Don’t Stay Past Midnight – Reflections on Knowing When to Sell Your Business (Part 4)

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If you’ve been with us for one or more of the prior weeks, you know that we’ve been walking through a list of six ways to objectively determine if it might be a good time to consider the sale of your private business.  Last week’s blog touched on the exercise of comparing the expected after-tax proceeds from a sale to your “Number” (i.e. the amount you need to achieve from a sale to meet your vision for life post transaction).  In summary, if a sale allows you to clear your pre-defined goal, then you may have yet another objective input to your decision to consider an exit.

This week, we’re going to explore #4 below which takes the analysis up a level and examines the state of the industry in which you’re operating:

  1. Valuations are Historically High
  2. You’ve Experienced Multi-Year Growth in Revenue and Profits
  3. Expected Proceeds from an Exit Exceed Your Previously Defined Goals (i.e. You’ll Hit Your “Number”)
  4. The Industry is Experiencing Tailwinds from Positive Trends
  5. Value Remains for the Next Buyer
  6. You See Your Competitors Deciding to Sell

If there’s one thing we’ve learned from investing in private companies for nearly 20 years, it’s that getting the industry right is a powerful force in driving good investment outcomes.  Not to oversimplify things, but Good Industry + Good CEO has proven to be more than half the battle in most cases. So, we pay close attention to the industry in which a company is operating if we are considering making an investment.  Here are some more detailed reflections on how to think about the state of your industry:

  • The Industry is Experiencing Tailwinds from Positive Trends. As a private equity investor we like growth, but we don’t necessarily look for rapid growth in an industry to compel the pursuit of a deal.  In fact, if we see graphs with industry growth rates that are too steep, we may often conclude that the sector is better suited for a VC investor who has the stomach for the valuations that accompany such growth.
  • In general, we want to invest in companies whose industry growth is comfortably beating GDP for tangible reasons, and we’ve historically pursued businesses operating in sectors with 5-15% expected annual growth for the foreseeable future.  Ideally, this growth is being propelled by factors that are easy to understand, concrete and sustainable.  Said another way, if you can explain why your industry is growing to a family member with no prior familiarity of it, then that is a good starting point.  Further, all industries go through cycles, so if you are currently on an upswing and can explain in simple terms why favorable trends are likely to persist, then this should resonate with investors.
  • Here’s a simple example to illustrate how an investor might evaluate the relative attractiveness of your business based on the growth of the industry in which you’re operating:

Stay tuned for the next blog where we’re going to address point #5 above, Value Remains for the Next Buyer.  As always, we’re interested in your feedback.  To start a conversation, please reach out to Joe Schmidt (jjs@clearlightpartners.com) or Mark Gartner (mpg@clearlightpartners.com).

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About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects.  Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value.  For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.

Don’t Stay Past Midnight – Reflections on Knowing When to Sell Your Business (Part 3)

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Welcome back to our blog series that tells you, a business owner, how we, a private equity fund, determine the proper timing to consider an exit.  Having been investing in private companies for nearly 20 years, this is a question with which we have had to contend many times.  As a result, we respect that it can be challenging and stressful, but if you strip away the emotion surrounding the exercise, you’re left with common sense indicators that can help you make an objective decision about when to sell.  These indicators are presented in the list below.

We’ve previously explored points #1 and #2.  This week, you guessed it, we’re going to touch on point #3 in more detail:

  1. Valuations are Historically High
  2. You’ve Experienced Multi-Year Growth in Revenue and Profits
  3. Expected Proceeds from an Exit Exceed Your Previously Defined Goals (i.e. You’ll Hit Your “Number”)
  4. The Industry is Experiencing Tailwinds from Positive Trends
  5. Value Remains for the Next Buyer
  6. You See Your Competitors Deciding to Sell

We could have also probably titled this one, “Pigs Get Fat, Hogs Get Slaughtered” but decided to go with a softer delivery.  Take a look at how we think about this point:

  • Expected Proceeds from an Exit Exceed Your Previously Defined Goals. Most professional investors have a pre-defined notion of what “good” looks like from a returns perspective. Classically, in the private equity business a good outcome is doubling or tripling your money in around 5 years.  Private equity funds might also describe success in terms of IRR %.  Therefore, when considering an exit, if a private equity firm has reason to believe that a sale will generate returns that exceed its pre-defined thresholds, then this becomes a fairly black and white input that helps inform the exit decision.  The benefit of defining these metrics ahead of time is that it wards off the judgement clouding effects of fear, irrational optimism, and/or whatever your gut is telling you that day.

