Middle Market Growth - January/February 2019 by Association for Corporate Growth

JAN/FEB 2019

// THE OFFICIAL PUBLICATION OF ACG

TRIANGLE ROCK CLUB

Expands Its Reach

Climbing is entering the mainstream as a fitness alternative with social appeal

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FROM THE EDITOR

Private Capital Gets in the Game

KATHRYN MULLIGAN Editor in Chief, Middle Market Growth kmulligan@acg.org

hether the draw is a league, tailgate or fantasy draft, sports have long had the power to bring people together. Increasingly, they are forging community in a literal sense, as professional sports venues attract new private capital investment. League restrictions on team ownership have largely prevented private equity firms from buying sports franchises, but they’re finding other ways to get in the game through real estate, restaurant concepts, and technology and media—a trend explored in this issue’s feature story (p. 28). Their investment has had a knock-on effect in cities like Detroit, whose downtown sports complex is attracting visitors who support new businesses that in turn create jobs, contributing to the city’s revitalization. Professional teams aren’t alone in their innovative use of real estate. Our cover story (p. 20) profiles Triangle Rock Club, a chain of indoor climbing gyms whose newest location will open later this year inside a former Walmart store. Climbing gyms across the country are cropping up in unlikely places to accommodate walls upward of 50 feet high, and a total footprint that can exceed 50,000 square feet. One gym—Hoosier Heights in Bloomington, Indiana—has opened up in a former church. Indoor climbing’s popularity has increased, in part, through exposure on “American Ninja Warrior” and via word of mouth as passionate climbers recruit their friends. For other segments of the sports and recreation industry, federal decision-makers have played a role in creating new demand. Following the 1972 passage of Title IX—which prohibited sex-based discrimination on campus, including in athletics—sports like rowing, soccer and field hockey saw a spike in participation as universities increased funding and scholarships for female athletes. That provided a foothold for emerging companies that supplied these sports, including Nielsen-Kellerman (p. 12). The company has since attracted private equity backing twice and expanded into new industries outside of rowing. Last summer, the U.S. Supreme Court struck down a law prohibiting sports gambling, and as PitchBook’s CEO writes in his Midpoints column (p. 15), investors are watching closely as some states move to reverse their own bans. Should this nascent industry take off with support from private capital, we’ll have yet another way to bond over sports—at the betting table. //

MIDDLE MARKET GROWTH // JAN/FEB 2019

EXECUTIVE SUMMARY

Kicking off the New Year

ANGELA MacPHEE Chairman, ACG Global Board of Directors, and Partner, Baker Tilly

middlemarketgrowth.org

he start of a new year is a great time for setting goals. Many of us have embarked on New Year’s resolutions—to get more sleep, improve our diets or pick up a new hobby. Likewise, ACG Global has defined its priorities for 2019, one of which is to expand its membership among young professionals. The association has long served as a place for middle-market deal-makers to come together for networking and education, and the ACG Global board of directors wants to ensure its offerings are relevant for the next generation of professionals. Keep an eye out for more under-40 networking events, career-related programming and mentorship initiatives. And if those don’t apply to you, please help spread the word to your younger colleagues. Like ACG, organizations across the world are exploring how to appeal to millennials and Generation Z. The growth of Triangle Rock Club, a chain of indoor climbing gyms and the subject of our cover story (p. 20), has benefited from the preference among 20- and 30-somethings to pay for experiences over tangible products. Unlike fitness centers where customers plug in their earbuds and work out solo, climbers at Triangle Rock Club see themselves as part of a community. They talk to other patrons, offer advice and discuss climbing techniques. Orangetheory, Flywheel and the cross-fit movement are other examples of a growing trend: To thrive, gyms need to offer more than just exercise. This edition of Middle Market Growth explores sports and recreation, an industry with significant ACG member activity. A managing partner of Triangle Rock Club, Joel Graybeal, is a member of ACG Raleigh Durham. The issue also looks at Nielsen-Kellerman (p. 12), a maker of components for rowing, and Hed Cycling (p. 17), a manufacturer of cycling parts. Both companies are led by active ACG members. It’s no coincidence that these thriving businesses are connected with ACG. Whatever your professional function within the middle market, there’s a spot for you on the ACG team. The members of this association support each other to build great companies and create jobs. Those connections happen at ACG events, both on the local chapter level and at ACG Global’s events. Our annual conference, InterGrowth—the association’s own Super Bowl—will be held on May 6-8 in Orlando, Florida. I look forward to seeing you there! //

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JAN/FEB 2019

DON’T MISS QUICK TAKES Hed Cycling Blazes a New Trail 17

A QUALIFIED OPINION Trends in Sports M&A 18

POLICY POINTS Revisiting the Volcker Rule 32

IN THIS ISSUE Cover and above photo by Ben McKeown

GROWTH STORY

From the Editor 1 Executive

Triangle Rock Club Expands Its Reach Since Triangle Rock Club opened its first indoor climbing gym, near Raleigh, North Carolina, interest in the sport has grown, particularly among millennials willing to pay for new experiences. Its fifth gym will open later this year in a former Walmart store, part of an industry-wide trend of repurposing former retail outlets that meet climbing’s expansive space needs. 20 TREND

Sports Investors’ New Playbook

Summary 2 Executive Suite 8 The Round 10 Vertical View 14 Midpoints by John Gabbert 15 Growth Economy 34 The Portfolio 35 ACG@Work 38

Shifts in the media landscape are changing revenue models for sports teams, leading them

The Ladder 43

to explore new partnerships and in-person experiences. And as new stadiums draw fans,

It’s the Small

private capital firms are investing in nearby

Things 44

restaurants and entertainment corridors, helping to revitalize cities’ downtowns. 28

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NEWS MMG WEEKLY The latest middlemarket trends, ACG events and timely industry

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Foreign buyers have steadily increased their M&A activity in the U.S. middle market, representing 21.4 percent of buyers of U.S.-based companies in 2017, up from 13.7 percent in 2013.*

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EXECUTIVE SUITE

The Deal Game: From Fundamentals to Audibles F What game plan should you have

MICHAEL VACCARELLA Title: Managing Director, Private Equity and Transaction Advisory Services Company: Wipfli LLP Location: Chicago Expertise: Vaccarella leads Wipfli’s National Private Equity Services practice with a focus on transaction advisory services. Wipfli is a top 20 CPA firm focused on middle-market growth, compliance and deal flow.

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going into a deal? There is a reason why coaches make their players do drills over and over again. Being able to predict what your team members will do before they do it is essential to success, which makes fundamentals core to any team interaction. The fundamentals of the deal process have been honed over decades. They include more defined letters of intent, deeper financial and tax due diligence, a detailed framework around net working capital, more timely appraisals and faster purchase agreement redlines. These deal fundamentals all move the ball down the field toward closing. But every team must evolve to stay competitive, and that’s where recent additions to the game plan come into play. As part of their M&A due diligence process, successful deal teams now perform cybersecurity audits, customer satisfaction surveys, management personality and emotional intelligence assessments, enterprise resource planning (ERP) integration compatibility reviews, culture assessments and employee engagement surveys. Your team must adapt and add these new tangible and intangible fundamentals to your game plan. F How are the best deal

teams built? While working with NFL teams, Wipfli LLP has seen how important

the right players are to successfully executing a strategy. It’s no different for a deal. The key to building a strong team is a mix of internal and outside professional help. Coordinated efforts yield more movement, and removing redundancy reduces seller frustration. Good defense—aka, managing the seller—is as much a part of the team’s work as due diligence and other gameplan fundamentals. F When do you call the

deal audible? Deal disruptions can catch a team off guard. During this crucial time, the transaction will either fall apart or move forward. Sometimes the audible is to walk away. Sometimes the audible is just a shift in mindset or change in expectations. We see this most often in the middle market with net-working-capital issues, cost accounting, customer deposits and revenue recognition. On top of those issues, an uncooperative seller with unreasonable demands puts real pressure on the team. The best teams have seen and are prepared for the trick plays, the trash talk and the deceptive formations that can potentially derail a deal. The key to winning the deal game is having a team that is equipped—both emotionally and mentally—to call an audible, strategize around the complexities, and create solutions that satisfy both the buyer and seller to get the deal done. //

Content Provided by ACG Partners and Featured Firms

VOICES OF THE MIDDLE MARKET In-depth interviews about the trends impacting midsize companies and M&A. Guests include CEOs, economists, private equity investors and other influencers who discuss what they’re seeing in the market.

