Page 1

WINTER 2017

// THE OFFICIAL PUBLICATION OF ACG

STOPPING TRAFFIC

with Technology

AWP Keeps Infrastructure Projects on Track


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EXECUTIVE SUMMARY

Middle Market Growth Debuts First Official Print Issue

W

JASON BROWN Chairman, ACG Global and Partner, Victory Park Capital

elcome to the first official print issue of Middle Market Growth, a significant milestone in the history of this evolving magazine. Now in its fourth year, MMG has come a long way since it was launched in April 2013 solely as a digital publication. With a fresh redesign that preserves the look and feel of its predecessor, MMG is now mailed quarterly to all 15,000 ACG members as a new exclusive member benefit. Readers will continue to find inspiring growth stories about middle-market company gems, trends affecting dealmaking, policy updates from Washington, D.C., and much more. They’ll also find additional content, including video and podcasts on our companion website, www.middlemarketgrowth.org. In this inaugural print issue of ACG’s official magazine, we take a look at Cleveland-based Area Wide Protective Services, a trafficcontrol company that is tapping into demand for improving aging U.S. infrastructure. Aided by a capital infusion from private equity parent The Riverside Company, AWP provides safe, professional and comprehensive traffic management to an expanding client base throughout the United States. This edition also examines ways private equity can bolster investment from sovereign wealth funds. Ranging from the Hong Kong Monetary Authority to the Canada Pension Plan Investment Board, SWFs are increasingly choosing to buy into private equity funds or to co-invest alongside them. On the public policy front, ACG’s efforts continue to gain traction. In September the U.S. House of Representatives passed H.R. 5424, a bill that would significantly modernize compliance requirements for midsize private capital providers. Other noteworthy advancements include the launch of an ACG political action committee, a move sure to heighten the organization’s visibility on Capitol Hill. Finally, as we look back on the success of the fourth EuroGrowth convention in Barcelona, ACG is gearing up for another blockbuster, InterGrowth, in Las Vegas in April 2017. Whether at these marquee conventions or any of the other 1,200 regional events hosted by ACG’s 59 chapters worldwide, members have year-round access to premier networking and thought leadership opportunities.

MIDDLE MARKET GROWTH // WINTER 2017

1


WINTER 2017

DON’T MISS

14

POLICY POINTS An Overview from ACG’s VP of Public Policy 26

A QUALIFIED OPINION Jimmy Hawkins, Leon Williams Contractors 12

QUICK TAKES M-D Products Wins with Homeowner Essentials 11

Cover and above photos by Billy Delfs

IN THIS ISSUE Executive

GROWTH STORY

Summary 1

AWP: Stopping Traffic with Technology Area Wide Protective is simplifying the business of keeping roads safe with systems that screen and deploy flaggers to construction zones quickly and efficiently. Fresh capital from The Riverside Company is helping to expand the company’s U.S. footprint amid increasing demand for infrastructure improvements.

Executive Suite 6 Midpoints by John Gabbert 7 The Round 8 Vertical View 10 Growth

TREND

Economy 28

Sovereign Wealth Funds Spell Opportunity for Private Equity

In Focus–An Inside

Sovereign wealth funds—the giants set up by

ACG@Work 44

Look at BKD 30 The Portfolio 35

governments around the world for a range of projects—are upping their investment in private

The Ladder 46

equity funds, including those focused on the

2

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middle market. Find out of the best strategies

It’s the Small

to get on their radar. 20

Things 48


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TECHNOLOGY SMARTS RELATIONSHIPS

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For more information, please contact: BRIAN P. KERWIN, Chair, Corporate Practice Group 312.499.6737 | bpkerwin@duanemorris.com RICHARD P. JAFFE, Head, Private Equity 215.979.1935 | rpjaffe@duanemorris.com CHESTER P. LEE, Co-Chair, Real Estate Group 212.692.1018 | cplee@duanemorris.com www.duanemorris.com Duane Morris LLP – A Delaware limited liability partnership


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Strength, solutions and strategic growth for private equity Audit | Tax | Advisory | grantthornton.com

“Grant Thornton” refers to Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd (GTIL), and/or refers to the brand under which the independent network of GTIL member firms provide services to their clients, as the context requires. GTIL and each of its member firms are not a worldwide partnership and are not liable for one another’s acts or omissions. In the United States, visit grantthornton.com for details. © 2016 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd


EXECUTIVE SUITE

Real Estate and REITs: A Conversation Richard Silfen, partner at Duane Morris LLP, recently sat down with P. Sheridan “Schecky” Schechner, managing director and Americas co-head of real estate investment banking at Barclays. Here is an excerpt from their conversation:

P. SHERIDAN “SCHECKY” SCHECHNER Managing Director, Barclays Schecky Schechner joined Barclays in 2008 from Lehman Brothers. Before that, he was managing director and national head of mortgage origination for JPMorgan Chase & Co. He started his career in 1984 at Goldman Sachs. Schechner has a double-major B.A. in economics/political science and molecular biophysics/ biochemistry from Yale University and a J.D./MBA from Harvard University.

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Q

Q

A

A

As measured by the metrics, the real estate investment trust sector has performed admirably over the past decade. What is the state of play for new REITs? The market continues to be open to forming publicly traded REITs. While the number of IPOs is lower than in previous years, IPOs were quite successful in 2016, and there is no reason that trend shouldn’t continue. However, as has always been the case, REITs that go public initially trade at a discount to comparable shares, which has to be taken into account as part of the cost of taking an REIT public. So, if the discounted value is less than net asset value in the private markets, sponsors have to think harder about the benefits of being public. But that’s been true since the IPO markets for modern equity REITs began in the 1990s. With non-traded REITs, the flow of capital significantly slowed in 2016, from a high-water mark of close to $20 billion down to approximately $5 billion. The drop-off is primarily attributable to some changes in the regulatory regime, the exit of leading sponsors from the business and firsttime sponsors finding it difficult to raise capital. However, capital flows will most likely change with the anticipated entry of a prominent sponsor into the sector.

Do you have any thoughts for sponsors considering launching non-traded REITs in this environment? One of the larger players in the real estate market is entering the non-traded REIT sector, making significant changes to the load structure to increase attractiveness to investors and accessing a different distribution network. This could prove an effective approach and might provide a roadmap for others considering a non-traded REIT strategy.

Q A

Which real estate sectors are strong right now? Which are ripe for a correction? Mixed-use properties near transportation hubs show promise. Whether multi-family, or office and retail, including hotels, there are projects of varying density that seem to make sense. Industrial projects also are doing well, particularly when connected to e-commerce fulfillment. (See the Portfolio article on page 39 of this magazine.) Hotel properties have been oversold and may be due for recovery. By contrast, apartments seem to suffer from oversupply, and B-malls and power centers may struggle as brick-and-mortar operations face challenges from the online space. In urban offices, as tenants’ needs shift from offices to highwalled cubicles to open spaces, floor layouts will be reconfigured accordingly. It’s unclear who will benefit. //

Content Provided by ACG Partners and Featured Firms


MIDPOINTS by John Gabbert

Building for Tomorrow: Public-Private Partnerships’ Role in U.S. Infrastructure

T

he United States is in dire need of infrastructure investment. In a recent Report Card for America’s Infrastructure, the American Society of Civil Engineers estimated that $3.6 trillion in investment was needed by 2020. From hazardous waste to transit, no single segment of U.S. infrastructure received a grade higher than B-. Many have been long aware of this pressing need, which is why infrastructure was part of presidential candidates’ platforms and, recently, a $9-billion water infrastructure bill passed the Senate. But addressing the multiple challenges involved in refurbishing American infrastructure shouldn’t be thought of solely in terms of politics and the public sphere. Rather, the role of private market actors including all types of private equity funds should be emphasized, particularly as public-private partnerships could prove one of the most effective tools in policymakers’ arsenals. Given the low cost of municipal bonds and ongoing debate around the costs and benefits of privatization, public-private partnerships can prove to be a bit of a wild card, but that is only currently. Recently, the Internal Revenue Service released a regulation that made it easier for infrastructure projects to be financed by public-private partnerships, essentially by clarifying what can and can’t be real property for REIT purposes. Furthermore, given the broader global investment landscape, U.S. infrastructure is becoming a more compelling

area in which to invest, given its lower volatility and risk profile. Granted, there are valid concerns, such as already-competitive pricing for the best-placed projects and the necessity for experience in infrastructure investment and ensuing business models. But as LPs grow more accepting of longer-term fund lifecycles and PE fund managers continue to face difficulties in traditionally sourcing quality deal flow, shifting focus to public-private partnerships to address infrastructure issues could prove JOHN GABBERT fruitful. Brownfield opportunities Founder and CEO, PitchBook (where existing projects such as toll roads or airports are turned over to private parties) as well as greenfield (construction of new assets) projects are everywhere in the United States. Take IFM Investors’ purchase of Indiana Toll Road Concession Company in May 2015, which had 70+ U.S. pension funds supplying significant equity even as the “…THE ROLE OF PRIVATE capital structure included MARKET ACTORS INCLUDING debt with maturities as long ALL TYPES OF PRIVATE as 40 years, as proof of both global investors’ hunger for EQUITY FUNDS SHOULD BE solid infrastructure opporEMPHASIZED…” tunities and LPs’ flexibility. Over the past few years, PE activity within the construction, rail, road and infrastructure sectors in the U.S. has been more than healthy; $14.6 billion was invested in 2015. This year has seen significant slowing, but increased political urgency, plus more amenable regulations around financing structures, will doubtlessly spur PE investors’ appetites. //

