy and works with portfolio companies throughout their investment cycle. He is a board member of Utility Pipeline Ltd, Iverify, Syntac Coated Products, GrowthPlay, focus4media, and Innovative Health. Before Driehaus Capital Management, Eli worked at Heller Financial’s International Group and Corporate Finance Group. Eli earned a B.A. from Vanderbilt University, and an MBA from the University of Chicago Booth School of Business. Eli is a co-founder of DePaul University’s Driehaus Symposium and a field director of the Horatio Alger Association. Eli is also a CFA charter holder, a member of ACG, YPO, and the Economic Club of Chicago.

Days of private equity firms demanding a majority stake in a business are largely over

Business owners often find traditional banking products don’t fit the bill when they need financing or additional capital. Because of the unique needs of small businesses, bank loans often don’t work due to the lack of capital available to lend, high monthly amortization payments or onerous terms.

If you’re seeking funds to accelerate growth, acquire competitors, buy out partners or just for liquidity, private equity could be a compelling alternative.

A growing number of small businesses are turning to private equity for capital, and more and more private equity firms are offering access to that crucial capital while allowing owners to retain a majority stake in their businesses.

The days of private equity firms demanding a majority stake are largely over. Most firms offer a variety of options to a business owner, from a full buyout to taking just a small stake in the company.

Here are some scenarios where a minority investment from a private equity firm can be a great fit:

  • Growth. We love working with a business that needs additional capital to keep growing. Private equity can provide growth capital that can pay for everything a growing business needs, including acquisition of competitors, entrance into new markets, new product development and many other tools to supercharge growth.
  • Gaining liquidity. You can sell a portion of your company without giving up control in a private equity transaction. With many private equity firms vying to invest, there is likely one matched to your needs.
  • Buying out partners. A private equity investment can provide liquidity to business partners that want or need it while allowing others to maintain or even increase their stake. As a neutral third party, a private equity investor can set a value that is acceptable to both selling shareholders and those who are rolling over.

A minority investment from a good private equity firm is about much more than cash. Private equity firms have resources and expertise that can really transform a company. Like many firms, Riverside helps its partners expand internationally, optimize operations, improve pricing, boost sales, source acquisitions more effectively and make dozens of other improvements to a business.

If you’re considering selling a stake in your business to private equity, be sure to shop around to find the best partner. Ask current and former executives from portfolio companies about how they operate. Dig in to their reputation and track record, and make sure they can offer more than just money as you work together to grow. Consider how their experience can add value to your business.

Growing a business is challenging even in the best of times, but a partnership with private equity can greatly assist in adding value. Selling a minority stake in your company delivers not only much needed capital for acquisitions or liquidity but also a partner with tools and expertise to help drive growth. That’s something no bank or lender can offer.

George Cole and Hal Greenberg are managing partners and co-fund managers of the Riverside Strategic Capital Fund. The Riverside Co. is a global private equity firm serving the smaller end of the middle market.

How private equity can grow and strengthen your businesses

Riverside Company’s co-CEO Stewart Kohl is an honorary chairman for ASPIRE 2016, a one-day conference focused on identifying opportunity in Northeast Ohio and beyond. Visit ASPIRE 2016 to register.

The Riverside Co.’s co-CEO Stewart Kohl is an honorary chairman for ASPIRE 2016, a one-day conference focused on identifying opportunity in Northeast Ohio and beyond. Visit ASPIRE 2016 to register.

Private equity grows and strengthens businesses. It’s that simple. But if you listened to certain politicians and pundits, you’d think private equity, or PE, solely takes advantage of companies for its own gain.

As a CEO who manages a private-equity backed company, I can say this couldn’t be further from the truth. In fact, it’s a basic tenet of the PE model that the companies in which they invest time and capital must succeed in order for the PE firms themselves to succeed over the long-term. This is the industry I know and have experienced.

When I describe my company, I begin by saying that we deliver peace-of-mind to our customers. That’s our fundamental mission. At MNX Global Logistics, we provide specialized, expedited transportation and logistics services. Whether it is transporting medication for a life-saving cancer treatment or an organ for a child who requires an emergency kidney transplant, we are responsible for the safe passage of essential items to the people who need them most.

