Who better to invest in tomorrows growing companies
than the savvy individuals who built todays? Thats the novel
idea behind one Connecticut private equity firm.
Investors looking for opportunities in small and midsize private companies like to say that management, not the financial statements, is the best gauge of potential. Well, sure. But how does a private investor looking for great opportunities put that insight to work? Many business owners can talk the talk and walk the walk, but collapse under pressure. Identifying those with the skill, resilience, and mettle to overcome the inevitable obstacles is next to impossible.
Seven years ago, Dan Levinson, then employed by a highly successful New York City private equity firm, had a flash of insight: Why not seek the advice of people who know entrepreneurs best those who have successfully built their own companies. Levinson quit his job and set up an investment pool funded by wealthy entrepreneurs as well as several New York area banks. With over 90 successful business owners as investors (also known as angels), Main Street Resources, run by Levinson and his team, has invested in several small and midsize businesses. It has investments in several northeastern companies, ranging from a distributor of stainless-steel fasteners to a supplier of DVD packaging, and is looking for more.
Main Street has attracted a lot of attention lately, not just for its ability to spot promising businesses, but for the way it leverages the expertise of its investors to maximize the performance of these companies. We make it our objective to become the CEOs closest advisor, Levinson told me recently in the companys Westport, Connecticut, offices. Here are some excerpts from our conversation.
RL: What do you look for in a potential portfolio company?
DL: Great management thats financially and emotionally committed to what theyre doing. We focus primarily on established companies that are growing based in the tri-state or the Northeast area, so we can get to them and be close to the CEOs. And we dont do any technology or start-ups.
RL: How do you find them?
DL: Companies generally come to us when they need capital to do any number of things such as acquire a competitor or to grow. Sometimes they might need money to open a new plant, or to take on a new product line. The company might be owned by a conglomerate or an estate, or a founder whos no longer active, and were very happy to help the guys that are running the company own a chunk of it themselves. Companies also want to use our capital to repay the bank and become safer, those types of things.
RL: What size companies are you looking for?
DL: Generally, $10 million to $100 million in sales.
RL: What other financing options do they have?
DL: Generally, pretty good bank financing, because theyre big enough to have credit lines of at least $5 million or $10 million. Theres also equity and mezzanine [a combination of debt and equity] funding. Those tend to be the pieces.
RL: Does your equity investment usually accompany debt, or is the debt usually in place?
DL: One of the things we bring to the table is the ability to line up new debt with better terms. Often, companies of this size have personally guaranteed debt from a local bank. We can bring in a more business-oriented bank that will eliminate the personal guarantees and usually be more aggressive in offering cheaper or more capital.
RL: Is there a minimum return you look for?
DL: Its a little bit a function of how risky we perceive the investment to be, but generally were looking for a minimum of three to four times return on our money, which could be also described as a rate of return in the high 20s to high 30s, depending on the amount of time until we exit.
RL: Whats your time horizon? How long do you like to keep your investments before cashing out?
DL: Five years is a good average, but it could be three; it could be six.
RL: How do you evaluate a companys own financial projections?
DL: We generally want to see that the future is securely based on the past, so if future projections have nothing to do with the past, then it starts to feel like a start-up, or a technology transaction. That may be fine for some investors, but its not usually within our comfort zone.
RL: It can be hard to predict the future from past performance. How do you get your hands around that?
DL: I dont mean the future has to
be a carbon copy, but its got to be grounded in the past.
RL: Can you give me an example?
DL: One of the companies we invested in was overleveraged with a bank that was being pretty restrictive to the business. Our capital could take the company out of the bank and give it the resources to operate more freely. So we adjusted the projections to take that into account. In another case, the company was owned by an 87-year-old son of the founder, who was a marvelous gentleman but had not put in the kinds of systems and controls that would allow it to evolve with the times. So we asked ourselves how the outlook might change if we were able to have control and do some other things.
RL: Who prepares the financial projections, you or the company?
DL: We do it together. We ask the management team to tell us what they believe they can achieve under various scenarios, and then we will discuss it.
RL: How does Main Street differ from other equity investment firms?
DL: Our niche comes from being willing to be minority investors and from taking a proactive value-added approach. We are pretty unique in having 90 individual investors. We do a lot of investing on a proprietary basis where a CEO knows an investor; theyll have a level of trust with us. Our investors may also know the customers, the industry, and whats going on. They may suggest a new customer or a new business perspective.
RL: So youre active investors?
DL: In our world active denotes a majority interest in a company. Active investors really own and run the company. We generally are not majority investors; were minority investors. The CEO and management team own the rest. So by that definition were passive. But were very proactive in terms of developing that relationship and opening up our resources to try to help the company. It differs by degrees from one of our portfolio companies to the next and can change over time. It really depends whats going on.