Content Sponsored by Dixon Hughes Goodman LLP

MIDDLE MARKET GROWTH // WINTER 2017

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THE ROUND

Morningstar Acquires Remaining Stake in PitchBook Founder John Gabbert to Continue as CEO

L

ongtime ACG Global partner PitchBook announced on Oct. 14 that investment research firm Morningstar would pay about $180 million to acquire the remaining 80 percent of the company it didn’t already own. The transaction will value the Seattle-based provider of M&A data at $225 million, PitchBook said in a statement announcing the deal. It allows Chicago-based Morningstar—which has historically focused on public companies—to apply its core data and software capabilities to private and institutional investors. “Data has always been Morningstar’s sweet

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spot, and we look forward to working with PitchBook to help investors and advisers better understand and navigate this evolving area of the market,” Morningstar President and incoming CEO Kunal Kapoor said in a statement. PitchBook Founder and CEO John Gabbert, who began the business in 2007 at the height of the Great Recession, will continue to run the company, which now serves some 1,800 customers seeking data on private equity, venture capital and other M&A deals. PitchBook had $31.1 million in revenue for the trailing 12 months ended June 30 and more than 300 employees.


“Joining forces with Morningstar will help us enter into our next stage of growth, including developing the next-generation version of our award-winning data and software platform, investing in our world-class sales and customer support functions, and expanding our business in Europe and Asia,” Gabbert said in a statement. PitchBook said its strong growth is reflected in sales bookings that have grown by a compound annual rate of more than 70 percent for the five years ended Dec. 31, 2015. ACG, for its part, will continue its close ties with PitchBook, which is a sponsor and partner at InterGrowth, EuroGrowth and a multitude of ACG chapter events. ACG members will continue to have access to the PitchBook platform formerly known as CapitalLink, said ACG Global President and CEO Gary LaBranche. “We look forward to continuing ACG’s beneficial partnership with PitchBook,” LaBranche said. In a blog post speaking about the Morningstar deal shortly after its announcement, Gabbert said: “PitchBook is all about the people—and this team is the biggest reason why we are successful. We call ourselves PitchBook Panthers…because we relentlessly pursue our work like a panther does, and I think we’ve done just that. I’m proud to be a Panther.” —Deborah L. Cohen

CEO’s Politics Influences Employees, Says Study

THE POWER OF

Do CEOs affect the political choices of their workers? Yes, according to a new study from university researchers. Company employees give three times more money to political candidates supported by their CEO than to those that are not, according to the August 2016 study, “Do CEOs Affect Employees’ Political Choices?” The study relied on data from the Federal Election Commission between 1999 and 2014. “It seems like there is a direct effect from CEO to employee,” says Ilona Babenko, an associate professor of finance at Arizona State University. Babenko, along with co-researchers from Italy’s Bocconi University and Switzerland’s University of Lugano and Swiss Finance Institute, examined a large sample of S&P 1,500 companies, based on individual contributions from employees. CEOs who tell their employees how politicians’ platforms will impact their companies can significantly influence workers’ political contributions and subsequently how they vote, says Babenko. However, executives must be very careful not to cross any ethical lines by coercing workers or tying politics to advancement or compensation, she adds. // —Deborah L. Cohen

ACG offers access to a global network of more than 90,000 top middle-market M&A professionals, including over 14,500 members in 59 chapters across 11 countries. Grow your business by connecting with the right people using ACG’s fully searchable

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SEE ALL THE BENEFITS THAT MEMBERSHIP

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MIDDLE MARKET GROWTH // WINTER 2017

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VERTICAL VIEW

Building Smart

Consulting services conglomerates WSP Global and Stantec tied for

The

$625 million

overall deal activity in construction in the past decade, each doing

27

purchase of

Target Logistics Management in 2013 by Algeco Scotsman illustrates PE’s appetite for portable housing—in this case built for remote workers.

transactions.

Faster, better, smarter. That’s why Honeywell International paid

$240 million in January for a 30% stake of

UOP Russell, which specializes in modular design.

BLUEPRINTS WITH A SIDE OF SERVICE Investment in companies

commercial services construction

offering components of service, including design, equipment such as cranes,

2014

448 20

is far outpacing those that solely construct buildings.

2015

From 2014 to August 2016 service deals numbered 1,176, compared to 43 for traditional building.

2016*

463 13 265 10

*through August

DEALS

logistics and rental of

“THE WORLD OF CONSTRUCTION LOGISTICS, SERVICES AND DESIGN REALLY APPEARS TO BE THE PREFERRED INVESTMENT.” HENRY APFEL PitchBook Analyst

All stats are from PitchBook.


QUICK TAKES

M-D Building Products: DIY Stuff with Staying Power

M

-D Building Products Inc. provides essential weatherproofing products for residential homeowners—basic DIY offerings that help position the company itself to be somewhat impervious to economic fluctuations in the broader economy. Continued demand for weather seals for windows, door and garages is a main reason that private equity firm Cyprium Partners, which makes non-control investments in profitable midsize companies, took an undisclosed stake in July 2015. “(Weather stripping) is something that is a reasonably low price point but it’s necessary,” says Beth Haas, a Cyprium partner who sits on the Oklahoma City-based company’s board. “They’ve figured out how to really merchandise it and lay it out in a way that makes it easy for the consumer to figure out what they need.” Cyprium’s portfolio includes investment in other construction and building-related businesses, including BackYard Products, a maker of residential woodsheds and playsets; and Weaber Lumber, which offers flooring and other hardwood lumber products. Haas says M-D has refreshed long-time staples, which besides weather stripping include flooring thresholds, plumbing and pipe insulation and aluminum sheeting with new formulations and easier application, while leading the category through strong merchandising and consumer education.

“What they’ve done is really take in a product line that’s been around for a hundred years and through some different technology and adhesive make it a lot more user friendly and easier to install—as we’ve all collectively gotten less handy,” Haas says. “A lot of their products are a lot more user friendly.” With the help of Cyprium’s capital infusion, M-D Products is now on the lookout for add-on acquisitions

that can help it achieve greater scale, she says. “This was an opportunity to invest directly into a family-owned business that was really poised for a lot of growth and had a lot of strategic opportunities ahead of them—and hopefully us,” Haas says. // —Deborah L. Cohen

MIDDLE MARKET GROWTH // WINTER 2017

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A QUALIFIED OPINION

Jimmy Hawkins President, Leon Williams Contractors

“MOST BUSINESS OWNERS HAVE THREE OPTIONS: EXPAND CURRENT SPACE, RENOVATE OTHER EXISTING SPACE OR BUILD NEW FROM THE GROUND UP.”

Business growth is a good problem to have but it’s not without its challenges, especially for business owners who are about to outgrow their current office space. Jimmy Hawkins, president of Maryville, Tennessee-based Leon Williams Contractors, has worked with many different business owners during this exciting time in the growth of their businesses. He’s an expert in identifying and understanding the unique needs of each business. Hawkins spoke to MMG about finding the right commercial space for a growing company.

Q A

What are the options for business owners considering office space expansion? When they get to a point where they’re considering expansion, most business owners have three options: expand the current space, renovate another existing space or build new from the ground up. Every case is going to be different, based on the business’ needs, what’s available, time frame and obviously cost constraints.

Q A

What are the factors to consider when choosing an option? It all starts with the constraints on your existing space. If you already own the space, renovating it will probably be an attractive option. Depending on what you’re looking to accomplish, you’ll need to consider the restrictions on your property. For instance, do you have enough property for your expansion, or can you add additional parking? With renovations, though, a lot of business owners will think, “Oh, we can just reconfigure this,” and that it won’t take much time, but then there ends up being a duct or electrical chase that turns a seemingly minor

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alteration into a much larger job. Looking at existing spaces, whether in current location or another building, requires extra attention to everything from the electrical wiring to the water service, sewer, etc. It’s not just about the building feeling right or being in the right location; it’s also about whether it can be renovated to fit your specific needs. Other things to consider include whether the business would be able to continue its operations during the renovation period and your time constraints. If you exhaust all of these options, your best route might be to build from the ground up.

Q A

When should a business consider expanding its current space? Expansion is certainly a viable option for any growing business, but it requires the most coordination. It’s a great option when the current location is important to either the employees or customers and there is adequate room for the expansion or renovation. Renovations are distracting and if your office is already full, it can be very difficult to go through the process. This is also a more expensive construction model because there


may be after-hours work, dust-protection issues and phasing to keep areas usable during renovation. Renovation can also result in more unanticipated costs as it is difficult to know what concealed conditions may be encountered or what deficiencies may be discovered during the process. Phasing and unknowns can extend the time required for a renovation as well.

Q A

When should a business renovate another existing office space? Renovating a location off-site brings the same challenges and unknowns as renovating your current office space, but it allows the current business to continue without distraction. There is no need for phasing, so construction can begin immediately and be done more efficiently. This is a good solution when time is critical because the structure already exists and is not affected by weather conditions. I love this option as it can take existing empty spaces and bring new life to them. It allows users to be good stewards of buildings that are currently available, rather than letting them stand empty while building a new structure down the road.

