Middle Market Growth - March/April 2018

MAR/APR 2018

// THE OFFICIAL PUBLICATION OF ACG

The Future Is Knotel’s revolutionary approach to office space

Flexible

we do a great deal

Resources are one thing, resourcefulness is our thing. With one simple point of contact, you have access to a breadth of services and numerous advantages at any stage of the fund or deal lifecycle.

DHG provides a one-stop solution for private equity groups, portfolio companies and companies that may be acquired or sold. We integrate our national industry sectors to bring experience, insight and tangible value to the middle market and private capital industry as a whole.

Assurance | Tax | Advisory | 855.357.5225 | dhgllp.com/private_equity

EXECUTIVE SUMMARY

A Victory Worth Celebrating

T

PAT MORRIS Chairman & CEO, ACG Global

he headwinds facing midsize businesses are diminishing.

I joined ACG Global in December, shortly before the passage of one of the largest tax overhauls in U.S. history.

While continued debate ensues about the long-term impact of this broad-sweeping legislation, one thing is certain—ACG remains diligent in its efforts to safeguard and improve important provisions of the tax code. Due to work by our lobbying arm in Washington, D.C., and partners such as the Businesses United for Interest and Loan Deductibility (BUILD) Coalition, as well as the voices of a host of ACG members, provisions such as interest deductibility were maintained, while important changes such as lower tax rates for passthrough businesses were achieved.

I spent my first few months as CEO attending ACG events, such as last year’s successful EuroGrowth conference in London, and visiting chapters to become more familiar with the issues relevant to midsize companies and their investors.

I look forward to meeting many more of you at InterGrowth 2018 at the San Diego Marriott Marquis & Marina on May 2-4. ACG expects record attendance of more than 2,000 middle-market professionals for this invaluable event featuring networking, deal flow and education.

Highlights include a keynote address from former longtime GE Chairman and CEO Jeffrey Immelt; panel sessions on trending topics, such as the workforce talent gap and investment in disruptive innovation (cryptocurrency, anyone?); updates from ACG’s public policy advisers; and the second annual women’s networking event.

Attendees can enjoy golf, tennis, yoga and spin classes, as well as San Diego’s renowned restaurant and cultural scene.

If you’re interested in cross-border M&A (and reports show that North American investors increasingly are), consider attending EuroGrowth 2018 at the Hilton Amsterdam on June 19-20. Despite potential impediments such as Brexit, deal flow in Europe showed significant strength in 2017. With excess private equity dry powder and strong corporate earnings resulting in more deployable cash on balance sheets, it’s unlikely that interest in European deals will wane anytime soon.

As the middle-market economy continues to fire on all cylinders, you’ll find more trends worth exploring in this issue of Middle Market Growth. We invite your feedback and ideas on what you’d like the MMG staff to cover. Happy reading.

MIDDLE MARKET GROWTH // MAR/APR 2018

1

FROM THE EDITOR

Start Thinking Like a Millennial

W

DEBORAH L. COHEN Editor-in-Chief, Middle Market Growth

2

middlemarketgrowth.org

e could all learn a few lessons from the millennial cohort.

One of the signature traits of the 20- to 36-year-old set is flexibility—their willingness to embrace change and to work, move and pursue career and life goals with a nimble mindset.

This generation values mobility and is largely averse to taking on mortgages, opting to rent instead.

Millennials have propelled co-working spaces into the mainstream, popularizing shared offices and short-term workspace rentals. New York-based Knotel, which writer S.A. Swanson profiles in this issue’s cover story, “The Future is Flexible,” has brought the trend to businesses, cashing in on the ethos of flexibility by offering growing companies personalized full-service workspaces without long-term leasing commitments. Surprisingly, the bulk of Knotel’s growing customer base is not made up of tech startups but rather companies involved in finance, media, retail and other non-tech sectors, including many midsize firms.

Freedom from the operational worries associated with designing and managing their offices gives these growing businesses the ability to focus more on strategic pursuits.

Flexibility is a dominant theme throughout the real estate sector, as we see more condos converted into rental properties, and as lesscostly midsize cities like Austin and Cleveland gain popularity with those seeking more affordable lifestyles. (See A Qualified Opinion with RSM’s Richard Edelheit.)

We see flexibility being applied to struggling mall spaces, as investors transform what were once primarily shopping destinations into lifestyle centers, enabling their occupants to better compete with the never-ending onslaught of e-commerce. Some malls are even incorporating residential space, as this month’s trend story about mall transformation illustrates. With the deep discounts that distressed mall properties offer, it appears that cautious private equity investors with creative solutions are developing some winning formulas.

Real estate is one of the sectors best positioned to take advantage of changes under recent tax reform and will be an interesting one to watch as the new rules take effect.

In the meantime, we hope you enjoy this issue of Middle Market Growth. We look forward to your feedback and ideas as we boost our frequency in 2018 to six print issues. //

GROW WITH US. MIDDLE MARKET GROWTH EXPANDS TO SIX ISSUES PER YEAR!

• Reach 90,000 M&A professionals • Lock in your spot for the July/August aging population issue • Hurry – The deadline is May 2 LEARN HOW. MIDDLEMARKETGROWTH.ORG/ADVERTISE

© 2018 Association for Corporate Growth. All Rights Reserved.

MAR/APR 2018

DON’T MISS

22

QUICK TAKES WattTime’s Energy Solution

19 A QUALIFIED OPINION RSM’s Richard Edelheit Talks Real Estate 20

POLICY POINTS Updates from D.C.

36 IN THIS ISSUE Cover and above photo by Richard Freeda

GROWTH STORY

Executive Summary 1

The Future Is Flexible: Knotel’s Revolutionary Approach to Office Space Modern companies are looking for flexibility as they grow and evolve.

Knotel is meeting that demand with a range of leasing choices, customized design features and outsourced services that remove the burden of office administration.

From the Editor 2 The Round 8 Midpoints by John Gabbert 17 Vertical View 18 Growth Economy 38 In Focus – An Inside Look at

TREND

Private Equity Finds Profit Potential in U.S. Malls PE firms are using cash on hand to devise

Insperity 40 The Portfolio 44 ACG@Work 46 The Ladder 50

innovative ways of transforming shopping

4

middlemarketgrowth.org

centers into multi-use hubs that foster

It’s the Small

community—and turn a profit. 30

Things 52

MIDDLE MARKET GROWTH ONLINE

PRESIDENT & CEO

MMG CONVERSATIONS

Patrick J. Morris pmorris@acg.org EDITOR-IN-CHIEF

Deborah L. Cohen dcohen@acg.org

ONLINE

ASSOCIATE EDITOR

Visit middle

Kathryn Mulligan kmulligan@acg.org

marketgrowth.org for exclusive con-

DIRECTOR, CREATIVE AND BRANDING

tent and to read

Brian Lubluban blubluban@acg.org

the latest issue.

DIRECTOR, COMMUNICATIONS & MARKETING

University of Chicago Professor Steven Kaplan NEWS

Steven Kaplan, a professor of entrepreneurship and finance at the University of Chicago Booth

MMG DAILY

School of Business and a leading researcher in

Opt-in news feed

private equity, discusses a groundbreaking new

featuring the

index he developed with Lincoln International

latest headlines

to measure changes in middle-market company

across the globe

value over time. He also talks about his research

from top news

into predicting CEO success, Booth’s private

outlets.

equity offerings and more.

Larry Guthrie lguthrie@acg.org VICE PRESIDENT, EVENTS, PARTNERSHIPS AND PUBLIC POLICY

Christine Melendes, CAE cmelendes@acg.org SENIOR MANAGER, NATIONAL ADVERTISING SALES

Kathleen Gallagher kgallagher@acg.org SALES REPRESENTATIVE

Joy Meredith jmeredith@acg.org

MMG WEEKLY The latest middle-

PODCAST Find this interview

market news,

and others by searching for “Middle

ACG events and

Market Growth Conversations” on

timely industry

the iTunes Store.

Custom media services provided by Network Media Partners

content.

THE LADDER Monthly publication about professional development

JOIN IN Find us on Twitter, Facebook and LinkedIn

news, trends and jobs.

Subcribe at middlemarket growth.org/

6

@ACG_MMG Search for Association for Corporate Growth Search for Middle Market Growth

Association for Corporate Growth 125 South Wacker Drive, Suite 3100 Chicago, IL 60606 ACG Membership: membership@acg.org www.acg.org Copyright 2018 Middle Market Growth®, InterGrowth® and the Association for Corporate Growth, Inc. All rights reserved.

subscribe.

Printed in the United States of America.

middlemarketgrowth.org

ISSN 2475-921X (print) ISSN 2475-9228 (online)

I met a contact at an ACG event that led to one of our biggest deals to date.

S E E T H E P O W E R T H AT MEMBERSHIP BRINGS. J O I N T O D AY AT W W W. A C G . O R G

THE POWER OF

© 2018 Association for Corporate Growth. All Rights Reserved.

THE ROUND

Public-Private Partnership Retail Vacancies Create Spaces for Community Revival

T Heather Stratman CEO, Association of California Cities-Orange County

8

he disruptive forces of online commerce, digital supply chains and mobile technology are transforming a diverse range of industries, from traditional retail to health care, finance and logistics. In the wake of this so-called creative destruction, the landscape of physical infrastructure in communities across the country is evolving rapidly.

Even five years ago, the traditional brick-andmortar spaces of urban and suburban malls were the norm. Flash forward to today and e-commerce has created widespread vacancies, as stores shutter amid pressure from online retailers. CNN Money reported that, as of October 2017, 6,700 stores had ceased operation through the first three quarters of last year.

Nearly every organization and industry today is assessing strategic and tactical measures to survive and ultimately prosper in this age of

middlemarketgrowth.org

digital innovation. The list of affected entities includes municipalities, which are facing enormous challenges, including the loss of tax revenue that follows store closures, and the reduced economic dynamism associated with classical storefront entrepreneurship. Meanwhile, in California, along with cities across the nation, elected officials failed to anticipate how online purchasing would frequently circumvent local sales tax and property tax laws.

Online sales made up more than 9 percent of total retail sales in the third quarter of 2017, according to the U.S. Department of Commerce, and they’re expected to continue growing rapidly over the next decade. As a result, municipalities will need to consider new tools to bolster their balance sheets.

One of the creative fixes cities are beginning to test is employing land-use authority—the

municipality’s governance focused on regulating the use of land to advance the public interest—as an instrument to mitigate retail parcel decline.

Brick-and-mortar store closures have led municipalities to consider reuse, redevelopment and rezoning. They might also create overlay zones, which are new zoning districts, set on top of existing zoning districts. These overlay zones may incorporate additional regulatory restrictions on type of use.

New overlay zones offer additional capability for city leaders to enhance the community. In California’s urban centers, officials are considering adding more housing units, refined commercial stock, and even new mobility and transit options to meet demand amid demographic shifts in the state, such as ethnicity, age, education, occupation and income, among others.

As traditional retail continues to face challenges, many aging and struggling cities are poised for a renaissance as they transition commercial real estate assets into alternative uses in the community. Consider an industry segment such as auto dealers, which in some cities have operations that span many dozens of acres. With the increasing popularity of autonomous vehicles and ride-sharing, demand for owned vehicles will likely diminish, and car dealers will require less space. These lots may become the next affordable housing complexes, entrepreneurial incubators or education ecosystems.

