PRIVCAPDIGEST/ The Monthly Magazine

of Privcap.comJuly 2013

This publication is exclusively for Privcap subscribers © 2013 Privcap LLC

Subtracting Value: The US Middle-Market Faces Healthcare Costs A senior executive from PE firm The Riverside Company talks Obamacare

In This Issue:

The Rise of Shadow Capital/ 04 The IFC’s Global Picks/ 06Investing in Manufacturing Companies / 10The 100-Day Plan/ 14

Privcap Digest / July 2013 / 2

2 / Contents

Privcap LLC

David SnowCo-founder and CEOGil TorrenCo-founder and President

Content

Matthew MaloneEditorial DirectorTanya KlichMedia ManagerKathleen O’DonnellMedia Coordinator

Design

Miguel BuckemeyerArt DirectorVasheena DoughtyProduction

Contributors

Tim DevaneyDanielle Fugazy Tom Stein

Contacts

EditorialDavid Snow / dsnow@privcap.com(646) 233.4558Matthew Malone / mmalone@privcap.com (646) 801.2337Sponsorships & SalesGill Torren / gtorren@privcap.com(646) 233.4559For subscriptions, please call 855-PRIVCAP or email subscribe@privcap.com

About Privcap Digest

Privcap Digest is a monthly publication exclusively for Privcap subscribers. It o!ers in-depth features and edited summaries of the most recent and important thought-leadership from Privcap.com. The Privcap editorial team has extensive experi-ence reporting on the global alternative investment industry.

For inquiries about the Digest, please contact Matt Malone at mmalone@privcap.com.Copyright © 2013 by Privcap LLCAll rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the Privcap LLC. For permission requests, contact Gill Torren at gtorren@privcap.com.

In This Issue

QuotableA roundup of market intelligence shared on Privcap.com

Snow’s NotesShadow Capital: When private capital forms outside of funds, does it count? By David Snow

The IFC’s David Wilton Looks AheadThe influential CIO discusses the IFC’s mission as well as important changes in China and India

Deal Story: Advanced Lighting Technology Christian Oberbeck of Saratoga Partners tells how his firm took the company from Chapter 11 to new growth.

Must See Upcoming programs on Privcap.com

FeaturesConsumer Brands and VCMeet the consumer-brand-focused early stage investor that counts NBA star Steve Nash as a partner.

The U.S. Manufacturing RenaissancePrivate equity is taking notice of this long-overlooked space for deal flow.

The Value of the 100-Day PlanHow do firms execute change during this critical timetable?

The Cost of Obamacare Pam Hendrickson of the Riverside Company on why the new health care act may be a burden for middle market private equity firms.

From Our SponsorsExpert Q&A Ed Kleinguetl of Grant Thonrton

Interview transcripts in this issue have been edited for clarity and length.

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Up Front

Privcap Digest / July 2013 / 3

Professionals from the following firms and organizations recently appeared on Privcap:

Kerogen Capital

Quotable/

A change at the CEO level more than doubles the complexity

around change.” Jack Purcell, Ridgemont Equity Partners, Management” )Link

!e overhang is coming up o" of its own nadir and is starting to

crest again.” Andrea Auderbach, Cam-bridge Associates, from “The Private Equity

)Link

What we've seen since 2001 is an increased professionalization of

the investment banking community in the lower middle market. As a result, it's become a much more competitive and e#cient market…” Scott Budo), Saw Mill Capital, from “Where Have All the Good

)Link

Is Brazil too hot, is it overheated? What we are seeing is that Brazil

has a great span of companies that could benefit from private equity capital.”Cesar Collier,

)Link

Form ADV is a very simple form, very straightforward. But the

obligations under that and the changes in the way you have to operate are burdensome and costly.” Richard Ja)e,

-raising and Regulation” )Link

I’m fairly bullish, and the reason for that is I think there is a high

degree of volatility and a high degree of uncertainty, and a di#culty in fore-casting the future…” Kevin Conway,

)Link

A roundup of market intelligence shared on Privcap.com

3 / Market Intelligence

On Camera

Privcap Digest / July 2013 / 4

tatistics from the private equity fund-raising market tell an important story, but increasingly they don’t tell the whole story.

As you read this, billions of dollars are being earmarked for private-capital strategies around the world. But not all of it will be deployed through traditional third-party limited partner-ships. If market participants want to make sense of the changing dynamics in private capital, they need to better chart what might be called the “shadow” market—money invested directly into private com-panies and assets by institutional investors and family o#ces, or via nontraditional vehicles that in-dustry data providers often don’t track.

!is important point was explained to me in a recent Privcap panel conversation I moderated about the so-called “overhang.” Cambridge Associ-ates’ Andrea Auerbach argued that the infamous overhang in capital commitments might not be re-ceding as slowly as has been widely observed. “!is overhang that we’re talking about is on traditional

private equity funds that have raised capital,” Auer-bach said. What wasn’t being counted, she said, was the overhang of co-investment vehicles. “!e num-ber of institutions that have capital earmarked for that could very well swamp this overhang and also create interesting dynamics in certain pockets of the market,” she explained.

