WEBINAR TRANSCRIPT

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Nick Donato: Hi, folks! Welcome to today’s webinar where we will be sharing five strategies that private equity professionals in the middle market just aren’t leveraging enough to win deals. I’m Navatar’s Nick Donato, and I’ll be your moderator. And these five strategies we’re about to hear came about after I spoke with a number of mid-market firms who were gracious enough to share with me a taste of their firms’ secret sauce. We have three of those industry professionals here with us today.

But before introducing them, let me get some quick housekeeping out of the way. First, a recording of the webinar will be e-mailed to all of you in the coming days, so look for that in your inbox. That will include a copy of the slides as well. Also, I encourage you to submit questions using the Go-To widget tool on your screen there. I want to make this as interactive as possible, so I’ll relay your questions to my panel here when appropriate. But I’ve also saved some time for the end of our presentation to take your questions then.

Now real quickly, how does Navatar fit into the picture? Well, we are a cloud provider and one that is fully dedicated to the financial services industry. What we do is provide private equity firms and other financial sectors the industry’s first connected growth platform, which is a way to combine your relationship management, fundraising, deal management, secure document exchange and certain other workflows together onto one shared system. In this context, what we basically do is help firms track and manage their relationships as well as provide workflows so that you have more discipline and processes and how you go about sourcing and managing deals. In fact, we will touch upon some of that in one of our strategies, moving forward.

But first, let me also share why Navatar is so curious about what’s happening in the mid-market. Take a look at this, so right now the private equity sector is on pace to raise a historic amount of capital. About $700 billion according to Triago, that is if you include co-investments, direct investments and separate accounts which is about 10 percent more than the previous fundraising mark. But at the same time that all this money is coming into the industry, your average private equity deal is getting smaller.

Almost half of all the deals in the US were under the $25 million mark during the first three quarters of the year according to Pitchbook, which takes me to a bigger point. It’s getting tougher these days for private equity firms to source the type of deals that they want because you have this flood of capital chasing smaller deals that is also being combined with just more competition. During the 15 year period from 2000 to 2014, the number of active private equity firms globally exploded, a 143 percent to 3,530 firms all out there searching for deals according to Pitchbook. And then of course it’s no longer just private equity firms competing for deals in the mid-market, you now also have some large buyout shops who are migrating down, searching for yield, and then you have entities like pension funds and sovereign wealth funds who have same access to the cheap credit making direct investments. Now this would all be fine, who doesn’t like a little competition right, If we saw a parallel rise in the number of target companies that funds could go after, but that’s just not the case. I looked into this and Deloitte crunched the numbers and the hard truth is that the number of US companies has barely budged over the past 20 years.

So okay, I think you see the problem then. But I don’t mean to imply that private equity is running out of road here, in fact we’re seeing a lot of market commentators now predicting an uptake in M&A activity in the year ahead. But the point stands, unless your firm offers some type of competitive edge, you’re going to have a tough time out there to win one of those highly sought after deals. There’s just too much cash and too much competition. Now the good news is that I have three private equity mid-market experts here with me today who are going to share some ways in how to lead the competition. Together we’ve identified five strategies your firm is probably already aware of and pursuing to some extent, but let us make the point that you may want to think harder about these five strategies that we’re going to lay out here. David, can we begin with you? Can you provide us the background on you and your firm and then we’ll also hear from Rob and Mark.

David Duke: Sure, quick commercial on Edgewater Capital Partners, we’re a Cleveland headquarter private equity group. I’ll tell you what makes us not unique, in that we are control buyers of lower middle market companies, typically below $15 million in EBITDA but what makes us pretty distinctive and unique is our sector focused. So we are a chemicals and materials focused firm. And we think of the world in a couple of buckets, especially chemicals, pharmaceutical ingredients and what we call performance materials. And so we tend to focus on a series of sub sectors and get into the weeds a little bit on a technical perspective in terms of underwriting. We have six companies in our portfolio to date, we will close on a seventh in January and my job at the firm are to lead what I call the front of the house. All the development sourcing and marketing for the entire organization.

Rob France: I’m Rob France with High Street Capital. We’ve been investing in the lower middle market which we define as companies with revenues of $10 to $100 million EBITDA of $3 to $12 million, since 1997, so we’re investing on our fourth fund now. We’ve got seven platform companies. We’ll likely have another platform company here in the next few months, in fund four, and we’re also going to be raising our fifth fund. I spend my time managing, both sourcing, acquisitions, executing on due diligence and closing transactions, and then managing from a board perspective. We’ve chosen at High Street not to separate the business development activities, and we’ll talk a little bit more about that later. And there’s pros and cons to that approach, of course. But we sort of do it all, soup to nuts, as principals within High Street Capital.

Mark Hollis: Yeah, good morning everyone. It’s Mark Hollis, with Centerfield Capital Partners. I’m a partner here at Centerfield. And Centerfield is an Indianapolis-based provider in junior capital. So we provide mezzanine financing in the form of subordinated debt, and we also make equity investments in the same companies in which we’re investing mezzanine in. We’re on our third fund now, and have invested in 48 companies since 2001. And really, we hope have established our reputation as a creative and flexible lender and investor, as well as a patient partner to companies and sponsors that we work with, in good times and bad, so, similar to Rob’s firm, we focus on the lower middle market, three to 15 in EBITDA. And our investment criteria is all out there at centerfieldcapital.com.

Industry-wise, we’re fairly general, but we do have some specific expertise within consumer products, chemicals, aerospace, and healthcare. We co-invest a lot with other small private equity firms. We also work with independent sponsors. We work with family offices. And, actually, have been fortunate enough to work with both Edgewater Capital, David’s firm, and Rob’s firm, High Street Capital, in investments. We also pursue what we call “non-sponsored opportunities”, which are situations that require mezzanine financing, or minority equity capital, for re-caps that aren’t changing control, acquisition and gross financing, management buyouts, etcetera. We’re typically investing $5 to $30 million per deal, and can provide up to half of our investment in the form of equity, which is a little bit more flexible, perhaps, than some other mezzanine funds out there.

