Are you making plans to grow your business? Are you looking to recapitalize? If you answered “yes” to either of those questions, you may have given at least some passing thought to working with a private equity group. While not every PE firm seeks to gain controlling interest in a company, investors won’t simply hand their money to just anyone. In fact, investors are more cautious and selective than ever when deciding whether to invest in a company. So what are investors looking for? What are their conditions and criteria? Chris Sheeren knows. He is a partner at Huron Capital Partners in Detroit, and he talks with us about what’s important to investors when considering working with a business.
If you want to stay actively involved in the business and have control over the future of your business and your legacy, the private equity option can be a very good one for you.
- Christopher Sheeren
Jeff: Chris let's start with a quick look at you and Huron Capital Partners, the types of transactions that you guys do and specialize in, and types of businesses that you like to help.
Chris: Sure. Huron Capital Partners is based in downtown Detroit. We've been around since 1999, which in the middle market private equity world makes us I guess one of the older firms around. But we invest in companies really all over the U.S. and Canada in four industry categories which are consumer, health care, specialty manufacturing, and business services. Companies generally in the size range from 20-200 million in revenue. So these are solidly lower-middle market businesses scattered throughout the U.S. and Canada.
Jeff: Chris, if you could rank them in any order, when you consider really the top three barriers, not drivers but barriers to growth in terms of value in a company, what would those three barriers be? Again, they don't have to be necessarily in any order.
Chris: Sure. We look at over a thousand different companies a year and we'll end up investing anywhere between five and ten. We see a pretty broad variety of companies but you certainly do see some general themes that occur throughout. And many of these are actually very fixable. Sometimes these things can be attractive to us if we see a company that's otherwise has a nice product or service that's important to the customer but yet they haven't been able to grow because of somebody's limiting factors. Number one I think is just kind of a weak financial systems or weak internal systems, which is usually driven by the lack of a strong CFO. Very often you'll see an entrepreneur run a company. Maybe they're making $50 million a year in revenue and you ask the owner how he or she did last year and the answer is they look at their bank account at the end of the year and they know how much cash they've made. Which is fine and for them that's good because at the end of the day that's what matters for them. But from an investor's perspective it's really important that the company and management can be able to tell you kind of on a daily basis how the performance of the business is. Are there key performance indicators in place that can tell you how sales were yesterday, this week, this month to date, is the company closing their books on a monthly basis, on an accrual basis? So you really can on an ongoing basis and on an interim basis know exactly what the performance of the company is and importantly to be able to spot trends. And companies that don't have that eventually are going to limit themselves pretty significantly. And certainly that's something we see a lot.
Another thing that we see is what we would call key person risk or over-reliance on one person at a company. Again, not uncommon in kind of entrepreneur, founder-run businesses where the patriarch or the founder has built this business from the ground up and done a great job of creating a nice business that has a product or service that's important to their customer. But very often that founder will have all or most of the key, important customer relationships. Or may the founder have the key knowledge of the technology of the business, or very often we'll see that the founder is really the idea generator and the creative driver of growth and new product development, new service development within the company. And again, that's fine and that works for the founder/CEO as long as he/she is there. But it’s the old “What happens if the CEO gets hit by a bus?” question, how will the business perform tomorrow? And so if the knowledge and the relationships are not scattered throughout multiple levels and multiple people within the company, that's a real risk factor. And that's a real limiting factor to a company's growth and the ability for a company to have a real franchiser or institutional value.
The third thing I would say, and this one is maybe a little bit less controllable to a degree, but it certainly act as a barrier to growth and certainly a barrier to attracting investment is customer concentration or over-reliance on one particular customer. Very often a company's growth will be driven by one big anchor client. That's great and no one ever wants to say no to new business, particularly if it's profitable business. But very often a company can be growing for a number of years and look up, and all of a sudden one customer, General Electric, or Ford Motor Company, or Verizon, or someone is 50 percent of their business or even more. Again, that's great for a time but what happens if something happens to that customer relationship or the financial health of that customer? That can put the entire company at risk. Any investor is going to be pretty cautious about investing in a company that is overly reliant on one particular customer, or maybe even two or sometimes three customers. If the entire business is composed of three customers that's a challenge as well.
We look at over a thousand different companies a year and we'll end up investing anywhere between five and ten.
