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Chasing Deals - Private equity Firms Invest in Small and Mid-size Businesses

By: Jim Freer - Date: 02/01/2007

If you are hearing a lot about private equity firms these days, you aren’t alone.

“It seems that every time the owner of a private company picks up the paper, he sees a story about the deals and prices,” said Craig Farlie, co-founding partner of Fort Lauderdale-based Farlie, Turner & Co.

So the logical question is: Why all the interest in private equity funds? For owners, they offer a source of cashing out or obtaining money to fuel expansion. For employees, they can offer a way to buy out an owner who is ready to move on.

Investors like the rates of returns that have historically exceeded the stock market.
Sarbanes-Oxley is fueling more deals nationally because companies don’t want to deal with being public. Money that could go to public companies is chasing private deals.
And then there’s the nature of our region.

“South Florida is a private company town with companies that are growing,” and are attractive to funds that invest in small and mid-size companies, Farlie said.

The number of transactions in all of the categories likely will keep growing, say officials of private equity firms and investment bankers who advise businesses that are seeking private equity.

Echoing Farlie’s comments, Peter Brockway, a managing partner at Boca Raton-based Brockway Moran & Partners, said: “South Florida is a hotbed of growth, especially for smaller and mid-size businesses.”

Many businesses that obtained private equity have reached their first growth targets and are “looking for a second bite of capital,” said Brockway, who joined Michael Moran in founding the firm in 1998. South Florida’s private equity industry includes Brockway Moran and several other firms that invest in mid-size and larger companies, with annual earnings of $20 million and higher, often outside Florida.

Palm Beach-based Palm Beach Capital and Aventura-based Florida Value Fund are among firms that invest in companies smaller than Brockway Moran’s range and focus on South Florida.

Private equity firms’ managers usually are former bankers, accountants or business owners and CEOs.

Brockway said his firm and most others take board seats, usually two, after investing in a company. Private equity firms usually retain management and employees. If a company’s owner and executives sell, the private equity partners use their contacts to find new CEOs and CFOs.

Private equity investment has grabbed worldwide headlines amid the trend of giant firms’ buyouts of private companies. Sellers’ boards and executives are eager to cash out and exit from this decade’s tighter regulation of public companies.
Legendary New York-based Kohlberg Kravis Roberts & Co. and Washington, D.C.-based Carlyle Group are among the investors.

Research done by Dow Jones Private Equity Analyst showed that private equity fundraising set a record $215.4 billion last year.

Pension funds, endowments, other institutional investors and wealthy individuals are putting money into private equity funds because of strong annual returns many funds are producing and the prospects of larger returns if private equity-run companies sell to larger companies.

Dow Jones Private Equity Analyst did not provide data on the amount of money private equity funds invested in companies.

The newsletter’s tracking of 322 funds showed a fundraising increase of 33 percent above the $161 billion those funds raised in 2005.

Of money raised in 2006, $149 billion was by funds whose investments are entirely equity. The remainder was by mezzanine funds, which use a combination of their equity and debt they raise to invest in companies.

The previous record for the Dow Jones survey was in 2000 – the peak of the high-tech and dot-com boom – when private equity firms raised $177.8 billion.

The 2006 surge is attributable to institutional investors accumulating cash during a strong economy and looking to diversify their investments, which include stocks and real estate, said James Cassel, senior managing director at Miami-based investment bank Ladenburg Thalmann & Co.

The number of private companies where private equity investors can place money has been growing partly because of requirements of the Sarbanes-Oxley Act, added Cassel, who advises businesses that are seeking private equity or arranging mergers and acquisitions. That 2002 law is deterring many companies from launching IPOs.
Private equity firms purchase stakes, sometimes full ownership, in private companies that meet their criteria in earnings, revenue, growth potential and type of industry. Some larger firms also buy stakes in public companies.

Unlike venture capital funds, private equity funds generally do not invest in startups or other young companies that have not become profitable.

Private equity firms obtain commitments from investors, and receive money when they have identified companies for investment.

The firms seek annual returns, based on companies’ earnings, and often anticipate a profit through a sale to a larger company or to a larger private equity firm within several years.

The latest data from Thomson Financial showed private equity firms that have a 10-year hold horizon had an average annualized return of 8.9 percent in last year’s second quarter. That compared with a 9.2 percent full-year return in 2005.
Those returns are a combination of distributions, such as dividends, and unrealized gains, such as appreciation of stock prices, as a percentage of investment.
The 2005 and mid-year 2006 private equity returns beat the Standard & Poor’s 500.

The stock market’s rise since last summer probably won’t deter private equity investors, said Michael Turner, Farlie, Turner & Co.’s other founding partner.
“[Private equity] investors have historically gotten a nice premium over the traditional S&P, and they know the funds that have a history of finding companies that can produce strong returns,” said Turner, whose investment banking firm advises companies on mergers and acquisitions, including private equity deals.

Florida Value Fund last year closed a fund with $20 million pledged by investors. The fund plans to invest between $1 million and $4 million, sometimes for full ownership, in South Florida businesses whose annual revenues are $30 million or less, said Gil Hermon, its senior partner.

“We are looking for companies that need financing for growth or for individuals who are retiring and want to sell a family business,” he said. “We do not have an industry focus. We are looking for businesses we can understand, and have strong management.”

Brockway Moran has a similar overview in looking for companies, but focuses on those with annual revenue between $50 million and $200 million.

Brockway Moran has stakes between 51 percent and slightly more than 90 percent in eight companies. Those companies are called “platform companies” in the venture capital industry. Fort Lauderdale-based International Bedding Corp., which makes mattresses and foundations, is Brockway Moran’s only South Florida company.
Private equity firms usually do not disclose purchase prices.

Many prices are in the range of two to three times the seller’s earnings before interest, taxation, dividends and amortization [EBITDA], Brockway said.
Another price gauge is a multiple of a business’s enterprise value – market capitalization plus preferred stock and debt, minus its cash and cash equivalents.
Private equity investment in South Florida is “word-of-mouth driven,” said Michael Schmickle, a Palm Beach Capital partner.

Bankers, attorneys and accountants tell Palm Beach Capital about companies whose owners want cash to expand or want to cash out.

Private equity seekers should be aware of the tough competition and screening process.

“We get information on 500-plus companies a year,” Palm Beach Capital partner James Harpel said. “We talk with about 15.” Then, Palm Beach Capital makes about five investments a year.

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