In this week’s episode of Not So Private Equity, we welcome Jeri Harman, Founder and Chairman of Avante Capital Partners. Jeri joins us to talk about how Avante Capital Partners was established and how they increase diversity in the industry.
The Not So Private Equity Podcast is co-hosted by Ken Kanara and Steven Haug. Steven leads this debut episode.
Steven Haug: Hey y’all, this is Steven, cohost of Not So Private Equity. We have a great discussion ahead of us today, but before we dive in I want to thank our sponsor, ECA Partners. ECA is an executive search and on-demand consulting firm specializing in low and mid-market private equity. To learn more about ECA’s services, you can reach them through their website, eca-partners.com or message me directly and I’ll point you in the right direction.
Now, I’m very excited to introduce our guest, Jeri Harman. Jeri is the Founder and Chairman of Avante Capital Partners, a woman-owned private credit and structured equity fund. They invest in established companies with three to twenty million EBITDA. Jeri, welcome to Not So Private Equity.
Jeri Harman: Thank you, Steven. I’m delighted to be here.
Steven Haug: We’re very excited to have you here. Now let’s go ahead and jump in at the beginning. I want to understand your career and how you ended up leading a private equity firm.
Jeri Harman: Sure. Well, given that I have over 35 years in the industry, I’ll try to be brief, but there’s a number of things potentially to unpack there. I actually started, believe it or not, undergrad as a dance major. That’s always a fun fact to start with. I ended up with a degree in quantitative analysis and then went on to get my MBA at Berkeley in finance. That kind of led me to a new, but still creative, path in my career. I joined Prudential Capital, which is one of the larger institutional investors in the private investing industry. A lot of people don’t know that insurance companies are big players in investing, particularly in private equity and private credit. I spent 11 years there, took on a lot of senior roles, but eventually left Prudential to move from San Francisco to the East Coast, and then back to LA. I went from doing some investment banking to joining American Capital, where I was asked to start their Los Angeles office, which meant building the team, building the market presence, and building the portfolio, which we managed out of the LA Office.
Four years later, I was recruited by another multi-billion dollar BDC, or business development company, called Allied Capital. In Allied’s case, I was responsible for the entire Western US and I also joined Allied’s Investment Committee. Between Allied and American Capital I invested over $650 million, and a couple dozen transactions, and had a great track record. But, 2009 hit, really, 2008 is when the financial markets were collapsing, as everybody may remember. Most of the publicly traded funds, including Allied and American Capital, but Allied in particular, where I was, were starting to shut down offices and have a reduction of forces and so forth.
I actually left a little bit before then, anticipating some of this and this was really one of those forks in the road we all face. I could either go join another firm where I felt that wasn’t happening, or start my own firm. A lot of people encouraged me at the time to start my own fund. It wasn’t something I had started out my career thinking I was going to do. I didn’t have that entrepreneurial spirit that many have from day one. I enjoyed working for large institutions and did well there, but it wasn’t really interesting to me to be able to control my own destiny. Since I had a good track record of people who were willing to join me and invest in the fund, we launched Avante Capital Partners. I put the team together, we embarked on our fundraising in 2009. Which was a crazy time to raise a fund, as you could imagine. What doesn’t kill you makes you stronger, which is clearly the case here. But thankfully we were successful. We raised a $218 million fund, went on to raise another $250 million fund in 2015, and we just finished raising a $450 million fund last year. That’s how Avante came to be. I’ll talk more about what we do in a little bit, but the other thing, just in terms of my journey is, along the way, I’ve been on over 20 boards, many of them from my portfolio companies, but also, a few years back, I joined a public board, not related to my investment activity at Avante and then actually, eventually became Chair of that public company board. I’ve been very involved in the board world, as well, and straddling both.
Steven Haug: I’m excited to learn more about the board world. I think a lot of our audience is curious about that as well because it’s a great and interesting way to spend the later part of someone’s career and leverage all their experience to help companies grow and provide advice there. Before we jump into that, I want to hear more about Avante. Of course, it’s a well- established firm at this point. You’ve been through lots of market changes. Can you tell us how Avante fits within the broader investment landscape or private equity landscape, and perhaps how it’s changed throughout the years or how you’ve pivoted given different market conditions?
