Morgan & Westfield Deal Talk
Exclusive Interview with Don Charlton
In this podcast, we talked to Don Charlton, Operating Partner and Managing Director at Argosy Private Equity (PE). Don Charlton is a private equity specialist whose firm has been around for 25 years and has completed over 100 transactions. He explained the important differences between private equity and venture capital, and what types of businesses PE firms are looking for. He discussed steps that you as a business owner can take to make your business more attractive to PE firms.
This podcast is part of our Deal Talk series wherein we talk to business experts to gain insights into how to build your bottom line and improve your company’s value.
Key Points From Our Conversation
Private equity firms expect that they're going to make solid bets on established businesses that already have positive cash flow.
Every PE firm has different criteria but there are some common themes that range across them.
Private equity gets painted in a poor light. People think that firms sell off assets, cut heads, and try to maximize with financial engineering. That couldn't be farther from the truth.
PE firms expect the owners of a company to be very forthright, be transparent with their banker, and be transparent with the potential acquirer of their company.
Currently some of the hot areas for private equity funding are e-commerce, manufacturing companies, and business process outsourcing companies.
Questions answered in this show:
Private equity versus venture capital: what is the real difference between the two and why is it so important to know that difference?
How can a business make itself more attractive to investors?
What kind of due diligence is involved prior to a PE firm deciding on whether or not it will invest in a company?
How frequently will an investor have an interest in a business without the objective of having controlling interest?
Is there a perfect or appropriate time for small business owners to consider approaching a PE firm?
Jeff: Private equity can help you take your company to the next level but PE firms are becoming very picky about the companies they invest in. To find out how private equity works and what investors are really looking for, you've come to the right place.
From our studio in Southern California, with guest experts from across the country and around the world this is Deal Talk, brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host Jeff Allen.
Jeff: Welcome to the web's number one content source for you and all small business owners committed to building a great business you will want to eventually sell. On Deal Talk it's our mission to provide information and guidance from our growing list of trusted experts that you can use to help you build your bottom line and improve your company's value. Private equity may or may not be right for your strategic growth plans, but to learn more about it from an investor's perspective we're pleased to talk with Mr. Don Charlton, Operating Partner and Managing Director at Argosy Private Equity. Don Charlton welcome to Deal Talk sir, it's good to have you.
Don: Thanks, Jeff.
Jeff: Private equity versus venture capital, many of us have kind of an idea of what really divides the two. They really are two different animals, but for those folks who are just kind of stepping in to this discussion: what is the real difference between the two and why is it so important to know that difference?
Don: Sure. I think the primary difference is most VC firms expect their funds’ returns to come from a few investments in their portfolio, perhaps two to three out of every 10 investments they would expect to produce extra-average returns. With private equity, most of the time we're dealing with established businesses, and we expect all of them to succeed. Now, not all of them do succeed but the hit rate for a successful investment in PE is much higher than it is for VC. I think in simplest terms VC's expect home run investments to return the fund, and PE firms expect that they're going to make solid bets on established businesses that already have positive cash flow. I'd say they're hitting for more doubles and triples than home runs.
I think the primary difference is most VC firms expect their funds’ returns to come from a few investments in their portfolio, perhaps two to three out of every 10 investments they would expect to produce extra-average returns.
Jeff: Okay. So private equity is more of a long-term kind of venture, is that kind of the way you see it as far as a long-term play is concerned?
Don: Well, typically a private equity firm goes out and raises a fund, and usually that fund life averages about seven years. So typically during the first couple of years it's investing the fund. And then it's actively trying to grow its portfolio investments. And then kind of in that five to seven-year time frame it's starting to harvest those investments and selling those companies either to financial buyers, strategic acquirers, or other private equity firms.
Jeff: Don, anyone has to just kind of go and visit your LinkedIn profile as I did in kind of getting set up for the show, and they can see that you have started and led many successful businesses. All businesses are different and they're all judged based on their own merits. But how can a business make itself more attractive to investors? You're on the investor side and you know what it takes. You know what you had to do with your businesses. So for those business owners who are looking at trying to attract the attention of investors what can they do to be more appealing, to make it easier for investors to say, "You know what, this is a target here worth taking a serious look at"?
