Middle Market Growth - October 2014

Growth MIDDLE MARKET

// OCTOBER 2014

PRIVATE EQUITY ENERGIZED

BY REGULATORY CHANGES IN MEXICO A QUALIFIED OPINION: TORBEN LUTH, PARTNER, JZ INTERNATIONAL

PHOBIO’S PHONE TRADE-INS:

two clicks and

BOOM! Meeting international demand for secondhand devices

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EXECUTIVE SUMMARY GARY LABRANCHE // ACG Global President & Chief Executive, FASAE, CAE

We Know Who You Are

W

e know who you are. You are part of a growing global community of readers of Middle Market Growth, the official magazine of the Association for Corporate Growth.

Over the past 13 issues, you have contributed to 224 percent growth in readership, reflecting the addition of 10,000 new readers.

And you know a good thing when you see it. MMG has garnered three awards since its launch in April 2013: • 2014 Apex Award, New Magazine, Journal & Tabloid • 2013 Folio Eddie Honorable Mention, Best Digital Edition • 2013 Association TRENDS All-Media, Monthly Association Publication You are also generous with story ideas and advice. You’ve helped source cover stories, such as the one this month about Phobio, a global broker for used phones led by Stephen Wakeling, a member of ACG Atlanta. Phobio was recently named one of the 40 fastest-growing companies in Georgia. The theme of global reach is also featured in the article by PrivCap’s Ainslie Chandler and in A Qualified Opinion, an interview with ACG Chicago member Torben Luth of JZ International.

The focus on global business reflects the international readership of MMG. Readers hail from everywhere that ACG has a chapter—North America, China, Brazil and Europe. But India, Russia and Mexico are also home to frequent readers. Wherever they are, readers access the magazine in many ways— desktop computers, tablets, smartphones or by visiting MiddleMarketGrowth.org.

Your input has helped to shape the coming year’s editorial calendar. Each issue will feature stories about growing companies, insights from M&A thought leaders and in-depth analysis of global trends. Please send your story suggestions or leads to Editor-in-Chief Deborah Cohen. With your help, MMG will continue to showcase middle-market companies around the world that have grown organically, through acquisitions or with the help of private capital.

You’ve shown your interest in connecting with the M&A community. Readers frequently click on the ACG calendar of events, which leads to more than 1,000 ACG chapter networking breakfasts, conferences and golf outings. Every year ACG chapters welcome more than 50,000 attendees to events around the world.

You also have something to look forward to: the January launch of a new website for MMG. In addition to stories from the magazine, this site will showcase middle-market news from a wide variety of sources.

Of all the things we know about you, the most important is this: without you, this magazine would have no purpose. With you, MMG is more than a magazine—it is an essential communications link to a dynamic global community that drives middle-market growth.

Please pass along the link to Middle Market Growth and encourage your colleagues and clients to download the MMG app. With your help, MMG will continue to add value and serve readers like you. //

MIDPOINTS RANDY SCHWIMMER // Founder and Publisher, The Lead Left

Inversion Therapy

A

fter a 10-year journey, the European Space Agency probe Rosetta has finally reached its target. The craft’s mission was to land on a comet. It is now circling 67P/Churyumov-Gerasi­

menko with the goal of hooking onto it by November.

That this astonishing feat got nary a mention in the major U.S. media shows the short shrift Europe gets these days. Another example is the recent kerfuffle on corporate inversions.

In case you’ve been stranded on a distant planetoid for a few months, a corporate inversion is the term for a foreign merger in which the domicile of the combined entity relocates to a non-U.S. country. Because our 35

BIO //

Randy Schwimmer shares his perspectives in MidPoints each issue. A former member of senior management and investment committees for two leading middle-market debt platforms, he is also founder and publisher of The Lead Left, a weekly newsletter about deals and trends in the capital markets.

Content sponsored by

percent federal corporate tax rate is the highest of any developed nation, the effect is to dramatically lower the tax bill of the total enterprise.