The Association of California Cities-Orange County is taking the lead in efforts to work with municipalities as they catalogue, assess and plan for the vast tracts of land currently occupied by retail, and evaluate how to repurpose them toward other productive uses in the future. To that end, the association is teaming up with the

Urban Land Institute on a grant program for cities to tap into education and learning outlets to develop robust competencies and capabilities in the areas of land-use development. With this partnership, municipalities will take the first steps toward enhancing their communities and creating economic synergies between business and government.

Cities, which can visualize the needs of their neighborhoods over the next 50 years, can take advantage of the opportunities for reuse over the next decade. With so many challenges facing municipalities, utilizing land-use authority to positive ends as retail continues to evolve is among the bright spots on the horizon for communities.

Heather Stratman is CEO of the Association of California Cities-Orange County, an organization representing

FIND YOUR

IDEAL CANDIDATE WITHOUT SORTING THROUGH

HUNDREDS THAT AREN’T.

the interests of Orange County’s 34 cities through education that empowers, policy that is collaborative, and advocacy that is service-oriented.

POST YOUR JOB O P E N I N G T O D A Y. JOBSOURCE.ACG.ORG

MORE ONLINE For the latest middle-market trends,

© 2018 Association for Corporate Growth. All Rights Reserved.

check out middlemarketgrowth.org.

MIDDLE MARKET GROWTH // MAR/APR 2018

9

THE ROUND

Six Real Estate Fundraising Trends to Know

Matthew L. Giles Partner, Goodwin

1. Large investors demand co-investment priority Increasingly, sovereign wealth funds, pensions and other large institutions are demanding priority for co-investment from their investment managers. They’re seeking lower fees and more control, and many of their managers are acceding to their requests.

This can add a layer of complexity to a fund; these deals often are negotiated as side letters to the limited partner agreement and can increase administrative and reporting burdens. It also requires an extra layer of transparency, because smaller investors want to make sure they’re not getting the short end of the stick.

In response to the increased demand, some managers are creating standalone vehicles with the aim of expediting the process. In practice, one of the main challenges of co-investment is timing—sponsors often need their co-investors to act quickly.

2. Investment allocation policies are top of mind As investors have become more sophisticated, investment allocation policies have become increasingly important.

That’s particularly so when a manager runs multiple real estate vehicles and the strategies of those vehicles overlap. Investors (and regulators) want to make sure there’s a clear process for allocating investments to each vehicle. Often the policy is based on “rotation,” with each vehicle getting an investment in turn.

These policies have taken on greater significance as managers look to expand their offerings in the form of separate accounts. All investors want to know that managers are focusing on their investments, and a transparent allocation policy can set them at ease.

10

middlemarketgrowth.org

3. “End of life” issues are being negotiated now The real estate world is still dealing with the fallout from the financial crisis, particularly for funds closed in the 2005-09 period. The lesson: Investors and managers need to think through what happens when the typical 10-year fund cycle nears its end.

When that happens, the fund needs to consider how it will handle everything from fees to possible liquidation. Some issues are easier than others. For instance, if a building is being sold late in a fund’s life and that sale requires keeping adequate cash on hand for a period of time, managers and investors can typically come to an agreement in real time to accommodate the sale.

Issues like fees can often be addressed up front, with the understanding that things can always be renegotiated as circumstances change.

4. Managers want longer investment periods Managers are seeking more flexibility in deploying capital. That flexibility is meant to boost returns—no manager wants to be forced into subpar deals due to an arbitrary timeline. Investors, on the other hand, are sensitive about paying fees, particularly commitment-based fees, and longer investment periods can mean higher costs.

Most funds still operate on the typical fourto-five-year investment timeline, but those that have been successful in lengthening it point to the financial crisis to show how flexibility can be particularly useful in times of distress.

5. The “key-person clause” is key Investors are increasingly asking managers questions about the GP’s internal structure.

How do you share carry? Who makes decisions?

Succession issues cause even more anxiety. If

the founder gets hit by a bus, who is calling the shots? Such questions inevitably lead to a discussion of the so-called key-person clause and succession planning. Many older real estate funds are looking to expand their key-person provisions to reflect the growth and development of the firm and demonstrate that it’s not a one-person show. But it’s a delicate balance, as investors like continuity. The best managers are actively engaged with their investors, showcasing and introducing the next generation of leaders well before it’s time for them to take over.

6. The use of credit is under scrutiny Subscription credit facilities have long been used in real estate—managers like them because they can conserve investor capital to fund expenses and deals. But one potential downside for investors is that by delaying capital calls, managers may get into the promote (carried interest) earlier than they would otherwise.

Gone are the days when a fund could delay all capital calls until a final closing to pump up fees, as investors typically require restrictions on how borrowings can remain outstanding. The SEC is actively monitoring funds to make sure proper disclosures are made—checking not just that a manager has a credit facility, but how it uses it, and how that impacts returns and compensation.

Attorney Matthew Giles is a partner in the business law department of Goodwin, whose practice includes real estate and private equity fund formation.

Used with permission of Privcap Media LLC

TRENDS

Co-Working Trend Has Long-Term Potential Co-working spaces aren’t just a fad—they’re here to stay, and they will likely make up a significantly larger share of office space in the next decade as established companies adapt to the trend, according to panelists at the Privcap Game Change: Real Estate 2017 conference on Nov. 2.

“It’s the beginning of a major supply shift, but the catalyst is really just demand,” said Michael Burke, director of real estate for New Yorkbased Convene, which works with landlords to adapt to the changing needs of office space tenants.

Thirty to 50 percent of office space contracts will be structured as short-term leases in the next 10 to 15 years, Burke said, compared with only 1 percent today.

The so-called gig economy, comprising contract workers, is one driver of the rise of co-working spaces, which include options to rent a single desk in a shared office and flexible short-term leasing options for growing companies. But co-working is no longer solely the domain of millennial entrepreneurs and small businesses.

“The customer is no longer a 22-year-old right out of college with a dream,” said Matthew Ward, senior managing director for commercial real estate advisory firm Newmark Knight Frank. “Now it’s everyone.”

Large companies are getting on board, responding to employees who want to work with more

E A Privcap panel discusses the co-working trend. From left: Matthew Malone, Privcap; Michael Burke, Convene; Matthew Ward, Newmark Knight Frank; and Richard Heby, LiquidSpace. Photo: Alyssa Schukar

flexibility, said Richard Heby of office space network LiquidSpace, who spoke alongside Burke and Ward on the panel “How Co-Working is Revolutionizing the Office” at The Mid-America Club in Chicago.

Shorter-term leases appeal to Fortune 500 companies because they’re less risky, allowing corporations to adapt their spaces to changing staff sizes. “They’re all looking at this as a portion of a larger real estate strategy,” Ward said.

The three panelists agreed that co-working won’t be a shortlived trend.

“Count on it; it’s not going away,” Burke said.

—Kathryn Mulligan

MIDDLE MARKET GROWTH // MAR/APR 2018

11

THE ROUND

The Middle-Market Reading List Business Leaders and Economists Suggest Eight Books that Challenge Conventional Thinking

M

MG editors asked leading economists and business leaders featured on the Middle Market Growth Conversations podcast about what they’re reading. Their answers included books that challenge conventional thinking with both direct and indirect applications to business—from works that theorize about how the global economy evolved into what it is today, to presidential biographies.

Below are recommendations from RSM US LLP Chief Economist Joseph Brusuelas, University of Chicago Professor Steven Kaplan and World Bicycle Relief President Dave Neiswander.

Joseph Brusuelas Chief Economist, RSM US LLP H “Machine, Platform, Crowd: Harnessing Our Digital Future” by Andrew McAfee and Erik Brynjolfsson

Brusuelas’ take: It’s about the evolution of developed economies. From, say, 1875 to 2014, the economy was essentially organized around this idea of mind. We’ll call that human capital—what it is that we produce or the services we provide. That was sufficient to get us through the evolution from steam to electricity, to a more advanced, sophisticated era of services.

12

middlemarketgrowth.org

But over the last couple of years, it’s very clear that things are changing. We have a different framework now. Instead of mind we have machine; instead of product we have platform; instead of core we have crowd. We used to be able just to concentrate on our core competency and innovation within our product space, and that would be good enough.

Now we’re going to layer machines on top of mind. We’re going to begin to integrate big data, artificial intelligence and machine learning into the provision and production of our goods and services. And then the feedback effects from the crowd: how we treat our ownership of structured and unstructured data, how we analyze, optimize, digitize—all of this. That’s a completely different economic framework. Across industries, across the economy and interindustry.

To me it seems that’s the big challenge going forward: How we all adapt in terms of our market space. For some middle-market firms that don’t intend to invest in software and equipment and intellectual property, that’s an existential risk at this point. You have to ride the tiger. You’ve got to get out there and do it and integrate these things into how you work.

“The Road to Somewhere: The Populist Revolt and the Future of Politics”

by David Goodhart F

Brusuelas’ take: How do we explain the aftermath of Brexit and Trump, and what does it mean for developed economies? The analytical framework of this text is essentially that there are people who are comfortable being anywhere, and there are people who are only comfortable being somewhere.

I feel comfortable working anywhere. I have global remit these days. I have to know what’s going on in Mexico and Canada, in Germany, in China. I have no problem setting up in a Starbucks, getting into Wi-Fi, whether I’m in Shanghai or Cincinnati. But there are other people who need to be rooted somewhere.

Whether it’s due to cultural or religious preferences, or lack of exposure and opportunity to engage in social and economic mobility.

We’ve got two economies, a new and an old. The new one is populated by about 15 cities and they’re growing between 3 and 5 percent. It’s like nothing ever happened; the Great Recession didn’t matter. They just picked up where they left off after the downturn and everything returned to normal. The rest of the country, not so much. The rest of the economy, not so much.

Even though I wouldn’t necessarily choose the analytical framework that this professor (Goodhart) does, he makes a good point about why we’ve seen the populist revolution in the developed economies and how we ought to think about that. My take on this, in terms of overarching policy, is that we need to begin to think about how to create pathways into the new economy for those who have been left behind.

Steven Kaplan Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance, University of Chicago Booth School of Business “Grant” by Ron Chernow

Kaplan’s take: It’s funny because (Ulysses S. Grant) was a great general, but he actually had some useful management lessons. He had this one quote that is so true, but it’s also consistent with the research I’ve done that predicts who is a successful CEO. It goes: “In war”— and I would say, also in business—“anything is better than indecision … If I am wrong, we shall soon find it out and can do the other thing. But not to decide wastes both time and money and may ruin everything.”

“A Brief History of Everyone Who Ever Lived: The Stories in Our Genes” by Adam Rutherford

Kaplan’s take: The book addresses what we know about DNA and what DNA tells us about the history of humanity.

H “Hit Refresh: The Quest to Rediscover Microsoft’s Soul and Imagine a Better Future for Everyone” by Satya Nadella

“Manias, Panics, and Crashes: A History of Financial Crises” by Charles P. Kindleberger

Brusuelas’ take: Read the portion of the book on Dutch tulips, which look a lot like bitcoin.