Jeri Harman: Sure. Let me talk about the landscape first and then get more into detail about what Avante does and how we fit in there, because it will make more sense–I’m assuming the audience is not as conversant in our industry as perhaps some other audiences. If you look at the private equity landscape, there are really different stages and types of private equity investing. It really starts with what’s probably the most commonly known, which is the venture capital side of it, but even venture capital has different types. You have seed or startup stage, then you have early stage, late stage. There’s a maturity level there or a spectrum, that even within venture capital, you have to be thoughtful about. The next type of private equity is, as I characterize it, as growth. These are established companies, but they’re in their high-growth stage. They may or may not be profitable, but they have clearly proven their business model from a product or service point of view of starting to achieve scale and so forth. Then we move into the buyout side. These are more mature companies that are now going to go through a change in control. By the way, growth is usually minority investing, not control. Now we move into control investing, or buyouts, where you have hundreds and hundreds of private equity funds that are focused on making these acquisitions of companies for control, and that’s what I call a more mature part of the business. Then, the final category I would mention is distressed. Even within buyouts, you can be looking at healthy growing companies, but then you also have a whole different world of companies that are not performing well or who are in distress situations or turnarounds. That’s a whole category of investing by itself.
The other way to look at the private equity landscape is also size. You have the different stages or types of investing, but then you also have the size. There are those who focus on, what I call, small cap or lower-middle market, which are the smaller end, typically less than 20 million of EBITDA, usually less than a couple 100 million of revenues, to get a sense of size.
Then you’re looking at middle market, which is the next size category, and definitions vary, by the way, these are just my approximations to give people a sense. In the middle market you’re looking at typically about 20 million, but probably below 75, maybe below 50 million of EBITDA. Then, finally, you have large cap, which would obviously be above all that. Again, the cut offs can vary but you get a sense of that. You have the big guys who do the Carlyles, and the KKRs, etc., of the world focused on these large cap. You have lots of middle market funds and you have some that focus on these smaller, lower-middle market, some 20 million of EBITDA companies.
So where do we fit in? Avante is lower-middle market. That lower end for us is three to twenty million of EBITDA, 20 to 150 million of revenues, healthy companies that are not distressed. Smaller or lower-middle markets are already risky enough without adding the distressed side of it. We are also focused on the bio side. So we’re not in venture, we’re not in growth per se, we’re not distressed as I mentioned. We’re really focused on the buyout, or what we call sponsor-driven. What that means, and we’re really, as you mentioned earlier, a private credit and structured equity fund, so that means we focus on debt and equity investing in the lower-middle market, in sponsored transactions. What does that mean? That means we partner with these private equity buyout funds to finance their deals. We’re providing term debt, we’re providing subordinated or mezzanine debt, but we’re also co-investing in the equity alongside of them. That’s where the equity part comes in. Probably about 80-plus percent, 80-85 percent of our investments are in these debt securities, financing these buyouts, in the balance of call it ten to twenty percent, then, equity co-investments alongside these private equity shops.
I should mention that another distinction sometimes in our world is sponsored versus non- sponsored. The sponsors partner with the private equity. If we were doing non-sponsored, which we plan to do in the future, by the way, we would be investing directly in companies in non-changing control deals providing any unseen, providing equity growth capital, or what have you. It just would not be a change of control transaction. We’re based in Los Angeles, but we focus across the U.S., so our portfolio is really pretty widely spread across the U.S. We are generalists, not all funds are, some are very focused on a specific sector. We happen to be generalists, which many private credit funds are. We do a lot in healthcare, business services, light industrial, consumer, tech-enabled software, and for-profit education. We stay away from real estate. That’s a really different world in the alternative space. We stay away from turnarounds, stay away from commodity businesses, those kinds of things. We have 20 team members. We are, as you mentioned, 100% women and minority-owned, which is very important to us, and 80% of our team are women, minorities or both. The final thing I’ll say about Avante, to understand kind of who we are really, and how we approach our market, is that our purpose, clearly, is to generate strong returns for our investors, which thankfully we do and have, because that enables us to pursue what is really our passion, which is to increase diversity in our industry and thereby increase access to capital for underserved markets and underserved groups.