Depending on your political leaning, inversions are viewed either as smart tax planning or unpatriotic behavior. The latter perspective seems to be holding sway, as the U.S. Treasury in September issued new rules designed to curb the scheme.

Why is this happening now? After all, tax minimization is as old as taxation itself, perhaps dating back to Biblical times when Noah established the first offshore vehicle.

For years, U.S. and international companies have set up specialpurpose holdcos or subsidiaries in the Cayman Islands, Bermuda, Ireland, Luxembourg and other havens as legal corporate tax shelters. It’s a given that with any cross-border M&A transaction, businesses spend mucho dinero on elaborate analyses to lower their overall tax rates.

These techniques are often buried in the footnotes of public companies’ financial disclosures, or in the case of private corporations, their filings with tax authorities. But moving headquarters out of the United States is putting mega-mergers like Medtronic, AbbVie and Mylan on the front page.

Continued on next page

MIDPOINTS RANDY SCHWIMMER // Founder and Publisher, The Lead Left ONE THING’S CERTAIN: REGARDLESS OF THE FATE OF CORPORATE INVERSIONS, CREATIVE TAX STRUCTURING IS IRREVERSIBLY GLOBAL.

Washington is squawking about lost tax revenues, yet no one seems to know how much. Lower corporate taxes mean better earnings and subsequently higher stock prices. Isn’t that good for American shareholders?

The real solution, of course, is lower U.S. corporate tax rates. Set them below the global average of 25 percent and watch overseas HQs head here in droves.

Our bet is these mergers have more to do with market share and growth opportunities than tax strategies. Walgreen Co. is moving ahead with its acquisition of Alliance Boots, sans inversion. The Pfizer/ AstraZeneca merger was abandoned for other concerns.

One thing’s certain: Regardless of the fate of corporate inversions, creative tax structuring is irreversibly global. International corporations will keep testing boundaries to get the most effective tax rates possible.

How far will they go? We know of one extraterrestrial body with a wayoffshore vehicle. Don’t know what the tax rate there is, but we’ll wager some enterprising M&A lawyer is already looking into it. //

Growth MIDDLE MARKET

// OCTOBER 2014

Cover and story photography by Gregory Miller

FEATURES

Phobio’s Global Phone Network Responding to rising consumer demand for smartphones in developing markets, Atlanta-based Phobio devised a way to collect used devices and sell them abroad. Using proprietary software and an extensive international network, Phobio is capitalizing on the fast-growing secondhand phone industry in China and beyond.

Read more.

Opportunity for PE in Mexican Energy

“CHINA BUYS EVERYTHING. THEY BUY EVERYTHING THAT WE ARE THROWING AWAY, AND THE NEW STUFF TOO.” // STEPHEN WAKELING, CHIEF EXECUTIVE, PHOBIO

Groundbreaking regulatory changes in Mexico are opening the market for investment in the country’s booming energy sector.

Read more.

TABLE OF CONTENTS

PRESIDENT & CEO Gary LaBranche, FASAE, CAE glabranche@acg.org

VICE PRESIDENT, COMMUNICATIONS & MARKETING Kristin Gomez kgomez@acg.org

EDITOR-IN-CHIEF Deborah L. Cohen dcohen@acg.org

IN EVERY ISSUE Executive Summary MidPoints

by Randy Schwimmer Face-to-Face The Ladder It’s the Small Things The Leadership B-Side

DEPARTMENTS THE ROUND • ACG Policy Expert Amber Landis Discusses Ex-Im Bank’s Future • Pepper Hamilton’s Steven Bortnick Weighs in on Corporate Inversions • A Pepperdine Study Shows Positive Effect of PE on Corporate Growth Read more.

ASSOCIATE EDITOR Kathryn Mulligan kmulligan@acg.org

DIRECTOR, CREATIVE AND BRANDING Brian Lubluban blubluban@acg.org

VICE PRESIDENT, CONFERENCES & PARTNERSHIPS Christine Melendes, CAE cmelendes@acg.org

A QUALIFIED OPINION

FOR ADVERTISING OPPORTUNITIES

Torben Luth, Partner, JZ International, Talks to MMG About Challenges and Opportunities Facing Investors in Europe.