Don: Certainly every private equity firm has different criteria but I think there's some common themes that kind of range across private equity firms. I'd say we're typically looking at the team first off. So the human capital component of an investment. How does the firm recruit? Does it have A player on its team? There's a saying that a private equity investor would rather have a B idea with an A team, than an A team with a B idea. It really starts with that.
We'd like the company to be on the path to being professionalized, so that means having its financial statements in order. Typically, it's a great idea to have either reviewed statements or audited statements. Certainly once a company becomes part of a private equity portfolio, almost all companies have to be audited. It's usually for lender purposes. If they're thinking about selling the company, hiring the right investment banker is really mission critical. I have seen so many transactions fail because they didn't hire a quality banker, or didn't think that it was worth spending the fees to hire a quality banker. But bankers have done hundreds of transactions, if you choose the right one and you have to find the right one for your company, but they're going to help you get prepared to sell your business. They're going to advise you on what private equity firms are looking for.
There's a saying that a private equity investor would rather have a B idea with an A team, than an A team with a B idea. It really starts with that.
Jeff: Don, this is a really good place for me to kind of jump in and we can camp out here on these points that you've made. Deal Talk is all about helping business owners not just manage their value but really make improvements that could really lead to increased value in their companies and you touched on the importance of selling your company and making sure that you do so really when you know that you can sell it at a value that you're happy with. You've talked about the importance of finding the right banker and so often companies don't do that. Small business owners, they don't find the right fit. So the question then is: how do you find that right company to work with? How does a business owner who's got his elbows and arms, up to his shoulders, up in his business how does he know how to find the right investment company that he can work with that will take him and his company to the next level?
Don: I think a lot of it typically will center around the size of the company. So if it's a much smaller company, your traditional business brokers would be a good avenue. And there's lots of groups that can recommend business brokers like the IBBA, the M&A Source Organization. And then if the company is larger, and when I say a small company like business broker I would say kind of less than 10 million in revenue and somewhere in the one or less than two million of EBITDA range. And then companies over 10 million in revenue that have something around two million in positive cash flow. I'd say trying to target the right industry bankers who understand your business, your industries, the risks, the upsides, the trends that are occurring out there in the M&A market. They could tell you the type of multiples that your company based on where it is from an enterprise value perspective could gain in the market place. And again, I think that really focusing on the right industry bankers would be helpful.
I'd say trying to target the right industry bankers who understand your business, your industries, the risks, the upsides, the trends that are occurring out there in the M&A market. They could tell you the type of multiples that your company based on where it is from an enterprise value perspective could gain in the market place. And again, I think that really focusing on the right industry bankers would be helpful.
Jeff: And that's for those larger companies. Don Charlton is the Operating Partner and Managing Director at Argosy Private Equity, you're listening to Deal Talk. My name is Jeff Allen. I'm so glad that you've made us part of your day-to-day. Due diligence is obviously very important to any investment banker. And to you Don, once again we talked about how you're a business owner yourself and you've had a chance to own and sell them. And now as a private equity specialist tell us, what kind of due diligence is really involved prior to deciding on whether or not you will invest in a company? What's important to you?
Don: I'd say a due diligence process typically last for about 90 days. I think it's critical for business owners to really kind of have their act together. And again, that banker will prepare you for this 90-day to 120-day period. But think of it as getting a Dropbox set-up with all the key documents that the private equity firm is going to need to look at. That includes financial statements, that means sales processes, organization charts, key titles, all the financial information that your banker and your attorney will help you put together. But the key areas that we are going to look at include the financials. We're going to hire an outside firm typically to come in and do what's called a quality of earnings. And certainly if the firm has been audited or reviewed before, that's very helpful to the process. And usually that's where the diligence starts, with looking at the financials and making sure the numbers are the numbers that the management team is representing to the private equity firm.
But we cover a broad array of areas including, we'll hire, if the firm has manufacturing operations or there's potential for environmental exposure, we'll hire an environmental firm to do a phase one study. We obviously will hire our attorneys to prepare all the corporate documentations as doc purchase agreements. We will hire accountants to look at the tax structuring of the transaction to make sure it's beneficial for both the seller and the buyer to minimize taxes. We will do background checks on the owners in the senior management team. We hire outside firms to do what's called a market study which will be a deep dive on the industry. And that'll include supplier calls, it'll include customer calls, and another reference calls that that firm would do. And typically they will output a market study that we can help use to grow the company post-transaction. We will do IT assessments, looking at the IT infrastructure, and that will also include kind of a cyber-security assessment. We will look at the human resources and human capital and benefits component of the firm. And we will look at the sales and marketing process. We will see whether the company has the right process in place for pipeline management.