Steven Haug: I appreciate that Jeri. That was a very concise overview of private equity. I’ll probably steal those distinctions as I talk to folks too, and they ask question about private equity. I’m curious about the emphasis on diversity and if that’s been a part of Avante since its beginning, or that has evolved along with the firm?
Jeri Harman: I would say that we’ve always been highly inclusive, which led to a real focus on a more intentional basis on diversity, as we recognized the value of diversity, not only just in our attitude about hiring, right, but really in how we do business. Diversity has become a really big strategic imperative for us, and advantage. It’s helped us to recruit and retain the best talent, and our funnel is wider because we are focused on diversity, right? Everybody who has the requisite skill set (is included). We don’t fish always in the same ponds. We find some great people and maybe have to train them a little bit differently because their backgrounds may not be the same as your typical past in private equity. But we’ve built just a fantastic team that’s one of the most diverse in the industry.
It’s also been really important, even in fundraising, limited partners or investors are investing in funds that are really focused on diversity. Why? Because it produces better results. Diverse teams, diverse boards, diverse management have better results. That’s been proven through a number of studies. You get better decision-making with diverse backgrounds and experiences, and so forth. So we think better decision making, I think more openness to different ideas, right? When we go to the investment committee, everybody has input, right? Everybody’s respected and heard. How we conduct our business, how we make decisions, at the Investment Committee level is informed by diversity. It also has really impacted how we find and win our business. We try to add value to our sponsors, the private equity people we partner with so that we can find our deals, but win them without over-levering or underpricing. We do that by trying to add value and we do that in a number of ways that are not diversity related, but on the diversity front, we have helped put together a SBIC-diverse intern scholar program, which is an undergrad program for women and people of color. We put the whole program together, we help place people across, last year over 30 funds across the country, and then we put the training program together and the speaker program, the whole cohort. We had speakers, every couple days a week, model training etc., but really allowing and helping these private equity funds, these SBIC’s, to access this diverse talent at the beginning. It’s the supply issue, right? That’s always the complaint, supply. We’re helping on supply end, and we’re helping, not only find them, but open our world up to them to make sure that they look at private equity and private credit as a career path, and show that they’re welcome and provide the confidence and nurturing that’s important, as well.
One of the more interesting and board-related things we’ve done recently on the diversity front, which may be of interest, is we started something called the Women’s Operating Network or won, W-O-N, and that’s a database for building board-qualified, board-ready women, who may or may not have been on a board before, many have, but if they haven’t, that’s okay, as long as they have the requisite skill set and experience to be on a board: C-level experience, functional expertise, sector expertise. The purpose of that is twofold. One, to help these women access private equity-owned company boards, but also to help, again, the value add to the private equity side, to help them access talent, but particularly, diverse talent at the board level, and potentially operating talent, too, if they’re looking for a CEO or something, at the portfolio company level. It’s more board focused, but it could be operating as well, being able to help on those fronts.
We’ve helped mentor women who are launching their own funds. All these things are helping increase diversity in the private equity world, helping us strategically to form these value added relationships, as well as the culture aspects of diversity within our firm, which we feel allows us to attract and retain the best talent. That’s a long-winded way, maybe, of answering your question on diversity, but it’s something we’re very passionate about because, at the end of the day, it produces results. We’ve been top quartile or top decile returns, across our first two funds, and hopefully on the way with that for our third fund.
Steven Haug: That’s incredible, Jeri. I want hear more about WON, Woman’s Operating Network, but before we chat about that, and the board details in depth, I want to chat about a couple of things. Avante adds a lot of value to the private equity firms, right? I certainly understand the supply issue that you talked about. Private equity firms, of course, run into that because they are looking for folks who are from these top-tier investment banks, and how do you get to the top tier investment bank? You would go to an Ivy League school and the diversity issue happens much lower in that funnel, so by the time they come up and the resume looks like a private equity resume, the diversity at that point, in that group of people, is quite low, so it takes a lot of effort to find folks outside of that normal pipeline there that can add value to the private equity firms. You’re adding value to the private equity firms, you’re adding social value as well, opening up capital to other groups of people that don’t generally know how to go about finding it, or it just hasn’t been historically provided to them, that seems to butt against the stigma that we hear often about private equity. Can you tell us a little bit more about that, as the general stigmas around private equity are that they come and cut jobs and generally reduce the value of a company in certain ways, and harm employment, and whether or not you think that’s true for the broader private equity community, and that you stand alone in the value that you bring to the table, or if that stigma is a bit misguided or perhaps outdated.