  • However, returns metrics are likely not how you as a business owner are looking at the world.  We’ve found that many entrepreneurs have a round number (after tax) in mind that they want to hit in order to have a post-transaction existence that fulfills their visions for the next phase of life.  This number might contemplate future travel, real estate purchases, boats, starting a new business and/or allocation of the sale proceeds to family members.  So, using the information available to you regarding valuation multiples, you should have a pretty good idea of whether a sale will allow you to hit your number.  If it does, then considering an exit might be a good idea.

  • Here’s a simple example to drive home the point:

Stay tuned for next week’s blog where we’re going to address point #4 above, The Industry is Experiencing Tailwinds from Positive Trends.  As always, we’re interested in your feedback.  To start a conversation, please reach out to Joe Schmidt (jjs@clearlightpartners.com) or Mark Gartner (mpg@clearlightpartners.com).

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About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects.  Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value.  For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.

How to Create Deal Sourcing Alpha

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Read time: 3 Minutes

“It is impossible to produce superior performance unless you do something different.”

(John Templeton)

In an investing context, “alpha” is a term used to describe a strategy’s ability to beat the market.  Simplistically, it could also be thought of as excess return.  Therefore, alpha from a deal sourcing perspective would be generating investment opportunities that your competition is not also seeing.  In the current state of the private equity game, alpha generation in deal sourcing is essential given elevated competition for the precious few higher quality opportunities in the market. 

While the deal sourcing role within private equity funds has evolved and grown more professionalized over time, there continues to exist several flavors of staffing and strategy.  However, one thing is clear – the “order taker” model of reactively waiting for widely-shopped deals to find you simply because you have a fund will not survive over the long term.  How then is a fund to produce leads that their peers are not also seeing?  Here are some ideas for strategic consideration – figuring out the tactics is up to you. 

  1. Develop a thesis. Sometimes this is easier said than done.  The bottleneck with this approach is having the good idea to begin with, but deal sourcing professionals observe every deal that comes in the door and should be able to recognize patterns that point to good investment ideas.  Once a sector has been chosen, the disciplined exploration and documentation of an industry’s trends, risks, opportunities, competitors, etc. will yield well-organized knowledge that can be used to approach targets and relevant referral sources proactively.  Further, an ancillary benefit to developing a thesis is being able to respond quickly and with conviction to deals from that industry that come in through traditional auction processes.  Everyone is looking for an angle in auctions – having a well-vetted thesis in the can is one of them. 
  1. Cultivate deep relationships with proven executives from sectors you like. Many executives have enjoyed long-tenured careers within sectors relevant to your investing efforts and have the respect and contacts to show for it.  Off-market deals tend to find their way to these industry luminaries, often before a business goes to a full auction.  These individuals will give your firm added credibility in speaking with business owners and often add significant value post-closing.  Therefore, you need to have an engine that identifies such individuals and nurtures ongoing relationships with them.
  1. Get smarter about marketing. Most firms are still trying to figure out what marketing means for a private equity fund.  However, leaders on the marketing front have emerged and have resources behind an array of channels including email campaigns, print publications, social media, and participation in various in-person events as moderators, panelists, etc.  The challenging part is getting ahold of the right metrics to quantitatively assess ROI, and the exercise is often muddled by the understanding that one deal can justify a year’s worth of marketing spend.  You may have heard John Wanamaker’s famous quote, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.”  Sophistication in private equity marketing means consistently driving down wasted advertising spend and not narcissistically gazing into the reflecting pool of vanity metrics at the top of the funnel.  It means generating differentiated, actionable leads that turn into indications of interest.
  1. Purposeful, proactive interactions with intermediaries. Intermediary coverage has gotten harder, largely due to the proliferation of newer, inexperienced sourcing professionals that annoy busy investment bankers with meaningless check in calls.  The good news is that you can do it better, and if you do it right, you’ll unearth hidden opportunities. This happens because by expressing proactive interest in specific sectors, you’ll trigger connections in the mind of intermediaries who can help with introductions to executives and/or businesses that are perhaps too small for a formal process.  It also gives you something interesting to talk about besides the weather in their particular city and positions you as a source of value-added information.         
  1. Go local. All things being equal, a fund should have a relative advantage over their competition in pursuing local deals.  Perhaps this is because dealing with local parties feels inherently more familiar and mollifies certain anxieties surrounding deal discussions.  Also, in most cities, the number of eligible lower middle market companies vastly outnumbers the list of private equity funds, so this creates a motivation to embrace and build a relationship with the local business community. In Orange County, for instance, there are around three million people and only a small handful of dedicated funds.  The numbers are likely in your favor.

