Often times, businesses can be compared to a child with the business owner as the parent, and that makes selling it harder. Private equity groups assist business owners in this endeavor with the option of allowing them to maintain operating control even after the sell. Lamar Stanley, the Head of Deal Origination in Gen Cap, explains the different options you have when dealing with private equity firms in detail. He talks about why it’s better to sell while your business still has room to grow as well as the different key points to consider preparing for during any transaction in order to avoid surprises that could possibly kill a deal.
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Lamar Stanley: Private Equity Groups
Are you a business owner that has always wondered if your business would be attractive to a private equity buyer? Do you know what to expect from private equity buyers? M&A Unplugged community, you are in for a real treat. We have Lamar Stanley with us who is the Vice President and Head of deal origination at Gen Cap America. Gen cap America is a private equity firm headquartered in Nashville, Tennessee and they specialize in the acquisition and recapitalization of middle market businesses with $2 million to $10 million in EBITDA. Lamar, welcome to the show. I look forward to diving into the world of private equity with you.
Thanks for having me.
Lamar, could you give everybody a quick background on yourself?
I joined Gen Cap America years ago. Previous to that, I was with a wealth management firm that had a private equity fund-to-fund strategy where I was making investments into GPs all around the country and that’s how I first got connected with Gen Cap. Prior to that, I was in business school and the reason I had to go to business school is my career up until that point was completely in the military. I had to go learn how to add and subtract before getting a real job.
This must be a real change.
It’s a different spot than the previous life. I’m happy to be with Gen Cap and also in Nashville.
First, I want to thank you for your service. I didn’t know that you were a veteran but thank you and I’m doubly pleased to have you on.
Thank you. It’s my pleasure, but I appreciate you saying that.
For the audience out there, talk a little bit about Gen Cap, their history, how they got started and their focus. We’re going to dive into, not all private equity groups were created equal, all have their different strategies and criteria. We’ll get there, but let’s talk a little bit about Gen Cap.
Gen Cap is older by private equity standards. We’ve been around since the late ‘80s. I’ve been doing this for years. Specifically, Gen Cap is on fund seven, although that is somewhat of a misnomer. This is our third institutional fund. Some of the early funds at Gen Cap were mostly friends and family and in around Nashville. Gen Cap, since the early days has been remarkably consistent in what we do. Specifically, what we’re doing is we’re targeting companies with $2 million to $10 million EBITDA in earnings and foreign investment. We make control only investments and the industries where we focus are manufacturing, distribution and basic service companies, but we’re much more industry-agnostic than that. The reason is that what we are looking for are qualities inside the company, specifically around the management team.
In our typical deal, what we are looking for is a situation where an owner wants to retire or at least step back considerably. There is a management team inside the company who we can back who we give a sweetheart deal on equity and then they run the company during our investment period, largely without as much relatively interference from us. Where a lot of private equity firms are touting their operational expertise and how they’ll parachute in operators to come help and assist, we are offering the opposite. We’re not going to fire off employees.
We’re going to stick with the management team and give them a sweetheart deal and equity and then they get to run the company going forward. Owners like that because they get to retire without having to stick around 3 to 5 years. A lot of firms typically want them to. Also, they get to know that their management teams, who have helped them out all along the way, are going to be taken care of and have a good shot at making good on a sweetheart deal on equity.
That’s different than a lot of other private equity groups, although there are others out there that have this main strategy. The fact that you’re looking for good management teams, looking to keep everything intact is definitely somewhat of a different strategy than others. Let’s peel back the onion a little bit for our audience. You mentioned being on your third institutional realm. Let’s talk a little bit about how you approach fundraising and getting a fund together and what that means for the folks out there that maybe don’t quite know how private equity groups go about doing that.