Read more.

Meredith Rollins mrollins@acg.org

ACG@WORK

DIRECTOR, STRATEGIC DEVELOPMENT

Custom media services provided by Network Media Partners, Inc.

• Edmonton Forms Stand-Alone ACG Chapter • ACG Detroit Turns 30 • Baseball and More at Deal Forum 2014 2014 Apex Award, New Magazine, Journal & Tabloid 2013 Folio Eddie Honorable Mention, best digital edition 2013 Association TRENDS All-Media, monthly publication

• DealFest Northeast’s New Take on Networking Read more.

THE PORTFOLIO The latest middle-market trends and thought leadership written exclusively by a team of expert ACG Partners.

Read more.

Association for Corporate Growth 125 South Wacker Drive, Suite 3100 Chicago, IL 60606 ACG Membership: membership@acg.org www.acg.org Copyright 2014 Middle Market Growth®, InterGrowth and the Association for Corporate Growth, Inc. All rights reserved.

FACE-TO-FACE CONNECT TO YOUR NEXT DEAL

Sir Winfried Bischoff will keynote EuroGrowth 2014.

To register to attend, visit eurogrowth.org.

Global M&A Deal Flow.

Two Days. One Event.

Join ACG for EuroGrowthÂŽ 2014 on Oct. 15-16 in London Most company executives today realize that expanding their business means pushing beyond traditional geographic boundaries. In fact, 82 percent of middle-market company leaders expected that more than one-fifth of their sales growth would come from foreign markets, according to a survey by the National Center for the Middle Market.

For investors looking to Europe, EuroGrowth 2014 keynote speaker Sir Winfried Bischoff, incoming JP Morgan Securities chairman, will share his insights on the investment landscape in Europe. Bischoff will address the progress made since the financial crisis, the interaction between regulators across continents and how to create a market more attractive to investors.

EuroGrowth 2014 is an essential event for companies looking to advance their crossborder dealmaking, including add-on acquisitions. This year’s event will take place on Oct. 15-16 in London. More than 200 financial professionals and capital providers from all segments across Europe and the globe will gather for uninterrupted quality networking and leading-edge sessions on best practices, analysis and discussions of global M&A. Attending EuroGrowth is the most effective way to tap into the global middle-market deal community in one convenient location. For more details and to register today, visit www.EuroGrowth.org. //

FACE-TO-FACE CONNECT TO YOUR NEXT DEAL

CHAPTER EVENTS Get involved! This fall, ACG chapters across the globe will host hundreds of local events. Check out what’s happening at your local chapter, register and join in on valuable educational and networking opportunities.

ACG Central Texas’ Annual Private Equity Two-Step Conference in San Antonio Left: Zach Wooldridge, partner, Elm Creek Partners, presented on his firm’s investment strategy.

Right: Business professionals from across the nation attended the event.

ACG 101 Chapter View Calendar

ACG Barcelona Chapter View Calendar

ACG Calgary Chapter View Calendar

ACG Chicago Chapter View Calendar

ACG Dallas/Fort Worth Chapter View Calendar

ACG Denver Chapter View Calendar

ACG Louisiana Chapter View Calendar

ACG New York Chapter View Calendar

ACG Orlando Chapter View Calendar

ACG Philadelphia Chapter View Calendar

ACG Pittsburgh Chapter View Calendar

ACG Tampa Bay Chapter View Calendar

ACG Toronto Chapter View Calendar

ACG UK Chapter View Calendar

Did you host a newsworthy chapter event?

Send a 150to 200-word summary and high-resolution photos to Associate Editor Kathryn Mulligan.

THE ROUND NEWS THAT MATTERS

Future of Ex-Im Bank Uncertain As lawmakers prepare for recess ahead of midterm elections, Congress voted on Sept.