Q A

When should a business consider building a new office space? Building a new office space allows business owners to get exactly what they want and start their design on a blank canvas. This is a great solution for companies with special requirements or those wishing to create a new brand or style. This is an exciting process, as the owner gets the opportunity to pick the site and to guide the looks and functionality of a building inside and out, without the restrictions that renovations impose. New construction can be a lengthy process with everything involved: land procurement, plan development, municipality approvals, site work and construction from the ground up. There can still be unknowns but they mostly exist underground. Keep in mind that the procurement, design and approvals can take every bit as long as the construction itself depending on the level of complexity. It is critical to select a team that has experience in your type of business because it will be more likely to quickly identify issues with the design before moving into the construction phase. //

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MIDDLE MARKET GROWTH // WINTER 2017

13


STOPPING TRAFFIC with

Technology AWP Keeps Infrastructure Projects on Track BY S.A. SWANSON

Photos by Billy Delfs


B

H AWP CEO John Sypek is working with his private equity backers to simplify traffic control

e safe.” That’s how John Sypek closes his work emails, and it’s more than just a well-wishing pleasantry. It’s the foundation of his company. Sypek is president and CEO of Area Wide Protective (AWP), which provides temporary traffic control, mainly for roadside utility workers. Each day, his front-line employees try to ensure safety for clients, motorists and themselves. He knows what they’re up against. Distracted driving isn’t a 21st-century invention: Consider that in 1956, Chrysler installed phonographs in some of its vehicles. But the widespread use of smartphones— including texting and social media apps like Snapchat—has shifted too many eyes off the road. In one survey of more than 1,900 U.S. drivers, 23 percent of respondents said they had seen people take selfies while behind the wheel. “I recognize the responsibility our people have, protecting the community, protecting the client,” Sypek says. On the face of it, that protection is fairly low-tech, with little change over decades (think orange plastic cones, flags and stop/slow paddles). But when you deploy more than 2,000 workers daily in 19 states—as AWP does—a surprising amount of technology exists in the background, streamlining business processes and reducing safety risks. Those upgrades were made possible by private equity investment, most recently by The Riverside Company, which acquired AWP in 2015. “We have the blueprint in place to more than double the size of the company within a couple years of our initial investment,” says Ryan Richards, a Riverside principal. Without strategic improvements in AWP’s tech, that growth potential would be severely limited. Says Sypek: “Technology is critical to successfully meeting our customers’ expectations for reliable, flexible service and in scaling our capabilities.”

MIDDLE MARKET GROWTH // WINTER 2017

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ENTER BLUE POINT AWP’s first outside invesAREA WIDE tor was Blue Point Capital. PROTECTIVE When it sought investHQ: Kent, Ohio ment opportunities for its second fund, worth $400 Services: Traffic control for million, it didn’t hunt roadwork, construction, utilities specifically for traffic-conScope: 2,000 workers operating trol companies. It had a in 19 states broader target: outsourced services for utilities. To Backing: Riverside Company, comply with regulations Blue Point Capital and improve business Strategy: Navigate hiring and models, utilities increaslogistics challenges with techingly outsource non-core nology functions, says Sean Ward, a Blue Point partner. WorkGrowth area: Infrastructure zone regulations can vary projects amid aging U.S. roads between municipalities, and bridges and when utilities don’t adhere to the rules, they can be cited for non-compliance by inspectors. When an auto accident occurs at a non-compliant site, it can create legal liabilities—not to mention bad publicity.  Although AWP does handle some special events such as marathons, revenue mainly comes from traffic services for utility maintenance and

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power outages. The nation’s aging infrastructure also keeps AWP busy, including water-main breaks and bridge repair. According to the American Society of Civil Engineers, about 240,000 water-main breaks occur annually in the United States, and one in nine U.S. bridges is considered structurally deficient. After considering a range of outsourcing businesses for utilities, including tree trimming, Blue Point recognized the significant growth potential in AWP, which is based in Kent, Ohio, just 40 miles from Blue Point’s Cleveland headquarters. In roughly 80 percent of its transactions, Blue Point has been the first private equity investor, Ward says. That trend continued with AWP, which joined Blue Point’s portfolio in August 2008; the firm won’t disclose details but says the investment fell within its typical range of $10 million to $50 million. Blue Point quickly brought in a CFO and implemented financial systems that provided real-time data. About 96 percent of AWP’s expenses are tied to labor, vehicles and fuel, and the CFO found ways to manage those variables better, Ward says. For example, before Blue Point, AWP didn’t hedge its fuel costs. Most of its client contracts specified an hourly rate (and still do), and when fuel prices increased, that hurt profit margins. AWP now buys forward a portion of the fuel it uses. “That led to some pretty attractive savings and allowed us to quote business with a higher understanding of our base costs,” Ward says. In 2009, Blue Point expanded AWP’s territory further south, acquiring Smyrna, Georgia-based U.S. Traffic Technologies. By June 2015, AWP’s EBITDA had increased more than 600 percent since Blue Point’s investment, with more than 75 percent organic growth. At that point, Riverside stepped in to acquire Blue Point’s majority investment (Blue Point reinvested and remains a minority holder in AWP). The investment was part of a $1.5-billion fund—the largest Riverside has raised so far. Riverside was impressed with AWP’s strong growth, which positioned the traffic-control


company as a market leader, says Richards, the Riverside principal. With AWP, Riverside saw favorable nationwide trends, including a steady climb in spending for U.S. infrastructure maintenance and construction. According to the U.S. Energy Information Administration, investment in new electricity transmission reached $14.1 billion in 2012, up from $2.7 billion in 1997.

LEAVE IT TO THE PROS By outsourcing traffic control, utilities can reduce risk and labor costs, says Tom Anderson, a Riverside operating partner. When they handle the process in-house, “it’s kind of a pain in the neck for them,” he says. “Their expensive labor—often unionized labor—will be doing traffic control. It’s not what they are trained to do.” At AWP, flaggers receive at least 20 hours of training before entering a work site and at least 40 (and traffic control specialist certification) before they can drive a company vehicle. That’s more than double the training hours provided by others in the industry, Sypek says. “Our No. 1 priority, the thing we think about

all the time, is providing safe and reliable traffic control specialists in field,” Anderson says. “That’s easy to say but hard to do.” For starters, it can be a thankless job. “They don’t get tremendous respect because some people think they are just standing there,” Sypek says. Among other things, “just standing there” can require more than eight hours a day in extreme cold, heat or rain. It can also be dangerous. Vehicle crashes in work zones injured 30,500 people in 2014, according to the National Safety Council.  With the job’s reputation—and a starting wage of $10 to $12 per hour for entry-level employees—it’s no surprise AWP struggles with retention (as does the entire traffic-control industry). So during the past year, the company created better opportunities for promotion and wage increases. But that still leaves AWP with a vetting problem. Turnover for flaggers is more than 100 percent a year, and some months AWP hires more than 500 entry-level workers from a pool of about 5,000 applicants, Anderson says.

E Road Crew: Anderson, Sypek and Richards

MIDDLE MARKET GROWTH // WINTER 2017

17


than 2,000 AWP workers receive automated texts with job details for the next morning. The workers confirm their schedule through a proprietary app. Previously, each of AWP’s 60 facilities handled job dispatch through a time-consuming manual process, says Sypek, who notes the new system enables quicker job confirmation, better accuracy and more flexibility.

Previously, the hiring process involved screening hundreds of candidates via phone interviews from AWP’s 60 facilities. Earlier this year, AWP implemented technology to help recruit the best candidates. After reviewing job requirements, would-be flaggers fill out an online questionnaire that predicts their safety and reliability. “In a matter of “OUR NO. 1 PRIORITY, minutes, we understand if THE THING WE THINK the candidate is well suited for the role and we can ABOUT ALL THE reach out to them for an TIME, IS PROVIDING interview,” says Richards, SAFE AND RELIABLE adding that the hiring process used to take two weeks TRAFFIC CONTROL or more. With the new SPECIALISTS IN FIELD. applicant tracking system, THAT’S EASY TO SAY it’s three to five days. Hiring isn’t the only proBUT HARD TO DO.” cess improved by technology. In 2016, the company TOM ANDERSON started using a centralized Riverside Operating Partner scheduling process, based on proprietary cloud-based software that takes customer requirements for more than 1,000 jobs each day, and matches them with capabilities and locations of AWP’s traffic control specialists. Each evening, more

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NAVIGATING COMPLEX WORK PLANS That’s something Nick Austin appreciates. He’s director of operations services at the Cleveland Electric Illuminating Co., which supplies power to about 750,000 northeast Ohio residents. The utility uses in-house traffic control for less-complicated jobs, but enlists AWP for about half of all roadside projects— many with last-minute changes. “The work plan that was laid out the week or month before is probably only 20 percent good, given weather conditions or other things,” Austin says. “AWP has shown it can roll with the dynamic nature of our scheduling.” Most of his crews consist of two or three people—at least one worker is suspended in a bucket 40 feet above ground, and another stands below, overseeing the project. Traffic rarely receives their undivided attention. “[AWP’s] job is to pay attention to those things, as opposed to having a lineman keeping an eye on his buddy in the air and also holding a stop sign,” Austin says. Previously when AWP created project work tickets, it relied on paper documents and a cumbersome process. The documents were collected at local facilities and sent to corporate headquarters, reviewed for accuracy and entered into the system. In 2016 AWP went paperless. Workers use tablets to fill out work-ticket information and submit it electronically to the corporate office, which reduces errors. Employees also use the tablets to confirm job completion with clients’ electronic signatures. What’s more, the tablet’s camera allows them to document proper setup of the work site.


