Making Private Equity Work

You need an influx of operating cash to tap into a growth opportunity for your business. Private equity firms flush [...]

March 6 2012 by Jennifer Pellet


You need an influx of operating cash to tap into a growth opportunity for your business. Private equity firms flush with the green stuff need to invest it. The concept has all the makings of the perfect symbiotic relationship. But in the private equity sphere things are rarely so simple, agreed CEOs representing both private equity firms and portfolio companies, who gathered recently for a roundtable discussion held in partnership with Fifth Street Finance and Rutan & Tucker, LLP.

Take the case of Brian Coll, CEO of Nicos. A few years back, Coll was about to lock down a deal to trade equity in a plastics recycling firm for the capital he needed to make an acquisition—or so he thought. “They led me right to the water,” he recounted. “I’m thinking they’re investing a certain amount so I can execute my growth strategy, and I’m giving them a certain amount of shares in my business. Then the term sheet came out and they were getting the equity stake but the investment was a loan. It was nothing like what we expected.”

The good news? Despite bumps along the way, many private equity deals play out to a successful endgame. In fact, Coll walked away from that deal and forged a successful one with his current equity partner, Fifth Street Finance. In discussing their collective deal-making experience, roundtable participants homed in on steps that can help CEOs and their private equity partners work together effectively.

Choose With Care

Since the relationship between the CEO and his private equity firm factors heavily in the deal’s ultimate success or failure, mutual trust is crucial, noted Len Tannenbaum, CEO of Fifth Street Finance, who urged CEOs to look for PE firms with a track record. “There are firms that are honest and straightforward and as a result the companies they work with tend to go back to them again and again,” he pointed out. “The reason some private equity firms are on their third, fourth or fifth fund is because they’re trustworthy.”

It’s mutual faith that will carry a partnership over the hurdles that inevitably arise. “I look for somebody who’s going to be fair and reasonable to the management team, and who will understand the challenges,” says Larry Nusbaum, president of Leeb Group. “It’s always easy to be friendly to management when times are good, but what happens when you hit a bump in the road? Do you have the kind of comfort level where you can tell your equity partner that you lost the Walmart account without wondering, ‘Am I going to get shot?’”

Sentinel Partners’ Paul Murphy, Leeb Group’s Larry Nusbaum, Fifth Street Finance’s Len Tannenbaum

Due diligence runs both ways, noted Paul Murphy, a partner at Sentinel Capital Partners. “Before we buy a company we do very extensive psycho-diagnostic testing on the CEO and every member of the management team,” he said. “Anybody can run the model for the right market prices, but we’ve walked away from a deals we could have had on price, because we didn’t think that the relationship with the CEO was going to work.”

Pick Partners With Partners

Ideally, a private equity partner will be willing and able to step up to the plate as problems arise. “When you lose a customer, are they going to say, ‘I’ve got a friend who’s the head of such-and-such. Let’s put the product in there?’” asked Nusbaum. “That’s the kind of value-add that goes beyond board level financial analysis.”

“They need to have both connections and the willingness to use them,” cautioned John Garbarino, CEO of Epic MedStaff. “I’ve worked with guys who said, ‘I don’t really want to call that guy about this,’ and I’ve also worked with others who have said, ‘Whatever it takes. Any relationship of mine is a relationship of yours.’”

Seek Industry Expertise

Experience in the specific marketplace or business can be helpful—as is awareness of a lack of understanding. “It’s helpful if your backers have some knowledge of your business,” added Garbarino. “It’s also really important that people know what they don’t know.”

Installing an experienced operating partner can act as a bridge between management and a private equity board member who lacks an industry background. “I once had an investor who was great but would come up with all kinds of crazy schemes,” recalled Garbarino. “I would do my best to dissuade him but at a certain point, I’d look over at the operator and he’d step in and explain, ‘Well, that won’t work because…’ That perspective can be [huge].”

“Looking back, if you can find a managing director who has operating experience other than in investment banking or private equity, that would be invaluable,” summed up Traver Hutchins, chairman of Remedy Health Media.