17 to reauthorize the Export-Import Bank, extending funding until June 30, 2015. The ExIm Bank—whose authorization was set to expire on Sept. 30—has been the official export credit agency of the United States for 80 years. It provides financing guarantees to small and large U.S. businesses, helping turn export opportunities into sales.

The overwhelming majority of U.S. export transactions are backed by traditional lenders; the Ex-Im Bank takes on the remaining 2 percent that the private sector cannot or will not back due to regulatory constraints, customer demands or banks’ inability to assess overseas risk. Since its establishment, Ex-Im has supported more than $567 billion of U.S. exports, mostly to developing markets.

Critics in Congress say the bank is an example of crony capitalism, likening its loans to subsidies. Meanwhile, supporters consider Ex-Im vital to the U.S. economy, citing the fact that some 90 percent of its transactions in 2013 provided working capital to small businesses.

Continued on next page

THE ROUND NEWS THAT MATTERS By law, the Ex-Im Bank cannot compete with commercial lenders. Ex-Im’s credit insurance provides PNC, Wells Fargo, Bank of America and other lending institutions some support to finance U.S. companies exporting abroad. Ex-Im also offers direct loans and insurance for the purchase of American goods by foreign buyers, often in Latin America, sub-Saharan Africa and other developing markets where local banks can’t always meet the needs of local businesses.

Proponents believe that without access to the Ex-Im Bank, many U.S. companies are in jeopardy of losing the business of overseas buyers. With 95 percent of the world’s customers living outside the United States, a thriving export trade is essential to America’s future prosperity and job growth. Without Ex-Im Bank support, export opportunities would go to Canadian, Chinese, European and Japanese companies receiving the same sort of export credit support from their governments, often in more generous amounts.

To learn more about the Ex-Im Coalition and the impact of the bank on your state, please visit www.exportersforexim.org.

—Amber Landis, director of public policy, ACG Global

THE ROUND NEWS THAT MATTERS CULTURE SHOCK

U.S. Companies Can Avoid Friction with Overseas Workers As companies plan international expansion, much attention is given to identifying target markets and establishing a sound growth strategy; often overlooked are the cultural differences in those new markets and who will make up the work force.

Companies need to consider cultural differences in order to fully integrate their operations.

That means researching the best way to onboard, manage and retain the best employees.

Overlooking the cultural aspects of expansion is among the main reasons international deals fail. Cultural intelligence about target markets must be a primary consideration when developing plans for international growth.

Establishing long-term relationships with important business and support partners can help you to navigate unfamiliar political, business and cultural landscapes, while also providing resources on the ground to educate your team about local best practices.

Remember, what works in your home market may not work overseas. Western economies, for example, rely on written contracts to provide a foundation for how a business relationship should proceed. In some cultures, however, face-to-face interaction at the outset has greater importance.

When expanding overseas, understanding your human capital can mean the difference between success and failure. Getting the right people in the right location will provide a competitive advantage. The quality of the local work force can be the deciding factor in determining whether to expand your business to a particular location and how successful the expansion will be.

When setting up a local work force in your target market, consider the following: • Is your company’s industry strongly represented in the new market?

• Will there be a deep talent pool?

• How much will your company need to invest in training?

Communication is one of the biggest challenges when expanding into a country where English is not the primary language. Although much of your new work force may speak your language, they may not understand nuances such as the idioms or humor used in the United States. A straightforward approach is best.

Also remember to be flexible. Tune into your environment, learn from your mistakes and apply best practices for successful growth.

—Lesley White, Managing Director, International Head, Global Commercial Banking, Bank of America Merrill Lynch

THE ROUND NEWS THAT MATTERS

‘Anti-Inversion’ Bill Could Dampen Cross-Border Deals The failed takeover of AstraZeneca by Pfizer might have delivered big benefits to the newly merged business: topping the list was a significantly lower tax rate following an intended move by U.S.-based Pfizer to reincorporate in Britain, home of its target.

