November 18, 2013
Interviewed by: David Snow
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Growth Equity Is the New Black

Brian Rich of Catalyst Investors says the private equity sub-asset class of growth equity is becoming a favorite among LPs. Rich defines the key characteristics of growth equity and describes why the NVCA has added these firms to its mandate. He tells why as more and more sophisticated participants enter this space, competition is becoming “fierce.”

Brian Rich of Catalyst Investors says the private equity sub-asset class of growth equity is becoming a favorite among LPs. Rich defines the key characteristics of growth equity and describes why the NVCA has added these firms to its mandate. He tells why as more and more sophisticated participants enter this space, competition is becoming “fierce.”

Growth Equity Is the New Black
With Brian Rich of Catalyst Investors

David Snow, Privcap: Today we are joined by Brian Rich of Catalyst Investors. Brian, welcome to Privcap today. Thanks for being here.

Brian Rich, Catalyst: Thank you for having me. I appreciate it.

Snow: So Catalyst Investors is a growth equity firm. I’ve noticed in recent years that many firms large and small are beginning to refer to themselves as growth equity firms. Why is this term becoming more popular and why are seemingly some groups seeking to redefine themselves as growth equity firms? I’d love your perspective.

Rich: Yeah, it’s funny. You know, we’ve been doing it since 2000 at Catalyst and previous to that, used to do growth equity for TD Bank. In some respects, I feel like growth equity is the new black. There was just a whole series of events, I think culminating recently with this Cambridge study that showed that growth equity as they define it has superior risk reward attributes to both venture capital and leveraged buyouts.

Needless to say, that’s very attractive to LP’s. They like that. They like the lower risk profile. They like the higher returns. They are taking more interest in the asset class and as a result, to no surprise, more GP’s now find themselves migrating from VC into growth on the one hand and from small market buyouts into growth equity on the other hand. So we’re thrilled that people have acknowledged the space.

Snow: Well, what is your definition of growth equity? What does a firm need to target in order to, in your mind, be able to label themselves growth equity investors?

Rich: Well, there are a couple of definitions out there. I happen to serve on the NVCA’s growth equity sub-committee. There are Cambridge’s definitions that are quite similar. They have nuances, but let me just sort of try to attack that from the 10,000-foot level. As I alluded to, I think growth equity sits between venture capital on the one hand and small market buyout on the other hand.

In the middle of that, you have a couple of commonalities. First, we invest in high growth businesses to the kind of businesses we invest in are in fact very similar to the kind of businesses that venture capitalists invest in, in an earlier stage. That being said, we come to investment companies that have proven products, tends to be the last round of capital that’s required before some form of exit, whether that’s an IPO or some other strategic exit.

Snow: So they’ve reached a level of self-sustainability?

Rich: Yes, although I’m often asked whether we will invest in companies that are only cash flow positive and the answer is we will do both. And when I say we, I’m speaking about growth equity investors generally, not just about catalysts. So that’s on the one side of it, on the venture capital side. On the other side, as comparing us to say small or mid-market buyout shops, we tend to not habitually use leverage. We will sometimes use leverage, but when we do use it, as we say lightly, our returns are not dependent upon the use of leverage. And many, many times we don’t use leverage at all.

Snow: Does your occasional and light use of leverage, nevertheless, trigger a definition of you as a buyout fund in some people’s eyes?

Rich: I think if you looked at our portfolio for instance, at Catalyst, you would conclude we are not a buyout shop. We use debt just every now and again on companies.

And as I said, use it lightly. So I don’t think there’s any question. I think there would be other managers who might try to characterize themselves as growth equity and one would have to go through their portfolio and really try to decide whether in fact the majority of the deals they did were growth equity deals or not.

Snow: Can you talk about what a company that you might target looks like as far as its stage of growth? You know, what its business looks likes, what are its needs and how can your firm or similar firms be supportive of its further growth?

Rich: Right, so you’re now talking about the line between late stage VC and growth equity and what’s the differentiating factor. And, you know, again, it’s not a bright line. But to our mind, we want to see that the company is, in fact, sustainable. That it’s replicable, that it does have high growth. And oftentimes, the high growth will drive the cash flow negative.

So we’ve made investments, many successful investments where the company was profitable until we invested and then by virtue of our investment, they were able to accelerate growth and therefore turn cash flow negative. As far as what the companies are looking for from us, as you would guess, these companies are further along. They’re often staffed, the managerial staff, often founder-owned but supplemented with professional managers. So they don’t need the same kind of really, really getting in there kind of venture capital help.

But, we consider ourselves to be professional board members. So we’re bringing in things like KPI’s, key performance indicators, guiding them to dramatically growing the business, helping them teach strategically, helping them with key managerial ads, and then of course as you get closer to exit, thinking about how you position them for the exit.

Snow: Not withstanding the recent Cambridge, I guess, index that you mentioned and showing that growth equity firms so defined have attracted risk return characteristics, how has the investor appetite for and understanding of growth equity evolved over the years?

Rich: It’s really funny. I mean I can remember, we started our firm in 2000 and we went around to the institutions for our first fund in that year. And you’d look at our fund-, one thing I didn’t mention that I should’ve is one of the other key distinctions of us versus say, buyout shops is that we are indifferent as to whether we’re majority or minority owners of a business.

We’re happy to be either and we know how to structure around it so that if we’re minority owners, we’re satisfied that we have sufficient governance. I can remember investors looking at me like I had two heads. Wait a second, you own 20% of this business and how do you possibly influence the outcome of this business? And I think that the investor bas has gotten far more sophisticated and up-to-speed about these kinds of things. I don’t ever get asked that question anymore.