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THE ROUND

Healthy Economic Outlook for Middle-Market Firms Business should keep humming in 2019

T Chris Giamo Head of Commercial Bank, TD Bank

he past year has brought significant regulatory, macroeconomic and policy changes for U.S. companies. While corporate tax reform, continued interest rate increases, tariffs on foreign goods and a tightening labor market have the potential to cause significant financial impact, most middle-market companies are approaching the 2019 calendar year feeling upbeat about the economy and their prospects for continued growth. This optimism is likely to translate into more business investment, higher wages, innovation and exploration of merger and acquisition opportunities over the coming months. Tax Reform Perks up Profits According to TD Bank’s 2018 Middle Market Survey of 350 U.S. companies with revenues from $50 million to $500 million, 71 percent of companies said tax reform will have a positive impact on their business. This should come as no surprise, especially given that the law cut the federal corporate income tax rate from 35 percent to 21 percent and repealed the corporate alternative minimum tax. These modifications to the tax code are expected to strengthen corporates’ capital, offering businesses deeper cash reserves and the financial flexibility to expand and grow. Thus far, middle-market businesses across all industries have been preemptively using these savings to invest in plants, equipment, technology, and research and development. Many companies are also actively investing in people, with 61 percent planning to make new hires, according to TD’s survey, and multiple businesses making headlines for raising wages for existing staff. Lower effective tax rates, coupled with a strong economy, also can make M&A activity more attractive in this segment. In fact, almost seven out of 10 middle-market businesses polled in the Middle Market Survey said they plan to

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engage in M&A activity within the next two years. Even though attractive deals have been slow to arise, whether because of high valuations or interest rate hikes, 85 percent of these businesses said they foresee no barriers to pursuing M&A opportunities. Challenges on the Horizon Though many midsize businesses have adopted a sunny outlook, they identified some challenges to their operations. Survey respondents called out domestic competition (41 percent), interest rate increases (34 percent) and global competition (32 percent) among the top issues they face. Middle-market executives are also keenly watching the tight labor market, with the unemployment rate hovering around its lowest levels since 2000, according to the U.S. Bureau of Labor Statistics. This is creating a two-fold problem: Companies now have capital for expansion, but they have trouble filling both skilled and unskilled positions to support that growth. And companies face increased competition for the available workforce, meaning they need to prioritize retaining key employees to avoid additional job openings. Overall, middle-market executives feel confident about their prospects heading into 2019. The key will be determining how best to navigate opportunities and challenges and position a company for long-term growth. As executives evaluate their growth plans, banks will continue to play a critical role and work closely with commercial customers to provide financing and guidance to help them succeed in the new year and beyond. Chris Giamo is head of Commercial Bank at TD Bank, overseeing commercial lending and banking across the bank’s Maine-to-Florida footprint. He joined TD Bank in 1998 as head of its New Jersey Middle Market Lending Group.

Content Provided by ACG Partners and Featured Firms

H Executive Director of ACG Raleigh Durham, Debra Michie

Curling Gains New Following in Southward Sweep Clubs report broadening membership as sport spreads from snow belt to sun belt

f all the ways Debra Michie may have imagined getting back into curling, a conversation in a North Carolina supermarket wasn’t one of them. Her chance meeting in the grocery aisle a decade ago led her to Triangle Curling Club. A lifelong curler, the Windsor, Ontario, native and executive director of ACG Raleigh Durham was surprised to find the winter sport in North Carolina and to discover how popular it was becoming throughout the southern United States. The rules of curling are relatively straightforward, Michie explains. Two teams of four players take turns sliding heavy stones called “rocks” across a strip of ice toward a circular target called “the house.” Points

are scored by how close a team gets its stones to the house center, or the “button,” compared with the other team. A curling competition is commonly called a “bonspiel.” Triangle Curling Club was founded in 1995 with the goal that one day it would open a dedicated curling facility in the Raleigh-Durham area. In a region whose summer temperatures frequently top 100 degrees and whose winter snowfall averages about six inches, generating interest in an unfamiliar winter sport seemed unlikely. But despite the odds, by 2008 curling was already finding a home in the South. Over the last 10 years, clubs have formed in North Carolina, in cities like Charlotte and Wilmington, and across the region, in Atlanta;

Charleston, South Carolina; Jacksonville, Florida; and Richmond, Virginia. However, only Charlotte and Atlanta had dedicated facilities. Raleigh joined those cities in 2015, when Triangle Curling Club’s members raised enough money to open their own facility. But the club was so cash poor, members had to chip in to cover utility costs, which was a source of anxiety, Michie remembers. “At first, we were like ‘Oh, please let this work,’” she says. Not long after the facility opened, ACG Raleigh Durham was scheduled to host its ACG Capital Connection and Conference, one of the chapter’s largest events. More than 400 people from across the Southeast were expected to attend, so Michie decided to try something different. One of the conference’s most popular activities was its golf outing, but for the 2015 conference, Michie added curling at Triangle Curling Club to the conference’s activities. That first year, curling drew about 30 people, but by 2018, it was selling out faster than the golf outing. “The questions we used to get were like ‘How many investment bankers are you going to have?’ But now it’s ‘Can I still get into the curling outing?’” she says. “It’s gotten to be kind of a cult thing.” Meanwhile, Triangle Curling Club’s membership reached 300 in 2018, up from the original 40 members. The club drew nearly 1,000 visitors last spring, many of whom have returned

MIDDLE MARKET GROWTH // JAN/FEB 2019

THE ROUND

for additional lessons, says Michie, who now serves on the club’s board of directors and as a team captain— called a “skip.” “It was absolutely amazing for us,” she says. Now the club is faced with a new challenge: “What do we do with all these people?” A Growing Sport Michie’s club is part of a broader trend. According to USA Curling—the sport’s governing body—there were only six clubs in all of the southern United States before 2010, but by 2018 there were more than 20. It isn’t clear why curling is growing in popularity so quickly, but Michie says it can be explained in part by exposure the sport received when it was reintroduced to the Winter Olympics in 1998. Another factor might be transplants from Canada and the northern United States who move south and bring the sport with them. Regardless of cause, the club’s growth has enabled Triangle Curling Club’s members to develop their teams. Michie led hers to fourth place in last year’s U.S. Women’s Curling Association National Bonspiel. She says the job of managing club resources, deciding when to take risks and strategic thinking has applicability beyond the ice rink. “The strategy of curling is not much different than running a chapter or running a business or running any organization,” Michie says. “It’s all about the strategy and doing what you can with the resources that are available to you and maximizing the potential of your players.” —Benjamin Glick

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E CEO Alix James is steering her company into new markets

Rowing in a New Direction First propelled by women athletes, Nielsen-Kellerman is now entering new markets

fter Congress passed a law banning gender-based discrimination in higher education more than 40 years ago, demand for women’s sports equipment increased. Today, one of the companies boosted by that new market continues to develop new and more advanced offerings, with applications that go far beyond athletics. When Title IX was passed in 1972, the federal law sought to eliminate gender inequality on college campuses, including in athletics programs. Over the 10-year period to comply with the new statute, universities sought to make men and women’s activities more equitable by investing in sports such as rowing, which created a market for a new set of businesses that supplied teams. Nielsen-Kellerman was founded in 1978 as a maker of rowing equipment, and it benefited from the new ranks of women rowers,

NIELSEN-KELLERMAN’S PRODUCTS HAVE A WIDE RANGE OF APPLICATIONS, FROM FIREFIGHTING AND METEOROLOGY TO LONG-RANGE SHOOTING AND AGRICULTURE. as did rowing attire companies, boat manufacturers and rowing machine-makers, according to Alix James, Nielsen-Kellerman’s CEO. “Every single one of those companies started in the late ’70s, and it’s not a coincidence,” says James, who rowed while attending Yale from 1979 to 1983. “We all got to grow on the backs of a sport that was growing, and a lot of that growth came from women.” To comply with Title IX’s requirement that schools provide equal opportunities to participate in athletics, universities looked for high-participation women’s sports. With an average of 64 athletes on the roster, women’s rowing was a good candidate. Colleges invested in building their rowing teams, creating new scholarships, improving facilities and purchasing new equipment to meet the needs of the expanding sport. In 1997, collegiate women’s rowing became a recognized NCAA sport, which led to further increases in women’s rowing programs. For Nielsen-Kellerman, this activity created a new market to sell equipment to, and it allowed the company to invest in product development. Today, its NK Sports product line includes computational devices that measure stroke rate—“think bike computers for rowing and paddling,” James says—and amplifier systems for the coxswain to communicate with rowers. Rowing continues to experience global growth. It has the second-most available Olympic medals, behind

swimming. For countries that want to up their medal count, rowing tends to be a sport they focus on, she adds. Entering New Markets Nielsen-Kellerman has expanded beyond rowing to other industries that require precise measurements. Under its Kestrel brand, the Boothwyn, Pennsylvania company sells weather instruments to detect environmental conditions at the source. Due to the product’s versatility, wildland firefighting has become a popular application. The instruments help firefighters detect wind speed, humidity and temperature to anticipate where a fire will move next. Kestrel products are also used in construction, meteorology and scientific research. Long-range shooting is another fast-growing market for the company, which developed a reliable shooting calculator to measure wind speed and other conditions. The product has military, law enforcement and other tactical applications, and is used for recreational and competitive shooting. Nielsen-Kellerman’s latest initiative is to build an online data management environment that will provide data visualizations and reports—a transition into software that’s new for a company historically focused on hardware. “It’s a big shift for us,” James says. When private equity firm Clearview Capital bought Nielsen-Kellerman in October 2017, it saw an opportunity

to help the company expand into new end markets by supporting sales and marketing efforts, according to Matthew Blevins, a partner at Clearview. He says the company is growing organically at about 20 percent and looking for opportunities for add-on acquisitions to access new markets. Blevins cites agriculture, in particular, as an area with high growth potential. “There are a lot of different applications for the company’s existing product line-up through the Kestrel brand that can be applied on the agriculture side of things, primarily through environmental measurements,” he says. States are increasingly regulating how crops are sprayed with chemicals and herbicides, which has increased demand in the industry for Kestrel handheld wind meters, according to James. Clearview is Nielsen-Kellerman’s second private equity owner, and James says she’s excited about the new opportunities to grow. “I hired a lot of people this year across sales and marketing, and engineering and product management,” she says. “We’ve always had more ideas than we could get done with the resources that we had. Our current backers are very enthusiastic about adding resources to let us bring more of those ideas to market sooner.” // —Kathryn Mulligan

MIDDLE MARKET GROWTH // JAN/FEB 2019

VERTICAL VIEW

Private Capital Plays Its Hand Investment in gambling and sports betting hit a decade high in 2010, when private equity and venture capital inves-

The largest private equity deal in the

tors deployed $631.6 million across

sports betting and gambling industry in

just five deals.

the past decade was Toronto-based Clairvest Group’s $475 million

The industry’s most active year by deal

investment in Midwest Gaming &

count was 2014, with 16 private capital

Entertainment, an owner and operator of

transactions—five done by individuals,

casinos based in Chicago.

three by private equity funds and eight by venture capital investors.