Jeri Harman: Yes, that’s a great question. Just to back up one second though, on the value add, as mentioned, the diversity value add, we do other value adds as well. We help them with diligence, with the firms we work with, we help them access customers. We’ve actually brought in customers for some of our portfolio companies. We help bring in other executives, not diversity related, and board members, and so forth. There are a variety of ways we add value, so to speak, to our private equity partners that hopefully differentiate us, but beauty is in the eye of the beholder. Just to be clear that the differentiation vis-à-vis, diversity, which is also a value add, but there’s other aspects, too, to value add.
In terms of private equity stigma, that’s been around for a long time, as you intimated. I would say that it’s probably used to be more true than it is today. I’m not saying it was totally true even historically, that I think a lot of it is exaggeration, or misrepresentation, or misperception, particularly, politically, right? “Let’s go after the people who appear to be making a lot of money,” or those kinds of things, and not looking at what how they’re doing it. I would say it’s a stigma that still exists, but less so. There always are bad players, or bad behaviors, in every industry, right? Whether it be industry, sector, political, nonprofit, profit, there are bad players. There are clearly going to be some bad players, right? People who don’t behave the way we’d all like them to behave in the private equity industry, but by and large, the private equity industry are not bad players. They are trying to create value in the companies they invest in. They’re trying to make money for their investors, which by the way, a lot of the investors in private equity are pension funds, so providing high returns for these pension funds, which is a real service and benefit. Everyone who’s subject to a public pension fund, unions and all sorts of other constituencies, and they typically are doing that by growing these companies, actually increasing employment, making them more stable, making them more sustainable, investing in their growth, whether it be CapEx, or new markets, or new locations or what have you. It’s about value creation at the end of the day. Now, sometimes they get in and see that, to get to the end result, you have to reorganize the company. It’s not usually the case, but that can be the case for companies that been underperforming or that may have a cost structure that’s not sustainable, then yes, they have to cut people or cut costs. They have to redirect the strategy, but they’re not doing it to drive it out of business, because they don’t make money. So at the end of the day, yes, they’re looking to make money, they meaning private equity, but they’re typically doing it in a way that’s good for society and good for the businesses, even if there’s some short term pain, occasionally, not always. That’s how I think of private equity.
Now, again, it has been vilified. Private equity has done a horrible job in PR, which has really allowed these misperceptions to take place. Then, the other thing is, the public and the politicians think about private equity through the eyes of the big, large cap private equity buyout shops by and large, and hedge funds. That’s a different world. I’m not saying that world doesn’t also do good things, but that’s just different. Yes, those guys make a lot of money, right, in terms of their own personal wealth, and there’s a lot going on there. But a lot of the private equity world, these middle markets, lower-middle market funds like ours, that I referred to earlier, in terms of different categories, are working with smaller businesses and really helping them to grow and to become stronger and truly create jobs. The SBIC program, the Small Business Investment Company Program, which is a public-private partnership with the SBA, with the government, where you get licensed–and all our funds are SBIC’s, by the way, it’s been around for 50 years. It’s a program where you get licensed by the SBA, and they provide low-cost leverage to help us invest. So if we raise 100 million of private LP or limited partner capital, we get maybe 175 million of low-cost debts, the maximum is 175 per fund, that’s long term, and now we’re investing 275 million if you add those two up. All that money goes to these smaller businesses, smaller meaning three to twenty million EBITDAS as I mentioned earlier, and if you look at the results of the overall program across all the funds, I think there are over 200 SBIC’s in the program at any given time, and it’s had enormous job creation results, and that’s the government’s data. It’s just an example of what’s not always seen, is what’s happening in the smaller end of market where small businesses really drive the economy and there is a lot of private equity going into these smaller, lower-middle market businesses and programs like the SBIC program, but also other programs. That’s my response to the stigma. It is there, we’re not good at addressing it as an industry as a whole, but it really is less and it’s definitely, in my mind, a misperception of what private equity is and can be. There are always going to be bad PR stories. Some private equity fund went in and did the wrong thing, or it didn’t work out as planned, that happens.