As always, I’m interested in your reactions and comments.  Fire away with feedback about anything I’ve missed or your experiences with these strategies. 

About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects. Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value. For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.

Don’t Stay Past Midnight – Reflections on Knowing When to Sell Your Business (Part 2)

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If you tuned in last week, you know we’re amidst a blog series on how to know it’s the right time to sell your business.  Last week, we explored how it can be hard to time an economic cycle but that assessing the relative strength of purchase multiples in your industry compared to historical averages is an objective exercise.  If multiples are high, and the timing is right for you personally, it could make sense to consider an exit lest you miss the window.   

This week, we’re going to touch on point #2 in the list below:

  1. Valuations are Historically High
  2. You’ve Experienced Multi-Year Growth in Revenue and Profits
  3. Expected Proceeds from an Exit Exceed Your Previously Defined Goals (i.e. You’ll Hit Your “Number”)
  4. The Industry is Experiencing Tailwinds from Positive Trends
  5. Value Remains for the Next Buyer
  6. You See Your Competitors Deciding to Sell

Having been investing in private companies for nearly 20 years, this next point is a key attribute we look for when determining whether to proceed with an investment opportunity.  So, without further ado:

  • You’ve Experienced Multi-Year Growth in Revenue and Profits. Bruce Lee said, “Long-term consistency trumps short term intensity.” This certainly applies to how investors will assess the quality, sustainability and growth potential of your company’s cash flow.  For instance, if you have a great year with outsized profitability, it can be tempting to conclude that you should exit to capitalize on a multiple being applied to your inflated earnings.  However, if your pop in EBITDA seems to be attributed to one-time revenue wins or other unsustainable factors, a buyer is not likely to give you full credit for it.  Further, if your financials have had significant volatility over the years such that there are a lot of ups and downs one year to the next, you’re not going to garner the same multiple as a business that elicits more confidence in future growth.

  • Conversely, if you have generated a steady upward trajectory in revenue and profits across multiple consecutive years, it will increase a buyer’s conviction that your historical results are replicable.  Given that the economy has been relatively healthy since the recovery from the Great Recession, we like to see steady growth at the top and bottom line since 2011 or so through the present.  The following exhibit will give you an idea for how an investor might value a company based on its historical performance:

Stay tuned for next week’s blog where we’re going to address point #3 above, Expected Proceeds from an Exit Exceed Your Previously Defined Goals.  As always, we’re interested in your feedback.  To start a conversation, please reach out to Joe Schmidt (jjs@clearlightpartners.com) or Mark Gartner (mpg@clearlightpartners.com).

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About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects.  Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value.  For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.

Don’t Stay Past Midnight – Reflections on Knowing When to Sell Your Business (Part 1)

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As of today, we are currently amidst the second longest period of economic expansion in our nation’s history.  To put this in perspective, between 19451 and the trough of the Great Recession in the late 2000’s there have been 11 periods of expansion that lasted, on average, 59 months.  Presently, we’re around 118 months into a growth cycle.  So, it’s hard not to wonder about when the next recession is going to arrive given that it seems content to be fashionably late.