I am one of six partners here at Centerfield. Going on my 10th year here. My entire career has been spent in the middle market. I was in commercial banking prior to joining Centerfield, and when I joined Centerfield, I was Centerfield’s first business development hire, and held that role for most of eight years. And over the past couple of years, I’ve been working more on deal execution and portfolio management.

Nick Donato: Thank you, David, Rob, and Mark. Let’s take a quick look at the agenda. Put simply, we’ll walk you through each of the five strategies that I’ve mentioned earlier, and then, take whatever questions we don’t address them here now at the end of the presentation. The first of those strategies really has to do with relationship management, which, believe it or not, a lot of private equity firms have room for improvement. And then we’ll get into the investment process, how firm culture has an impact. Using size to your advantage, so smaller shops have a few built-in advantages that they can leverage. And then, the role of technology within our conversation. And then, again, at the end, we’ll get into audience Q&A.

Now, I envision this as being a back and forth type conversation. I’m also happy to relay pertinent audience questions, as they arrive. But what I’d like from each of you, is to provide your firm’s own vantage point, and a taste of that secret sauce in each of the five strategies today. I want to start with relationship building, which is something that we all do naturally. But Rob, can you kick things off here by describing your firm’s strategy for doing things like, engaging intermediaries, and reaching sellers?

Rob France: Yeah, I think, on the intermediary side, for sure. The reason that we’ve chosen not to have a dedicated business development person is because we feel it’s important to provide access early on in the process to the individual that the seller can expect to be working with during their entire relationship within High Street. And so, we sort of sell that, and say, “Listen, you’re talking to the people that are going to be doing the due diligence, and we’re going to be your partner. So we’re your partner from the beginning.” Now, the downside to that approach is that, when we get heads down, so I’m one of five partners, and one of seven folks at High Street, full-time folks, when we get heads down on a deal, what falls off is sourcing, right? And I’ll kind of let David and Mark, because I think they both come from environments where they do have dedicated business development. But, for us, you just simply have to make it a priority. It’s the same way you have to schedule family time, almost as a priority, in a business where you’re traveling all the time, and working very hard. You just simply have to not let sourcing slip when you’re in our seat.

And I think that you kind of build that reputation with every interaction. And so, we call it “honoring the referral.” So you respond, you respond in the same day. You’re consistent. You do what you say you’re going to do. If the deal isn’t a fit for you, but you happen to know somebody that it might be a fit for, then you share that with the intermediary source because you really do have to honor that referral. And as you talk about things being crowded in the market, it’s interesting. We had a recent sale process that went out to 300 financial buyers, and there were essentially 200 or 150 that really weren’t that responsive. And so, you look at that, and say, “Wow, okay, it’s crowded.” But if I’m that intermediary, and I’ve sent an opportunity to somebody, and they can’t bother to respond, that’s the way you differentiate. So it’s not sexy, it’s very basic, and you earn it every day. And you just have to be consistent. That’s our view.

Nick Donato: David, we heard Rob make the point about having a dedicated business development professional. Your thoughts on that?

David Duke: Yeah. So we came at it from a unique perspective. I joined the firm September. It was a year, so it’d been over a year and a quarter thereabouts having joined the firm. I spent 16 years as an investment banker. And when we started the dialogue, because I’d covered the sectors that we focused on, the firm had never really given much thought prior to about having a dedicated source. I think the approach was much in line with High Street. Everybody had some responsibility for it. But it became somewhat of a pain point when certainly in the deal bunker opportunities were lost. And given that the additional magnitude that we focus on a smaller number of companies, and therefore it’s even more important to be in the marketplace, it became acutely obvious that we needed to, as a firm, have more of a dedicated focus. So the timing aligned nicely. And as we went through and developed a business plan, the thought of not just having a dedicated person in myself, but how that business plan is going to lay out.

So ultimately the simple approach that I take to manage that. And everybody, by the way, at the firm has sourcing responsibility. My job is to hold everybody accountable, organize for that, push people in the right direction, especially when they are focused on managing portfolio issues and other deal net transaction responsibilities they have on a daily basis. But the predominant focus that I have is really splitting the world into two areas. One, direct or the industries that we focus on. So that could be anything from calling on, obviously, potential targets, but also spending time going to trade shows within our sectors, talking to corporate development folks. Because one half of the deals that we’ve done have been corporate carve-outs. Other executives that can provide value and either diligence or for potential opportunities.

And then the other half of my time is spent in the intermediary community. So building those relationships is just important as it would be for High Street. And it is, to Rob’s point, very much a simple equation. You have to build the level of trust, respect. You have to be responsive. You have to be thoughtful. If it’s not an opportunity for you, where else it can go. It just so happens to be that if there are 100 firms in the US, I’m making up numbers to make a point, but I’m only going to really spend time with maybe 30-40 percent of those given the industry overlap. So it’s more of a balanced approach from our standpoint. But in terms of the need, I think we were just in a unique position where the development role became a little bit more pronounced because of some of the challenges we faced when we were in the deal bunker. And I think here in the recent past, we’ve actually closed three transactions in the last 30 days.

And I can tell you from a standpoint of getting in the weeds, my colleagues in Cleveland have been extremely busy and really unable to do much of anything else. And all the more important, been covering the market while we’re trying to get things accomplished. So on one hand, very similar in terms of relationships. But on the other hand we come at it from a slightly different perspective in terms of covering the industries that we focus on.

Nick Donato: David, you’d mentioned prioritizing relationships, say if you have 100 intermediary relationships within your Rolodex that you only have time for 30 to 40. Can you give us some sense for how you’d prioritize certain relationships over others?