In other words, significant money being put to work, but not in the usual, well-documented ways. With a market characterized by larger institutions, including huge new entrants, bypassing limited partnerships in favor of co-investment and direct investment, it is clear that the definition of “capital formation” needs to be broadened.

Take, for example, the recent deal news from Canada, the Saudi Arabia of institutional direct-investment capital, which saw two public entities partner to acquire a business via their direct-invest-ment programs. OMERS Private Equity (a#liated with the Ontario Municipal Employees’ Retirement System) and Alberta Investment Management Corp. will buy the European theater chain Vue Entertain-ment for C$1.5 billion. !e money comes directly from the balance sheets of public pensions and en-dowments. If we assume that about $500 million in equity is going into this deal, it’s $500 million that in an earlier era would have gone through a fund and been counted in fundraising statistics.

Years ago, before I co-founded Privcap, I was de-veloping the methodology behind what is now called the PEI 300—a widely used ranking of the largest private equity programs in the world—and faced a similar challenge. !e core ranking meth-od counted how much equity had been raised by a given GP over the most recent five-year period. But we kept bumping into groups that didn’t primar-ily raise capital in blind-pool, third-party funds. One firm, American Capital, had raised a substantial amount from the public markets and deployed it in private equity. Another, the CPP Investment Board, got its PE money from the Canada Pension Plan. We expanded our methodology to include “capital

Market analysis by Privcap CEO David Snow

If market participants want to make sense of the changing dynamics in private capital, they need to better chart what might be called the “shadow” market—money invested directly into private companies and assets by institutional investors and family o!ces, or via nontraditional vehicles that industry data providers often don’t track.

. CONTINUES ON NEXT PAGE

4 / Commentary

Snow’s Notes

Shadow CapitalWhen private capital forms outside of funds, does it count?

Privcap Digest / July 2013 / 5

formed” where regular fundraising did not apply. Today, the CPP Investment Board ranks 20th among the largest private equity funds in the world, with no regular fundraising at all.

!e growth of this “shadow” market won’t re-verse itself. In fact, the opening of new markets to the asset class will only increase nontraditional structures. Consider the rush among some large PE firms to create “40-Act” vehicles—publicly listed en-tities that feed capital from public-market investors into alternative investment strategies. Consider, too, e"orts by firms like Pantheon Ventures to create vehicles for “defined-contribution” investors, the 401(k)-like counterparts to defined-benefit plans, to allocate to private equity strategies.

!e deal of the future may look like this: An oper-ating team acquires a private business using capital cobbled together from a sovereign wealth fund, a private equity fund, and a collection of investment

5 / Commentary

vehicles raised via public markets and defined-contribution plans. !e investments are expertly screened, acquired, and managed, but the capital comes together in ways we are only just beginning to accept as normal.

!e good news for the private equity market is that an uptick in fundraising numbers doesn’t fully reflect an even stronger desire among global inves-tors to allocate capital to the asset class. !e bad news? Managers of traditional funds won’t direct-ly control the entire measure of this interest, or at least be able to charge full fees against it.

$Private capital will continue to become more complex as it grows larger and larger. !e bean-counting specialists that emerge to accurately chart its many moving parts will become enormously valuable.$ !

L Follow David Snow on Twitter @SnowsNotes

Privcap Digest / July 2013 / 6

The IFC is looking at new frontiers within well emerged markets

By Christopher Santoro

avid Wilton, CIO of the Internation-al Finance Corporation (IFC), mapped out for Privcap in a recent interview his firm’s mandate with regard to the emerging markets. He spoke at length about changes to the In-

dia and China markets, and why pockets of fron-tier-like growth remain in these otherwise very emerged markets.

Since 2000, the World Bank’s private equity arm, the IFC, has backed private equity managers in emerging and frontier markets across world. It has been an early and significant investor in the now-robust private equity markets of China, India and Brazil. Today, the IFC is busy in less-developed markets like Indonesia, the Philippines and !ai-land. !e IFC intends to commit $500 million a year to achieve its goals of capital-markets devel-opment in key markets.

Evolving Mandate A key goal of the World Bank is development and job growth in the developing world. !e develop-ment of local private equity markets is seen as be-ing key to this goal as it funnels capital to entre-preneurs and helps in the development of local capital markets.

!e IFC’s mission has been largely successful in the larger markets like China and India—so successful in fact that the IFC has seen fit to with-draw as an investor in the many well developed managers in these regions. However, Wilton o"ered his views on the new dynamics in these markets. In China, Wilton has witnessed the transition from state-level socialist intervention to a more e#cient market economy. A “genera-tional change,” according to Wilton, is causing control positions to open up for o"-shore buyers with the wherewithal to access them. !e genera-tional deal-flow is in part attributable to China’s

long-established one-child policy, creating even more pressure on founders. “In these evolving markets, you always get a surprise, and that’s been one of them,” he said.

In India, the IFC has watched giant conglom-erates slowly become open to selling parts of their empire. Like China, there has been an increased availability post-crisis of control positions for GP’s. Pre-crisis, division sales were “just not a part of their culture,” said Wilton. !is is also owing to a concur-rent increase in competitive pressure to consolidate. More and more, “there is no loss of prestige with portfolio wealth. So exiting a company is becoming less psychologically di#cult.”

