Middle Market Growth - September/October 2019 by Association for Corporate Growth

Digitalizing Performance to Optimize Profit Are you ready to take the digital journey to stay competitive and drive profitability?

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FROM THE EDITOR

Show Me the Money, Faster

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

ecently, I persuaded my mom to download the Venmo app after a digital transaction between our bank accounts expired. Who knew 2019 would be the year I’d swap electronic cash with my parents on a payments and social networking app—or that sending $27 with a smiling emoji would be just the tip of the iceberg? The consumer applications for financial technology get the lion’s share of attention, but behind the scenes, fintech is changing the way many industries do business. This issue’s cover story (p. 24) profiles Fattmerchant, an Orlandobased company that offers flat-rate payment processing with price transparency that it says its competitors lack. But the company’s services go beyond just financial transactions. By integrating with accounting software and displaying data in a meaningful way, Fattmerchant provides customers with tools that enable better informed decision-making. Health care, a notoriously complicated and inefficient industry, is another area where back-office technology is being deployed, ultimately to improve patient care. Revenue cycle management software, for example, can help avoid denials from insurance, speed time to payment and automate processes to allow doctors to focus on their core objective—treating patients. The creators of these tech-enabled solutions are promising dramatic change. If companies like Fattmerchant can help businesses operate more efficiently, imagine the economic impact from improved business performance and receipts. Or picture a health care industry where the complex relationship of patient, payer and provider is streamlined to lower costs and make the American health care system easier to navigate. For many of the companies that develop these technologies, private capital investors are helping them get their offerings to market. Fattmerchant credits its private equity backer, Fulcrum Equity Partners, with providing operational support and helping the company forge new partnerships. Meanwhile, the health care investors and consultants I spoke with described their role working with health care organizations to select the right software for their practice and implement it effectively (p. 12). Perhaps with investors’ help, we’ll soon see the day when paying a medical bill is as easy as Venmo-ing your mom. //

MIDDLE MARKET GROWTH // SEP/OCT 2019

EXECUTIVE SUMMARY

Change Is in the Air

MARTIN OKNER Chairman, ACG Global Board of Directors, and President and COO, dpHUE

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t’s an exciting time to operate a midsize business for many reasons, not least of which is the rapid pace of technological change impacting organizations across industries. It’s an honor to assume the role of chairman of the ACG Global Board of Directors when so much innovation is happening within the middle market. I will step into the role on Sept. 1 following my predecessor, Angela MacPhee, and I look forward to the year ahead and the new initiatives underway at ACG. I’ve seen the impact of technology firsthand working within the beauty industry, where I’ve spent the last 15 years of my career. Around 2012, digital transformation took the $800 billion industry by surprise and changed the entire marketing, distribution and supplier landscape within just three years. This issue of Middle Market Growth explores a specific subset of technology—fintech—and how it’s impacting middle-market companies and financial services. Fintech is often associated with business-to-consumer transactions, yet behind the scenes, it’s transforming B2B functions and creating new opportunities for investors. Fintech is also altering longstanding business models for banks, insurers and other financial services firms. With disruption comes both opportunity and uncertainty—and it makes ACG’s community more valuable than ever. From panel discussions at chapter events to conversations with peers during networking receptions, ACG members have access to the expertise and relationships needed to navigate digital transformation. ACG has long been a go-to source for expert intelligence, and we’re expanding those offerings this fall with our inaugural Strategic Acquirer Summit, which will bring together corporate development professionals in Dallas on Nov. 4-5 for panel sessions, networking and more. Another major priority for ACG is to advance middle-market issues in Washington, D.C. In June, more than 40 ACG members participated in our Middle-Market Fly-In to discuss the issues facing their businesses and clients with congressional staffers. It was inspiring to see so many ACG members participating in the democratic process, and it reflects the momentum building in Washington in support of middle-market issues ahead of the 2020 elections. I’m honored to serve as your chairman at a time when the business landscape is evolving rapidly in the face of technological innovation and policy changes, and I can assure you that ACG will remain on the forefront of these developments to help channel their impact toward driving middle-market growth. //

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DON’T MISS QUICK TAKES StreetShares Enlists AI for Lending 21

A QUALIFIED OPINION Trends in Tech Deals 22

POLICY POINTS ACG Members Go to Washington 36 Fintech Draws Regulatory Scrutiny 38 Cover and above photo by Scott Cook Photography

GROWTH STORY

Merchants of Efficiency After Suneera Madhani’s employer ignored her idea for a new approach to payment processing, she left to start Fattmerchant, an Orlando company that offers its customers a flat-rate subscription model and real-time payment data. Since it was founded in 2014, Fattmerchant has grown to 100 employees and, with the help of Fulcrum Equity Partners, it’s forging new partnerships with software providers and nearing its fourth consecutive year of more than 200% revenue growth. 24

TREND

IN THIS ISSUE From the Editor 1 Executive Summary 2 Executive Suite 8 The Round 10 Perspectives 18 Midpoints by John Gabbert 19 Growth Economy 40

The Future’s at Stake

The Portfolio 46

Investing in private equity is no longer limited to a

ACG@Work 48

fund commitment. A growing number of large GPs have sold stakes in their underlying management

The Ladder 54

companies as a way to pursue new strategies and

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fund succession planning initiatives, and middle-

It’s the Small

market firms are starting to follow suit. 32

Things 56

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EXECUTIVE SUITE

Distract or Enhance: How Tech Is Disrupting Portfolio Audit Teams F How have data-aggregation and

KEVIN OWENS Title: Partner, Private Equity Services Company: Wipfli LLP Location: Chicago Expertise: With extensive experience in purchase accounting and leveraged recapitalizations, Owens focuses on annual financial statement audits and reviews for private equity-owned and closely held businesses. Wipfli is a top 20 CPA firm focused on middle-market growth, compliance and deal flow.

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technological tools impacted company audits? The rapid pace of technological change and disruptive technologies— such as robotic process automation, industrial internet of things (IIOT), artificial intelligence (AI), blockchain and others—will continue to push audit firms to think about how to utilize technology to produce a higher-quality audit. In the meantime, we see technology being utilized by our clients to assist with real-time inventory reporting and job profitability monitoring, to name just two, which is providing audit teams with better data to analyze. In addition, with the use of IIOT, companies are monitoring inventory production and key performance indicators, which can reduce profit leakage, lost capacity and machine downtime, and provide other benefits. As a result, we can bring ideas to our clients and act as a trusted adviser. Let’s not forget about the use of drones in inventory observation. Ever try to count cows roaming on a dairy farm? Or large equipment on a five-acre rental yard? Audit firms can use drones to assist with observation to cover more samples and a larger space. At times, drones can achieve a more accurate reading by scanning bar codes and comparing them with inventory records in real time.

F How will AI transform the audit?

By utilizing AI in audits, audit teams will be able to analyze full populations of data, identify outliers or exceptions within populations, and provide better information for predictive analytics. By using machine learning (a form of AI), for example, audit teams will be able to analyze larger populations of contracts—such as leases or revenue—in a shorter time frame and with more accurate results. Audit teams will then be able to focus their time on the outliers of the population. Ultimately, the evolution of AI will lead to a higher-quality audit. F What is technology’s biggest

benefit for audit teams? Besides the obvious benefit of being able to work on engagements from anywhere in the world, the days of lugging heavy paper files to and from clients are long gone. Advancements in technology have truly helped with speed and knowledge transfer from the deal team to the audit team. The sharing of real-time data and conversations among audit, legal and insurance departments, and internal management and investors has been the biggest eye-opener. Teams now have the data and tools to deliver answers instantly. //

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THE ROUND

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How Middle-Market Companies Can Reduce Cybersecurity Risks By Benjamin Glick

n the past, middle-market companies thought they were too small to be the target of a cyberattack, but in recent years, that illusion has become increasingly difficult to maintain. According to the 2019 Cybersecurity Special Report from RSM US, 15% of middle-market C-suite executives reported a data breach in the last year, an increase from 13% in 2018 and up 5 percentage points from four years ago. Whether they’ve read about high-profile data breaches at largecap companies, such as Capital

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One and Equifax, or experienced an attack at their own company, executives are aware of the nightmare scenarios. Colin Zarbough, cybersecurity due diligence director at RSM, suggests it’s time to shift the focus of the conversation about cybersecurity. “I think there’s a real opportunity to educate businesses now, rather than just focus on war stories,” he says. After consulting with hundreds of companies over his career, Zarbough has identified areas where middle-market companies leave themselves vulnerable.

Assessing Cybersecurity Posture Many midsize companies have valuable data in the form of customer information and intellectual property but lack the resources of larger organizations—and hackers and other cybercriminals smell blood in the water. The rising sophistication of criminals and malicious software coincided with companies’ growing reliance on digital technologies—such as virtual workspaces, accounting and human resource software, and other cloudbased services. However, the security implications of these systems often receive insufficient scrutiny, Zarbough says. When a company adopts new software as it grows, such as more sophisticated sales tools, it’s not uncommon for business leaders to focus on scaling up those capabilities quickly, rather than giving IT personnel enough time to spot gaps in security. Effective cybersecurity policies

include routine procedures like data encryption and software updates, as well as assessments of the access employees or vendors have to certain types of information. Zarbough recommends compartmentalizing company data by department to minimize exposure in the event of a data breach. “An organization’s network security should look like a labyrinth or a maze,” he says. “You want it set up so that if a hacker gets into the environment, it’s hard to move around.” When a company is acquired, the buyer too often performs what Zarbough calls “light” cybersecurity diligence, which is little more than box-checking. Even during transactions totaling hundreds of millions of dollars or more, companies only devote a few hours to cybersecurity considerations, he says. “If you’re laying out that amount of capital for an asset, to spend two or three hours to look at cybersecurity, I’m not sure how that computes.” One large corporate buyer Zarbough worked with purchased 35 companies a year. It required each target company to fill out a 30-page questionnaire before they finalized the deal. “I would love to start to see that level of diligence across private equity funds,” he says. Overcoming the Human Factor Laura Bacon, managing director at Fahrenheit Advisors, a Richmond, Virginia-based advisory firm, remembers a time when information technology didn’t come with the serious security consequences to company value and reputation that it does today. “When I first started doing M&A transactions what seems like eons ago, I think the only IT question on our due diligence checklist was ‘How

“IT’S A COMPLETELY DIFFERENT WORLD TODAY. YOU MUST EVALUATE THE RISKS AND UNDERSTAND THE VULNERABILITIES AN ACQUIRED COMPANY CAN BRING TO THE PARENT COMPANY.” LAURA BACON Managing Director, Fahrenheit Advisors

many computers do you have and do you have the appropriate number of software licenses?’” she says. Bacon has held finance, strategic planning and corporate development roles in public and private companies, and she has managed over $1.5 billion in completed M&A transactions. Since she entered the technology space in 2001 as the CFO of a software company, Bacon has seen how companies have succeeded and failed with their cybersecurity countermeasures and how they can impact M&A. “It’s a completely different world today,” she says. “You must evaluate the risks and understand the vulnerabilities an acquired company can bring to the parent company.” The biggest vulnerability, according to Bacon, is human behavior: An employee clicked on a bad link, they fell for a fraudulent e-mail, or they kept their password on a sticky note on their desk. Human error can extend up the corporate ladder, too. She says company leaders can be their own worst enemy when constructing cybersecurity defenses. While working for one company in a previous role, Bacon recalls enforcing a password change every 90 days—a best practice, she says—which frustrated the CEO, who saw it as hampering progress. The experience taught her that even basic procedures require buy-in from management.

