January 30, 2013
Interviewed by: David Snow
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Growth Investors Tell Obstacle and Success Stories

Firing a family member can be a gut-wrenching decision, yet the experts in this panel discussion have seen this happen often in private equity-backed businesses. These stories are shared by Chris Masto of FFL, Jeffrey Bunder of EY, and Deepak Sindwani of Bain Capital in the third of a three-part thought-leadership series called “Igniting Growth and Innovation: Private Capital and Entrepreneurs.” The segment ends with an expert Q&A with Bunder of EY, sponsor of this series.

Firing a family member can be a gut-wrenching decision, yet the experts in this panel discussion have seen this happen often in private equity-backed businesses. These stories are shared by Chris Masto of FFL, Jeffrey Bunder of EY, and Deepak Sindwani of Bain Capital in the third of a three-part thought-leadership series called “Igniting Growth and Innovation: Private Capital and Entrepreneurs.” The segment ends with an expert Q&A with Bunder of EY, sponsor of this series.

David Snow, Privcap: Today we’re joined by Chris Masto of FFL, Jeff Bunder of Ernst and Young, and Deepak Sindwani of Bain Capital Ventures. Gentleman, welcome to Privcap today.

We are talking all about the partnerships that are often forged between entrepreneurs with growing companies and investment firms, private capital firms, private equity firms. All of you are very active in this space, and I’m sure you have great stories. Maybe starting with Chris, what are some good examples of success stories that nevertheless had some winding paths to success?

Chris Masto, FFL: Maybe one good example to touch on here is a company that we were involved in called Milestone Audiovisual, and we invested in 2003 and were involved for, I think, about six years. It had a great, successful outcome.

Milestone was a maker of flat screen mounts and LCD projector mounts, and when we first got involved in the company, it was led by its entrepreneur who actually wasn’t technically the founder of the business. He practically was, but he had bought a small company that made slide projector carts and evolved the business. Rather than viewing himself as a slide projector cart maker, he viewed themselves as being in the presentation support business and involved with the technology, and it created a very nice business.

When we got involved, strategically they were purely focused on working with commercial channel, kind of value added resellers and installers. And that was a very attractive channel, and we thought that had a lot of growth to it, so it was a great business. If they did nothing but that, we felt that would be a good investment.

But through our work in studying the industry and the opportunities ahead, we felt it really made a lot of sense to try to get into the consumer business. And at that time, there was very little consumer flat screen penetration, but we kind of expected that to come. And this was an area where the entrepreneur had a real aversion to getting into the consumer business. He didn’t want to be dealing with the retail channel, tougher margins in a consumer space. And so, he had a visceral kind of resistance to wanting to go in that direction.

So we really worked through a process of sharing all the work we did and due diligence about the market opportunity, the reasons why we thought that was important, kind of collaboratively came up with a strategy to approach doing that, and kind of manage risk. And ended up agreeing to move down that path.

So, I think in the end, that was certainly, as you might imagine, a strong contributor to the success of the business where we saw our revenues were around 50 when we first got involved, and ended up above 250. So really, a great outcome for the business. Again, it would have been a strong outcome, but much stronger for having thought hard together about the strategy and embraced a broadening of the strategy to move in that other direction.

Snow: I would imagine that’s a great example of a key ingredient to success when entrepreneurs take in private investment money, which is getting the strategic vision correct or aligned. And so, here was someone who was resistant to going into a channel that he was less aware of, whereas that was a strategy that your firm had a lot of experience in.

Jeff, you must have a lot of interesting stories serving so many clients in the growth capital and growth stage company sector. Any come to mind as being really illustrative of something that would be good for entrepreneurs and for private capital investors to learn about success?

Jeffrey Bunder, Ernst & Young: Sure, plenty. But we’ll leave the names.

Snow: Witness protection program?

Bunder: But certainly, it’s interesting. I think it falls in two different buckets. One situation we had, again, a strong entrepreneur running the business. And then part of the diligence, we were working through the financial statements, real challenging. The business didn’t really have a good finance function.

And ultimately came up with a bunch of questions around certain assets that were on the balance sheet which ultimately included a fleet of Mercedes Benz cars and assorted other vehicles. And it became very clear that the entrepreneur was not only using the business to fund his toys, but also as we walked through the org chart, it seemed like every family member had a job in the business.

And what was interesting was initially, it was a serious issue when addressed. Conflict. The deal sort of went sideways for some period of time. And unfortunately what they did was just it made everything difficult, because there was seemingly a bit of a lack of trust and a bit of a feeling that, OK, these guys are coming in with capital, and all of a sudden they’re going to throw out every family member, and we’re going to have to change the way we do business, and there’s all of that that, again, just created a bad situation, bad vibe.

Snow: But was it ever resolved?

Bunder: It was ultimately resolved. It took some time. It took, I think, the founder to understand and appreciate that he had to change the way he was operating this business, and he had to make some tough decisions around who in the family was really providing value.

Masto: I looked closely one business we didn’t end up investing, but where you had some of those same issues, and an entrepreneur had a couple sons involved in some key positions in the company. And it became clear as we were advancing in our discussions that that really wasn’t appropriate for the long term health of the business.

And interestingly, the entrepreneur, he knew it, but as long as he was going to carry on as a family-owned business, that was going to persist. But he understood that if he were to do a transaction, that would change, it would need to change, and in effect he was kind of looking if we were to do the deal for me to have that conversation and have someone else be the bad guy to say this is the right thing for the company. Again, for a variety of reasons, it wasn’t something we did.

Snow: You tried to buy News Corp? Is that what you’re saying?