Kaplan’s take: (Microsoft CEO Satya Nadella) is a former student, so it’s always fun to read that. continued on next page

MIDDLE MARKET GROWTH // MAR/APR 2018

13

THE ROUND

H “Eisenhower in War and Peace”

by Jean Edward Smith

Kaplan’s take: Eisenhower is so underappreciated and was unbelievably impressive as a general and as a president. I read a biography on him and one on FDR back to back. You compare these two guys, who politically are completely different, but they were both adults, they were both so serious, they wanted what was best for the country. Eisenhower had very humble beginnings, and it’s very impressive when you read how he rose. Most people know FDR’s story, but they know less about Eisenhower’s.

Dave Neiswander President, World Bicycle Relief H “Essentialism: The Disciplined Pursuit of Less” by Greg McKeown

Neiswander’s take: One of the challenges we have as a team (at World Bicycle Relief) is that we’re so excited, so passionate about what we’re doing and the impact that we see. I think it’s important for us to step back and say, “How can we be most impactful in doing potentially fewer things but doing them better?” We get stretched and we don’t want to stretch ourselves too thin.

As with any organization, be it profit or nonprofit, you have limited resources, so it’s how you get the highest return on investment using the resources that you have.

14

middlemarketgrowth.org

Multiple Reasons Valuations Seem High

T

here’s no question that deal valuations are at a post-recession peak, yet many middle-market deal-makers suspect prices are even higher than the data suggest, in large part because of the characteristics of the businesses they’re buying, such as size and industry niche.

“Their view of the market may be more skewed than they realize by their own selectivity,” said Andrew T. Greenberg, CEO of GF Data, whose third-quarter 2017 report elicited responses from private equity principals who believed its stated valuations were too low.

“Often these concerns come from individuals who believe they’re expressing a general sense of the market, when in fact it’s a sense of the particular cut in which they operate,” he added.

Greenberg identified five features that characterize the 30 deals that attracted valuation multiples above nine times EBITDA, roughly the average for deals between $100 million and $250 million in enterprise value, based on self-reported data from 200 private equity firms. The high-value deals made up about 18.5 percent of the total deals completed by firms in GF Data’s network in the second and third quarters of 2017.

Deals that closed at higher-than-average valuations involve some combination of exceptional financial performance, relatively large businesses, strong industry niches, seamless transition of management and private equity ownership.

The A-Pluses Unsurprisingly, the best-performing businesses attract higher valuation multiples. For the 30 deals with above-average valuations, the median EBITDA margin was 22 percent and median revenue growth was 14.4 percent—that vastly exceeds the 10 percent margin and revenue

growth that characterize strong financial performers, according to GF Data’s definition.

Highly valued deals also include a management solution—either a senior management team that will remain with the company after closing, or a management team put in place by the buyer, as often happens with an add-on purchase for an existing portfolio company.

The amount a business is able to borrow is another key factor in the deal price, according to Greenberg. “To a great extent, this unprecedented sellers’ market involves equity values being driven by debt levels,” he said.

Nonbank lenders are more interested in providing debt support for larger deals, where the payoff is greater. Among the transactions GF Data analyzed, only 10 percent of completed deals with $10 million to $50 million of business value reached or exceeded the nine times EBITDA valuation multiple. For those between $100 million and $200 million, it was 54 percent.

Industry niche plays a role too. Only 13 percent of manufacturing deals fell within the highly valued category, whereas 23 percent of deals in a more prized subset—branded consumer products—attracted higher-than-average valuation multiples.

Finally, ownership matters. GF Data found that a business owned by a private equity firm or corporation will attract a higher valuation than a similar business held by an individual or family owner, all things being equal.

“The greater professionalization of the business, including financial controls, tends to outweigh the perception that the individually owned business has left more meat on the bone for a buyer,” Greenberg said.

Data Don’t Lie The perception of deal multiples in the market is shaped by a variety of factors, from the types of businesses an individual private equity buyer is focused on, to preliminary estimates from lenders on the amount of debt they’re willing to provide. Plus, deal professionals prefer to broadcast their highly valued transactions, skewing the market perception toward higher multiples.

E Andrew T. Greenberg, CEO of GF Data

“TO A GREAT EXTENT, THIS UNPRECEDENTED SELLERS’ MARKET INVOLVES EQUITY VALUES BEING DRIVEN BY DEBT LEVELS.” ANDREW T. GREENBERG

Despite objections from deal-makers, Greenberg stands by the data and expects that middle-market investment banks are seeing similar numbers.

“For the vast majority of middle-market M&A firms, if you were to say, ‘What do you have in-house, what are you working on?’ the valuations correspond to what we’re reporting,” he said. “The sense that a deal professional has of the market at any one time is based on a constellation of a lot of different things, not just completed deal pricing.” // —Kathryn Mulligan

MIDDLE MARKET GROWTH // MAR/APR 2018

15

© 2017 Wipfli LLP

To Get to Higher Ground, You Gotta Go Through the Mud. The middle market is rife with opportunity but it’s also clear as mud. That doesn’t mean you shouldn’t take the road less traveled. When you’re interested in the territory, you want a guide who thoroughly knows the terrain.

Wipfli is your Private Equity Guide, taking you where you’re going, faster, with audit, tax, technology consulting, and advisory services. From fund and transaction advisory services, to portfolio performance and management, you get powerful direction to navigate the muddy middle market, achieving growth while balancing compliance, without getting bogged down or stuck.

16

Your Private Equity Adventure is Calling. Let’s Get Out There. middlemarketgrowth.org

wipfli.com/PrivateEquity

MIDPOINTS by John Gabbert

Real Estate’s Wake-up Call

S

martphones and social networks are good examples of technologies that have changed our lives in unpredictable ways, dramatically altering how we interact with the world. Ask an older millennial if he went to his high school reunion and he might question the need—what’s the point of attending an actual event when you can just log on to Facebook for regular updates?

Similarly, the rise of Uber and its competitors has been stratospheric— in addition to the company’s sky-high valuation, Uber’s name has become a verb, a sure sign of its pervasive integration into society. It’s not likely that on its first day of business, Uber drew bull’s-eyes on downtown parking garages or suburban park-nrides. But its users might make them unintended targets, especially if the company succeeds with self-driving technology. Cars that can drive us to work and take themselves back home could, in theory, dampen demand for parking lots, or in future-speak, “unnecessary piles of concrete sitting on valuable real estate.” Green Street Advisors, a real estate research firm, estimates that a significant reduction in car ownership might halve our demand for parking in the span of three decades.

If that premise seems far-fetched, a similar trend is already happening with shopping malls. E-commerce caught on so quickly that hundreds of physical sites, once an integral part of the retail experience (and a very important part of social life), have turned into ghost towns. The retailers themselves, if they’re surviving, have migrated further online and closed thousands of

stores to stanch the bleeding.

Private equity investors should take note. While roads, bridges and airports aren’t going anywhere anytime soon, new technology has the potential to alter just about any current norm we can think of, in a surprisingly short amount of time. Many PE firms were blindsided by the e-commerce revolution, which created retail graveyards with tombstones under the Toys R Us, Payless ShoeSource and Gymboree names, just a smattering of the PE-backed retailers to file JOHN GABBERT for bankruptcy last year, with more Founder and CEO, expected to fail.

PitchBook Once a hotbed of PE activity, retail now constitutes a risky investment thesis on Wall Street. Diligence is not just about picking the winners anymore; investors now need to keep an eye on the sectors themselves. PE can fix ailing companies, but there isn’t much it can do “ONCE A HOTBED OF PE about waning industries.

Right now big money is ACTIVITY, RETAIL IS NOW A flowing into aging infraRISKY INVESTMENT THESIS structure. PE knows how ON WALL STREET.” to funnel money effectively into roads and bridges—it’s in the business of improving assets that already exist. The bigger issue for long-term investors is what the world will look like in 10 or 20 years, not 50 years or longer. Shopping malls went from staples in our daily lives to curious afterthoughts within a couple of decades, with lots Content Sponsored by of PE investors writing down losses when the dust started to settle.

It turns out some of the PE firms best positioned to benefit from e-commerce might be real estate investors. Who saw that coming? //

MIDDLE MARKET GROWTH // MAR/APR 2018

17

VERTICAL VIEW

Building by the Numbers A group of private equity firms invested $103.5

million

in Portland-based online vacation rental company Vacasa in October 2017 in an effort to enter the high-end rental business and take on Airbnb, according to Bloomberg. Riverwood Capital led the investment and was joined by Level Equity, NewSpring Capital and others.

Private equity real estate investor Origin Investments raised

more than $150 million for its third fund via crowd-

funding, a method of fundraising that has gained popularity in the real estate market in recent years in large part because of the 2012 Jumpstart Our Business Startups—or JOBS—Act, according to Forbes. The law enables funds like Origin to accept up to 2,000 investors into a single fund, up from the previous limit of 100.

The Harvard Management Company, which administers the university’s endowment fund, has been offloading parts of its portfolio, including real estate holdings. In January, it sold its majority stake in a 13-building portfolio to private equity giant Blackstone Group for $243.6

million, according to

The Real Deal. Last December, Harvard Management struck a deal with Bain Capital, which will take over management of the university’s $3.4 billion real estate portfolio.

Quarterly fundraising by real estate-focused private equity firms in the third quarter of 2017 hit

its lowest level since the first quarter of 2013, “largely due to lower levels of higher-risk fundraising,” according to Preqin. Carlyle Realty Partners VIII raised a $4 billion fund, the largest closed in the quarter.

18

middlemarketgrowth.org

QUICK TAKES

Does Your Building Know ‘WattTime’ Is Best for Its Carbon Footprint?

D

on’t flip that switch—yet.

Despite high-tech advances in building controls, most businesses don’t have a handle on how their energy use correlates to environmental impact.

That’s the premise behind Oakland, California-based WattTime, a nonprofit deploying software-based technology to help building operators make more sustainable choices about energy consumption.

“We detect in real time where (electricity) is going to come from and what the emissions are going to be,” says Gavin McCormick, WattTime’s co-founder and CEO. He says many commercial energy users don’t realize that electricity is delivered from a variety of power plants, depending on the time of day. WattTime combines real-time data from power grid operators, the Environmental Protection Agency and other sources to find times when energy use will have a lower carbon footprint.

Still in its nascent phase, WattTime in June became a subsidiary of the Rocky Mountain Institute, a larger nonprofit focused on helping companies, communities and other organizations shift away from fossil fuels to renewable energy. A partnership with Microsoft allows the software to run on Azure, the tech giant’s cloudbased platform.

WattTime’s pilot sites include buildings at UI LABS, a Chicago organization advancing smart-city technologies, along with Princeton

E WattTime tracks where energy is coming from in real time

University, Harvard University and other academic institutions. McCormick says universities and Fortune 500 companies are the first targets; users start with a free trial and then pay a variable cost, based on the size of the organization.

“Companies that want to use more sustainable energy can get it with a click plug-and-play software solution,” says McCormick, 33, a former Ph.D. candidate in economics at UC Berkeley.

WattTime is McCormick’s first foray into business. He developed the

concept about three years ago during a hack-athon event in San Francisco where participants created environment-focused software apps. WattTime now has seven employees and a growing team of volunteers.

