Consolidating Equity Opportunity Industry Investors by mzh44232


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									               CIVC PARTNERS ROUNDTABLE
                                                 August 30, 2001 Chicago

              Editor’s Note: The following roundtable discussion took place prior to the unprecedented
           terrorist attacks of September 11, 2001. The subject matter as originally discussed is now even
                      more relevant in light of an increasingly challenging economic landscape.

LORI BOLIN: Good afternoon, and               result, an extraordinary amount of         the economy, we meet today with
welcome to CIVC Partners. As one of           private equity capital is available for    four partners of a successful,
the seven private equity investment           investment. According to Buyouts,          longstanding private equity invest-
arms of Bank of America, CIVC Part-           the buyout fund segment of the             ment firm. CIVC Partners, with 30
ners manages more than $700 million           private equity market where CIVC           years of private equity investment
in private equity capital provided            operates raised $62 billion in 2000,       experience, has offered to give us an
exclusively by the bank, primarily for        up from $3 billion in 1990. Total          “insider’s view” of its investment man-
leveraged buyouts and growth eq-              buyout funds under management              agement approach in today’s envi-
uity investments in mid-size compa-           have increased from $55 billion to         ronment. In our discussion, we will
nies in North America. We are here            $374 billion over the same period.         focus on four key points: First, we will
today, in the financial district of down-        On a related front, it is evident to    look at the impact of the current
town Chicago, for a discussion with           all of us that the banking industry has    market reality on CIVC. Second, we
four partners from CIVC.                      been consolidating at a rapid rate, and    will discuss the reduced margin for
    The main subject of this discussion       this consolidation is changing the         error associated with today’s private
is the strategies that this leading private   rules for private equity investors.        equity investments. Third, we will
equity player is pursuing to manage           Today’s commercial lending institu-        discuss CIVC’s investment strategies
investments in these unsettled eco-           tions prefer larger debt packages—a        and the impact of risk on those strat-
nomic times. The private equity mar-          change that tends to squeeze out all       egies. Last, we will focus our attention
ket is experiencing considerable tur-         but the most bulletproof middle mar-       on CIVC’s “continuous due diligence”
bulence as a result of heightened com-        ket acquisitions. At the same time, the    approach—along with CIVC’s advice
petition, a changing economy, and             overall availability of debt capital has   on evaluating an investment partner.
volatile capital markets. There has been      declined, as banks tighten their reins        Let me now introduce our panel-
a dramatic increase in the number of          on risk in the midst of an unstable        ists from CIVC:
private equity investors as well as in        economy. These changes, along with            To my left is MARCUS WEDNER.
the size of their investments. A new          change and instability in the public       During the past decade, Marcus has
report from Pricewaterhouse-Coopers           markets, have caused many busi-            developed an expertise in com-
and 3i Group PLC indicates that the           nesses to turn to private equity in-       munications and media and has fo-
total worldwide investment level for          vestments as a means of raising capi-      cused his efforts on opportunities in
private equity and venture capital was        tal. And this means that, in today’s       these areas. He also regularly evalu-
$177 billion in 2000, up 30% from             market, a majority of investment           ates investments in many other in-
1999. Moreover, companies raised              opportunities are under consider-          dustries, and assists portfolio compa-
$225 billion in new private investment        ation by private equity investors.         nies in developing long-range plans.
funds in 2000, a staggering increase of          So, in the midst of change in the       Marcus shares overall strategic and
67% from the previous year. As a              private equity industry as well as in      operating responsibility for CIVC.