Once commercial money is seen entering a local market, the IFC considers its mission complete and redirects its attention to other interesting oppor-tunities in the region.

Frontier Markets While Shanghai and Mumbai may not be in need of the IFC’s capital as much as these markets once were, the IFC has been active in the under-penetrated portions of the Pacific Rim. While some countries have graduated from their dependency on IFC investment, others are still showing deal flow capable of absorbing further incoming capital. !e Philippines and !ailand are among those attractive markets. !e IFC is also in the first phase of vetting possible control positions in Myanmar after its transition from military rule. “!ere are two sets of issues. One is just: Is there enough deal-flow suitable for private equity? Another is the extent of [political] exposure.” Until the IFC has gained clarity on these two issues, the verdict is still out on the appropriate level of private equity investment in Myanmar.

Vietnam has become less attractive for the IFC in recent years, as the Vietnamese government continues to mishandle its accession to the WTO, and various other macro issues prevent the free flow of private equity deals. But Wilton remains optimistic. “We think that’s going to fix itself... So Vietnam remains of interest.”

A key strategy of the IFC has been to identify sub-regions within big countries like China, India and Brazil that can still benefit from more private equity capital and therefore warrant support from the IFC. Says Wilton of China: “We just decided last year to start expanding, trying to find opportunities in the far west and the far north.” !

China, India 2.0Click to watch this video at privcap.com

6 / Emerging Markets

7 / Deal Story

Privcap Digest / March 2013 / 7

Saratoga Partners !Advanced Lighting Technologies (ADLT)

As told by Christian Oberbeck, Managing Partner

When senior lenders forced ADLT into bankruptcy, Saratoga Partners looked closer and saw vibrant earn-ings due to operations in India. Saratoga worked with management to learn the unique cyclicality of the industrial-lighting business. “One of the oversights was that that entity didn’t properly take care of management; management was an afterthought,” said Oberbeck. !e firm was able to consolidate control through a “cram-up plan” via a so-called indubitable equivalent. Soon after, it acquired a German light-ing business and GE’s CEMA brand in India. !e company has since doubled in EBITDA. Watch the whole story here )Link.

The Story

Before the announced

reorganization plan, the company’s

revenues were at

*($!M and EBITDA at

*('M

Click to watch this video at privcap.com

“ We found the outstanding publicly announced organization bid by the major creditor was mispricing the company. The company was actually worth a lot more.” –Christian Oberbeck

The companyOriginally spun o! from General Electric, ADLT designs, manufactures, and markets lighting materials for large spaces, e.g., sports stadiums, parking lots, airports, conven-tion centers, streets, gas stations, construction projects, etc.

Deal Details Saratoga acquired it in 2003 by co-sponsoring a Chapter 11 reorganization plan with company management.

Other investors Wells Fargo Foothill, with a $30 million senior secured credit facility.

"##$

Privcap Digest / July 2013 / 8

Must See /Upcoming programs on Privcap.com

8 / Calendar

Upcoming programs on Privcap.com

Calendar July 2, 2013

Sourcing, Financing and Closing Deals Experts from Denham, Vision Brasil and Ernst & Young discuss how to execute" Brazilian real asset deals

PE Capital Confidence is Up Mike Rogers highlights the key findings of Ernst & Young’s recent PE Global Capital Confidence Barometer report.

July 8, 2013

Complex Carve-Outs A conversation with Joshua Adams of OpenGate Capital.

Food and Beverage Part 1 The kicko! to Privcap’s series on PE trends in the food sector.

Expert Q&A with William Spizman A conversation with the"managing director in RSM McGladrey’s National Transaction Advisory Services Group.

AIFMD’s Impact in Europe and Beyond A Privcap conversation with Kamran Anwar, EMEA Head of Private Equity Services, and Andrew Hoemann, Americas Region Head, at Citi Private Equity Services, Inc.

July 15, 2013

When 100-Day Plans Go Wrong The fourth and final installment of the Art & Science of Investing series.

Africa Value Creation Africa is the Continent of Exits—an expert panel series on private equity opportunities in the “final frontier.”

July 22, 2013

Deal Story: Bima As told by Andrew Kuper of LeapFrog Investments.

Investor Appetite for Energy A conversation with Carlos Rangel of the Kellogg Foundation.

Privcap Digest / July 2013 / 9

9 / Venture Capital

By Tom Stein and Tim Devaney

Meet the consumer-brand-focused early stage investor that counts NBA star Steve Nash as a partner

ichael Duda runs a venture firm with a twist. His compa-ny, Consigliere Brand Capital, is a combination marketing consultancy/investment fund.

It lives at the intersection of Wall Street and Madi-son Avenue, taking stakes in young companies and growing them through better marketing opera-tions.

“A lot of people in the investment world look at marketing as an expense, not as an investment,” says Duda, who spent 18 years in advertising, most recently as chief corporate-strategy o#cer at Deutsch. “Done poorly, it’s absolutely the worst expense ever. Done well, it could be the greatest investment in terms of getting shared mind, shared wallet and more money.”

Duda founded Consigliere with L.A. Lakers point guard Steve Nash, who in 2008 completed a three-month internship at Deutsch’s Manhattan o#ce and now has his own film-production company, Meathawk, which has created ads for Nike and Vitamin Water. Nash also has a company called Apoko, which helps athletes and celebrities connect with fans via Twitter and Facebook. It’s these new media marketing strategies that Consigliere emphasizes with its companies.