“You have to have a champion in a senior role in the organization to lead the way to changing behaviors that will protect your company and its most valuable asset—data,” she says. A Storm Before the Calm Some cybersecurity systems and their procedures can cost as much as $1 million to set up—a significant barrier for companies as they try to address risks. But for companies looking to sell to private equity, implementing cybersecurity protections can be a way to appeal to prospective buyers. “Showing that you have a robust compliance policy and practices in place will give investors confidence that you pay attention to the details and understand risk management,” Bacon says. “The value of business data is one of the main things [buyers] are paying for in an acquisition.” Zarbough foresees more “cataclysmic” breaches at large companies, which may in turn convince middle-market investors to demand cybersecurity countermeasures as a non-negotiable feature when buying a business. “Once that happens and it gets all these companies to start implementing the proper cyber risk process and procedures during the hold period, it will just be better for the entire ecosystem,” he says. //

MIDDLE MARKET GROWTH // SEP/OCT 2019

THE ROUND

Treating Pain Points in Health Care Software solutions aim to reduce inefficiencies, maximize time spent with patients By Kathryn Mulligan

complex series of transactions among health care providers, payers and patients underpin American health care. From the time a patient checks in at the front desk to when insurance reimburses a claim, there are many opportunities for error that can prevent or delay payment and distract from health care’s intended purpose—serving patients. “The pain points are numerous and growing and really impact the health care organization’s ability to collect the dollars for the services they provided,” says Duane J. Fitch, a partner at Plante Moran who works with health care providers, payers and consultants. To address these obstacles, many organizations are turning to tech-enabled solutions for revenue cycle management, which address everything from coding bills to processing claims and auditing reimbursement. RCM solutions can help physician practices, hospital systems and other providers maximize the amount they collect for their services. By tracking documentation, they can cut down on the number of claims that are denied by insurance payers. They help with coding accuracy, too. By making it simpler for providers to classify their services correctly, tech-enabled RCM solutions can help a provider bill for the right amount. They can also speed time to payment by ensuring providers submit bills

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that comply with their contracts with payers. Optimizing revenue cycle performance can also benefit patients by increasing the number of claims that are settled without requiring patient involvement. In recent years, technology solutions have become more accessible and the return on investment has helped justify their cost, according to Fitch. “It’s not uncommon to see improvements of 2 to 4% of net collections by implementing some type of revenue cycle enhancement strategies,” he says. With those gains in mind, Plante

Moran has worked with private equity clients to evaluate the revenue cycle performance of a target and factor performance enhancements into the firm’s underwriting and quality of earnings analysis. When pursuing health care investments, private equity firm Alpine Investors doesn’t look exclusively for organizations whose systems need improvements, says Haley Beck, a vice president at the firm, which invests in software and services businesses in health care and other industries. But in some cases, there is room to automate or streamline revenue cycle

management processes. Alpine helps its companies select the best solutions for their practices, according to Beck. “There’s some software that works really well in dental, and that looks different from software in ophthalmology,” she says. “We help health care providers evaluate different options and select the best solutions for their practices, even if those solutions may be outside of our own portfolio.” Technology also has the potential to benefit individuals who interact with the health system, where bills

illuminate a problem like high levels of claim denials. But data alone can’t resolve the underlying issue. Nearly everyone in a health care setting touches the revenue cycle, so reducing denials requires establishing new policies and training staff with the help of internal experts or outside advisers, he says. To ensure its portfolio companies are prepared to utilize new technology systems, Alpine Investors uses a trainthe-trainer model as well as third-party consultants—specialists in revenue cycle management or billing, for

“IT’S NOT UNCOMMON TO SEE IMPROVEMENTS OF 2 TO 4% OF NET COLLECTIONS BY IMPLEMENTING SOME TYPE OF REVENUE CYCLE ENHANCEMENT STRATEGIES.” DUANE J. FITCH Partner, Plante Moran

are notoriously difficult to interpret. Ken Marlin, founder and managing partner of investment bank Marlin and Associates, suggests advancements that have simplified mortgage or credit card payments could make health care transactions more transparent, too. Improved revenue cycle management processes could one day enable the cost of services to be listed in a way that’s clear to providers, payers and patients. “The goal would be for me to get a bill that I actually understand,” Marlin says. Powered by People Despite its promise, technology is only effective when used in conjunction with trained staff. Fitch cites the example of data analytics, which can

example—to assist with implementing software and preparing an organization to use it. Employees who perform revenue cycle, coding and collection functions aren’t the only professionals within a health care organization who require RCM technology, says Matthew Thompson, a partner at private equity firm Enhanced Healthcare Partners. Health care practitioners also need tools for improving efficiency and compliance when documenting the services they perform by taking notes or coding a chart—activities that often can’t be fully automated. “It’s an inherently human function, because health care is an inherently human interaction and service that is then translated into a code that

ultimately is electronically billed for,” Thompson says. “That bridge, between service to bits in the air, that is all humans today.” Software Systems As health care organizations turn to technology solutions, medical software providers are becoming increasingly attractive investment targets. Enhanced Healthcare Partners invests in health care providers as well as health care technology solutions and health care business services. According to Thompson, observing providers’ hang-ups and the role of technology in addressing them has helped his firm identify new targets. “The challenges we observe and support our provider groups through absolutely inform our thesis when investing in technology,” he says. Investors aren’t the only firms betting on solutions that impact the revenue cycle. A number of large financial, health care and tech organizations are adding new capabilities around health care payments. For example, JPMorgan announced in May that it will acquire InstaMed, whose cloud-based platform processes health care transactions. In June, UnitedHealth Group agreed to buy Equian LLC, a health care payments firm owned by PE firm New Mountain Capital. At the same time, Apple is rumored to be developing capabilities around medical billing. While corporate buyers might offer a path to exit, they also pose a threat to PE-backed health care technology businesses, Marlin says. “If you have a cool idea, but you can’t protect it, IBM [can] come along and basically duplicate it—or Google for that matter.” //

MIDDLE MARKET GROWTH // SEP/OCT 2019

THE ROUND

EuroGrowth Yields Global Insight, Cross-Border Connections By Karen Craven

ttendees at the Association for Corporate Growth’s EuroGrowth conference learned that an economic slowdown in the United States and China is more likely to occur than a recession, and the impact will be less severe than a decade ago—thanks in part to countries whose economies are still developing. EuroGrowth, held June 11-12 at the Hilton London Bankside, opened with a discussion with Trevor Williams, former chief economist at Lloyds Bank, about the myriad factors impacting the global economy. Stewart Licudi, managing director of financial sponsors at William Blair, joined Williams for an engaging dialogue about how the global economy is impacted by the foreign trade policies of the U.S. and China, and how political disagreement on trade threatens to disrupt global supply chains. Williams said consumers remain generally positive, but corporate debt is growing, and the technologies that connect national economies require greater cooperation and open markets. “With slowing growth comes slower inflation and lower interest rates, which make the cost of capital less. It’s cheaper to buy and invest,” Williams said, adding that economic growth will undoubtedly slow. However, he noted that has yet to happen because the global economy is still experiencing a recovery—in large part because of regulations that stymied a greater economic collapse a decade ago. According to PitchBook, European

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E Stewart Licudi (right) interviews Trevor Williams during EuroGrowth private equity deal value reached £414.9 billion in 2017, before dipping to £396.3 billion in 2018. When Licudi asked about the role private capital plays in the European economy, Williams noted how appropriate EuroGrowth’s tagline of “deals without borders” is, given how both small business and global companies rely on the middle market for their own growth. Moreover, fueling the economic growth of many developing countries are technology solutions, often backed by private capital, that have decreased wage inequality and will likely prevent another downturn like 2008. Angela MacPhee, the 2018-2019 chair of the ACG Global Board of Directors and a partner with Baker Tilly, welcomed 150 attendees from 13 countries to the conference. Previous EuroGrowth participant feedback prompted additional networking time this year. In all, attendees pre-scheduled nearly 200 one-on-one meetings.

“EuroGrowth’s size is its best secret,” MacPhee said. “Its intimate nature affords us the opportunity to move beyond polite conversation and develop meaningful relationships that strengthen our professional network.” Seven breakout sessions covered contemporary issues, including relationships with limited partners, managing employees during the postacquisition integration, and increased investment activity by family offices. The most lively and physical of the breakouts was a session featuring a showdown between private equity and private debt. Boxing gloves and all, Jo Bennett-Coles, managing director at FGI Finance, readied for a faceoff with The Riverside Company’s Tommy Seddon. Three hypothetical case studies set the foundation for the duo’s arguments. While delegates were split in their support, there was universal appreciation for the debaters’ dramatic flair and acting chops.

Cultural Considerations The importance of people proved to be a constant theme and was a major focus of Wednesday’s keynote addresses. Natasha Buckley, investment practices senior manager, private equity, at Principles for Responsible Investment, led a discussion titled “Evaluating Cultural Diversity and the Impact on Business.” The session featured panelists who shared candid stories about forgoing investments when the makeup of the senior leadership team lacked diversity. Maria Blair, a partner at ghSMART, said an increasing number of investors are paying attention to cultural fit during the due diligence process. Blair told a story of a private equity

firm that walked away from a deal in the 11th hour upon learning that the management team of the company to be acquired neither respected the CEO nor his decision to sell a stake in the company. Josien Bakker, an investment manager at Robeco, and Freerk Smit, a financial portfolio manager at Karmijn Kapitaal, rounded out the panel. They agreed that diversity within their own firms equips them with different perspectives that create an environment for better decision-making. The trajectory of a cross-border deal took center stage during the closing keynote, led by Benjamin Procter, a senior partner at the Watermill Group in Boston. Proctor walked the audience through Watermill’s

acquisition of U.K.-based Cooper & Turner and how the deal nearly failed. Proctor candidly discussed the challenges in building a trustworthy relationship with the existing management team and the regulatory and legal issues found within a global supply chain. He joined MacPhee for a discussion about the deal, and he addressed how the topics of gender diversity and building teams with an array of experiences apply to Watermill. At the end of the event, attendees walked away with new connections and expert insights. Said William Blair’s Licudi: “If you don’t leave here with a deal, you’ll at least leave with the knowledge to be more thoughtful and productive in your M&A work.” //

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MIDDLE MARKET GROWTH // SEP/OCT 2019

THE ROUND

E From left, panelists Vaibhav Saraiya, Elizabeth Browne, Rick Blank and moderator Ben Redman

A Family Affair Panelists delve into the success of family offices at InterGrowth By Benjamin Glick

igh net worth families have been reliable investors in private equity funds historically, but in recent years, many families have taken on a more active—and competitive—investing role. ACG highlighted this growing trend at its InterGrowth conference earlier this year. During a Middle-Market Insights Theater session sponsored by DHG, panelists discussed how a number of family offices have transitioned from partners to competitors in a relatively short amount of time by offering an alternative model to traditional private equity investment. “It’s not because we view business differently, it’s that we bring a

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fundamentally idiosyncratic form of capital to the table,” said Elizabeth Browne, vice president and head of business development at DNS Capital, a Chicago-based family investment office affiliated with the Pritzker family. While family offices’ direct investing strategies vary, they do share some common characteristics, including long-term planning and a focus on culture. “That’s the DNA of a family office,” said Rick Blank, managing director at Stephens Capital Partners, a family office based in Little Rock, Arkansas. As recently as 10 years ago, the idea that a family would independently

source and execute deals on par with private equity funds was novel. “[Family offices] could write big checks, but not lead deals,” said Vaibhav Saraiya, principal of Solamere Capital, a multi-family office formerly run by Mitt Romney. Today, family offices have become a significant segment of the investment ecosystem. According to a report from Ernst and Young, at least half of the 10,000 family offices worldwide were established in the last 15 years and are valued at $1.2 trillion, as reported by the Family Wealth Alliance. Blank explained that while traditional private equity groups typically hold companies for five to seven years, Stephens Capital plans on an investment period of at least seven to 10. One company has been in the firm’s portfolio for nearly 60 years. But the distinguishing feature of Stephens Capital’s investment strategy isn’t a long holding period. Like

