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Private Equity

3 Types of Complexity That Will Kill a Company: A Q&A with Mangrove Equity Partners

A recurring theme in this frothy market is that picture-perfect companies are hard to find and heavily bid-up when they do come to market.  Which means, as a buyer, it’s worth thinking about which imperfections you can live with and how you want to handle them. We sat down with Glenn Oken, an MD at private equity firm Mangrove Equity Partners, to hear how they solve for “deal complexity.”

MMR: A lot of PE firms talk about having operational experience either on the team or in the network. Has Mangrove done something you view as unique?

Glenn: We were one of the earliest lower middle market firms to recruit internal operating partners. These are full-time members of the team who have half of the ownership of the firm. Historically, private equity has made a hollow promise to portfolio companies in terms of truly being able to help them grow and optimize operations. PE firms tended to be run by numbers people and deal people.

It’s another thing to have internal operating partners with multiple engineering degrees who have been serial CEO’s, COO’s & CFO’s who can roll up their sleeves to help optimize any functional area that is an impediment to growth and value creation. These are partners with a strong tool set who can come alongside an owner/operator and work through an effective strategic planning process to identify the vital few things that will have the greatest impact, and provide the business with tools and coaching to execute on those initiatives.

But of all the skills these guys have, the most important tool is cultural. They behave like good partners rather than coming across as overbearing jerks. We always start by assessing needs, focusing on small wins, and coming alongside our portfolio partners in a way that works for our management teams.

MMR: Most companies have challenges of one sort or another. Which ones are your biggest red flags?

Glenn: There are three types of complexity most likely to kill a company, or make for a bad investment: 1. customer concentration, 2. over-leverage, and 3. cyclicality. In rare instances, there can be mitigating circumstances regarding customer concentrations. There are, however, myriad other types of complexity that a fund with internal operating partners may be able to brave and rectify.

MMR: What kinds of imperfections do you take on and work through?

Glenn: A basic but common one is the lack of management depth and insufficient delegation. The reasons this occurs are many, but ultimately, this hurts a company’s ability to scale and build capacity. Our operating team helps the CEO identify and hire the right talent, delegate effectively with clear lines of individual responsibility and appropriate support and rewards.

Another shortcoming is insufficient information systems. It is very rare to find an entrepreneur or owner/operator for whom information systems are a competency and a focus. It is not something they typically enjoy. They see it as a necessary evil and thus it is under-developed. Even when they do have strong systems, these tend to be under-utilized. Without good information, it is really hard to do strategic planning, or to prioritize the vital few initiatives that will truly move the needle.

If they don’t have good systems, it is important to help them procure an appropriate solution and assist them with implementation and utilization. If they do have a system in place, we coach them on getting the most out of it. It’s actually not rare to find people who have the right tool already, but it’s underutilized.

MMR: How have you tried to solve for revenue risks such as seasonality or concentration?

Glenn: We recently exited a business that had two revenue risks: seasonality and geographic concentration. The company manufactures and rents powerful industrial heaters and they have a business model that generates great cash flow. They design and sell custom heating solutions — for example, imagine a site where the correct temperature is needed to cure concrete or for adhesives to work

We helped complete and integrate two add-on acquisitions in industrial cooling, adding a summer season to their business, mitigating their seasonality. The teams were able to cross-pollinate and sell throughout the year. These acquisitions also helped with geographic concentration, adding 16 branch offices across a broad geography. Over this period, the company’s EBITDA tripled.

While we are wary of concentration, it is not always prohibitive. For example, we invested in a manufacturer of mission-critical components for U.S. Navy vessels. The company is the sole-source provider of composite tiles that maintain a stealthy signature for submarines and surface ships. The mission cannot go away, the products are nondiscretionary to protect lives and valuable assets, and no one else can produce these products in volume. We didn’t think the upside was in reducing that focus, but rather in improving operations. One of our operating partners coached the team through a 99% reduction in scrap over a 4-month period. Together, we more than tripled the enterprise value of the company.

Customer concentration is one of the most challenging and dangerous forms of complexity, but when the demand cannot go away, and no one else can perform for the customer, an investment in a concentrated company can be opportune.

MMR: How do your operating partners help with add-ons?

Glenn: It’s not uncommon for the management teams at our portfolio companies to be familiar with great targets, but lack the capital and experience to close on add-ons and effectively integrate them. We serve as the M&A arm of our portfolio companies, and help them with due diligence, completion of the transaction, and cultural/operational integration. The operating partners have been through many integrations from the inside and can make sure that the process goes smoothly. Who better to help get the most out of add-ons than operators?

MMR: Are your operating partners actually on the ground with the company?

Glenn: First, we start by listening and figuring out the kind of assistance the management team wants and needs. We aren’t on site on a permanent basis. Rather, we are present periodically as the work requires, with frequent communication in between. We are on-site more initially as we learn about the business’ needs and as we work together through a collaborative process to find the vital few things that will be most impactful in building value. We help the team plan how to address those vital few, and provide the tools and support to see them to fruition. When we get started, it is important to have quick successes, even if small, in order to build trust. We begin by planning what should be done and who should take the lead on a project, whether one of our partners or an internal resource at the company. It should be an exciting, collaborative, inclusive process.

One of my favorite examples of a quick but important victory occurred at a manufacturing plant that had a robotics line that never worked properly. On our first visit, one of our partners asked for permission to help. He rolled up his sleeves, and fixed it on the spot within a half hour, and rejoined our tour. They thanked him but he pointed to the CEO/Founder and said, “Thank Paul, he’s the one who invited us to visit.” This sort of thing builds trust, credibility, and buy-in.

MMR: How much “complexity” is your team truly willing to take on?

Glenn: The answer is obviously “it depends” but we find, in this environment, that it is a gift to be able to do quite well with everything from squeaky clean companies to turnarounds. In the case of the latter, we are only interested when we very much like the industry and when the manufacturer or service company is in a non-commoditized sector with barriers to entry. In other words, we like companies that are well positioned competitively in good industries that have low lying fruit for improvement related to balance sheet and/or operations. We still like squeaky clean, but we can charge ahead with the right complex situations to our benefit and that of the companies and the intermediaries trying to get those deals done.

Mangrove recently created a video that highlights their approach and includes interviews of CEOs they have partnered with. You can view it on https://mangroveequity.com.

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