                                    BANK OF AMERICA      JOURNAL OF APPLIED CORPORATE FINANCE
           “In the midst of this challenging environment, the private equity market is now experiencing
           increased competition. That competition, and the pressure to invest large amounts of capital,
                          has exposed the depth and quality of equity players’ strategies.”
                                                   —LORI CULP BOLIN—

He joined CIVC in 1988 and became          The Current Reality                         cycles—even we were not totally im-
a partner in 1992. He previously                                                       mune to getting caught up in the
worked in sales and marketing with         BOLIN: When an individual survives          situation that we’ve experienced the
Pacific Telesis Group and as an asso-      a heart attack, he or she often reevalu-    last couple of years. But we never got
ciate with Goldman, Sachs & Co.            ates the roles and relationships of life.   near the extremes that were evident
Marcus received his MBA from               If the private equity market, with its      in Internet or emerging telecom com-
Harvard and holds a BA from UCLA.          portfolio values crashing, has had the      panies. Nor did we believe we could
    Next to Marcus is GREGG WILSON.        equivalent of a heart attack, how has       invest in foreign markets, or try to
Gregg leads CIVC’s CEO-focused in-         that prompted CIVC to reassess its          arbitrage public and private market
vestment strategy and is responsible for   role in the market and the relation-        values in quick flip plays. We never
the firm’s marketing activities. Previ-    ships it participates in?                   went that far; but I think we found
ously, he founded and managed Maxim        WEDNER: I think we certainly have a         ourselves in real dilemmas about
Corporate Partners, a private equity       greater sense of our own mortality at       paying higher prices for companies
investment firm that acquired niche        CIVC, both in terms of our place            than we would ordinarily have felt
manufacturing companies. Gregg’s           within the private equity community         comfortable paying, because we did
buyout experience also includes stints     and at the portfolio company level.         feel the need to put money to work.
in leveraged finance with both Citicorp    Some of our companies are in the            HELLE: While I agree with that, I
Leveraged Capital and Continental          midst of some real recessionary times,      would say it also exposed a strength
Bank, and he has served as interim         and the kind of performance they’re         in our fundamental strategy of focus-
CEO of a CIVC portfolio company. He        experiencing is not unlike a cata-          ing on value. In the last couple years,
received his MBA and BS degrees from       strophic illness. I’m not sure we would     we couldn’t find good investment
Indiana University.                        ever have dared to predict that it          values. So, we focused on where we
    To my right is DAN HELLE. Dan          could really get this bad. The experi-      could find the best relative values.
directs CIVC’s Financial Services in-      ence here the last year or so has been      Especially in the lower middle market