Steven Haug: Of course. As you mentioned, the lower-middle market sector, which you operate in and, of course, here at ECA, most of our clients are the private firms and those portfolio companies, and I’ve found that almost every time when you dive into the stories of those portfolio companies that the private equity firms are involved with, it’s not uncommon that the story is that a company was built by someone and they want to retire, but the only way to do that is to sell the company off, so this is an opportunity for them to leave it in good hands so that their employees can continue to have a job and flourish, because the other option is to retire and shut down the business, right?
Jeri Harman: Yes.
Steven Haug: So I think that you’re right.
Jeri Harman: I think that brings up a good point. There are really two reasons that someone sells to a private equity fund. One, as you said, they’re retiring, they need to have an exit for themselves and they want it to go into the hands of someone that will keep the employees, hopefully grow the company, etc. The other is that the owners are not looking to exit yet and they want to continue to be involved in running the business, but they realize they need help, and capital, to take the company to the next level. That’s not uncommon at all. You actually will have the entrepreneur or the family owner stay in the business for some period of time, at least, maybe in a different role, maybe not, to sell this control to bring in this capital to help, to give him some liquidity, of course, they’re going to take some chips off the table, but that’s a fairly common scenario.
Steven Haug: Yes, that’s a good point. I’ve seen it happen before where you’ll have someone who’s a brilliant scientist, with a Ph.D. in computer engineering. They build a great product, build an incredible business, and at some point it’s helpful to have someone come in who know show to scale businesses effectively, and give them a piece of the business, and everyone really does benefit in those scenarios. Let’s hear more about the board side of your business. Can you tell us why companies have boards?
Jeri Harman: Boards are really for governance, to make sure that the shareholders are represented, that their interests are represented. As you know, there are different kinds. It’s really important to understand the different boards. Boards do share responsibilities, that’s actually a legal term, which I’m not a lawyer, so I’m not going to get too much into defining that, but basically it’s looking out for the best interest of the shareholders. If the company is insolvent, that also could be looking out for the best interest of the lenders. At that point, that’s, effectively, whose interests are most important. To understand the different types of boards you’re talking about, everyone understands public boards. Publicly traded companies, they have a board that is very structured and very defined in terms of what has to be done, how they’re supposed to do it, what are the requirements and responsibilities, and we can talk more about what that looks like.
Then you’re talking about private boards. The private boards I categorize in two buckets, one are private equity owned boards, which we were alluding to earlier. These are companies that are owned more than 50% by the private equity firms and they have put a board together, but their boards look very different than a public board. The roles and responsibilities can look really different too, and I’m happy to compare and contrast that in a minute. The other type of private board is a normal family office or entrepreneurially-owned company, a non-public company. It’s not owned by a private equity firm. That could be a business that has been in the family for years, and they have boards because they’re required to have a board, legally. You have to have it for legal, corporation, and other reasons, but how they operate may be very informal, and may not really be anywhere close to what a public board or a private equity board might look like. Or, if it’s a larger private company, operate very much almost like a public company board. It really does vary and we can talk more about that. There are also nonprofit boards, SPAC boards, advisory boards, board observer roles, where you don’t actually have a voting board seat, but you have an observer role which is kind of advisory or monitoring in some cases. Then the final category of boards, I would say are government agency or commission type boards, which is a whole different world which I am not equipped to get into but that’s just to round out the description.
Steven Haug: Is there a specific space where one plays among all those different types of boards and board roles?
Jeri Harman: It’s important for people, if they’re looking at boards and looking at going on the board, to really understand the differences between these different boards. The commonality is you have a responsibility. Once you’re on a board you have a legal responsibility and you need to understand what that looks like. That’s the fiduciary responsibility I mentioned, which typically means to represent the shareholders. Whether the board really controls, whether the board is truly independent versus not independent makes a huge difference. In a private equity-owned board, the private equity fund controls the board. They may bring on one or two independent board members or much larger companies, maybe more, but at the end of the day, the private equity firm controls the decisions, controls the board, they’re the control owner.
