Private equity may be seen by some as the evil step-child in the investment banking world, but the truth is, more and more businesses are turning to private equity as a means to help them expand their operations into other markets and grow their companies. The effect that this can have on the overall value of a company can be exponential. Today, it’s becoming commonplace for small businesses with as little as $1 million in annual revenue to benefit from the capital injection from aggressive PE firms. So what are investors most interested in, and what kinds of businesses are they attracted to? Find out when Jeff Allen visits with Phil Brennan, managing partner at Go Capital, on this edition of “Deal Talk.”
The general theme is that these companies, they're not new, they're not ideas, they're real businesses with teams, with revenue, with profits, and with customers.
- Phil Brennan
Jeff: Welcome to Deal Talk brought to you by Morgan & Westfield, I'm Jeff Allen. If you're looking to sell your company now or at some point in the future it's our mission to provide information and advice from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
Private equity firms equate to big business both in their own industry in investment banking, and of course in those businesses they invest in. Now more than ever even the smallest of small businesses are benefiting from private equity investment. Your business could be one of them. To fill us in on the subject of using private equity to fund private business I'm joined on the Morgan & Westfield guest line by Mr. Phil Brennan, managing partner of Go Capital. He's made his career out of investing in business across a broad spectrum of industries generating less than $50 million in revenue. Phil Brennan welcome to Deal Talk sir, it's good to have you.
Phil: It's great to be here. Thanks for having me.
Jeff: Phil, I was wondering, so much has changed in over really the last 25-30 years and so many people have kind of jumped on the business ownership bandwagon during that time. And really sometimes when you're trying to run your business, despite all of the media that's available to you, despite the Internet and being able to look at the Wall Street Journal at a moment's notice, and watch CNBC, and do all these other things that a lot of folks are interested in the news do, many folks are simply trying to run their business and they're caught up in the day-to-day. And they may not necessarily know about all of the resources that are available to them. And what I thought we’d do today on the program, Phil, is talk a little bit about private equity but we're going to kind of attack this from, first I think kind of an elementary perspective. And what I thought I'd like to do first of all is just kind of get a ground floor explanation from you, the difference between for example, a private equity investor, venture capital investor, and an angel investor. Most of us are already familiar with the terms but could you just kind of set the record straight, the difference between those three.
Phil: Sure. I can give it a try. I'm not a venture capitalist or an angel investor so I should throw that out there first as a disclaimer, but I'm happy to give it a go. I think private equity, when you hear that term it's really a reference to a group of investors who look to invest in companies that have established track records. So the types of companies they invest in have typically been around for a while, they’ve proven a model of earning revenue and typically also profitability. And they've reached a stage in their life cycle where they’re ready to take on new capital and a new partner. And that could be triggered from a bunch of different reasons. It can be for growth, it can be because the owner wants to take some "chips" off the table in the form of a liquidity event. But the general theme is that these companies, they're not new, they're not ideas, they're real businesses with teams, with revenue, with profits, and with customers. If you contrast that with a venture capital firm, venture investing, a lot of that tends to revolve around the idea of investing in an idea. Or maybe it's more than just an idea, it's actually a concept that's been developed into a business plan and there's a team but the business tends to be either in its nascent stages - perhaps it's generating some revenue but not profitability. And it's just earlier in its life cycle. And so what you're looking for in a partner is different. You're usually not looking for a partner that's there to create the liquidity event for the management team. Usually you're looking for money to grow. And so the whole process of evaluating those companies, valuing them, and investing in them is quite different from when you hear the words private equity investor, what they look for and how they invest. And angel investors are similar in a lot of respects to venture capitalists. When I hear the phrase angel I actually think of even a less institutionalized, less formalized process for investing in very small companies or ideas. And so it's probably more similar to venture investing than it is private equity, but even at an earlier and often smaller stage.
When I hear the phrase angel I actually think of even a less institutionalized, less formalized process for investing in very small companies or ideas.
Jeff: Are there some companies out there, Phil, that will actually take and perform two of those functions as a private investor, private equity investor, and venture capital investor? It seems to me that there are probably some big firms out there that might engage in both or have maybe different departments that engage in both.