You’ve probably heard the saying, “Pigs get fat, hogs get slaughtered.”  This essentially means, do your best to maximize your outcome, but don’t wait too long and miss out on the prudent window to sell.  As investors, we can’t and don’t attempt to time economic cycles, but there are indicators that we’ve learned to recognize in evaluating the best time for an exit.  In this multi-part series, we’re going to explore the following six business and market conditions that suggest that the timing could be right:

  1. Valuations are Historically High
  2. You’ve Experienced Multi-Year Growth in Revenue and Profits
  3. Expected Proceeds from an Exit Exceed Your Previously Defined Goals (i.e. You’ll Hit Your “Number”)
  4. The Industry is Experiencing Tailwinds from Positive Trends
  5. Value Remains for the Next Buyer
  6. You See Your Competitors Deciding to Sell

To kick off this series let’s start with a topic that we’re living in real time as investors:

  • Valuations are Historically High. You can’t plan for a favorable market to exit, but there’s more than enough data readily available to help you assess where valuations sit relative to historical levels. If valuations are at a premium to where you bought in and/or are elevated compared to prior averages, this can be a positive indicator that the timing for a sale is good. 
  • In case you’re wondering, “Yes, Virginia, valuations are indeed historically high.” This is due to a host of factors including a substantial amount of uninvested capital (or, “dry powder”) controlled by an increasing number of private equity funds, sustained low interest rates, and the emergence of other types of investors (e.g. family offices, search funds).  To put some numbers around the discussion, please see the chart below that highlights the average EBITDA Multiples for companies valued between $25-$250MM.  There have been some ups and downs over the past several years, but it’s an undisputed seller’s market right now.

Source: Pitchbook
  • And, don’t just take my word for it.  Andrew Carnegie said, “As I grow older, I pay less attention to what men say.  I just watch what they do.”  Consider how people who do this for a living, the private equity community, have behaved in this period of elevated valuations – many are selling anything that isn’t nailed down.

Stay tuned for the next post where we’re going to address point #2 from the list above, You’ve Experienced Multi-Year Growth in Revenue and Profits.  As always, we’re interested in your feedback.  To start a conversation, please reach out to Joe Schmidt (jjs@clearlightpartners.com) or Mark Gartner (mpg@clearlightpartners.com). 

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1 We begin this measurement period at 1945 which is when many economic indicators became standardized and thus creates a good baseline for objective analysis.

About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects.  Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value.  For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.

The Value of Time has Increased…So, What Now?

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“Time is relative; its only worth depends upon what we do as it is passing.” (Albert Einstein)

For a while now, I’ve had this feeling that the value of time has been increasing. At first, I just sensed a hastening in the pace of business.  Anyone who uses email can probably attest to this.  Did you know that if you don’t respond to a colleague’s email within four hours, you may be triggering anxiety within them based on an innate fear of social rejection?  Sad, but true.  Anyway, I went on to wonder whether each moment in our modern lives has more intrinsic value given what can now be produced with that time, thanks largely to technology.  However, I felt in danger of wandering into the realm of quantum physics and figured I would focus on fighting other metaphysical fires.

Then, I read a short but powerful blog by Seth Godin called, “Opportunity Costs Just Went Up.” Godin posits that every decision has a price given that you are forced to give up alternatives upon choosing a course of action. He goes on to say, “Our access to the world of learning and online resources means that the alternatives are far more valuable than they used to be.”  Well said.  So, this implies that because we all have finite lifespans, it behooves us to not only understand the alternatives we are giving up, but also derive ways to optimize our decision-making process to maximize the ROI on time spent.

So, how are we to respond to make best use of the time we are allotted?  Sometimes it’s easier to identify things we should stop doing than those that we should start doing, but I propose a few ideas and life hacks here.

For Business:

  1. Develop Time-Denominated KPIs. This is easier in concept than in practice because it requires measurement of the time required to complete a specific task or produce a certain output. However, think about how powerful a material reduction in, say, hold time can be for the customer experience. This piece from Inc. Magazine touches on this point in an article entitled, “Forget About Saving Customers Money. Save Them Time Instead.”  Then, you might check out this admittedly VERY deep cut on YouTube…tune in around 0:48 where Herrell says, “…The new currency of business is time.”  His ensuing commentary is a fascinating exploration of the significance of rapid response times in a globally connected world.  You never know, we may get to a point where dashboards begin reporting on Profit (or Revenue) generated per hour spent on a specific task.  I’d love to have more visibility into how that could apply in my own world and have made some progress by implementing time management software called RescueTime.
  2. Set Weekly Goals. We all have to-do lists, but sometimes the deadline is too far into the future or, worse even, undefined.  It’s relatively easy to conceptualize the things we need to get done over the course of a week, so defining a list of tasks to be completed over this time period can be quite powerful in reducing anxiety and stimulating action in the present.  Also, we know that the brain rewards the completion of unfinished tasks by freeing up focus for new challenges, a phenomenon known as the Zeigarnik Effect1.
  3. Safeguard the Time of Your Future Self. It’s tempting to commit to future activities out of a sense of reciprocity to the person who invites you or because of that nagging fear of missing out. Remember, though, that future calendar items that you really don’t feel like doing become pesky obligations in the present before too long.  I read somewhere that you can always tell how you feel about a person or activity when you reflect on the face you make when receiving a call, email or letter from them.  If the face you make is anything approximating a wince, then it’s safe to say that you should politely decline.