Technology also nudges employees toward safer driving. This year, the company added a GPS system to its fleet of more than 1,400 trucks, and it tracks driver behaviors like sudden braking or speeding. AWP encourages managers at each facility to reward drivers who have top driver-safety scores with gift cards, AWP apparel and public recognition, Sypek says.

STRATEGIC OVERSIGHT In addition to helping AWP adopt technology, Riverside has also expanded the company’s territory. In just over 14 months, AWP completed three acquisitions: All State Traffic Control, in Bristol, Connecticut; N-LINE in Bryan, Texas; and Traffic Specialties Inc. in Stone Mountain, Georgia. “When we first learned about traffic management, we found that you can go to any small town and find a company doing this,” Richards says. While the barrier to entry is low, the barrier to scale is high—and that benefits AWP. “The utilities place a lot of value on being able to go to a large player…as opposed to cobbling

together 10 different “WE HAVE THE providers to cover their BLUEPRINT IN PLACE regional footprint,” he says. TO MORE THAN Amid the ongoing expansion, AWP’s metrics still DOUBLE THE SIZE reflect its mainstay safety OF THE COMPANY emphasis, Sypek says. “One WITHIN A COUPLE thing we look at is hours driven between occurYEARS OF OUR INITIAL rences, and over the last INVESTMENT.” few years that’s continued to improve each year.” RYAN RICHARDS He’s also noticed a Riverside Principal meaningful improvement in perception of the industry overall. “Before, I think traffic control was looked down upon,” he says. “It’s like, ‘Well, anybody can put out a cone and hold out a stop-and-slow panel.’ I really see that changing now.” // S.A. Swanson is a business writer based in the Chicago area.

MIDDLE MARKET GROWTH // WINTER 2017

19


Sovereign Wealth Funds Spell Opportunity for Private Equity BY MYRA THOMAS

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W

ith considerable assets at their disposal, sovereign wealth funds are fast becoming a growing source of capital for private equity— good news for middle-market PE funds. These state-owned investment vehicles, focused on returns to boost the economies of their home countries, tend to be long-term institutional investors with diverse investment portfolios. But their diversity presents hurdles for private equity firms looking to woo investment. Fund priorities vary, whether for pension obligations, savings, government policy initiatives or social welfare. In addition, the size, investment capacity and transparency of SWFs are as wide ranging as the cultures creating them. Compare, for instance, the State Administration of Foreign Exchange of the People’s Republic of China—worth $474 billion— which was set up to help manage China’s foreign exchange reserves, with the Alaska Permanent Fund Corporation, a $54-billion fund that can spend its profits on any public purpose in the state. According to the Sovereign Wealth Fund Institute, some $454.6 billion was allocated to private equity from sovereign wealth funds in the 12 months ended June 2016, up from $432 billion in the same period a year earlier. The top five private equity funders were Investment Corporation of Dubai, Temasek Holdings (Singapore), Mubadala Development Company (UAE–Abu Dhabi), China Corporation and the Qatar Investment Authority, according to SWFI data. One thing is clear: as SWFs chase higher-yield investments, private equity is getting a boost. And PE firms with a clear understanding of how to build relationships with them are winning the business. “Knowing a prospective (SWF’s) investment objectives, strategy and style preferences all help to avoid wasted efforts and resources,” says Patrick J. Schena, co-head of the Fletcher Network for Sovereign Wealth and Global Capital at Tufts University’s Fletcher School of Law and Diplomacy.

MIDDLE MARKET GROWTH // WINTER 2017

21


96

Global PE Buyout Deal Flow with SWF Investor Involvement

100

$

90

80

80

60

64

64

$

60 45

41

2006

2007

Capital Invested ($B)

2008

29

20

17

13

11

$

40

2009

2010

2011

2012

2013

2014

2015

Deal Count

*Through September 14, 2016; includes completed and announced deals

Average Buyout size:

$1,778.34M

Median Buyout size:

$588.40M

TAILORING THE APPROACH When private equity is ready to connect, a third party is one of the best ways to get an introduction, as well as to narrow information gaps, Schena says. Cross-border investment can be complicated, so an experienced investment banker, global law firm or placement agent can help facilitate a deal. “Because most sovereign wealth funds are non-U.S., the logistics of introductions, traveling and relationship-building will likely contribute to challenges and greater “YOU HAVE TO BE ABLE investment in time and resources,” Schena says, TO EXPLAIN YOUR adding that it’s important to build relationships with STRATEGY AND senior investment staff at EXPLAIN IT WELL, AND the SWF. IT ALWAYS HELPS TO SWFs are particularly HAVE CONTACTS.” interested in co-investment opportunities that MICHAEL MADUELL allow them to “sidestep the President of Sovereign Wealth Fund hefty fees that come with Institute traditional GP/LP partnership structures,” says Nizar Tarhuni, a senior analyst at PitchBook, the research firm that tracks private capital. “They can really participate in a larger

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ɋɋ Government of Singapore Investment Corporation ɋɋ Temasek Holdings ɋɋ Caisse des Depots Groups

5

0

9 0

21

20

16

17

18

30

33

18

20

$

18

40

$

51

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Most Active SWF Investors in PE Deals

2016*

0

Most Active PE Co-Investors with SWFs ɋɋ TPG Capital ɋɋ The Blackstone Group ɋɋ Bain Capital

chunk of the investment’s upside by holding equity in the direct asset being acquired.” Understanding the SWF’s future liabilities is also important, Tarhuni says. For instance, if a fund hails from a fairly resource-dependent country, that fund may need to hedge against potential downturns in commodity prices through a predefined minimum level of return, he says.

THE EARLY BIRD GETS THE WORM Private equity managers need to begin the investor relations process early, Tarhuni says, identifying if the SWF can benefit from the PE fund’s strategy and if the PE fund can adequately manage the outsized commitments SWFs typically deploy. Meanwhile, SWFs based outside of the United States often look to develop relationships with a private equity firm’s general partners before the PE fund actually comes to market. “Reaching out to them before a fundraising is officially launched is often the best way to proceed,” says Kelly DePonte, managing director for Probitas Partners, an independent global placement advisory firm. Stressing the wide diversity of SWFs, he says funds should tailor their pitches specifically to the SWF and avoid standard templates.


private equity

we do a great deal

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


Kelly DePonte

Josh Lerner

Michael Maduell

Due to their massive scale, SWFs typically look at the size of the private equity fund and not necessarily the size of the companies being bought, DePonte says, noting that when considering middle-market funds, they tend to prefer those with a minimum $1 billion or higher.

“MOST SOPHISTICATED SOVEREIGN WEALTH FUNDS HAVE STRONG CAPABILITIES IN-HOUSE, AND IF YOU HAVE A COMPELLING STORY AND GOOD RETURN NUMBERS, THEY’LL BE INTERESTED IN MIDDLE-MARKET GROUPS.” JOSH LERNER Harvard Business School

Once a private equity firm is in the door, it’s up to its fund manager to make a good case, says Josh Lerner, Jacob H. Schiff professor of investment banking and head of the entrepreneurial management unit at Harvard Business School. “Most sophisticated sovereign wealth funds have strong capabilities in house, and if you have a compelling story and good return numbers, they’ll be interested in middle-market groups,” Lerner says.

ADDITIONAL CONSIDERATIONS While compliance and risk management are concerns for any deal, the political climate and social concerns in an SWF’s home country also come into play. There are no hard and fast rules for managing reputational risk. While well-documented human rights violations might be impossible to ignore, other ethical considerations could be

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Patrick J. Schena

Nizar Tarhuni

more subjective, DePonte says. A fund manager needs to consider the potential for negative publicity and how it might impact other large investors in their fund. Regulatory and legal considerations vary by region. In the United States, PE funds are subject to the Federal Corrupt Practices Act, in addition to a host of other antitrust, banking and securities laws. Investment in U.S.-based entities by SWFs requires review by the Committee on Foreign Investment in the United States, or CFIUS. But according to DePonte, CFIUS focuses its efforts on foreign entities that buy controlling interests in U.S. companies.

THROUGH THE SWF LENS On the flip side, SWFs have their own legal and regulatory considerations, says Harvard’s Lerner. Investment bankers and other professionals familiar with a specific country can help navigate the challenges a cross-border deal might present. Time frames to close vary considerably by country. Working with SWFs in Asia and the Persian Gulf, for instance, can take more time than deals in Europe, says Michael Maduell, president of the Sovereign Wealth Fund Institute. “You have to be able to explain your strategy and explain it well, and it always helps to have contacts,” Maduell says. // Myra Thomas is a business writer based in northern New Jersey.