David Duke: So let me rephrase that. I think what I intended is that out of all of the intermediaries in North America… And frankly for that matter except Canada… There are only going to be a certain percentage of those intermediaries that are going to have likely deal flow that makes sense for us. And so it’s an allocation of time based upon the particular firm. If it’s a firm that’s a boutique that focuses on IT technology or health care services or consumer-only, it doesn’t make a lot of sense for them to spend time with me and vice versa, because they’re just not going to have deal flow that lines up well. And so with that, I focus on those firms that ultimately maybe in a year, maybe it’s once every couple years, or multiple times a year, are going to have a chemicals and materials opportunity. And within that grouping, I certainly am prioritizing. But it really is a matter of spending ample time with all of them, because you have to be front of mind and to be a firm that focuses on their industrial group as a chemicals practice, or a firm that might be a generalist firm that does a decent number of industrial deals and is only going to see one or two deals maybe every four or five years for us. You have to build those relationships long-term.

Nick Donato: Mark I want to get you in the conversation here. When it comes to engaging intermediaries, when it comes to sourcing relationships, how does your firm go about doing this and what are some tips and strategies that firms are not leveraging enough to win the deal?

Mark Hollis: Yeah sure so, it’s Mark Hollis. So at Centerfield our approach is a little different because we’re actually a lender, and at times, we’re also an equity investor so we see a lot of deal flow from other private equity firms, which is a little bit of a different relationship building process because you’re also going to have a relationship post-closing, with that sponsor or investor versus an intermediary relationship and you know similar to David, I was hired to help really amp up Centerfield’s deal flow. I came on board before we launched our second fund, and we had doubled our fund size at that point. And really similar to David, I was tasked with helping the firm get organized, developing a sales and marketing plan, and helping us going out and execute that. And part of it was Centerfield was looking to really expand and put its name on the map more than it had up to that point. Prior to 2007 we were really a mid-west regionally-focused firm and then we took that, and we now are a nationally focused firm.

Being organized is just one part of it. It’s funny when people ask me at other private equity firms whether or not the BD role is right for them, I think you’ve got to look at first what your firms objectives are in terms of what you’re going to accomplish. If you want to close one deal in the next five years and you’re two people, you probably don’t need a business development professional. If you’re growing from four people to eight and doubling the size of your fund, maybe it’s right for you to hire somebody to help you organize and be more consistent out in the market place. So there is not one size fits all answer for every private equity firm and every firm has a little bit of a different approach.

In terms of your questions, regarding how we engage our source of the deal flow, which again include other private equity firms as well as intermediaries. We do, first of all, try to identify who they are, which there are a lot of new ones coming into the market each year and we try to track those through our CRM which, here’s the pitch for Navatar, but we’ve used Navatar for eight years and that’s how we stay organized. Everybody here at the firm is responsible for business development, similar to David’s firm. Although, as a BD representative at Centerfield, you’re responsible for organizing it and you’re doing it more often than everybody else but it’s hard to say just one person is going to maintain your relationships so we all use Navatar to help us communicate internally. And we do actually rank our source of the deal flow based on tier strategy; which is five tiers, and really for those tiers we have different levels of engagement and the important thing is you want to try and build a relationship with people showing you deals, and David and Rob alluded to some good practices being responsive and courteous. Making sure you get to a quick no, if it’s a no, is another good one.

But when you talk about a relationship, a relationship is a two way street so you can’t just take this part of the relationship and expect it to be productive in the long term. So one of the things I think about and we think about is how we can be value added to our source of the deal flow. And part of the time that’s providing creative capital solutions. But if it’s not a fit it could be providing them a referral to another mezzanine firm, private equity firm that we know that we’ve worked with, or providing them information that’s helpful to them in terms of managing their business. In terms of managing those relationships, I think you do have to develop an approach in terms of where you’re going to see the most deal flow and engage them.

And also I think one of the things that’s important too is that when you meet with them for the first time, you really have to establish your credibility as much as you can early. It’s nice to just say hello. There’s a lot of friendly people out there in our industry. But when you meet that person for the first time, that’s your opportunity to really explain why your firm is different and why they should work with you or show you a deal. We attempt to do that by providing them some information about who we are, our reputation, our background to give them comfort that there is going to be a way to develop a relationship there between the two of us. And then you just got to stay engaged and in-person meetups are always good but you can supplement with phone calls, emails, and other personal communication as well as marketing via e-mail and the website.

Nick Donato: Yeah and some of this is communication etiquette 101, but again you would be surprised by the number of firms that fail to do something simple like that whether it’s a follow up email or a referral. Would you agree with that, Mark?

Mark Hollis: Yeah, it’s tough, right? You know, if you want to try to make five outbound phone calls a day just to catch up with your network, try doing that for one week and making 25 touch claims and it’s difficult, but relationship does require communication and I think as we all know, the obvious is, you want to try to stay top in line and stay engaged so, an e-mail and a phone call can be good ways to do that.

Nick Donato: Yeah they go a mile. I want to get into our second strategy here and this is about having more discipline in the investment process. And again here too, every firm is going to have a different take on what that discipline looks like or even what level of discipline that they’ve been able to achieve but when we begin identifying these five strategies that firms are not leveraging enough, this theme kept propping up. And it relates to having a more process-driven approach. It relates to having more coordination among staff. David, can you kick things off here about how you interpret this strategy?

David Duke: Sure. And I think, as we were chatting, Rob, and Mark, and I think we all agree there has to be some series of protocols. I think probably they are nuanced for each firm based upon the asset class that we’re focused on. But the importance of small firms on creating in a system, if you will, for screening for assignments internally for the, as we call it, deal-flow process is extremely critical. The most precious resource is time in all three of our organizations given our size. And for us certainly, and I can’t take credit for it because it was well-built by the time I arrived. Over 16 years have developed a series of stage-gate protocols that starts from the very first email or phone call or conversation that I or anybody has with a perspective transaction.