vestment strategy and shares overall       very humbling. It has forced us to          where we’ve been operating, our
strategic and operating responsibility     think about the basics, about what          focus will remain on value and invest-
for CIVC. He joined CIVC in 1990 and       we’re really here to do, and the kind       ing in growth. It may be a manufactur-
has been a partner since 1992. Dan         of principles that have driven our          ing company, it may be a service
spent many years in the Mezzanine          business historically that probably         company, but it’s going to have to be
Investments Group with Continental         got a bit out of whack in the last two      a good relative value in terms of its
Bank and in Citicorp’s Leveraged           or three years. We are working very         growth potential.
Capital Division. He received an MS        hard both to return to the basics and       BOLIN: Today’s environment is also
in Finance and Economics from the          to spend a lot more time thinking           springboarding a number of “spe-
University of Illinois and a BS from       through how we will adjust to what          cialty” investors in the private equity
Western Illinois University.               could be a challenging environment          market. How do you differentiate a
    Also joining us is CHRIS PERRY.        for quite some time.                        generalist from a specialist? How
Chris shares overall strategic and         BOLIN: In the midst of this challeng-       would you define yourselves?
operating responsibility for CIVC, and     ing environment, the private equity         HELLE: I think that there are a lot of
has led most of the firm’s Business        market is now experiencing increased        specialty firms that could focus on
Services investments. He joined the        competition. That competition, and          healthcare, insurance or telecom,
private equity business as a partner at    the pressure to invest large amounts        etc. It’s tough to focus on any particu-
CIVC in 1994, after running Continen-      of capital, has exposed the depth and       lar industry; however, because each
tal Bank’s Mezzanine Investing and         quality of equity players’ strategies.      segment has its own cycles. If you
Structured Finance businesses. Previ-      What have the last two years or so          focus your entire firm on, say, health-
ously, Chris served in the Corporate       exposed within CIVC and your port-          care, you could find yourself with
Finance Department of The Northern         folio?                                      very few investment opportunities
Trust Company. Chris received an           WEDNER: I guess the way I would             for a period of three or four years. It’s
MBA from Pepperdine University and         answer that question is to say that         tough to build a firm with a narrow
is a certified public accountant. He       even our very conservatively run            focus. We are a multispecialty firm,
earned a BS from the University of         group—a group that’s been around a          with expertise in media, communi-
Illinois.                                  long time and has been through some         cations, financial services, business