“You can have one-to-one relationships with consumers like never before,” Duda points out. Companies can leverage new technologies to connect directly with individuals, and early-stage companies can use these technologies faster and better because they’re not hindered by the legacy systems that slow campaigns—and drain budgets—at more mature businesses.

“I’m amazed by the amount of wasted advertis-

Consumer Brands and VCClick to watch this video at privcap.com

ing out there from big companies that will launch new campaigns, hundreds of millions of dollars of television advertising,” Duda says. “How e"ective is that?”

More e"ective, he says, are the new marketing strategies instilled at the young companies in Consigliere’s fund portfolio, most of which are in consumer, retail, and e-commerce. !ose are sectors where one-to-one relationship marketing strategies can seize mindshare for a brand and power growth, all for a relatively small cost.

Consigliere has helped propel e-commerce com-panies Birchbox (cosmetics) and Warby Parker (eye-glasses) to considerable success through marketing techniques that build relationships with consum-ers, mostly through a combination of high-level data analysis and high-touch customer service.

But the same new-marketing approach can drive growth for more established companies like GNC, the vitamin and supplement retailer. “We helped them look at what they were doing, spend-ing a lot on advertising,” Duda says. “!ey didn’t need to. We helped them do their first segmenta-tion study in seven, eight years, so they knew who their customer was. And from there, it was like, ‘Wow, these are our customers. !ere’s a di"erent way we can spend our marketing dollars.’”

GNC shifted emphasis from o%ine to online marketing. It changed brand strategy and ad agencies. It cut advertising costs and lifted annual comps to nine percent without any acquisition. It became a high-growth company and later had the top IPO of 2011.

Consigliere tends to work as a minority investor. It has worked with lead investors including Kleiner Perkins, Exelis, and First Run Capital, firms that share Consigliere’s belief that companies can market themselves and grow not by shouting at consumers but by having a conversation.

“We like to see consumer transactions to model behavior from,” Duda says, “because if you get that, consumers will give you permission to help you serve them better. Consumers ultimately give you permission to succeed or not. Ask JC Penney. Ask Ron Johnson.” !

Consigliere Brand Capital Facts

Privcap Digest / July 2013 / 10

10 / Sector Deep Dive

Manufacturing Renaissance

. CONTINUES ON NEXT PAGE

U.S. manufacturing is undergoing a renaissance, and private equity firms have taken notice. In this fascinating discussion, Donald Charlton of Argosy Private Equity, Anand Philip of Castle Harlan, and Steven Menaker of McGladrey compare notes on ways that private equity firms are driving growth in their manufacturing portfolio companies and taking advantage of new opportunities in this long-overlooked space.

Click to watch this video at privcap.com

Privcap: What are some of the biggest drivers of change in the manufacturing space, and what do those changes mean for private equity investors?

Anand Philip: Castle Harlan has been an investor in the industrial sector, and manufacturing broadly, for a very long time. On an almost a weekly basis we’re walking plant floors of portfolio companies we own and companies we’re looking to acquire.

One of the big changes we’ve seen over the last 15 years is in relative cost positions. Fifteen years ago, manufacturing wages in China, for example, were significantly lower than what they were in the United States. !ey were 33 times lower. You then take wage inflation in China, combined with a lack of wage inflation here in the U.S., and today that delta is more like a five-to-six-times di"erence.

So what you’ve got is a scenario where you don’t have China being as cost-e"ective as it was. You throw in the hidden costs of o"shoring—which are, for example, a longer lead time, tying up your inventory costs as your products flow across the ocean—and e"ectively the U.S. is much more com-petitive relative to China today.

We’re seeing a resurgence of manufacturing in the United States. We’ve seen reports that 10 per-cent to 30 percent of jobs that have gone away could come back to the U.S.

So the dynamic around the world is changing, and there is now more manufacturing activ-ity coming to America. How does that change the private equity opportunity? What are some important ways that private equity firms can partner with manufacturing companies to grow value?

Donald Charlton: A lot of the companies that we’re looking at are in the lower middle market. !ese are companies that have enterprise value from, say, $15 million up to $50 million. Many of them have gone through the recession of ’08 and ’09 and really had to cut costs.

!ose businesses are starting to rebound right now, but they conserved capital, so I think there’s a really good opportunity in the manufacturing sector, especially in that lower middle market, to handle controlled costs. But also those owners can provide new capital by which to take advantage of some of the trends we’ve been talking about here today.

Can we expect to see more private equity deals in the manufacturing space in the near future?

Steven Menaker: I think with this renaissance of manufacturing—you’ve seen the politicians speak-ing about it—companies are driving more manu-

Privcap Digest / July 2013 / 11

11 / Sector Deep Dive

facturing into the United States. One of the other activities we’ve seen is really about large corpora-tions taking non-core businesses and putting them into the market. And we’ve really seen quite a lot of equity activity around that space, where they know who the buyers are. It’s not trying to encourage the family business to sell it when he wants to hold on to it as his medal of honor. And so I think that transactions are becoming a little bit more active and a little bit more aggressive.