Jeff: Chris Sheeren, partner at Huron Capital Partners is joining us today on Deal Talk. And we're talking about private equity and really how it can work with businesses to help them improve their values and to help them grow. Really, at the end of the day that's what it's all about. Chris, do you find that in your industry there is more of a movement by private equity firms to tailor their services if you would to companies to appeal more to them on a personal business leadership level? Because as a business owner for example, what I'm trying to drive at, when I think of a private equity firm I think of a company that is going to come in, is going to provide me with some capital. They may take over either a controlling interest or a minority stake and they're going to do what they need to do to help me grow. And then in five, seven, ten years, whatever the case may be they're going to either go or if they have controlling interest, they may have an interest in shopping my company and selling it off. But it sounds to me that there is actually kind of a human connection that you kind of take at your firm. How important is it that you participate in a hands-on kind of way to truly help these companies kind of overcome these barriers and move forward? Tell me about how important that is.
Chris: Frankly there's a little bit of a balance in terms of how hands-on we are or we think we need to be, and that's driven by a number of factors. Number one, it's just kind of the depth and strength of the management team. If it's a team that has proven their ability and we think we've got all the right people in place at the company, we're perhaps not as likely to be effectively involved in that situation. Whereas if it's a company that's more in transition, the type of company I described earlier that maybe they really need to be investing in their systems, and upgrading systems, and upgrading the talent, we'll certainly get involved if the company needs to bring in a strong CFO, that's not uncommon. I can give you one example. We had invested in a company in Wisconsin, a plastic film manufacture, which was operationally a very well-managed business but had been frankly a little bit sleepy on the revenue growth side and had been a family owned business, and we were one of a handful of prospective investors that were looking at the business, and the company... Again, a family-run business, it was actually the widow of the patriarch who had passed away. The widow was selling the business on behalf of the family. It was very important to her who the new partners and who the new investors were going to be. She didn't want to sell to a strategic buyer. She wanted to go with someone who knew that was going to keep the business. This was kind of the largest employer in town and it was very important to her that the nature of the people that would be partnering with. And so we were able to bring to the table a very strong, a very business development-oriented CEO that we had been working with to look at making investments in the plastic film space. And so it really was a nice marriage. Our CEO came in day one after our investment and took the reins of the business, and really installed a very strong sales and marketing oriented culture to take this company operationally. And from a production standpoint it was very well run but to really kind of turn on the jets from a growth perspective.
And so we were able to lean pretty heavily on our CEO and we stay involved at the board level, not looking to take an operating role but one of our CEO partner of ours did step in and run the company, and did a phenomenal job. And actually we just exited our investment in that business a couple of weeks ago, and it was a great success. We completed an add-on acquisition along the way. But importantly we're able to keep the jobs in this town in Wisconsin and grow the jobs in the town of Wisconsin and grow that business. And show to the sellers that we are the type of people that they wanted to do business with and they wanted as a partner.
Jeff: Ultimately, maybe it's a silly question. You'll call me on it. That's okay. We'll keep your comments in. I won't edit them out. But shouldn't that be the job of a private equity firm who's in a marketplace to help the businesses there while at the same time providing their investors with value? Shouldn't that be kind of the ultimate goal, is to keep the business up and running, but grow it, in other words grow it, make it become successful, try to keep those jobs in the local economy whenever possible?
Chris: Yeah, for sure, that's certainly always the goal. To be honest there are different firms, mostly some of the larger firms you might hear about may have a little bit more of a model that may be more focused on relocating, or downsizing, or that sort of thing. But really broadly speaking private equity firms are as you said earlier very accurately all about growth. And so we're always trying to figure out what is the best way to grow this business. Inevitably and invariably the best investments we do are the ones where we grew the business, we grew sales, we added jobs, we expanded, those are always going to be the big winners. It's tough to make a living slashing and burning. And I think unfortunately often private equity will kind of get tagged with that sort of image. And I think it's a bit unfair because at the end of the day our goal is to grow these businesses.
From an investor's perspective it's really important that the company and management can be able to tell you on a daily basis how the performance of the business is.
Jeff: We're talking with Chris Sheeren. He's a partner at Huron Capital Partners. And when we come back a really important part of our conversation, we're going to talk about the pros and cons of selling to a strategic buyer versus private equity. I'm Jeff Allen. I'll be back with Chris Sheeren, once again, partner at Huron Capital Partners in Detroit when Deal Talk continues in a moment.
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Jeff: I'm Jeff Allen with my guest Chris Sheeren, partner at Huron Capital Partners in Detroit. Chris, let's talk a little bit about it. Pros and cons of selling to a strategic buyer versus private equity, what say you about that?