And the discipline that we have to make that a priority whether it be before we go to our weekly call, the series of emails back and forth on does this even… Is it even raised to the level of getting to the top of the funnel? But it’s very purposeful and it’s a very specific set of steps and stage gates that allow us to stay disciplined, allow the process to be somewhat efficient, frankly, allow us to say no. We have somewhat of a unique benefit of being able to do that often even if it’s a chemicals or materials business because of our level of expertise and relationships in the market.

But even on those, we have to make sure that we are all committed and not spinning our wheels. And so with that, there is somewhat of a culture of accountability that everybody is going to arrive no matter where you are on the deal. Call or meeting in person. If you are responsible for commenting on a particular deal that you’ve done your homework upfront. And the deal team has to remain disciplined once it gets beyond a certain stage gate to internally work within the protocols. If the protocols aren’t working, we need to have that larger discussion.

And ultimately what pops, that is just a more efficient process to get from teaser, all the way down to indication of interest and certainly indication of interest forward to letter of intent and close. And so for a small organization like us, a structure is something that’s very meaningful. And I think that process driven approach is something we’ve taken to heart. And I’ve certainly been impressed with the firm and people who have been there with certainly the commitment to it because you can talk about it and put it on paper and never ever have it happen but it yields results and we all get that that ultimately, on that precious resource that we talked about which is time.

Nick Donato: David, that’s an interesting point about having that methodical approach to your deal management and the investment evaluation. Is part of the objective there speed that you want to be reviewing as many deals as possible and don’t kick things up if they don’t meet that thesis or is part of it we only want to be spending time on the most quality deals and creating that filter process? And to what extent do you have to rely on say, junior level staff to make that judgment call early in the investment process?

David Duke: I think it’s certainly both of those points. It’s time. It’s saying which deals are we going to spend time on more than others. We have a tendency to have the very first part of the screening process be top heavy so the investment committee, which in our firm, brief folks at the firm, and the principles of the firm. We want to make sure that they’re early stacking hands to say… Is this something that once we get a book in, A) whose going to take the deal lead and be responsible for digging into it and B) before we even do that, is this based upon what we know about and it might be chemistry, it might be a series of applications, it might be a series of end markets that we know something about. Is this an area we want to invest time in? Because knowing that you’re going to have the team really apply a lot of work to it even prior to IOI because our IOIs tend to be fairly vetted and that includes some third-party industry relationships that we have. So we’ve decided we commit those resources up front and so we have senior level folks opine on the quality of the deal early as opposed to try to pushing it and then ultimately it ends up just floating around and it doesn’t do anybody any good to just having it sitting out there as a maybe; that also helps my relationships, frankly, if it’s a banked deal that I can call that advisor quickly and say here,  it wasn’t a fit, even though its chemicals these are the four or five reasons why it’s just not something for us. And that goes a long way and that takes a lot of extra effort, but that wouldn’t be something that I can take advantage of if it was something that was haphazard process.

Nick Donato: Rob, I want to loop you back in the conversation here because one thing that I’ve also been hearing is that there’s a risk that you can become a slave to these protocols and processes and you’re not doing what should be the heart of the exercise, which is saying, “Is this deal good enough? Is this deal one that we want to win?” Your thoughts on that.

Rob France: Yeah, well I think for us, so we do all business to business investments in services, manufacturing, and distribution. So we’re in generalists, that’s a pretty broad category, 10 to 100 million in revenue is a pretty broad category. So, our funnel is pretty big. We review in detail five to six hundred deals per year. We see many more than that. But those are the ones we sort of take a closer look at to ultimately do one to three deals a year. And so that is a huge funnel. And so, how do you manage it? How do you avoid becoming bureaucratic in your approach? A trend we’re seeing in the industry is that everything is moving faster, so it use to be that IOIs didn’t matter so much. And for us, they were always more vetted than I think than a typical IOI in the market. And then the LOIs are sort of what mattered. So, people would run around and put IOIs out and then try to build a case with LOI and it would either fall apart or not. But what’s happening now we’re being pressed in relatively small deals to just get the deal done post LOI and sort of skip over the due diligence. Everyone is worried about legal documents and those things. And you still have due diligence to do. So, our response to that to make sure that everybody within the firm, including our operating partners, so two of our five partners are operators who typically had gotten post LOI. Now we have those folks actually reading offering memorandums. Okay, probably skimming offering memorandums if the truth be told, but the point is, is we’re getting our operating partners feeding into the very earliest stage of a process because we find that they may have a relationship somewhere or they may know something about this. Or they may say, “Avoid this because this just looks exactly like this other thing that didn’t go well for me. And I don’t like the dynamics of that industry.” Whereas before, we would say, well, they’re operating guys and we’ll bring them in if it becomes more serious. We’re sort of inverting the model to use the folks we’re counting on to build value in that company to go find businesses.

So, are we taking more time, yes. Does it make sense to pay operators to read offering memorandums, I don’t know. But for us, we’ve been doing this now for about a year where we have sort of inverted our process. And we’re seeing a tone of integration so that we’re spending our time, which is the most important resource we have, on transactions that our operating partners are excited about. And know something about and feel that these are areas where they can add value. So for me, my job is almost to find things that my operating partners are excited to go visit. And does it add a little bit of bureaucracy, maybe, but for us, it’s really been very successful.

Nick Donato: Mark, your thoughts?

Mark Hollis: So, discipline is key as an investor. Having a process is key. Just like you would invest in a company that doesn’t have a process to manage their business. I’ll just comment on a couple of things. One is focus on the quantity of quality and not the quantity alone because the quantity of quality is really what matters. And you really got to be efficient at the top-end of the funnel and try to avoid rabbit holes. In my opinion, if you want to try to improve your overall process because there’s a balance between spending three hours reading a ‘sim’, versus picking up the phone or going out and having three to five meetings to try to source that next best opportunity. So, those are some of the things you kind of develop over time…

And your firm develops over time. We most certainly do have a process. We have similar to Dave, and it sounds like Rob, our investment committee reviews deals that we think have an interest and we track all of that actually in Navatar, which is one of the ways we measure our quantity of quality, but again, you have to have a process. You have to think about where you’re spending your time and your resources. Maybe you sit down and say, “Hey, for the firm we’re going to track our activities and our hours spent in certain areas over the next three weeks,” and that’s an interesting analysis.

