Founders Advantage Capital Offers Liquidity Without Boredom
This era of high multiples and easy capital makes for an interesting capital dance for longtime operators who want a bit of the action but don’t want to sell the farm. It’s kind of like a high school dance with a whole lot of girls on one end of the gym and a whole lot of boys on the other end.
That puts Founders Advantage Capital in the middle, spiking the punch and getting reluctant sellers into the mix.
The unique Canadian firm specializes in partner buy-outs, partial liquidity events and monetizing ownership in growth-minded companies. Essentially, the firm buys a majority share in a business, becoming long-term partners for the investee company. But unlike a typical equity partnership, the business remains largely intact.
“We designed ourselves to deal with companies that are not for sale,” said president and CEO Stephen Reid. “We’re willing to give them a meaningful industry multiple monetization, and a disproportionate share of their upside because we think talent is important. And then we leave them to run their business long-term.”
Harpreet Padda, SVP and co-head of investments at Founders, said it’s a wildly different path than traditional private equity.
“We’re passive equity, we do everything opposite than private equity. We don’t want to own the business, we don’t retire the talent,” said Padda. “Our model is to put permanent capital inside their company just so they can get some chips off the table or get rid of some investors who are bugging them to sell.”
To make both sides of the transaction happy, Founders Advantage Capital buys a chunk of the business as it stands, but gives the lion's share of any growth to the operator. Padda said in the first two transactions, they bought 60% of the common shares, allowing for a meaningful liquidity event for the operator, and an additional carrot for any future growth.
“In all those cases we drew a line of up until today, where we’re 60-40 partners, but all go-forward gain is going to be 30-70,” said Padda, who admitted 70% of the upside for the operator is unusual, but necessary. “Maybe we’re not making enough money, but it’s a safer bet to keep them tuned in—that’s the essence of our model.”
Reid said bankers are quick to call them crazy, but pushing out strong leaders is pretty crazy, too.
“Some people look at this and say, ‘You guys are nuts, you’re giving away too much,’” said Reid. “We don’t see it that way, there’s a lot of money out there, but not a lot of talent out there. We think talent wins and money is second.”
A lower cost of capital also allows the firm to avoid the typical heavy handedness of private equity. That means they don’t have to push for efficiency, cut corners or slash overhead to keep the money flowing. Since they borrow only on a long-term basis and are otherwise bankrolled by shareholders, they don't need to be too aggressive.
“It’s not a hurdle rate of 20% if we were a PE firm, so we don’t need to go in and gouge these guys to create all kinds of money,” said Reid.
Reid said a change in how people live their lives has empowered their model as seasoned leaders work well into their later years, and everyone is connected via technology.
“There's a lot of social reasons this works, there’s technology where you can keep in touch with the business and not have to be there every day. And 50 is the new 40, 60 is the new 50—the idea that only grinders work after 55 is all gone. The new way is just make yourself happy,” said Reid.
A hypothetical situation is that a leader would go from president to chairman of a board on which Founders Advantage Capital has presence, and enjoy the newfound liquidity with a little travel or some golf. But instead of getting bored in Palm Springs, that leader will still oversee the business.
Reid said the all-important multiple won’t be embarrassing either. In fact, he says, leaders who keep growing stand to have an even better multiple to brag about. In a recent acquisition, bidders valued a Canadian company at 8x forward earnings. But once the CFO ran the numbers against the growth projections given the 70% upside on growth, the offer came in at 15x—not a bad number to bring to the golf course.
“It’s the trophy of you got the most money from someone. In our case, lots of it’s up front, but a lot of it is later too, and later is OK for guys who weren’t going to leave anyway,” said Reid. “So mathematically the model also pats the entrepreneur on the back and says, ‘You worked hard, you built a company, you risked everything, you missed some soccer games but guess what? This is also the biggest cash win for you.”
So what’s the catch? They’re extremely selective in their search for the three to four U.S. franchise operator deals they seek each year. They like the stability of mature systems; they like good financials and they require an extremely strong culture and they like EBITDA between $5 million and $40 million. The target investment size is $20 million to $200 million.
“If we have an Achilles' heel it's that we’re picky, we like well-managed companies. We only look for companies that have great looking financials, but when we meet the people there has to be a culture there. We hang our hats on that,” said Reid. “Since we’re not flippers, the reality is that we need to see the intellect, capacity and drive to be a very competitive interesting company, will they innovate, do they know how to market, are they using IT to their advantage. Then we have to look at where the company will be 10 years from now.”
He said anyone operating on that small target stands to enjoy the multiples, without exiting completely.
“We’re for the guy that’s in between who knows he should do something because multiples are ridiculous, but will only do it under the right situation,” said Reid.