Fantasy sports platform FanDuel has attracted substantial VC investment

In 2017, PE investment in gambling and

over the last five years. In 2016, it raised

sports betting outpaced VC for the first

$41.9 million in its eighth round of venture

time since 2010: Private equity firms

funding, following a $275 million round the

deployed $25 million compared with

year prior. BetFair Group, a public online

venture capital firms’ $1.23 million.

betting and gaming company, acquired FanDuel last July for $465 million.

U.K.-based Pentech Ventures and San Francisco-based Bullpen Capital are the most active sports betting and gambling investors in the U.S. Each venture capitalist firm completed six transactions in the industry from 2008 to 2018.

Data provided by PitchBook

MIDPOINTS by John Gabbert

Investors Eye Legalized Sports Gambling

ew markets take time to grow, but in some instances, simple legislation or a court decision can speed up the process. In those cases, the “new” market already exists in the shadows, and legalizing an activity—or re-legalizing it, as with the end of Prohibition—can be the starting point for an industry’s rapid development. That seems to be the case for sports betting, a market that investors are watching closely. In May 2018, the Supreme Court struck down a 1992 ruling that effectively prohibited sports gambling in most states. Many states have since made moves to legalize it. New Jersey was particularly eager to get in on the action: It challenged the existing federal law and legalized wagering in the state within days of the Supreme Court’s decision. There were exceptions prior to the ruling; betting was legal in Las Vegas, for example. But the ruling created an expanding market—one that investors, including private equity firms, may find appealing. Sports betting could fit well with the PE model, which prioritizes predictability and steady cash flow. Betting is inherently risky, but there’s truth to a well-worn cliché: “The house always wins.” PE involvement in the industry has been sparse to date, with very few dollars invested. It’s likely private equity interest will start with casinos, a well-established venue for betting and one where private equity has years of experience. Legalized gambling will provide casinos with a new source of revenue, especially when high-profile sporting events

come to town. From there, it’s hard to predict how PE investors will participate in the legal gambling industry, but it’s safe to assume they will. Venture capitalists have a longer history in this market. VC investment in sports betting has ranged from a few million dollars a year in 2010 to almost $300 million in 2015. Much of that capital was earmarked to one of two fantasy sports providers, DraftKings and FanDuel. There are others, but they aren’t household names—yet. New York State’s JOHN GABBERT Gaming Commission reported that Founder and CEO, daily fantasy sports generated about PitchBook $3.2 billion in entry fees and $335 million in revenue during the state’s 2017-2018 fiscal year, a number that’s expected to grow in coming years. On the heels of fantasy sports comes a new category, esports, which involves competitive video game playing. Professional SPORTS BETTING COULD gamers command envious FIT WELL WITH THE PE earnings, and spectators fill stadiums to watch compeMODEL, WHICH PRIORITIZES titions. Placing wagers on PREDICTABILITY AND STEADY those games is expected CASH FLOW. to become common in the coming years—and lucrative. One market researcher estimated that esports betting, even when it was unregulated, generated north of $7 billion in turnover in 2016. By 2020 that number is projected to reach $23 billion, with more than $1.8 billion in revenue. Those aren’t the highest numbers in the world, but they’re expected to grow with time. Investors eyeing a payoff should consider where to place their bets. //

MIDDLE MARKET GROWTH // JAN/FEB 2019

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QUICK TAKES

Hed Cycling Blazes a Trail with Female CEO

ven as women continue to be underrepresented in the C-suite, some female executives are using gender as a way to differentiate their businesses and expand into new markets. Anne Hed is among them. Her company, Hed Cycling, manufactures wheels, carbon rims and other components for competitive cycling. Last summer, it became a certified woman-run business enterprise, a designation she says could attract customers who appreciate what she’s doing. “This is not easy. It’s pretty much a male-dominated industry,” says Hed, the company’s CEO. Hed Cycling is based in Roseville, Minnesota, where it does most of its manufacturing and assembly. It was founded in 1984 by Anne and her husband, Steve Hed, whom she met after qualifying for the Hawaiian Ironman Triathlon. In need of $100 to cover the entrance fee, Anne approached Steve at his bicycle shop to ask for the money on the recommendation of a friend. He gave her the cash, and also tinkered with a new disc wheel design that Anne began using to compete. With Steve’s newly invented wheel, Anne won a competition on the East Coast that awarded her a car. The two used the title as collateral and secured a $14,000 bank loan to start a business selling wheels based on Steve’s design. For brand exposure, they gave away wheels to athletes. “The next leap was me getting a phone call from a kid in Texas. He didn’t have any money, and I decided to send him a wheel, and he broke it,” Hed recalls. “His name was Lance Armstrong.”

E Hed Cycling CEO Anne Hed in the company’s manufacturing facility

The company’s wheels have since been used to win a number of Tour de France races, as well as Olympic titles, including a gold medal in Rio de Janeiro. It holds several patents and patents pending for its wheel design. Bike-maker Cervelo eventually commissioned Hed Cycling to build an aerodynamic bicycle frame. In 2014 it developed a prototype for an advanced, one-piece molded frame made of composite materials—a complicated undertaking in the world of carbon fiber molding. Steve called Anne to tell her the first prototype was a success. But on the next call she received, she learned he’d collapsed and died unexpectedly. For Anne, continuing the project

was a way to honor her husband’s legacy and the frames have since won several composite awards, she says. The endeavor sparked ideas about other complex products the company can mold from carbon fiber, and how it might sell into industries such as aerospace and defense. For government or corporate contracts that mandate supplier diversity, the certification from the Women’s Business Enterprise National Council could benefit Hed Cycling and its nearly 50 employees. “I’m still in the infancy of trying to figure that all out,” Hed says. “I’m pretty sure I’m the only female-owned fiber molding manufacturer in the U.S. So how do you get the word out?” // —Kathryn Mulligan

MIDDLE MARKET GROWTH // JAN/FEB 2019

A QUALIFIED OPINION

Mary K. Braza Co-Chair, Sports Industry Team, Foley & Lardner LLP Mary K. Braza has more than 30 years of experience in litigation and dealmaking in sports, including as a strategic adviser and counselor to Major League Baseball under former Commissioner Allan H. Selig. She is a founding member of Foley & Lardner’s Sports Industry Team. Braza corresponded with MMG about the trends impacting investment in sports.

“PRICES FOR ALL PROFESSIONAL SPORTS PROPERTIES HAVE SKYROCKETED, EVEN FOR STRUGGLING FRANCHISES OR THOSE THAT HAVE TOPPED OUT THEIR REVENUE STREAMS.”

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Q A

What are the major trends impacting sports M&A? The two most important factors are scarcity and popularity. Scarcity makes a professional team in the U.S. a true collector’s item. There are only 32 NFL franchises, 30 MLB clubs, 30 NBA teams and 30 NHL teams. This drives interest not only in owning one of the “big four” teams, but in owning professional soccer and minor league baseball teams, and teams in newer leagues, such as lacrosse and rugby. Popularity of sports also drives interest; Forbes predicts the North American sports industry will reach $73.5 billion in 2019. But the most influential trend has been “new wealth” entering the market and driving up prices. It comes primarily from the financial sector, such as owners of private equity and hedge funds, and technology entrepreneurs. Meanwhile, leagues have allowed bidders with no previous ties to the local communities to come in as owners. Another trend to watch is legalized gambling on professional sports. In May 2018, the U.S. Supreme Court ruled that states may promote and license sports gambling operations. Legalized gambling could fuel even greater interest in professional sports, potentially leading to higher fees for

broadcast rights and higher franchise values.

Q A

How have valuations for sports franchises shifted? The shift has been dramatic. In 2000, the New York Yankees— the highest-valued MLB club—had a value slightly over $500 million, but by 2016 that had increased to almost $3.5 billion, according to Marquette University’s National Sports Law Institute. That trend was consistent across all big four professional sports. This uptick in valuations started in the late 2000s, when in the midst of the recession some iconic franchises became available—such as the Cubs and Dodgers—and sold for then record-setting prices. But the almost hockey stick-like growth started in 2014 with Steve Ballmer’s acquisition of the Los Angeles Clippers, the less valuable of the city’s NBA franchises, for a whopping $2 billion. Since then, prices for all professional sports properties have skyrocketed, even for struggling franchises or those that have topped out their revenue streams.