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POLICY POINTS

ACG Public Policy Impacts Beltway and Beyond

A

AMBER LANDIS ACG Global Vice President of Public Policy

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

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CG’s Washington, D.C., office has made tremendous progress carrying the voice of the middle market to political decision makers. Under the new administration and the 115th Congress, however, ACG’s advocacy work remains more challenging than ever. A potential repeal of Dodd-Frank, new leadership at the SEC and tax reform are just some of the changes on the horizon. That’s why the D.C. office has been working proactively through events including meetings and ACG member fly-ins to engage directly with regulators and legislators about ways to improve ambiguous regulations. ACG and its Private Equity Regulatory Task Force, PERT, helped to shepherd a bipartisan bill through Congress that promises to modernize 75-year-old reporting requirements for middle-market private equity firms. The bill—the Investment Advisers Modernization Act—tailors aspects of outdated legislation dating to 1940 to reflect the private equity investor model, while maintaining investor protections. On Sept. 9, the bill—H.R. 5424— received a favorable vote of 261 to 145. This progress is important and a first for ACG, but the Senate has yet to pick up companion legislation amid continued opposition from influential lawmakers.

Middle Market Public Policy Summit These and many other issues will be discussed at the Middle Market Public Policy Summit on Feb. 14. ACG’s Private Equity Task Force is working hard to arm ACG members with powerful resources. PERT members are developing best practices for compliance on hot button issues such as fees and expenses, cybersecurity, and advertising and marketing, among others. We are also gearing up for what will be a very active national discussion on tax and tax reform early in the new congressional session. In October, in partnership with ACG Houston, ACG invited House Ways and Means Committee Chairman Kevin Brady (R-Texas) to speak about the GOP’s “A Better Way Forward” tax plan. During the presentation, the chairman solicited input from ACG members. The goal of this tax blueprint is to allow Americans to complete their tax returns on a simple postcard. ACG continues to review and provide feedback on this tax strategy. Concerns include the chairman’s push to move away from the corporate interest tax deduction toward 100-percent expensing. In a study conducted by RGL Forensics and ACG, the elimination of CIT deduction would lead to a drop in equity value of middle-market companies by 6.3 percent, or $1.1 trillion in value. ACG continues to work with House Ways and Means Committee staff to help achieve a simpler,


fairer tax code that doesn’t penalize growing midsize companies. A New PAC As the industry has learned, government decisions made every day have the ability to impact all aspects of the middle-market economy, including companies’ bottom lines. ACG members can impact the policy process by being engaged and focused. The recent launch of ACG’s political action committee, dubbed simply the ACG PAC, will help achieve these goals. The PAC gives ACG a unified voice and provides a powerful political presence on Capitol Hill and back home in congressional districts. The bipartisan PAC will support candidates for federal office who understand private capital investment and that a robust middle market means a stronger American economy. For more information about the PAC, please visit www.acg.org/PAC. ACG members who are U.S. citizens are allowed to contribute personal funds up to $5,000 per calendar year to the ACG PAC. PAC contributions are not tax deductible. //

CONTACT

NEWS

Public Comment on PERT Principles In November, ACG’s Private Equity Regulatory Task Force released a public comment draft of its PERT Principles™. The goals of the PERT Principles are to encourage regulators and policymakers to accept and adopt regulations consistent with middle-market private equity industry practices and to promote general consistency and transparency, within certain parameters, among middle-market private equity funds. The PERT Principles are developed through an iterative process by CFO, CCO and in-house general counsel members of PERT and reflect countless hours of surveying, discussion and deliberation. Subjects included in the draft included advertising and marketing; co-investment; cybersecurity; disclosure of fees and expenses; and valuations. The public comment period provided an opportunity for anyone to comment on the draft of the PERT Principles. It formally ended on Wednesday, Nov. 30, 2016. PERT Steering Committee members and ACG staff are currently reviewing comments submitted by industry stakeholders, regulators and partners. ACG looks forward to releasing a final set of its PERT Principles early in 2017. //

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For more information about the PAC, please contact Amber Landis, vice president of public policy, ACG Global

© 2016 Association for Corporate Growth. All Rights Reserved.

at alandis@acg.org.

MIDDLE MARKET GROWTH // WINTER 2017

27


GROWTH ECONOMY

TEXAS // 1998 – 2015 Texas has seen tremendous jobs and sales growth driven by private-equity backed middle-market businesses, including a jobs growth rate nearly four times that of other businesses in the state.

SALES

207.7%

JOBS GROWTH % BY SEGMENT 0.1% 12.5%

SALES GROWTH IN PE-BACKED BUSINESSES

26% 38.9% 23.1%

DALLAS/ FORT WORTH

SALES GROWTH % BY SEGMENT 0% 34.9%

HOUSTON

31.7% 23.1% 10.3%

18.7%

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

SALES GROWTH IN ALL BUSINESSES

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

JOBS

GROWTH IN PE-BACKED BUSINESSES

GROWTH IN ALL BUSINESSES

JOBS CREATED BY PE-BACKED BUSINESSES

138.3% 37.6% 102,359

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.

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P A R T N E R S I N D R I V I N G M I D D L E - M A R K E T G R O W T H .® To d a y ’s

fast-paced

market

requires

an

edge.

ACG

Global

Partners

provide you with the expertise and best practices needed to close the deal.

L E A R N M O R E A B O U T A C G PA R T N E R S H I P S , V I S I T A C G . O R G / PA R T N E R S H I P S © 2016 Association for Corporate Growth. All Rights Reserved.


BKD’s Succession Team: (L-R) Tony Giordano, Jerry Henderson and Chris Dalton

Photos by Tom Hussey


IN FOCUS BKD

Smart Succession Ensure a Lasting Legacy

I

t’s been said that some 10,000 baby boomers turn 65 every day. For boomers who own companies, the decision to retire is more complicated than just a retirement party and gold watch. In many cases, these business owners seek a liquidity event that will give them a comfortable retirement and also ensure the health and growth of the business. That creates a wealth of opportunity for private equity groups seeking to invest in the middle market. BKD, LLP, which has nearly 100 years of working with closely held companies, is especially well qualified to help private equity groups find these businesses. Founded in 1923 and headquartered in Springfield, Missouri, the firm has grown to more than a half a billion dollars in annual revenue. Now, as more of these aging business owners are seeking liquidity, BKD has the trusted relationships and the expertise to introduce them to private equity buyers, says CEO Ted Dickman. “We analyze the quality of earnings, use our tax expertise in structuring deals and bring our specialty of data analytics into the due diligence process,” he says. In a recent survey by BKD of closely held companies, 40 percent of respondents said their businesses had never had a change of ownership or even a different CEO. Meanwhile, there’s close to $600 billion in private equity capital in the market today, much of it moving to the middle market in search of quality companies, says

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Anthony M. Giordano, president and managing director of BKD Corporate Finance, LLC, a subsidiary of BKD, LLP. “This is often the biggest event that a family will experience while owning the business,” notes Giordano, stressing that the firm takes a long-term approach to business.

A LONG-TERM APPROACH BKD offers several services that help private equity groups find, evaluate, purchase and sell quality assets in the middle market. BKD Corporate Finance, its investment banking arm specializing in sell-side, buy-side and capital raising services, educates closely held businesses about the advantages private equity can offer when evaluating the client’s liquidity options. For example, an insurance business was recently approached by several private equity groups but had little experience with such buyers. BKDCF consulted their client on multiple private equity liquidity options, including how each would impact the company. “We spent a year working with our client before we brought them to market, explaining to them the different types of deal structures available from private equity and the benefits a private equity partner could bring to their business,” Giordano says. BKD’s transaction services division performs due diligence on earnings, cash flows and balance sheet movements, looking for any red flags, says Chris Dalton, partner and national practice

MIDDLE MARKET GROWTH // WINTER 2017

31


ANALYTICS, NOT ANECDOTES

“OUR LEGACY OF SERVING CLOSELY HELD BUSINESSES MATCHED WITH OUR EXPERIENCE IN SERVING PRIVATE EQUITYOWNED BUSINESS HAS BECOME A REALLY VALUABLE CONNECTION POINT.” JERRY HENDERSON Partner and private equity practice leader, BKD

leader of BKD’s transaction services. “We make sure we—and the private equity buyer—understand the way the business operates,” he says. Using our unique approach of “diligence through data analytics” and specialists with operational and IT experience, BKD extracts and analyzes data from business systems and thereby produces useful insights. “The sellers know their business well from an anecdotal perspective, but don’t necessarily have the metrics to allow a secondary type of analysis or to prove the value proposition to third parties,” explains Dalton. BKD analytics can slice and dice the data in many different ways, including revenue or gross margin by product, customer, geography and market channel. “We often uncover things—especially if this is the first time institutional capital is coming in to the business,” he says.

