DNS Capital has no interest in cycling through management personnel when it invests in a company, says Elizabeth Browne, head of business development at the family office for Gigi Pritzker and Michael Pucker.
“It’s not always the case that the CEO, CFO and senior members of the management team have the capacity or appetite to stay for 10-plus years,” Browne says. “We either need it to be the case that they can or we need the existing team to have done a great job of cultivating that next layer of talent.”
DNS typically looks to invest in companies with $10 million or more of EBITDA that have experienced management teams in place, Browne says. This type of company is not always easy to find.
“The hardest thing about investing in those businesses is finding management teams that we really like and enjoy spending time with and vice versa,” Browne says. “It's very much a dating process in that vein.”
This week, we return to our earlier conversation with Browne to learn more about the challenges in finding the right company in which to invest.
Know what you want
DNS Capital’s sweet spot when it comes to investing is a family-owned or closely held business.
“A perfect, middle-of-the-fairway scenario for us is a management team that has meaningful equity in the business today,” Browne says. “At the same time, there are very few instances in which we say that a given business is fundamentally unattractive based on the industry or sector in which it resides. The only industry and sector in which we won't invest are related to guns and ammunition. But outside of that, we have no explicit constraints or bars on where we will spend time.”
One of the challenges in today’s economic climate is that it’s become difficult to find companies that are attractively valued, Browne says.
“As long-term or permanent capital investors, we don't think in terms of IRR,” she says. “Because we think in terms of multiples of invested capital, we are not nearly as beholden to strict investment timeframes. But it's still important to be able to pay a fair price for a good business. When you see companies trading for two or three or four turns of EBITDA higher than you think they're reasonably worth, it becomes hard not just to justify the investment, but to think that what you're investing in is inherently that valuable.
“Even when you find a really good business with attractive recurring cash flow characteristics and an industry and or company that has built a defensible moat, all of the characteristics we would typically look for, including a great management team, those businesses are inherently in this environment going to be so much more expensive than they would have been five years ago. It's just a reality of thinking about investing. It won't stop us from deploying capital, but we are not going to overpay for a good business either.”
Seek strategic alignment
A strong management team that takes a long-term view of the company it leads will always be attractive to Browne. It doesn’t guarantee investment, but it will likely earn a longer look from potential suitors who share DNS Capital’s approach.
“As businesses continue to grow, if they're taking on outside capital of any form,” she says, “it becomes really critical to develop early on, in our view, the capacity to be incredibly transparent with your board and/or your investors and to cultivate a suite of investors who reflect your own values. Values in this case are not just things like high integrity and transparency. We tend to invest in management teams which have a bias toward being very long-term thinkers. If we want to invest for 10-plus years, our management teams are going to tend to reflect the same degree of interest in longevity and duration of the investment.”
Finding companies that are a match for this archetype can be tricky. Inflated values are one concern. An inconsistent growth strategy is another.
“We're increasingly seeing some earlier, less mature businesses that took on more traditional institutional capital and are then looking down the path,” she says. “Having that institutional capital, they want to make very overarching operational changes or de-emphasize investment in innovation for the sake of popping their EBITDA higher in anticipation of a sale or things like that. The management team is then frustrated and trying to figure out different investment alternatives at the point that it’s almost too late.”
It’s a big reason why DNS Capital puts such an emphasis on finding that alignment with the people who lead a business on the direction of the business before making an investment.
“I would say for a business that's growing, while it's incredibly important to be able to have sufficient capital in order to grow, the type of capital and the source of capital is equally important,” she says.