Gen Cap has made a transition over the years. In the early days where Gen Cap started, it was through our founder Barney Byrd who raised money in and around Nashville through friends and family. A lot of high net worth individuals making investments in him to go out and buy small companies. Where we shifted in terms of what our fundraise looked like was with Fund Five. In Fund Five, Gen Cap started to exclusively go out and target institutional investors, pension funds and endowments and those types. It is good and bad to both individual investors. You can do it the small bite size way and fill up a fund with lots of individuals. For us, it makes fundraising a little bit easier when you go to these bigger institutions that can write bigger checks and have a little bit more standardized process for making a decision on whether or not they will invest.Always have a fall back option in case of unforeseen circumstances with regards to taking over a company. Click To Tweet
I’m assuming your funds were committed funds, correct?
They are, yes. This fund is a fund seven is a $250 million fund that we raised back in 2016.
How far along are you into that fund? How long will it take you to go through fund seven?
Our investment period is six years. I know some funds do a little bit shorter, maybe 4 or 5. The reason for our six-month investment window is because it’s a $250 million fund. Our bite sizes are investments in companies $2 million to $10 million of EBITDA that’s a lot of smaller investments relative to the size of the fund so we need a little bit more time to do it. We’re roughly halfway there, which is about where we need to be in terms of on glide slope but still a lot of work to do in a competitive market. There is no rest for the weary.
It is a competitive market. I want to ask you some questions about that. Sticking with Gen Cap, you’ve got the criteria of $2 million to $10 million of EBITDA. You’ve talked about the fact that you want management teams that are willing to stick around, which gives you continuity. When you’re looking at deals, what other things are important to you as a private equity buyer at a high level will tell you whether or not you’re even willing to take the next step to a management meeting potentially or to look at further documentation?
There are three things that are going to get a company through our first wicket and our model is relatively simple. That’s the way we like to keep it but just because it’s been working for so long. Those things are stability and we like stable, predictable cashflows and I realize we are not unique in that situation. We are somewhat unique from other private equity firms and that we prefer stability over rapid growth. What I mean by that is, if a company is a rocket ship doubling every year in terms of revenue and cashflow, that’s not a great fit for us, because that growth looks a lot like volatility to us and for that reason, it’s not going to be a fit.
Our preference is flat to that type of growth and obviously a little bit of growth is a great thing for us as well, but it can’t be overwhelming. The second thing that we’re looking for is the management team. There are a lot of businesses out there that have an owner who is the secret sauce and unfortunately. Those are not great fits for us since we are not the group that’s going to be able to parachute in the operators and replace the owner going to our focus on stability. We like to back a team that’s been inside the company for some time.
Preferably that team is the guys or girls that were sweeping the shop floor twenty years ago and they’ve worked their way up to be the boss or maybe a child of the boss, son or daughter. That’s another critical piece and the third piece is what they don’t have or we would characterize as downside protection. Customer concentration is something that we can’t bend on too often. If they’re in an industry that’s cyclical, that doesn’t work great for us. If there are some unfavorable industry trends, if you’re selling buggy whips, that’s not something we’re going to jump into because we don’t have the operational expertise to fight against those types of headwinds.
In deals where management teams want to stick around and maybe the owner even wants to stick around, what happens in those deals? Are you creating a new executive structure for that company? Do you create a board of directors? Do you take a position on the board? How does Gen Cap approach those?
It’s not an issue if the owner does want to stick around, we have plenty of examples of that. We have nineteen portfolio companies but 4 or 5 of them the old owner is still in the business, either in the business every day or at least a chairman of the board, which we’re always happy to have that corporate knowledge hanging around. In terms of structuring the C-suite after our transactions, what’s important for us is that the next wrong of leadership is identified. What I mean by that is, in many cases, the owner wants to continue to be the CEO and that’s fine with us, but in the event that they get hit by the proverbial bus, we need to know that there is a fallback option. He has or she has that GM or plant manager or head of sales that could take over in the event that that person said, “I’ve received a big check for this company. I’m tired of working and I’d like to hand the baton.” In the end we are transition capital. We’re the guys who are trying to keep these successful businesses successful without much disruption.