Q A

What types of buyers do professional sports franchises attract? They attract very wealthy sports fans, most of whom made their billions in other industries, such as

finance, technology and oil. Most recent buyers of professional sports franchises had no previous experience in the sports industry, with the exception of Carolina Panthers owner David Tepper—the founder of global hedge fund Appaloosa Management and a former minority owner of the Pittsburgh Steelers. Often these lead buyers will add others with sports experience to their ownership group, although for the most part that experience comes from playing the game— not owning or running a team.

Q A

Which emerging sports are drawing interest from buyers? Esports is drawing huge interest from buyers. This interest was fueled by the inaugural year of the

Overwatch League, in which teams representing major cities throughout the world squared off in a season-long competition, much like a traditional sports league. One reason esports franchises are drawing huge interest is the attractive demographics of esports fans and video game players. The average age of an Overwatch player is 22, with reportedly 40 million players worldwide. Esports provides a new and largely untapped fan base, but the question is whether the owners of esports franchises will actually make money. Most bought early and at artificial prices, largely for the opportunity to be on the ground floor. But if trends continue, franchise values and interest in these teams will continue to grow.

Q A

Do broadcast assets present an opportunity for investors? A big question is whether regional sports networks—22 of which are currently up for sale—will attract big money. The sale is required as part of the Department of Justice approval of the sale of Fox broadcasting assets to Disney. Fox’s 22 regional sports networks (RSNs) are spread across the country, and the most valuable is the YES Network. The RSNs have the rights to 44 pro teams across the MLB, NBA and NHL. Guggenheim Securities has valued Fox’s regional sports network portfolio at $25 billion. The sale has reportedly drawn some unexpected bidders, including Amazon and PE firms Apollo Global Management, KKR and Blackstone. //

Our Private Equity practice guides funds forward ` Specialized resources dedicated to Private Equity ` 50+ due diligence & valuation professionals ` Hundreds of national private equity & portfolio company relationships ` Advisory experience on 1,000+ deals with transaction value of $75B+ Learn more about our unique approach to Private Equity Scott M. Moss, CPA | smoss@cbh.com

Cherry Bekaert Expands Private Equity Team

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Fund Services | PE Tax | Deal Support Portfolio Company Compliance & Advisory

MIDDLE MARKET GROWTH // JAN/FEB 2019

TRIANGLE ROCK CLUB

EXPANDS ITS REACH Once considered an extreme sport, climbing is entering the mainstream as a fitness alternative with social appealÂ BY S.A. SWANSON

Photos by Ben McKeown

H Previous spread: Andrew Kratz (left) and Joel Graybeal scale a wall at TRC’s Morrisville gym

ost people’s “happy place” involves comfort and security, perhaps a tropical beach. For Andrew Kratz, it’s an environment rife with uncertainty. He served in the Marines for six years in the Force Reconnaissance unit, which regularly operates behind enemy lines. For four years, he worked on security detail for the crown prince of Morocco. It’s not surprising, then, that hanging from a rope, suspended 2,900 feet above the ground, is Kratz’s idea of a good time. Kratz taught himself to rock climb from a book—not an approach he recommends to anyone else—and he loved it immediately. For the past 11 years, he’s helped instill that joy of climbing in others, at Triangle Rock Club, the chain of climbing gyms he co-founded. When TRC opened its first location a decade ago, it was among the early gyms to add amenities and social activities to appeal to a customer base beyond outdoor climbers. With four locations and a fifth under construction, TRC’s revenue has grown an average of 36 percent annually for the past nine years. The military, climbing and entrepreneurship all fit with Kratz’s penchant for uncertainty. “When you’re climbing, there are real risks of injury or death. In the business world, it’s real risk of financial failure. So being able to comfortably and competently make decisions in those environments—I think all those things have a very good crossover application.”

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SOUTHERN CHARM Climbing gyms had no place in Kratz’s original entrepreneurial vision. He planned on becoming an outdoor rock climbing guide, but a climbing mishap in which he fell and broke both feet prompted him to reevaluate the long-term economics of that path. “I realized if you get injured, your income will stop,” Kratz says. “And I met much better rock climbers than me who were living out of their trucks.” Opening a climbing gym would provide a more stable paycheck, he reasoned, and it could also spread his passion for the sport. As Kratz developed a business strategy, the process felt familiar, and not unlike a military patrol order. “It’s basically saying, ‘This is the mission, this is what we’re going to do, this is how we’re going to do it, and these are the things we’re going to need to do it.’” He traveled the country to study other climbing gyms, and in 2006, he wandered into a Raleigh facility. As Kratz recalls, it was dirty and lacked air conditioning. It had bad lighting and smelled terrible, and although the gym was poorly run, it was packed with customers. Kratz believed he could do it better. “I had this vision in my head of what it should look like, and I wanted it to be clean and professional, and I wanted it to be welcoming,” he says. Raleigh is growing quickly. It now has more than 450,000 residents, an increase of more than 60 percent since the year 2000. And when Kratz

TRIANGLE ROCK CLUB Business: Indoor rock climbing gyms Locations: Morrisville, NC; Raleigh, NC; Fayetteville, NC; and Richmond, VA. TRC’s newest location will open later this year in Durham, NC Expansion Capital: Six rounds of Small Business Administration financing

discovered the city ranked high on lists like “top places to start a family,” he decided it was the right place to start his business. In 2006, Kratz left his job at a Pennsylvania military academy and moved to Raleigh with his wife and two young children. He didn’t have a building yet for the gym. And if the business didn’t succeed, there was no Plan B for supporting his family. “It’s like Cortes in the New World. You burn your boats to make your men work harder,” Kratz says. After looking at more than a dozen properties, Kratz found one with 24-foot ceilings in a town called Morrisville about 14 miles outside Raleigh. To launch the business, he needed half a million dollars. The climbing wall handholds alone cost about $50,000. “That’s more money than I’ve ever spent in my entire life on anything,” Kratz remembers thinking. He and his business partner, Luis Jauregui— another former Marine—each put in about $100,000, and they raised an additional $100,000 from family and friends. That meant a loan was still required to bridge the gap. Kratz quickly

E TRC Managing Partner Andrew Kratz set out to make climbing accessible

realized he needed a small bank, where he could speak directly with a decision-maker to convey the commitment he and Jauregui had to the business. He knew how implausible it all looked on paper. “A startup with two Marines, with no business experience whatsoever, who are bootstrapping indoor rock climbing,” Kratz says. “That was 11 years ago, and it sounded crazier back then than it does now.” It sounded sane enough for the first small Raleigh bank he approached, which approved a $200,000 loan.

LEARNING THE ROPES When Triangle Rock Club opened in December 2007, one of its first customers was Joel Graybeal. He was new to rock climbing, but he soon became a regular at the gym. In 2011, Graybeal decided to end his 25-year career in investment banking. While determining his next move, Graybeal offered to help Kratz. He didn’t intend to become a business partner, but that changed as he learned more about TRC. “This small gym, with not very tall

MIDDLE MARKET GROWTH // JAN/FEB 2019

walls, was getting an immense amount of attention, and it just kept getting busier and busier.” Graybeal saw the potential to expand well beyond one location, but for Kratz, the prospect of multiple gyms felt like a nightmare. “I was running on all cylinders doing one location,” he says. He had a hands-on role in the gym’s marketing and employee management—he even signed up new members. So Graybeal gave him some advice, which Kratz now passes along to aspiring entrepreneurs. “I say, ‘Your most valuable commodity is your time, and as a business owner, you should be focusing your time on things that only you can do.’ ” That meant hiring more staff—the company now has 225 employees—allowing Kratz to focus on running the business, which Graybeal does as well. He became a minority partner in 2011, and an equal partner three years later. (Jauregui, Kratz’s co-founder, is still a TRC partner but is no longer involved in day-to-day operations.) During the past five years, TRC opened three additional locations—in Raleigh, North Carolina; Fayetteville, North Carolina; and Richmond, Virginia. Its fifth gym is slated to open later this year in Durham, North Carolina.

“THIS SMALL GYM, WITH NOT VERY TALL WALLS, WAS GETTING AN IMMENSE AMOUNT OF ATTENTION, AND IT JUST KEPT GETTING BUSIER AND BUSIER.” JOEL GRAYBEAL Managing Partner, Triangle Rock Club

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‘DRIVING THE SPORT’ “Climbing gyms are a fad.” Mike Helt, editor in chief of Climbing Business Journal, has heard that assertion for the past decade. He encounters it less frequently now, in part because the number of climbing gym locations increased between 7 percent and 10 percent since 2011, according to Helt. He says that 45 U.S climbing gyms opened in 2017, bringing the total to 454 by the end of that year. Helt sees promise in Triangle Rock Club’s development strategy. By focusing on the Southeast, the company has targeted a region underserved by climbing gyms and its locations are sized appropriately. “They’re not getting in over their heads and building a $10 million facility in a city that doesn’t need it,” he says. “Their gyms are basically small-to-medium size, which is really sustainable—and an interesting model, which I think we’re going to see more of.”