For Life:

  1. Avoid “Cheap” Dopamine. With great power comes great responsibility…to not waste time on your smart phone!  Our phones, and the myriad of apps on them, are in many cases designed to promote engagement with them at a neurological level.  It’s not a coincidence that alerts show up in RED and video games offer delightful visual and auditory rewards to keep you coming back. Think about the creative ideas you could have formulated while you were nose-to-screen during that 30-minute Fortnite session.  To that end, I’ve taken drastic measures such as deleting all games and turning my screen to grayscale to change my phone from a dopamine producer back into a productivity tool.
  2. Resist Click-Bait News Headlines. I’m experimenting with a new life hack which is to essentially ignore all digital news and only read the physical newspaper that arrives every Sunday.  I figure, if it’s fit to print on Sunday, then it’s survived the weekly flurry of activity and worth my time to consume the information. This hasn’t been easy, but it seems to be freeing up a good amount of time that I could be spending more productively, and my screen time metric has been plummeting.  One day at a time.  The daily tug of war between screen time and real life is a zero-sum game, and we now live in a 24-hour news cycle that will stop at nothing to capture our attention. So, less news = more time for potentially better uses of our ocular energies, like eye contact with another human.
  3. Proceed Cautiously with Streaming Content. I’ve got a love / hate relationship with Netflix.  On the one hand, it’s frequently my first stop after firing up the Apple TV.  On the other, I’ve been guilty of spending an entire episode’s worth of time just scrolling through titles to find something worthy of viewing.  This is not only a terrific waste of time, it also drives my wife insane.  If, against all odds, I do ultimately land on a title that I deem worthy of watching, I’m often disappointed.  So, I’ve started to apply the test of waiting to get a referral from three or more humans whose opinion I trust (i.e. not a recommendation engine) rather than venturing into the rabbit hole of title surfing2.  Come to think of it, maybe I’ll just go cold turkey until Game of Thrones Season 8 premiers on April 14thon HBO at which point, I’ll be doing a swan dive off the wagon.
  4. Generally, Avoid the “Feed” on Social Media Sites3. The “Feed” enjoys elevated status in the pantheon of time wasters.  It’s a fabulous way to distract yourself with everyone else’s overshares, self-promotions and marketing messages to the detriment of your productive energies.  I can count on one hand the number of people in my network who consistently share high value content, and most of these contributors have their own blogs.  If this is the case for you too, just visit their blog sites for updates so that you don’t have to get sucked into the vortex of meaningless posts.
  5. When Possible, Read Physical Books. If we assume that we should spend some amount of time reading for the purpose of self-improvement, then it’s better to spend that time with physical books.  To start, most online articles or digital content is written in a format for rapid consumption.  For instance, this piece is what’s called a “listicle” which means that the content is presented wholly or partly in the form of a list.  However, this can result in relatively weaker retention of information.  As reported in Scientific American back in 2013, when people read on a screen, they tend to take shortcuts and look for keywords rather than going line by line as they would on a paper-based document.  As a result, the reader can miss out on the subtleties of creative or academic writing and more quickly forget valuable information which invalidates the exercise of reading in the first place.  You also miss out on the psychic benefit of turning pages which reinforces a sense of accomplishment.  And, most importantly, how else are people going to know how smart you are until they see all of your knowledge trophies (i.e. books) on your bookshelf?

Well, hopefully this was worth the 3-4 minutes, and I’d be interested to get any additional ideas about how to enhance the ROI on all of our valuable time. Comments please!

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1Russian psychologist Dr. Bluma Zeigarnik stumbled upon this finding in the 1920’s after observing that upon returning to a restaurant where she had just finished lunch, her waiter did not remember her, where she was sitting or what she had ordered. She found this peculiar given that the waiter had previously taken everyone’s order accurately without writing anything down.  Zeigarnik later conducted a series of experiments that reinforced the conclusion that the human brain remains more focused on unfinished tasks – something that’s also been referred to as the “inner nag”.