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For example, BKD analytics helped a private equity buyer better understand a leasing business. Initially, the buyer was uncertain how the business was achieving such great returns, and suspected it may not have invested enough in equipment maintenance. If that were true, the buyer would need to make a large investment in capital equipment right off the bat. However, BKD was able to extract and summarize detailed data, showing that the company was profiting not by neglecting maintenance but by using a dynamic pricing strategy. Because of this analysis, “our client knew they had a good deal on their hands, and they were able to move forward with the transaction,” Dalton says. “They even started using that pricing strategy in some of their other portfolio companies.” In another instance, private equity firm KLH Capital was evaluating a company, but could not get a clear understanding of the business from the general ledger. “We try to move the accounting from a cash basis to GAAP, but sometimes you can’t do that using just the general ledger information,” explains Will Dowden, partner at KLH Capital, which has $320 million in three funds. The firm hired BKD, which used its analytics to sort through data buried in the company’s systems and reconstructed margins on projects, even though the company originally had not tracked that information. BKD produced estimates that allowed KLH to see profit by project, which resulted in a restructuring of the deal. Most impressive, however, was BKD’s strong rapport with the owner of the company, Dowden says. Even though the restructuring meant that part of the payout would need to be stretched over a couple of years and based upon meeting certain performance metrics, the owner understood why. When BKD showed him the data and analysis, he agreed with their assessment. “BKD got us through a conversation that otherwise could’ve been highly contentious,” says Dowden. Instead, everyone was satisfied. “The seller got the valuation he wanted and we got assurance of the future performance of the business that justified our valuation,” Dowden notes. “BKD


provided excellent counsel. Now, whenever we have a potential acquisition with complicated issues, we call them.”

SPECIALIZED TAX SERVICES BKD also offers specialized tax advice on the structure of transactions, an important and sometimes overlooked aspect of deals, according to Jerry Henderson, partner and private equity practice leader at BKD. Even if a specialist is not requested by the client, BKD brings one in “because in 19 of 20 transactions that specialist will find very significant value for our client,” Henderson says. Most recently, BKD launched an initiative, called BKD Next, to assist closely held companies through the entire life cycle of their business, including liquidity options and succession planning. It’s all part of BKD’s philosophy of taking a long-term view. “We spend time with clients to make sure we’re addressing their ultimate objectives,” says Giordano. “We may work with a client for five years before we get to the liquidity

event, making sure their business is prepared to go to market and our clients understand all the liquidity options particular to their business.” “Our advisers take a long-term view and a broad perspective, showing family-owned businesses an array of paths in terms of succession,” Dickman says. BKD’s fluency in closely held businesses, and its knowledge of the nuances required in such relationships, is one of BKD’s strongest competitive advantages. “We believe in getting a client talking about these issues and their options sooner rather than later,” he says. “Then they can take some proactive steps to get their house in order to improve and bolster the value of the business.” The result is the large number of quality lower and middle-market companies that BKD brings to private equity buyers, which is especially valuable in today’s robust, competitive deal market. “Our legacy of serving closely held businesses matched with our experience in serving private equity owned business has become a really valuable connection point,” Henderson says. //

E Succession Specialists: Dalton (L) and Giordano

MIDDLE MARKET GROWTH // WINTER 2017

33


P A R T N E R S I N D R I V I N G M I D D L E - M A R K E T G R O W T H .ÂŽ Yo u on

can all

rely

on

aspects

operations,

ACG of

Global

M&A

taxation,

Partners

transactions, regulatory

as

trusted

including issues

advisers financing,

and

more.

L E A R N M O R E A B O U T A C G PA R T N E R S H I P S , V I S I T A C G . O R G / PA R T N E R S H I P S Š 2016 Association for Corporate Growth. All Rights Reserved.

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THE PORTFOLIO

Expense Oversight MIDMARKET TRENDS // Latest Developments in Private Equity Fund Management

I Julia D. Corelli Partner, Pepper Hamilton LLP’s Corporate and Securities Practice Group

have written many articles highlighting the difficulties fund managers face in today’s complicated private equity environment. From an increase in enforcement actions to the complexities of co-investments, these are interesting and extraordinary times. One of the biggest issues is the tension between general partners and limited partners—a tension rooted in the manager’s and the investor’s fundamental goals to succeed, measured as that is by monetary rewards. In 2014 and 2016, Pepper Hamilton participated in industry surveys with “Private Funds Management” about how fund managers deal with fees and expenses. In both surveys, more than 80 percent of respondents were managers with less than $1 billion in assets under management, and approximately 20 percent had AUM under $100 million. Each survey revealed the minutiae of decisionmaking that a fund manager undertakes when determining what is a fund expense vs. a manager expense. Comparison of the two reveals consistency in many areas, but the numbers and our experience also show the difficulty smaller managers face when they try to increase top-line revenue sufficiently to accommodate their growing expenses while avoiding strategy drift/shift. One area where fund managers have “held the high ground” is in broken-deal expenses. While investors want to shift more broken-deal costs to managers, the surveys showed managers have increasingly succeeded in making them fund expenses. We asked who was responsible—management company or fund—for legal, accounting or consulting costs during diligence both before and after a letter of intent is signed. The surveys indicate that the fund is picking up more, and the management company less, broken-deal costs: ɋɋ In 2016, 13 percent of respondents said the management company should pay for

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broken-deal costs incurred before an LOI is signed—down from 34 percent in 2014. ɋɋ In 2016, only 6 percent of respondents said the management company should pay for broken-deal costs incurred after an LOI is signed—down from 22 percent in 2014. Managers in middle-market funds have refined their policies and disclosures about broken-deal costs to become more precise and offer greater predictability to investors. Other areas where the surveys showed manager-friendly trends were co-investment and regulatory examination costs. In all of these areas, regulatory/ enforcement and investor pressures have forced managers to adopt more rigid and transparent guidelines on the treatment of fees and expenses. This has led to many more limited partner advisory committee approvals and partnership agreement amendments when the guidelines fail to predict what ultimately transpires. The managers’ solutions are often creative and heavily scrutinized by investors, resulting in longer, more complicated partnership agreements and side letters. One bright spot is that investor-initiated litigation is rare, as the dearth of case law interpreting fund agreements shows. The SEC’s regulations and enforcement cases have supplanted that to weed out the bad apples and re-educate the bad judgment. // Julia D. Corelli is a partner in Pepper Hamilton LLP’s Corporate and Securities Practice Group and co-chairs its Funds Services Group.

MIDDLE MARKET GROWTH // WINTER 2017

35


THE PORTFOLIO

A Solid Foundation MIDMARKET TRENDS // Appetite Builds for Construction M&A Deals

A

s of the second quarter, 2016 compared positively with every post-crisis year barring the last two. It appears that the M&A market is normalizing rather than plummeting. With this normalization and the continuing economic recovery, we expect a much stronger appetite for M&A, especially in the construction sector.

Richard A. Martin Jr. Senior Director, Merrill Corp.

Forecast and Outlook PricewaterhouseCoopers released its Global Engineering & Construction M&A Deals Insights, a report that provides a comprehensive look at the industry. Despite constant deal volume, deal value declined, implying average deal size has dropped. Q2 saw 68 deals total, 19 of which were in the construction materials manufacturing subsector, followed by civil engineering and home building subsectors with 14 deals each. Construction materials manufacturing made up the largest share of both value and volume—30 percent and 28 percent, respectively. While overall deal value was down, deal volume remained relatively level. Despite a host of factors, including unknown economic implications deriving from geopolitical uncertainties, the middle market remains active. Subsectors Ready to Build? Construction markets are expected to rebound because new home building is still lower than historical levels, which should make building-product companies attractive M&A targets. This sector had several IPOs recently, and companies have favorable multiples in the seven to nine times range. In general, construction companies are healthier than commodity-related companies. Another major area of M&A activity is industrial technology, a much sought-after subsector. Technology with a focus on improving efficiencies will continue to foster M&A activity. On

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a similar front, civil engineering is one of the few subsectors that saw strong growth in the second quarter, with 62 percent growth in value. PricewaterhouseCoopers expects investment in transportation infrastructure to grow 5 percent annually through 2025, according to its report on Assessing the Global Transport Infrastructure Market: Outlook to 2025. It expects the APAC region to lead the way with a projective cumulative infrastructure investment of roughly $8 trillion by 2025. Local vs. Cross-Border Investments Local deals continue to take up the majority of transactions within the construction sector. While the deal volume in North America was on the low end, deal value surpassed every other region. The APAC region continues to hold the largest number of transactions, but the average deal size remains low. With the continued strength of the U.S. economy, more opportunities should become available for both domestic and inbound transactions. The complexity of this sector yields tremendous opportunities to support growth, globalization and more. Will geopolitical uncertainty inspire alliances and joint ventures allowing for balanced geographic opportunities? One thing is certain: desire within the C-suite to close deals is still the focus. See more in our newest release, The CEO and Global M&A Strategy from the Best Practices of the Best Dealmakers series. // Richard A. Martin Jr. is a senior director at Merrill Corp., responsible for Merrill DataSite’s global marketing group.