“The paper I was working on at the time was nine years in the making,” McCormick says. “The first version of Watt took nine hours.”

For more information, email contact@watttime.org. // —Deborah L. Cohen

MIDDLE MARKET GROWTH // MAR/APR 2018

19

A QUALIFIED OPINION

Richard Edelheit National Real Estate Industry Leader, RSM US LLP Richard Edelheit is the national real estate industry leader for RSM US LLP. He has more than 35 years of experience in the industry and oversees all activities for the firm’s national real estate practice across a broad array of areas, including assurance, tax, transactional due diligence, lease consulting and other consulting services.

“WE’RE VERY OPTIMISTIC, NOT WITHSTANDING TAX REFORM, FOR 2018 AS WELL.”

MORE ONLINE Read more interviews at middlemarketgrowth.org.

20

middlemarketgrowth.org

Q A

What is the outlook for real estate M&A this year?

Transactions in 2017 marked a record year, representing close to a half a trillion dollars worldwide.

Our larger clients in the private equity space are continuing to do deals, helped by all the dry powder. We’re very optimistic, not withstanding tax reform, for 2018 as well. Consider that Brookfield made a bid for General Growth Properties, a huge mall owner, in a big deal worth well into the billions of dollars of transaction value. We’re going to see more of that this year, helped by tax reform, which I believe will be a boon to real estate.

Investment dollars will likely come in from foreign countries; certainly China’s going to be coming back, and Europe is going to be taking a look.

I think we’re going to see a lot more coming through in 2018 on deals.

Property valuations in the last two years have just continued to escalate.

They’re probably equal to or higher than they were prior to the (2008) crash. We anticipate a continuation of the same for 2018. I think we’ll see incremental interest rate increases, but I believe property values are going to continue to stay strong.

Q A

Which are the most attractive geographies you’re seeing?

In general, attractive markets have an attractive tax structure, such as in Houston, Dallas and Austin—because Texas, as an example, is without a state income tax. You’re going to see continued growth and greater opportunities in similar types of markets. Seattle continues to be a strong market; there’s a shortage of housing, and I think you’ll see some strong growth. You’ll also continue to see growth in Atlanta and Denver.

Chicago is an interesting place because I believe it’s a really good indicator for what’s going on in major markets throughout the country— Chicago is losing population. When you’re talking about young professionals today, they want a combination of lifestyle and a different kind of focus on career choice. They’re looking at secondary markets where it’s not as costly to live. I think that this will continue to be a trend going forward in 2018.

Q A

How is the tax reform package likely to impact corporate site selection?

As an example, I believe there’s going to be a reexamination by Amazon of where its second corporate headquarters will be located, given some of the changes in the individual

tax rates. Tax reform is likely to have some negative impact in the larger markets, including some of the large blue states, such as New York, California and Illinois. Businesses are going to take a real hard look at where they open corporate headquarters across the country because of the (tax) impact to individuals and what’s in the overall best interest regarding employment.

Q A

What other changes are we likely to see?

The reconfiguration and redevelopment of brick-and-mortar retail is likely the most interesting thing that we’re going to see. There are potential opportunities for redevelopment of those properties from retail to some sort of mixed use. I also believe multifamily (residential) properties are still a good place to be, not only in new development, but in refurbishment. We see continued activity and value added in that sector. On the industrial side, we are still seeing a lot of activity for obvious reasons, such as the impact of web-based sales and the need for warehousing and shipping space. //

VOICES OF THE MIDDLE MARKET In-depth interviews about the trends impacting midsize companies and M&A. Guests include CEOs, economists, private equity investors and other influencers who discuss what they’re seeing in the market.

LISTEN & SUBSCRIBE TODAY. “THE RECONFIGURATION AND REDEVELOPMENT OF BRICK-ANDMORTAR RETAIL IS LIKELY THE MOST INTERESTING THING THAT WE’RE GOING TO SEE.”

© 2018 Association for Corporate Growth. All Rights Reserved.

MIDDLE MARKET GROWTH // MAR/APR 2018

21

The Future Is

Flexible Knotel’s revolutionary approach to office space

Photos by Richard Freeda

BY S.A. SWANSON

A

H CEO Amol Sarva drew from his own workspace experience to co-found Knotel

s a serial entrepreneur, Amol Sarva has plenty of experience helping companies expand. That also means he’s seen his share of moving trucks and hefty rent checks.

“Virtually every company that I’ve built over the years has had to navigate the problem of just where to be located,” Sarva says. He designed his businesses for growth, which meant moving nearly every year— sometimes to a bigger space, sometimes a smaller one.

The main headache wasn’t the logistics but the cost. That was the case after Sarva co-founded Virgin Mobile USA. “We’d move every six to 12 months, and we would raise money, and then a big chunk of the money we had raised from our investors would always end up going directly into paying landlords a bunch of money … and not get invested in any of the good stuff we were planning on inventing and doing,” he says. “That’s pretty annoying.”

He knew other business owners shared that sentiment.

They didn’t want to pay for space they didn’t need. And they wanted to focus on improving their businesses, not waste resources choosing, designing and maintaining their headquarters.

With that challenge in mind, Sarva co-founded Knotel, a provider of flexible office space. Knotel does more than give companies the option of month-to-month terms (although most clients choose terms of a year or more). It helps design and furnish offices that reflect each company’s culture and preferences, and it handles the essential details of office maintenance. That role inspired Knotel’s tagline: “Headquarters as a service.”

MIDDLE MARKET GROWTH // MAR/APR 2018

23

KNOTEL Business: Flexible full-service workspaces for growing companies Founder & CEO: Serial entrepreneur Amol Sarva Clients: 200 and growing, including BentoBox and The Body Shop Scope: Sites in New York and San Francisco; Boston, Chicago,

That service fills a need for Knotel’s nearly 200 clients. Among them is Krystle Mobayeni, CEO of restaurant website development firm BentoBox, which has found value outsourcing services to Knotel.

“It has been very beneficial for us as a company to bypass spending time finding property and instead focus on building a great company,” she says.

London, Shanghai and Tokyo in

TO EACH HIS OWN

the works

Sarva, who has founded startups including Peek, Halo Neuroscience and Knotable, recognized that companies need flexibility as they grow, but he questioned whether shared workspaces held the answer, despite the buzz. “If you listen to the co-working companies, they certainly seem to think that. They think that in the near future everybody will have a beard and ride a bicycle and have tattoos and work in a co-working desk somewhere,” he says.

He wanted Knotel to serve businesses that had more than just a handful of employees, and ones that valued space with a personalized aesthetic, unlike a co-working office that couldn’t be customized.

“WEWORK BUILT A PRODUCT FOR FREELANCERS AND SMALL TEAMS. IT RELIES ON IDENTICAL CELLS AND HIGH DENSITY. IT’S GREAT FOR SHORT-TERM STAYS, BUT IT’S NOT FOR MATURE BUSINESSES THAT REQUIRE MORE CUSTOMIZATION.” JONATHAN GOLDBERG Chief Operating Officer, Knotel

24

middlemarketgrowth.org

“WeWork built a product for freelancers and small teams. It relies on identical cells and high density,” says Jonathan Goldberg, Knotel’s chief operating officer. “It’s great for short-term stays, but it’s not for mature businesses that require more customization.”

With Knotel, no two offices look the same, he says. “There’s a categorical difference in design, infrastructure and operations that makes one a home and the other a way station.”

BEYOND TECH In 2016, a year after Sarva co-founded the company, Knotel’s clients had an average of 20 employees. By the end of 2017, that number rose to 200, due to the headcount growth of existing clients and new clients with larger staffs. The company has also seen a big shift in the industries it serves. “In January 2016, we were 100 percent composed of venture-backed technology companies,” says Sarva, who is also Knotel’s CEO. “Now we are overwhelmingly not that.”

Almost 80 percent of Knotel’s clients are in nontech fields, such as finance, media, advertising, fashion, retail and nonprofit, including many that qualify as midsize companies.

When Knotel started in 2015, it had one 10,000-square-foot leased spot in Manhattan.

Twelve months later, it had 100,000 square feet throughout New York City. By the end of 2017, its real estate portfolio reached more than 500,000 square feet, including two San Francisco locations added in September 2017.

Knotel’s portfolio includes a mix of leases (“We try to do as long as we can—around 20 years,” Sarva says), sublets, owned spaces and locations that have management agreements—a contract common in the hotel industry in which a property manager pays a percentage of revenue and profits to the property owner.

For Knotel’s management agreements, the company provides landlords with a percentage of revenue. Roughly 25 percent of Knotel’s properties have this type of arrangement, and that number is growing, says Eugene Lee, global head of real estate and business development for the company.

“Management agreements are an important component of our expansion strategy. They align our interests with owners who are interested in attracting the large, fast-growing companies Knotel serves,” he says. “Because real estate is cyclical, flexibility is important, but management agreements also enable owners to generate higher income for themselves.”

DISRUPTING A COMMODITY

By February 2017, Knotel had raised $25 million in Series A funding. One of its investors was Pankaj Jain, a partner at 500 Startups. “Whenever you get veteran entrepreneurs taking on an antiquated industry, interesting things happen,” Jain says. “Knotel is disrupting a commodity that everyone uses: an office. Traditional leases are unsuitable for modern companies given their inflexibility, and co-working really only works for small teams.”

He says many tech observers believe it’s unrealistic to tackle real estate, that it’s too slow to change, too cyclical, too cash-intensive. But

Knotel makes the process more efficient, in part, by redefining how spaces are designed and built.

“Companies rely on multiple stakeholders to build their space—contractors, engineers, architects, designers, IT specialists—which can take months and hundreds of dollars per square foot,” says Knotel COO Goldberg. Because Knotel has those workers on staff, it can design, build and furnish an office for a client in just a few weeks at a fraction of the cost, he says.

The Body Shop is one example. The cosmetics and skin care retailer moved its North American headquarters into a 20,000-square-foot Knotel space in 2017. “They figured out what they wanted to do in five weeks, and we got it set and perfect and ready to open in four weeks,” Sarva says. “If you contrast it with the traditional real estate cycle—12 to 18 months of search and customization and build-out and all that—the other process is a huge headache for the top management on down. And they want a build that matches their mental image of innovation.”

They also want the space flexibility that

E Knotel’s New York headquarters showcases flexible space

MIDDLE MARKET GROWTH // MAR/APR 2018

25

INVESTOR DOLLARS MOVE INTO CO-WORKING SPACE The recent buzz around

Fund. With a valuation of

office space-leasing startups

$21 billion, WeWork is the

makes it easy to forget that

third-largest U.S. startup,

flexible workspaces date

behind Uber and Airbnb,

back to the previous century.

according to PitchBook.

Consider that Sydney-based

launched its first co-working

in 54 cities, has provided

space in India, but it’s not the

office space with flexible

only business catering to the

terms since 1978. Regus,

country’s office needs. Awfis

a Luxembourg-based

Space Solutions, a co-work-

provider of flexible office

ing startup in India, raised

space, has locations in

$20 million in 2017 from

900 cities. In December

Sequoia Capital India.