Your role on a private equity-owned company board is different. They’re bringing independent board members on to help in the value creation process. They might be looking for somebody that has market channel experience in a particular market channel they’re looking to penetrate, maybe someone who has sector expertise in the sectors they’re in or want to get in, maybe somebody who has great manufacturing operational expertise that can be a value add, again, to the company and their value creation. It really depends on what their strategy is and where they can bring in outside expertise onto the board to help in that. It could just be somebody to mentor the CEO, someone who’s been the CEO or is one and comes in to mentor. Those are the kinds of people they bring in. Their role is fairly finite and narrow, in terms of what the expectation might be. It always involves strategy and input on strategy, but beyond that, it’s kind of where does their expertise apply. What is the private equity fund looking for from them as a board member? It may be just their Rolodex too, for customers and things like that.
In a public board, you’re looking at a very structured board where you have committees. You have the governance committee, you have compensation committee, you have a chairman, maybe the CEO, it might be an independent, non-executive chairman like I am on my public company, but the focus, the board members in total, primarily is on leadership in the CEO. The main responsibility for representing shareholders, the main lever they have, is to hire or fire the CEO if they’re not doing the right thing. The saying is, for board members in public companies, “Nose in, fingers out.” You’re not operating the business. You’re not getting down into the real operational aspects in terms of hands on. You might be in the private equity-owned board or a private board, but in the public board you’re not. So you’re really focused on strategy, governance, is there proper governance and oversight, reporting, compliance and risk. There’s other foci, ESG and other things, but those are the primary areas, cybersecurity and things like that, that public boards are focused on. More formality, more risk because there’s more liability for public board members, but that’s how I think about public versus a private equity-owned board.
If you look at non-private equity-owned boards, they usually hugely varied in terms of the dynamics. If it’s a family-owned company that’s been in the family for years and you’re coming in as the one independent board member, you may be more of a therapist than you are anything else, because you might be dealing with family dynamics, different roles, and conflicts, or a very strong entrepreneur that has an iron fist on everything and you may give advice but it may or may not be taken. You have to understand what you’re walking into in a non-private equity-owned board, what their expectations are, what your role is and what influence you really can have.
The other difference I think a non-private equity-owned, private board is that they are more open to financial, accounting, and legal talent, as well as the functional sector talent I mentioned in the other regard. Both public and non-PE-owned boards really do value financial, legal and accounting talent, as well as sector and operational expertise and experience. The reason private equity doesn’t is they have the financial expertise they’re bringing themselves, and they hire the accounting and the legal, so they don’t typically look to bring that kind of knowledge or expertise on to the board. That’s just another thing, a nuance there. I could go on and on, which I won’t, but there are other differences between public, private, and private equity and non-private equity-owned private boards, but those are some of the things to think about.
Steven Haug: Does the Women’s Operating Network work mostly with private equity-backed companies to fill positions on their boards?
Jeri Harman: Yes, that’s the purpose, to help them access private equity board opportunities that particularly, in the lower-middle market where we play, which is much more opaque, it’s harder to find and access those. It’s also to help the private equity funds in the lower end of the market to access talent and particularly, the women, the diverse talent, because again, they maybe don’t have the same networks that the big guys have in doing so.
Steven Haug: If someone’s listening to this and they’d like to be a board member at some point, how should they go about getting in touch with the Women’s Operating network and what should they think about in terms of their background, to evaluate whether or not they would be an effective board member, or whether or not they are someone who should reach out to you?
Jeri Harman: Let me give you a little bit of what we look for to go into the Women’s Operating Network. We look for women who have strong C-level experience, typically. That could be CMO, CEO, CIO, etc., Chief People Officer, what have you, but somebody who’s had good C-level or divisional P&L responsibility. They’re a senior executive and they’ve had enough industry experience. Sector expertise is a big thing, too, in any of the sectors I mentioned earlier: business services, healthcare, product service, consumer, manufacturing etc., tech-enabled, and then functional expertise. It could be that somebody’s really strong in marketing, really strong in IT, really strong in operational aspects, international, etc. They have to bring some combination of those things to the table. They don’t have to have been on a board before, although it’s nice, it’s not a requirement, but they have to be ready to be on a board. Ideally, they’ve reported to a board to at least understand that dynamic, but again, it’s not required, but it’s helpful in terms of accessing us. They can certainly e-mail me their information at [email protected] , or of course, contact you, Steven, and you know how to get to me.