What do these manufacturing companies need to get to the next level of growth? Do they need technology? Do they need better management? What can a private equity firm bring to improve the value of these manufacturing companies?

Menaker: All the above. A situation that I’ve seen is that you have companies that have been mature, they’ve nurtured themselves, and these owners really don’t know what to do next, because they’re only doing what they’ve known forever. !e mar-ket’s changed the way the world communicates, the speed at which you have to react into the market-place, so they’re not really capable or experienced in making that change, and I think there are signifi-cant resources that private equity or other investors bring to the mix.

Is everyone in agreement on that?

Philip: Business as usual hasn’t worked for a little bit of time, and it’s definitely not going work going forward. So all the things you talked about—imple-menting new systems that allow you to take the data that you have as a company and make action-able decisions based on it—those types of things are going to be critical going forward. We see compa-nies all the time that have information that they don’t use, and part of what we do is try to help them analyze that information in much more e"ective ways.

A very simple example is a company that has a good understanding of its business down to a gross profit line—and certainly might have through its manufacturing costs. But when you take its full cost structure, they absolutely don’t understand how the business works. And if you can help analyze

the business in those matters, you can make better decisions in terms of which customers you should be targeting, which customers you maybe want to fire to some extent, and other types of appropriate business decisions.

Are there other areas where private equity can make a di)erence?

Charlton: !ey say one of the most undermanaged resources in all business is pricing. A lot of times a company spends so much time and resources and team members focused on cost control, but pricing really has a much bigger impact on the bottom line. So we typically bring in experts who do this for a living and have done it for hundreds of companies. And I think it really opens the owners’ eyes. !ey can see, just like you said, that some customers may be actually costing you money, and you have to fire them.

!e way to implement a price increase may not be across the board but stratifying all your prod-ucts and figuring out where you can gain the most ground. Many times they think their customer is going to leave when, in actuality, rarely do they leave.

What is the mood like now in U.S. manufactur-ing? Compared to 10 years ago, is there a big di)erence?

Menaker: !ere’s clearly a lot more talk about manufacturing being the right place to be in this market. We continue to be the largest manufactur-ing country in the world. We’re the largest economy in the world. So we shouldn’t discount that. We’re the most productive of any employment force in the world. We absolutely sell more, so we just have to find that opportunity to grow. Without that push to growth, it’s really going to be impossible to get there.

What are some of the biggest challenges that could derail that growth?

Charlton: We see that a lot of owners struggle with finding talent because manufacturing technology

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“ Fifteen years ago, manufacturing wages in China, for example, were significantly lower than what they were in the United States. They were 33 times lower. You then take wage inflation in China, combined with a lack of wage inflation here in the U.S., and today that delta is more like a five-to-six-times di"erence.” —Anand Philip

Privcap Digest / July 2013 / 12

has increased. A lot of our college graduates aren’t going into these programs, and I think we’re losing somewhat of an edge internationally by not getting our best and brightest in the manufacturing field.

!e ones that have been successful are actually small manufacturing companies who take it on their own. !ey say, “I’m going to go to a local tech-nical school. I’m going to set up my own program. I’m going to fund it.” And it provides a great source of highly skilled labor, and they can cater the cur-riculum to the type of worker that they want.

Philip: We actually had one instance where we had a bus service that would bus in workers from nearby towns because a lot of them wouldn’t necessar-ily want to otherwise commute. At certain levels, you’re absolutely right—it’s very hard to find the tal-ent. Say you want to find a technical position, like a CNC machinist. !ere are not a lot of guys out there who are willing to fill a position like that, partly be-cause, as you said, they don’t have the expertise, and the guys who did it are from generations ago. And once they phase out, there’s a huge gap.

12 / Sector Deep Dive

What is driving deal flow in manufacturing, given the many changes around the world that are a)ecting the space?

Charlton: One area I’ve been looking at recently is machining. !ere’s a plethora of machining compa-nies out there, and some people say the U.S. is going through a renaissance and machining is underval-ued. !e owners are getting up in age and have no succession plan.

But machining is tough. !e multiples are fairly low unless you’re in a hot area. Like, the South Caro-lina area is a very hot area right now; Boeing just built a big manufacturing plant there. So the com-panies down there that have invested in technology to compete in machining are commanding higher multiples. But ones that rely on the old way to do things trade at a much lower multiple.

Menaker: When you look at what sectors are doing well—clearly oil and drilling and heavy machinery. Large corporate heavy-equipment manufacturers like Caterpillar have done very well as a result of the worldwide economy. But there are some sectors that are struggling, like housing. So you just have to find that right space, and it has to have the opportu-nity for growth. If there’s not that growth, it doesn’t matter, really, what they’re doing or what they’re making, it’s going be a tough sell.

Let’s talk about the motivations of sellers—whether it’s an individual seller, the founder of the company, or a corporate seller. Why are they seeking a liquidity event, and what is unique about the current environment compared to previous cycles?

