Different Investment Strategies

Family offices and fundless sponsors look to gain traction

Traditional private equity firms continue to dominate the dealmaking environment, but an increasing number of firms that act as limited partners in private equity funds are looking to source deals directly. These players have been around forever, but their efforts are making more of an impression on the business than ever before. Mergers & Acquisitions convened a special roundtable to discuss the benefits and challenges associated with different investment strategies. Benesch, Friedlander, Coplan & Aronoff LLP sponsored the event, and the excerpted discussion that follows provides a range of perspectives from key players who are investing into companies using different strategies. Participants included a traditional private equity investor, a placement agent, a fundless sponsor, a pension plan investor with a direct investment and co-investment program, a family office investor who invests in companies directly and an attorney.

Fugazy (moderator): How has private equity changed over the years?

Hill (Benesch): I started practicing law in 1978 in Chicago and immediately jumped into a middle market M&A practice involving private equity firms. In those days it was very different. The capital markets were very inefficient, and not every company was auctioned. In private equity there were more fees-transaction fees, portfolio company management fees, disposition fees, and these were not offset against the 2 percent management fee on committed capital. There was also less buyer competition in general. There were fewer private equity firms, and many middle market private equity firms were still under the radar.

Today, the capital markets are much more efficient. We've all seen companies that are being auctioned off with a $3 million Ebitda, which you would not have seen in the '80s or '90s. There is more fee pressure on smaller funds because the limited partners are now limiting what you can actually charge as fees offsetting the 2 percent fee. Compliance has become a big issue. It's expensive, but funds are required to do it. It's another expense with which middle market private equity firms have to contend. Lastly, there's much more scrutiny on funds by limited partners looking, not just for cash-on-cash returns, but the continuity of the team, the industry focus and its operational capabilities And some limited partners are saying "maybe I don't want to pay these fees, maybe I should direct invest."

DePonte (Probitas): If we go back in history, this business used to be called leveraged buyouts. For the most part people were buying companies on credit, and a lot of the returns that were being made were coming off the leverage. Now LPs are looking for fund managers with a competitive advantage. LPs want GPs on the boards of portfolio companies, making strategic changes, improving operations and replacing weak management. To build a successful company and generate profitability today very often requires a lot of activity from the GP at the company level.

Fugazy: Everyone present has a different investment strategy. Please tell us why your investment strategy is successful.

Morgan: (Castle Harlan): It's important for us to stick to our discipline. At Castle Harlan our general approach hasn't changed radically in 25 years. We're quite disciplined buyers of businesses. We like to think we don't overpay, at least on purpose, and we try to add a lot of value to our companies. We can demonstrate that most of our returns come from growing Ebitda. Having been in a business a long time the Castle Harlan brand alone generates a lot of deal flow. We are also global, so that adds a dimension for growth as well. We do two or three deals a year and hopefully one or two of those are proprietary.

Lipson (Rotunda): We focus on the lower middle market, and investment banks have no time for us. We're in proprietary deal flow market more than anywhere else. We network and use partners' networks to further advance our business development.

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Danielle Fugazy