Though Pfizer ultimately walked away from the $118 billion deal, U.S. lawmakers, reacting to yet another in a spate of so-called inversions, introduced a bill to counter the trend. The Stop Corporate Inversions Act of 2014 was introduced in both the House and Senate in May to thwart avoidance of U.S. corporate taxation through expansion of non-U.S. business activities by a U.S. company under a foreign parent. Separately, in mid-August Senate Democrats proposed additional restrictions to limit the practice known as earnings stripping, when U.S. companies borrow from their foreign parents and deduct the interest expense on their U.S. taxes.

The SCIA could dampen not just mega-mergers but also cross-border deals by midsized companies, potentially impacting the investments of middle-market private equity firms. To hedge against the harmful implications of the proposed legislation, investors must understand the details of the SCIA in the context of their own deal terms and management control structure.

Continued on next page

THE ROUND NEWS THAT MATTERS If passed, the SCIA would treat a foreign corporation as a U.S. corporation for U.S. tax purposes, including subjecting foreign investors to a tax on dividends, if the U.S.-international tie-up meets the following majority-ownership conditions: • The foreign corporation acquires substantially all of the properties held directly or indirectly by a domestic corporation, and; • Shareholders, whether U.S. or foreign, of the U.S. target corporation own 50 percent or more of the foreign transferee corporation due to their ownership of the U.S. corporation (down from the current law’s 80 percent). The reduction in the ownership threshold is significant because former owners of the U.S. corporation will have to cede control of the foreign transferee in order to avoid inversion treatment.

If those majority-ownership conditions aren’t met, the SCIA has an alternative stopgap provision: a “management and control” test to assess whether the company’s primary decision-makers are operating in the United States.

Following a merger, the foreign corporation would be treated as an “inverted domestic company” and taxed as a U.S. corporation if: • Management and control of the affiliated group of which the foreign corporation is a member occurs (directly or indirectly) primarily in the United States, and; • The affiliated group conducts significant business activities (generally 25 percent of compensation, employees, assets or income) in the United States.

Management and control will be considered to be primarily in the United States if substantially all the employees exercising day-to-day responsibility for strategic, financial and operational policy decisions of the affiliated group are based or primarily located in the United States. The U.S. Treasury has broad authority to interpret this provision, including reducing the measure.

As existing U.S. operations and management of the group are considered in determining whether this alternative test is satisfied, the SCIA may adversely impact existing global groups that effect even minor acquisitions of U.S. corporations, whether these acquisitions represent strategic purchases or bolt-on acquisitions by private equity funds.

To hedge against this pending legislation, private equity firms and strategic acquirers should consider including an escape clause in stock purchase agreements.

Additionally, prior to an acquisition, the parties should consider the potential impact of management and control in the United States, and whether senior managers should move abroad to avoid tripping the management and control test. // —Attorney Steven D. Bortnick is a partner in Pepper Hamilton LLP’s Tax Practice Group and the firm’s Investment Funds Industry Group, an interdisciplinary industry group comprised of more than 60 lawyers assisting all types of investment funds throughout their entire life cycle.

THE ROUND Q&A WITH MARETNO A. HARJOTO AND JOHN K. PAGLIA // Pepperdine University’s Graziadio School of Business and Management

RESEARCH TEAM // Maretno A. Harjoto (left) and John K. Paglia (right) authored the Pepperdine study.

GROWING MIDDLE-MARKET BUSINESSES

Pepperdine Study Shows Private Equity’s Long-Term Impact What are the general findings of this study and what makes it groundbreaking compared to other studies of private equity inflows?