“I THINK OF IT AS ONE OF THE GREATEST COMPLIMENTS TO FAMILY OFFICES WHEN LARGE-CAP PE FIRMS START THEIR OWN LONG-DATED FUND EQUIVALENTS.” ELIZABETH BROWNE Vice President and Head of Business Development, DNS Capital

other family offices, it looks for companies that share its goals. “Finding the right partner can be difficult, but it’s the most important part,” he said. The same is true for DNS, and that has led the firm to take an unconventional approach to due diligence in the past. While DNS was in the middle of negotiating investment terms with a company based in Boyne City, Michigan, the firm’s chairman and CEO, Michael Pucker, and other DNS leaders decided on a whim to book a flight and meet with the company’s management team. Pucker, Browne and other DNS employees flew to the small city, tucked into a corner of the state’s Lower Peninsula, and invited the company’s owners to dinner. Going around the investment bank that arranged the deal for a spontaneous visit was a risky move, Browne recalled, but it reflects the character of the firm. “Our office doesn’t abide well with process formality.” The visit let DNS and the company’s leaders meet without mediators, allowing Pucker and his team to assess the investment beyond just marketing materials and financial figures. It wanted to evaluate cultural orientation,

which is important when you’re thinking on decadeslong timetables, said Browne. “They really are entering a long-term marriage with us.” The influx of direct investment by family offices has led some traditional private equity firms to adapt their own strategies. According to PitchBook, private equity funds are staying active for longer periods of time and some are raising so-called “long-dated funds.” Firms like The Carlyle Group, Blackstone and Apollo Global Management have formed funds intended to last 15 years or longer. “I think of it as one of the greatest compliments to family offices when large-cap PE firms start their own long-dated fund equivalents,” Browne said. To remain competitive in an increasingly crowded market, Browne suggests family offices should discard their notoriously private character and make their “story” known to potential partners. “We are very staunch believers in the idea that you have to go out and tell the story because it’s a story worth telling,” she said. //

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MIDDLE MARKET GROWTH // SEP/OCT 2019

PERSPECTIVES

PERSPECTIVES // On Fintech and Digital Transformation

“If you look at 2018, it set a record for the amount of fintech deal value that was brought to market in terms of private equity buying fintech deals. You saw the same thing in health care—not in terms of total capital invested, but you saw a record in terms of the count of businesses within the health tech space.”

NIZAR TARHUNI Director of Research and Analysis, PitchBook, speaking on the Middle Market Growth Conversations podcast about emerging areas for PE investment

“Financial services by itself is just a big, big buyer of technology, and the speed that technology moves, there’s always the opportunity to build a new company … Fintech is probably one of the biggest markets that PE and VC investors like to put money into.”

JIM DOUGLASS Fulcrum Equity Partners, speaking at the Atlanta ACG Capital Connection about opportunities for investing in fintech

“We are truly entering a post-digital era. Post-digital doesn’t mean digital is dead. It simply means that digital is no longer a differentiating advantage for organizations. In this new environment, businesses and consumers alike are less interested in the products, and even the service as a wrapper, and more interested in the experience.”

BRIAN IRWIN Automotive and Industrial Lead, Accenture, speaking during the “Investing in the Internet of Things” MiddleMarket Insights Theater session at InterGrowth

middlemarketgrowth.org

WE KNOW FOR SURE THAT THOSE WHO WILL WIN IN THEIR OWN MARKETS WILL BE USING DATA, INSIGHTS AND, BY EXTENSION, ARTIFICIAL INTELLIGENCE. SHELBY AUSTIN Managing Partner, Omnia AI, Deloitte Canada, speaking at the Toronto ACG Capital Connection about middle-market companies adopting artificial intelligence

MIDPOINTS by John Gabbert

Insurance for the Digital Age

nsurance probably isn’t the industry that comes to mind when you think about disruption. Dry, low-margin industries seem like they should be shielded from Silicon Valley’s influence. Yet among the subsectors of financial technology, insurance technology, or “insurtech,” attracted more institutional funding last year than better-known spaces like personal finance or money transfer. At first glance, insurance is an unlikely industry to target. Profit margins tend to be low and incumbents are difficult to knock off. Consumers are notoriously price-sensitive, and regulatory and marketing costs are significant. It takes a lot of capital just to be competitive, which is no guarantee of survival. Guevara, a peer-to-peer car insurance upstart that failed in 2017, was one of the more promising “digital insurers” to break into the scene. While several others, such as Oscar and Lemonade, are still at it, there aren’t many insurance startups with the appetite to take on the big guys. If most insurtech companies aren’t looking to replace traditional insurers, what’s the opportunity? Like much of the broader fintech sector, the answer lies in developing platforms that can work in concert with established players. Large organizations are often the slowest to change, but what they lack in innovation they make up for in customer trust. Trust is a hard-won commodity in the financial industry, and most newcomers will never achieve the same level of customer confidence as brands like MassMutual or Blue Cross Blue Shield. Partnerships between private

capital investors and the insurance industry may be the way forward. Many of the biggest insurance organizations have corporate venture capital arms, which connect their brands with new tech innovations. VC arms of insurers like American Family Insurance, Aflac, Nationwide, Allianz and Liberty Mutual have made dozens of insurtech investments over the years. The insurance giants may or may not eventually acquire their venture funds’ holdings, but either way, insurtech M&A is expected to boom in the coming years. That’s one reason why the industry is attracting investment dollars. Last year saw more than $2.8 billion invested in insurtech, a record that will likely be eclipsed this year. As of June, $2 billion had already been funneled into insurtech startups. Investors will capitalize on their existing insurtech holdings while expanding to serve other sectors, such as the gig economy. Part-time driver insurance for ride-sharing employees is one type of offering, and autonomous vehicle insurance is on the way. While many of the biggest incumbents offer cybersecurity insurance products, there’s room for insurance companies that focus solely on this market. Like most up-and-coming industries, insurtech’s beginnings are humble. The earliest platforms were used to help insurance agents find new clients, but over time, insurtech has found far more uses and applications. Today, insurtech offers new insurance models tailored for the modern world, something traditional insurers haven’t yet been able to perfect on their own. //

JOHN GABBERT Founder and CEO, PitchBook

MIDDLE MARKET GROWTH // SEP/OCT 2019

November 4 -5 | W Dallas â&#x20AC;&#x201C; Victory Hotel | Dallas, TX

Corporate Development Officers Wanted Join your corporate peers* in Dallas, Texas this fall. Expect to learn M&A best practices and enjoy panel discussions led by industry experts. The program affords attendees ample time to meet with their corporate development peers who can provide counsel, share forward-thinking techniques and contribute advice on navigating the M&A challenges unique to corporate settings.

L E A R N M O R E AT A C G . E V E N T S / T H E S U M M I T 2 0 1 9 * Summit attendees are subject to approval by ACG. Qualified participants are limited to individuals whose primary job responsibilities relate to the acquisition and divestiture activities of the company, including strategy, deal origination, valuation, negotiation and post-acquisition integration.

QUICK TAKES

StreetShares Helps Veteran-Run Businesses Build Momentum

rad Halsey is a problem-solver. After serving in the U.S. Navy and as the head of a think tank focused on futuristic challenges, he went to the Middle East as a consultant for the Army. “I ran around Iraq for about a year just MacGyvering stuff together,” he says, “whether it was welding and soldering, or making something robotic or something sensor-related.” During that time, he developed a program to train other engineers. At the urging of a Marine Corps general, he applied for an award to build a mobile lab that would enable him to train Marines across the country. He won the award, but he needed money to get started. He sought a loan from his bank and through the Small Business Administration. When he didn’t hear back, he turned to an online lending platform called StreetShares to borrow $25,000. There is about one veteran-owned firm for every 10 veterans, according to the SBA, but like Halsey, many struggle to secure a traditional bank loan. To help meet that need for capital, in 2014 two military veterans, Mark L. Rockefeller and Mickey Konson, founded StreetShares. The firm originally operated as a peer-to-peer lender, where veterans could pool money used for loans to veteran-run businesses. After two years, StreetShares began using its own capital for loans, paired with its efficient underwriting technology. As a prospective borrower fills out a loan application, StreetShares’

E Building Momentum’s mobile training lab

platform uses more than 400 data points for intelligent, dynamic underwriting, adjusting subsequent questions based on the applicants’ earlier responses, according to Rockefeller, StreetShares’ CEO. The application also collects data in real time from social media, Google Earth storefront images, seasonal industry trends and more. “It’s able to do it in a smart enough way that we don’t even have to do a hard credit pull,” he says. Last year, StreetShares began partnering with banks. Known as “lending as a service,” the model enables banks to integrate StreetShares’ technology within their websites to digitally underwrite loans and to use StreetShares’ capital to fund all or part of the loans. Banks also have the option to invest in the loans. The interest rate is typically in the midteens—lower than the rates offered by many online lenders, which can be as high as 40%. StreetShares’ lending-as-a-service

technology can also be used by nonbanks. The firm plans to expand its partnerships to organizations—such as consulting firms, or an online community like Pinterest—whose clients or users might need a business loan. Although StreetShares no longer serves military veterans exclusively, they still make up 80% of borrowers. Several months after Halsey paid back his initial loan to StreetShares, he finally heard back from his bank. It had rejected his loan application, as had the SBA. He has since taken out two more loans from StreetShares—both of which he’s paid back—and he currently has a line of credit through the firm. Today his company, Building Momentum, occupies a 20,000 square-foot facility in Alexandria, Virginia, and employs a staff of 13. “All of it would have been nearly impossible without that first $25,000 from StreetShares,” Halsey says. // – Kathryn Mulligan

MIDDLE MARKET GROWTH // SEP/OCT 2019

A QUALIFIED OPINION

Christine Ing Partner, McCarthy Tetrault Christine Ing is an equity partner and co-leader of McCarthy Tetrault’s Information Technology Law Group and FinTech Group. She is based in Toronto and is nationally recognized as an expert in commercial transactions involving information technology, data security and intellectual property. Ing corresponded with MMG about how technology is transforming the financial services industry and considerations for investors.

“THERE IS NO ONE SET OF REGULATIONS THAT APPLIES TO FINTECH, SO NAVIGATING COMPLIANCE REQUIREMENTS FROM MULTIPLE REGULATORS BECOMES CRITICAL.”

MORE ONLINE Find more interviews at middlemarketgrowth.org.

middlemarketgrowth.org

Q A

How will fintech innovation change middle-market financial services? Fintech innovation is shifting the way organizations engage with customers, particularly in the consumer and small and medium-sized business segment. Financial services players have embraced a customer-centric approach to their services. This means knowing your customers and their preferences and anticipating and meeting their needs in a personalized way. Innovation is being used to leverage many different data sources (both internal and external) to enhance an organization’s understanding of customer needs. Fintech innovation is also enabling organizations, such as private equity firms and investment banks, to use big data to supplement traditional business intelligence on investment opportunities. This allows for more insightful decision-making, increasingly through the use of machine learning models. As a result of fintech innovation, we continue to see the middle market rely on next-generation service providers that extract insights and value out of data. We are also seeing tech- and data-savvy financial services players emerging in the market. They are identifying areas that are ripe for disruption, including those where convenient, digital, user-focused experience appeals to customers.