Chris: I think there are pros and cons of both. Maybe we can consider a strategic buyer first.
There's a little bit of a balance in terms of how hands-on we are or we think we need to be, and that's driven by a number of factors.
Chris: Strategic buyer being defined as, if you're a business owner running a company, it would be competitor or perhaps a customer or supplier, someone in your supply chain who is potentially a competitor looking to buy you. And on the plus side very often a strategic buyer will pay the highest price for your business. If you have a product they may be able to take that product and take it into their channels, or their retailers, or whatever, and really be able to grow quickly. That very often is the fastest route to growth, with the strategic buyer. And if you're someone looking to exit the business, it really can be your number option. But there are downsides to that and trade-offs that go along with that. The reason that a strategic buyer can pay the higher prices usually because they see some sort of synergies. And synergy is kind of an overused term. Sometimes it means yes, they can sell your product in their channels, but more likely it means that there are cost synergies which is another way of saying that they're going to lay people off and quite possibly close an office or facility. Those are real hard cost synergies that any strategic buyer is going to look at. Those are certainly things to be concerned about if you are thinking about selling to a strategic. You will lose control over the future of the business and frankly your legacy. So if you want to stay more actively involved in the business then have more control over the future of your business and frankly the legacy of your business, the private equity option can be a very good one for you. You might not get as high a price as you would going with a strategic, at least initially. But what is also available to you is what is often referred to as the second bite of the apple.
You may sell 60 percent of your business to a private equity firm and be able to put some money in your pocket and maybe take care of some of your estate planning needs, but you'll continue to have this, in my example a 40 percent ownership stake in this business which hopefully you will be able to continue to grow that business and that business will increase in value if things go well and if you're working with a quality private equity partner. And so five years down the road you may be able to sell all of your equity ownership or even just a portion of it and retain it. And then you'll have a second liquidity event again, four, five, six years down the road. Very often we'll see that folks can actually make more money going the private equity route and continued to stay involved than they would've if they had sold out altogether at the time of their initial exit.
I'll give you an example. We invested in a company in Michigan, an education business where the president of the company owned a chunk of the equity. When we recapitalized the business he could've taken some money off the table. He instead chose to put it all back into the company and the company grew from about $3.5 million of EBITDA to around $30 million of EBITDA over the next five years.
There's a little bit of a balance in terms of how hands-on we are or we think we need to be, and that's driven by a number of factors.
Jeff: Oh, that's stunning.
Chris: Yeah, he was pretty happy. And don't get me wrong, that's an unusual result and unusually good, and they don't all go that way. But for his case he believed in the business, he believed in himself, and he believed in us as a partner. And he was much, much, much better off because the value of his shares were much higher five years down the road than they were initially. Again, it doesn't always work perfectly like that but that opportunity and that upside is there.
The one trade-off I will say in all candor working with a private equity firm, and this is something that a seller needs to think about, while yes there's the opportunity to stay actively involved in management and participate in the future growth of your business the flip-side is you will as a seller, especially if you're selling a majority equity stake, you will for better or for worse have a "boss" or someone that you'll be reporting to. And that may be new to you as an entrepreneur or a business owner. So that's something folks need to think about. "Do I want to have a board of directors and some investors that I need to be working with and reporting to? Or would I rather just take my football and go home?" That's fine. Everyone has their own specific situation, their own specific needs, but these are things that folks need to think about.
Jeff: Chris, and this is just real briefly, maybe a 15, 20 second answer. Have you ever been in a situation where you were involved in an acquisition and the boss had to report to you, and there was some push back, there were some difficult personality issues?
Chris: That happens, there's no question. Especially for folks who have been the founder, owners, and CEOs of businesses, very often it's a difficult transition for folks to change the paradigm and say, "Okay, I need to be making sure I'm keeping my investors on the loop on things” rather than just having previously have the freedom to, if we need to spend half a million dollars on this new production line, I used to be able to do that because I owned and ran 100 percent of the business. Now with a partner we need to make sure we're keeping everybody in the loop, and there is a transition period there for sure.
Jeff: By the way, Chris Sheeren, partner at Huron Capital Partners in Detroit is joining us today on Deal Talk. What advice do you have for business owners who may be trying to come to a decision between recapitalizing or simply selling outright? If someone was in this position that they were trying to make a decision here, what would you say to them?