And then lastly, this is a little bit different than most other firms. We do a behavioral assessment of all the key executives on the team. And that helps us to be able to know how to work with those individuals and manage them prospectively.
We do a behavioral assessment of all the key executives on the team. And that helps us to be able to know how to work with those individuals and manage them prospectively.
Jeff: And right there you're touching on the idea of intangibles in character and personalities. It's so important. And particularly in this day and age, more than ever it seems, Don, that we're finding out about this. You mentioned quality of earnings. Do you also require a full comprehensive valuation from a third party appraiser as well?
Don: We typically do not. So typically that's our business, to value firms. Mostly that's based on multiples of cash flow. The range of multiples of cash flow that you're going to pay depend on the level of positive cash flow that you have. Sometimes when a company will reach five million of EBITDA there's a certain multiple. And if it gets to 10 million of EBITDA then the multiples increase. So you'll hear private equity firms talk about multiple expansion, which means they're going to grow the company organically through helping with active value creation. They'll help grow the company through acquisition. And then if the earnings reach certain levels they'll get a multiple expansion. So if you bought the company hypothetically, at let's just say a 5x multiple and you got EBITDA to a certain level, you're going to grow that EBITDA and grow the value. But you'll also if you reach a certain level get an increase in that multiple. So that may be seven or eight that you'd be able to sell the company for.
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Jeff: This is the kind of discussion that I was really looking forward to having with you, Don, and so far so good. Really enjoying the time with you and I'm glad that you've been able to take time out of your schedule to join us today. My name is Jeff Allen and I'll be back with Mr. Don Charlton, Operating Partner and Managing Director at Argosy Capital Partners, when Deal Talk continues in a moment.
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Jeff: Welcome back to Deal Talk where we are becoming the Internet's go-to resource to help business owners understand what it takes to sell their companies successfully. Now available on iTunes as well as Stitcher Radio, and of course morganandwestfield.com. This is the place where you can find a wealth of resources along with all Deal Talk episodes of course just by visiting morganandwestfield.com, iTunes, or Stitcher as I'd mentioned. Jeff Allen is my name, and that man on the other side over there is Don Charlton. He's Operating Partner and Managing Director of Argosy Capital Partners. We're talking a little bit about private equity today and we're kind of getting in the head of Don who with his team there at Argosy Capital Partners, obviously very discerning folks over there, very selective in the types of companies that they work with. Don, what industries right now are most attractive to you at this time and what is your team looking at and always kind of, I guess you might say, kind of got your feelers out in the world of business as far as next potential targets are concerned?
Don: Sure. My firm has been around for 25 years and it has done over 100 transactions. There's not an industry we probably haven't touched in some form or another. I'd say currently some of the hot areas are e-commerce. Those businesses that are tech-enabled businesses that are leveraging either software or technology in a traditional business. We're seeing a resurgence of manufacturing companies. A while back there was a lot off-shoring but one of the trends we're seeing now is a lot of on-shoring or a lot of domestic OEMs are starting to bring their manufacturing from off-shore back to the shores of the United States. Business process outsourcing companies are pretty hot. We like the municipal outsourcing areas, the federal outsourcing areas had a big boom over the last 15 years. And we see municipal outsourcing as kind of one of the new trends that also follow that path of federal outsourcing. We're not big technology investors but we do monitor that. Obviously everybody's heard about the Internet of Things, and there are lots of interesting businesses and infrastructure businesses that are in and around that area to support that industry.
Business process outsourcing companies are pretty hot. We like the municipal outsourcing areas, the federal outsourcing areas had a big boom over the last 15 years. And we see municipal outsourcing as kind of one of the new trends that also follow that path of federal outsourcing.