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“ When you look at what sectors are doing well—clearly oil and drilling and heavy machinery. Large corporate heavy-equipment manufacturers like Caterpillar have done very well as a result of the worldwide economy.” —Steven Menaker

Privcap Digest / July 2013 / 13

Philip: Companies tend to be cyclical. And you’ve got an entire industry that went through the great-est financial crisis since the Great Depression, so they saw how bad it could get. If you lived through that and you came out with your equity intact and now you’re starting to see an upswing, this might be a good time to get out. Especially if you’ve been a business owner and had your company for 20 or 30 years and are looking to succession issues, this might be a good time to lock in what is a good run of the business.

Now, we have certainly seen a dichotomy in terms of good businesses and bad businesses. Good businesses are ones that made it through the recession relatively well and can command very attractive multiples. You’re finding those are very hot properties, and a lot of people are chasing them. !e companies that didn’t do so well need to create a story around why they’re going to be di"erent in the future, and those are the kinds of opportunities you can get at a much better valuation. !e ques-tion there is understanding whether you’re truly going to be able to change the business model or if you’re just waiting for the next cycle to catch you.

Are there a lot of founders out there who are looking for an opportunity to completely sell and go to the beach? How many of these founders want to stay on and participate with the private equity firm in the next stage of growth?

Charlton: !e majority of our deals, management is always rolling some piece of equity. I’d say about 80 percent of the deals we do, we back management, and then there’s an orderly transition that’s agreed upon up front—which puts a little bit of risk in the deal, because you’re taking the seller out who used to be the person who’s controlling the company. And you’ve got to recruit the right type of person in behind that person and get the right team in place to help grow the company.

Philip: Absolutely. You’d want to have a very deep bench. Sometimes in middle-market companies—we’re typically doing acquisitions between $100 million up to a billion, roughly speaking—in many of these opportunities the team is very good at the top, but it drops o" very quickly after that. And so part of what we try to do is complement the bench by bringing in a board that has at least three inde-pendent members.

In addition, we’ve got an a#liates network which consists of 40-odd individuals, the majority of whom are C-level executives of former portfolio companies. !ey could help us with due diligence in manufacturing opportunities. !ey could be

walking the plant floor with us when we meet with a company. And to some extent they could be involved with the company post-close.

One of the things we’ve found with entrepre-neurs who have had businesses for a very long time is that they still have the best relationships with the major customers, not the VP of sales. So we need to see through the management team and understand all those dynamics before we allow someone to take 100 percent of their proceeds and go to the beach.

Charlton: And you hope those entrepreneurs can adapt. But many times they can’t adapt. !ey can’t adapt to even a 100-day plan, because they never operated their business with a 100-day plan. !ey didn’t operate on a budget, so many times they just can’t adapt. And that’s the time when you have to bring somebody in. !

“One of the things we’ve found with

entrepreneurs who have had

businesses for a very long time is that they still have the best relationships

with the major customers, not the VP of sales. So we need to

see through the management

team and understand all

those dynamics before we allow someone to take

100 percent of their proceeds and go to the

beach. —Anand Phillip

13 / Sector Deep Dive

Privcap Digest / July 2013 / 14

The Value of the 100-Day Plan

The first 100 days are critical to the success of a deal. It’s what Grant Thorton’s Ed Kleinguetl calls the “magic” time, when partners can turn a good company into gold. “It’s the opportu-nity for change,” he says. “If change doesn’t happen in the first 100 days, people go to business as usual.” To make sure it does happen, most firms design a 100-day plan that dictates what changes need to take place and when. We spoke with Kleinguetl and two other leading PE professionals—Rob Ospalik of Baird Capital and Jack Purcell of Ridgemont Equity Part-ners—to understand how a 100-day plan can make or break a deal.

Key Findings

Finding 1

Operational improvements must happen early

Successful GPs understand that the time frame implicit in a 100-day plan is more than a sug-gestion—it’s a necessity. !at means operational changes must be defined and done early, or they may not get done at all.

Kleinguetl calls the first 100 days the “mag-ic” time, the period when partners have their best chance to turn a good company into gold. “It’s the opportunity for change,” he says. “And if change doesn’t happen within the first 100 days, typically it dissipates and people go to business as usual.”

!is is when those essential company improve-ments identified in the reporting process are fresh and urgent—and this is the time to make them.

Whether aimed at value creation or growth, up-grades are more likely to take hold and work if they’re put in place quickly.

“Some people have told me, ‘Well, we have two years to figure it out,’” Kleinguetl says. “!e real-ity is, if you don’t figure it out in the first 100 days, it probably isn’t going to happen as successfully as it could.”

!e same goes for entrepreneurs. !e first 100 days is the time for them to establish a stable and profitable relationship with their new partners. !e honeymoon sets the tone for the marriage.

“Sometimes the owners, with a liquidity event, they feel like ‘I can take a pause in my business,’” Kleinguetl says. “But it’s an important time to press forward, not take the foot o" the pedal. A CFO from a private equity firm coined it best. He says sometimes former owners have this ‘going-to-the-beach syndrome.’”

14 / Dealmaking Art & Science

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% Operational improvements must happen early & Management buy-in is'essential ( Plans should start to take shape during due'diligence ) Managing to benchmarks keeps companies on track * Leadership changes may put plans on hold

Privcap Digest / July 2013 / 15

“If it’s one of these aggressive auction process-es, you don’t have a ton of time to do your dili-gence and spend time with management,” Pur-cell says. “!e amount of time you can dedicate to prepping a 100-day plan could be condensed to two, three, four weeks before you ultimately close.”