2Incidentally, if you’re into mind-bending dystopian movies, check out the 2011 Sci-Fi thriller, In Time, starring Justin Timberlake.  Imagine a world where a new economic system has been devised where the currency is time itself and each person has a rechargeable clock on their arm that counts down how long they have to live.  Note that I happen to disagree with Rotten Tomatoes on this one and suggest that it’s worth the 109 minutes to watch it.  I believe you can rent it on iTunes.

3It’s not lost on me that this piece will likely get some engagement from its appearance on my network’s wall.  Sorry not sorry.

About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects.  Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value.  For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.

Mark Gartner, Principal & Head of Investment Development

Private Equity Trends & Predictions for 2019

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“Prediction is difficult – particularly when it involves the future.” (Mark Twain)

I know all of the reasons I shouldn’t make predictions about the private equity industry or any other industry for that matter. After all, blog predictions are generally worth what you pay for them, and I’ve been incorrectly forecasting a recession for the past four years. However, I’m going to do it anyway through a blend of trendspotting and inferences about where this might take us. With any luck, one or more of these prognostications will prove to be true. Note that this list is not intended to be comprehensive, nor do I suggest that anyone act on any of the ideas below without sufficient contemplation or investigation lest you be dealt a heavy dose of regretful rumination.

  • The Hunt for Recession Resistance Continues. We’re currently amidst the second longest period of economic expansion in our country’s history (second only to 1991-2001), and the list of investors willing to sign up for the career risk of championing an inherently cyclical business at peak valuations is ever diminishing. Therefore, companies that existed pre-2008 and weathered the Great Recession without issue or even grew will continue to enjoy elevated status during Monday Morning Meeting new deal discussions. Some typically defensive sectors or strategies might include healthcare, legal services, “found money” business models that compensate service providers based on savings generated, small luxuries, regulatory / compliance-driven businesses, and other non-discretionary services.
  • Add-On Strategies Remain Important but Grow More Challenging. A great way to grow when valuations are high is through a disciplined acquisition strategy. This is because add-ons can usually be acquired for an EBITDA multiple that is less than the multiple applied to the larger acquiring entity. I don’t see pricing for relatively smaller businesses (say, <$3MM of EBITDA) ever reaching parity with the larger entities that have achieved the critical mass to historically enjoy a valuation premium, but the gap between purchase multiples based on size has been narrowing in many sectors. This is due, in part, to the growing competition for smaller assets by lower middle market private equity, search funds, independent sponsors, family offices and private equity-backed portfolio companies. Investors should preserve a healthy skepticism for new platform investments predicated on add-ons to create value that don’t also have a credible organic growth story.
  • Everything-as-a-Service (“EaaS”). This was the year that recurring revenue jumped the shark. Just when I thought I had heard them all, I was recently introduced to Dental Practice Management and Digital Marketing as-a-Service. The valuation benefit afforded to companies that generate a majority of their revenue from ongoing payments has driven many sectors to attempt to re-tool their revenue models accordingly. Investment banks have followed suit in their presentation of these businesses which has forced us to take a much more critical eye to any revenue streams presented as recurring.
  • De-Commoditization (or Humanization) of Capital. If I have to regurgitate the dry powder statistic one more time, then I myself may regurgitate. Ok, fine, only for you do I do this…there is over $1 trillion of private equity capital globally sitting on the (gulp) sidelines. What does this mean for the industry? In short, “Mo Money Mo Problems” 1 . In other words, private equity funds will have to increasingly fend off the image of commoditization given the dizzying number of firms from which an investment bank and/or business owner must choose. Prepare to see a lot more touchy-feely stuff on websites accompanied by an increasingly sophisticated marketing presence to lend a humanized element to private equity. I’m personally betting on the growing prevalence of things like testimonial videos, Mission Vision Values statements, clever digital marketing initiatives, snazzier websites and print advertising in our industry. With any luck, these efforts will succeed in driving business owners to the best private equity partner to suit their personal and professional objectives which is the ideal outcome for both parties.