                                               VOLUME 14 NUMBER 3     FALL 2001
          “We’ve never had a home-run orientation. And we’ve taken specific steps to deal with the lower
            margin of error...If you go back five years ago and compare yesterday’s management teams
               to the teams we have today, there is no question that we are absolutely more selective
                                  about the people we are willing to partner with.”
                                                    —MARCUS WEDNER—

services, and facility-based business      investments. As you said, there’s less     BOLIN: Word on the street is that
services. We think this is a sustain-      margin for error and, over the long        there are very few really good private
able business model that gives us          term, we know that strategy will pay       equity deals today. So it’s not just
enough opportunity to build on.            off for us.                                finding a needle in a haystack—it’s
WEDNER: We have certainly gravi-           WEDNER: I agree. We’ve never had a         finding the right needle in the right
tated more toward our historical           home-run orientation. And we’ve            haystack. How does the performance
industry specialties—to the point          taken specific steps to deal with the      of your portfolio validate your strate-
that we are far more discriminating        lower margin of error. First, we sub-      gies for pinpointing the right deals?
within those industry specialties. The     stantially raised the bar on the quality   HELLE: Let me give you an example:
best proof of this is that we are much     of the management teams we invest          In the financial services area, we zero
more likely to turn down an invest-        in. If you go back five years ago and      in on segments that we think combine
ment opportunity if it doesn’t hit         compare yesterday’s management             growth with some sustainability and
something we either know or are in         teams to the teams we have today,          long-term strategic buyer appeal. For
the process of studying. We can            there is no question that we are           instance, when we look at insurance,
identify a “fit” far sooner than we        absolutely more selective about the        there are lots of segments within the
could five or ten years ago.               people we are willing to partner with.     insurance industry that we just gener-
PERRY: And yet, we also better un-         Second, we make better use of out-         ally wouldn’t find appealing. But our
derstand what types of business char-      side resources for corporate gover-        own research showed that long-term-
acteristics we’re looking for, so when     nance. At one time, we relied on           care insurance made good invest-
an opportunity comes along that            ourselves to a large degree, and were      ment sense—so we actively sought
doesn’t necessarily fall neatly into a     only sporadic users of independent         out a specific long-term-care insur-
box, we’re still capable of respond-       board members for the company              ance company. We liked the com-
ing. We recently did a deal with LA        boards we sit on. Today it is much         pany, we liked the management team,
Fitness that didn’t fit our boundaries,    more important for us to have outside      and we made a proposal for an invest-
but we loved the business model            board members who add value, who           ment that would provide capital for
and it met our criteria for value and      understand the business, and who           statutory purposes and support
growth potential.                          can help out the management team           growth, as well as buy out some
                                           by bringing in the perspective as well     shareholders. They didn’t like our
Reduced Margin for Error                   as the competence and credibility that     valuation at the time and passed on
                                           companies with $50-200 million in          our offer. In the meantime, we looked
BOLIN: When it comes to new deals,         revenue really benefit from. So we’ve      at a number of other long-term-care
there is less margin for error in the      taken some specific steps to try to        companies and, even though it is a
private equity market today than a         attack this margin of error problem.       good segment in terms of pricing
few years back. It’s as though equity      PERRY: The private equity invest-          and returns, we did not find any
players are trying to hit a home run       ment business has become a lower-          other good, well-rounded compa-
every time they’re at bat—and at a         return business in part because of the     nies that fit our criteria. So when the
time when you no longer get three          vast amount of capital that has been       original company came back to us
strikes.                                   raised for private equity investments      we were prepared to move. But in
HELLE: I think you’re right, although      but also because of the reduced ac-        the meantime we did not feel that it
CIVC Partners has historically chosen      cess to debt capital. We’re no longer      was necessary to get into that seg-
to pursue a lower-volatility invest-       able to put just 10% equity into com-      ment just to be in that segment.
ment strategy. That means we take          panies. In most cases, we now have         WEDNER: We have also been a lot
fewer risks—and maybe sacrifice a          to put in 40%. While this clearly          more active in terms of investing
few home runs in the process. There        reduces downside risk, it puts more        additional capital into our portfolio
have been moments in the past when         pressure on growth. To achieve the         companies and being able to operate
we’ve really regretted that strategy,      50-60% returns we’ve become ac-            as a strategic buyer. That means in
but today it is paying off. I have no      customed to, everything has to work        each instance, we have a haystack
doubt there will be a time when we’ll      right, including a premium exit valu-      and a needle we already know. And
regret it again, but we will continue to   ation. And we absolutely have to stay      rather than go and try to find another
stick to what we know best, and            close to our companies and proactively     haystack or another needle in the
continue to stick to lower-volatility      add value.                                 same haystack, we have said, “Let’s