In other situations—for example, when a firm holds lengthy negotiations with an entrepreneur or a family—the plan may coalesce over a number of months. In these cases, the plan is more likely to achieve buy-in from the owner and the man-agement team, “and that’s where you can hit the ground running,” Purcell says. But either way, he adds, “before your dollars go in, that plan needs to be baked.”

Ospalik says the 100-day plan usually begins to take shape in tandem with due diligence. “As you get into your diligence and the process of buy-ing the company, that builds on the plan. You’re learning more about the company, you’ve got some takeaways, you’ve got some cleanup items, perhaps. !ose are going into the plan. So by the time you’re getting to your final approval, that plan has essentially been developed. It’s not fully set, because the important part is still to sit down with your management team post-closing and make sure you’ve got complete alignment.”

Finding +

Managing to benchmarks keeps companies on track

!e first step is to have a plan. !e next step is to set benchmarks and meet them to make the plan work.

“You really want to keep track of certain metrics within the business,” Kleinguetl says. “!at’s the important part. Whether it’s customer-acquisition costs or days sales outstanding—whatever the key performance metrics—those need to go into place. And get people educated to manage the business around those.”

Ospalik says Baird draws up a “pilot’s checklist” for each newly acquired portfolio company and reviews the list weekly with the CEO. It also boils down the detailed requirements in each of its op-erating agreements to a concise set of instruc-tions.

“We take that long, nasty-looking legal docu-ment that virtually no one wants to read, and we

15 / Dealmaking Art & Science

Finding ,

Management buy-in is-essential

!e other side of that coin is the excitement many management teams feel at the moment of investment. !ey’re not thinking about the beach; they’re ready to dive into their new partnership. So the first 100 days is the ideal time for GPs to get the management buy-in they need to lead the company to value.

“!at first period is a nice opportunity to es-tablish that there’s a new regime,” Purcell says. “!ere’s a new mind-set around capital allocation, there’s a new mind-set around risk tolerance. Us-ing that first 100 days to all get on the same page about risk-return decision-making, it can really get the business o" with some nice momentum.”

Ospalik notes that 100-day plans at Baird Capi-tal routinely include a sit-down with manage-ment several weeks after closing in which part-ners lay out “what it means to be a Baird portfolio company.”

“!is allows the management team to devel-op that cadence, in terms of how we’re going to move forward,” he says. “It establishes that rap-port in a really positive way. !e better you come o" in that meeting, the better cadence you estab-lish, the better you look in the eyes of the partners that you’re going forward with. It’s a really posi-tive way to kick things o".”

Finding .

Plans should start to take shape during due-diligence

Ideally, a 100-day plan starts before day one—be-fore the investment is made. How long before de-pends on the deal.

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“ Some people have told me, ‘Well, we have two years to figure it out.’ The reality is, if you don’t figure it out in the first 100 days, it probably isn’t going to happen as successfully as it could.”–Ed Kleinguetl

Privcap Digest / July 2013 / 16

Finding /

Leadership changes may put plans on hold

Your 100-day plan may be ticking along like an Audemars Piguet. Then a leadership change throws sand in the movement. When that hap-pens, the plan may need to be put on hold while stability is reestablished. “Make sure nothing goes backward before things go forward,” Kleinguetl says.

The plan is important, Purcell explains, but the company at the heart of the plan is more impor-tant. “When a private equity firm invests in a busi-ness, there’s a change in the way things are done. And when you add to that a change at the CEO level, it more than doubles the complexity around change.”

Keep the company on track. In times of tran-sition, that’s the primary focus. “One order of change with new private equity ownership, a sec-ond order of change with a new CEO and a play-book that’s packed with having a business enter new markets, having a business try and grow at a rate that it’s never grown before—that can com-pletely cripple an organization,” Purcell says. “And that’s the last thing you want to do as a private eq-uity investor.”&

create a very simple laminated one-pager and hand it to the CEO. And we say, ‘Hey, if you’re thinking about making a capital investment, if you’re thinking about selling a division within the company, this is when you need board approval, this is when you don’t.’ It’s sort of a Cli"sNotes version of the operating agreement. !at’s really helped with our portfolio companies.”

But as Purcell notes, not every CEO has the right stu". !at’s why, before making any new investment, Ridgemont Equity Partners puts the top managers at the prospective company though a rigorous half-day psychological assessment. !e idea is to peel the onion and figure out which ex-ecutives are really up to the challenge of private equity ownership.

!e finance department usually gets a lot of the attention. “!e amount of stress and strain on a finance department pre– and post–private equi-ty ownership can be pretty intense,” Purcell says. “A very, very good CFO or controller in an entre-preneur-owner environment might not pivot and transition well in a private equity environment. In those cases, we’ve had to make transitions or augment the finance sta" to really deal with the financial reporting and analysis that any private equity investor is going to require.”

16 / Dealmaking Art & Science

Your 100-day plan may be ticking along like an Audemars Piguet. Then a leadership change throws sand in the movement. When that happens, the plan may need to be put on hold while stability is reestablished.

Privcap Digest / July 2013 / 17

Privcap: Why is The Riverside Company a successful middle-market private equity firm?