Commitment is critical

As MNX began to grow, it not only required a firm that could commit necessary capital, but a partner who could commit to its mission. This is when the private equity firm The Riverside Co. stepped in and ensured the company’s new leadership — including myself — was committed to this vision.

Riverside recognizes that when the values of quality service, investment in people, and fiscal responsibility are implemented, the company will be successful and subsequently, Riverside’s investment will be worthwhile. Generally, this is how all private equity firms approach companies to invest in. And, in turn, this approach has helped drive the growth that has made MNX develop as a leader in our industry.

Let me provide a few examples.

Because of Riverside, MNX was able to invest in and build a state-of-the-art customer excellence center in Columbus, Ohio. We have been able to expand our presence in the U.S., Europe and the Asia-Pacific. And in a rapidly changing world, we’ve been able to invest in technology that enhances our visibility, security and efficiency of shipments.

The people count

While I recognize that the best technologies and systems are important, I also know that the people who operate those systems are even more important.

One of our largest investments at MNX has been employee training. By streamlining our processes for efficient and effective training, we not only prepare our employees for their day-to-day work, but we integrate leadership training every step of the way.

The investment in our employees is a direct result of investment decisions coordinated by MNX’s leadership and our partners at Riverside.

MNX is not the only company to benefit from private equity. PE firms currently partner with companies to help employ more than 11 million people in the U.S. alone. Often, these are companies with good paying jobs that provide training to employees for personal and professional growth. Companies like mine.

Economies of scale

Here’s how Riverside made a difference to MNX employees: We have been able to add employees in 22 states, including Ohio, Florida, and Georgia. In addition, with economies of scale derived from our relationship with Riverside, we were able to reduce the cost of healthcare for our employees while improving the benefits provided.

We also improved the employee 401K plan, and are in a position to attract and hire talented employees with salary and benefits packages above the industry average.

It’s important to recognize that over-regulating and over-taxing PE firms will result in less investment in small to mid-sized companies such as MNX. Critics of the PE industry would be wise to examine the PE business model more closely and realize the true value they provide to companies — like mine — throughout the United States.

Needless to say, private equity benefits American workers and businesses. At our headquarters in Irvine, California, we are proof that PE investments can increase hiring, provide expertise to guide expansion, and help companies innovate and remain competitive.

It is because of our partnership with Riverside that we continue to deliver essential materials, life-saving technology, and most importantly, piece-of-mind.

Paul Martins is the president and CEO of MNX Global Logistics.

Selling your business: How to benefit from private equity’s middle-market shopping spree

I have been advising middle-market companies on issues such as succession planning and M&A for more than 40 years. During this time, I’ve seen a tidal wave of change when it comes to options for selling a business. Where owners were once restricted to selling to a family member, the management team or possibly a competitor, today the choices are far broader — and as witnessed by the number of people slated to attend this year’s Aspire conference May 18 in Cleveland, one of those options is private equity.

More and more, PE firms awash in capital and with access to relatively easy credit are searching for growth opportunities among middle market companies. In fact, it is the middle market that is driving PE today. With close to $1 trillion in “dry powder,” these firms are competing for the best deals and are willing to offer attractive terms to sellers.

If you are thinking about selling your company, here are some reasons that a PE buyer might be the right choice for you:

  • PE firms have an abundant supply of capital. With their deep pockets, they are well positioned to invest in the long-term growth of the companies they buy.
  • PE firms excel at operations. Many of them have sophisticated networks of both internal and external advisers. This means they are prepared to jump in and shore up any area of the business that might require support.
  • You may be able to retain an ownership interest in your company. Perhaps you aren’t ready to leave your business. PE firms frequently buy a majority stake in a middle-market business, while the owners retain a minority percentage. In fact, many firms prefer to do deals where the owners maintain some skin in the game. Because PE firms are especially focused on growing and improving the businesses they purchase, when they eventually exit, your stake may well be worth considerably more than on the date of the original deal.
  • Selling to a PE firm may be the best bet for your employees. Often, when owners sell to a strategic buyer or competitor, cuts in personnel may ensue due to redundancies between the two companies. PE firms, on the other hand, are more likely to continue with the current employees and existing management team.
  • You may have the opportunity to join a larger ecosystem. Many middle-market PE firms specialize in a particular industry, building a portfolio of “platform companies” that together offer synergies and economies of scale. If your company fits within a buyer’s platform as an “add-on” purchase, you will have access to the platform’s resources, giving you a significant opportunity to increase the value of your business.