2017, its holding company,

WeWork has also played

International Workplace

the role of investor. That

Group, or IWG, received

includes leading a $32

a bid approach from two

million round of funding for

Canadian companies: private

The Wing, a women-only

equity firm Onex and the

co-working space with

private equity division of

amenities such as lactation

investment firm Brookfield

rooms and hair blowouts

Asset Management. (Take-

on demand. WeWork has

over discussions ended as of

also made at least one

early February.)

curious investment—in 2017,

Although the idea of

it reportedly purchased a

flexible workspace isn’t new,

large stake in wave-pool-

the investment fervor around

maker Wavegarden.

it is. In 2017, the industry

With 34 U.S. locations, the

received more than $4

co-working company Indus-

billion in U.S. funding—but

trious received some invest-

without WeWork, that figure

ment in recent years too. In

would only be in the millions.

September 2016, it raised

Founded in 2010, WeWork

$37 million in Series B

has more than 280 office

funding, led by private equity

locations around the world.

firm Riverwood Capital—and

In July 2017, it raised $760

in March 2017, Industrious

million in new capital. One

received an additional $25

month later, it received $4.4

million in new capital.

billion from SoftBank’s $98

—S.A. Swanson

billion tech-focused Vision

26

Last year, WeWork

Servcorp, with locations

middlemarketgrowth.org

Knotel allows. If the company needs more space or less, it can move to another Knotel location that doesn’t change employees’ commute.

Leases force companies to put real estate goals above business goals, Goldberg says. “They spend lots of time and money just to get an office and then more headcount to operate it.

When the space inevitably becomes too small or too big, they start the process again.”

OUTSIDE THE BOX Growing companies want to invest strategically in growing their businesses, not in office management. That was the case at Well&Good, a content provider whose website focuses on lifestyle and wellness topics. The company was based in a WeWork space in Manhattan’s Financial District for about two years before moving to its Knotel headquarters in the Flatiron District, a more convenient location for meetings with the company’s partners and clients. Knotel’s pricing was lower than WeWork’s, but that’s not the only reason for the switch, says Jessica Muse, Well&Good’s chief operating officer. “We wanted something that was still managed, like what we had at WeWork, but space that felt a little bit more like our own, where we could infuse our own culture.”

The previous office had WeWork branding and suites that didn’t foster collaboration among teams. At the new office, Knotel helped design a workspace that reflected Well&Good’s brand and culture.

“We are a wellness company, so that was the vibe we were going for—very airy, lots of plants, lots of light,” Muse says. “If you walked into our office, no one ever would know it’s a Knotel office.

Everyone thinks it’s entirely owned or leased.”

Knotel’s design team searched online for decor ideas and presented them to the client for approval, allowing Well&Good to focus on its core business, rather than being distracted by “design duty,” Muse says.

Well&Good likes the flexibility of only paying for the space it needs. When it first moved into the office, it had about 20 employees and occupied half a floor. By December 2017, that number

Photo: Courtesy of Knotel

had increased to 47 and the company occupied the entire floor.

Knotel has enabled Well&Good to hand off the tedious but essential tasks that keep office life running smoothly. Each Knotel property has a general manager to handle those responsibilities—whether it’s refilling milk in the kitchen or making sure the internet connection works.

“I’m COO, so for me to not have to call up the internet vendor when the internet goes down and spending who knows how long troubleshooting, that’s very valuable,” Muse says. And when the company had an event that required rearranging furniture, it called Knotel to send people up to help move couches and tables. “It really frees up the senior people’s time, not being bogged down with those issues,” she adds.

BentoBox CEO Krystle Mobayeni had similar concerns about flexibility. Before the company moved to its Knotel office in SoHo in January 2017, it was headquartered in a space it subleased from a large tech company. That didn’t allow much opportunity for customization, plus it needed a larger space for the hiring it planned to do for 2017. (Headcount tripled that year, to 45 employees from 15.)

BentoBox considered getting its own commercial lease, or subleasing again from a larger company, before a broker mentioned Knotel.

“We ultimately decided that our time would be better spent growing BentoBox rather than searching for and furnishing an office,” Mobayeni says. “We liked Knotel’s concept of ‘headquarters as a service.’”

Traditional co-working spaces can feel compartmentalized and unfriendly, she notes.

“IT HAS BEEN VERY BENEFICIAL FOR US AS A COMPANY TO BYPASS SPENDING TIME FINDING PROPERTY AND INSTEAD FOCUS ON BUILDING A GREAT COMPANY.” KRYSTLE MOBAYENI CEO, BentoBox

“Given that we are a hospitality-focused company, it is important that our office be a comfortable and inviting space.” To reflect that, Knotel helped design a living room-style seating area with a couch and a bar, a customized design that wasn’t possible in the office BentoBox subleased previously.

Mobayeni also appreciates having access to other Knotel properties. Using Knotel’s app, she can reserve meeting rooms in Knotel spaces that aren’t occupied by other companies. “Having multiple home bases around the city to take a phone call or have a meeting is really convenient,” she says. “Working with Knotel offers us the flexibility to expand without any long-term commitment or fear of outgrowing our space.”

E Krystle Mobayeni Above left: Knotel enabled BentoBox to customize its office

THE SIZE OF THREE MANHATTANS The initial driver of demand for co-working and flexible space was freelancers and startups looking for alternatives to working from home or in coffee shops, says Scott Homa, director of U.S. office research at JLL, a Chicago-based commercial real estate services firm. “The subsequent wave of corporate demand has been driven largely by a general need for more flexibility and agility—shorter lease terms, faster move-in, variable length of commitment—as well as reducing initial out-of-pocket expenses,” he says.

Homa expects demand to continue, based on JLL’s research. As JLL defines it, flexible space has at least one of the following elements: The space is co-located with other companies; it is subleased; or it has short-duration lease terms that could be month-to-month but are less than 36 months.

MIDDLE MARKET GROWTH // MAR/APR 2018

27

“ONE OF THE STRIKING THINGS IS HOW LITTLE EXPLANATION IT TAKES FOR CEOS … MIDSIZE COMPANIES ARE JUST LIKE, ‘OH, OF COURSE. WHY WOULD WE DO ANYTHING ELSE?’” AMOL SARVA Co-Founder and CEO, Knotel

Flexible space accounts for less than 5 percent of the U.S. office market, but it has grown rapidly, Homa says, tripling its share of large-block leasing activity (leases of at least 20,000 square feet) in just two years. “We project 30 percent of the office market could be defined as flexible space by 2030,” he says. “That’s as much as 1.2 billion square feet of office space, or the size of three Manhattans.”

EXPANDING OPTIONS

Photo: Courtesy of Knotel

G Well&Good opted for an airy space

28

middlemarketgrowth.org

Sarva has watched Knotel grow at an accelerated pace, although he didn’t necessarily expect that outcome two years ago. “This is not an idea that anyone thought was inevitable,” he says.

But the numbers underscore a business need.

Knotel’s revenue and square footage increased tenfold in December 2017 compared with the previous year. It added more square feet during six weeks in November and December 2017 than it did in the 15 months from January 2016 to March 2017.

In the Manhattan market for space of less than 12,000 square feet, Knotel leased almost half of what property landlords made available in 2017.

During the past couple of years, aspects of the New York City real estate market have surprised Sarva. “We thought Brooklyn would be more popular than it is,” he says. “(There’s) a lot of interesting stuff over there, but CEOs don’t want to put their company in Brooklyn, not yet.

We opened two locations there, and we haven’t opened any more.”

Another eye-opener: Having locations on the same block is a good thing. “One Knotel next to another makes them both stronger,” he says.

The company isn’t profitable yet, by design, he says. “We’re going to invest to grow a lot.

We could stop. Then we’d just be a profitable small business, but we are building a vast global enterprise, and that will require opening a lot of Knotels all around the world for years and years and years.”

Sarva came up with the company name—he liked the nod to “knowledge” and used a similar conceit for another firm he founded, Knotable. “Knotel is a place where knowledge comes to stay,” he says. “It moves in, not just for the night.”

The company plans to have properties in London, Boston, Chicago, Tokyo and Shanghai within the next five years. As Knotel expands, that means more options for clients, Sarva says.

“They may want to move their headquarters to be bigger and take another floor next door. They might want to open a satellite somewhere else in town so their engineers can have a separate lab to work from.”

Over the years, Sarva has seen companies whose “last lifeline might have been the $1 million or $2 million of security deposits, or prepayments of rent, or build-out expenses that they had sunk into their office.” He adds: “They took a space that was three times bigger than they needed, planning on all kinds of future growth.”

Above all, company owners want flexibility that will make their business stronger.

That helps explain why, of all the companies Sarva has founded, Knotel requires the least vigorous sales pitch.

“One of the striking things is how little explanation it takes for CEOs,” he says. “They’ve had the same experience that I had in building my various companies. Midsize companies are just like, ‘Oh, of course. Why would we do anything else?’ I’ll meet entrepreneurs who’ve been running multiple businesses over the years, and they’re just like, ‘I can’t believe this hasn’t happened sooner.’” //

RULE CHANGE HEIGHTENS SHORT-TERM LEASE APPEAL Knotel and other providers

more disclosures related to

of flexible office space have

leasing transactions,” FASB

found an unexpected ally:

Chair Russell G. Golden

the Financial Accounting

stated in a press release.

Standards Board, commonly known as FASB. Currently, companies

As part of the change, companies will need to help investors “better understand

aren’t required to include

the amount, timing, and

real estate leases on their

uncertainty of cash flows

balance sheets. That will

arising from leases,” accord-

change by the end of 2018,

ing to FASB’s press release.

thanks to an accounting

That means giving investors

standards modification that’s

disclosures that “include

designed to improve financial

qualitative and quantitative

reporting about leases.

requirements, providing

First announced in Feb-

additional information about

ruary 2016, the rule change

the amounts recorded in the

was 10 years in the making

financial statements.”

and affects all leased assets,

The change will take effect

including manufacturing

for public companies begin-

equipment and airplanes. It

ning after Dec. 15, 2018, and

requires companies to rec-

one year later for all other

ognize assets and liabilities

organizations. In 2017, Knotel

for leases with terms longer

was already leveraging that

than 12 months. Previously,

looming accounting head-

organizations only had to

ache in its sales pitches,

include capital leases on

reminding potential clients

balance sheets, but with

the rule change doesn’t

the rule change, they must

apply to leases that are 12

include operating leases too.

months or shorter.

“The new guidance

“The FASB rule change

responds to requests from

will impose meaningful

investors and other financial

administrative and reporting

statement users for a more

costs on companies with

faithful representation of an

leases,” says Eugene Lee,

organization’s leasing activ-

Knotel’s global head of

ities. It ends what the U.S.

real estate and business

Securities and Exchange

development. “The flexible,

Commission and other

shorter-term arrangements

stakeholders have identi-

that Knotel specializes in can

fied as one of the largest

help reduce that burden.”

S.A. Swanson is a freelance business writer in the

forms of off-balance sheet

—S.A. Swanson

Chicago area and a frequent MMG contributor.

accounting, while requiring

MIDDLE MARKET GROWTH // MAR/APR 2018

29

30

middlemarketgrowth.org

Private Equity Sees

Profit Potential in U.S. Malls

BY MYRA THOMAS

T

o say that the American mall is dead is a gross exaggeration. While many shopping centers across the country are struggling, so-called Class A mall real estate, typically in densely populated major metropolitan areas with attractive demographics and innovative concepts, is doing well and piquing investor interest.