Hammer Out a Plan

The more clearly roles can be delineated, the better, said several participants. “We spend our first 90 days living with a company, not to watch what they’re doing, but to build the relationship,” said Rich Latto, managing director of Longroad Investment Capital. “In a turnaround, you often need to put more money in to restructure the business, so you really need to define your plan. The CEO needs to know what his roles and responsibilities are, and we need to know what ours are. That is paramount to a good relationship.”

At the same time, it helps to have a partner who can roll with the punches, noted Smith Yewell, CEO of Welocalize, a provider of translation services. “Anybody is a good partner when the times are good,” he said. “Six months after LLR Partners invested in us in 1999, I had clients go bankrupt and it was the end of the world. But they stuck by us and 10 years later, they got 10 times on their money.”

Keep Communicating

Open lines of communication can help CEOs and their private equity partners survive such a maelstrom. “One of the best CEOs in our portfolio saw his business decline 15 percent the first year out of the box,” said Murphy. “We were way off our plan, but we stuck by the CEO because of the communication we had with him. He made some cuts, deferred some things and tried some less capital-intensive ways to grow the business. Because of the way he handled the situation it never even occurred to us that we would fire that CEO. A few years later, we’re at an all-time high in EBITDA.”

Ultimately, such happy endings are the result of management and private equity alignment. But since partnerships invariably involve a certain amount of conflict, it’s a good idea to have a policy on how to handle an impasse, noted Murphy. “We have a pretty firm rule that everybody has veto rights,” he said. “If we can’t convince the CEO that something is the right thing to do, we’re not going to do it because trying to shove something down somebody’s throat is a recipe for disaster.”

Private Equity Roundtable Participants

  • Juan Alva, Partner, Fifth Street Finance
  • Brian Coll, CEO, Nicos
  • Wayne Cooper, Chairman, Greenhaven Partners
  • J.P. Donlon, Editor, Chief Executive
  • Derek Dundas, Partner, Rutan & Tucker
  • Alexander Frank, CFO, Fifth Street Finance
  • John Garbarino, CEO, Epic MedStaff
  • Traver Hutchins, Chairman, Remedy Health Media
  • Ted Kennedy Jr., President, Marwood Group
  • Rich Latto, Managing Director, Longroad Investment Capital
  • Peter Magas, Principal, Beecken Petty & O’Keefe
  • William Meehan, Partner, Rutan & Tucker
  • Randy Mehl, Partner, Baird Capital Partners
  • Paul Murphy, Partner, Sentinel Partners
  • Larry Nusbaum, President, Leeb Group
  • Kenneth O’Keefe, Managing Partner, Beecken Petty & O’Keefe
  • Leonard Tannenbaum, CEO, Fifth Street Finance
  • Smith Yewell, CEO, Welocalize
Remedy Healthcare’s Traver Hutchins and Marwood Group’s Ted Kennedy, Jr.

Remedy Healthcare’s Traver Hutchins and Marwood Group’s Ted Kennedy, Jr.

Beecken Petty & O’Keefe’s Peter Magas, Welocalize’s Smith Yewell, Beecken Petty & O’Keefe’s Kenneth O’Keefe

Beecken Petty & O’Keefe’s Peter Magas, Welocalize’s Smith Yewell, Beecken Petty & O’Keefe’s Kenneth O’Keefe

Rutan & Tucker’s Bill Meehan, Rutan & Tucker’s Derek Dundas, Fifth Street Finance’s Alexander Frank

Rutan & Tucker’s Bill Meehan, Rutan & Tucker’s Derek Dundas, Fifth Street Finance’s Alexander Frank

Epic MedStaff’s John Garbarino, Baird Capital’s Randy Mehl, Nicos’ Brian Coll, Longroad Investment Capital’s Richard Latto

Epic MedStaff’s John Garbarino, Baird Capital’s Randy Mehl, Nicos’ Brian Coll, Longroad Investment Capital’s Richard Latto