Earbuds are rare at TRCâ&#x20AC;&#x2122;s gyms, where climbers talk and exchange tips

MIDDLE MARKET GROWTH // JAN/FEB 2019

E Millennials make up about 75 percent of climbers at TRC’s gyms

Of the industry shifts Helt has witnessed, the makeup of climbing gyms’ clientele is one of the biggest. Gyms are no longer dominated by devoted outdoor climbers seeking a winter training spot. “Fifteen years ago, [climbing] was an outlier, an extreme sport that crazy people did,” Kratz says. The sport now has a higher profile—it will be an Olympic event for the first time in 2020— but what’s more notable is the broad appeal of today’s climbing gyms. The dingy facility that Kratz visited years ago probably wasn’t a hotspot for kids’ birthday parties, church youth group outings or corporate team building—events that TRC gyms host regularly. “Of our membership base, I’d say less than 25 percent will ever touch real rock outside,” Kratz says. “Indoor climbing is the caboose that has become the engine. We’re driving the industry now. We’re driving the sport.” TRC’s gyms also have treadmills and elliptical machines, free weights, and yoga and Pilates

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classes. By offering more exercise options, it hopes to sway customers deciding whether to join a climbing gym or a conventional fitness club. Members pay their membership fees monthly, not annually, and TRC also offers $19 day passes and a discounted 10-day pass. There were an estimated 676,000 commercial climbing gym members in 2017, according to the Climbing Wall Association. Meanwhile, figures from the International Health, Racquet & Sportsclub Association show 60.9 million people in the U.S. have a traditional health club membership. That disparity represents a huge market opportunity for climbing. By converting just a fraction of existing fitness club members, the industry would grow dramatically, Graybeal says.

TIES THAT BIND The physical and mental challenge of climbing draws customers to gyms, but a social atmosphere helps keep them there. Mark Phillips, managing director at Jacobs Capital, a boutique

investment banking firm in Chapel Hill, North Carolina, saw this firsthand when he visited a Triangle Rock Club gym in 2017. “One of the things that was really surprising was nobody in the entire gym had earphones in,” he says. That’s highly unusual for any 21st-century public space, but particularly in a gym— and one where about 75 percent of climbers are millennials. At TRC, Phillips saw people actually talking to each other. Climbing culture tends to be collaborative: When waiting for their turn on the wall, climbers often share suggestions for tackling a route. TRC has designed ways to foster even more interaction among its members. It hosts an annual Memberfest (which has included a climbing-wall version of Twister) and quarterly member-appreciation parties. It also posts events on meetup.com to bring people together for dinner or drinks after climbing. Those social connections are good for customer retention. If a member knows a bunch of people at the gym, that individual is more likely to come back, Kratz says. That’s true for Casey Peterson, a 29-yearold financial adviser who joined TRC’s Raleigh location in July 2017. Prior to that, Peterson had memberships at other fitness centers, but he never stayed for more than six months. Working out “felt like a chore,” he says. Then a friend with a TRC membership invited him to come along using a free day pass. In addition to discovering some neglected forearm muscles during his first visit (“I could barely open my car door the next day”), he found the other climbers offered plenty of encouragement. Now Peterson visits TRC about three times a week. When he’s planning a climb, sometimes he’ll text other friends who are members, but if they can’t join him, that’s OK. “I never feel like I’m going by myself,” he says. “I’m always going to know somebody there. It’s a community for sure.”

CLIMBING HIGHER Thanks to six rounds of Small Business Administration financing, Triangle Rock Club has expanded to serve more members. But finding the right real estate has proved difficult. After

a 4 1/2-year search, TRC finally found its newest location, slated to open later this year in a former Walmart building in Durham, North Carolina. “We’re hopeful that the retail contraction trends will provide some additional opportunities for us down the road. But it’s tough to find existing buildings with 40-foot clear height,” Graybeal says. Climbing’s unique space needs have led to some unusual repurposing of buildings—including a climbing gym that’s housed in a former Methodist church in Bloomington, Indiana. In 2018, the country’s largest climbing gym opened in Englewood, Colorado, in a 53,000-square-foot complex that formerly housed the headquarters of defunct retailer Sports Authority. Triangle Rock Club has no plans to open a mega-gym. Its largest location is 33,000 square feet. But Kratz does expect to open more locations in the Southeast. He’s closely studying several markets so the company can act quickly when the right real estate opportunity emerges. Adapting to the industry trend toward taller walls, TRC is more than doubling the height of some of the walls at its Morrisville gym from 24 feet to 55 feet. Some portions will remain at the lower height—in part because shorter routes are better at hooking beginners. Kratz says he wants climbing newbies to enjoy success, rather than just the thrill of a novelty experience or the feeling of defeat if they don’t make it to the top. A few months ago, Kratz enjoyed the view from the peak of Mt. Whitney, the highest point in the continental United States. He still devotes time each year to outdoor climbing, and this was not the first time he scaled the California mountain. But on this occasion, he and his fellow climbers took a new route, one with 1,500 feet of straight granite. The trek could be a stand-in for his experience as an entrepreneur. Describing the climb that day, Kratz says, “We had to figure it out along the way.” // S.A. Swanson is a business writer based in the Chicago area.

MIDDLE MARKET GROWTH // JAN/FEB 2019

Sports

Investorsâ&#x20AC;&#x2122;

New

Playbook Industry disruption pushes teams and investors to get creative

BY BAILEY McCANN

few years ago, the sports business was in a bit of a slump. With the rise of ultra-high definition television and more affordable surround-sound systems, fans increasingly opted to watch teams play from home. Others used apps to catch highlights or games on the go. But organizations have since bounced back, creating experiences inside and outside of the arena that are filling seats and attracting private capital. “One of the things team owners in the U.S. have done very well is to figure out how best to monetize these assets,” says Charles Baker, co-chair of O’Melveny & Myers’ Sports Industry group. Beyond simply owning a team, leagues, owners and private investors can all get a piece of the revenue streams that go along with sports teams. Premium stadium seating is among the ways teams can drive revenue. Suites have long been a source for corporate sponsorships and building bridges with wealthy fans who later become investors on other projects or, in some cases, team owners. “While leagues generally impose revenuesharing on national media and league-wide sponsorships, licensing and merchandise, teams generally keep the suite revenues, as well as ancillary revenue opportunities around the stadium. Those opportunities can also draw specific investor interest,” Baker says.

MIDDLE MARKET GROWTH // JAN/FEB 2019

Leagues are increasingly looking for opportunities outside of their stadiums, too. Many have reimagined their brands, transforming them from single teams with a local fan base into global properties that sell broadcast rights and, in many cases, operate their own networks. The result has been to turn the in-home viewing experience into a significant growth driver. “Where you’ve seen people start to ‘cut the cord,’ sports viewing isn’t going down,” Baker says. “Some people are paying for sports streaming, and when we see the next round of media rights bidding open up, I wouldn’t be surprised to see Amazon, Facebook or Google continue bidding for those rights alongside major networks.” Baker adds that fans want to be able to watch their teams from wherever they are. Airing of American sporting events abroad has increased, and there are now more options for viewing global soccer matches and other international sports stateside. For the Jacksonville Jaguars, going global has helped the Florida football team expand its fan base and attract new sponsorship opportunities, according to Mike DeMartino, the Jaguars’ vice president of corporate sponsorships. The Jaguars’ owner, Shahid Khan, set out to grow the team’s brand after he agreed to buy the franchise in 2011. Khan and the team’s leadership identified an opportunity to expand its audience in London, where NFL teams were beginning to play games. Market research showed the Jaguars were among the least-recognized franchises in the

“WHEN YOU PUT TOGETHER A PLAN THAT IS GOING TO REDEVELOP A MAJOR AMERICAN CITY IN A VERY SHORT TIME AND CENTER THAT DEVELOPMENT ON ALREADY PROFITABLE ORGANIZATIONS, EVERYONE WANTS TO GET INVOLVED.” TOM WILSON President and CEO, Olympia Entertainment

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U.K. market. To improve their visibility, they began working out at London’s Wembley Stadium, where they play one game every season. The strategy worked. Six seasons later, analytics show the Jaguars as a top-10 NFL brand in London, according to DeMartino.

