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The notion that private equity firms buy companies to slash costs and strip them down to their core is fading, but still persists, says Al Melchiorre, founder and president at MelCap Partners LLC.

“Change for change sake isn’t something a private equity firm is looking to do,” Melchiorre says. “They are looking to add value. It could be IT, manufacturing capabilities, production capacity and product quality. There are so many different aspects of a business where a PE firm is going to say, ‘Alright, how do we add value to help this company transition to the next level?’”

MC Sign CEO Tim Eippert agrees.

“Every single time I tell somebody I’m owned by private equity, their first reaction is they clench and go, ‘Oh,’” Eippert told Smart Business Dealmakers last year. “The news media makes private equity sound bad.

“My experience has been different,” says Eippert, who has sold his company to private equity three times, always keeping a piece of the business. “Every single experience I’ve had with private equity in middle-market America is exactly the opposite of the perception of big bad private equity.

“The last thing they want to do is come in and start causing problems and upset the apple cart. It will put their investment at risk.”

This week, Smart Business Dealmakers takes a look at how private equity investments are just the fuel companies need to drive growth.

Fueling growth

The Association for Corporate Growth has been tracking the impact of private equity on the middle market. Working with researchers from the University of Wisconsin, it’s found that over a 20-year period, PE-backed companies grow sales a 3.6 times the rate of other businesses.

The figures don’t surprise Blue Point Capital’s Jim Marra.

“There’s really only one reason why a PE firm owns a portfolio company,” says Marra, director of business development at Blue Point. “That’s to build value at an accelerated rate with the goal of selling that company for a lot more money than what was paid for it.”

Private equity deals are ideal for business owners looking for some liquidity or looking to take their business to the next level, Melchiorre says. “They may have outstripped their ability to borrow from a bank and private equity can help support or facilitate additional growth.

“That growth many times can be through add-on strategic acquisitions,” he explains. “We’ve had clients where we helped them do their first private equity deal and they are 10 times the size they were when we did the first deal.”

Marra agrees. “We focus on businesses that have an ability to grow, that aren’t overly cyclical and that already have some critical mass,” he says. “So there’s some self-selection effect in (the ACG data), but I know from our experience at Blue Point that the typical result of our ownership of a company for five years or so is that it is a substantially larger, more valuable business and employs more people when we are finished owning it.”

With the relatively high valuations that PE firms are placing on middle-market businesses —driven by the huge amount of committed capital managed by PE firms — many business owners across the country have generated significant wealth by selling all or part of their business to PE firms, Marra says.

Another local PE success story is Matt Kaulig, founder of LeafFilter Gutter Protection.

“We chose Gridiron Capital to be our private equity company in selling my business,” Kaulig told Smart Business Dealmakers last year. “We sold it for more than a nine-figure deal, and even since then, we’ve more than doubled our business. It’s been a year and a half and we’ve more than doubled the value of the company.”

Local impact

It’s been well-documented that there’s more than $1 trillion in global private equity ready to be invested. Northeast Ohio has its own pot of PE gold, with $6.7 billion in dry powder, Melchiorre says.

That $6.7 billion could conservatively be leveraged to nearly $20 billion in buying power, he says. “That tells me there is still plenty of dry powder to invest to support M&A activity.”

Between September 2017 and September 2018, there were 57 private equity deals in the Cleveland area, Melchiorre reports. During this same time period, however, strategic buyers closed 222 transactions.

With so much local capital ready to be invested, why aren’t more PE deals getting done in Cleveland?

“I think this is a reflection of the amount of cash that strategic buyers have on their balance sheets, which needs to be deployed in order to enhance shareholder value,” Melchiorre says.

“Cleveland has a pretty robust M&A community via private equity, investment bankers, lawyers, accountants and insurance,” he adds. “It’s all supporting M&A activity. But just because private equity funds may be headquartered here or investment banking firms are here, that doesn’t mean all your deals and investments are in Northeast Ohio.”

Local firms and investors can support local deals in more ways than just providing capital, says Jerry Frantz, senior managing partner, entrepreneurial services and investing, at JumpStart Inc.

“Local investors doing mostly deals outside the region are, of course, providing less immediate local impact,” Frantz says. “That said, local investors who make money outside the region still can benefit the local startup community, as the money they make elsewhere increases the available dollars that they can redeploy locally. Also, investors who have participated in deals outside the region can make connections to funders in other regions that they can then bring into local deals.”

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