Jeff: It really does cover a very broad space, does the Internet of Things. We get back into our conversation here about private equity. Don, I think that there is a concern that many small business owners have. They've been involved in their businesses for many years, and in some cases maybe they're only at it for maybe five or six years but they're kind of on a nice maintainable growth trajectory, at least that's what their customers are telling them, and that’s what their books are telling them. But when it comes to growth and when it comes to thinking about financing for that growth, and you bring up private equity in the conversation, I think that there are some business owners who may have it in their head, "I don't know if I want to do that or not because investors, they want to take over the company. They want to have it their way. They want to go ahead and essentially take over ownership and control of the way that we do things." So there is the concern of surrendering control to a private equity investor and that things will never be the same. The owner doesn't actually have that full say anymore. I kind of wanted to talk to you a little bit about that. How frequently will an investor have an interest in a business without the objective of having controlling interest, and is this really something that business owners need to worry so much about when they're looking at coming up with a financing option to really help them put their company into that fast growth trajectory that they want to see ultimately take their business to the highest levels of success?
Don: Sure. I'll speak for Argosy's standpoint as a private equity firm, we tend to be very flexible capital providers. So we do debt financing in which we are taking very little control of the company. Perhaps maybe a warrant attached to some subordinated debt, which allows the owner to keep and maintain almost total control of the company. We do growth equity investments where the owner is maintaining control from an ownership perspective but needs growth capital to continue their growth plans, or we do buy-outs. And I think there's kind of misinformation about buy-outs. we tend to do lots of family transitions where the owner is selling control but maintaining a material ownership in the company. We try to approach owners as partners and help partner with private equity firm to help meet the new growth objectives and the growth trajectory that most private equity firms would like to take the company. And most like to double revenues and double the cash flow of the company over their investment horizon. We really work hand-in-hand with management in putting together that growth plan once we make an investment in the company. But the key is that our capital can be very flexible.
Jeff: I think that's a really, really great way to address one of the myths that so many business owners may have out there about private equity groups. You talk about it obviously from Argosy's perspective and there is may be other private equity groups that have a different philosophy out there but we certainly do appreciate that feedback. Sticking on with that subject of pre-conceived notions, are there any other notions out there, Don, that you're aware of from a business owner's area of expertise - and again, we've talked about how you've owned many - about private equity groups that you want to dispute or myths that you want to dispel out there?
Don: I think private equity does get painted in a poor light. I think people look at the movie Wall Street and think that private equity firms come in and sell off assets, and cut heads, and just try to maximize with financial engineering. And I'd say that couldn't be farther from the truth at least as it relates to most of the middle market private equity firms that are out there. We're focused on helping family transitions. We're helping business owners diversify their net worth, and we're trying to grow the business and in return grow jobs. I think private equity does a great service to the economy in helping to take these businesses at one level with active value creation, help them grow, and in the process of growing create more profits, and in turn allowing them to hire more employees, and for U.S. to be more competitive.
I think private equity does a great service to the economy in helping to take these businesses at one level with active value creation, help them grow, and in the process of growing create more profits, and in turn allowing them to hire more employees, and for U.S. to be more competitive.
Jeff: And that's really what I think most of us would like to see, Don. So really you're I think preaching to most of the choir here on Deal Talk as far as our philosophy and our listenership is concerned. Is there a perfect or appropriate time for small business owners to consider approaching a PE firm, or might it be best for some businesses to consider other sources of funding first?
Don: Like I said, every PE firm has a different screen. Our screen is typically the company needs to have at least $2 million of positive EBITDA. Something below that, many firms call that the deep value space which means the company may not be ready for a steep growth trajectory. It's all about timing. I think age comes into it in terms of how close they are to retirement, how much of their net worth is tied up in the business. Many times owners approach us because they're just uncomfortable with all their net worth being in the business. So many diversify and they sell a majority control of the company but maintain 20 percent or 30 percent or 40 percent of the company. And that's called equity role in which they sell to the private equity firm. They're still on board managing the company during some transition period, and we like to call that getting a second bite of the apple, whereby when the private equity firm sells that firm, if they have a 20 percent to 30 percent interest in the company and the company's doubled in size they're going to get a nice check when that exit happens.
Jeff: Don, as we're starting to near the end of our conversation on this edition of Deal Talk I wanted to find out if you have any key takeaways or important pieces of advice that maybe you can leave in just a matter of seconds for those business owners who might be plugged in. But if there's only just a few things that they remember from the conversation today what might those be?
Don: Get your house in order. Again, I can't stress enough having solid, sound financial statements is critical. Having that banker that can really help you prepare the company and craft the company story. And then thirdly, being honest and transparent. When we approach companies we're very transparent about what we plan to do, and we expect the owners of the company to be very forthright, be transparent with your banker, and be transparent with the potential acquirer of your company.