                                  BANK OF AMERICA     JOURNAL OF APPLIED CORPORATE FINANCE
          “In the financial services area, we zero in on segments that we think combine growth with some
        sustainability and long-term strategic buyer appeal. For instance, when we look at insurance there
         are lots of segments within the insurance industry that we just generally wouldn’t find appealing.
            But our own research showed that long-term care insurance made good investment sense—
                       so we actively sought out a specific long-term care insurance company.”
                                                       —DAN HELLE—

work this one very, very hard.” Al-        we’re investing in an existing portfo-        unrealistic. The best businesses are
though we have been fortunate in           lio company or in a new company as            those that are built over time, because
finding new opportunities, the best        long as we’re investing profitably.           those are the ones that are by defini-
opportunities for us have been the         Ultimately, what we’re looking to do          tion sustainable and have developed
ones that we have already created.         is maximize capital gains on the dol-         a competitive advantage and a place
                                           lars that our limited partners are giv-       in the market. There’s just no substi-
Investment Strategies: New                 ing us to invest. That’s the real test.       tute for time to really get there. If you
Platforms or Portfolio                     WEDNER: I think that’s right. The             want to build a great business, if you
Reinvestment?                              private equity business, as it has grown,     want to create the kind of business
                                           has attracted a lot more press cover-         that you can develop through acqui-
BOLIN: We’ve been talking quite a bit      age—both general press and trade              sitions, then you should get involved
about industry specialization. Marcus,     press coverage. It can be a colorful          in a business that’s got the kind of
you’ve just said that you see more         business; it includes colorful person-        return on capital potential to enable
value in the strategy of investing         alities. It’s highly competitive—and          you to stay with it for a long time so
through your current portfolio com-        there’s been a much greater focus on          that you do not have to turn the
panies. How would you respond to           public relations, although it’s true that     portfolio just for the sake of turning
industry critics that might say you’re     the new deals tend to get the press.          the portfolio. For that, you simply
being short-sighted, and that you’re       You don’t get as much publicity by            must have patience.
really just pulling in the horns during    saying, “Transwestern Publishing, the         BOLIN: Has your patience some-
an economic downturn?                      independent yellow pages company,             times frustrated other partners?
WEDNER: Frankly, I think that maybe        just did a $200 million acquisition for       WEDNER: In situations where we’re
a year ago, some people might have         a fantastic price.” So we don’t see our       in control, people have sometimes
had those criticisms. But I would be       names in lights as much. But that’s           thought we should be doing things
quite surprised if someone were now        not a focus for us. Frankly, if we had        that we felt were too expedient and so
criticizing us for sticking to our knit-   enough strong companies with                  we disagreed with them, but it hasn’t
ting. During a period when prices          strong management teams that we               really affected our approach. Even in
were high and leverage was difficult,      didn’t have to do another new deal            situations where we share control of
competition for transactions was in-       for two or three years, nothing would         a company with other private equity
tense. It was really those factors that    make us happier. It’s a very efficient        firms, there have never really been
led us to work with our existing           investment model. Doing deals for             any times when we’ve said either
portfolio companies, rather than a         the sake of doing deals has proven,           “Let’s stay the course,” or “Let’s keep
feeling that “we’re frightened of the      time and time again, to be a disas-           the investment longer,” and our in-
environment, let’s pull in our horns.”     trous approach to the business. We            vestment partner didn’t think it was a
By the same token, acquisition prices      simply have a more patient approach           good idea.
are down, so this year has been a          to investing.                                 HELLE: That’s certainly true. On the
pretty active year for us even though      BOLIN: Why does patience matter?              other hand, I think our patience has
it has been fairly slow in the business    WEDNER: Well, I’ve always thought             sometimes frustrated other constitu-
generally. We expect next year to be       that middle market companies, which           ents from the standpoint of our not
an even more active year as well. So       are the companies we get involved             investing private equity capital at a
we expect to be criticized for taking      with, are rather fragile entities by          huge rate, so that a year goes by and
risks in a very uncertain economic         nature. They tend to rely on a small          we find we’ve only done a couple of
environment—but that kind of criti-        number of managers, on the chemis-            deals. Then maybe our limited part-
cism I think we can live with.             try those managers have together,             ner has gotten a little impatient with
WILSON: By the way, investing in           and on the relationships they’ve got          us, and maybe our junior staff has
existing portfolio companies and           with their customers and suppliers. If        gotten a little impatient with us be-
building existing portfolio companies      a culture changes or a business envi-         cause the pace of activity has been
through add-on acquisitions is an          ronment changes, then the fragility of        slow. But, again, there are times when
excellent way to create value and to       this structure is exposed. So the idea        it should be slow.
generate growth—and to earn above-         that you’re going to take a terrific little   WEDNER: As entrepreneurial as we
average returns in the business. Fun-      car and try to drop a big monster             may seem to many of our banking
damentally, it doesn’t matter whether      engine in it and say “Go!” is just            community friends, the entrepreneurs