Phil: There are. There's a handful of names that you read in the Wall Street Journal that at this point have developed teams and built business around investing in just about every type of investment class, asset class if you will. So those firms are out there. And there's plenty of hybrids that their model is to invest in both mature companies and early stage companies. I would say they're more of the exception than the norm though. I think most investors try to be good at one thing, stick to their knitting. And then from a branding perspective it's easier to articulate to the market who you are when you really have a clear, single focus. And so if you were to take a poll of the broad world of private investing groups, most tend to stick to one form of investing versus multiple.
Jeff: You should probably say too that you've got a depth of experience that goes back to working for one of the larger firms. JP Morgan is a matter of fact is one that you come from and so you have a lot to be able to contribute in the discussion and to talk to us about those types of experiences that you've had in working for those larger types of firms. What do you believe though makes one PE firm, private equity firm, more suitable than others for businesses that are looking to raise capital?
Phil: That's a very good question. I think it depends on what you're looking for as a business owner and as a seller. There are so many options out there in terms of the investor groups that you can partner with. You have to be really clear about what you're looking for. Are you looking for just money, or are you looking for an investor that offers more than money: operational expertise, strategic insights, relationships? Because certain investment groups, they will be very clear that we're money people. We make a lot of investments in different businesses and our time is spread fairly thin across all those investments. And really what we're here to provide is money for you and then sit on a board of directors and try to be counsel when we can. But that's about it. There are other investing groups that I think my firm Go Capital fits into more of this bucket that say, "No, we're not only going to be a capital provider but we want to roll up our sleeves and try to help you in the areas you need help." And so I think it's a question that the business owner has to ask themselves, is what am I really looking for here in a transaction? Am I looking for just money? Am I looking to exit completely or just get capital to grow, but I want the investor to stay out of the day-to-day, or could I use the help in whatever capacity I need the help? In which case maybe you're looking for that investor that offers that too.
There are so many options out there in terms of the investor groups that you can partner with. You have to be really clear about what you're looking for.
Jeff: Let's go ahead and let's kind of just camp out for just a moment right here on this point, Phil. When you're talking about helping out you're talking about contributing and being able to make suggestions in order to help a company perform at a higher level. Does that mean taking controlling interest of a company through your investment?
Phil: It doesn't have to. You can be a minority investor in a company but also play a more hands-on role. There are ways to structure those types of transactions, so it doesn't have to. But I would say the majority of investors out there, and also frankly the majority of sellers, are usually looking for a deal where the investor takes a majority position in the company. And often a company in that investment can need the kind of operational strategic assistance that I've described. But again, I hate saying there's a hard and fast rule because in the modern era of private equity investing there aren’t those rules that maybe at one time existed. There are just so many different models out there that you'll see minority investors who also roll up their sleeves.
Jeff: Phil Brennan is a managing partner of Go Capital and my name is Jeff Allen. You're listening to Deal Talk brought to you by Morgan & Westfield talking about private equity today. How does the process work? Are you scouting the businesses you want to have in your portfolio actively every day, the first thing you do when you get to the office in the morning, or do you also have business owners approach you saying, "Hey, I think we deserve a look. If you're not familiar with us we'd like to talk to you a little bit about what we do and see what you think."
Phil: I would love for that to happen but that rarely happens to be perfectly honest with you. So the short answer is we're doing a lot of the outreach. And that really comes in two forms. One is we work through a broad network of business brokers, investment bankers, and other, for lack of a better term, intermediaries who typically represent business owners and help them navigate the process of selling their company or selling an interest in their company. And so we've developed over the last 15 years a network of over 10,000 of these intermediaries, I refer to them as, spread across the country and we're regularly either emailing them or having direct conversations with them over the phone or in person about their current clients and whether those clients would be a fit for us. Then the other thing we're doing every day is reaching out to business owners directly, and that is done the old fashioned way. It's looking up their information online, it's attending trade shows, it's trying to attend as many events as you can where you get in front of business owners in sectors that are of interest to you, and it's developing a relationship, it's developing a bond where they view you as a strong candidate for an investor and then you get to know their business better and decide it's a place you want to put your firm's money. So those are really the two ways we find, source, and execute deals. Unfortunately, we don't get a lot of business owners talking to us directly but we would love that, we would encourage that.