Q A

Which fintech applications are attracting the most investor interest? The challenge for investors is discerning hype from reality. Technologies like cryptocurrencies generate a lot of buzz, but they still face challenges with commercial viability. At the moment, there is strong investor interest in fintech companies that offer lending, payments and personal finance services, often in the consumer and small business domain. Fintech lenders can quickly assess the creditworthiness of borrowers and underwrite loans based on automated processes. The largest fintech lenders now have portfolios that rival middle-market financial institutions. The payments and transfers space is ripe for disruption because of the many frictions in moving money from A to B in the incumbent model. Sending money quickly and cost-effectively is an area begging for new investment. In the personal finance space, robo-advisers are among the leading fintech companies for attracting venture financing and developing customer relationships. Having financing to expand quickly will become even more important in a future with open banking.

What are the key due diligence considerations during a fintech acquisition?

Although many of the same considerations related to the acquisition or sale of any technology company apply, regulatory and compliance considerations are key in fintech. Appropriate due diligence of a fintech target involves a heightened focus on compliance issues, including privacy, consumer protection and anti-money laundering, and knowyour-client matters. Because fintech companies often collect, process and use personal and sensitive financial information, cybersecurity hygiene is of paramount interest to potential acquirers. Thorough diligence requires understanding what a target’s compliance programs have looked like since the very beginning and the details of any significant

hiccups along the way. For prospective sellers, this means being aware of buyers’ interest in compliance matters and ensuring the target’s compliance procedures are implemented such that they reflect risk tolerances that are acceptable to potential acquirers and enhance the company’s value.

Q A

What are the regulatory hurdles to be aware of when it comes to fintech? There is no one set of regulations that applies to fintech, so navigating compliance requirements from multiple regulators becomes critical. It is also important to continually monitor evolving laws and requirements, which vary across jurisdictions.

If the business collects individuals’ personal information, it will be subject to privacy legislation. Data protection is an important consideration and the reputational consequences of experiencing a data breach are quite severe. Anti-spam legislation also restricts the types of electronic communications that can be sent based on whether the business has consent and the nature of that consent. Businesses serving retail consumers should be aware of consumer protection legislation, such as reporting requirements for the cost of consumer credit. In addition, securities laws may apply to fintech business models such as cryptocurrency trading, crowdfunding platforms, peer-to-peer lending and robo-advising. //

MIDDLE MARKET GROWTH // SEP/OCT 2019

Merchants of

Efficiency How Fattmerchant overcame the odds to offer a new payment processing model

Photos by Scott Cook Photography

BY S.A. SWANSON

H Fattmerchant founder and CEO Suneera Madhani

uring the first few months after Fattmerchant launched, callers may have noticed something unusual: The company’s CEO, sales representative and customer support rep had very similar voices. That’s because they were all Suneera Madhani, Fattmerchant’s founder. When Fattmerchant consisted of just Madhani and two other employees, they each had three job titles and different names to go with them. “I was Sunny, I was Sadie, I was Suneera,” she says. If Madhani was taking a call as the sales rep and someone asked to speak to the CEO, she’d put the caller on hold, wait a few seconds, and then pick up the phone again. “It’s comical now,” she says. That backstage sleight-of-hand—creating nine employees out of three—was the only illusion Madhani wanted her customers to experience. She founded Fattmerchant to bring more transparency to the merchant services industry. Also known as payment processors, these companies allow businesses to accept customer payments through credit, debit or other electronic transactions. While working for another payment processing company, Madhani heard from business owners who were confused about processing costs and frustrated by long-term contracts. That prompted her to think about a different approach—a subscription-based service with a flat monthly fee and no penalties for canceling. This unconventional model would underpin the company she would later found. The “fatt” in Fattmerchant stands for “fast affordable transaction technology.” Beyond offering a new pricing model for payment processing, the Orlando-based company helps small and midsize businesses improve their operations by providing detailed, real-time payment data on one platform. It also integrates its technology with other software companies’ applications. Fattmerchant’s overarching goal is to help entrepreneurs save time by running financial operations more efficiently—and also analyze payment data to help those customers identify business opportunities.

MIDDLE MARKET GROWTH // SEP/OCT 2019

FATTMERCHANT Business: Flat-rate, subscription-based payment processing services, plus data analytics Customers: Small and midsize companies, including providers of professional and field services, medical offices and retailers Headquarters: Orlando Number of employees: 100

This was not part of Madhani’s original vision for her career path. “My intention was never to start my own company,” she says. “I actually come from a family of entrepreneurs, and I’ve always not wanted to be an entrepreneur. I’m very risk-averse. Or so I thought.”

STARTING UP

Madhani still has the notes Annual revenue growth: she began keeping in 2012 200%, for four consecutive years while working for her former employer. “I would write down every customer complaint. All of their horror stories,” she says. Lack of pricing transparency was a common refrain. Madhani says that was true not just for her employer, but for payment processors in general. They would advertise a rate for credit card transactions—say, 1.39%— but not make it clear that the percentage is added on to the interchange rate (the fee charged by credit card companies when their cards are used, which varies depending on the card). Customers were typically required to sign up for three-to-fiveyear contracts, and payment processors would often add other fees. Madhani remembers customers asking, “Why are these statements so hard to read?” She wanted to change the perception that “I DIDN’T GO TO CEO payment processors SCHOOL, BUT I ALWAYS are “a necessary evil” by offering customers KNOW HOW TO RAISE a flat fee (on top of the MY HAND AND ASK credit-card interchange FOR HELP, AND I KNOW rate) and a monthly subscription, so they HOW TO GET THE RIGHT aren’t trapped in longRESOURCES TOGETHER.” term contracts. She envisioned technology that would bring SUNEERA MADHANI all of the customer’s Founder and CEO, Fattmerchant

middlemarketgrowth.org

transactions—whether online, in-store or mobile—on to one platform, and provide data analytics to help improve business performance. Madhani presented the idea to her employer. When she didn’t receive support, she realized she would have to do it on her own. She registered Fattmerchant as a business in April 2014. Madhani had been planning to pursue an MBA, and she took what she’d saved for that degree—about $20,000—and put it into the business. She moved in with her mom and gave herself a deadline: If she didn’t have 100 customers subscribed after six months, she’d scrap the idea and head to business school. Madhani’s novel approach to payment processing proved to be a double-edged sword. Fattmerchant’s new model got business owners’ attention, but it also drew skepticism. As Madhani recalls, common sentiments included: “It’s never going to work.” “It’s too good to be true.” “Who are you and why the hell should I trust you with my money?” Her risk-free subscription approach—no sign-up costs, no contracts, no cancellation fees—helped her slowly push beyond those misgivings. “Getting the first hundred [customers] was tough,” she says. “I can’t tell you how many times I probably thought of quitting, that this wasn’t going to work, even during the first year.” Initial funding for the business came from Madhani’s success at pitch competitions, where entrepreneurs try to wow potential investors. She participated in about a dozen between 2013 and 2014, winning a total of $200,000 in prize money from event organizers. In the early days of Fattmerchant, Madhani’s brother Sal Rehmetullah offered support and business advice. He was working for Deloitte at the time and also had entrepreneurship experience. When he was 19, Rehmetullah co-founded a burger franchise, which ultimately folded, but he was confident his sister’s business would succeed—on a small scale, at least. “Did I think that she can make $150,000 or $200,000 a year doing this? Absolutely,” he says. “Would she be able to do it long term, consistently, and turn it into a 100-person business? Absolutely not.

E Madhaniâ&#x20AC;&#x2122;s brother Sal Rehmetullah serves as Fattmerchantâ&#x20AC;&#x2122;s co-founder and president

DATA-DRIVEN DECISIONS

E Fattmerchant’s staff has grown to about 100 employees

That didn’t really cross my mind, or frankly, even her mind.” That changed in late 2014, when Fast Company ran a story about Madhani and Fattmerchant. At the time, she was working with three other employees in a 150-square-foot shared office space. After the story was published, the phones rang constantly for three weeks, and the company’s website crashed. “Every startup on our floor was helping us answer phone calls,” Madhani says. “We had no CRM system, so we had Post-it notes all over the wall.” A few months later, Rehmetullah left his his job with a software firm in San Francisco and moved to Florida to work full-time for Fattmerchant, where he now serves as president and co-founder. In 2015, Madhani joined a tech accelerator in Orlando to help develop the technology needed to bring all customer transactions into one platform, and ultimately to integrate that platform with other applications, like QuickBooks. “I didn’t go to CEO school, but I always know how to raise my hand and ask for help, and I know how to get the right resources together,” Madhani says. “That has probably been my biggest reason for my personal success.”

middlemarketgrowth.org

In 2014, Fattmerchant processed $5 million in payments for its customers. That number jumped to $110 million in 2015, and $750 million in 2016. As of July, the company has processed more than $5 billion in total volume for its customers, who fall primarily into four groups: professional services, field services (such as plumbers), medical offices, and online and brick-and-mortar retailers. The ideal customer is a business that’s been open for at least a year and processes at least $10,000 in credit card transactions each month. Because Fattmerchant charges a flat monthly rate, businesses with high-volume credit card transactions often save money. The company has more than 5,000 customers. On average, those businesses save about 30% annually on credit card processing costs, according to Fattmerchant. Some businesses pay more for Fattmerchant’s service, compared with the previous vendor they used. The reason those customers switch, Rehmetullah says, is because they appreciate how Fattmerchant’s technology helps simplify their payment data. For example, a small business that has online sales, in-store sales and mobile credit card readers often ends up using a different merchant services provider for each type of transaction. That means the business owner won’t be able to see all transaction data in one place. Yet each day, the owner must consolidate it all and add it to QuickBooks or another accounting system. With Fattmerchant, payment data is aggregated into one online platform, and the information is added to QuickBooks (or another system) in real time. That eliminates a step and helps business owners access the information they need to make decisions about their operation. Users can log on to the Fattmerchant app to view sales trends, the number of repeat customers, and the relative performance of different locations, according to Madhani. “It provides realtime data for no additional cost to the merchant, so they can actually make better, smarter, faster decisions about their business,” she says. Fattmerchant continues to educate businesses that assume they’re not big enough to benefit

from data. “People think, no, that’s not for me—that’s for those global 2,000 companies,” Rehmetullah says. Fattmerchant works hard to demonstrate that real-time data is not only easily accessible, but also an effective tool for small and midsize companies, he says.

PIVOTAL PARTNERSHIP “This is a payment technology business that makes the lives of small businesses easier,” says Jim Douglass, partner at Fulcrum Equity Partners, Fattmerchant’s largest investor. His firm has invested about $15 million in Fattmerchant—$5 million in Series B funding and $10.5 million in Series C. According to Douglass, if Fattmerchant provided basic payment processing and nothing more, his firm would have passed. Instead, it saw an opportunity to help the company grow into new markets and leverage its data capabilities. One way Fulcrum has helped Fattmerchant expand its revenue sources is through partnerships with independent software vendors, known as ISVs. Some ISVs offer products for particular industries—one example is practice-management software used by dentists— but their software packages don’t always have a payment feature. ISVs that partner with Fattmerchant include the company’s payment and data capabilities with the software packages they sell to clients. The more than 15 partnerships that Fattmerchant has with software vendors represent about 30% of the company’s revenue; direct sales to individual businesses make up the rest. By 2021, Madhani expects half of Fattmerchant’s revenue will come from partnerships. Because Fulcrum invests in health care services, health care IT and B2B enterprise software companies, the firm is able to connect Fattmerchant with additional partnership opportunities, Douglass says. Two software vendors in Fulcrum’s portfolio use Fattmerchant’s payment platform. Fulcrum’s partners are all former business owners or operators, which shapes their investor perspective, Rehmetullah says.