While the shopping center of the past was largely dependent on large, well-known retail anchor stores, today’s mall developers are retrofitting space to become lifestyle hubs, relying on a mix of fine dining, entertainment, hotels, offices, health care providers and retail, among other concepts, to help generate traffic.

“There are more upscale restaurants and more activity in malls today,” says James Cassel, chairman and co-founder of Cassel Salpeter, a Miami-based investment banking firm. “Malls have to change to bring people through the doors to help out their other tenants.”

MIDDLE MARKET GROWTH // MAR/APR 2018

31

Brookfield Asset Management’s $14.8 billion takeover bid for publicly traded General Growth Properties in November made it abundantly clear that Class A malls are still in vogue. The following month, Australia-based mall owner Westfield “THE FOCUS FOR Corp. disclosed that it was PRIVATE EQUITY IS ON looking at a “potentially MAJOR METRO AREAS. significant” corporate LOCATION IS THE KEY.” transaction.

While only 20 percent of malls qualify as Class A, GREG ROSS they account for 72 percent National Managing Partner, of mall sales, with the top 10 Grant Thornton in the U.S. averaging more than $1,000 per square foot, or 2.5 times the industry average, according to data from Fung Global Retail & Technology.

As they evaluate opportunities, investors are doing more legwork before taking on projects, looking closely at population trends and lease

32

middlemarketgrowth.org

terms, says Greg Ross, national managing partner for the construction, real estate, hospitality and restaurants industry practice at accounting firm Grant Thornton. According to historical deal volume data from real estate research firm CoStar, private equity investment in U.S. malls in the past decade peaked in 2015, and 2017 appears to have had significantly less activity, though numbers are still being compiled.

“The focus for private equity is on major metro areas,” Ross says. “Location is the key.”

LOCATION, LOCATION, LOCATION …

AND CREATIVITY The creativity of developers is as important as location as innovative retailers look for ways to compete with online sales, says Ronald Goldstone, senior vice president of NAI Farbman, a suburban Detroit-based real estate developer and brokerage. And that means coming up against 1970s zoning laws that don’t take into

account the more sophisticated, mixed-use plans of today.

Despite complicated ordinances, repurposing must happen without delay, says Steve Agran, managing director at New York-based investment bank Carl Marks Advisors. “They’ve got to view (a property) as something they can turn around in a short period of time—something they can monetize quickly,” he says, adding that PE investors simply can’t afford to sit on large real estate holdings.

Agran contends that the shopping mall needs to foster a sense of community, incorporating residential space into the commercial mix. “We have a complete upheaval in the industry, and we are running up against (retail) overcapacity … so we’re seeing heavy-duty repurposing, whether it’s a car dealership in a section or housing and condos above ground,” he says.

Paul Laudano, chair of the real estate department of Boston-based law firm Choate Hall &

Stewart LLP, notes that the shifts in retail are not a brand-new phenomenon. “These are gradual trends, and it is a fair hypothesis that the better-located and more flexible assets will survive just fine in the foreseeable future,” he says.

E Class A malls attract investors

CHOOSE WISELY High-end malls are attractive to investors for their revenue potential, but the most deeply discounted real estate assets lie outside major metropolitan areas. Many remaining malls in the United States, especially those in rural areas, have seen a drop in sales, as their anchor retailers, such as Sears, Macy’s and JCPenney, shutter stores.

“Everyone is certainly talking about anchors going away and the need to completely reposition regional malls,” Laudano says.

Despite lower levels of private equity activity, mergers and acquisitions of mall real estate are trending upward, according to JPMorgan Chase & Co.

MIDDLE MARKET GROWTH // MAR/APR 2018

33

“There is increased activity globally in the regional mall space in the form of mergers and acquisitions, shareholder activism, and buying from well-known value investors,” the bank wrote in a note, reported by Bloomberg, before Westfield’s announcement. “This activity reflects a sector trading at a material discount to fundamental valuations.”

THE PRIVATE EQUITY ADVANTAGE Filling space left by a massive anchor store can be challenging but not insurmountable, says Joshua Harris, academic director and clinical assistant professor of real estate at New York University’s Schack Institute of Real Estate. He points to the addition of a Xerox SunPass customer service center and a Bed Bath & Beyond commerce call center at the lagging West Oaks Mall in the Orlando metropolitan area; department stores Sears and Belk had vacated the property, which is now owned by private equity firm Moonbeam Capital Investments.

According to Harris, private equity players have an advantage. “They don’t have quarterly reporting requirements, and they have the free cash needed to do rehabs and conversions, and to change the configuration for new tenants,” he says. “Private equity is looking for deals, but it’s very individualistic.”

It takes the right spot, the right government incentive, and the right people to make the repurposing work. Once a big retailer goes under, that’s when a value-oriented investor can come in, add capital, and turn a property around, he says.

“For a mall to work, it has to be all about innovation—delivering on experience, whether it’s concerts, spas, consumers going hands-on in an Apple store, upscale dining,” says Grant Thornton’s Ross. “In the past, the retail anchor was the thing. Now malls have to rebrand as family and entertainment centers.” //

34

CHANGING BEHAVIOR

A recent Cowen

Consumers

Hassles of online

Inc. report

like the brands,

shopping include

revealed that cus-

experience,

browsing challenges, difficulty

tomers still prefer

current styles and

to shop in physical

immediate gratifi-

with returns,

stores 75 percent

cation offered by

and inconsistent

of the time

physical stores

merchandise

Source: Cowen Inc., April 2017

“THESE ARE GRADUAL TRENDS, AND IT IS A FAIR HYPOTHESIS THAT THE BETTER-LOCATED AND MORE FLEXIBLE ASSETS WILL SURVIVE JUST FINE IN THE FORESEEABLE FUTURE.”

Myra Thomas is a business writer based in

PAUL LAUDANO

northern New Jersey.

Chair of Real Estate Group, Choate Hall & Stewart LLP

middlemarketgrowth.org

ACG has the top global network for middle-market businesses, hands down.

S E E T H E P O W E R T H AT MEMBERSHIP BRINGS. J O I N T O D AY AT W W W. A C G . O R G

THE POWER OF

© 2018 Association for Corporate Growth. All Rights Reserved.

POLICY POINTS

Regulatory Update

S SCOTT GLUCK Special Counsel, Duane Morris LLP

MORE ONLINE Find updates and insight on policy issues at middlemarketgrowth.org.

36

middlemarketgrowth.org

ince the formation of its Private Equity Regulatory Task Force in 2014, ACG has actively engaged with the Securities and Exchange Commission on a variety of issues to try to reduce the regulatory burden for middle-market private equity firms.

The past few months have been a busy time for PERT. At September’s annual PERT Washington, D.C., fly-in, PERT members met with SEC Commissioner Michael Piwowar to discuss some of the regulatory challenges that middle-market private equity firms face. Later, in October, ACG leaders had the opportunity to meet with the new SEC chairman, Jay Clayton. At the meeting with the chairman, we discussed: ɋɋ Broker-Dealer Registration – ACG explained why private equity firms taking transaction fees on their own deals should not be treated like broker-dealers and indicated the organization’s willingness to work with the SEC on drafting a potential no-action letter or providing other regulatory relief. ɋɋ Form PF – Advisers to private equity firms with more than $150 million of assets under management are required to complete Form PF annually, designed to

detect and deter systemic risk.

ACG explained that Section 4 of Form PF seeks portfolio company-​level information that does not help detect or deter systemic risk in any meaningful way, and the association urged the SEC to revise Section 4 or eliminate it altogether. ɋɋ Custody Rule – ACG urged the SEC to expand the relief granted in 2014 and determine that the custody rule should not apply to certain investment special-purpose vehicles where the only outside investors are, for example, employees of the portfolio company. ɋɋ Advertising/Marketing – ACG described some of the challenges posed by specific provisions of the advertising/marketing rule and requested helpful clarifications on matters such as firm websites and CEO testimonials.

ACG is actively following up on the meeting with Chairman Clayton and looks forward to a busy, productive 2018.

Scott Gluck, special counsel to Duane Morris LLP, works on regulatory issues on behalf of ACG Global.

“ACG IS ACTIVELY FOLLOWING UP ON THE MEETING WITH CHAIRMAN CLAYTON AND LOOKS FORWARD TO A BUSY, PRODUCTIVE 2018.”

From the Legislative Front

A

CG has been very active with advocacy efforts on Capitol Hill, as the impact of tax reform is of great importance to the middle market.

ACG is an active member of the Businesses United for Interest and Loan Deductibility, known as the BUILD Coalition, which has advocated in both the House and Senate for maintaining the full deduction for business interest expense in the tax code. Through the BUILD Coalition, ACG has leveraged its relationships with lawmakers on both the House Ways and Means and LANGSTON Senate Finance Committees in order to advocate for EMERSON the middle market. Executives from ACG member Managing Director, firms visited Capitol Hill during the ACG Global Public The Cypress Group Policy Summit in September and discussed the issue of interest deductibility with lawmakers on both sides of the aisle. ACG will continue to advocate for interest deductibility treatment and other tax issues of importance to the middle market, such as carried interest and pass-through treatment.

ACG has also engaged with SEC staff members and commissioners—including Chairman Jay Clayton and Commissioner Michael Piwowar. Piwowar spoke at “ACG WILL CONTINUE TO the Public Policy Summit in order to address midADVOCATE FOR INTEREST dle-market issues, such as DEDUCTIBILITY TREATMENT investment adviser regisAND OTHER TAX ISSUES OF tration and broker-dealer concerns. Furthermore, IMPORTANCE TO THE ACG has proactively disMIDDLE MARKET...” cussed with lawmakers in both chambers implementation of registration changes mirroring the provisions in the House-passed H.R. 5424, such as amending Form PF and the custody rule. The association will continue to engage in discussions with both the SEC and lawmakers on Capitol Hill about implementing these and other middle-market regulatory relief provisions. //

CRACKING THE COMPLIANCE CODE Become a Member of ACG’s Private Equity Regulatory Task Force

ACG PERT gathers together CFOs, CCOs and in-house legal counsel of middle-market private equity firms nationwide. As a member of PERT, your firm will join a national network focused on shaping compliance best practices alongside federal regulators.

FOR MORE INFORMATION, CONTACT CHRISTINE MELENDES,

Langston Emerson is managing director of The Cypress Group, a Washington, D.C.-based advocacy firm that lobbies on behalf of ACG Global, among other clients.

AT CMELENDES@ACG.ORG. © 2018 Association for Corporate Growth. All Rights Reserved.

MIDDLE MARKET GROWTH // MAR/APR 2018

37

GROWTH ECONOMY

WASHINGTON // 1998–2015 Large private equity-backed companies with more than $1 billion in sales led the way for job creation in the state of Washington between 1998 and 2015, accounting for nearly 74 percent of jobs growth. IT saw the greatest share of deal flow in the state, accounting for 40 percent, followed by business-to-business transactions, which made up 18 percent of deal flow between 2003–14.