They ask me very in-depth questions about how do we structure it, how do we govern, what are the positive and negative rights that we have, how do we contemplate the exits and these sorts of questions.

Snow: You mentioned being a part of an NVCA group focused on growth equity. Can you talk a bit more about what the goals of that group are?

Rich: So within the NVCA, there are well over 400 member firms of the NVCA and as the name applies, National Venture Capital Association, it is the venture capital industry. We would consider ourselves to be a subset of the venture capital industry, I think.

So I think within the NVCA, there is a nicely sized constituency of growth equity managers. And I think given what we’ve just talked about of the further acknowledgement of growth equity being a separate asset class, more capital getting attracted to the asset class, and just the membership of the NVCA, it was decided that it would be a good thing for that group to have its own separate subcommittee to represent its interests. We’re focused on regulatory matters. We’re focused on just how growth equity is perceived within the venture capital world and issues such as that.

Snow: I want to talk a bit about competition, the development of the growth equity market and the more and more participants that are coming into it. You’re targeting companies that are growing quickly that presumably have very confident, supercharged management and/or entrepreneurial founders. And that are already attracting a lot of attention from suitors and all kinds of investors. So how do you invest in that environment from presumably companies that maybe wonder why they need your capital and your guidance.

Rich: No, that’s right and there’s no question, by the way, that the competition has gotten fiercer or more fierce, I guess I should say. But you do have people who have acknowledged that it’s a very strong investment thesis and so consequently, you have more GP’s who look at this style. So the companies are being courted by more firms like us.

So what we’ve done in response to that over the last five or six years is to continue to differentiate ourselves. And to do that by being, for instance, thought leaders in our particular verticals. So we spend extra time and energy making sure that we’re on industry panels that our network of operating partners that are a network of what we call core bankers are robust. And that we proactively look for the particular sectors that we think are interesting and then go after the companies that we find interesting within those, very, very proactively. The flip side of that, if you’re the CEO or the decision maker as to who you want to select as your capital provider, we hope they would choose us because we’re bringing more than just capital to the table.

Snow: I’m interested in hearing about your firm’s current investment thesis that it is working on and there’s lots of different companies out there that are growing fast, lots of industries that are growing fast. Can you talk about a few industry silos that you are particularly interested in?

Rich: We’ve got 36% topline revenue growth year-over-year, weighted average in our portfolio, which is extraordinary.

I mean we’re in a relatively still slow growth economy and to say that you have a portfolio with 36% growth is pretty attractive. So we are looking at macro trends of course, and then drilling down and then trying to figure out how do we invest at a reasonable price. So we’re looking for growth at a reasonable price, not just unfettered growth at any price. We want our portfolio. We want to build a portfolio that’s going to have the lost characteristics of a buyout fund or better. But if we do our jobs well, we’ll have out of a portfolio of say a dozen companies, we’ll have three or four that have extraordinary returns. So that’s the objective. Then we back into what are the verticals.

So some of the themes, obviously mobility is a big theme that you hear everybody talking about. For us, we’ve had a particular expertise in wireless communications really going back 20 years as a firm, having invested in wireless spectrum, having invested in cellular service providers. So now when you fast forward, we continue to invest in wireless spectrum. We look at things like mobile advertising, digital advertising, advertising technologies. All of the old advertising businesses that we used to invest in, in an analog world, you now fast forward into a digital world and it’s really interesting. So we’ve got several portfolio companies in that frame.

Snow: What’s an example of a business model from the analog world that is on the decline and being replaced by one of these new businesses that you’re targeting?

Rich: We have many. I’ll name one or two. So we have a company called Wedding Wire, which is a company that’s a real interesting business. It’s sort of Yelp for weddings. So instead of looking for a restaurant, you look for all of the vendors if you were getting married. I know you’re not.

Snow: Been there, done that, loving it.

Rich: So they help local merchants find customers. It’s a lead gen business. It’s totally digital. It’s market by market. It helps out young brides and grooms to find their vendors, companies growing. Last year it grew at 100%. This year it’s growing at 70%. So super high growth, high value-add for the merchants.

Snow: These are merchants that are advertising?

Rich: Exactly, they do. Just like in Yelp, they pay to elevate their listings and users give them reviews. And so these are merchants who just, some years ago, were advertising in the Yellow Book or in the local white pages or local newspaper and now they’re advertising on Wedding Wire.

Snow: How about the technology trend or thesis or whatever you want to call it, the cloud? I know there are more sophisticated ways to refer to that phenomenon but are you interested in that as an investment thesis?

Rich: Absolutely. You’d be hard-pressed not to be interested in it is the truthful answer. Because the shift from desktop computing to cloud computing is clear. It’s happened largely at the enterprise level. It’s now moved down to what we call the SMB level or small medium business level.

You will be, in a few years’ time, you will be hard-pressed to find an application that isn’t cloud-based. So it’s very attractive. It trades at very high multiples led by public companies like Sales Force. We have several companies within our portfolio, most notably one called Mind Body, which does it for health clubs, spas, yoga studios, things of that sort.

Snow:Following up on your comment about investing in the wireless spectrum, what to you represents interesting opportunities today in that space?

Rich: So we have an investment, for instance, in cell towers, which continues to be a high growth business. That being defined as something growing faster than 10%. It is a staple. Your phones just won’t work and the consumption of data is growing so fast that the components that are required are interesting investment opportunities. For us, we have a lot of experience relatively uniquely. I don’t think there are that many investors that do it, in wireless spectrum. So spectrum is the other building block that’s required to make your phones work. And we have a particular expertise and have done very well in the space. We happen to be spending a lot of time in that space right now.

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