  • Renewed & More Systematic Pursuit of the Proprietary Deal. Believe it or not, proprietary deals could once comprise a material portion of a private equity fund’s deal flow. While many current private equity professionals may not have lived through or have yet been born during this era, it was a thing (or so I hear). Lately, many funds have differentiated themselves by sourcing deals through less competitive auction processes, but if necessity is the mother of all invention, we may see a revival in the pursuit of proprietary deals. However, this time around it is likely to be more sophisticated through the use of new data and direct marketing tools that were not previously available. We’ll call this Proprietary Deals 2.0. TBD if / how successful this strategy will be, because proprietary deals tend to have this timelessly elusive quality that make them hard to systematize regardless of the tools at one’s disposal.
  • Private Equity Grows More Technology Enabled. The English word technology is derived from the Greek word teknologia which means, “A systematic treatment of an art, craft or technique”. Fascinating to compare that definition to the current state of private equity work streams which have been changing for a while now from more artisanal approaches to behaviors that are increasingly automated and technology driven. Today, technology has permeated nearly every functional area of the private equity activity set including business development, marketing, due diligence, financial reporting, and capital raising. What’s fascinating it that adoption is consistent in certain areas, such as CRMs which are now ubiquitous, but also inconsistent in others. In other words, our industry is still figuring out how to apply technology where it generates the highest ROI, and this creates opportunities for the early adopters who figure it out first.
  • Cyber Security Creates Both Risks and Opportunities. Not to be too much of an alarmist, but the cyber-villain community is getting better at what they do. Perhaps they realized that the jig was up on the “Just Wire Me a Few Thousand Dollars, and I’ll Send You $100 million in Return,” game and decided to develop some new material, but I’m noticing increasingly creative strategies to attempt to relieve me or my firm of our financial resources. A recently popular rouse is to mimic the email address of a firm leader and direct an employee of the firm or one of our portfolio companies to do something beneficial to the scammer. For now, these sorts of schemes can be defended by (i) trusting one’s intuition about something that seems fishy, and/or (ii) hovering over the email address to inspect the link. However, my gut tells me that we will need to be increasingly vigilant to these sorts of attacks in the New Year. The good news is that where a problem arises, so does a business opportunity. Be on the lookout for new ways to play cyber security from an investment perspective.
  • Pursuit of Historically Neglected Sectors. Competition is increasingly driving private equity to sectors that haven’t historically felt the love from investors. In a market characterized by elevated valuations and abundant capital, the creative investor will win the day if they can unlock strategies to deploy capital in industries previously perceived to not present compelling returns potential. A good example of this is the rise of private equity-backed retail healthcare. This year alone, I’ve been contacted about investment opportunities in Podiatry, Pediatrics, Ophthalmology, Oral Surgery, and Dermatology. Don’t be surprised if you start seeing private equity creeping into other consumer services realms such as drycleaners, plumbers, roofers or nail salons.

So, what do you think, do any of these trends or predictions resonate with you? Fire away with comments. Here’s to a Happy New Year and a successful 2019!

1 Notorious B.I.G.

About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects. Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value. For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.

What to Expect When You’re Expecting…To Sell Your Business

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Yes, you read the title of this piece correctly. I’ve analogized the process of selling a business to childbirth1. I went around and around to find any other metaphor but kept coming back to this one. Both happen relatively infrequently during a lifetime, are fraught with fear of the unknown, profoundly and forever affect the participants, and present a host of opportunities to say, “I thought we were friends, how come you never told me about that?!” Therefore, as a proud father of two with nearly 15 years of experience in the M&A industry, I thought I would share some candid reflections on things a business owner should expect in their journey to achieving liquidity. So, put your feet up, remember to breathe, stay hydrated, and we’ll get through this together2.