JOBS GROWTH % BY SEGMENT

SALES

0% 4.6% 14.2% 7.5% 73.8%

ACG SEATTLE

SALES GROWTH % BY SEGMENT 13% 12.8% 31%

SALES GROWTH IN PE-BACKED BUSINESSES

SALES GROWTH IN ALL BUSINESSES

39.3%

56.6%

4.7% 38.5%

Small: Less than $10M in sales MM Seg 1: $10-50M in sales MM Seg 2: $50-100M in sales

TOTAL CAPITAL INVESTED IN WASHINGTON IN 2015

$5.67 BILLION

MM Seg 3: $100M-1B in sales Large: More than $1B in sales

JOBS

GROWTH IN PE-BACKED BUSINESSES

GROWTH IN ALL BUSINESSES

153.2% 30%

JOBS CREATED

BY PE-BACKED BUSINESSES

38,629

MORE ONLINE See the impact of middlemarket private equity on your state at GrowthEconomy.org.

All stats are from PitchBook and the Business Dynamics Research Consortium at the University of Wisconsin-Extension.

38

middlemarketgrowth.org

I found the right investor to grow my client’s business through ACG. S E E T H E P O W E R T H AT MEMBERSHIP BRINGS. J O I N T O D AY AT W W W. A C G . O R G

THE POWER OF

© 2018 Association for Corporate Growth. All Rights Reserved.

Photos by Robert Seale

IN FOCUS INSPERITY

The Human Touch

Insperity Handles HR from Pre-Acquisition to Strategic Execution

A

t age 29, Paul Sarvadi had an epiphany.

A born entrepreneur, he had already launched several businesses, but he hadn’t yet found his niche. He learned enough, though, to know that any company’s success depended on five key areas: finance, sales, operations, technology and people.

“What struck me as astonishing was the fact that the success of the first four areas depend on execution by the fifth—the people,” Sarvadi says. But many small and midsize companies didn’t have the bandwidth or expertise to fully capitalize on this vital asset.

So in 1986, Sarvadi co-founded a company to help these businesses achieve success by making the most of their human capital. The company, called Insperity, would specialize in human resources (HR), handling that entire function for small and midsize companies. Eleven years later, he took the company public, and today Insperity has nearly $3 billion in revenue. Sarvadi, chairman and CEO, has remained at the helm throughout the company’s 31 years.

In the beginning, Sarvadi had to launch not just a company but an entire industry. The idea of outsourcing HR was new, and it didn’t fit into the existing regulatory framework. Sarvadi

Content Provided by ACG Partners and Featured Firms

pioneered a novel legal construct called co-employment, whereby Insperity entered into a relationship with a client company and the client’s existing employees, including the business owner. Under this arrangement, Insperity assumed or shared many of the responsibilities of being an employer. Then Insperity could aggregate the employees of all its clients on a common platform, which created a way for small companies to offer big-company benefits at a reasonable cost. Sarvadi fought and won a number of legal and regulatory battles, establishing a basis for what has become known as the Professional Employer Organization, or PEO, industry.

Today that industry is estimated to generate more than $136 billion in gross revenue.

Insperity is based on a philosophy that values people above all. Among the key tenets are that businesses should hire people for their input (i.e., their creativity and talents), and should recognize the value of how each individual contributes to the success of the whole. That’s especially important in the middle market. “In small and midsize companies, every person needs to be a game-changer, because there are not that many people,” he notes. The company also encourages a healthy work-life balance.

MIDDLE MARKET GROWTH // MAR/APR 2018

41

“OUR GOAL ISN’T JUST TO PROVIDE HR SERVICES. OUR GOAL IS TO HELP BUSINESSES SUCCEED. IN THIS WAY, WE HELP THEM REACH FINANCIAL OBJECTIVES, MAXIMIZING VALUE WHILE MINIMIZING RISK. IF THAT’S NOT WHAT PRIVATE EQUITY’S ABOUT, I DON’T KNOW WHAT IS.” PAUL SARVADI Chairman and CEO, Insperity

That philosophy informs the services Insperity provides: handling employee benefits, including health, dental and vision insurance; 401(k) plans; payroll processing; HR administration; workers’ compensation; and regulatory compliance. It also helps with hiring and retaining talent.

These factors bolster the valuation of a company. A study by Insperity compared the valuations of public companies on Fortune’s 100 Best Companies to Work For list with other

INSPERITY AT A GLANCE Founded: 1986 in a 600-square-foot office Headquarters: Kingwood, Texas Public listing: 1997 on the NYSE under ticker symbol NSP 2016 revenue: $2.9 billion Number of employees: 2,700 Number of businesses served: Over 100,000 Range in size of customers: From five to 5,000 employees Contact: www.insperity.com/acg; (866) 814-6817

42

middlemarketgrowth.org

public companies of similar sizes in the same industries. It found that the best companies to work for were consistently valued higher, retained more of their value in economic downturns, and recovered more quickly.

Insperity’s HR services can help private equity firms to standardize HR across their portfolio companies as well as their own organizations. This reduces costs and risk, while freeing management to focus on business strategy and execution.

For example, Los Angeles-based private investment firm StoneCalibre sought help in managing HR across its portfolio companies. “We needed HR oversight to help ensure compliance with employment laws,” says Mike Drury, the firm’s CFO and portfolio manager. “We also wanted our employees to have big-company benefits without the administrative burden of managing our own plans.” By using Insperity, the portfolio companies benefit from Insperity’s expertise, their HR is run efficiently and smoothly, and StoneCalibre “can focus on what we do best,” Drury says.

Insperity also helps ensure alignment between an organization’s goals and its HR strategy. “Our goal isn’t just to provide HR services,” Sarvadi says. “Our goal is to help businesses succeed.”

Insperity assesses portfolio companies to make sure their HR strategy aligns with the PE firm’s objectives. Sarvadi adds: “In this way, we help

them reach financial objectives, maximizing value while minimizing risk. If that’s not what private equity’s about, I don’t know what is.”

Evaluating the leadership and staff of potential acquisitions is an especially valuable Insperity service. “When you’re buying a company, you may start with the financials and the multiples, but what’s driving those numbers are the people who are executing their roles every day,” Sarvadi says. Insperity is an independent party that can make an objective assessment. Often a company’s stated policies and practices differ from how things really operate. “Many times those don’t exactly line up because there has not been systematic and strategic thinking,” Sarvadi says. A clear-eyed evaluation reduces risk and increases the odds for success. “When you’re in the PE business, you’re going to win some, you’re going to lose some, and you’re going to lose more than you win,” he explains. “But if you can find out and avoid potential loss up front,

your winning percentage is going to be much better than the next guy’s.”

Once a deal closes, Insperity helps ensure alignment and smooth integration of processes at the newly purchased business. “The last thing we want (when acquiring a company) is an avoidable glitch with negative employee impact, such as mishandling payroll,” Drury says. “Working with Insperity helps ensure the integration process into StoneCalibre is as smooth as possible.”

When Sarvadi launched Insperity, he could not have foreseen how successful his company, and indeed the PEO industry, would become.

But his faith in the value of people and the role they play in business success has not wavered.

In fact, with today’s low unemployment rate, hiring and retaining talented people is more important than ever. With Insperity’s help, private equity firms can build and profit from that human capital. //

E Paul Sarvadi has been at Insperity’s helm for 31 years

MIDDLE MARKET GROWTH // MAR/APR 2018

43

THE PORTFOLIO

Data Analytics and the Real Estate Industry

BY THE NUMBERS // Technology Investments Give REITs a Competitive Edge

A Greg Ross National Managing Partner, Grant Thornton LLP

s with many industries, the real estate sector is experiencing great change as technology creates new ways of operating. Real estate investment trusts, or REITs, continue to play a major role in the industry and are working to implement the technological changes needed to keep up with the rest of the industry as it matures. Technology can enable better decision-making within the REIT sector, yet historically speaking, REITs have struggled to leverage data as efficiently as they might. This is often because systems and capabilities have not been put in place, and integrating existing data in a way that makes analysis possible is a common pain point.

Investment in technology—and the talent needed to take advantage of that technology— should be on the radar of all REIT executives.

From the outset, these investments must be evaluated in terms of the impact of growth of the REIT portfolio.

What REITs Should Consider Often the first consideration is whether a large investment in a new enterprise resource planning system should be made. In other cases, there may be the opportunity to add on capabilities to existing systems, such as property management software. When considering such an expenditure, management should consider the increased value that might be derived from enhanced access to information and analysis.

There is no standard answer, and larger organizations may well have already planned for enhanced systems.

Examining the end goals and priorities for each organization and its stakeholders will help with this decision. Whether considering a cloud-based system, or something more modest, specific features that will serve industry needs should be paramount among the considerations.

44

middlemarketgrowth.org

Focus Areas for REITs and Data Analytics Growth plans, new property investments and other changes in the business require reporting systems that enable management to monitor the current situation as well as forecast for future goals. Key elements to making REIT reporting more robust include: ɋɋ Accessibility of data across the portfolio ɋɋ Ability to integrate data from disparate properties ɋɋ Consistent reporting to provide a comprehensive view of all holdings The introduction of analytics software will aid in implementing all these elements. This will drive greater return on investment, demonstrating the value of the initial technology investment to the REIT. Ultimately, increased use of analytics will also lead to savings in time and labor load, greater transparency and improved results for stakeholders. In the long term, REITs that adopt and utilize a data analytics approach will drive stronger performance and a competitive edge in a highly competitive industry. //

WHAT CAN BE GAINED THROUGH DATA ANALYTICS? ɋɋ Process efficiencies ɋɋ Enhanced decision-making ɋɋ Quick access to reporting ɋɋ Improved forecasting

Greg Ross leads Grant Thornton’s construction, real estate, hospitality and restaurants industry group, drawing on more than 25 years’ experience with clients in these sectors. He also has significant experience advising an array of public and private companies.

Content Provided by ACG Partners and Featured Firms

THE PORTFOLIO

The Real Estate Question in Distressed Deals SOUND DECISIONS // Is It Better to Buy or Lease a Struggling Company’s Real Estate Assets?

W

hen purchasing a leveraged or distressed company, a buyer often must decide whether to acquire the real estate associated with the operating business or to lease it instead.

Howard Bailey, CTP Senior Managing Director, Arch + Beam, San Francisco Bay Area

Matthew English, CTP, CIRA Senior Managing Director, Arch + Beam, San Francisco Bay Area

The Pros There are compelling reasons to purchase the real estate along with the operating business.

Historically, real estate has appreciated over time and the equity can increase, but this is uncertain and can take time.

A real estate owner will also avoid lease-rate market fluctuations because the lease rate is fixed (or in one’s control). The operating business need not be concerned about a landlord dramatically increasing real estate lease costs at the termination of a lease.

Finally, significant appreciation of real estate value can create excess equity that might be accessed via a real estate refinance to help fund working capital for the operating business.

The Cons There are also downsides to acquiring the real estate along with the operating business.

Banks look at aggregate exposure, and real estate financing potentially limits an acquirer’s ultimate borrowing amount. And if the credit profile deteriorates, borrowing costs could increase substantially. Meanwhile, many leveraged cash-flow and asset-based lenders typically do not favor real estate loans or collateral.