There are just so many different models out there that you'll see minority investors who also roll up their sleeves.
Jeff: Let's talk a little bit about those types of businesses that you look at, that Go Capital looks at. The businesses and industries that are kind of in your sweet spot, that are attractive to you.
Phil: Well, we look at across a lot of different industry verticals so it's not an easy question to answer if you're just talking about industry. I would say it's easier to describe the size of the company we look for and then the situation. The size is typically a company that makes between a million dollars of revenue all the way up to 50 million in revenue annually. And earnings or even EBITDA which is a common phrase used in the industry which stands for Earnings Before Interest Taxes Depreciation and Amortization. And really it's a metric that people in our profession use to describe cash flow. We look for businesses that have cash flow or EBITDA between $500,000 and about $3 million a year. And so if a business meets that size criterion, we're going to be interested. Then the second criterion we look at is what is the situation. Is the business owner looking for a capital partner because they want to retire off into the sunset and just go do something else with their life, that is a very common theme because there are so many baby boomer business owners, that's a mouthful, reaching the point where they're ready to retire now but they just don't have a very good transition plan in place. And so we're there to help them in those situations. They've reached the point where they're ready to do a transaction. We would come in, provide capital, and actually roll up our sleeves and play some kind of role building out their teams so that they can retire and go off into the sunset and do whatever else that's next in their life. And so the whole retirement being a catalyst for a transaction is very much a situation that we're interested in. Another situation that we're interested in is we're a company that's growing. We've grown a lot more than we ever thought we would grow, and we need a capital partner to help us navigate all this growth. We're just in a little bit over our heads. We need help determining things like building out bigger teams, systems, all the kind of things that happen to companies as they grow from very small businesses to mid-size businesses. So as companies reach that stage and they’re almost crying out for help, we love getting involved in those situations.
My answer isn't a direct one. It's more driven by situation and also size than it is industry. But the truth of the matter is those are the most important things to us. It's a separate question but I could talk to you about some sectors that we think are hotter right now versus others. But we never lead with that as criterion because the other two criterion I mentioned are even more important.
Jeff: Involving a private equity firm to help fund your business to help raise capital to get involved, that's what we're talking about with my guest Phil Brennan, managing partner of Go Capital. I'm Jeff Allen and we'll be back on Deal Talk after this.
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Jeff: Welcome back to Deal Talk, I'm Jeff Allen with my guest Phil Brennan, managing partner of Go Capital in Chicago. We're talking about the subject of private equity and getting those outside your company involved in your organization. If you're looking to raise capital, if you're looking to take the next step, and that might include bringing on investors, then Phil Brennan has a lot of experience in that in his professional background. Phil, we so very much appreciate your participation today in Deal Talk. We're glad to have you. As we continue our conversation I'm kind of wondering how a business owner out there can make his or her company a lot more attractive to an investor. Maybe it's not something that they necessarily trying to do. This could be a company that quite honestly has seen some success, maybe it's one that you've missed and maybe they're trying to somehow maybe raise their own value or try to kind of get your attention. How do they go about doing that and maybe you can just kind of give us some tips.