  • You will learn new vocabulary words. You’ll begin to develop a fluency in two new groupings of words. The first are words with which you were previously only superficially familiar. You might have heard others in your network, perhaps other business owners who sold their companies, use certain terminology when describing the process. Without firsthand experience, these words lacked any visceral or practical meaning. Get ready to intimately understand what things like exclusivity, indemnity, and working capital adjustment mean. If you’re lucky, you’ll be surrounded by trusted advisors and working with an investor with a good bedside manner who can explain everything in English. The second group of words are the insider jargon used by accountants, lawyers and investment bankers that, even after the process, still won’t make any sense. Don’t waste any energy trying to figure out what things like synergy practically mean for your business.
  • Strangers will demand access to private information. It would be perfectly normal to recoil the first time someone you don’t know very well asks you how much EBITDA you are generating and how much you paid yourself last year. However, you can expect more than a few questions from people you would have liked to have known a bit better before revealing the intimate details of your business. While these types of inquiries may feel a tad forward, understand that the people asking them are professionals who intend only to use the answers as one of many datapoints necessary to advance the deal towards a close.
  • Uncomfortable procedures. I’m not going to sugarcoat this, the due diligence phase may smart a little bit. Business due diligence usually comes first and will be led by your new investor. It will typically entail someone that appears to be the same age as one of your kids (or grandchildren) asking a series of questions that makes you wonder if they grasp what your company does. In reality, they are simply making sure to build a strong foundation for their understanding of the business based on the information you’ve provided. Then, the accountants arrive. If you’ve been putting off an audit because you thought the process would be too painful, just wait until you experience a Quality of Earnings assessment. This exercise will include a near cellular look at the constituents of revenue and cost to assess the accuracy and sustainability of your company’s reported financial performance. You can also expect legal, environmental and insurance-related investigations into the business. Just know that while one or more of these exercises will feel like an exam, they are a part of nearly every deal that gets done to help an investor build conviction that they’re not buying a lemon. The good news is that, afterwards, the company will likely be better organized and more self-aware about its health than it has ever been.
  • Tense moments with your partner. In this case, the partner to which I’m referring is the new investor in the business. It’s easy for emotion to take hold of a negotiation, but the key is to remain dispassionate and use the benefit of time and deep breathing before responding to sensitive deal points. This is especially important if you will be retaining some ownership in the business alongside the new partner going forward. Like many relationships, effective communication will protect against a lot of conflict that arises from misaligned expectations. Further, maintaining a strong working relationship will allow you to focus on constructively growing the business together once the deal has closed.
  • You’ll be ready for it to be over. In most instances, the gestation period of a transaction with a private equity fund is 3-6 months from “hello” to the closing dinner. You will inevitably encounter deal fatigue and other frustrations regarding why things are not moving along more quickly. However, it’s important to remember that by the time you are saying, “I just want this to be over,” the investor will have likely incurred substantial legal, accounting, and other due diligences expenses to drive towards a close. This accumulating cost creates an incentive for the investor to close as quickly as possible. And, believe it or not, investors want to get the deal done too and move on to the important business of growing the company. Your interests are aligned in this way. Stay vigilant, though, to make sure that anyone getting paid by the hour isn’t dragging out the process to their benefit. Sometimes the most efficient solution is to speak directly to the new investor to fix any bottlenecks.
  • New perspectives on the other side. Having experienced a transaction is binary – you’ve either gone through it, or you haven’t. If you have, you gain an array of memories that will forever affect your outlook on business and life. You’ll also be equipped with a ton of advice you can dispense for free and on an unsolicited basis to other business owners thinking about selling their companies. And, perhaps most importantly, you will have the transcendent satisfaction that you’ve lived the entirety of the circle of entrepreneurial life.

I know what you’re thinking, some of this sounds a little scary. Not to worry, just like with having kids, the less pleasant experiences tend to fade away while the positive aspects linger. If that wasn’t the case, then people wouldn’t strive to sell multiple businesses (or have multiple kids). And, don’t lose sight of the fact that a successful sale brings the liquidity and wealth diversification long pursued by many an entrepreneur. What’s more, a deal with a private equity fund can create an opportunity for a “second bite of the apple” whereby any ownership you retain in the business has the potential to appreciate in value before another future sale. In some cases, we’ve seen the second bite be worth more than the first.

If you’re considering an exit or taking on a partner, it’s a good idea to start doing your homework early. Part of the learning process might include informal conversations with investors to get their perspectives on your business and to begin to develop trust with possible suitors. Please get in touch with us any time if you want to learn more about our investment criteria, philosophy for creating value and/or stories about how we’ve helped other business owners navigate an exit

1Rest assured that this passed editorial review by my wife.

2For maximum effect, I recommend playing “The Circle of Life” from The Lion King in the background while you read this blog.

About ClearLight Partners

ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects. Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value. For more information, visit www.clearlightpartners.com.

Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.