Deepak, you must have a lot of interesting stories.

Deepak Sindwani, Bain Capital Ventures: Yeah, I do want to share it, and I do want to pile onto the family comment here. Actually, the second venture investment I ever made, probably 10 years ago now, was in a company that– that situation I’ll hopefully never touch again. But it had two brothers as a CEO and a CTO, and then their best friend as the chief scientist.

And it was an earlier stage company, and we ended up having to let go one of the two brothers, and it caused all kinds of problems in terms of just corporate governance and strategy. And it was just a messed up situation.

But I want to take a little different vantage point. Bain Capital Ventures focuses both on early stage and growth stage. I happen to spend my time more on growth equity, but we get to see I think from a little bit of a different vantage point early stage companies try to transition into growth stage companies.

And one of the things that I’ve just learned in this business is that’s the biggest risk area for us as investors, is how do you take a company to a certain level, and then take it to its growth stage, and really generate a significant amount of profit and still keep your eye on the ball?

And there’s countless stores. I won’t name names, but we’ve had several situations. I wish we didn’t, but it what happens in the business where you have a founder/CEO who takes a business, and it’s typically in the $10 to $20 million revenue range where we start to have issues of can this person scale? Do they have all the tools? Do they realize that they don’t have some of the tools?

And that’s where what we found, and we like to do that frequently, is with founder CEOs, we like to at some point in the business– and in some cases we never do it, or never suggested, I should say– bring in or suggest that we together bring in a president. And that president may end up becoming a CEO or not, but this concept of a partner for the founding entrepreneur to really grow the business who has that skill set from having done it and seen around corners a little bit. We think in an ideal situation, the team together, there’s a one plus one equals three situation

So that’s in general, we’ve had several of those situations where what oftentimes happened is that founder/CEO is resistant based on ego and other things to bringing in a business partner. But after we get to that point and after the person’s installed, it’s almost a massive sense of relief. How could I ever have operated the business without this person? Now I can focus on the things that I’m good at and let this person focus on the things that he or she is good at. So, it was probably 10 different companies where that’s been an example for us.

Another situation that I think is relevant for entrepreneurs and founders to think of is there are situations where if a company is bootstrapped for a long enough in addition to, I think, personal expenses sometimes running through, which I’ve seen it multiple times as well, you can get a little bit over your head in terms of debt obligations and other things that can be very impactful for a company. And then if you have a bad quarter or a bad half of the year or bad year, you can really be in a bad situation.

so I was involved in a transaction the last couple years where we had to renegotiate with essentially the debt provider in the business, and did a recapitalization where the equity replaced some of the debt. And it was painful, I think, for all sides included. I think we have an exciting business going forward, but it was a classic example of a really interesting business that actually brought in an outside CEO, but had a bad balance sheet that needed to be fixed.

Snow: Final point to make, is it safe to say that one of the most challenging things that the marriage between a private capital firm and an entrepreneur can go through is the entrepreneur himself or herself being forced to reevaluate their own role within the company? Is that typically the most gut wrenching or difficult transition to make it through?

Sindwani: I think so. I mean, I think that that is a natural situation in every company in certain circumstances. It happens in other circumstances. It doesn’t happen. I don’t think there’s any direct correlation between there should be a transition or not. It’s just really case-dependent.

But it usually is a situation that causes angst because there’s a perception of this is my company and a certain level of control, and frankly, from an economic standpoint, that may be the case. And I think a lot of the decision to raise outside capital has to do with do I want the advice, can I use to help, am I open other team members? And I think it’s a critical decision for founders and entrepreneurs to make.

Bunder: And the issue, it’s emotional. There’s a business there that there’s competing interests, and you may see a little schizophrenic behavior on the part of the entrepreneur. They want to bring their business to the next level, create a legacy, but at the end of the day, they want to keep their business small, that family feel, and there’s seems to be that constant tension or internal debate in an entrepreneur as to how do try to go forward Well, keep this business small and a core family while at the same time creating something larger. And in many ways, also, just learning to give up some of those roles and responsibilities.

Masto: The best approach, if you can make it work, often is to have the transition be a gradual one, one that you’re doing in complete alignment even if it’s a process of getting to that alignment with the entrepreneur. Creating some new roles in the company that maybe even didn’t exist, new boxes in the org chart so that the entrepreneur doesn’t have everyone reporting in to him, and bringing in some great talent from the outside.

But when making those additions, being very careful to find the right cultural fit, people that can work well with that entrepreneur, and bring the skills and experiences from the outside, but integrate well into the culture so that there’s not a shock to the system. And so, the process of managing the pacing of that change and finding the right cultural fit from outsiders is very tricky.

Expert Q&A With Jeffrey Bunder, Ernst & Young

Privcap:  Please discuss Ernst & Young’s history of working with growth-stage companies

Jeffrey Bunder, Ernst & Young: We’ve had a long history. Some of the household names now that are public, well-established companies were formerly small-growth businesses that we’ve serviced all long the spectrum of growth. And it’s certainly an area that we focused on. We call it an entrepreneurship.

It’s a focus on working alongside businesses as they look to grow and need that level of assistance and support and advice. We’ve been there for these companies and worked alongside these companies. It’s pretty fulfilling, because you end up seeing a business that may have started in someone’s garage that ultimately, over a number years, has moved to become a major player in a market, achieved public-company status. Working alongside those companies is something we value tremendously.

Privcap: What unique challenges do growth-stage companies face?

Bunder: Companies that are in the growth stage are perpetually changing. What we’ve seen historically is these companies are not necessarily best in class in terms of governance, best in class in terms of operations or finance, and need assistance.

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