MH and JP: Our study focuses on single-entity business establishments (firms), allowing us to cleanly measure the impact of private equity and venture capital investments on these firms’ organic sales and employment growth. By examining single-entity firms, we remove the confounding growth effects that come from acquisitions and divestitures as well as growth from arms-length subsidiaries that are aggregated into a corporate entity. We isolate the pure impact of PE and VC funding on a firm’s internal growth rate measured by the firm’s annual revenue and number of employees. Additionally, we examine smaller firms than in previous studies: In our study, the medians of annual net sales and number of employees are $3.5 million and 40 employees, respectively. So using the Small Business Administration’s definition, our study focuses on small- to medium-sized private businesses that represent 63 percent of net new private sector jobs, 48.5 percent of private sector employment and 46 percent of private sector output.

Continued on next page

THE ROUND Q&A WITH MARETNO A. HARJOTO AND JOHN K. PAGLIA // Pepperdine University’s Graziadio School of Business and Management

What is private equity’s impact on mid-sized companies’ sales and employment growth, compared to capital infusions from venture capital firms?

MH and JP: We find there are fundamental differential impacts between private equity versus venture capital financing on net sales and employment growth in terms of the timing and the long-lasting impact. The positive impact of PE financing materializes one year after the firms receive funding and persists for three years after funding. In contrast, the positive impact of VC funding is realized immediately after a firm receives funding and lasts for two years. We believe that it takes some time for private equity firms to execute their strategies to propel their targets’ growth; in contrast, venture capital can immediately influence companies’ potential growth since VC targets are more likely capital-constrained. However, the duration of the impact of VC funding tends to be shorter compared to PE funding. This led to the phenomenon that we observe in the market of multiple rounds of VC funding compared to fewer rounds of PE funding.

Recently members of the U.S. House of Representatives formed the Congressional Caucus for Middle Market Growth. Why should Congress be interested in considering favorable policies toward the middle market and the capital providers that serve it?

MH and JP: Middle-market companies are strong contributors to GDP and employment growth in the United States; however, their growth is constrained by the availability of private equity and other sources of funds. With over half of middle-market companies planning to raise new capital and financing in the next six months, the consequences of an unsuccessful capital raise are severe. According to the Pepperdine Private Capital Markets Project, 67 percent of middle-market businesses would expect slower business growth, while 57 percent would expect layoffs in the case of an unsuccessful financing event. Given that just 38 percent of middle-market companies say it would be easy to raise new equity financing, there are still significant headwinds to generating more GDP and employment growth. Our research speaks to the economic significance of putting private equity capital in the hands of highquality businesses. // —Professors Maretno A. Harjoto and John K. Paglia of Pepperdine University’s Graziadio School of Business and Management weigh in on the results of their new study, “The Effects of Private Equity and Venture Capital on Sales and Employment Growth in Small and Medium Sized Businesses.” The study appears in the October issue of the Journal of Banking and Finance.

THE ROUND NEWS THAT MATTERS

VERTICAL VIEW // INVESTING ACROSS BORDERS

Last year the B2C sector surpassed B2B in attracting the most foreign investment for the first time in over four years, skewed in part by several mega-deals.

The U.K. is the top locale for U.S.-based private equity firms investing internationally, followed

by Canada, with $34.7 billion and $11.7 billion, respectively, deployed in 2013.

Cross-border middle-market M&A is on the rise: In 2013, $178.9 billion was invested in such deals compared with $130.7 billion in 2012.

4,608

2,944 Global private equity deal count has increased dramatically, to 4,608 deals in 2013 from 2,944 in 2009.

3.5 BILLION

$

The $3.5 billion sale of the electricity distribution unit of Finnish-based Fortum to Suomi Power Networks Oy, a consortium of international investors, was the largest cross-border deal in the first half of 2014.

Between 2008 and 2013, China was the fastest-growing emerging market for PE funding, which increased at a compound annual rate of 18.5%, followed by Russia at 18.1%.

All statistics are from PitchBook for the middle market (deal values from $25 million to $1 billion).

Phobio’s Stephen Wakeling and his co-founders devised a way to meet global demand for used phones.

PHOBIO’S PHONE TRADE-INS:

Boom!