In the event of a restructuring or bankruptcy, there are more options with a lease than an owned property. We have worked with companies that have rejected multiple leases within the first 30 days, including moving from their headquarters to a lower-cost location, which isn’t possible if the real estate is owned.

Lenders will typically require landlord waivers

Content Provided by ACG Partners and Featured Firms

that enable a lender, at a fixed cost, to enter rented property legally to access and sell collateral for a period of months in the case of a loan default of the operating company. This can delay a sale of the real estate even if it has been excluded from the lender’s collateral.

The purchase of real estate makes the buyer part of the chain of title that could result in the company, directors and officers being held liable for environmental clean-up costs if the real estate is found to have contamination issues—at times even if they were caused by a prior owner.

Key Considerations Acquirers that decide to lease must understand whether the lease is below, at or above market.

Will the landlord want to keep you as a tenant in the long term?

It’s advisable to evaluate whether there are cost-effective alternative real estate locations that could be leased. If the company requires very specialized real estate or zoning and it would be costly or impossible to move to a new location, then leasing can create a significant risk, and the operating business could be impacted negatively should the lease not be renewed. Thus, obtain favorable terms with multiple lease extensions or purchase options.

For those that choose to buy, consider financing the real estate separately with a long-term lender, such as an insurance company. Try to avoid cross-collateralization in your credit agreements to keep real estate truly separate.

Finally, speak with a tax accountant and an attorney about the best legal entity structure to hold the real estate, whether it be standalone, parent-sub or part of the operating company. // Howard Bailey, CTP, and Matthew English, CTP, CIRA, are senior managing directors of Arch + Beam, a restructuring and advisory firm.

MIDDLE MARKET GROWTH // MAR/APR 2018

45

ACG@WORK

ACG NEW YORK F ACG New York introduced its first Middle Market Week on Nov. 27–Dec. 1, featuring a variety of events for dealmaking professionals to network and enhance their long-term relationships. On Nov. 29, the chapter hosted its premier event, the 15th Annual Wine Tasting (pictured), where more than 900 attendees networked while sampling fine wines.

H ACG WESTERN NEW YORK ACG Western New York hosted its launch meeting on Nov. 20 at The Buffalo Club.

Local industry professionals spoke about the corporate growth and activity in Buffalo, New York, that prompted the formation of ACG’s newest chapter.

ACG NATIONAL CAPITAL F More than 130 attendees heard from former Fox News host Gretchen Carlson at the Washington Women’s Leadership Initiative Luncheon on Oct. 16. Carlson was promoting her new book, “Be Fierce: Stop Harassment and Take Your Power Back,” in which she addresses abuse and injustice in the workplace.

46

middlemarketgrowth.org

H ACG ATLANTA On Nov. 2, ACG Atlanta recognized seven outstanding Deals of the Year at the Atlanta History Center. More than 120 people attended to see which of the finalists would walk away with the awards. Pictured (from left) are Scott Kingsfield, Luminate Capital Partners; Jimmy Frangis, PDI; Lisa Ramji; Asif Ramji, Paymetric; and Melanie Brandt, ACG Atlanta.

G ACG ORANGE COUNTY ACG Orange County hosted its Finance Meets Fashion event on July 19 at Bloomingdales. This women-focused event featured a fashion show spotlighting the latest trends in business attire.

E ACG NEW JERSEY ACG New Jersey hosted its Women of Leadership annual summer event on Aug. 10 at the Liberty House in Jersey City. Attendees played trivia and networked in front of beautiful views of the New York skyline.

MIDDLE MARKET GROWTH // MAR/APR 2018

47

ACG@WORK

H ACG CENTRAL TEXAS TOAST TO PRIVATE EQUITY ACG Central Texas hosted over 100 people at its Toast to Private Equity reception on Oct. 25 at the InterContinental Stephen F. Austin Hotel in Austin, Texas. Attendees honored middlemarket private equity investors from across the state for their contributions to the regional economy.

ACG CENTRAL TEXAS TWOSTEP CONFERENCE F On Nov. 2, more than 90 people attended ACG Central Texas’ 5th Annual Private Equity Two-Step conference at the Plaza Club in San Antonio. Attendees heard from private equity firms looking to invest in technology companies in Central Texas. Pictured is Tom Caughlin of The CapStreet Group.

CONTACT Want to share photos from your recent chapter event? Email us at editor@acg.org.

48

middlemarketgrowth.org

H EUROGROWTH More than 200 international deal-makers convened in London on Nov. 6-7 for EuroGrowth 2017, ACG’s premier networking event for cross-border M&A. The opening reception (pictured) allowed attendees to mingle and jumpstart their networking.

EUROGROWTH F EuroGrowth keynote speaker Lord Karan Bilimoria, founder and chairman of Cobra Beer and the Cobra Foundation, shared his story of building the Cobra Beer partnership with Molson Coors and his company’s commitment to social responsibility.

H EUROGROWTH—ECONOMIC REVIEW OF EUROPE Journalist and Editor Stuart Rock (far left) moderated the EuroGrowth keynote panel, Economic Review of Europe, featuring David J. E. Chmiel, managing director, Global Torchlight; Kallum Pickering, senior U.K. economist, Berenberg Bank; and Trevor Williams, economist and visiting professor, Derby University. The panelists discussed the economic and investment landscape of Europe and the effects of Brexit.

—Compiled by Hollie Merrick

MIDDLE MARKET GROWTH // MAR/APR 2018

49

THE LADDER

MICHAEL MCSTAY has joined the Chicago office of McDermott Will & Emery as partner of the corporate and transactional practice group.

McStay will focus on middle-market private equity and counsel clients on complex transactional matters.

MICHAEL MCCARTHY has joined international law firm Dorsey & Whitney LLP in the firm’s real estate and land practice group as partner in New York. McCarthy will focus on representing commercial lenders and borrowers in connection with mortgage and mezzanine financing secured by commercial real estate.

McCarthy was previously a partner with Haynes and Boone LLP in its real estate practice.

JOSEPH LEHRER has been named senior vice president for Citibank’s asset-based finance group in Chicago. Lehrer will focus on sourcing, restructuring and closing ABL solutions for companies in the Midwest region. Lehrer joins Citibank with more than 25 years of experience in the commercial finance industry.

Grant Thornton LLP named RIMMA TABAKH leader of the greater Bay Area audit practice.

Tabakh will lead the practice and provide audit services to clients in the San Francisco and Silicon Valley offices. Tabakh most recently led audits of U.S.-listed companies in China for Grant Thornton China.

TROY JAMISON has joined Victory Park Capital, an investment firm focused on middle-market debt and equity investments, as chief risk officer for the firm’s nonbank financial services portfolio. Jamison will oversee the assessment and risk management of the firm’s credit and equity portfolios.

He joined Victory Park Capital from Capital One with more than 20 years of experience.

BRIAN STEEL has been named chief executive officer of Tenere Inc., a full-service provider of complex metal and plastic components and assemblies for Fortune 500 companies. Steel was promoted from vice president of global sales and marketing at Tenere.

MMG profiled Tenere in its February 2014 issue.

Platte River Equity announced that ANDREW GUSTIN has joined the firm as principal, head of business development. Gustin was previously with Hammond, Kennedy, Whitney & Company. He brings more than 10 years of experience to his new role, including sourcing new investment opportunities and developing new business relationships.

—Compiled by Hollie Merrick

MORE CAREER INFO Watch for more career information in The Ladder newsletter delivered to your inbox.

50

middlemarketgrowth.org

Share your insights on __________.

HOST A WEBINAR AND REACH 90,000 MIDDLE-MARKET PROFESSIONALS WORLDWIDE. ACG Middle-Market Insights webinars explore current issues with topical information. Expert content from your thought leaders will reach more than 90,000 middlemarket professionals in ACG’s broad professional network.

Contact Maggie Endres at mendres@acg.org // 312-957-4257 or Kathleen Gallagher at kgallagher@acg.org // 312-957-4270 © 2018 Association for Corporate Growth. All Rights Reserved.

IT’S THE SMALL THINGS

REAL ESTATE INDUSTRY TRENDS // If you build it, will they come?

1

2

Real Estate Is Having a Senior Moment Demand for more senior housing tops the list of all

5

Buildings Are Showing off Their Smarts A MarketsandMarkets report predicts the global

residential segments. With this group projected to

smart building market will grow to $24.73 billion by

grow by 25 million in the next 15 years, the present

2021 from $5.73 billion in 2016, increasing at a com-

supply is lagging.

pound annual growth rate of 34% over the period.

—PwC

—Constructiondive.com

Home Sales Growth Goes South When it comes to home sales growth, bet on

6

Invest for Success By 2020, investable real estate will have grown

southern cities to beat the national average in

by more than 55% compared with 2012. And by

2018. In particular, Tulsa, Oklahoma; Little Rock,

2025, emerging markets will host 60% of global

Arkansas; Dallas, Texas; and Charlotte, North

construction activity.

Carolina, are expected to see 6% growth or more,

—PwC

compared with 2.5% nationally.

—Realtor.com

3

Millennials Are the Perennial Favorite Millennials were the largest group of home buyers

Co-Working Is Flexing Its Muscles

(34%) for the fourth consecutive year, according

At the end of 2017, nearly 1.2 million people world-

to the National Association of Realtors’ 2017

wide have likely worked in a flexible work space.

Home Buyer and Seller Generational Trends study.

While 60% of all shared offices are not profitable,

By comparison, baby boomers represented 30%

co-working has definitely been a huge trend in the

of buyers.

last 10 years.

—NBC News

—Forbes.com

4

7

Real Estate Tech Is Virtually Unstoppable Despite the commercial failure of ’90s-era virtual reality products, commercial real estate professionals agree that VR’s time has finally arrived with virtual reality sales predicted to reach $40.26 billion by 2020, according to SuperData Research Inc. —GlobeSt.com

—Larry Guthrie, director, communications & marketing, ACG Global

WARM UP YOUR DEAL FLOW THIS MAY. JOIN

2,000

MIDDLE-MARKET

PROFESSIONALS INTERGROWTH FOR

2/3

OF

REGISTER

BY

IN

SUNNY

AT T E N D E E S

T O TA L APRIL

U.S. 27

PE &

W W W. I N T E R G R O W T H . O R G

*Data courtesy of PitchBook utilizing extrapolation methodology © 2018 Association for Corporate Growth. All Rights Reserved.

M&A

SAN

D I E G O.

ACCOUNT DEALS.*

SAVE

$400!

Look closely and see the world’s preeminent authority on maximizing asset value.

ACCOUNTS RECEIVABLE INVENTORY DISPOSITION

l

l IP

APPRAISAL

l

M&E

l

l

l

BRAND ADVISORY

RETAIL CONSULTING

l

EQUITY INVESTMENTS REAL ESTATE

l

SECURITY

An examination of Hilco Global today illuminates the unparalleled depth and breadth of our integrated services. Our team has a unique understanding of tangible and intangible assets built upon decades of experience in providing both healthy and distressed companies with creative solutions. We often support our recommendations with capital, sharing both risk and reward. As principal or agent, we have completed billions of dollars of transactions, and are truly vested in your success. Please contact Gary Epstein at +1 847 418 2712 or gepstein@hilcoglobal.com.

www.hilcoglobal.com North America / South America / Europe / Asia / Australia