So those are things to think about, but in terms of Centerfield and how we approach it internally and externally over communication, communicating internally and externally often, setting expectations, trying to make sure all parties understand as much as we can and give confidence where we stand and vice versa. And then as I mentioned earlier, a quick “No” is always helpful too, to your sources of the deal flow because they appreciate that. It’s even better if you can follow that up with a “No, but here’s someplace else you can go for it”. Just one final comment, in terms of taking a look at opportunities, you got to consider the source as well, which we always do. Where is it coming from, in terms of our tier ranking? And you have to consider the stage at where it’s at, and also the opportunity. While you have a process and a framework, you still have to be opportunistic. We have 11 people here at Centerfield, and each person probably handles it a little bit differently. But it’s not a one-size-fits-all type approach, which is what makes it fun.

Nick Donato: There is a question coming in: If you’re targeting deals in the Midwest, would a firm have a natural advantage by being headquartered there, or does geography not matter? Rob, you want to take a crack at that one being from the Midwest?

Rob France: As a kid from Livonia, Michigan, I often talk a lot about it. I think there are kind of “Midwestern” people all over the country. I think it matters, right? So I think it matters more how you’re built, than where you were born. But, just for the record, I was born in Livonia, Michigan. And I’m a nice Midwestern boy.

[chuckle]

Nick Donato: Okay, I want to… Oh, go ahead.

Mark Hollis: I would just comment, I think that there are some perceptions that certain people may have, relative to their geography. Our approach at Centerfield is we look to work with good people that are experienced. And there’s a lot of good people in a lot of different places. But certainly there can be some biases among certain people in the Midwest, to those outside of their geography. Just, probably, as is the east coasters with east coasters with west coasters with west coasters.

Nick Donato: I want to shift this over to firm culture, which is another area, it is our third strategy for a lot of the reasons that mid-market firms are losing deals today. Because, even if you do have the perfect processes in place, if you’re great at sourcing relationships, the first of our two strategies, things can break down if you operate in a culture where, for instance, you don’t have the ability to say no to a deal. Maybe you feel that you’re too junior, and don’t want to stand up to a more senior-level partner. So firm culture is important in this conversation. David, can you give us a vantage point from your firm and how you tackle this?

David Duke: Yeah, I think that because we are 10 people, and take two of those out, actually three of those out, that have more administrative functions, the team has been unofficially given a lot of responsibility and ability to comment on deals throughout the process. And it’s encouraged, it’s tested. If you come in and you’ve sponsored a deal, if you will, at the top of the funnel, you’ve gotten senior-level sign off, you’re going to be looked at, at least, and this is the case even for me, where I’m not completely passing it over-the-transom, but the senior phone will say “Well, great, over the course of the next week, I like the … let’s all kind of peel it out, and let’s all, to include me, come back with two or three reasons why we think this is a good opportunity we should spend more time on or not.” And that’s encouraged, all the way down to the associate level, as well.

And certainly I think that cuts both ways, where that can be, on one hand, comments on wanting to sponsor, but also the ability to push back, if at any given time, there’s one or two critical incidents that somebody has identified and has concerns with. So, I think from our perspective, it is very much an open policy. And often that can be having to say, “Everybody is busy”, say “Hey, just FYI, I’m going to engage somebody else on this discussion,” even though the person is not necessarily on the deal team. And, the usual response is “That’s great, because I’m heads down on the next 48 hours on something and I’d love their perspective as well.” It very much is a 60 type series of engagements internally. Me coming in, I live in Atlanta, Georgia, and work for a firm that’s in Ohio, so I spend a lot of time obviously on the road. And for me, that was a critical element of culture. Where you’ve got, not only folks that like each other, do some things socially together, but have a professional rapport, that egos are put to the side, we’re all stacked cans here, it’s a one-firm firm attitude. And that matters when it comes down to critical steps in our stage-gate process. I think that’s sort of an unofficial culture that the firm has. Critical, in my view, as I think about the dynamics of this industry, as well as the size and just the velocity and speed at which things have to get done.

Nick Donato: And not only speed, Mark, I know that you’ve spoken in the past about the importance of junior-level talent retention. And that if firms are not giving this enough thought, it could creep up to the investment process and result in lost deals, your thoughts?

Mark Hollis: Well, Nick, certainly culture is very important to us here at Centerfield and for us, more important than making a mezzanine or equity investment in a company is actually hiring somebody here at our firm because we intend to develop that person most of the time, we have some analysts that may come in and out into a long term, part of our family here at Centerfield. So, culture is critically important and I think David’s firm, the way he described it is very similar to how we handle it here at Centerfield. Which is, open communication, although communication lines are established and known and respected, but we want out junior professionals to learn, we want them to ask questions and try to support their reasoning with facts and data and perhaps their experience, if it’s different than ours. And that has to be respected so if you really want to continue to sustain your firm long term, it’s important to have that culture and really drag that throughout the organization.

Nick Donato: Rob, your thoughts?

Rob France: Yeah, I think at High Street, ideas are respected more than tenure or title, and that extends to everyone, so as a smaller firm, we’re seven now going to nine in our next fund, which will be starting to raise next year, and we’ll start having more of these challenges. We typically use MBA interns as our associate class, and so these are folks that may not be with us for the long term, there are some that we may want to make a play to try to bring back on a long term basis when we raise the next fund and we continue to build what we’re doing at High Street. But everyone’s expected to have an opinion and everyone’s plugged right into it so we’re having MBA interns on their first day in partners meetings and if they’ve been there and had time to review the materials, “What do you think John?” or “What do you think Chen?” And that’s an interesting environment. And so, everyone’s allowed to have that opinion, encouraged to have that opinion.