Chris: I guess there's some things to think about in the process. Number one, if you have a valuable business, and valuable is certainly a relative term. But let's say you've dealt a successful business and are thinking about an exit. One of the things to think about quite frankly is how much money do you need to be set personally. Some folks they have a number in their head, or they want to make sure all their kids are taken care of, and they want to set aside money to give to charity, and they want money to live off of. Sometimes you're only going to get that number if you sell to a strategic buyer or you sell it and get out. Some folks say, "I've done this. I've busted my butt for 60 years and here I am. Someone's going to give me $20 million for my business. I'm done." That's great.
Again, folks should start with figuring out how much they need. And if they can get it and then the next question becomes, "Will I be happy working with a partner? Am I the type of person who is willing to give up some control in order to bring out a partner that hopefully can help me grow the business?" And then also, as I alluded to it earlier, just this notion of a legacy. This company that I built, what do I think will happen to it if I sell the company and retire, versus if I stay on, am I concerned about what happens to the business? Is it... Of course folks are concerned but is there a risk that the business will be damaged in some way or the plant will shut down if a strategic buyer comes in? Is there a risk to that? Or if I stay involved do I think there's additional growth? There's a whole host of factors, but I think the important thing is that the entrepreneur really just be honest with himself or herself and figure out, "What do I need? Do I want to work with a partner? Do I still have the fire in the belly to continue to work to grow this business?" And also, “Do I think is there a future growth here that I'm excited about participating in?”
Jeff: Chris, any truth to the theory that acquisitions are more common in mature industries because maybe organic growth is simply more difficult to achieve in those industries when companies just seem to kind of be in a state where they're not stunted but just where they’re stagnant and they just don't seem to grow anymore?
Chris: I think there probably is some merit to that. I've never really seen any sort of industry data or research that has addressed that, it may be out there, I haven't seen it and I think it would be interesting to see. But I think no, I think there's certainly something to be said for that. Just from our perspective as a private equity investor when we invest in the company we effectively, and then we start looking for add-on acquisitions, we effectively become a quasi-strategic buyer. But at the end of the day as I said earlier, we're all about growth. And if growth is going to be difficult to come by organically then certainly it makes sense to think about growth through acquisitions. I think the theory that you propose is probably a good one. Again, I haven't seen the data there to analyze that but I think that makes a lot of sense.
Jeff: Chris, as we start to near the end of our program today and given everything that we've talked about what advice do you have for business owners? Maybe some final thoughts or key take-aways from our discussion? Maybe they're out there and they're making considerations for the future of their company? Maybe about continuing to grow their company before they decide to go ahead and get out and sell altogether, what advice do you have for them?
Chris: I would certainly advise folks to give themselves plenty of time to plan. It's not something that one should jump into lightly, in selling a business or bringing in a partner. And so having the right team of professionals and advisors around you is important. Certainly a good accountant to help you understand your financials inside and out and your trends, and be able to explain questions that folks may have. Certainly a good experienced M&A attorney, because when you get to the point of negotiating transaction documents you don't want to waste time. If you have an inexperienced attorney, or an attorney who's not an expert in transactions you don't want to waste time on things that really aren't as relevant and aren't as important. Having the right attorney is important. Some folks will choose to hire an investment banker, and an investment banker can certainly help you prep for sale and could certainly bring you a number of prospective buyers. That's just the decision that folks need to decide, do they want to go through that process. There's going to be a lot of time, and what we call brain damage involved in parading a whole number of prospective buyers and investors through your company that can create some confusion among the employee base. Folks need to think about that for sure.
Finally, I would say as you're honing on a potential prospective investor do your diligence on them because they're certainly going to be doing diligence on you and frankly it's only fair. But if you're thinking about a five plus year relationship with this company, this firm, these people it's really important that you know who you're partnering up with.
Having the right team of professionals and advisors around you is important.
Jeff: Chris, anyone who might be listening out there is welcome obviously to get in touch with you directly should they have any questions. How can they reach you?
Chris: Easiest way is probably by email which is email@example.com. You can certainly go to our website at huroncapital.com and learn more about Huron. Or I can also be reached directly at 313-962-5805.
Jeff: Chris, it's been a pleasure having you on board today. Thank you so much for joining us and I do hope that we can have you back on again in the near future.
Chris: Thanks Jeff, the pleasure is mine.
Jeff: Chris Sheeren, partner at Huron Capital Partners has been my guest. We hope that you enjoyed the discussion and we hope also that you'll take a moment to let us know.
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Deal Talk is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com today. My name is Jeff Allen. Thanks so much for listening.
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