If you are considering a PE buyer, it’s important to do your research. Every buyer brings something different to the table — some are bigger, some have more capital, some are better operationally and others may have deep expertise in a particular industry. What’s more, each has different strategies, motivations and priorities. Working with a professional adviser can help you vet potential buyers and determine which ones are the best fit. Given the fierce competition among PE firms to land the best deals, this is an especially attractive time to go the private equity route.

Mark Goldfarb has more than 40 years of experience serving both business and individual clients, including advising and assisting them with their financial and operational endeavors. He previously served as the co-founder and senior managing director of SS&G, which joined BDO in January 2015.

Assume you’ll be pitching to sophisticated investors

You have an idea for a business, but you need funding. How do you get started? The angel investors that provide capital in exchange for equity ownership of a startup company come in various shapes and sizes. There are sophisticated angels, unsophisticated angels, guardian angels, super angels and angel groups or angel funds. With so many types of angels, how can a founder ever determine how to prepare for such a motley group of prospects?

The answer is to always assume that at some point, you will end up pitching your opportunity to sophisticated investors, and therefore, prepare for it.

Demonstrate expertise

Sophisticated investors expect to see a well-defined business plan and spreadsheets with projections of revenue, expenses and net income, with a cash flow analysis. They expect you to demonstrate your market research, industry prowess and ability to understand the buyer of your product or service.

If there are any particular manufacturing processes or operations specific to your business, you will need to demonstrate your knowledge of them. They want you to know the competitive landscape, discuss barriers to product entry and to be knowledgeable about the sales and marketing aspects of your business.

An ability to execute

Angel investors invest in the business, not the idea — therefore they will analyze you and your team’s ability to execute. They want to know your advisers and whether you are using them wisely.

In real estate investment, there is an axiom for success: location, location, location. In startup investing, the axiom for success is “management, management, management.” You can have a great idea or a great plan, but if you can’t execute it, it goes nowhere. Your team is most important.

That’s why many angel investors become guardian angels that are actively involved with the team, providing valuable advice and key introductions to suppliers, bankers, sales people, etc.

Investors will try to assess how well you surround yourself with good people for all the resources necessary to ensure your success.

Prepare to pitch

When you make an appointment with an angel investor, send him or her your executive summary of the business. Be upfront with your intention, and explain why you are requesting the meeting.

Have your business plan handy when he or she asks for it, as well as all your financials. Prepare a pitch deck of discussion points. The pitch deck should follow the 10, 20, 30 rule — 10 slides, 20 minutes and 30-point font.

Don’t expect sophisticated investors to sign a nondisclosure agreement. They see hundreds of deals annually and will not get involved in a trivial lawsuit over something they viewed that might be similar in nature to yours.

Finally, do your homework and research whom you want to approach. Network like crazy. Attend startup demos and venture fairs, visit incubators and accelerators, and attend clubs designed to assist startups, such as TiE, MIT Enterprise Forum, the Pittsburgh Venture Capital Association or the Pittsburgh Technology Council. Many universities have programs to assist startups, and don’t forget to contact the local office of the Small Business Administration.

How private equity grows companies, acting as lifeblood for the economy

Jackie Hopkins, managing director, Sponsor Finance Group, FirstMerit Bank

Jackie Hopkins, managing director, Sponsor Finance Group, FirstMerit Bank

Private equity firms use pools of capital that are raised from a variety of sources. This capital comes not only from wealthy individuals, but also from insurance companies (that pay retirement plans and annuities) and pension funds.

As a result, school teachers, police officers and others often have a portion of their retirement assets allocated to private equity, which bolsters the overall investment returns of the fiduciaries that run these funds. These higher returns are increasingly important in today’s low interest rate environment. Private equity firms use this capital to invest in all sorts of companies, creating jobs and economic growth along the way.

“Private equity firms are easily and inaccurately portrayed as corporate pirates,” says Jackie Hopkins, managing director, Sponsor Finance Group, at FirstMerit Bank.