Pam Hendrickson: As a lot of private equity firms found success, they moved upmarket. !at was typical, but we decided we really love little deals, because there are lots of little levers that you can pull to create growth at the small end of the middle market. So instead of moving upmarket, we expanded globally and now own companies in developed Asia as well as all over Europe.

We have been successful by being real activist managers. We have 27 operating partners on our sta". !ey are not advisers, which is common at firms. Our operating partners are involved in our due diligence and have a variety of experiences, from consumer branded goods to working at Intel. Our operating partners are with us every day look-ing for ways to help our companies grow.

You’ve said that the A)ordable Care Act presents the greatest immediate financial challenge to the middle market. Why? What are some of the biggest impacts at the portfolio company level?

Hendrickson: Benefits are very often the second- or third-largest cost for our employers. !e A"ord-able Care Act (ACA) goes into e"ect in January 2014, and all of our companies are wondering what that means for them. We’ve been spending a lot of time trying to figure out what it actually means. One of the challenges is that nobody’s 100 percent sure what it means yet.

!e health insurance exchanges are not up and running, so nobody knows what they will look like. For companies that have more than 100 employees, they’re looking at an eight percent increase in cost as a result of fees and taxes. !at’s before they have any claims work done. !e Riverside Company has about $10 million in medical premium across the portfolio; eight percent is $3.2 million. If you put a seven multiple on that, !e Riverside Company has lost $22 million of equity value just in additional fees and taxes.

17 / Keynote

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Bio

Pam Hendrickson joined Riverside in 2006 after 22 years at JP Morgan Chase—13 of them with the private bank and most recently as division head for one of the largest regions in the U.S. Private Bank. She was also managing director—global head of lending and liquid-ity products. Her education includes an MBA, Finance and Marketing, cum laude—Kellogg School of Manage-

History, cum laude—Duke University.

A conversation with Pam Hendrickson of The Riverside Company

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The Middle-Market Downside of Obamacare

Privcap Digest / July 2013 / 18

“ We are trying to diagnose what the ACA means, educating our portfolio companies, and then trying to come up with a global solution for our whole portfolio.”

18 / Keynote

below 100 employees, its premium can increase. Additionally, the regulatory and compliance burden of ACA is enormous.

Companies with just about 50 employees are going to have the hardest time. Let’s say you have a company that has a front o#ce sta" and a ware-house. !e front o#ce workers get insurance ben-efits, but the warehouse employees don’t, largely because your employees have told you they don't want them or can’t a"ord them. However, as an employer, if you don’t o"er the benefits, the com-pany is subject to a $3,000-per-person fine for all the people in the warehouse.

When you are looking at buying companies, you have to really think about the demographic of the work population and what potential fines you may be subject to as a result.

What is the impact of ACA on individual private equity firms?

Hendrickson: Just thinking through what things could impact a company that you’re looking to buy is going to be more complicated. For example, if you are thinking of exiting in the fourth quarter of 2015, you might be looking at a price hit, because the buyer might realize benefit costs are going to go up by 150 percent because of the community rating. Firms will also to have to think through their due diligence processes and really focus on what ACA means to the company they are buying or selling. !

However, the increases are going to be much larger than that, because as they adjust for claims history, there will be more increases. Companies with less than 100 employees are probably look-ing at 15 percent to 25 percent increases as a result of the community rating rule. If a company drops

Riverside University: Competitive Edge 101

The firm launched Riverside University in 2010 for executive management teams, board members, and Riverside employees to share best practices.

The Curriculum Web-based and classroom-based course o!erings cover a wide scope of topics:

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Summit Over 300 executives and Riversiders from around the globe attend the two-day event on intensive training in management tactics and strategies.

Sammy the Salamander —the mascot of

Privcap Digest / July 2013 / 19

What is the magic of the 100-Day Plan? Why is itsuch a valuable tool?

At the day of closing, according to generalmarket study, there’s only so much energy

toward change. On day one, you have maximumvelocity, and you’ve got about a hundred days toimplement a number of those changes, particu-larly, in terms of trajectory. After that, peoplesettle back to business as usual, kind of hunkerdown. If the right trajectory isn’t set duringthat period of time, then the value will ulti-mately not be realized. It doesn’t take two yearsto figure this out. If the first hundred daysaren’t correct, it will not be as liable a deal as itshould be.

Tell me about what is unique about how GrantThornton works with Private Equity firms ontheir 100-Day Plan?

First is the value creation component. !e integration component is part of the

transaction advisory services within Grant!ornton. Whereas in other firms, it’s part of business consulting, and it’s not typicallybrought into bear as part of the transactionprocess. So it’s separate and distinct. Second,within Grant !ornton, there are a number of deep subject matter advisers that can be brought to bear in terms of systems, financial controls, a focus on the human capital com-ponents of the business. A focus on customer strategies, bringing in those key subject matter advisers in the key areas that a client wants to grow, that makes Grant !ornton quite unique.!

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Ed Kleinguetl,

email: email@grantthornton.com Web: www.grantthornton.com

Ed Kleinguetl,of Grant Thornton

Expert Q&A/

Snapshot

Expertise: Leads Grant Thornton’s national transaction integra-tion o!ering within the TAS practice

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