                                               VOLUME 14 NUMBER 3       FALL 2001
who own growing companies are             BOLIN: So are you saying, in more          tion. Somebody else was willing to
often very impatient with us and          turbulent times, you have to adjust        pay eight times—but the lenders
think that we’re far too conservative     your IRR expectations based on ex-         weren’t willing to lend more money,
in our approach to things. Their feel-    pected risk?                               so they just put in more equity to do
ing will be, “Gee, we really ought to     PERRY: Absolutely. And while there’s       the deal. If we had done the deal,
be running down the road on this          no “formula,” if in our judgment a         and everything had worked out, we
one,” and we’ll be saying, “Where         company has low earnings volatility        would have achieved a 30% rate of
does that road lead? Build the busi-      and a valuable liquid asset base, then     return on our investment. But we
ness plan. Forecast the outcomes. We      the return we should expect from           knew, due to the customer concen-
don’t mean just stick your finger in      investing in it is going to be lower.      tration risk, that we needed at least
the air and feel which way the wind       From a risk-adjusted standpoint, of        a 40-45% rate of return to do the
is blowing. Measure things.” And          course, it can still be very good. For     transaction. People will have differ-
when we do that, it often frustrates      example, several years ago we in-          ent judgments about the relative risk.
people. But in the end, these strate-     vested in a reinsurance company, not       A 30% IRR might be okay in some
gies lead to greater and greater risk-    because we thought we were going to        cases—and it might underprice the
adjusted IRRs.                            make a 35 or 40% rate of return on it—     risk in the company in other cases.
BOLIN: How do you measure the             in fact, our projection showed we’d
risk-adjusted IRR?                        make considerably below this norm—         Continuous Due Diligence
WEDNER: People in our industry            but because on a risk-adjusted basis,
tend to talk about internal rates of      we were confident of a very good           BOLIN: Evaluating those risks is part
return or IRRs in general terms, al-      return. For an inherently low-risk         of the due diligence process. How has
though individuals managing institu-      business, we are willing to accept a       your approach to due diligence
tional funds certainly can appreciate     lower absolute return.                     changed over the last few years?
the concept of a risk-adjusted IRR.       HELLE: As another good example of          WILSON: We’ve always been very
And they know the difference be-          that, seven years ago we looked at a       due diligence intensive—but we now
tween a 100% IRR that has resulted in     plastic injection molding company. It      perceive it to be much more of a
a doubling of the investment, versus      was supplying a global communica-          continual activity, and we are much
a 30% IRR that has resulted in seven      tion company’s cellular phone divi-        more formal and proactive in analyz-
times the investment. Unfortunately,      sion with plastic parts for the housing    ing industry and industry segment
there’s no standard by which to distin-   of the phone itself as well as for the     data. We seek out corporate leaders
guish between a general and a risk-       battery. Somebody else swooped in          with specific industry expertise to
adjusted IRR. So you’re left with more    and bought them for a multiple that        independently advise us as to the
of a qualitative approach if you’re       was about two multiple points of cash      nuances of the industries we are
trying to compare the track record of     flow higher than what our analysis         involved in or are considering getting
one private equity group with an-         suggested. They rationalized that price    involved in. We have always sought
other. You need to look past the IRRs     to their limited partners by saying that   to understand the underlying eco-
and ask what kinds of businesses          it was based on the growth of the          nomics of any industry in which we
they are investing in and the inher-      cellular phone business. If you bought     invest. Today we are simply doing a
ent risk—technology, financial, or        Motorola, for example, it would sell       more thorough job of analyzing our
balance sheet risk—of those sorts of      for 40 times earnings but they had         information.
investments. You need to look at how      only paid eight times earnings for that    PERRY: If you were to ask people
they’ve made their money. Has the         same growth. But there were some           we’ve done deals with, they would
business appreciated in value be-         specific risks there, too, and two         say we’ve been consistently demand-
cause cash flow has grown? Because        years later the global client company      ing over the years, and probably very
multiples have gone up? We’re fortu-      had entirely shifted its strategy for      frustrating, in our due diligence pro-
nate in that we’ve got very high risk-    the procurement of the battery hous-       cess. If we’ve made any changes,
adjusted IRRs, and good absolute          ing, so this company lost one-third        they’ve been at the margin. We’ve
IRRs too. But when you add in some        of its business. We had determined         always focused on understanding his-
of these qualitative factors, you get a   that we would only pay about five          torical financial performance, basic
better picture of the risks associated    times cash flow because of the risk        business economics, the competi-
with the investment.                      inherent in the customer concentra-        tive landscape, strategic pluses and

          “We’ve always been very due diligence intensive—but we now perceive it to be much more of a
        continual activity, and we are much more formal and proactive in analyzing industry and industry
       segment data. We seek out corporate leaders with specific industry expertise to independently advise
          us as to the nuances of the industries we are involved in or are considering getting involved in.”
                                                     —GREGG WILSON—