Steven Haug: Yes, of course. We are always happy to make those introductions and facilitate those conversations. Jeri, there’s lots of hesitation in the market these days, early 2023. Can you tell us about trends that you’re recognizing?
Jeri Harman: Sure. In the private equity world and things?
Steven Haug: Yes, private equity, yes.
Jeri Harman: To start with, if you’re going to look at private equity, for a long time now there’s been this equity overhang. There have been billions and billions of dollars of private equity funds raised, all of which are looking for companies to invest in, maybe in any one of the ends of the markets we talked about earlier but there are a lot of capital chasing deals. That’s driven valuations up and that’s a struggle because if you have to pay more for the company, it’s harder to achieve the return you want when you have to exit, and hopefully you’re exiting at a higher valuation than you bought it at. Certainly, if you’ve improved the operations or increased the EBITDA and the revenues, then even it’s the same multiple, hopefully you’ve increased value and you’ve done well. Nevertheless, valuation continues to be a problem, even in the market right now, and I’ll mention why it’s more difficult, valuation is still high for the good companies. What’s happening now, when you have a difficult economic environment and a lot of headwinds in different areas, is that the market becomes more selective. Those marginal deals, more difficult deals are harder to get done. Those companies don’t sell, or they certainly don’t sell anywhere near the kind of valuation they would like, so they tend to go off the market. Those good companies, the growing, solid companies, that’s what everyone’s chasing. You have a lot of dollars chasing those deals and that keeps those valuations up.
I will say though, that right now, it feels like valuations are moderating. They’re not continuing to increase right now. In some cases they come down a little bit, which is good, but they’re coming down from pretty big multiples. The other big thing that’s happening right now is debt availability. A lot of banks have retreated because of the economic environment, uncertainties, and headwinds, and so you’ve got fewer players on the debt side, at least the more traditional, commercial banks playing. There are lots of alternative credit funds like ours that are playing, but everybody’s pulled back a bit because there’s more risk. You have to be more thoughtful about it. Debt availability to finance these buyouts in the private equity world is becoming more difficult and it’s more costly because rates have gone up. Now cost more and the amount of debt you can get to leverage your transactions, to support your purchase price, support your valuation, is less, so that if you can’t get more debt, you returns are going to be lower by definition, because you’re not getting the benefit of leverage, and then the interest costs are going up which is impacting availability.
I mentioned all this more difficult environment, it’s no news to anybody listening. You’re talking about inflation, labor issues, supply chain issues, recession, and then for the companies that already have the leverage on their balance sheets, if they have a lot of floating rate leverage, now you’ve got interest rates going up significantly, so their margin for error, their debt service coverage are much lower and more scary. That’s what I meant by headwinds.
I think the other thing to recognize that’s happened in the private equity world, it used to be a lot about financial engineering. You go and buy in a company, you buy low, sell high and you use leverage. Now, the focus, both from the investors into the funds, what they look for, what kind of the funds they’d like to invest in, and the funds themselves, have recognized that it’s really value creation and operational excellence that’s going to create value and financial engineering is not the main tool. It’s a different mindset.
The final comment I’d make on what’s happening in the private equity world is there is an increased focus on diversity. I think it’s a lot more talk than action, but there’s more action than there used to be. It’s going in a good direction, but we have a long way to go on diversity. It is a huge topic, both limited partners, as well as the funds themselves, and many of our really trying, genuinely and authentically to embrace diversity and do what they need to do to adopt it and to implement it, because at the end of the day, the firm is only as good as the talent they can recruit and retain. That’s what it comes down to and that’s the big challenge for the industry: recruiting and retaining top talent, especially diverse talent. Those are the things I would say are happening that people might want to be aware of in the private equity industry.
Steven Haug: I appreciate that Jeri, and I know that Avante, regardless of the headwinds, has found ways to succeed, regardless of the market. I’m always excited to keep an eye on the portfolios. I know that you’ve had quite a few big wins there throughout the history of the firm. Thanks so much for joining us on Not So Private Equity, I really do always enjoy our conversations.
Jeri Harman: Thank you, Steven, for having me. It was a delight to talk with you.