You hit on something that we talk about a lot of with our clients and it’s come up a ton on the show. For our audience out there, Lamar is talking about infrastructure and if you’re the owner of a business and you are the key person in any function or any phase. You need to think about limiting yourself in that capacity and bringing in additional resources or delegating some of those so that you’re not a bottleneck. It will probably make your life a lot easier and at the end of the day, increase the value and marketability of your business. Are there any other things that you look at in a deal? Once you start to get into a deal you look at it and say, “That is a nonstarter. There’s no way we could get past this.”
There are a few. The biggest one that we run into a lot revolves around customer concentration. I won’t say that our hard line is at 20% customer concentration, but we certainly started taking a hard look at what the makeup of the customer base is at that point. Our hard-red line is probably around 30% customer concentration and I mean that in terms of revenue. Not all customers are the same. Yes, if Walmart represents 25% of your business and you’re in consumer industry, that’s going to be tough.
We all know there are businesses where there is some customer concentration up to 30% in some of our businesses but there’s a good explanation for either why that customer needs our company or why the relationship is particularly sticky that helps us get over that hurdle. Past 30%, it’s tough for us. Frankly, we look at over a thousand deals every year and we’ll only do 3 to 5. Time is critically important for us. Consequently, we’re not going to waste other people’s time digging in on something when we see an issue like that. It’s not the best use of everyone’s time.
You gave the audience another key message. Gen Cap is not alone in this. You’re looking at a thousand deals a year and maybe you’ll do 2 to 3. For the business owners out there that are reading, it’s important that your business stand out and that all of the key value drivers be put in the best light before you go to market. Lamar is talking about a critical one here, which is his client concentration. Lamar, you see a thousand deals and you go down the path with a bunch of those. When you get to LOI stage and you get something agreed to with an owner, what’s your approach? What’s Gen Cap’s approach as a private equity group to diligence? How do you conduct that? What I’m asking is, as an education for the business owners out there, what to expect when a group like yours comes in to due diligence?In every process, there are going to be surprises; it’s best to try and avoid as many as possible. Click To Tweet
We are going to hire a QofE firm to help us with diligence. They should expect a minimum phone call from this group.
Lamar, can you stop for one second and describe QofE, make sure everybody understands what that is.
QofE is Quality of Earnings. Effectively what we’re doing is we’re hiring a CPA firm to go in and vouch for the numbers. Point to that, yes, the earnings metrics that we have been provided look like those are what the business is producing, which to us is the most important part. We are going to be a little bit lighter as a firm on the industry diligence. The most important part for us is the cashflow that the company is reporting is that what’s been happening historically? Two, revolves around that management team.
While we don’t push owners to allow us access to the management team, we’re going to back because a lot of these transactions can be somewhat sensitive up until the later stages. We do at least want to have some hard conversations with the owner to confirm that the management team that we are backing is in fact capable of running the company. Frankly, it’s not a huge issue that we’ve run into, I should say, in the past. A lot of times these owners are not interested in setting their management teams up for failure. They will be candid with us in terms of, can the management team that works underneath them runs a business or not?
I’m assuming that while that QofE work is going on, you’re parallel processing, you’re lending in debt facilities. Is that a correct assumption?
That’s correct. Thankfully, years of doing this have earned us some great relationships with banks, both here locally in Nashville as well as other places in the country. We are relatively light in terms of the debt that we use in buying these companies. We are going to use a senior term loan from a big bank. We are probably going to finance roughly half of the transaction from that group. Some portion is going to be financed out of our fund. We’re going to try to whittle down the amount of common shares of equity in the transaction that will be smaller so we can give the management team that we are backing a larger portion to participate in.
If you’re uncomfortable giving me actual numbers, can you talk maybe about your methodology? Every private equity group has its return on investment parameters, the numbers that they’re trying to hit. How does your group approach general returns on your investments?
I don’t love giving out numbers because a lot of our LPs have warned us against doing that. I do appreciate that it’s an interesting topic. What I will tell people is, the stability focus and downside protection focus of our diligence extends across everything that we do here at Gen Cap. We, like every other private equity fund, love to show great returns and we are happy to report that we are top quartile fund, we also are extremely focused on ensuring that we maintain our record as a fund that has never lost money on a deal. We are not the fund that is going to have these nuclear grand slam investments but that has a lot to do with the fact that we are investing in companies that tend to be a little bit more mature, a little bit more stable. We are also the firm that doesn’t have wipeouts. The way that I describe our fund and the way that we look at our returns is the low beta model. We are trying to keep the volatility at a minimum and keep cranking out singles and doubles.