minuses, etc. But today we are far          accurate predictor of future perfor-       of distribution and it doesn’t really
more analytical about the operation         mance. So, frankly, we look for indus-     make sense to try to change it. But in
of the business within its industry,        tries with limited volatility—which        a lot of businesses, whether they
about its management team—and its           puts less pressure on management.          operate in industrial products or ser-
agility. We want to know if this horse      Brickman, one of our very well-run         vices, there are multiple ways to de-
we’re about to ride can really run.         portfolio companies, is a commercial       liver to the customer. There’s a direct
BOLIN: How do you assess a man-             landscape services company with a          method; there’s an indirect method;
agement team—particularly in tough          recurring revenue business model.          there’s a higher-touch, higher-service
economic times?                             Transwestern, our yellow pages com-        method; and there’s a lower-touch,
HELLE: We’ve been through good              pany, has a terrific management team,      lower-service, lower-cost method.
times and bad with many different           and yet it really doesn’t experience       One of the things that the information
companies, so we’ve learned to be           the impact of economic downturns           revolution has enabled people to do
able to judge when a CEO is sales and       the way many other companies do.           is to open and explore different chan-
marketing oriented to the exclusion         WEDNER: There are other aspects            nels of distribution that used to be
of good cost containment, especially        of the business model that we are          cost ineffective. We closely monitor
when the market is turning. Those           probably a lot more sensitive to than      how dependent our portfolio compa-
two abilities won’t always exist within     we might have been in the past. One        nies are, or could be, on direct versus
the same individual. The question then      is customer concentration. Particu-        indirect distribution channels. Do we
becomes whether another senior              larly during the real robust eco-          have higher fixed costs through a
member of the team has the ability to       nomic growth days, there were              direct distribution model, or lower
contain costs and to react to a down-       people who built small companies           costs through an indirect model that
turn—and whether the CEO will               into medium-size companies on the          we don’t control? Are there other
permit that. And if not, at what point      back of very strong sales and mar-         players out there that are trying to
is a change in management neces-            keting. They call it “grabbing the         attack the distribution channel differ-
sary to avoid a crisis? I think we try to   tiger by the tail.” Then, when it came     ently? We’re far more aware of this
do as good a job as we can to find          time for an additional equity invest-      today than we were five years ago.
agile CEOs, but they are not always         ment, they recognized that they            BOLIN: Given today’s fast-moving
the right people for all of the circum-     hadn’t really built up the discipline      environment, has your intensive due
stances one can envision.                   or the internal know-how to manage         diligence been a help or a hindrance?
WEDNER: It may sound simplistic,            for growth or to manage their costs        WEDNER: It has certainly slowed us
but the quickest way to identify            down again. They were in a highly          down in some cases. But, on balance,
whether or not somebody can man-            vulnerable position. I think we’re a       it has been a big positive for us
age during a downturn is to look back       lot more sensitive to that problem,        because it has prevented us from
at who first raised the issue of con-       having learned the hard way what           doing things that we shouldn’t have
tinuing with the existing strategy ver-     it’s like to be at the end of that whip.   done far more times than it has pre-
sus changing the strategy given the         HELLE: I agree completely. It’s what       vented us from doing things we should
current environment. If you took our        companies saw in the ’60s with Sears.      have done.
portfolio and asked who approached          Sears was a great customer to have         PERRY: I can think of two recent
whom in a downturn—did they ap-             and they rode it up high. Then they all    examples where we were in highly
proach us or did we have to go to           got whacked in the ’70s. And in the        competitive situations that we wanted
them?—you would have a very neat            ’70s, different people were making         to pursue—but lost or passed on the
division between those managers who         the same mistake with IBM. And in          deal because the process set up by the
have the right mindset and those who        the ’80s they were making it all over      sellers wouldn’t allow a thorough due
perhaps aren’t quite as agile. They         again with Hewlett Packard, and in         diligence process. One of them has
may not have the tools necessary to         the ’90s with Home Depot or Wal-           since had trouble, for exactly the
manage through, but it all starts with      Mart. You can play that game, but don’t    reasons we identified in our due
the mindset.                                kid yourself about the risk entailed.      diligence. Would we have walked
WILSON: Another way to address              WEDNER: Another area of the busi-          away from the deal? Not necessarily,
that issue is to accept that inevitably     ness model we’re more sensitive to is      but we would have taken a different
management teams are tough to               the distribution strategy. Sometimes       approach than the strategy they
judge and it’s rare that the past is an     there’s one obvious low-cost channel       wanted to pursue.