RL: How do you define proactive?
DL: We make it our objective to become the CEOs closest advisor. We spend a lot of time dealing with that person, and we make ourselves available to help. We may refer senior managers when the company needs to expand its team. We can provide entrée to customers. When one of our portfolio companies buys another company, we can have someone on our team go in and work at the acquired company for a few months and assist with the integration.
RL: If you conclude that a prospective portfolio company requires a change in management to get to the next level, will you still consider it?
DL: We would definitely consider that
if the new team was identified. However, we are unlikely to
be interested if someone wants to raise money and then go find
some new people, because our whole thought process starts with
Whos the CEO. Whos the team? Are we comfortable with
RL: Youve got to know the jockey.
DL: Yes. And once were comfortable with the CEO and the team, well look at a lot of stuff, different kinds of transactions, different deals.
RL: Are you actively pursuing portfolio companies, or are companies coming to you?
RL: From the first point of contact, as a general rule, how long does the process take?
DL: It really varies. It can be immediate if theres a burning need at the business and we click. Or it can literally be years. Well meet someone, but their need for money slips, then theyll come back a year later. Generally, from the time that we have a handshake with a CEO to the close of the deal is two to four months, including the legal work and some due diligence. We are here, flexible, motivated, with money to invest. The time schedule is usually set by the management team.
RL: When should a company be considering debt as opposed to equity financing?
DL: Well our view on debt is debt is better than equity for a companys perspective. Its cheaper; theoretically if they believe in the company, the equitys going to be worth a lot more. So they should get debt when they can; when they can support it with their cash flow. Most companies need to have a pretty steady track record, and a decent amount of assets, and be of a certain size to attract lending. Then a reason to go to the equity is if youre tapped out on the debt, or you want a real partner to help you grow the business.
RL: When youre looking at the potential investment how do you determine if theres x-number of dollars needed, how do you determine what percentage should be debt, or how much you can debt and how much will be equity?
DL:Its usually determined by the transaction, and it can be anywhere on the spectrum. So were happy to do an MBO, a management buy out, with a lot of leverage if the company can support, and the financial team wants it. But on the other hand, were happy to invest per equity with no debt if thats a very growing company where they really need all the capital they can get. So we try to match up the amount of leverage with the nature of the business and the nature of the business planning, and every case is different. Weve been everywhere on the continuum.
RL: Banks usually like to create assets, particularly ones that are collateralized, does the same go for private equity and funding for Main Street?
DL: No, we dont think of things the same way as bank does.
RL:In some cases, its hard to look at the past as a predictor of future performance. How do you get your hands on that?
DL: We sort of can. I dont mean the future has to be a carbon copy, but its got to be grounded in the past. So one of the companies that we invested in was over leveraged with Fleet Bank. And Fleet was being pretty restrictive to the business, so we went in; we provided the capital to take the company out of the bank. And so we said, We looked at the past results, and we added to it assuming we have the resources to operate more freely. In another case, we acquired a company from an 87 year old son of a founder who was a marvellous gentleman, but had not allowed the company to evolve into the current time with systems and control, and so forth. And so we took what was there and we sort of projected if we were able to have control and do some other things.
RL:Is there a risk of getting too involved?
DL: What we do is try to make our investors available to a CEO if we think any of the individuals in our network can add value. It doesnt always happen. A lot of CEOs think they know it all, and often they do, so its really up to them. If they are really yearning to talk with people on our advisory board, we set it up. If theyre happy to take the money and call us when they need us kind of thing, thats fine. We work with them either way.
RL:Do you look for synergies among your portfolio companies?
DL:We dont have to have it, but when we can its a real win.
RL: How has the environment for private equity investors changed post Internet bubble?
DL: Its all changed. Its back to basic business and making real money. But for good companies there will always be capital. We didnt get too involved in the internet thing on the upside or the downside, so were just quietly going about our business looking for great teams with business plans that make sense. But I do think funding is starting to come back for high tech as well.
RL: If an investor is interested in speaking with you whats the best route?
DL:Well, the problem with the way were set up is with private equity funds you generally raise the money then you invest the money then you raise money. So there isnt a mechanism right now for someone to invest in our fund. Its called a closed fund. But a couple years from now if we do a good job with this well raise more and keep going.
RL:How many investments this year so far?
DL:None this year. We would like to do it one per quarter, but its generally lumpy, so we could have a quiet year and then a busy year. Weve made six investments in this fund that weve had for a couple years, two or three years. And four of those companies have acquired competitors.
RL:If a potential portfolio company is looking to get in touch with you?
DL: They should just call, or email, or
go to the website.