You mentioned and referenced a couple of times that you have the management and maybe even the previous owner retain some portion of the company, is there a benchmark that you look for? Is there a narrow range there or is it all over the map?
It is all over the map. I should first make sure I’m clarifying it appropriately. The ownership that we buy the company from, those guys leave without any ownership. We’re trying to do a 100% buyout if that’s what they would prefer. The folks who will wind up with a chunk of equity is the management team that sits beneath the primary owner post-transaction. Those groups, they can land anywhere between 10% and 49% ownership of the company. More often than not, it’s right around 25% or 30% ownership. What decides that portion is their appetite for buying in. We do ask that the management teams that we back do kick in some money. It doesn’t have to be a ton. It needs to be a meaningful amount to them.
We want to feel like they have skin in the game and we’re happy to finance them for some portion of their investment. Their appetite for equity will decide some portion of how much they have. What’s also deciding is how much equity they had before we showed up. If there’s a manager who already had 10% of the business, he or she will probably have more post-transaction, whereas someone who had none before we showed up or have a little bit lighter equity stake.
You’re looking at a thousand deals a year. Let’s talk about the market a little bit. What are you seeing in the market? What do you like that you see? What concerns you? I’m interested to get your overall perspective seeing that you’re looking at many deals.
Not much concerns me other than the pricing. We have tracked and we did a little research here looking at our deals over fund 5, 6, and 7 and we’ve seen the processes where we’re able to win. The ones where we haven’t won, it appears that the numbers have steadily increased in terms of what the purchase prices have been. In terms of the deal flow, that’s probably the most remarkable change, particularly in the August and September timeframe, we saw a real spike in terms of deal flow.
To give you a little bit of historical significance of that. August has been a light month for us in terms of seeing deals. A lot of investment bankers that are going to kick off processes, we’ve seen them hold back deals until after the Labor Day holiday. That did not happen. I don’t have a great explanation for it, but in August and September, there was a 25% increase in the number of deals that we’ve seen per month. I’m always hesitant to provide much data because we see what we see and it’s hard to tell what’s statistically significant but that was definitely a statistically significant spike. Through conversations with business owners and investment banks, some of that relates to coming into an election year. A lot of owners are anxious to get out there before uncertainty starts to strike in the market. We’ve been saying for a long time, there are a lot of Baby Boomers out there with businesses that they’re going to want to exit soon. Maybe we’re seeing that happen soon.Don’t try to time the market. It can get you caught up on the wrong side of a downturn. Click To Tweet
Are you seeing more deals in one sector than another? Any sort of trends along those lines that you’re seeing?
I don’t have the data to support this, I’m only speaking anecdotally. I feel like we’ve seen a lot of aerospace and defense deals coming, particularly when I’ve talked to intermediaries about that. They tend to be the industries where an election has the biggest impact in terms of their marketability. There could be some explanation there in terms of them wanting to get to market before they’re impacted by uncertainty around the political elections.
We were involved into aerospace transactions and I know of a third significant one that traded. It’s interesting you should say that. We did see an uptick in that sector ourselves. How about Baby Boomers? We’ve all been talking about them for years. We had expected that wave to hit back probably in the 2010 timeframe, but the recession delayed that. Are you seeing more Baby Boomers starting to come to market with their businesses?
I think we are. I don’t have the data to support that either. I do feel like there’s a large contingent of business owners that probably would’ve liked to exit. Unfortunately, 2009, 2010 happened and it pushed out their exit date a little bit, because the business wasn’t where they wanted it to be at an exit. They’ve ridden part of the cycle all the way up. I’m not predicting that it’s going to turn down anytime soon. Frankly, we’ve been saying that we expected a slight drawback. We’re not much at predicting, but a lot of those owners that survived 2008, 2009, 2010, they’re probably are looking at their business is now stronger than ever. They recognize that if the downturn does come, they don’t want to be caught on the wrong side of it. I feel like we’re seeing more of those Baby Boomers coming to market. We’ve certainly bought businesses from all types so it’s hard to say.