I think another element of the culture that’s important in small funds is how you manage the transition. So, you have a lot of funds now where partners are kind aging out and you’re going to start to see them become second generation and third generation partners coming up and that’s complicated. It’s economics, it’s government, it’s strategy, and it can be hard to get it right with everybody feeling that they’re being treated fairly. And I guess the way we view that is we say, “How do our decisions today, make High Street a thriving enterprise 20 years from now and what does that mean?” What it means is we hire people that we think are better than we are. Right? We’re not threatened by bringing new talent into the firm. We’re not territorial, we’re not parochial. And so, I think you have to have that view. And when you create an environment where people can have an opinion and that opinion’s valued. No, it needs to be supported, right? You’re going to be challenged on your ideas but the strength of the ideas are what’s really going to win at High Street.

Nick Donato: It’s interesting that you say that because I know of a few associates at the larger firms, think your Blackstone, KKR-type sizes, where it’s more difficult; they’re part of a larger organization, there’s more of a hierarchy and they don’t always have that freedom to challenge deals or support them. Which takes us into our fourth strategy and that’s how smaller shops, which is the majority in the mid-market, if we’re comparing them to the likes of your KKRs and Blackstone’s, can use their size to their advantage. So, turn a weakness into a strength. David, I know that you have some thoughts on this.

David Duke: Yeah. I guess, a couple thoughts. One, I think our history has gotten to us to a point where we think our competitive advantage is our focus. Right? So, not only our size but it’s the focus that frankly allows me to be more efficient where I spend my time as well as our ability in those deals that are even close to the sectors that we like. Now, the other way that I think about this is maybe often a little bit from a competitive nature in the eyes of our investors, which is obviously who we work for. And from our perspective, our size forces us to stay disciplined to how we underwrite our transactions.

And so, in this current environment where there are very lofty evaluations and very lofty evaluation expectations, it is critical for us to use the size and knowledge that we have to focus on those deals that we think we can win. That we think we can win at a valuation that makes sense for how we underwrite it because ultimately, getting away from that discipline means ultimately we’re going to overpay for deals that we start to give up what is an expected level of return for our investors. And that is going to matter when we go out to raise our next fund. We don’t as a firm, have a philosophy to move upstream over the course of the next decade. We think there’s still opportunities in the areas and size that we focus on and so from our view to be competitive when we’re talking to new and existing limited partners on all the other opportunity to deploy their capital it’s return expectations. And so, yeah, I think that all roles up into, “What are we here doing?”

And it’s to return a good solid returns for our investors. And so, from our prospective, we have to be nimble and use our size, and focus to be competitive where we can. And sometimes, that can be frustrating because in this environment, we see some really attractive businesses that we think we would be very smart on. But if the market is dictating a full turn more than we think it’s justifiable, then we have to say no. And so that discipline, it certainly is a challenge in this environment, but I think it’s so critical because if you get away from that, then you start to dilute what it is that your investors look to you to provide as they put capital in your fund.

Nick Donato: Mark, what do you think? Are me and David right here to describe smallness as a potential advantage?

Mark Hollis: Yes, I think David did make some good points. And if you are smaller, you certainly have the ability to be more nimble, and quick, and efficient. If you’re one person, you’re the decision maker. If you’re four, it’s a little bit of different process. If you grow to 11, 12, 20, you can still achieve the advantage of being small, and quick, and nimble, as long as you grow your team, and it’s done thoughtfully, but it becomes more challenging. So certainly there’s, I think also on the other side of the table, the perceived execution is a little bit less perhaps. If you can establish yourself as being quick, and nimble, and small. And to David’s point, I think your investors do appreciate a firm that’s growing at a measured pace, rather than doubling the size of the fund every three or four years which has been successful for some firms, and has been more challenging for others.

Nick Donato: And then, Rob, do you agree? What types of pressures change when growing from a small to medium-sized firm?

Rob France: Yeah. It’s interesting for us because we’re at a little bit of a transition point. Historically, the majority of our investors have been high net worth individuals, many of whom worked with my partners in other businesses, and they’ve been in investors in all of our funds since 1997. And we’ve done well by them, and they’ve done well together. And so, historically, we’ve not had a lot of pressure. Nobody talks to us about deal velocity, or some of the things that you get into when you take institutional money. And for us, that may be changing as we broaden our base and fund five. But I think it’s so important for us in sort of that stock selection, if you will, it’s increasingly important given the valuations that you have today. And so, I think, it’ll be interesting to see how we kind of manage those competing priorities of putting money to work but maintaining discipline. That’ll be interesting for us as a firm as we go through to that.

I think, kind of externally, or looking at it from a seller’s perspective, we’ve got a great story. So we can say, “Look, we’ve done 30 transactions, we’ve been together as High Street Capital for 20 years. We’re really established but we’re still small enough that you individually matter”. So a lot of times, we have two investment partners who are looking at a deal, and one sort of leading it, and then we have an operating partner. So, we can be in a room with an entrepreneur, and we do a lot of first time institutional capital transactions. And that entrepreneur who maybe is rolling over 30 percent or 40 percent of their investment into the new transaction is sitting with three fifths of the partnership and three sevenths of the team. And so they feel important, and they’re right, they are. They’re not just sort of another portfolio company or sort of a large, faceless kind of enterprise. They’re dealing with the group. And so, for us, that’s an advantage. Now, as we grow to nine, and then 11, and then 13, can we maintain that? I think we can. I don’t think High Street’s going to be 50 people. And I think, that’s the closer of High Street, and it’s kind of incumbent upon me and some of the other kind of younger partners to carry that forward.

Nick Donato: So, I want to touch on our fifth strategy here that we’ve identified before kicking it over to audience question, we’ve got few coming in. And that relates to technology. And I can tell you that I had visited a number of private equity firms, and many of them, especially still in the mid market are still relying on Outlook for email and Excel to do their budgeting, or tracking deal flow, and it’s antiquated. I can also tell you that when they show this to investors who are conducting operational due diligence, it becomes a red flag to them. But not only that, it’s a slowdown in their processes, and their operations. Speaking to that point, Mark, can you describe for us how technology place in this conversation of ultimately winning deals that others aren’t perhaps because they don’t have the right technology in place?