Phil: Sure. I think putting myself in my own shoes the first thing we look for when we look at a potential investment is can they grow? I think a business that's in an industry that's just going to have a hard time growing makes for a tougher investment. So I think from an owner’s perspective it's being able to articulate what the growth path for the future investment partner would look like, and also a blueprint for how that growth would be achieved. I think to the extent you can really lay that out, really think hard about it than lay it out so that you can have a meaningful conversation with the potential investor about it you're going to be more likely to strike a deal because you're just going to get their excitement level, their enthusiasm, and their belief in your business up relative to where it was before. Beyond growth, I think it's having a strong history, so a track record of strong business performance. Things like lack of customer concentration or concentration around one specific product or supplier. I think bridging beyond those things and demonstrating some diversification is always a really good thing. But then beyond the stability of the business and its growth potential, some of the softer things. Don't take them for granted because they're just as important. And by that I mean a management team that's not only competent but can grow and evolve with the next investment group. I've seen enough businesses that generate a lot of profit and they've got a good track record of growth. But when you really need the team you're struck by how spread thin everybody is, and the lack of bench strength that there is to really support the business as it goes to the next level. A business owner needs to think about that and be willing to make the investments in people that they believe can grow and evolve as the company grows and evolves. That's a really important thing and I understand it's extremely difficult to do. But building that strong management bench strength is very important from the investor's perspective because these are the people that they're going to be partnering with for the future. And then culture is the last thing I would say too. It's amazing how much of culture can be driven by a business owner, often the founder or the entrepreneur of the business. And having a strong culture, one that they can be proud of but then also one that translates in terms of the investor's fit into that culture is really important. If you're a hard-edged, hard-nosed investor and you're looking at a business that doesn't have that same hard edge to it, you can't necessarily put that on paper what that means as far as future implications for the business. But I think having some alignment around some of the cultural aspects of business, whether it's how employees are treated or customers are treated, it actually is important. It's quite important, and maybe just as important as all the other things I mentioned. It's not one thing. I think it starts with growth but it's cultural fit and it's management, and it's stability as well.
I think a business that's in an industry that's just going to have a hard time growing makes for a tougher investment. So I think from an owner’s perspective it's being able to articulate what the growth path for the future investment partner would look like,
Jeff: So intangibles are given a lot of weight and really you're looking for companies that do business the same way that you do business. You're looking for standards that kind of equal one another, and I think that's really for both sides. And I'm glad that you pointed that out, Phil. When you have two sides that are coming together, or that have an interest in doing business with one another. You've got the business over here and then you've got the private equity firm over here. There is going to be I think a point where you'll decide, "Okay, we want to look more deeply at this as a real possibility here” and then you start to move forward with a process that we're very familiar with here on Deal Talk. We talk about this often and that's due diligence. How critical is it not only for the business owner but also too for your company to go through that process of due diligence, to make sure that you're making the right move and that this is also too the right move that the business needs to make as well?
Phil: Well, it's extremely important, and I understand from the business owner's perspective it can be a pain, it can be like pulling teeth because it takes a lot of time and energy away from the myriad things you have going on every day. But I would say it's important to the investor and it's also important to you, the business owner. And the main reason is it just helps both sides work through issues ahead of time that they're going to have to encounter down the road anyway. And so why not bubble them up before you close the deal so that both sides, A, have the best set of information they can possibly have about working together. And, B, you can actually start tackling those issues and seeing how each side thinks and how they work before you sign on the dotted line and move forward with the deal. It's just always better in a deal of this magnitude and importance to a business owner to really understand how their partner thinks, how they're going to respond to certain issues, and likewise for the investor it's great to know all those things for the business owner too. So it is painstaking but just keep in mind that every time you send along a document or answer a diligence request you're not only helping the investor get smarter about your business but you're creating that opportunity for each of you to work together through an issue and understand how one another thinks. And you're just one step closer to kind of hitting the ground running once you've closed. If you wait to do all these stuff til after due diligence you're going to have some speed bumps and you're not going to know each other as well as you should. It's just better to front load a lot of this, and get to know each other and get to know the business as well as you possibly can. So the short answer is: it's extremely important. And I think if you're a business owner it may not always feel this way but it's helping you out in the long run too.
Jeff: Phil, this is being redundant perhaps. I'm asking you to give us an answer that you've already discussed, I'm sure of it. But maybe you can just fill us in again the data that you scrutinize most heavily when it comes to looking at the documentation, the books of these companies during your part of the due diligence process.