I would say that we feel the same way, we’re starting to sense that folks don’t want to get caught up in another downturn and the market has been hot. It’s a seller’s market. It’s starting to get some people to take notice and maybe get their businesses out there. Lamar, in bringing this to a head and capping off the interview and I appreciate all the information that you’ve shared with the audience. What advice would you offer to business owners who are thinking that maybe a private equity buyer is the right buyer? What would you say to those owners if you had a roomful of them?
I would say, one, don’t try and time the market because you can probably get caught on the wrong side of a downturn. Two, this is related to that. You’re selling your business based on the expectation that there’s still room for growth, just because you’re not at the peak is not necessarily a bad thing if you’re a business owner trying to sell. The private equity firms have some expectation of a possibility for growth. We always tell business owners that it’s best to get the bad news out early and the reason for that is, it’s the best use of everyone’s time. Like I used that example of customer concentration, it’s best to know that early so you’re not wasting everyone’s time but also, it becomes a point for negotiation if there are surprises later in a deal process. Inevitably, in every process, there are going to be surprises. It’s best to try and avoid as many as possible for both parties.
That’s awesome advice. Lamar, I appreciate you being with us. If folks in the M&A Unplugged community wanted to reach out to you, how could they get in touch with you?
We are at Gen Cap America and that’s the website GenCapAmerica.com, you can find all of our contact information there. My email address is [email protected]. If you’re looking to ask questions or want to reach out and talk, feel free to give us a ring.
Thank you so much. I appreciate you being with us and sharing all this information.
Thanks. I appreciate it.
M&A Unplugged community, let me recap a few things that Lamar talked about. For Gen Cap, they have specific criteria. They’re looking for stable companies. They’re looking for the management teams to stick around. They’re trying to protect against downside. That’s one flavor of private equity. There are many different flavors of private equity. Others are looking for rocket growth. It depends. It’s not a one size fits all. They happen to have their methodology that’s worked for them for a long time.
It’s important to talk to advisors to understand where does your opportunity best fit in the marketplace if you’re getting ready to take it out. Lamar talked about a couple of other things that are critical. We’ve mentioned them on other podcasts. If you’re the owner of the business and you are an integral part of that business and you are in an operating position, it’s best to try to delegate those tasks and get yourself out of many of those things before you go to market. One, it will make your life a lot less complicated and two, it will increase the marketability and the value of your business.
Lamar also talked about client concentration. This comes up a lot. Gen Caps benchmark happens to be about 20% maybe 30%. Every private equity group approaches this a little bit differently and some of it is industry-specific. Client concentrations can come back to bite you so you want to try to minimize those as much as you can before you get ready to go to market. Once you are in the market, Lamar was spot on, get the bad news out early. There’s no hiding from bad news. I promise you. Once you get into due diligence, smart buyers are going to find the bad news. Get it out. Get it out early and figure out if your business is sellable. A lot of that can be done well in advance.
I hope you enjoyed this episode. If you would like to learn more about the process of acquiring or selling a business, please visit our website at SunAcquisitions.com or feel free to reach out to me at [email protected]. I look forward to seeing you again on the next episode of the M&A Unplugged podcast. Until then, please remember that scaling, acquiring or selling a business takes time, preparation and the proper knowledge.
About Lamar Stanley
Mr. Stanley joined Gen Cap in 2016. Previously, Mr. Stanley was with Diversified Trust Company, a Nashville-based wealth management firm where Mr. Stanley worked in their private-equity strategy group.
Prior to Diversified Trust Company, Mr. Stanley served as an Intelligence Officer in the United States Navy. He holds a B.A. degree from The University of the South, in Sewanee, TN and an M.B.A. from The University of Chicago.
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