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THE PORTFOLIO

Pension Pitfalls MIDMARKET TRENDS // Sun Capital Case Underscores Importance of Pension Review

O Jane A. Meyer Partner, Dentons US LLP

Dylan E. Donley Associate, Dentons US LLP

n March 28, the District Court of Massachusetts issued a highly anticipated decision in Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund. On remand, the federal court determined that private equity funds had formed a partnership-in-fact, were engaged in a trade or business that was part of a controlled group and, as a result, were jointly and severally liable for the pension plan withdrawal liability obligations of their portfolio company, Scott Brass, Inc. The court found that the economic benefits Sun Capital Partners III L.P. (Fund III) and Sun Capital Partners IV LP (Fund IV) received, including from management fee offsets and management fee offset carryforwards, were over and above the return that an ordinary passive investor would expect to receive. When combined with the funds’ active involvement in the management of Scott Brass operations, the court found that the funds were each engaged in trade or business for purposes of the Multiemployer Pension Plan Amendments Act of 1980. In addition, the court determined that the funds had formed a partnership-in-fact; looking at, among other things, the facts that the funds created a holding company in order to invest in the portfolio company, that they engaged in joint activities prior to the acquisition of the portfolio company to determine whether to co-invest in it, and that they previously co-invested in five other portfolio companies. In determining that a partnership-in-fact existed, the court held that the de facto partnership was itself a trade or business. Even though neither fund held 80 percent of the portfolio company, the de facto partnership was under “common control” with the portfolio company within the meaning of the Employee Retirement Income Security Act of 1974. As a result, the court determined that this

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partnership and consequently its partners (the funds) were jointly and severally liable for the portfolio company’s pension plan withdrawal liability obligations. Although still subject to appeal, the Sun Capital case highlights the need for a thorough examination of a target company’s pension plan and possible withdrawal liabilities. In addition, private equity funds should consider carefully how they structure co-investments, especially by related funds with overlapping management. It is also important to note that in its analysis of whether or not the funds or the de facto partnership were engaged in trade or business or under common control with Scott Brass, the court looked to federal income tax principals for guidance. It is therefore possible that the determinations in Sun Capital could be used to bring actions against funds for other portfolio company obligations, including tax liabilities. // Jane A. Meyer primarily focuses on representing private equity and SBIC funds in the negotiation and drafting of senior, mezzanine and equity financing documents, as well as joint venture, acquisition and disposition agreements. Dylan E. Donley focuses on general corporate matters, with an emphasis on mergers and acquisitions for private businesses, public companies and private equity firms.

MIDDLE MARKET GROWTH // WINTER 2017

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P A R T N E R S I N D R I V I N G M I D D L E - M A R K E T G R O W T H .ÂŽ ACG

Global

providing and

a

Partners valuable

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THE PORTFOLIO

The Butterfly Effect MIDMARKET TRENDS // E-Commerce and Real Estate Opportunities

T Chester Lee Duane Morris LLP

Richard Silfen Duane Morris LLP

he pervasive nature of e-commerce has had a direct impact on the commercial real estate industry. It seems counterintuitive. Real estate is, after all, the ultimate brick-and-mortar business and the online space is the definition of “not.” Yet the internet’s influence on real estate valuations and investing has been major and ongoing, albeit with different repercussions depending on sector. The sheer scale of e-commerce is astonishing, its presence ubiquitous. Amazon is now responsible for about one in every three retail transactions in North America. It is merely the largest of thousands of e-commerce sites, which offer everything from private jets to industrial chemicals. Not coincidentally, many traditional brickand-mortar retailers are struggling, partially as a result of this online onslaught. Their struggles, in turn, have contributed to the weakening of retail property valuations. According to P. Sheridan “Schecky” Schechner, managing director and co-head of Americas real estate investment banking at Barclays: “Retail is becoming more challenged—all forms of retail— due to the internet. This is particularly true with department stores.” Conversely, online retail has provided a tailwind for the industrial sector, particularly in e-commerce distribution and fulfillment. Observes Schechner: “Industrial is in vogue because of fulfillment. Meaning, how do you get all these boxes where they need to go?” What e-commerce giveth, it can also taketh away, it seems. The hospitality industry offers another example of the impact of e-commerce on commercial real estate. Hotel property valuations have been pressured by several factors, including the rapid rise of Airbnb. Airbnb added significant quantities of on-demand inventory to hotel markets around the world. Schechner sees Airbnb and other participants in the so-called sharing

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economy as disruptive competitors to the traditional hospitality industry, observing that “the sector is going through a lot. Right now the pricing is very cheap and the valuations are down. Most investors are uncertain as to Airbnb’s impact on hotels.” In this volatile environment, in which valuations and markets are vulnerable to extraneous, disruptive forces powered by the internet, Schechner is watching for a pronounced shift toward a focus on yields over appreciation for real estate investors, potentially using public or private mortgage REITs as vehicles. “Mortgage REITs are perfect, because they’re yield vehicles, not capital appreciation vehicles,” says Schechner. “It is unusual for mortgage REITs to trade at a significant premium to book value. You have to remember that the upside to a mortgage is par.” One interesting sector to watch will be the shadow banks established by the larger, innovative private equity funds. Private equity sponsors are forming larger funds and funding larger and larger loans. Mortgage-based funds, set up to originate and invest in real estate mortgages, seem a natural progression and a logical response to the volatility in valuations created in the real estate market by e-commerce. And not available online—yet. // Chester Lee is a partner in the New York office of Duane Morris LLP and co-head of the Real Estate Practice Group. Richard Silfen is a partner in the Philadelphia office of Duane Morris LLP. He has represented REITs in capital raising and M&A transactions for more than 20 years and formerly was general counsel of a traded REIT and several non-traded REITs.

MIDDLE MARKET GROWTH // WINTER 2017

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THE PORTFOLIO

Navigating Cross-Border Deals SOUND DECISIONS // International Transactions Face Myriad Legal Challenges

T Charles J. Morton Jr. Partner, Venable LLP

40

homas Freidman’s provocative 2005 book, The World Is Flat, anticipated an economy characterized by growing international interdependence. For years, however, the middle market was relatively insulated from global shifts impacting larger companies. Those days are quickly becoming ancient history as cross-border deals multiply, even for relatively small players, and the number of companies without international connections shrinks. Ensuring that cross-border deals are properly executed and documented from a legal perspective can be challenging, but is essential if they are to succeed. Clarity is paramount, regardless of whether a domestic company is making its first overseas acquisition or considering a sale to a foreign acquirer. In both cases, many moving pieces often become even more complicated. Nonetheless, when done well, the returns can be compelling. The core of any lawyer’s job is to reflect in documents the precise agreement reached by businesspeople. When principals for the parties come to the discussion with shared expectations and vocabulary, lawyers can be confident that little is lost in translation. However, in discussions between parties from different countries, the potential to miss nuances, even by people with strong language skills, is magnified, requiring a more careful, patient and communicative approach than may be customary for a domestic transaction. Deals happen only when the parties are able to develop the trust essential to close. Cultural norms offer important “tells” that, if misunderstood, can lead to mixed messages and confusion. Helping parties navigate cultural differences in cross-border deals can distinguish great lawyers from merely good ones. Challenges common to all deals are more complicated in cross-border transactions. Three areas can be particularly complex and should

middlemarketgrowth.org

be handled with great care: tax, regulation, and labor and employment issues. Tax is always an important consideration. When the permutations of potential taxing authorities grow, so too does the need to consider structuring alternatives. The tax characteristics of the entity in which income is earned often determine whether a transaction makes sense. Close coordination among the client, accounting and legal professionals is essential for a positive outcome. The U.S. regulatory environment is a labyrinth, while other countries offer equally complex systems. Perhaps most threatening are countries where tax treatment is similar, but not identical, to that in the United States. Expectations of how certain things will be handled must be tested carefully from all sides of the border to avoid surprises. For middle-market companies accustomed to a particular geographic footprint, these efforts can seem daunting. For many companies, the most important asset is employees. Rules governing hiring, firing and properly capturing the work product of employees vary dramatically by country. Understanding when you can let employees go is essential to post-transaction integration. When exploring a possible sale to a non-U.S. acquirer, educating the suitor could be an important part of the process. The ability to take advantage of cross-border deals rippling through the middle market is increasingly essential for those who plan to thrive. // Charles J. Morton Jr. co-chairs Venable’s Corporate Group, focusing on the health care, technology and consumer products industries. He is a past chairman of ACG Global’s board of directors.

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THE PORTFOLIO

Mind the Gap SOUND DECISIONS // Recognizing Soft Power and its Limitations

I Alvin Wade National Managing Partner Real Estate Industry Practice, Grant Thornton

nternational real estate investment offers abundant global opportunity. While many investors conduct extensive research before investing, they also look for quicker ways to filter their options. Many feel confident putting their money into familiar territories. This familiarity is often determined by the level of so-called soft power a country projects and the direct experience an investor has with it. Developed by Joseph Nye at Harvard University, soft power is used to measure a nation’s cultural attractiveness and the factors that influence people to view that nation positively—things like a prominence in the arts or quality of education. Investing Instinctively Rather than rely on complex modelling and in-depth analysis of politics, investors often go with their gut. According to Grant’s Thornton’s International Business Report, a quarterly mid market business confidence monitor, instinctive decision-making can, when left unchecked, override other considerations. When senior executives were asked about their decision to make a significant investment in a foreign market, many responded that “it simply feels like a good fit.” The instinctive approach is adopted for about half of all direct real estate investment decisions and valued at about $250 billion per year. Balancing Hard Evidence with Instinct Instinctive investments in familiar territories can make for solid deals, but additional opportunities open up when decisions are complemented by researching broader options. Findings reveal a cluster of potentially hidden gems that offer the high levels of political stability investors crave, but to date haven’t attracted the levels of investment of destinations with more soft power clout. Of the 10 countries receiving major inward

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real estate investment in 2014, only 25 percent of investment went to the five ranked highest in the World Bank’s political stability index— Singapore, Canada, Australia, Japan and Germany. Others offer investors the potential to enter markets that currently have a lower level of investment, but provide the high levels of political stability needed to act with confidence. It is clear that soft power is a factor in drawing real estate investment. What Can Investors Do? ɋɋ Be aware of the lure of soft power. Reflect on the factors that inform perceptions of a territory and whether they are accurate indicators of likely returns. Ensure that instinct isn’t being overly influenced by unconscious biases driven by soft power. ɋɋ Consider which personal experiences are most likely to sway your decision-making. One compelling trend we’ve identified is the close correlation between where overseas students go and where real estate money goes. A better understanding of these trends and dynamics will provide better context for your own investment decisions. ɋɋ Complement instinct with hard analysis to spot new opportunities. Savvy investors incorporate local expertise in conjunction with good judgement, which often presents opportunities that may not have otherwise been considered. // Alvin Wade is the national managing partner of Grant Thornton’s Construction, Real Estate, Hospitality and Restaurant practice and the regional Audit Services practice leader for the Central Region.