Mark Hollis: Well, first of all, I’ll say that we still use Outlook for email, so hopefully, everybody is not laughing at us out there. But we have used as I’ve mentioned earlier, Navatar now. I think we’re eight years into it, and it’s been a fantastic product for us just in terms of helping us manage our sources of deal flow, and including our investors, and other points of contact as well. So, it also helps us communicate better internally as an organization for instance, if I go meet with Rob in Chicago, I can get on the elevator afterward, pull up the mobile app and log a call really quickly with Rob in Navatar. And then, one of my colleagues would see I just spoke with Rob within the last 30 days, and perhaps they focus their time and attention elsewhere.

So, being more efficient, just better decision making just with the data that we track within our technology systems, directly track all of our deal flow, the gates including what we talk about internally on a Monday morning to what we actually submit a proposal on. And it helps you generate better information from which you can make decisions, and then hopefully become more efficient as part of that process. And it’s really integrated into our firm now at this point. And to do it correctly you really do need a champion I think internally to say, “This is how we’re going to approach it as a firm. It’s got to be a top down approach where your senior leadership lies in and is pushing that down to organization.” You know for full disclosure, we’re pretty good at it, we could probably be better as most firms can. But you also have to focus on making sure you’re really focused on the information you need to put into the system. Meaning, if you need to put everything into this system or can you just put in some essential things. So that means you’re not wasting your time putting data in a system where it’s not going to be as efficient for you and helpful for you in terms of improving your business practices. Garbage-in, garbage-out in terms of what you’re putting in and what you’re getting out, but to do it effectively I think you do have to get the whole firm to buy into it and use it as a tool. Particularly how it relates to your CRM and use of Navatar.

Rob France: Hey Mark, I got to cut in here, I’m sorry Nick, I got to cut in here. Mark, I thought I was more than just another Navatar entry to you. Is what our relationship has become?

[laughter]

Mark Hollis: You are Rob. Sorry to use you as an example but you’re the first one that came to mind.

Rob France: Okay, alright. I forgive you.

[laughter]

Nick Donato: If it helps Rob, the system allows you to tag a contact as a high priority which I’m sure Mark has done to you.

Rob France: That warms my heart, Nick. It warms my heart.

Mark Hollis: You’re in the top tier.

Nick Donato: Rob, in fact, if we could hear from you on this – you had mentioned earlier that your firm is in a period of growth. How do you use technology to not only help facilitate that growth but to win deals?

Rob France: When I joined in 2008, we were still passing data around to everyone’s computer so the person who started it had to get it last and then resync all the contacts. It was a disaster. I found Navatar in 08-09 right around that time and we’ve been using Navatar ever since. And I think, I’d echo what Mark said, I think you need a minimum commitment from all team members. We’ve got some people who are super users that log every email they ever send. And then we have some people that are a little shakier on it, but everybody kind of embraces it as the helpful tool that it is. For me, the single biggest thing that it helps me do is figure out, because we’re finding and grinding and minding right? We’re doing all three of those things, it helps kind of keep me honest and I will go into a city view and say, “here are the cities I cover and here are kind of my top tier contacts.” And sort them, and who have I not reached recently. And it just makes that discipline of keeping my head in the sourcing game when I’ve got 10 other competing priorities, it’s really important. And when you talked a little bit about how the market’s changing. There’s 400 financial buyers including family offices that can be on every list of every $5 million EBITDA business. You just, it’s incumbent upon us to say top of mind. And without a tool like Navatar I don’t know how we would do it. I don’t think we could effectively do it.

Nick Donato: And before I turn this to audience questions. David can you give us quickly some insights into what types of factors go in to purchasing technology or giving an overhaul of your IT and systems?

David Duke: I would put us squarely in the antiquated bucket, and I know Nick’s going to be calling me afterwards because we are ultimately a prospect. When I joined, I got handed a file for some of my other colleagues saying, “Congratulations, you’re now responsible for looking at CRM.” And so we went through a very exhaustive process, ultimately we have put a pin in it, and frankly that has a lot to do with what you heard from both Rob and Mark. Which is the senior level buy in, not that the senior level folks weren’t necessarily bought in but I think the perspective of me educating them on what time commitment that takes to pull data from multiple different places. Even if we had a phenomenal tool like Navatar and a consultant, that is a lot of commitment of investment of time.

Ultimately then also we have competing needs for the limited budget that we have and so, altogether I think we decided maybe it’s not the right time to make a big shift to a large IT project like a CRM. Because if we’re going to do it, it’s not a Band-Aid it should be something that’s thoughtful and that even the lowest common denominator of a senior person is going to use the tools. I would absolutely agree with everything Mark and Rob have laid out as they’re seeing it in real time the benefits. We frankly struggle with some of those things that we don’t have the benefit of technology to help us on. And I think from our perspective we wanted to make that we are thoughtful in how we are not only picking the right platform but really saying to each other, “this is a commitment, a very significant commitment and we’re only going to do it when we’re ready to do it.”

And it’s a big project and so I think that’s one of the takeaways I took from it is there are plenty of good resources. Certainly think Navatar is a very good tool from what I understand. But there’s no magic elf that comes in in day one and just presses a button and it’s all working seamlessly without a significant amount of work. And that’s okay, it’s just a matter of everybody has to say, “I’m going into it eyes wide open.” And so for us, we’re not quite there and, frankly, have had the benefit of being very busy elsewhere and it’s just a matter of finding the time and resources to do it.

Nick Donato: So I want to kick us over to audience questions and there’s one coming in here that I see as the most challenging so I want to get to this one first. We heard the point today that the middle market is becoming more competitive and someone is asking should that mean that investors should anticipate lower private equity returns moving forward? Open floor for whoever would like to take that one first.