Phil: Well, it depends on the deal. If I had to generalize I would probably say the financial information. And the reason for that is in the size of deals that I look at, the $50 million revenue company and smaller, there's just a lot of different ways companies prepare their financials, or don't prepare their financials. And getting them to a place where everyone is speaking the same language sometimes just takes more work. And by that I mean the typical business owner, maybe they're running their financials on QuickBooks and maybe they're on cash basis accounting. That's a very common theme we see amongst business owners. And the language of private equity and the language of businesses that are that next size range up is more of the gap generally agreed upon accounting principles language. And so there's a little bit of sometimes an education that goes on. But ultimately it's all good. And the reason is getting your financials in a place where the business owner can understand them extremely well usually means that you, the business owner, learn some things about your business that you didn't know before. And so that's probably the area that's most heavily scrutinized. But I think, again, in the long term it's value for both sides. You're going to also look at the makeup of your customers, that's probably the second most scrutinized thing. And often what you'll see investors do is actually reach out to your top customers and make phone calls towards the very end of a diligence process. Really, to kind of check the box on understanding who these customers are, validate that in fact the relationship does exist, but also just get a sense for how customers are talking about your business, and again that's important because as you think about growth you're thinking about, "What did we learn from the customers? What areas are we not meeting their needs that we could? Or what are some services that we aren't currently providing that we could in the future?" And so again, those customer calls very similar to the financial due diligence piece, I think business owners end up learning something through that process too. So hopefully it makes both sides better once they’ve closed the deal.
I think business owners end up learning something through that process too. So hopefully it makes both sides better once they’ve closed the deal.
Jeff: Let me do a sanity check Phil as we're kind of starting to wind down just a little on this edition of Deal Talk. Hypothetical, I'm running a business and business has been stagnant. In fact I'm falling behind and I'm just not bringing in the revenue that I had. Will private equity firms be interested in my business and will they be interested, are they ever interested, in businesses that some people might call distressed?
Phil: Sure. There's an entire group of private equity investors that focus on distressed companies. And so all is not lost if you find yourself in that position and there can be lots of reasons why you could be in that position. I think not unlike the private equity investors who don't focus on distressed companies, the key is going to be, again, laying out a blueprint for why are you in the spot that you are and what needs to happen in order for you to get out of it. And being as forthright, honest and open minded about that, it just encourages good dialogue and it makes the investor more comfortable with the opportunity. Because a lot of this, it really is psychological and it's getting an investment group comfortable in the opportunity that they understand it and confident in you. So even if a company is distressed, that the investor is comfortable, they grasp the opportunity and what needs to happen to turn things around, and confident in you then it might be your deal that they say, “This has a lot of potential because we believe in the team and its ability to turn things around and grow.” So the short answer is yes, they're out there. I'm not particularly one who focuses on that asset class but there are a bunch of investors for those situations that are great opportunities.
Jeff: Phil, I consider that actually kind of a positive way to end our discussion today. I appreciate your time. No doubt we've got some people in our Deal Talk listening audience who are kind of making some notes and also they've written your name down. And they may have an interest in contacting you, and I know that you talked about why you'd love to have business owners contact you who might be interested in having a conversation. How can they reach you, Phil, or your business partner? I understand that you've got a couple of different offices not only in Chicago but also too one in New York, is that right?
Phil: Yeah, that's right. Sure, there's more than one way. You can email us and you can also go to our website first to learn more about us. Our website is www.gocapllc.com. My email is firstname.lastname@example.org. And you can also reach me on my direct phone number which is 224-234-0779. And the website also contains the contact information for my business partner Chris Duggan who is based in New York as well. Yeah, we'd love to hear from anybody interested even if you're not sure whether you want to transact now or sometime down the road. We love just meeting business owners and learning more about their company and what they plan to do in the future. They’re fun phone calls and we're happy to provide more detail about the private equity world too. So regardless of your interest level or seriousness about a transaction we welcome all phone calls.
And so all is not lost if you find yourself in that position and there can be lots of reasons why you could be in that position.
Jeff: Great conversation and great value too. There's a tremendous value in networking and you never do know where those initial network contacts may end up. Phil Brennan, we're out of time. Thank you so much for joining us today on Deal Talk.
Phil: Thanks Jeff, I appreciate it. It was fun.
Jeff: Phil Brennan, managing partner at Go Capital has been my guest.
If you're a professional who normally consults with small business owners, a serial entrepreneur who owns multiple successful businesses, or a small business owner who has sold a business and you'd like to share your experience with our listeners, we'd like to hear from you about joining us as a possible future guest on Deal Talk. Simply give us a call at 888-693-7834. Deal Talk is presented as always by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one, call Morgan & Westfield today at 888-693-7834 or visit morganandestfield.com. For Deal Talk I'm Jeff Allen, thanks so much for listening. We'll talk to you again soon.