“THIS IS A PAYMENT TECHNOLOGY BUSINESS THAT MAKES THE LIVES OF SMALL BUSINESSES EASIER.” JIM DOUGLASS Partner, Fulcrum Equity Partners

MIDDLE MARKET GROWTH // SEP/OCT 2019

“REVIEWS IN GENERAL ARE A BIG WAY TO DRIVE BUSINESS, SPECIFICALLY FOR SMBs. WE WANT TO BE ABLE TO HELP THEM WITH THAT.” SAL REHMETULLAH Co-Founder and President, Fattmerchant

At board meetings, Fattmerchant doesn’t even present a profit and loss statement. Instead, Fulcrum focuses on operational challenges and Fattmerchant’s long-term growth, he says. A big part of that long-term growth is continually adding software features that streamline the work of small business owners. One new feature, introduced earlier this year, is designed to make social media management more convenient for businesses. Fattmerchant has integrated its software with popular online review sites, including Yelp, Facebook and Google. When users log in to their Fattmerchant account, they can see reviews and respond to them directly through Fattmerchant’s platform. “Reviews in general are a big way to drive business, specifically for SMBs,” Rehmetullah says. “We want to be able to help them with that.” Next year,

middlemarketgrowth.org

Fattmerchant hopes to implement AI technology that can respond to reviews automatically.

PROCESSING SUCCESS Although new features show Fattmerchant’s awareness of customers’ changing needs, the company’s founding principle—pricing transparency with a monthly subscription—remains a big draw. “Simplicity sells,” says David True, partner at PayGility Advisors, a New York-based payments industry consulting firm. That’s particularly valuable in an industry known for its complicated pricing and sales pitches that boast of a better deal. One of the main challenges for payment processors that serve small and midsize businesses is customer churn. True has observed more payment processors becoming payment facilitators in response, a switch Fattmerchant made in 2018. As a payment facilitator, Fattmerchant takes on the risk of managing payments for its software partners’ end users, which speeds the approval process for getting an end user on to Fattmerchant’s system. The process used to take a day or two; now it takes about 20 minutes. When payment capabilities are added to software that business owners rely on, it makes

GIVING VOICE TO BUSINESS OWNERS When Fattmerchant launched,

says. “The more you give us,

the company offered cus-

the more we can provide direct

tomers a flat-rate monthly

recommendations.”

subscription and free cancella-

H The Fattmerchant team cheers on a payment consultant who has hit the monthly quota

those owners less likely to look elsewhere for payment services. “I think you’ll see that more and more in the future,” True says. “If your payments are bundled into inventory software, a sales guy cannot come to you and say, ‘Show me your statements and I’ll save you a little bit of money.’” That prediction bodes well for Fattmerchant. By the end of 2019, the company will have achieved four consecutive years of revenue growth exceeding 200%. Its staff now includes about 100 employees. (Unlike in the early days of Fattmerchant, none of them use fake names.) The company won’t reveal annual revenue, but Rehmetullah says it exceeds eight figures, and both he and Madhani believe Fattmerchant has the potential to become a billion-dollar business. When Madhani needs extra motivation to work toward that goal, she reflects on the skepticism she heard during the early days of Fattmerchant: “She’ll never land any investors.” “Her idea will never scale.” “She’ll never be able to execute.” Says Madhani: “I always used the naysayers for fuel.” //

The company takes an

tion. Although it still uses that

iterative approach with its

price structure, Fattmerchant

technology, he says, and

has since evolved beyond the

seeks feedback from cus-

original vision, according to Sal

tomers to learn which AI

Rehmetullah, the company’s

additions are useful for them

co-founder and president.

(or not), and what’s on their

“Payment processing—or

wish list for improvements

merchant services—is like a

to Fattmerchant’s platform.

dirty word in our organization,”

“We’re trying to effectively do

he says. “It’s something that

everything that helps a small

we aren’t. The payments

business operate, while also

piece is just the commodity.”

managing their payments,”

Fattmerchant’s real focus is on

says Jim Douglass, partner

analyzing data to help custom-

at Fulcrum Equity Partners,

ers improve their businesses.

Fattmerchant’s largest investor.

To that end, Fattmerchant is

When Fattmerchant

developing software that uses

launches its AI software, it

artificial intelligence to offer

plans to add voice commands,

recommendations to business

allowing business owners

owners, based on data they

to ask, “What were my sales

provide. The new offering is

today?” instead of typing

expected to roll out at the end

and clicking their way to that

of next year. Initially, the soft-

information. Several banks

ware will highlight sales trends

already have virtual assistants

or anomalies, for example, and

with voice recognition, includ-

suggest that business owners

ing Bank of America, whose

dig deeper. But Fattmerchant’s

mobile app has a chatbot

goal is to continually add AI

named Erica that responds to

capabilities that can make

spoken requests.

specific recommendations

The voice-enabled capa-

based on sales patterns—like

bility is part of Fattmerchant’s

extending business hours on

efforts to help its customers

particular days.

access information easily, says

The recommendations that

Douglass. “You can see what’s

Fattmerchant’s platform can

going on in your business on a

generate depend on the amount

regular basis without having to

of data its customers share.

go sit down at your desktop and

“If you link your QuickBooks

dig in to your QuickBooks,” he

online, we can give you more

says. “Voice [commands] and

information. If you link your

AI are just a further extension of

S.A. Swanson is a business writer based in the

CRM system, we can give you

making it easy for you to finan-

Chicago area.

more information,” Rehmetullah

cially operate your business.” –S.A. Swanson

MIDDLE MARKET GROWTH // SEP/OCT 2019

THE

Futureâ&#x20AC;&#x2122;s AT Stake

Z_WEI/GETTY IMAGES

New GP financing strategies can be a lifeline for middle-market PE firms BY BAILEY McCANN

imited partners are no longer focused solely on committing capital to an investment fund. Increasingly, they want a stake in the firm itself. Taking a minority interest in a private equity firm or other asset manager has grown in popularity among limited partners in recent years. Now many are setting their sights on the middle market, where PE firms are eager to use the capital to pursue new strategies and to support succession planning. Investing in the management of general partners has been around in some form for decades, led by limited partners seeking a share of the management fees and carried interest earned by private equity firms. Today, one in six LPs invests in funds pursuing so-called “GP stakes” investments, according to findings from Coller Capital. Bain & Company’s 2019 Global Private Equity Report said funds targeting GP stakes have raised $17 billion collectively and are on pace to raise another $14 billion more. To date, most active GP stakes investors—including The Blackstone Group, Goldman Sachs and Neuberger Berman—have bought stakes in well-established private equity managers tied to big, successful funds. But as the model proved itself at large buyout firms, many investors began adopting strategies to target smaller firms. GP stakes funds have pivoted to the middle market, in part, as they seek to put growing piles of dry powder to work. In addition, the middle market offers greater variety for investors. Private equity firms in this segment outnumber their large-cap counterparts and employ a diverse set of strategies across geographies. To capitalize on the opportunity, earlier this year a team of veteran GP stakes investors announced they were launching Stonyrock Partners, which will target GP stakes in middle-market investment firms. Together, Stonyrock’s leaders—Craig Schortzmann, a Blackstone alum, and Sean Gallary, who was previously at

MIDDLE MARKET GROWTH // SEP/OCT 2019

is $23.4 billion, compared with $1 billion for a firm that hasn’t sold a stake in its management. Selling a piece of themselves can create a virtuous circle for top performing firms as they seek commitments for future funds. Buying a stake in a GP can be seen as an endorsement from a limited partner and send a signal to other investors that a firm has strong growth prospects, which can help attract other investors. Z_WEI/GETTY IMAGES

The Carlyle Group—have made 20 investments in asset managers over their careers. They say the opportunity in the middle market is significant as this segment of private equity continues to grow and mature. This isn’t new territory for all investors. Lovell Minnick Partners has been investing in asset managers and financial firms in the middle market for 20 years. Over that time, it has completed over 50 transactions. Jason Barg, a partner at the firm, isn’t surprised to see new entrants investing in GP stakes in this space; Lovell Minnick Partners has long seen the appeal. “Middle-market firms tend to offer a broader range of strategies for us to invest in and there are still inefficiencies throughout the market,” he says. “We like that because it gives our portfolio companies the ability to generate outperformance and build up through acquisitions.” Barg adds that Lovell Minnick views specialization as a key part of long-term growth among financial firms. Middle-market firms tend to focus on a particular area, either through their investment strategy or through the services they offer. Specialization can take many forms, whether it’s providing financing exclusively for a specific sector, pioneering strategies and investment products, or creating new sponsorship structures. The firms that have attracted GP stakes investors tend to be high performers with a strong track record, according to PitchBook, whose data show the average capital raised for a firm that has received GP stakes investment

middlemarketgrowth.org

THROWING A LIFELINE For limited partners, buying a stake in a private equity firm allows them to share in the firm’s success through a share of fees and an appreciation of their equity stake. By taking an interest in the firm itself, LPs avoid the risk involved with committing to an individual fund and can reallocate the resources they would otherwise spend on capital calls and due diligence for each fund they commit to. For many private equity firms on the other side of the deal, the proceeds from selling a stake have become a lifeline. According to Investec’s 2019 GP trends study, private equity partners say it’s growing harder to maintain their personal stake in ever-larger funds. Investors tend to prefer GPs that have “skin in the game,” requiring that a PE firms’ partners commit personal capital into each fund they raise. This is easier in middle-market funds compared with a multi-billion-dollar Carlyle fund, to be sure. But it can be difficult to make a sizeable commitment while providing capital to support business operations and compliance efforts. Selling a stake to an outside investor can remove some of that pressure by providing capital to grow the business while freeing up more GP dollars to align with fund investors. GPs also say selling stakes is often more efficient than going public, which requires increased reporting and significant work to file for an IPO. Eric Zoller, founder and partner of Sixpoint Partners, an investment bank that provides advisory and financial services to middle-market firms, says Sixpoint is advising more firms than

ever before on GP stakes sales. “Our view generally is that the GP stakes sponsors are coming to the middle market,” he says. Zoller attributes the shift to a recognition that middle-market private equity firms have more growth potential than their larger counterparts. “From the sponsor side, with the middle market you’re catching firms right at that inflection point as they are scaling up,” he says. “There is an embedded growth opportunity. It’s different from large managers where they hit that growth level long ago.” Scaling up can mean a specialist firm adds a related sub-specialty, opening up new investment opportunities. It could also mean raising larger funds, or building business partnerships that enhance a firm’s offerings to portfolio companies through operational support or financing solutions. Some GPs are also using stakes sales to support succession planning, according to Zoller. Many middle-market firms are at a critical point where their founders are approaching retirement. Once they leave, their firms will have to reckon with how to replace the capital provided by the founder. Selling a stake in the firm can lessen the blow and help founders create a path for their eventual exit.

SPURRING INNOVATION As GP stakes sales have become increasingly common, they’ve also helped spur innovation in GP financing more broadly. According to Doug Cruikshank, head of fund financing for Hark Capital, a division of Aberdeen Standard Investments, GPs are becoming more open about using outside capital. “It’s definitely been an evolution,” he says. Hark Capital offers middle-market GPs a product called net asset value loans, based on the strength of their portfolio companies. NAV loans can be used in a similar way to GP stakes capital, but they are typically divested in a shorter time frame. “Our model gives GPs an option to bridge some of those financing gaps without having to give up equity,” Cruikshank explains. NAV loans can be used more than once—presenting an alternative source of

“OUR VIEW GENERALLY IS THAT THE GP STAKES SPONSORS ARE COMING TO THE MIDDLE MARKET.” ERIC ZOLLER Founder and Partner, Sixpoint Partners

financing for GPs that aren’t ready to give up a long-term stake in their firm. Another strategy, known as seeding, is also gaining ground as investors look for ways to get involved with GPs even earlier. Through seeding, investors provide capital to first-time funds in exchange for equity in the firm, usually charging either low fees or none at all. Sixpoint Partners recently launched an affiliated company—SP Capital Partners—to invest in GP stakes and to seed deals with middle-market GPs. According to Zoller, a seed investment is akin to taking a GP stake, but in a less mature firm. SP Capital wants to see a clear growth trajectory and a proven management team. “Seeding has always been very beneficial for early-stage investors because they get a piece of equity and a piece of the economics,” Zoller says. Even as GP financing strategies like GP stakes, NAV loans and seed funding gain traction in the middle market, they remain relatively new, and it’s unclear how they’ll be impacted by an economic downturn. Lovell Minnick’s Barg points to observations his firm has made over the past two decades. “Private equity investments tend to be uncorrelated from economic cycles,” he says. “We’ve been invested for two decades, so we have seen the cycles.” Still, the firm has factored a possible recession into its models in anticipation of such an event. “We always include the possibility in our diligence and we try to support companies that we think are going to weather the storm,” he says. “You have to trust your underwriting.” // Bailey McCann is a writer and author based in New York.