David Duke: Yeah, I’ll jump in. I mean look the short answer is I certainly hope it’s not Edgewater Capital that’s producing lower returns and that goes back to the discipline that we talk about on a regular basis because it’s challenging in this environment. I think globally, if you will, the conversations that I have, be it at ACG events or elsewhere, I always bring up the subject when it’s in this current environment because it’s, frankly, head scratching on some assets that we’ve seen going for extremely large multiples that we just can’t… We certainly can’t make the math work and we just can’t get our head around it.

And I’ve had some interesting feedback from some people that have been in this industry longer than I have and certainly understand the institutional world and I think they’re, in general, in an environment with low rates that the stock market is extremely volatile. I think to some extent some institutions look at a series of or a handful of or a large percentage market and say as long as my capital is deployed at an efficient rate and it’s a significant amount of capital and I feel like there’s a nice risk/reward balance, I’m okay with X, Y, Z capital at slightly lower than top core tower returns because I know it’s going to be deployed at that rate. And for us, we don’t have the benefit of being looked at as a deployment-high-velocity shop.

Does systemically that mean over the course of time, limited partners are getting comfortable or that they will see lower returns, I don’t know the answer to that, but I do know that, frankly, there are some that are starting to stomach that simply because of the supply and demand and so much capital chasing so fewer deals. And, Nick, you hit it on the head, the number of companies hasn’t increased and so it’s Economics 101. More demand and less supply means prices go up. And so I think they’re smart in realizing that some of that’s going to trickle down to lower returns. That’s why it’s even harder for us to say to our investors on a regular basis, we’re going to underwrite three times cash on cash return and be consistent about it. And that takes a lot of discipline in the market where we currently are.

Nick Donato: Rob and Mark, I’ll spare you a question on potentially lower returns just to get to these other questions. We have someone asking to the panel what is your approach to compensating intermediaries? Do you do referral fees? Do you do diligence costs? What’s your approach?

Rob France: We usually send out Harry and David baskets of pears so…

[laughter]

Rob France: People like pears. We send a lot of those out to our friends. We pay standard referral fees. There’s no debate about that. I mean the cost of acquisition of finding a good deal makes it a no-brainer for us to pay standard Lehman fees or whatever it is almost to people… Whatever it is within reason that people are looking for in a closed transaction.

Mark Hollis: Yeah, and from Centerfield’s perspective, we do pay fees as well and certainly welcome the opportunity to do that. It’s a little bit different for us if we’re just providing a mezzanine debt investment then we typically would pay one to two percent of the investment size and we pay two percent if it’s what we consider proprietary and a little bit less at one percent if it’s not a proprietary opportunity subject to, we’ve got some flexibility there, but if it’s more equity focused, minority-equity, we have some flexibility there to increase our fees. But we certainly do pay fees to intermediaries and we feel like our fees are quite competitive relative to some other firms in our space.

Nick Donato: Another question coming in, how are your firms sourcing non-option deal flow, which I’m interpreting to mean proprietary deal flow, assuming if that is an objective of yours.

David Duke: I’ll hit that. Unique perspective given Edgewater’s focus so where I spend some of my time is within the corporate development community within the large strategics. Obviously, there’s a lot going on with activist shareholders in the chemical space so I try to spend time with them in the opportunities that they’re either going to run processes by themselves or auction processes. Certainly call direct to companies and we can certainly start dialogues with owners and learn about their sectors.

But, I’ll tell you and I think probably these guys would second me, the market is so efficient, the internet has obviously changed the game and so any owner or operator, by the time I’ve talked to them at a trade show or introductions or what have you, has been approached and had conversation with two or three investment banks, two or three private equity groups and others. And by the time they talk to their friends, they’re likely going to choose an investment bank if they’re really serious about selling. We’ve had a few semi-proprietary situations, we just closed one that was an old relationship of mine last week. That was eight years in the making. They do happen, but I think the analogy is you’re covering all parts of that, not just one area, so you do have to approach it from that perspective and I think being thoughtful and have an angle when you’re going into a specific company or target area. In our experience is a higher probability, but gosh, it’s just extremely competitive for their time, and I think the unicorn that is a proprietary deal is few and far between but they certainly do happen.

Nick Donato: We have time for one final question. How can a firm which is sector agnostic still remain knowledgeable and competitive across a wide range of industries?

Rob France: Yeah, I’ll take that one Nick. I think there’s some basic… And lot of times in the businesses that we’re going into, you’ve got unsophisticated processes, and poor systems, and sometimes they don’t know why they’re making their margin or where they’re making their margin. There’s a lot of opportunity to round out some kind of square wheels in a broad based playbook, okay? And then, I think further within that, as generalists we all still have experience in certain industries that we build from and leverage. And, when we say we have food ingredients business that we successfully managed and sold, now we’re credible food ingredient guys, and you kind of build from there. So, it’s not like, “Well, we’re just are completely undisciplined, we do whatever.” It’s, “Where’s our knowledge base, and what case studies can we bring to bear, and what industry relationships do we build because we’ve had success in these industries before.” So it’s really industry verticals underneath an agnostic platform. But, yeah definitely with the competition that you have now, with the prices you have to pay now, we’re going to have to earn that return, so you better know what you’re doing.

Nick Donato: So, I think that’s just about does it for time here. A big thanks to David Duke of Edgewater Capital, Rob France of High Street Capital, and Mark Hollis of Centerfield Capital for their time here today. As mentioned at the start of the webinar, a recording of today’s broadcast, including the slides will be emailed to you in the coming days. And if you’d like to learn more about Navatar Private Equity and how we can help you with both deal origination and deal management, or if you have any follow up questions for our panelist here, including where you can buy those pears, please do reach out. You can see our contact details on that last slide there. So, on behalf of Navatar, I’m Nick Donato, enjoy the rest of your day.