Private investment firm VSS raised its first private equity fund in 1987 to invest in media businesses. The firm has since pivoted to focus on flexible structured capital solutions for tech-enabled lower mid-market companies in the healthcare, education, and business services and information industries, and has completed 80 different platform investments which, in turn, have made 350 add-on acquisitions.
We talked to Managing Partner Jeffrey Stevenson about the firm’s strategy and how they’re responding to the current market climate.
VSS provides “creative capital solutions” to lower middle market businesses. What do you mean by this?
Most of the private equity landscape is broken down into buyout funds or debt providers to those buyout funds, which are involved in change of control transitions where a company is selling 100% or close to 100% of its equity. There’s another whole world out there of businesses that don’t necessarily want to sell control, but still need capital for their growth. Often times, they are still owned and managed by the founder/entrepreneur. That’s the market we’re addressing where we can provide capital in the form of debt and equity, typically by taking a minority non-control position.
This represents an underserved end of the market, particularly for lower middle market companies that don’t have the same access to public markets as larger businesses do to larger pools of debt capital. From our standpoint, this is beneficial because we are able to structure these deals with a combination of debt and equity, with the debt providing a level of current income and protection on the downside, and the equity providing the upside.
How has your approach to deal origination changed over the years?
Since our first fund launched 32 years ago, the industry has significantly changed. Probably the biggest change is that the term “proprietary” is not as meaningful today as it was back then. We source deals much like a buyout fund — we’re calling on companies directly, we attend numerous industry conferences, and we access our wide network of over 300 boutique investment banks. The intermediary market has also gotten much more fragmented over the past several years. There are hundreds of intermediaries today compared to just a fraction of that number when we started out. So, it’s become increasingly important to cast a wide net to find those banks that are focused on our particular industries and develop good relationships.
How are you preparing for a potential downturn?
We think having less leverage in the capital structure, and particularly less leverage in front of us, is in general a good point of focus in anticipation of the next downturn. Both good and bad companies can get into trouble in a downturn, but the precipitating factor often is carrying too much leverage.
Of course, nothing is recession-proof but the industries in which VSS invests are relatively recession-resistant by decision. When you think about healthcare, people need it regardless of the economic cycle. The same is true for education. And, in the case of business services most of those companies are providing a service enabled by technology at a lower cost than the alternative.
Do you have any advice for business owners thinking about a potential recession?
First, it would again be to not take on too much leverage, i.e., add leverage over time instead of all up front. You can finance add-on acquisitions that are accretive with debt capacity that’s created by having less leverage up front, and use it for financing those add-ons acquisitions further along in the investment’s holding period.
Another focus can be beefing up their finance department. Oftentimes, we find companies in the lower middle market have under-invested in this regard. That means, they may not have the best information available to help them manage their business in challenging times.