INNOVATING AT HOME For teams that operate in a mid-tier media market, going along with the NFL’s global media distribution plan isn’t enough to remain relevant. The Jaguars are thinking through new ways to attract local customers and investors. With support from management, the team has embarked on new initiatives, some of which have led to corporate sponsorships that bring people to the stadium even when there isn’t a game in play. In one example, DeMartino and his team worked with a local homebuilder to create a permanent model home that sits at the entrance to the stadium. Visitors can tour the house and speak with salespeople about the builder’s offerings. Inside the stadium complex is a dog park, which DeMartino and his team developed in partnership with a local pet company. Ticketholders can play with their dogs while watching the game on one of the screens installed in the park. “You have to get comfortable selling things that may not exist yet,” he says. Some of these new ideas have faced hurdles—city permitting, for example—but the team’s owners have been supportive of the initiatives, DeMartino says. “It’s been critical for us to have ownership that is interested in ideation and is willing to take some risks.” The team is now working with a local developer to create a mixed-use corridor connecting the stadium to a nearby port area. When complete, it will include restaurants, upmarket real estate and hotels that will create an entertainment area around the stadium. For many teams, fostering a community centered around a sports complex is the way of the future. Building up these areas, especially in midsize cities, creates a draw for locals and tourists alike. In Detroit, the transition of the downtown into a sports and entertainment hub

is speeding up the revival of one of America’s major cities—and attracting major acts, tourism and private capital. Tom Wilson, president and chief executive officer of Olympia Entertainment, has been at the forefront of this development. Olympia Entertainment handles business operations for the Detroit Red Wings hockey team and collaborates with the Detroit Tigers baseball team. Olympia Entertainment has been an anchor organization in the development of The District Detroit, a 50-block revitalization of the city’s downtown. The area has attracted other Detroit sports franchises, including the Pistons basketball team, and evolved into a hub that now houses several concert and theater venues alongside the city’s NHL, NBA and MLB teams. “What our ownership recognized is that there was an opportunity to connect midtown and downtown Detroit, have a hotel, have some real estate, and really create a front door to the city,” Wilson says. “We’ve grown exponentially and we’re partnering with organizations on sports, on concerts, on what is effectively the redevelopment of the city.” Private capital has played a significant role in the sports-driven development happening in Detroit and Jacksonville, despite challenges to investing in teams directly. Most U.S. leagues limit the number of owners a team can have and the size of their equity stakes. League rules tend to treat each limited partner in a fund as an owner, disqualifying private equity firms from buying a team—although PE executives have invested in teams on their own. But when teams start eyeing real estate, restaurant concepts, technology and media, there are plenty of opportunities for private equity funds to support those efforts. “When you put together a plan that is going to redevelop a major American city in a very short time and center that development on already profitable organizations, everyone wants to get involved,” Wilson says. “Our owners are very invested in the future of Detroit and we have been able to partner with stakeholders who share that passion.”

NEW GAMES, NEW LEAGUES, NEW TECH Private equity is also supporting sports innovation by financing the creation of new leagues and helping to expand sports technology as a field—an area dominated by middle-market companies. One firm, Causeway Media Partners, now owns Formula E, the electric car version of Formula One. Another private capital investor, RSE Ventures, has a stake in the Drone Racing League, which serves a brand-new sport that runs drones through complex routes. Other firms have bought into new competitions known as “cups.” Similar to well-known brands such as the Stanley Cup or America’s Cup, these emerging contests serve American soccer teams or minor league sports, which tend to have growing regional audiences outside of major markets. To capitalize on the opportunity, in 2015 Steel Sports acquired the National Youth Baseball Championships, whose games are televised on CBS Sports and streamed live on MLB.com. The firm plans to help the competition series grow through corporate sponsorships, celebrity appearances, and continued television and online coverage of games, according to its website. Sports technology is another area catching private equity’s attention. Companies in this space provide virtual training, data and analytics. Their offerings serve teams, help athletes improve, and engage fans involved with fantasy teams, which thrive on the statistical side of sports. PEAK6 Sports, a venture capital firm in Chicago, expects to see further innovation in sports technology. “We see an opportunity to apply technology and data in unique ways in the sports industry that haven’t been tried before,” says Jay Coppoletta, the firm’s chief corporate development and legal officer. “Sports tech is a really high-growth area. These aren’t just technologies for professional sports teams. There are broad applications for tech from youth sports all the way up, and that’s really compelling.” // Bailey McCann is a business writer and author based in New York.

MIDDLE MARKET GROWTH // JAN/FEB 2019

POLICY POINTS

Revisiting the Volcker Rule ACG advocates to exclude middle-market private funds from the Volcker Rule

MARIA WOLVIN Vice President and Senior Counsel, Public Policy, ACG Global

ACG IS LAYING THE GROUNDWORK TO OPEN UP A VALUABLE SOURCE OF CAPITAL THAT CAN BE INJECTED INTO U.S. MIDDLE-MARKET BUSINESSES.

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he Volcker Rule was a core component in Congress’ quest to achieve financial stability following the Great Recession, but the provision has prevented banks from investing in middle-market private funds, even though these funds lack the characteristics that raise systemic risk concerns. Federal agencies have since indicated they’re open to modifying the rule, including narrowing the definition of funds prohibited from receiving investment capital from banks. When Congress passed the Volcker Rule in a package of sweeping financial reform legislation in 2010, its aim was to minimize systemic risk by prohibiting banks from engaging in proprietary trading—a form of trading that allows banks to profit by investing their own money instead of trading on behalf of clients. To prevent banks from skirting this prohibition, the Volcker Rule generally prohibits banks from sponsoring, acquiring or retaining an ownership interest in hedge funds and private equity funds—a blanket restriction that has impacted sources of capital for the middle market. Five federal agencies, including the Federal Reserve Board and the Securities and Exchange Commission, are responsible for administering the Volcker Rule. It is the responsibility of these agencies to interpret the Volcker Rule and to issue rules to implement what Congress intended while adhering to the text of the statute. In 2013, the joint agencies adopted a complex final rule that included hedge

funds and private equity funds under the single umbrella of a “covered fund,” despite fundamental differences between the two. Since this time, banks have been prohibited from investing directly into private funds, including those in the middle market. On May 30, 2018, the Federal Reserve Board kicked off a new round of rulemaking related to the Volcker Rule, announcing it was seeking comment on a proposed rule to simplify and tailor compliance requirements, including potential changes to the definition of a covered fund. The other four agencies followed suit and on July 17, a notice of proposed rulemaking was published in the Federal Register. ACG’s Advocacy While there is widespread speculation that the agencies are seeking to exclude venture capital funds from the definition of a covered fund, the Association for Corporate Growth believes this rulemaking is an important opportunity to advocate that certain middle-market private funds do not pose a threat to systemic risk and should therefore also be carved out from the reach of the Volcker Rule. In a comment letter filed on Oct. 17, ACG argued that the current onesize-fits-all approach to the definition of a covered fund has deprived banking entities from investing in middle-market private funds that pose no systemic risk, do not share the characteristics of the types of investment vehicles the Volcker Rule was primarily designed to protect against,

and provide much-needed investment capital to growing U.S. businesses. Specifically, ACG asserted that middle-market private funds make longterm investments in privately held businesses, do not employ significant leverage at the fund level or engage in risky derivatives, and generally disallow redemption rights for investors. These factors provide inherent fund-level stability for middle-market private funds, a finding supported by SEC data. Driving Middle-Market Growth In the comment letter, ACG advocated that private funds that are not managed by large private equity advisers—defined on reporting document Form PF as an adviser with at least $2 billion in private equity fund assets under management—should be excluded from the Volcker Rule’s definition of a covered fund. This means banks would no longer be prohibited from investing in private funds with less than $2 billion in assets under management. ACG’s solution fulfills several important conditions designed to increase the chance for success: It relies on definitions already found within the current regulatory framework, it uses a bright-line threshold that banks can easily verify, and it can be implemented with minimal cost or burden to banks. Furthermore, ACG’s position fulfills its mission to drive middle-market growth. By advocating to allow banks to invest in middle-market private funds, ACG is laying the groundwork to open up a valuable source of capital that can be injected into U.S. middle-market businesses, helping these economy-boosting companies to grow and expand.

Political Action Committee 101 Defining a PAC, how it works and why it matters

s part of its mission to drive middle-market growth, the Association for Corporate Growth in 2016 formed a political action committee to elect likeminded candidates to federal office. In the 2018 midterm elections, the ACG PAC contributed $2,700 to each of four congressional candidates on both sides of the aisle. But what is a political action committee and how does it work? PACs allow organizations to pool personal money from individuals or other PACs and donate on their behalf to the election campaigns of candidates who champion policies those donors want to support. PACs, which are overseen by the Federal Election Commission, can be operated as individual enterprises, or in connection with an organization or association. Organizations of all sorts operate PACs, from the Humane Society to the American Association of Nurse Practitioners. PACs serve an essential purpose: They allow individuals to identify an election issue that’s important to them, and to delegate to political professionals the task of identifying candidates for political office who support that issue. For associations like ACG, which operates a federal PAC, these vehicles are the only way to support and elect candidates to national office who are committed to the causes they care about. The brand and reputation of the PAC’s affiliated organization is crucial. A donation from a PAC that is connected to an association with a

strong presence on Capitol Hill can have a greater impact on an issue’s visibility than a campaign contribution from an individual donor. PACs donate strategically on behalf of entire industries and market segments, providing strength in numbers through a unified voice. PACs should not be confused with so-called “Super PACs,” vehicles through which individuals and corporations contribute unlimited amounts of money to be used for political activities outside of direct coordination with parties and candidates. In contrast, federal PAC collections and disbursements have stringent limitations. PACs may only donate up to $2,700 or $5,000—depending on the status of the PAC—to a campaign on behalf of individual donors. ACG formed the ACG PAC to pool personal, voluntary funds from individual ACG members to help support and elect federal candidates that are champions of the middle market. The ACG PAC is bipartisan and complies with all federal election laws. To assist ACG members who work as investment advisers, the ACG PAC fully complies with all federal “pay to play” laws and only supports campaigns of candidates for federal office. PAC donors must be U.S. citizens or resident aliens. // —Ben Marsico

MORE ONLINE To learn more, contact policy@acg.org.

MIDDLE MARKET GROWTH // JAN/FEB 2019

GROWTH ECONOMY

NORTH CAROLINA // 1998â&#x20AC;&#x201C;2017 The number of jobs created by private equity-backed businesses in North Carolina grew more than twice the rate of the broader business community over the past two decades. Sales fared even better. The revenue of private equitybacked companies grew more than three times the rate of other businesses in the state. While North Carolina had a record-breaking year in 2017 with over $17 billion across 114 deals, a large portion of deal flow continues to be concentrated in the business-to-business sector, which has represented a 40.1 percent share of PE activity since 2010.