MIDDLE MARKET GROWTH // SEP/OCT 2019

POLICY POINTS

ACG Goes to Washington ACG members appeal to Congress to spread the word of the middle market

“CONGRESS ISN’T SEEING WHAT’S HAPPENING AT SMALLER FIRMS INVESTING IN THE MIDDLE MARKET, WHICH IS THE UNDERPINNING OF THE ENTIRE U.S. ECONOMY.” JAMES LEE Partner, K&L Gates

MORE ONLINE Find updates and insight on policy issues at middlemarketgrowth.org.

middlemarketgrowth.org

iddle-market companies represent one-third of U.S. GDP and jobs. If the middle market was its own country, it would be the 5th largest in the world, based on revenue. Yet despite its significance, the middle market can sometimes feel like the forgotten middle child in the nation’s capital, caught between startups and large organizations. To raise awareness of the market segment, more than 40 ACG members gathered in Washington, D.C., on June 19 to meet with staff from congressional offices on both sides of the aisle. “Everyone on the Hill gets a vote, so everyone has to understand how their decisions impact their districts,” said Gretchen Perkins, a partner at Huron Capital and co-chair of ACG’s Public Policy Committee, during opening remarks at the MiddleMarket Fly-In. During meetings held in ornate offices and makeshift meeting rooms—or improvised in hallways when offices became too crowded— groups of ACG participants, who represented banks, private capital providers, corporate acquirers and advisers, shared their stories about working with middle-market companies. “ACG has done something great by allowing the opportunity for banks, other types of lenders and private capital to come together to speak firsthand with members of Congress and congressional aides

about what we do, how we’re helping the economy, how we’re helping their constituency,” said Hillary Thomas, vice president of global commercial banking at Bank of America Merrill Lynch’s Atlanta branch. During meetings with members of the House, ACG participants asked their representatives to join the Congressional Caucus for Middle Market Growth. When meeting with senators, ACG members encouraged them to consider how future legislation could impact access to capital and talent, and how certain regulations could stifle growth. Attendees were sorted into groups based on where their firms are located and which members of Congress represent their district. Over the course of the day, the groups met with 54 federal lawmakers or their staff. Few lawmakers or their aides were familiar with the middle market, Thomas said, but she was encouraged that many seemed interested in learning more. “I’m glad that we had the opportunity to present to members of Congress, and that we could talk to them firsthand.” Increasing the understanding of the middle market by lawmakers was the overarching goal of the event. For James Lee, a partner in the New York office of law firm K&L Gates, this included the opportunity to educate policymakers about the important role of private capital for growing middle-market businesses. “There’s this misconception out

there that we go in, buy companies, strip them of all their assets and we’re out in two years, but you can’t win deals like that,” he said. “Congress isn’t seeing what’s happening at smaller firms investing in the middle market, which is the underpinning of the entire U.S. economy.” Lee explained to one senator’s office how K&L Gates recently represented a client that acquired a company in New York whose management was not confident it could make it another year without outside capital. According to Lee, that was the face of private equity he wanted federal lawmakers to see. “Now there are 250 jobs that are staying in Upstate New York,” he said. “And that’s just in New York. Across the country, there are thousands more jobs being created and sustained, which is just the nature of our business model.” Lee, who immigrated to the United States and became a citizen while in college, said the event was significant for him personally. “It was one of the better experiences of my life,” he said. “We tend to forget in this country that if you take the time, you have access to your representatives. And all I’m out is a train ticket and a few hours. The moment I was done, I called my partners and said, ‘Make sure you come down here next year.’” Following the Hill visits, ACG Board of Directors Incoming Chairman Martin Okner presented Rep. Steve Stivers, R-Ohio, with the ACG Growth Award in recognition of his work on the Congressional Caucus for Middle Market Growth, which he co-founded in 2014. “[The middle market] is really the engine of our economy locally and

E Pictured from left are Bryant Cornett, DTSpade; Melanie Brandt, ACG Atlanta; and Hillary Thomas, Bank of America Merrill Lynch

nationally, and yet policies that come out of Washington frequently ignore middle-market companies,” Stivers said while accepting the honor. “[I] pledge to you that I’ll work hard every day to make you proud that you gave me this award and make you proud that we’re trying to look out for the 44 million people that every day count on you for a paycheck and help you deliver value to your clients and customers and to our overall economy.” Maintaining a presence in the nation’s capital is critical for ACG and its members to ensure lawmakers consider the middle market as they craft policies, said Richard Jaffe, a partner at law firm Duane Morris. Without those relationships, the middle market could become a target. “If

you’re not at the table, you’re on the menu,” he said. The June fly-in presented an opportunity to engage with lawmakers, but it’s just one part of ACG’s long-term strategy for engaging with policymakers and educating them about the middle market’s contributions. “One meeting will not do it. Today, we’re laying the seeds and building trust,” said Maria Wolvin, ACG’s vice president and senior counsel for public policy. “This will be an iterative process, and the more people we can bring to events like these, the greater impact we can have as an organization on Capitol Hill.” // – Benjamin Glick

MIDDLE MARKET GROWTH // SEP/OCT 2019

POLICY POINTS

Tailoring New Rules for Fintech Washington weighs its options

ctivity in Washington, D.C., in recent months has ignited hopes that policymakers may implement reforms that will better accommodate financial technology companies. Businesses that provide technology and software-enabled financial services have grown rapidly in recent years. Between 2012 and 2018, global investment in fintech companies rose from $16 billion to $146 billion, according to PitchBook. As fintech companies have drawn investor interest and expanded into nearly every corner of the financial services industry—including payment processing, investing, lending and advising—they have drawn the attention of lawmakers who say they want to place safeguards on the fastevolving technology. “The velocity of this change is immense and unprecedented, and we need to encourage responsible innovation,” said Rep. Stephen Lynch, D-Mass., during the inaugural hearing of the House Committee on Financial Services’ Fintech Task Force, which was created to monitor developments in financial technology and inform policy changes. Lynch is one of many members of Congress concerned that current laws don’t adequately address the risks posed by fintech, such as data privacy or predatory lending. That sentiment helped drive the creation of the task force in May. Many of the laws regulating the financial services industry are nearly

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TARIKVISION/GETTY IMAGES

a decade old, and they’re not aging well. The last major round of financial reform came in the aftermath of the Financial Crisis when lawmakers passed the Dodd-Frank Act in 2010, before many of today’s young fintech companies were founded. But lawmakers are seeking more than consumer protections. Despite the proliferation in fintech businesses in recent years, their executives say current laws present a major hurdle to their growth. Historically, financial legislation, including Dodd-Frank, has been designed for traditional financial institutions, not the growing number of entities leveraging technology and data analysis to provide financial

services to individuals and businesses. Currently, no laws and few regulations directly address financial technology. As a result, fintech companies must adhere to the same legal framework as large, established firms. Failing to comply with these rules can result in costly enforcement actions, including fines and litigation. “The federal government is not moving at the pace it should be,” says Amy Zirkle, interim CEO of the Electronic Transactions Association, a trade organization representing more than 500 payments technology companies. To address some of these challenges, Reps. David Scott, D-Ga.,

and Barry Loudermilk, R-Ga.—the co-chairs of a House Financial Services subcommittee focused on financial and payments technology— introduced new legislation in March. If passed, the so-called Fintech Act would require federal financial regulators to develop a uniform set of rules for fintech companies while eliminating duplicative or conflicting regulations. The bill also mandates the creation of a council that would screen new fintech services before they come to market and implement other safeguards. The bill has received bipartisan support and is under review in multiple subcommittees as of August.

to a 2016 Government Accountability Office report, banking institutions have to abide by the rules of at least five federal agencies, in addition to bank regulators in each of the states in which they operate. If a fintech company engaged in banking activity, it would have to abide by the same framework that applies to traditional banks. This can be difficult for small and medium-sized companies that lack the resources to interpret the rules of multiple agencies, but there are real costs for failing to comply. In 2018, the Financial Industry Regulatory Authority levied a $400,000 fine on Betterment, a

“THE VELOCITY OF THIS CHANGE IS IMMENSE AND UNPRECEDENTED, AND WE NEED TO ENCOURAGE RESPONSIBLE INNOVATION.” REP. STEPHEN LYNCH D-Massachusetts

Solutions from Regulators Federal agencies have also acknowledged that the regulatory environment is too complex for fintech providers to flourish. Oversight responsibilities often overlap across multiple regulatory bodies, creating confusion that can hinder company growth. “It’s vast,” Zirkle says. “There are different regulators that own a different piece of the pie.” In the United States, different rules apply depending on a fintech company’s line of business. Those that offer lending services or engage in other bank-like activities can face the steepest requirements. According

provider of online investment services, for improper bookkeeping. In April of this year, peer-to-peer lender Prosper agreed to pay a $3 million penalty for miscalculating returns in reports to stakeholders, according to the SEC. To help fintech organizations comply with regulations, federal agencies have taken steps to relieve some of the compliance burden and provide resources for companies. Over the last year, the SEC and the Consumer Financial Protection Bureau have each opened offices that provide support for financial technology businesses on their compliance efforts. To address the multiple layers of

regulation, in July 2018 the Office of the Comptroller of the Currency, the primary regulator of national banks, began offering a special-purpose national bank charter that would help fintech companies avoid some statelevel regulations on lending, money transfers and virtual currencies and make it easier for them to expand nationally. Additionally, the Federal Reserve proposed a new rule in April that would ease restrictions on banks that want to invest in or acquire fintech companies without triggering additional oversight from the Fed and other agencies. When it comes to monitoring the fintech industry, policymakers aren’t all on the same page. There appears to be a divide between elected officials in Congress who support a legislative solution that provides wide-ranging relief for fintech companies, and appointed regulators who want to tweak existing regulations without fundamentally altering the landscape. Yet both groups seem to agree the country needs an updated framework tailored for the new class of tech-enabled financial services providers. “I think some minimal law is out there, and we have a wide range of issues that would need to be dealt with,” said Rep. Warren Davidson, R-Ohio, during the Fintech Task Force’s June meeting. “As we would potentially say in Ohio, the field has been plowed. We’re ready to plant.” // – Benjamin Glick

MIDDLE MARKET GROWTH // SEP/OCT 2019

GROWTH ECONOMY

INDIANA // 1998â&#x20AC;&#x201C;2017 The number of jobs created by private equity-backed businesses in Indiana grew at nearly three times the rate of the broader business community over the past two decades. During that period, revenue of private equity-backed businesses grew at more than three times the rate of other businesses in the state. After a slow 2016, there were nearly 80 completed transactions in 2017 valued collectively at $3 billion.

SALES GROWTH % BY SEGMENT

SALES

0.5% 0% 12.3% 87.3% 0% ACG INDIANA

JOB GROWTH % BY SEGMENT 0.1% 6.6% 9.9% 83.4% 0%

115%

SALES GROWTH IN PE-BACKED BUSINESSES

29.5%

SALES GROWTH IN ALL OTHER BUSINESSES

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

40.7%

13.8%

13,974

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.

