There is no prototype for the companies that we invest in. Every lower middle market business has nuances and eccentricities which make the evaluation of fit more about situational dynamics than anything else. Our approach is flexible enough where we are willing to consider investing in opportunities that other private equity funds may dismiss out of hand, yet we commonly turn down opportunities to invest in “in favor” businesses because they simply don’t match with our mandate. We’d rather review and turn down a potential investment than miss out on an interesting opportunity that we would have pursued – evaluating and visiting with the myriad investment opportunities that we come across is perhaps the most enjoyable part of what we do. Some commonalities across the deals that we pursue include:
Continuing, Incented Management
There are many private equity funds out there that look to purchase majority stakes in companies – we are not one of them. We seek to partner with business owners and management teams who desire to remain with, rather than cash out of their business. As such, we look for continuity of executive and mid-level management as a primary consideration, and we will very rarely take on management transition risk. We always seek to align our incentives with the management teams of our partner companies so that we share the same upside and downside risks and the ultimate success of our investment is married to theirs.
Meaningful Operating History
We invest in businesses with staying power, and view length of operating history as a leading indicator of market acceptance and a company’s ability to weather future challenges. Accordingly, we do not invest in startups, project financings, turnarounds or businesses without at least 5-10 years of successful operating continuity.
Niche Market Leader With Differentiated Products or Services
We favor investment opportunities in companies which offer differentiated products or services that possess a sustainable advantage relative to their competition. Such an advantage might be due to outsized market share, control or concentration within a geographic territory, pricing power owing to proprietary innovation, or exceptional brand awareness. We are not favorably disposed to companies that provide commodity products or services or which compete in industries with relatively low barriers to entry.
Stability of Cash Flows
In our 20+ year history, we’ve come to understand that companies perform differently through macroeconomic cycles depending on a number of factors such as industry beta, strength of customer relationships, cost variability and managerial fortitude. We look to invest in companies with a proven ability to weather economic headwinds with their cash flows intact. We find that such businesses often exhibit recurring or contractual revenue characteristics, have inelastic demand for their products or services, and/or participate in industries with relatively low betas.
Reasonable Senior Leverage
We view senior debt as a useful and cost-efficient tool to fund a company’s high NPV projects, but we are also aware of its limitations. Senior debt providers don’t get paid to take cash flow or enterprise value risk, and in trying times they can affect outcomes which are at odds with the long-term health and viability of a business. As patient capital investors, we prefer to invest in situations where there is limited senior leverage ahead of us in the capital structure to afford maximum cash flow flexibility such that management’s primary focus is on operations and long-term capital appreciation, not monthly or quarterly covenants and required principal amortization.