“But these firms are willing to invest in businesses that need capital to grow as well as companies that might go bankrupt if not supported with new capital in exchange for ownership. In order to induce them to accept the risk of these investments, private equity firms need high returns. Sometimes the returns are very large. Sometimes the firms lose their investment. Either way, they provide critical capital that allows the economy to grow.”

Smart Business spoke with Hopkins, who lends to private equity firms, about how these serial entrepreneurs operate.

How does the private equity world work?

Private equity companies use pools of capital from investors, called limited partners. The general partner of the private equity firm is tasked with finding good investment opportunities to generate above average returns. The partner is usually paid operating expenses and a portion of the profits earned. In most cases, the general partner buys a controlling interest in a company with a leveraged buyout (LBO), and uses his or her expertise to improve revenue and profitability, such as helping a Midwest firm expand product sales internationally. After three to seven years, the company is typically resold.

What is a leveraged buyout?

In an LBO, an investor uses debt to finance a portion of the purchase price of a company. Depending on the underlying business risk of the transaction, the amount of debt can be very low or up to 65 percent of the purchase price. Using debt allows the investor to amplify his or her return. In addition, interest costs are deductible while equity capital is not, providing a built-in bias toward debt financing in the capital structure.

The debt to equity ratio changes depending on market conditions — today, the average equity investment for a middle market company is 40 to 45 percent in a LBO. For larger companies, it is usually less, because a bigger company can absorb more financial risk.

How is private equity financing different than traditional middle market bank loans?

Traditional middle market loans focus on the balance sheet —assets, inventory, receivables, equipment, real estate, etc. — so if the company  is unable to service its debt out of earnings, the collateral can be sold to repay the debt.

Private equity financing tends to be enterprise value loans, looking at the company’s earnings before interest, taxes, depreciation and amortization (EBITDA). Financial institutions look at selling the entire company as an enterprise for a multiple of EBITDA. They consider how sustainable the EBITDA is to figure out how much debt the company can safely carry. So, if you think the average multiple of a middle market company is six times (that is, its total value is six times its most recent EBITDA), the bank might lend up to three times. The inherent risk is the possibility that EBITDA will decline or that the prospects for the company or the industry lead to a lower multiple. So to qualify for this type of enterprise loan, a company should have a sustainable level of EBITDA that is not too concentrated in terms of customers, products or suppliers, and is not prone to cyclical swings.

Jackie Hopkins is managing director of the Sponsor Finance Group at FirstMerit Bank. Reach her at (312) 429-3618 or [email protected]

Website: Get information about FirstMerit’s Sponsor Finance Group services.

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Josh Harmsen – How private equity can support growth, not just provide liquidity

Josh Harmsen

Josh Harmsen, principal, Solis Capital Partners

I was recently having lunch with a private company CEO and the topic of private equity came up. When asked if he had ever considered seeking a private equity partner to fund and support his planned growth initiatives, his answer was expectedly, “No, we don’t want to sell the business yet. We want to focus on growing the business.”

While I can certainly appreciate his perspective, that opinion is consistent among many business owners and leaders. Namely, that private equity is primarily a liquidity mechanism, not a preferred tool to fund and support company growth. Moreover, many business leaders often see their growth plans as incompatible with private equity, which they associate with high leverage and limited financial flexibility.

This perspective of incompatibility was also on display during the recent presidential election. Private equity firms were broadly characterized as opportunistic value extractors, rather than enablers of company growth and job creation.

While the purpose of this article isn’t to defend private equity (there certainly are some firms worthy of this negative characterization), significant evidence exists to suggest that, in general, private-equity-backed companies experience proportionally greater growth. This is particularly true for small-to-medium-sized businesses.

Private capital a key to growth

According to studies performed by between 1995 and 2009, U.S. private-capital-backed business grew jobs by 81.5 percent and revenue by 132.8 percent, compared to 11.7 percent and 28.0 percent, respectively, for all other companies.

In California, over the same period, the story was even more favorable to private equity.  Private-capital-backed businesses grew jobs and revenues by 123.1 percent and 155.2 percent respectively, compared to 11.3 percent and 26.4 percent for all other California businesses.

While each situation is unique, there are many reasons why private-equity-backed companies experience greater growth.

Access to capital

With the continued tightness in the credit market for small-to-medium-sized businesses, private equity can be a source of capital to support growth initiatives.

