It’s no secret that more and more family- and founder-run businesses in the lower middle-market companies look to private equity capital to finance their growth strategies. In addition to capital, however, these companies often lack access to seasoned industry executives with the right leadership skills and experience to drive and support this growth. At the same time, many family- and founder-owned businesses have a hard time finding and attracting the outside talent they need to help take their company to the next level. Some private equity firms look to address this issue by dropping in operating executives after the deal has closed to supplement existing management.

An alternative approach that we have found to be successful is for the private equity firm to partner with an industry executive before even identifying the acquisition target and to pro-actively search for investment opportunities together. This collaboration can create two key benefits. By partnering with an operating executive up-front, the sponsor can leverage the talents of an experienced senior executive within a target industry as part of due diligence and evaluation, which helps them make better investment decisions. For the operating executive, they have the opportunity to not only be a senior operator in a business, but also have the chance to become a true owner of a business.

Creating wealth opportunities
Let’s look at the advantages of this approach from the executive’s perspective:

First, many senior managers in any given industry have not had the opportunity to create significant personal wealth. Locked into a salary-plus-bonus structure, often with no, or minimal, equity, they can do well financially, but not create the long-term wealth they desire.

Second, many of these executives are truly talented managers with the entrepreneurial vision and drive to execute compelling investment strategies. What they lack is a partner that can help to make that vision a reality.

So, what are the tangible benefits to executives in partnering with a private equity firm to find deals, develop an acquisition strategy, and grow the companies they acquire together? Those benefits include:

• A greater likelihood of acquiring a business than if they pursued an acquisition search on their own
• Access to the resources and relationships (e.g. investment bankers, industry consultants, lenders) of a private equity firm focused on the lower middle-market
• The instant credibility of having a financial partner with ready access to capital
• A mutual and exclusive commitment to working together to proactively search for acquisitions within the executive’s industry or expertise
• The support of a private equity firm’s marketing program to assist in identifying acquisition opportunities
• And with it, a significant wealth creation opportunity

The right partner is important
There are also significant advantages to the private equity partner in taking this approach.

First, it provides access to an executive with a compelling investment thesis that is grounded in specific experience and industry knowledge. At that point, finding the appropriate acquisition target to meet an executive’s investment thesis becomes a proactive and collaborative process between the two partners.

Second, partnering with an executive with deep connections and networks within a target industry can create a significant competitive advantage that may avoid broad auction deals. The lower middle market is increasingly competitive, and as a result, an innovative approach to identifying and acquiring companies in proprietary or less competitive transactions can be vital.

Third, the executive can sharpen the private equity partner’s understanding of the opportunities and challenges that a company may face, providing valuable insight during due diligence and in developing the growth plan post-closing.

And finally, in pursuing a successful bid, the private equity sponsor has in hand a true partner who can then integrate into the acquisition’s management team, leading it forward with the vision and drive that first attracted the private equity firm to him in the first place.

Finding success in specialty chemicals
That was certainly the case in the successful collaboration between Post Capital, which has an exclusive focus on the lower middle market but is a generalist in its investment strategy, with Phil Johnson, who spent nearly 25 years as an executive in the specialty chemicals industry.

After being introduced to Phil, Post Capital set up an exclusive partnership with him and commenced on a proactive acquisition search.

Based on his significant experience in the industry, Phil identified the water treatment segment as one with a robust universe of potential investment opportunities and growth potential.

After working together and identifying multiple investment opportunities, BHS Specialty Chemicals was selected as the acquisition of choice. In July 2010, the investment was made and Phil became CEO and part owner of BHS. Under Phil’s leadership, BHS’ revenues grew 75 percent and gross profit expanded by nearly 70 percent as the company moved into more value-added, direct-to-customer segments of specialty chemical production and technical service.

When the company was sold to DuBois Chemicals in June 2017, Phil remained in a senior management position.

While there are enormous opportunities for private equity firms in the lower middle market, the sector itself is highly fragmented. Any competitive advantage gained by the sponsor in identifying acquisition targets, negotiating and completing the acquisition and then successfully managing the company for growth (and eventual sale) can have a direct and positive impact on investment returns.

For the executive, this approach to investing in the lower middle-market can create ownership opportunities that might not otherwise exist as a typical operating partner.

Michael Pfeffer co-founded Post Capital Partners in 2004 and has more than 25 years of private equity and M&A experience. Phil Johnson is the CEO of BHS Specialty Chemicals and serves an operations executive with Dubois Chemical.