We interviewed Martec’s resident Private Equity expert, Rick Claar, after his recent meetings with several of our leading PE clients in Cleveland to find out what he had to say about trends in the industry. Read on for his take on fundless sponsors, the rise of business development positions, and a new approach to due diligence.
Q: What did you notice about the due diligence process that is different than in the past?
A: I noticed that we are seeing more of a “2-step process” where there is a pre-due diligence aspect. Private Equity firms want to do a bit of up-front due diligence during which they limit spending to get a basic idea of the company they’re considering investing in. If the outlook is positive, then they will proceed with the more in-depth process. This two-step process is being driven more by the bankers than anyone.
Q: What is the benefit of this 2-step approach?
A: Well, rather than jumping in with no background and spending a significant amount of money only to find out the investment isn’t a good fit, they can ensure there is a clear pathway forward with the target. With the 2-step process, the risk is significantly reduced. Martec is reacting to this trend and allowing private equity to look at a target and its environment without significant spend by providing this pre-due diligence. In fact, we just recently completed several projects of this scope. Ordinarily, we would be called in once the LOI is set or our client is in Round 2 of the auction.
Q: What trends have you noticed regarding the workforce in the private equity industry? Anything new?
A: It seems as though lots of these guys are leaving one firm to go to another. By that, I mean I met with multiple people who had left their previous firm to start up their own, (in most cases) smaller firm.
Q: Why would they do that?
A: Well, the reasoning seemed to consistently center around getting back to the core principles they started with. Once people had achieved certain levels of experience, they might realize they weren’t comfortable with the direction of the firm – say, the size of the deals or funds the firm began targeting. If they started at a firm doing lower-level market deals, for example, and the firm got bigger over time, the individuals weren’t comfortable and wanted to go back to the basics. That’s when they decided to split off and do their own thing.
Q: So, there is a desire to go back to doing things on a smaller level?
A: Yes, that seemed to be a common theme. Maybe the firm strayed from their core principles when they expanded, and the guys wanted to get back to how they started. Plus, it is going to be “easier” to find proprietary deals in the lower- markets.
Q: Continuing with the idea of individuals in the private equity industry, does it seem to be status quo when it comes to the types of positions found at private equity firms?
A: No, actually. I’ve noticed a prevalence of business development people out there in the private equity space that didn’t exist before. Although there have been BD guys in this space for years, it seems that now PE firms are putting more resources toward this function to canvas the industry.
Q: How would a private equity firm leverage someone in business development?
A: It’s quite resourceful, actually. They send these BD folks out there to find the right companies that are setting up to be a deal 3-5 years down the road, so that the company doesn’t go to auction and thus benefits from the final sale price and the process being streamlined. They establish a relationship with these companies so that when it comes time for them to sell, they go straight to the private equity firm without the PE guys having to come to them.
Q: How does this relate to trends in types of funds?
A: There appear to be more independent sponsors (or fundless sponsors) out there today. These independent sponsors are able to match up their limited partner investors with individual deals to ensure the best fit. This way, they can go to someone they know who truly understands the industry that the company operates within, resulting in a better success rate.
Q: Is this a new phenomenon – “fundless” funds?
A: No. Fundless sponsors and fundless funds have existed for awhile now, but there was a sort of stigma that came with them. That stigma is fading more and more as companies and investors realize there are advantages to being nimble like this, especially because fundraising beforehand takes time. This process can be more expedient.
Q: What would you say is the key takeaway here?
A: What I would say stood out to me the most it this lesson: as multiples have continued to stay high, PE firms are putting a premium on doing the right amount of due diligence because the risk factor is so great. It’s more important than ever that PE firms are doing their diligence extremely well and thoroughly, so there is more “full” due diligence being done.
Q: Are there any further trends that you noticed?
A: Well, I’m seeing more early-on hiring of operating execs before a new platform has started; firms are getting an operating partner or executive first in segments they like, then acquiring companies in that individual’s wheelhouse.
Also, I just have to say that after talking to a number of firms there about what was going on in the city, it was really apparent that Cleveland is booming within the PE community. There are so many important firms there, and I believe it will only continue to grow.