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I found the right investor to grow my client’s business through ACG. S E E T H E P O W E R T H AT MEMBERSHIP BRINGS. J O I N T O D AY AT W W W. A C G . O R G

THE POWER OF

From left, Kathy Shea, Charles Baker, Kelly McCrann and Jessica Babb at EyeCareâ&#x20AC;&#x2122;s headquarters

Photos by Mark Katzman, FK Photo

IN FOCUS WELLS FARGO

Banking on EyeCare’s Vision Wells Fargo’s expertise in private equity and health care is the right prescription for EyeCare Partners

yeCare Partners LLC is always looking for its next acquisition. The private equity-backed company has made over 40 acquisitions in the last four years, growing from 60 to more than 330 optometry and ophthalmology locations. A company that pursues such a fast-paced buy-and-build strategy needs a banking partner that can keep pace, which is why EyeCare began working with Wells Fargo in 2017. EyeCare was created in 2015 when FFL Partners, a San Francisco-based private equity firm, bought Clarkson EyeCare, an optometry practice in St. Louis. From the beginning, EyeCare’s strategy has been to acquire practices and provide them with a central platform to support their business and patient-management operations. The company eases the burden of running a business, so that the doctors can focus on taking care of patients. EyeCare handles billing, payments and insurance claims. It also generates more business for the practices—it has a program that automatically reminds patients to stay up to date with their eye care, for example. Through acquisitions, the company has acquired ophthalmology and optometry practices throughout the Midwest, Southeast and mid-Atlantic regions. “We are an acquirer and operator of exceptional optometry and ophthalmology practices,” says Kelly McCrann, chief executive officer of EyeCare. “Our plan is to continue both increasing the density of our

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practices in those geographies and to expand to other geographies as well.” EyeCare’s relationship with Wells Fargo has helped the company make those plans a reality. Wells Fargo understands the growing St. Louisbased company’s buy-and-build strategy and offers tailored services and a full team of expert professionals to help handle those needs. “There are huge pain points in buying and integrating so many practices so quickly,” says Kathy Shea, EyeCare’s chief financial officer. “Wells Fargo takes many of them away, especially ones that have been manually intensive and very expensive.” The bank also understands what a highly leveraged business needs, such as deposit account control agreements, known as DACAs. “These DACAs are complex, sophisticated agreements,” Shea says. “Having a partner like Wells Fargo that understands and is comfortable with them is important.”

MANAGING MONEY AND CLAIMS A reliable and streamlined escrow agent is critical for success in the early stages of an M&A transaction. For its acquisitions, EyeCare uses Wells Fargo as the escrow agent. Charles Baker, a Wells Fargo vice president and corporate trust services sales representative, estimates he has worked with EyeCare on about a dozen transactions. Additional financial services that Wells Fargo provides EyeCare include treasury management,

MIDDLE MARKET GROWTH // SEP/OCT 2019

remittance advice—known as an ERA—which in turn must be reconciled in the practice’s books. Before becoming a Wells Fargo customer, EyeCare did that manually. “We had people physically [handling] every single ERA that came in,” Shea explains. Now the ERAs (as well as cash payments) come into a lockbox at Wells Fargo, which automates the process and reduces EyeCare’s cost to collect significantly. The bank can offer such services because it understands the health care market in general, and the claims adjudication process in particular. “There are probably only a handful of banks that really understand the claims automation piece,” Shea notes. Wells Fargo also serves as EyeCare’s clearinghouse for check processing and credit card transactions, reducing costs. Those savings are passed along to the doctors in EyeCare practices. ECharles Baker and Jessica Babb are part of the Wells Fargo team supporting EyeCare

claims processing, and merchant and cash services. Wells Fargo treasury management involves establishing bank accounts for EyeCare’s new acquisitions, a function led by Jessica Babb, a Wells Fargo senior vice president and treasury management sales consultant. Each roll-up brings new bank accounts that need to be consolidated, but “having hundreds of different banks to interact with on a daily or weekly basis is daunting,” Shea says. As a large national bank, Wells Fargo’s expansive branch network of over 5,500 branch locations provides convenient access for EyeCare’s new acquisitions. In addition, EyeCare can always see the latest cash balances through Wells Fargo’s online portal, Commercial Electronic Office®, also known as CEO®. The bank’s consolidation of funds “has a material impact not only on our cash visibility but also our speed to close our books every month,” Shea says. “Having a centralized bank gives us tremendous efficiencies.” Equally important is Wells Fargo’s automation of the health insurance claims adjudication process. Insurance companies pay eye care providers through a monthly electronic

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PRIVATE EQUITY SAVVY Wells Fargo understands not just the business escrow products it offers to support M&A, but also the particulars of private equity-backed businesses. “Because it understands highly leveraged environments, Wells Fargo doesn’t freak out when they see our financial statement,” Shea says. Wells Fargo has begun offering EyeCare more financial services, which are attractive, in part, because they are integrated—not siloed as in many banks. This creates opportunities for EyeCare to use other services as it grows. The knowledge and services provided by Wells Fargo are just part of the equation. They’re complemented by a strong partnership between the bank’s representatives and the client, and their mutual commitment to success. “The EyeCare team has invested significant time and energy in this process,” says Rhoads Hall, Wells Fargo senior vice president and relationship manager, based in St. Louis, who works with EyeCare. “That has resulted in a meaningful relationship for both sides.” It’s a partnership that both parties value. “We’ve been very pleased with the support that Wells Fargo has provided,” McCrann says. “We are glad we made the choice we did.” //

WELLS FARGO CORPORATE TRUST SERVICES With more than 80 years of experience in this industry, Wells Fargo Corporate Trust Services has a legacy of service and stability. In 2018, it had more than $28 billion in deposits and held more than $68 billion in total assets. In addition, it conducted nearly 900 new business escrows and collateral trusts for the year. The bank’s Corporate Trust Services division offers many services for private equity, including debt trustee for high-yield debt, business escrows for mergers and acquisitions, performance guarantees, insurance obligations and other needs, along with a broad selection of investment options. Escrow services can be especially advantageous when firms are acquiring and merging companies quickly. Specifically, Wells Fargo offers: ɋɋ Swift service. Private equity firms move swiftly and need a partner that can keep up. Wells Fargo has streamlined processes to open accounts, conduct due diligence and bring new clients on board quickly. The bank’s staff proactively follow up, says Erin Courcey, Wells Fargo senior vice president and business development officer, based in New York City. “We put a sense of urgency around our services.” ɋɋ Wide-ranging geographic and industry coverage. “One of the things that attracted me to work for Wells Fargo was the broad footprint and variety,” says Jose Matamoros, vice president of business development, based in Los Angeles, California. “We have clients in technology, media and telecommunications, retail, health care, real estate, restaurant finance, life sciences, leasing and investment banking, among other industries.” ɋɋ Customized investment options. Corporate Trust Services has a highly experienced team of industry expert professionals dedicated to identifying investment solutions for escrow customers, who may want higher yield options than are typically available. “In today’s competitive banking environment, many institutions are choosing to enter the deposit-gathering business,” says Steve Giurlando, senior vice president of business development, based in New York City. “They may start calling themselves escrow agents, but they may not have the appropriate experience required to service today’s fast-paced, complex transactions.” With more than 80 years in the market, Wells Fargo Corporate Trust Services stands out from the crowd.

MIDDLE MARKET GROWTH // SEP/OCT 2019

THE PORTFOLIO

Complex Structures Create Valuation Challenges SOUND DECISIONS // What to consider when estimating ownership interest

W Brian Steen Principal, Private Equity and Valuation Services, DHG LLP

ith the increase in private equity investment activity in recent years, today is an advantageous time to sell a private company. Valuation multiples are elevated, and owners are increasingly able to obtain liquidity. However, as private equity investment has grown, management and ownership structures have become more sophisticated and complex, which has made it more difficult to estimate the value of an ownership interest and created new risks for less sophisticated investors. A private equity investment can be structured in different ways. In general, the sources of capital and forms of ownership include senior debt, mezzanine debt, preferred stock, common stock, and options and warrants. Depending on the entity’s legal form, ownership interests have different names, such as membership interests, profits interest or common stock, but the economic rights and valuation issues are essentially the same. Furthermore, an instrument can have characteristics of some or all of the different forms of ownership; yet, even seemingly straightforward investments can be complex and create challenges when attempting to value the various instruments and ownership classes. The value of the different ownership classes matters. It can have financial reporting and tax implications, and the valuation impact of certain provisions will be important when structuring an investment’s terms. In addition, the investor should know and understand the impact that different provisions have on the interest’s value, including the rights and privileges of other securities in the capital structure. Estimating the ownership interest of a company requires taking a variety of considerations into account. The company’s overall value is obviously important. However, economic rights and other factors must also be considered when

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estimating the value of different ownership classes. Key economic drivers include contractual liquidation and return rights, growth opportunities and the expected hold period. Liquidation and contractual return provisions provide an investor downside and return protections, while the investment’s growth potential can be especially attractive in the case of a high-growth company. In some instances, the hold period—often estimated as the time until a liquidation event—can be a benefit by providing more time for the investment to grow, but it can also be a marketability issue for a minority owner who wants to exit. There are three common methods for valuing an investment in a company with a complex capital structure, and each comes with advantages and challenges. The first is known as the liquidation/waterfall method, which estimates the value of the interest based on the assumption that a sale occurs on the date of valuation. This method is relatively easy to apply, but it does not consider the hold period and may not fully reflect the investment’s growth opportunities. The other two methods are the probability of expected outcomes and option pricing, often using a Monte Carlo simulation. Both approaches consider the growth opportunities and the hold period, but they are more complex to execute and interpret than the liquidation/ waterfall method. Owners exiting in today’s market are doing so at an opportune time. By considering the economic rights and privileges across investments tranches and using an appropriate valuation method, they’re more likely to value their ownership interest correctly and, ultimately, to achieve their desired payout. // Brian Steen is a principal in DHG’s Private Equity and Valuation Services practice.

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THE PORTFOLIO

Five Value Levers for Post-Merger Savings SOUND DECISIONS // M&A procurement strategy is not one-size-fits-all

W Brian Prantil Vice President, Insight Sourcing Group

ith M&A activity projected to remain strong into 2020, companies should look to post-merger procurement optimization to unlock value, improve EBITDA and create a measurable impact on the company’s financial results. However, the challenge is that M&A procurement is not a one-size-fits-all approach; there are various savings levers that can be pulled, depending on the M&A situation. To capture M&A savings effectively, we recommend using five value levers: “best-price” harmonization, compliance, strategic sourcing, technical specification modification and demand management. Best-price harmonization involves assessing the spend of both companies on overlapping goods and services and using the best price to benefit the other company. Both companies must have the exact same product specifications for this to work. This strategy will only apply to about 10% of spend, but it can usually achieve up to 2% in savings. Compliance refers to adhering to contracts that have been put in place following a sourcing process. Compliance applies to approximately 25% of spend, and up to 5% in savings can be achieved. Strategic sourcing involves assessing the supplier market, identifying qualified suppliers and engaging in a rigorous request for proposal effort. One company often has a more thorough approach to sourcing, so we recommend applying the same philosophy to both companies. Strategic sourcing can usually achieve between 8-10% in savings. Technical specification modification refers to changing the specification of what one company buys—think of corrugated shipping boxes, and each company using a different thickness of container. This strategy is not used often, but in cases where it is, it can generate between 2-3% in savings.

