February 26, 2013
Interviewed by: David Snow
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Why Smaller Businesses Need Private Equity

Small businesses facing the “wonderful mess” that is the US and global economy today need to become “small giants” by tapping the resources, expertise and networks that a private equity firm can provide, according to Terrence Mullen, a Partner at New York-based Arsenal Capital Partners. In a Privcap interview, Mullen describes the mission of his firm and why he focuses on acquiring smaller businesses. He also explains the need for entrepreneurs to strengthen their management team and expand internationally. Mullen also details the impact that cash-flush corporations are having on deal flow.

Small businesses facing the “wonderful mess” that is the US and global economy today need to become “small giants” by tapping the resources, expertise and networks that a private equity firm can provide, according to Terrence Mullen, a Partner at New York-based Arsenal Capital Partners. In a Privcap interview, Mullen describes the mission of his firm and why he focuses on acquiring smaller businesses. He also explains the need for entrepreneurs to strengthen their management team and expand internationally. Mullen also details the impact that cash-flush corporations are having on deal flow.

<b>Terrence Mullen, Arsenal Capital Partners: </b>So Arsenal is a small firm. We started 12 years ago in 2000, to help small businesses become exceptional companies. We had a view we wanted to invest in small businesses with high growth potential. However, to do that and do it consistently, we thought you needed to have deep sector expertise, which we built and we call special industrials. And in health care, and also have in house operating in general management skills to enable these smaller businesses to become much better businesses. And to infuse that with a real investment discipline around finding these high growth companies, and enabling them to be the superior businesses that they have the potential to be.

<b>Privcap: What benefits do private equity firms bring to smaller companies?</b>

<b>Mullen:</b> Entrepreneurs need a lot of help. And I say that with all due respect to entrepreneurs, but the world”s incredibly challenging. In a more benign growth environment, say in the “90s or the last decade, growth was reasonable, and if not abundant. Today, growth is not abundant and there are significant structural and fundamental problems with the US economy, with certainly, Europe is under major challenge.

Emerging markets have had periods of very high growth here, but those growth rates are even moderating more. So entrepreneurs have generally done well, have done that by creating a product or service that the market needs, but if they want to grow further, they can”t just rely upon general market growth. They”ve got to find ways to access new adjacent markets, invest in technologies, and bring them to market.

And a big issue for entrepreneurs is actually accessing global growth. So many– we invest in US headquartered businesses, many of these entrepreneurs have done very well, yet there”s a huge world that they can access. And markets, particularly industrial markets that we specialize in, very connected on the supply chain between customers and suppliers, and so enabling small companies to access and achieve global growth is a huge opportunity.

The second is competition for resources. Management talent is scarce, so we match up particularly well, when we find very talented CEOs, entrepreneurs who”ve done well getting to a certain stage, yet to get to maybe double or triple the size of the business, which they are often looking to do, they need to strengthen their team. They need to be complemented.

In some cases, we”ll find entrepreneurs who are looking to retire, we need to bring in a replacement who can manage the business to that next level. And we enable these smaller businesses to really compete. We call them small giants. They enable small companies to act with global sophistication, plug into our network, many people in our firm have worked for global 500 companies, have run businesses around the world, and so those arbitrages, if you will, or asymmetries, that we can bring to these small businesses, create a lot of value for them.

<b>Privcap: What’s your view of the current economic landscape?</b>

<b>Mullen:</b> Economic landscape is a big mess. I mean, it”s a wonderful mess. And I say that one part fairly personally distressed for the unfortunate dysfunctional political environments in America that”s evolved. But, I will say that the combination of this kind of structural overhang, lack of fiscal responsibility, tax and deficit spending where there”s a tremendous tension, and really, a consumer who”s really probably confused, and from this last election shows, it”s pretty bifurcated America and that”s an unfortunate thing.

What does that mean for entrepreneurs and business owners? That means that they need more help than ever, and I think that these entrepreneurs see opportunities in their markets, in these micro markets, where these ways, there are good growth trends, there are good substitution trends. There”s a great emergence of technology and innovation in America. There are good trends, macro trends, and micro trends to play, but they need more help doing it.

Doing– if they”re not in those more interesting areas, they”re probably not growing. They may be declining, and so we”re finding that the business environment, some part because of the fiscal and political environment, but really just the general status of the economy, that the average company is really in a low growth or a survivor mode. And it is actually a company that can out think and out execute, that we can enable those companies to do extremely well. And it is a bit more of a winner take all market.

<b>Privcap: How does the state of corporate America impact your investment opportunities?</b>

<b>Mullen:</b> So the state of America right now in corporations, large and small, it”s a fairly mixed market. Everyone knows that corporates are hoarding cash. They”re viewing this as a turbulent time and these complex markets make that appropriate. But we”re seeing them being very fickle and selective, so they are, corporates, are willing sellers, in some cases, when they”ve got a clear plan and they determine certain assets don”t fit them any longer, and they have been buyers as well, and they”ve been good buyers of business. As far as BSF, one of our businesses this spring, we”ve sold businesses to Eastman and others over the last couple years. And so we find when you build a high quality business, corporates are looking for high growth, high quality, but they”re very discriminating on the standards.

<b>Privcap: What role do international markets play in your investment strategy?</b>

<b>Mullen:</b> International is a huge part of our investment strategies, and enabling small companies to compete and win globally is a huge factor. So on one hand it”s a defensive standpoint, enabling, say US headquartered business to be the best in the world, so they are protected or more immune to international competition.

That”s one part of it, but the more exciting part to us is growth. Growth rates in certain parts of the world are stronger than the US and in some markets, double digits still, and certainly in high value added businesses. So we think that the ability to one, understand these global markets, the trends, the drivers, the competitive landscape.

Two, to understand the technologies that are applicable and can win there. And three, the experience and judgment to enable these small companies to enter markets sometimes with a wholly owned subsidiaries, sometimes with joint venture partners or distribution partners, but enabling small companies to enter these markets and do it successfully, and recognizing as well that cultural sensitivity.

And really building relationships around the world is not an overnight activity, so leveraging the networks and relationships that many people on our team have over the number of decades in these markets, in these geographies is a huge aspect. We”ve got a great team in China, and we”ve done a lot in China over the last decade

Six of our 10 companies in fund one alone had meaningful operations, joint venture partners, all majority owned in China, enabled us not just to do low cost sourcing and manufacturing, which a lot of people think about, but really access high growth in those markets.

And so that”s something we”ve continued in fund two, and in our current fund three, is enabling small businesses to access global growth, to achieve higher growth and penetration with superior products. And so we see that our ability to help small companies grow and compete globally is a major advantage for Arsenal versus most of our lower mid-market peers who just don”t have the global reach or sophistication.

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