Jeff: Don Charlton, people listening to the program today, they may have some questions for you specifically, and in fact they may want to talk to you about their own situation and how you might be able to help them. How can they reach out to you?
Don: They can reach out to me via my email address which is don@argosyprivateequity.com.
Jeff: That's don@argosyprivateequity.com. Make sure that you write that down, keep that tucked away someplace, or come back and listen to this episode again. Don Charlton, it has been a pleasure having you, my friend, and we have enjoyed this discussion tremendously and we would like to have you back on again for a future visit where maybe we can go into a deeper discussion about private equity and some other related associated topics with you on a future program.
Don: Thanks Jeff, my pleasure.
Jeff: That's Don Charlton, Operating Partner and Managing Director at Argosy Private Equity. He's been our guest today and we hope that you enjoyed our discussion.
To listen to more Deal Talk visit morganandwestfield.com and click on the podcast link at the top of the site. And if you consult or work with business owners prior to, during, or after the transaction process and you'd like to join us as a future guest expert to share your expertise like Don Charlton just did, contact me directly at 888-693-7834, extension 190, or you can email me at jeff@morganandwestfield.com.
Deal Talk is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Find out how Morgan & Westfield can help you at morganandwestfield.com. For everyone here at Deal Talk, my name is Jeff Allen, thanks again for listening, we'll talk to you again soon.
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Don Charlton's Bio
Operating Partner and Managing Director, Argosy Private Equity
950 West Valley Road; Suite 2900; Wayne, PA 19087-1845
(Located in the Suburbs of Philadelphia, PA)
Phone: 610.971.9685
Fax: 610.964.9524
http://www.argosyprivateequity.com/
don@argosycapital.com
Don Charlton has joined Argosy Capital as an Operating Partner in our Private Equity Group. He will be responsible for originating, performing due diligence, closing, monitoring and exiting investments for the Argosy Investment Partners and Argosy Capital Group funds. Don brings over 23 years experience as a C-Suite athlete with growth oriented private equity backed companies. Don was a founding management team member of InPhonic, the 2004 INC 500 #1 ranked fastest growing private company in the US, where the team raised $90 million in private equity and completed a $150 million IPO exit. InPhonic grew to $300 million in revenues and 700 employees in less than 5 years. He has diverse industry experience spanning technology, software, manufacturing, ecommerce, Internet advertising/marketing and professional services. He brings solid middle market buyout experience having completed 14 aquisitions during his career.
Don started his career with Coopers & Lybrand (now PriceWaterhouseCoopers) and held management positions at Baxter Healthcare, Osage Venture Partners, InPhonic (now Simplexity), XM Satellite Radio, Gratis Internet and Venture Catalyst Consulting. Don earned his B.S. from the University of Scranton, a MBA from New York University’s Stern School of Business and is a CPA.
Founding management team member of InPhonic, Inc.(now Simplexity) , achieving INC 500 #1 ranking in 2004
Successfully secured $90M in venture capital by effectively leading teams to raise, present, and coordinate five different investment rounds (Series A – E) and $150 mm IPO.
Led turnaround at Gratis Internet in 2005 taking over a company losing ($1mm) per qtr to $1mm in profit per qtr in 2008 with no outside funding. Achieved $53+ mm in bootstrapped revenues in three years.
President, COO, CFO
SOCIALCASH (Formerly Gratis Internet, Inc), Washington, D.C. 2005-2009 ,$25mm, Global performance-based (CPA) Internet advertising/marketing firm focused on online customer acquisition, social network monetization and affiliate marketing. Recruited by company founders to enhance teams and infrastructure for projected rapid growth.
Officer, EVP of Strategic Development & M&A
InPhonic, Inc. (NASDAQ: INPC) ), Washington, D.C. \ 2000-2005, $300 mm, Leading e-commerce and customer acquisition company in the wireless sector, “the Expedia of Wireless”.
Appointed to various leadership capacities including CFO, COO, President Liberty Wireless, and EVP Corporate Development. Oversaw recruitment and hiring team of executive professionals. Generated $300M in annual revenue by recruiting CXO team to launch sales channels, identifying and completing ten strategic acquisitions, executing key business development deals and new carrier agreements and launching 5K+ private labeled websites.
MBA NYU Stern School of Business
BS University of Scranton
CPA
Specialties:Middle Market Private Equity\ M&A
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