                                                VOLUME 14 NUMBER 3     FALL 2001
         “We’re no longer able to put just 10% equity into companies. In most cases, we now have to put in
           40%. While this clearly reduces downside risk, it puts more pressure on growth. To achieve the
        50-60% returns we’ve become accustomed to, everything has to work right, including a premium exit
            valuation. And we absolutely have to stay close to our companies and proactively add value.”
                                                          —CHRIS PERRY—

HELLE: Another good example is our             Concluding Advice                             It’s not hard to find out how long their
investment in First Franklin. That’s a                                                       hold periods are, and it’s certainly not
case where we were able to see value           BOLIN: Well, we have certainly cov-           hard to find out where in the course
in a segment that other people didn’t          ered a lot of ground today. I’d like to       of the life of their fund they are.
see. We first got involved with the            conclude with this question: What             Compatibility is important in all of
company in May of 1996 and closed              advice would you give about evaluat-          these areas. We have had situations,
it that November. There were many              ing a potential investment partner’s          even with people we know well, where
times along the way when we didn’t             due diligence process and their ability       on the front end of a transaction we
know whether or not the deal would             to effectively identify an appropriate        agreed on a hold period of three to
close. Each step of the way, new               investment—particularly in today’s            seven years, and then 18 months into
information would be revealed, and             changing environment?                         it the partner wanted out because
we would insist on an adjustment in            WEDNER: Certainly if you know the             “their circumstances have changed.”
valuation—so the negotiations                  group already, it makes things a lot          Particularly if things are going well,
stretched on and were very challeng-           easier. There are certain groups we           that is a potential source for tension.
ing. A couple of years later we might          have worked with multiple times               HELLE: I would also advise making
not have been given the opportunity            whom we understand and who gen-               sure that your investment partner
to be as thorough as we were—we                erally think like we do and who have          thoroughly understands the funda-
would have lost the deal to someone            led us to, if not always profitable           mentals. They need to be able to
who was willing to move more quickly.          relationships, at least consistent think-     articulate the macro trends affecting the
But it turned out to be a great value for      ing during the course of the invest-          business as well as the basic unit eco-
us. And having been through that               ment. When you’re evaluating a new            nomics of providing the service or the
exercise, we were then able to respond         investment partner, you need to spend         product. As Marcus mentioned earlier,
very quickly on many other transactions        a lot of time really figuring out how         they need to understand each of the
in that segment—although we walked             decisions are made in that partner’s          channels through which they deliver
away from most of them, and in hind-           firm. For one thing, the person you’re        that service or product. If they can’t talk
sight, we’re glad we did. But I think that     talking to—even if they appear to be          about the cost of delivering that product
our experiences in multiple sectors            calling the shots—may not be the              or service and the value available through
have allowed us to become faster judges,       decision-maker at all. Without a clear        each of the channels, as well as the
although we’ve had to go through a lot         understanding of the decision-                macro factors that will affect demand
of arduous education to get there.             making process, you’re going to get           over the next several years, and the
WILSON: And responding quickly in              inconsistency with an investment part-        competitive situation over the next
a transaction is less about how much           ner both on the front end and through-        several years, then I would really
due diligence you do, but how quickly          out the investment. You also need to          question their span of control over
you can organize the information—              look at how the potential partner ap-         that particular opportunity.
how quickly you can assimilate your            proaches the corporate governance             BOLIN: Good advice. Thanks to ev-
findings and understand them and               process as well as its exit strategies. You   eryone here at CIVC Partners for a
process those results. It’s not just the       have to be compatible on those fronts.        lively discussion. I appreciate your
amount of ground you cover. If you             It’s not at all hard to find out how          willingness to speak so candidly
know an industry well, you can cover           people tend to exit their investments—        about your strategies for managing
a lot of ground a lot faster than some-        through an IPO, through a recap,              private equity investments in these
body without that industry expertise.          through a sale to a strategic buyer, etc.     turbulent economic times.


is President and Owner of Corporate
Creations, Inc. and a strategy consultant to
the financial services industry.

                                     BANK OF AMERICA       JOURNAL OF APPLIED CORPORATE FINANCE

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