MIDDLE MARKET GROWTH // WINTER 2017

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THE PORTFOLIO

Factor in Culture SOUND DECISIONS // Don’t Overlook an Important Component in Your Next Deal

W Michelle Mikesell Managing Director, Insperity

hen combining two businesses, you always hope for that old adage: the whole is greater than the sum of its parts. But too often in mergers and acquisitions one plus one can equal less than two. It’s rare that company A and company B do things the same way, even though they’re in the same industry, sell similar products and are structured alike. What’s Missing? Typically, the financial implications of integrating two workforces, such as merging back-office processes and combining cultures, are excluded from the financial analysis and make it nearly impossible to achieve the alignment needed for a successful deal. Cultural due diligence is often limited to examining employee turnover, conducting exit interviews and administering satisfaction surveys. When it comes to gaining a true understanding of company culture, these are only a few pieces of a larger puzzle. Investing in a human capital strategy can bring significant returns, while failing to plan can lead to lower performance and a loss in transactional value. This loss is frequently unaccounted for in financial projections. Measuring Cultural Compatibility Company culture is the way work is done at each company; it’s the atmosphere, respect, mission and even how the customers are treated. Frequently, organizations believe delving into the cultural details isn’t required in the transaction’s early stages. But tackling culture early can set the tone for the rest of the transaction. Human capital due diligence should allow companies to answer the following questions: ɋɋ Recruiting – Does the newly combined company have enough bench strength to meet

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short- and long-term targets? ɋɋ Benefits – What does the new benefits package look like? What can continue to be offered and what is no longer available? How will ancillary benefits such as 401(k), pension plans and AD&D be integrated? ɋɋ Compensation – Do salaries for similar positions match across organizations? Are the commission plans equitable and do they encourage the right behaviors? ɋɋ Payroll – Are the pay cycles similar? Are all employees classified correctly? ɋɋ HR support – How do HR policies, procedures and practices differ? ɋɋ Organizational design – Which leaders from each business will assume a leadership role in the newly formed organization? How will job titles change? ɋɋ Decision making – Will decisions in the new organization be made at the top of a hierarchy or by group consensus? ɋɋ Performance – What are the current skills and abilities of the present workforce? What skills are required for the future? ɋɋ Training – What training is needed to educate employees on new products? ɋɋ Technology – Which existing systems will be used to support the new organization? What does conversion look like? Each of these categories provides insight into the assumptions and scenarios that should be included in business forecasts. Once potential areas of difference are identified, planning for the alignment of systems can be initiated. A thorough due diligence process can help identify all the possible implications of changes that will be implemented. // Michelle Mikesell is managing director of midmarket consulting and development for Insperity.

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P A R T N E R S I N D R I V I N G M I D D L E - M A R K E T G R O W T H .ÂŽ From

consultants

specialists, than

30,000

ACG

to

C PA s

Global

and

Partners

professionals

in

a

host guide

the

of

other

the

middle

advisers

success market

of

and more

worldwide.

L E A R N M O R E A B O U T A C G PA R T N E R S H I P S , V I S I T A C G . O R G / PA R T N E R S H I P S Š 2016 Association for Corporate Growth. All Rights Reserved.


ACG@WORK

SUMMIT AWARD F ACG in October received the prestigious “Power of A Summit Award” for its GrowthEconomy.org research project. The Summit Award is the highest award by ASAE: The Center for Association Leadership.

G ACG LOS ANGELES ACG LA’s DealSource event in June drew more than 200 attendees at Santa Monica’s Hotel Casa Del Mar.

H ACG CHARLOTTE The ACG Charlotte Deal Crawl in September drew more than 350 deal-makers for two days of meetings and networking at various locales in Charlotte’s Uptown city center.

ACG INDIANA F Panelists were featured at ACG Indiana’s Capital Markets Showcase in January. The event was held at the city’s CNO Financial Conference Center and included a wine and bourbon tasting.

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ACG DALLAS F ACG Dallas/Fort Worth was back to business in August as more than 250 M&A professionals convened on the 33rd floor of Altitude at the W Victory Hotel as the all new ACG DFW was unveiled.

H MIKE QUIGLEY U.S. Rep. Mike Quigley, an Illinois Democrat, joined ACG Global in October to discuss the role of women in finance.

H ACG PITTSBURGH Participants at the ACG Pittsburgh Golf Outing swung into summer at the chapter’s annual Golf Outing in June. The event featured 18 holes and dinner at the Club at Nevillewood.

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

MIDDLE MARKET GROWTH // WINTER 2017

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THE LADDER

PETER LODWICK has joined the executive team at RGT Wealth Advisors executive team as managing director and general counsel. Prior to joining RGT, Lodwick served as vice president and general counsel at The Container Store for two years. He was previously a partner for 29 years at the law firm of Thompson & Knight LLP, counseling clients in the areas of mergers and acquisitions corporate finance, securities transactions, and corporate governance.

TOM FIRST has joined Castanea Partners, a middle market private equity firm, as an operating partner focused on opportunities in the food and beverage sector. First was previously a managing partner at First Beverage Ventures, the investment arm of First Beverage Group. He was also cofounder of Nantucket Nectars, an award-winning branded juice business which is now owned by the Dr. Pepper Snapple Group.

JOHN BROCK has joined accounting firm Dixon Hughes Goodman as a partner in its Atlanta office. Brock previously worked at a Big Four accounting firm for 13 years, specializing for nine years in health-care transaction advisory services. He will work with DHG’s national health care practice team.

Bank of America named SETH BENEFIELD marketing manager for the Eastern United States and Europe for its Bank of America Business Capital arm, part of the wholesale credit division at Bank of America Merrill Lynch. Benefield will lead a team of business development professionals who provide asset-based solutions and banking products to large and middle-market companies. He was most recently a credit products manager of specialized industries.

Monroe Credit Advisors announced that KENT FOSTER has joined the firm as vice president in its Chicago office. Foster will be responsible for assisting in the execution of client engagements. He was previously a vice president at GE Capital where he held several positions across the leveraged lending platform.

BARRY M. SCHNECK has joined Gerber Finance, a New York City-based asset lender, as senior vice president, responsible for New York, New Jersey and the remaining mid-Atlantic region. He has spent 45 years focusing on the working capital needs of small to midsized companies.

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

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IT’S THE SMALL THINGS

CONSTRUCTION INDUSTRY TRENDS //

If You Build It, They Will Come…

1

LIKE A BRIDGE OVER TROUBLED WATER The U.S. Department of Transportation released data indicating there are 61,064 “compromised” bridges handling 215 million crossings every day, mostly within the Interstate Highway System. —Reuters

2

AND NOW FOR THE OTHER 1 PERCENT Up to $320 billion in economic output would be generated in 2020 if U.S. infrastructure investment were boosted by 1 percent of GDP per year. —Business Roundtable

3

ACTUALLY, IT IS EASY BEING GREEN In the residential sector, green building accounts for 26 to 33 percent of the total market and has helped contribute to the industry’s recovery after the recession. —Dodge Data & Analytics

4

GEARING UP IN 2016 The number of contractors who expect to purchase new equipment has doubled since 2013 to 42 percent. Overall, 94 percent expected to acquire new equipment in 2016. —Wells Fargo 2016 Construction Industry Forecast

5

I’M FEELING A LITTLE NEGLECTED HERE Infrastructure spending has been neglected since the 2008 recession, but worldwide annual spending could grow from a little over $4 trillion a year today to more than $9 trillion a year by 2025. —PricewaterhouseCoopers

6

BIM BANG BOOM! A growing number of governments globally support building information modeling. For instance, in the U.K., BIM has been mandated in major government projects such as Cross Rail or its new iteration the HS2. —The Fifth Estate

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


ACG MIDDLE-MARKET PUBLIC POLICY SUMMIT F E B R U A R Y F O U R

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Middle Market Growth - Winter 2017  

The official publication of the Association for Corporate Growth (ACG)

Middle Market Growth - Winter 2017  

The official publication of the Association for Corporate Growth (ACG)