Additionally, private equity firms often have preferred relationships with lenders, giving businesses more access to attractive and flexible debt financing where appropriate. With greater access to capital, companies can more quickly, nimbly and opportunistically implement growth initiatives.

Strategic guidance and ongoing operational support

A private equity partner can provide much-needed strategic and operational resources to support the company’s growth initiatives and ongoing operations. This often leads to more thorough and refined growth strategies, as well as more effective plan execution and implementation.

Private equity firms often have large networks of industry experts and experienced operators that they can bring to bear to support company growth and operations.

Increased capacity for acquisitions

Private-equity-backed companies are significantly more acquisitive than other private businesses. Acquisitions can be an attractive source of growth, allowing companies to increase their customer footprint, expand geographically, create greater scale and enhance capabilities in a relatively short time frame.

However, successfully identifying, executing and integrating acquisitions can be very difficult. Many business leaders don’t have the time or experience to effectively pursue acquisitions. Private equity firms generally have expertise executing acquisition strategies and can be valuable partners in supporting companies as they identify, negotiate, execute and integrate acquisitions.

Private equity can be a compatible and effective tool to support and achieve company growth — not simply a mechanism to achieve liquidity. While private equity is not appropriate in every situation, and not all private equity firms are growth-oriented, business owners and leaders should carefully consider a private equity partnership when evaluating their ongoing growth initiatives and funding options.

Josh Harmsen is a principal at Solis Capital Partners ( a private equity firm in Newport Beach, Calif. Solis focuses on disciplined investment in lower middle-market companies. Harmsen was previously with Morgan Stanley & Co. and holds an MBA from Harvard Business School.

How private equity firms are working to clear up misperceptions about their industry

Scott McRill, CPA, Director in Transaction Advisory Services Cleveland, Ohio, SS&G

The role that private equity firms play in our economy through business growth and job creation is fundamental. However, the general public — and many astute business owners — mistakenly think of private equity firms as if they were Gordon Gekko, character from the movie, “Wall Street,” taking over businesses, eliminating jobs and trying to make money by shutting down companies and selling assets.

“I’ve often been astounded by the disconnect between the actual performance of private equity-backed businesses and the general public’s perception of what private equity is all about,” says Scott McRill, CPA, director in transaction advisory services at SS&G’s Cleveland, Ohio, office.

As a result, the private equity industry has recognized the need to be more open and vocal about what they are, what they do and the positives they bring to the economy, he says.

Smart Business spoke with McRill about the misperception of private equity’s role and how companies can benefit from this type of capital.

How has the private equity market evolved into what it is today?

In the 1970s, many business owners who started companies with family money in the post-WWII era had limited choices if they wanted to grow their business. They could take the company public through the public equity markets, infuse more family money or sell the business outright to a larger company. Private equity capital became a viable alternative, giving business owners another option. If you compare the job growth of companies owned by private equity to the overall economy over the past 10 to 15 years, it’s pretty astronomical. From 1995 to 2009, private capital-owned companies produced job growth at a rate of 81.5 percent compared to only 11.7 percent for all other businesses. Similarly, in the same period, private capital-backed companies produced sales growth of 132.8 percent compared to 28 percent for all other businesses, a surprising statistic to many.

How have lending policies driven more businesses toward private capital investment?

The lending environment always goes in cycles, and the involvement of private equity as a rule hasn’t gone away. However, the ratio of how much funding comes directly from private equity firms in the form of equity versus from banks and lenders in the form of debt has changed.

In the mid-2000s, there was a lot of economic growth and private equity investment, but the amount of money private equity firms were required to put into deals was less as a percentage of the total capital required to get a deal done than it is today. For example, 80 or even 90 percent might have come from lenders in the form of debt and the remaining 10 or 20 percent in the form of equity capital.

After the credit markets froze in 2008, private equity continued to invest in businesses but became more cautious and were required to put more of their own money into deals. In 2009 and 2010, it was not uncommon to see 50 to 75 percent of the capital coming from private equity firms, and lenders only providing 25 to 50 percent.

The lending environment has loosened some in the past couple of years, but it’s still relatively difficult, which can be partly attributed to the uncertainty regarding tax laws, interest rates, etc. Deals in the past 12 months might have a leverage model that is, for example, one-third equity, two-thirds debt.