SALES GROWTH % BY SEGMENT

SALES

10.9% 12.9% 37.2% 38.9%

ACG RALEIGH DURHAM 0%

ACG CHARLOTTE

JOB GROWTH % BY SEGMENT 0.3% 20.6% 26.8%

130.9%

SALES GROWTH IN PE-BACKED BUSINESSES

41.4%

SALES GROWTH IN ALL BUSINESSES

52.3% 0% Small: Less than $10M in sales MM Seg 1: $10-50M in sales MM Seg 2: $50-100M in sales MM Seg 3: $100M-1B in sales Large: More than $1B in sales

JOBS

GROWTH IN PE-BACKED BUSINESSES

GROWTH IN ALL BUSINESSES

JOBS CREATED BY PE-BACKED BUSINESSES

52.5%

27.6%

17,850

MORE ONLINE See the impact of middlemarket private equity on your state at GrowthEconomy.org.

All stats are from PitchBook and the Business Dynamics Research Consortium at the University of Wisconsin-Extension.

middlemarketgrowth.org

THE PORTFOLIO

Cybercrime and the Middle Market SOUND DECISIONS // Data show midsize companies are particularly vulnerable

T Daimon Geopfert Principal and National Security, Privacy and Risk Leader, RSM US LLP

he age of big data translates to even bigger risks for businesses of all sizes, but middle-market companies are particularly vulnerable. While widely reported hacks of large corporations such as Equifax and Uber made headlines in 2017, there was less news coverage of the security breaches of midsize businesses, which are increasingly landing in the crosshairs of cybercriminals. The number of middle-market companies that have experienced data breaches over the last three years significantly increased—to 13 percent from 5 percent, according to the RSM US Middle Market Business Index. Bigger middle-market businesses with enough scale to attract cybercriminals typically lack the defensive resources of their large-cap rivals and have become targets, according to data collected from about 400 middle-market executives.

CYBERCRIME BEHAVES MUCH LIKE A MUTABLE DISEASE, CONTINUALLY EVOLVING, PUSHING NEW BOUNDARIES, FINDING VULNERABILITIES AND SUBSEQUENTLY EXPLOITING WEAKNESSES. From ransomware attacks and identity theft to intellectual property risks and privacy concerns associated with the increased use of digital currency, the security of electronic information is set to remain among the biggest challenges facing companies in the 21st century. There are few signs of crime abatement in the ever-changing cyber landscape. Nearly 50 percent of midsize companies expect they will face unauthorized users attempting to breach

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their data or systems this year, according to the executives surveyed. Moreover, despite incidents of rising cybercrime, just half of the businesses surveyed carry cyber insurance policies to protect against internet-based risk. The RSM study shows that many of those policies may fall short of comprehensive coverage. Meanwhile, the C-level executives surveyed may be overly confident in their firms’ internal abilities to thwart an attack. Some 93 percent of respondents were confident in their organizations’ ability to safeguard customer data. The reality—based on actual incident reports—is proving that confidence may be misguided. While smaller companies were hardest hit last year, midsize companies with annual revenues of $50 million to $300 million accounted for a fifth of cyber incidents, according to NetDiligence, which produces a yearly report, sponsored by RSM, that tracks cybercrime. Those companies with higher levels of income suffered significantly fewer incidents. Cybercrime behaves much like a mutable disease, continually evolving, pushing new boundaries, finding vulnerabilities and subsequently exploiting weaknesses. The RSM US Middle Market Business Index special report was developed to shed light on some of the important trends related to cyber incidents in the middle market, and the steps that midsize companies can take to mitigate ongoing risk. For more information and to download the report, visit rsmus.com/cybersecurityreport. // Daimon Geopfert is responsible for the development of RSM’s strategy related to security, privacy and risk services. He has over 20 years of experience with information security disciplines.

MIDDLE MARKET GROWTH // JAN/FEB 2019

THE PORTFOLIO

Turning Passion into Profit MIDMARKET TRENDS // Investing in consumer enthusiast businesses pays off

I Ted Morgan Principal, Plante Moran

love fast cars. I’ve been driving them since I was 18, and over the years, I’ve really enjoyed letting others drive my cars to share in the fun. And when I hear there’s something that can improve my driving experience, I’ve been known to rush out and buy it. I’m a classic “consumer enthusiast”: an individual with a hobby who’s not afraid to spend disposable income on it. These consumer interests can spell steady profits from the companies that serve them—from makers of high-performance auto parts for car enthusiasts, to boating accessories for water lovers. Because of the passion and loyalty of their customers, these companies’ sales tend to have an extra layer of insulation during economic downturns. Conversely, when the economy is healthy, revenue and profits can soar. And consumer enthusiasts are influential, so their recommendations can juice demand with friends and family.

ENTHUSIASTS ALWAYS WANT THE NEXT COOL THING AND OFTEN THEY ARE WILLING TO PAY FOR IT. Typically founded and owned by enthusiasts themselves, these companies often are small-tomidsize businesses and family-owned. Many of these companies have reached a certain size and seek investment and guidance to get to the next level, creating significant opportunity in this market for private equity investors. Plante Moran’s decades of experience in manufacturing and consumer-focused markets have led us into this interesting niche. In particular, we’ve worked extensively with Monomoy Capital Partners, a private equity firm with $1.5 billion in committed capital.

middlemarketgrowth.org

In one engagement, Plante Moran performed market planning, strategic growth analysis and due diligence for one of Monomoy’s consumer enthusiast businesses. As a result, the company has been able to meet the goals that Monomoy set forth when the business was acquired. This rewarded both the company’s existing stakeholders while providing a runway for future owners to take it to the next level. Enthusiasts always want the next cool thing and often they are willing to pay for it. With proper due diligence and growth planning, prospective buyers can uncover a company’s potential, and fresh investment can help the company expand product lines and speed up the pace of new product introduction. A private equity firm also can help improve the company’s brand position and deepen engagement with customers. After all, for enthusiasts, it’s all about community. Enthusiast companies often are less sophisticated in terms of systems, business infrastructure and strategic planning. Owners may have operated the same way for years. This creates opportunities for operational and financial process improvements. New technologies can increase efficiencies and lower costs. Monomoy and Plante Moran have teamed together for nearly a decade working on these initiatives throughout Monomoy’s portfolio of investments. So remember, that hobby that gets you excited could just be the next big investment opportunity. // Ted Morgan is a principal with Plante Moran. He has more than 20 years of experience providing strategic and operational guidance that drives profitable growth to manufacturing clients and private equity firms.

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THE PORTFOLIO

Foreign Buyers in the U.S. Middle Market PE LAW // M&A appetite remains strong despite headwinds

T Alp Basaran Corporate Associate, Pepper Hamilton LLP

he U.S. M&A market remains attractive for foreign acquirers because of the predictability of the country’s legal system and the purchasing power of American consumers. Deal activity is expected to remain strong due to low costs of entry, potential for fast-paced growth, and the ability to transform companies easily. Foreign buyers steadily increased their M&A activity in the U.S. middle market from 2013 to 2017. It remains to be seen how tariffs, reform legislation involving the Committee on Foreign Investment in the United States (CFIUS), higher interest rates and a strong dollar will impact middle-market M&A activity, but foreign buyers have continued their acquisition activity in the first three quarters of 2018 at a rate comparable to that of 2017. Based on trends and forecasts, foreign buyers likely will continue to find the U.S. middle market attractive. For M&A deals valued at $10 million to $1 billion in 2013, foreign entities made up 13.7 percent of all buyers of U.S.-based targets, according to data from S&P Capital IQ. In 2017, that number grew to 21.4 percent. In the first three quarters of 2018, foreign buyers constituted nearly 21 percent of buyers. Like U.S.-based buyers, most foreign acquirers prefer transactions in the $10 million to $100 million range, followed by increasingly larger middle-market deal sizes. In terms of overall value, deals involving foreign buyers contributed to 15.8 percent of total deal value in 2013. That grew to 20.4 percent in 2017. At press time, foreign-buyer deals have contributed to 19.6 percent of total deal value in 2018. S&P Capital IQ’s data show that during the period from 2013 to 2017, foreign buyers were most active in real estate, followed by the consumer discretionary, information technology, health care, industrials and materials industries.

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This is generally consistent with broader trends for U.S. buyers, except that U.S. buyers showed more interest in the financial industry. The first three quarters of 2018 showed similar trends. CFIUS reform legislation enacted last August may negatively impact M&A activity in certain industries. The new law increases scrutiny of deals involving a buyer based in a country of special concern that has the strategic goal of acquiring critical technology or critical infrastructure, such as those in the information technology, biotechnology, defense or infrastructure industries. China is widely understood to be a country of special concern. Indeed, CFIUS has blocked several transactions, even before the enactment of more rigorous legislation—including in instances where the target was a foreign company with a U.S.-based business. Any slowdown in deals with Chinese or other foreign buyers may not affect the broader U.S. middle market because most foreign buyers are from countries that have not been deemed threats to U.S. national security. From 2013 to 2017, the top countries represented by foreign acquirers in the U.S. middle market, in order of deal share, were Canada, the United Kingdom, China, Germany and Ireland. In the first three quarters of 2018, they were Canada, the United Kingdom, China, South Korea and Switzerland. Overall, we expect the pipeline for middlemarket transactions to remain robust for the foreseeable future. // Alpaslan “Alp” Basaran is a corporate associate in the New York office of Pepper Hamilton LLP. He focuses primarily on M&A and general corporate matters, and he has represented public and private companies, as well as private equity firms, in a variety of U.S. and international transactions.