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Demand management involves optimizing internal practices to eliminate or decrease the volume of goods or services—think of the travel policies of two recently merged companies. Demand management is limited to specific “indirect” categories— purchases unrelated to manufacturing, such as travel or marketing expenses—but it can be used to achieve between 4-6% in savings. Mergers generally fit into one of four categories: companies that offer the same or similar products or services in the same geography; companies that offer the same or similar products or services in different geographies; companies that offer different products or services in the same geography; and companies that offer different products or services in different geographies. The applicability of the five savings levers will depend on the type of M&A scenario and whether the spend category is considered “direct”—directly related to manufacturing—or indirect. Same Product, Same Geography: For indirect spend, all five levers apply. For direct spend, all levers except for demand management apply. Same Product, Different Geographies: For indirect spend, technical spec modification, demand management and sourcing apply. For direct spend, all levers except for demand management apply. Different Products, Same Geography: For indirect spend, all five levers apply. For direct spend, only strategic sourcing applies. Different Products, Different Geographies: For indirect spend, technical spec modification, demand management and sourcing apply. For direct spend, only strategic sourcing applies. // Brian Prantil is a vice president with Insight Sourcing Group and leads the firm’s M&A practice.

MIDDLE MARKET GROWTH // SEP/OCT 2019

ACG@WORK

H ACG CINCINNATI ACG Cincinnati held its 20th Annual Deal Maker Awards. The event recognizes organizations and individuals with proven track records of leadership, innovation and success through the art of the deal. Each of the winners has challenged conventional thinking in order to drive growth in their organization and the business community. Pictured (from left) are Aric Hassel, Commerce Bank; Kendra Bach, Wells Fargo; and Ross Gottula, Hampshire Properties.

ACG KANSAS CITY F More than 250 ACG members and guests networked while sampling wine and local craft beer at the Kansas City ACG Capital Connection and Wine Tasting. Pictured (from left) are Nicole Doyle, Sunesis Advisors; Jacquie Ward, UMB; and Julia Moyer, BKD.

H ACG LOS ANGELES ACG Los Angeles honored area companies during its 9th annual ACG LA Awards Ceremony held at the Walt Disney Concert Hall. The awards distinguish local companies that have made an important impact in the region. Anastasia Soare, CEO and founder of Anastasia Beverly Hills (pictured), accepted the Deal of the Year award.

middlemarketgrowth.org

ACG MINNESOTA F More than 400 attendees gathered for the 15th Annual Upper Midwest ACG Capital Connection. Hosted by ACG Minnesota at the Renaissance Minneapolis Hotel, the event brought together deal-makers from across the country for two days of networking and deal sourcing. Pictured (from left) are Insperity’s Dannie Diego, Courtney Howard, Dave Bruni and Jennifer Anderson.

H ACG NATIONAL CAPITAL ACG National Capital held the 17th annual Corporate Growth Awards Gala at the Ritz-Carlton Tysons Corner. More than 400 attendees gathered to celebrate the successful accomplishments of the D.C. metro region’s corporate growth executives, investors and transaction teams. They included Tenable, which won in the category of deals valued over $250 million for their 2018 IPO. Pictured (from left) are David Bartholomew, Tenable; Mark Zuckerman, Tenable; Diane Zanetti, Capital One; John Song, Baird; and Don Irwin, JPMorgan. All were part of the team that executed the deal.

ACG NEW YORK F More than 100 professionals attended ACG New York’s 12th Annual Industrial Conference. This year’s conference featured experts who spoke about the future of the industrial industry, economic conditions and select end markets. Pictured (from left) are attendees David Clark, Raymond James; David Acharya, AGI Partners; and Rich Prestegaard, High Road Capital Partners.

MIDDLE MARKET GROWTH // SEP/OCT 2019

ACG@WORK

E ACG ORANGE COUNTY ACG Orange County hosted its 24th Annual Awards Gala, where nearly 500 corporate executives and professional advisers gathered to celebrate 30 of the highest performing companies in Orange County and Inland Empire, 10 of which were awarded top honors. Some of the winners included Mitch Whitaker and the Vans team (pictured left), and Chris Myers, Chris Dewhurst and the team at Citizens Bank (right).

ACG EDMONTON F ACG Edmonton held its 7th Annual Corporate Growth Summit, which drew 250 attendees. The event featured a keynote address from former Prime Minister of Canada Stephen Harper (center). Pictured (from left) with Harper are Fausto Franceschi and Leah Tolton, Dentons; Mark Donnelly, ACG Summit Chair; and Mike Mack, ACG Edmonton chapter president.

H ACG PHILADELPHIA ACG members came together at Merion Golf Club in metro Philadelphia to sample hand-selected wines poured by regional private equity firms, while networking and forging new connections with leading M&A deal-makers. Pictured (from left) is Aaron Suh, Morgan Lewis; Kristy DelMuto, LLR Partners and ACG Philadelphia Board of Directors member; and Barbara Shander, Morgan Lewis, and ACGWomen and Programs Committee member.

middlemarketgrowth.org

ACG TORONTO F More than 100 attendees gathered for ACG Toronto’s 13th annual Golf Classic, held at the Copper Creek Golf Club. Pictured (from left) are Darin Brock, TorQuest Partners; Benoit Lacelle, Scotiabank; Nick Lalani, BMO Financial Group and ACG Toronto Golf Tournament co-chair; and Greg Debicki, IMCO.

H ACG HOLLAND ACG Holland hosted its fourth annual Growth Awards in Amsterdam to recognize companies and individuals who have demonstrated leadership in their fields. Pictured (from left) is Joof Verhees, formerly of Kempen & Co.; Mark van Rijn, Bolster Investments; and “Best Advisor” award winner Liesbeth de Boorder, De Breij.

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

MIDDLE MARKET GROWTH // SEP/OCT 2019

ACG@WORK

EUROGROWTH 2019 F More than 150 attendees gathered in London for the seventh EuroGrowth conference, hosted by ACG Global. During one of the panel sessions, a group of investment professionals discussed diversityâ&#x20AC;&#x2122;s impact on business. Pictured (from left) are Maria Blair, ghSMART; Josien Bakker, Robeco; Freerk Smit, Karmijn Kapitaal; and Natasha Buckley, Principles for Responsible Investment.

H MIDDLE-MARKET FLY-IN More than 40 ACG members from across the country gathered in Washington, D.C., to strengthen the voice of the middle market on Capitol Hill. Attendees visited the Capitol to raise awareness of the vital market segment to congressional staffers on both sides of the aisle. After a day of meetings with federal lawmakers, participants regrouped at the Capitol Hill Club, where incoming ACG Board Chairman Martin Okner (right) presented Rep. Steve Stivers, R-Ohio, the ACG Growth Award for his contribution to the middle market as a founding member of the Congressional Caucus for Middle Market Growth.

middlemarketgrowth.org

INTERGROWTH 2019 H Keynote session InterGrowth, the Association for Corporate Growth’s annual cornerstone event, drew more than 2,000 attendees for this year’s conference in Orlando, Florida. During the closing keynote session, baseball legend Alex “A-Rod” Rodriguez (left), discussed how he launched the second act of his career as founder and CEO of investment firm A-Rod Corp during a Q&A session with Jason Brown of Victory Park Capital.

InterGrowth Lounge F Attendees gathered in the InterGrowth Lounge, the center of activity at the conference, for networking and private meetings.

H Keynote session Former SoulCycle CEO and co-founder Elizabeth Cutler (left) joined Monroe Capital’s Karin Kovacic for a fireside chat to recap how the company grew from humble beginnings to become a fitness phenomenon spanning dozens of locations nationwide.

MIDDLE MARKET GROWTH // SEP/OCT 2019

THE LADDER

CYNTHIA ROMANO has joined CohnReznick as principal and co-leader of the firm’s Restructuring and Dispute Resolution practice where she oversees strategic growth, client relations, marketing and talent development. Based in CohnReznick’s New York City and Long Island offices, she brings more than 25 years of experience in performance improvement, turnaround management, transaction support and investment analysis.

ERIC KAMSTRA has joined Gun Lake Investments, the economic development arm of the Gun Lake Tribe, as director in Grand Rapids, Michigan. He will support the organization as it pursues alternative investments to help diversify the tribal economy. Kamstra also serves as a member of the board for ACG Western Michigan.

AMANDA LEECH has joined Akerman LLP as a corporate partner in the law firm’s Atlanta office. She focuses her practice on general corporate counseling of both privately held and public companies. She has advised clients in a broad range of sectors on mergers, acquisitions, divestitures, joint ventures and strategic alliances.

Cozen O’Connor has promoted business attorney EVAN BERQUIST from associate to member in the firm. Berquist, who is based in Minneapolis, advises clients on a wide range of transactional matters, with a focus on mergers and acquisitions. His clients include startups, middle-market companies, private equity investors and large multinational corporations.

middlemarketgrowth.org

MARTI KOPACZ has joined Gordon Brothers as chief development officer in the firm’s Boston headquarters. In her new role, she will build and lead marketing, business development and corporate development, while creating and propelling new business opportunities. Her career prior to joining Gordon Brothers included roles in professional services practices and as a senior financial adviser.

BRIAN SCHWINN has joined Capital One to lead the Financial Institutions Group’s Underwriting and Portfolio Management team in the firm’s New York office. He joins Capital One from Santander Bank, where he served most recently as EVP, head of asset-based lending and restructuring finance.

Monroe Capital announced it has added six managing directors and one director to its originations team, who will be responsible for relationship sourcing and the origination of new business opportunities. DAVID FISCHER (pictured above) and NICK McDEARIS (below) will co-lead efforts in the Southeast; DAN LETIZIA will focus on the Midwest; JACK BERNSTEIN will focus on the East Coast; TOMMY RYAN will focus on the health care industry on the West Coast; STEWART HANLON will co-lead efforts in the technology industry; and ALEX PATIL will focus on the West Coast.

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

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IT’S THE SMALL THINGS

THE TECH REVOLUTION // Pardon the disruption

Banking on Innovation Large payment processors like PayPal and

Tech Fights for Defense Contracts In an effort to get ahead of mounting cyber threats,

Western Union were among the first companies

military and intelligence agencies are upgrading

to adopt electronic money transfers, which

their roster of defense contractors by tapping

helped expand digital transactions around the

established tech companies and startups to help

globe. Since then, small innovative money transfer

detect fabricated audio and video files, known as

services, such as Kenya-based M-Pesa, have

“deep fakes,” identify objects in drone photographs,

emerged to serve populations who lack access

and more. – Axios

to traditional banking services by providing a safe way to deposit funds and make purchases via phone application. – Forbes

Tapping into Virtual Workspaces As technology enables more workers to telecommute, software will become an increasingly valu-

Insurtech Takes the Wheel

able tool to bring them together virtually. According

The success of insurance technology startups

to one group of market researchers, team collabo-

like Lemonade, which provides home and renters

ration software is poised to grow to more than $16

insurance, have raised the profile of insurance

billion by 2025, up from $8 billion in 2018.

companies that leverage algorithms and artificial

– Grand View Research

intelligence to analyze policyholder risk and reduce costs. Meanwhile, changes in car design have created inroads for new auto insurers like

Disruptors Target Real Estate Reined in for decades by brokerages and regula-

Avinew, whose coverage rewards customers who

tion, real estate may be the next industry affected

use autonomous safety features. – VentureBeat

by technological disruption. Access to information is allowing more home buyers to circumvent agents

The Rise of Robo-Regulation Monitoring

and unravelling the traditional real estate model.

Increasing levels of regulation have created an

Entrepreneurs are offering cloud-based data

opening for so-called “regtech” providers, which

platforms for buyers and sellers to make better and

help their clients establish consistent regula-

faster decisions. – Forbes

tory monitoring and reporting and compliance practices to avoid penalties and adapt quickly to new laws and regulations. The global market for regtech is expected to grow to $12.3 billion by 2023, up from $4.3 billion in 2018. – Research and Markets

—Benjamin Glick

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