Where does the negative perception of private equity come from?

There are always risks from private equity, and news stories are often negative about a private equity-backed business shutting plants down or a company that went bankrupt. Of course that happens, but the raw statistics show in many more cases private equity helps grow businesses, make them more profitable and create more jobs over the long term.

Other negative connotations can be attributed to the misperception that private equity is a secretive ‘club,’ which is highlighted by the nature of the word ‘private.’ Private equity firms receive a management fee for their expertise, but make the majority of their money by growing companies, producing more profits within those companies, and typically selling that company to another investor and sometimes taking the company public. Many have assumed bad things are going on behind the scenes at private equity firms, but private equity firms normally want the company to expand and become more profitable.

How are private equity firms responding to the negative bias, along with pressure for more disclosure?

The private equity industry has realized that the negative perception has to be dealt with, and industry professionals are trying to open up a widespread dialog about the industry and the positive things it has done for the economy. At the same time, they recognize there is going to have to be more, rather than less, disclosure and transparency about the industry. By the nature of the ‘private’ equity investments, the specific details of individual deals are private and confidential and probably won’t ever be disclosed widely by the industry. However, the inner workings of private equity firms — how they operate, the management fees they charge and, most importantly, the story about the economic growth engine they provide for small businesses — could become more widely available, especially with the political pressure for disclosure.

Many very entrepreneurial and talented business owners or operators are really good at what they do. They are really good at making widgets, selling certain services and serving their customers. But, the private equity world is foreign to many of them; it’s not something that they’ve ever really needed to tap into, so all they’ve heard is the negative soundbites. A faction of very talented business owners still need to be better educated about the good things the private equity industry does to expand companies and create more jobs.

Scott McRill, CPA, is a director in Transaction Advisory Services at SS&G’s Cleveland, Ohio, office. Reach him at (440) 248-8787 or [email protected]

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PF Chang’s to go private in $1.1 billion deal with private equity firm

SCOTTSDALE, Ariz., Tue May 1, 2012 – P.F. Chang’s China Bistro Inc (PFCB.O), which has been fighting to recover from ill-timed price increases, said it would go private in a $1.1 billion deal with Centerbridge Partners, sending its shares up 30 percent.

Centerbridge, a private equity firm that owns restaurant holding company CraftWorks Restaurants & Breweries, will pay $51.50 per share for P.F. Chang’s, a premium of about 30 percent to the stock’s closing price on Monday.

The shares jumped $11.83 to $51.52 on the Nasdaq Tuesday morning. The stock, which had fallen about 20 percent over the year to Monday, last traded above $50 in February 2011.

“It looks like a fair price,” said Morningstar analyst R.J. Hottovy.

The deal comes in at about 8 times trailing earnings before interest, tax, depreciation and amortization (EBITDA), right where most deals in the last year have landed, including Golden Gate Capital’s acquisition of California Pizza Kitchen in July 2011, he said.

“If you find a company that’s been beaten up but there’s no structural damage to the company, this may be the time for a deal,” Hottovy said.

Shares in other full-service restaurants, including Cheesecake Factory Inc. and Buffalo Wild Wings Inc., moved higher on the P.F. Chang’s news.

In a week brimming with consumer sector news, Microsoft Corp. said it would invest $605 million over five years in Barnes & Noble Inc.’s Nook e-reader and college business; Collective Brands Inc., owner of the discount footwear chain Payless ShoeSource, signed a deal to be bought by shoemaker Wolverine Worldwide Inc. and two private equity firms for $1.32 billion; and DineEquity Inc. found a buyer for 39 of its Applebee’s restaurants in Virginia.

P.F. Chang’s CEO Rick Federico said going private would give his company greater flexibility to pursue its long-term strategy to increase traffic and improve performance.

P.F. Chang’s, which operates namesake Bistro restaurants and the smaller Pei Wei quick-service chain, is free to solicit superior proposals through May 31, the parties to the deal said.

“Although we do not anticipate any other potential suitors now, we think any potential buyer will pave the way for greater cost scrutiny, potential closures of underperforming units and a more rapid turnaround,” Miller Tabak restaurant analyst Stephen Anderson wrote in a note to clients.