MIDDLE MARKET GROWTH // JAN/FEB 2019

ACG@WORK

G ACG BOSTON ACG Boston hosted its inaugural Family Offices and Founders Networking Breakfast with almost 30 participants. The event featured an intimate roundtable discussion with Grant Gund, managing partner of Coppermine Capital, and James Atwood, CEO of Agile Magnetics, one of Coppermine’s portfolio companies. The two covered their history, their working relationship and lessons learned along the way. The event generated interest and excitement among attendees for

E ACG BOSTON

future family and founder events through ACG Boston.

ACG Boston hosted ACCELERATOR 2018, a leadership development program for rising leaders in the M&A community. The program launched in 2014 and provides young participants with immediate connections to a diverse group of deal professionals, valuable presentations on effective leadership and communication skills, and a chance to learn from and connect with industry leaders. It is structured to ensure lasting and valuable relationships across the New England deal community.

H ACG BOSTON DealFest Northeast brought together more than 700 deal professionals— capital providers, intermediaries, corporates and strategic buyers—from across the country for two days of efficient and dynamic networking in a relaxed brewery-style atmosphere. Attendees participated in DealFest and DealSource Select.

middlemarketgrowth.org

H ACG ST. LOUIS The ACG St. Louis Pro-Am Invitational was held at Meadowbrook Country Club with 165 attendees. The Pro-Am Invitational is a unique tournament where the areaâ&#x20AC;&#x2122;s best golf professionals are invited to play with foursomes of ACG St. Louis members. Attendees were able to network with industry professionals, potential clients and corporate executives.

G ACG KENTUCKY ACG Kentucky hosted a golf outing this summer at the Valhalla PGA Golf Course in Louisville. The event provided 85 participants the opportunity to network and build camaraderie while out on the green. A portion of the proceeds was awarded to Junior Achievement of Kentuckiana, a nonprofit focused on financial literacy and education.

E ACG PITTSBURGH ACG Pittsburgh hosted an event at Topgolf Pittsburgh, where more than 50 attendees honed their golf skills while networking with industry professionals.

MIDDLE MARKET GROWTH // JAN/FEB 2019

ACG@WORK

G ACG ORANGE COUNTY ACG Orange County held its Women’s Networking Tea and Speaker event, a forum for the chapter’s Women in Leadership group to network and promote middle- market clients. The event’s speaker, Lola Gershfeld, a board dynamics specialist, discussed a science-based approach to improving board and team performance using emotional connection.

E ACG NEW YORK ACG New York’s New Member, Board and Sponsor Reception was held at the Southwest Porch-Bryant Park. This networking event drew 100 attendees and provided an opportunity for networking with a new group of people. Pictured (from left) are Jennifer White, Frank Marcucci and Frances Schlosstein.

H ACG WESTERN MICHIGAN ACG Global CEO Pat Morris (right) presented the 2017 Mid-Size Chapter of the Year award to ACG Western Michigan at the chapter’s September breakfast. This is the second Chapter of the Year award for Western Michigan. Pictured with Morris (from left) are ACG Western Michigan’s Julie Metsker, executive director; Jason Brinks, membership chair; Jon Siebers, vice president; and Dan Lynn, chapter president.

middlemarketgrowth.org

E ACG CINCINNATI ACG Cincinnati hosted a women’s lunch featuring speaker Krissi Barr, CEO of Barr Corporate Success and author of “The Fido Factor: How to Get a Leg up at Work.” She spoke about her book, which was inspired by 15 years of executive coaching experience and 20 years in corporate leadership positions. Now entering its fourth year,

G ACG SAN DIEGO

ACG Cincinnati’s Women’s Initiative hosts quarterly

ACG San Diego hosted its annual Surfside

events to help promote women’s representation in

Social, a popular event among the chapter’s

the M&A and financial sector.

members and non-members. More than 140 attendees gathered at the La Jolla Beach and Tennis Club to network in the sand.

MIDDLE MARKET GROWTH // JAN/FEB 2019

ACG@WORK

H ACG ATLANTA ACG Atlanta hosted its annual Around the World Wine Tasting in September at Mason Fine Art. More than 500 attendees enjoyed a selection of over 40 premium and cult wines. Pictured (from left) are Reese Henson, CIBC Bank USA; Katie Stapleton, SunTrust; and Anthony DeAngelis, CIBC Bank USA.

ACG ATLANTA F ACG Atlanta Deals with Globalization was hosted at the Buckhead Club with 95 attendees. The eventâ&#x20AC;&#x2122;s panel session addressed sovereign funds, tariffs and cross-border investment. ACG Atlantaâ&#x20AC;&#x2122;s chairman of the board, Patrick Putman, moderated the discussion, which focused on the impact of these three topics on the investment and business landscape.

CONTACT Want to share photos from your recent chapter event? Email us at editor@acg.org.

middlemarketgrowth.org

THE LADDER

BakerHostetler announced FRANK MILLER has rejoined the firm as partner. He brings more than 20 years of experience in the health care industry and previously served as the lead transactional attorney for one of the country’s largest integrated health care systems.

Ravinia Capital announced JOHN KEMP has joined the firm as partner. Kemp brings over three decades of experience as an operating and financial executive. In his new role, he will work with Ravinia to help companies that are looking for capital to invest or buy more time in tough situations, and those seeking succession, ownership transition or exit strategies.

Gerber Finance named HOWARD MOORE III vice president of marketing. Moore brings extensive experience working with a wide variety of companies. In this role, he will be responsible for generating, analyzing, building and managing new client relationships.

Vistra announced the appointment of SCOTT KRAEMER as managing director of alternative investments in North America. Kraemer has over 25 years of experience in financial services and served most recently at State Street as senior vice president in the Private Equity & Real Asset Fund Services group.

First Business Growth Funding announced ANDREW WILHELMY has joined the firm as vice president, business development. Wilhelmy brings experience from owning a factoring firm, and from roles in commercial banking, lending and as a financial adviser. Wilhelmy previously served as vice president of Intermountain West.

DESIREE CASTILLEJOS joined Kimball Electronics as chief strategy officer and vice president of corporate development and M&A. Castillejos will be responsible for the inorganic growth of the company. She has over 15 years of experience working in corporate development and strategy in the technology industry and served most recently as vice president, corporate strategy and development, at Nokia.

Apex Leaders announced it has hired ANDREW MABEY as vice president of business development, where he will focus on growth initiatives and sales. Mabey has more than a decade of experience in M&A. Most recently, he served as global head of accounts at Third Bridge.

MORE CAREER INFO Watch for more career information in The Ladder monthly e-newsletter.

MIDDLE MARKET GROWTH // JAN/FEB 2019

IT’S THE SMALL THINGS

SPORTS AND RECREATION TRENDS // What’s in play?

Soccer Scores More Fans in U.S. The world’s game is on track to become America’s

Getting Reacquainted with the Great Outdoors

third-favorite spectator sport. A poll released

Participation in outdoor recreation grew by nearly

earlier this year found 7% of Americans say soccer

3 million people to 145 million from 2015 to 2017.

is their favorite sport to watch, representing a

The South Atlantic region, which includes the

three-percentage-point gain from just four years

southern states on the Eastern Seaboard and West

ago. Viewership trends suggest soccer will surpass

Virginia, had the highest rate of outdoor partici-

baseball to join football and basketball as the three

pation in the country at 19% of the population and

most-watched sports. —Forbes

$179.1 billion spent on outdoor recreation products. —The Outdoor Foundation

It’s All Uphill for Winter Sports The number of people getting out in the snow continues to grow. Winter sports participation

Ready Player One? Esports became a $1.5 billion industry in 2017 and

increased 1.7% over the past three years, accord-

there’s little sign of it slowing down. Professional

ing to a report by Snowsports Industries America.

and high-level amateur gaming competitions are

About 12 million participants hit the slopes during

expected to grow 26% to nearly $2 billion by 2020,

the 2017–18 season, and the related products

driven by audiences expanding into the mainstream

industry has grown 5.5% to $4.7 billion between

and leagues raising revenue through brand spon-

the 2011–12 and 2015–16 seasons.

sorships, advertisements, ticket sales and team

—Snowsports Industries America

merchandise. —SuperData Research

Athleisure for Your Pleasure Healthier lifestyles and stronger participation in

Cutting the Cord While overall viewership declined during last year’s

sports and fitness activities are propelling substan-

NFL season, the number of people watching a

tial growth in the fitness apparel market. Estimates

streaming service increased 60%, according to

predict global revenue of sportswear, which

NBC. The bulk of that increase is due to the growth

includes items such as yoga pants and activewear,

of services like Sling TV and DirecTV Now, which

will reach more than $230 billion by 2024.

have more than 2 million subscribers today.

—Business Insider

—Sports Business Daily

—Benjamin Glick

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