Two Clicks and

Meeting international demand for secondhand devices

BY SUSAN NADEAU

Photos by Gregory Miller

PHOBIO // Business: Mobile phone trade-ins and resale Headquarters: Atlanta, Georgia Number of Employees: 50 International operations: Australia, Germany, Italy, China, Hong Kong Yearly trades: Two million projected for 2014 Website: www.phobio.com

W

alk into a Z Wireless Verizon retail store and you’ll notice posters promising lucrative cell phone trade-ins and ensuring that phone recycling saves wildlife habitats. The program seems to be the retailer’s own; store clerks use their computers to quickly navigate price-checking programs, offering cash off a new phone in exchange for an old one on the spot.

What you’re really seeing is Phobio at work. Phobio is an international technology, marketing and phone buying-and-selling company that has developed software and a full-service program for retailers and wireless phone companies, allowing them to seamlessly provide cell phone trade-ins.

“It’s two clicks and boom, we’re done,” says Paul McGilvra, a sales associate at a Z Wireless store in southeastern Wisconsin. “There’s nothing to look up in a book or check on eBay.”

PREPPING FOR MARKET // Traded-in phones are evaluated at Phobio’s processing center before being sent out for resale.

The software is provided free of charge and gives a quick price quote for the used phone followed by a process to erase stored numbers, photos and other personal information, readying the phone for repair and resale.

Phones are then shipped to a Phobio processing center, and after review, the company typically sends them to its facility in Hong Kong for resale to retailers in China.

“We design everything we do around making it so simple that anybody can get it right every time,” says Chief Executive Stephen Wakeling, who together with his brother Matt Wakeling and friend Drew Yeaton, founded the Atlanta-based company in 2010.

The strategy appears to be working. Phobio is already profitable and on track to increase revenue by 50 percent this year. Over the past two years, its revenue has more than tripled, according to Chief Marketing Officer Denny Juge, who declines to discuss specifics.

CITIZENS OF THE WORLD A big factor in Phobio’s quick success is its decidedly international flare. The Hong Kong sales operation provides a base for 80 percent of sales. With just four years under its belt, Phobio has operations on four continents. It feeds used phones to China not only from the United States, but also from Australia, Germany and Italy.

“The founders feel like they are citizens of the world, not penned into the U.S. market,” says CEO Wakeling, a member of ACG Atlanta whose company won the chapter’s 2014 Georgia Fast 40 award.

It all started when Wakeling landed a job with a young company called Flipswap, a pioneer in the phone resale business. He then brought his friend Drew Yeaton on board. That’s about when Matt Wakeling moved to Shanghai, aiming to hone his Mandarin-language skills after taking classes in college. He, too, joined the startup, setting up its Chinese distribution channel.

Flipswap was acquired in a last-ditch deal (“They were just a bit too early to market,” Stephen Wakeling says), but the seed was firmly planted for Yeaton and the Wakeling brothers, who were confident they could make a go of it on their own in the market for recycled phones.

GLOBAL OPERATION // Operations Specialist Brandon Holloman in Phobio’s warehouse, where phones from the U.S., Australia and Europe are packaged for resale.

During that time, they stayed in touch with friends and family living abroad—paramount, Stephen Wakeling says, to their international success down the road.

The secondhand phone market is “poised to explode,” according to a May 2013 Forbes article citing research from the investment firm Sanford C. Bernstein. The firm forecasts the market growing from 53 million to 257 million units over five years. “By 2018, we estimate that used phones will cannibalize 8 percent of total new smartphone sales, up from 3 percent in 2012,” Bernstein analyst Toni Sacconaghi told Forbes.

EMERGING APPETITES

“ANYTHING WE DO IS BASED ON LISTENING TO OUR RETAILERS...WE GET FEEDBACK, SEE WHAT WORKS, WHAT THEY LIKE AND DON’T, AND WE CONSTANTLY SHARPEN THAT AXE.” Drew Yeaton Co-founder and Chief Technology Officer, Phobio

A good portion of those sales are in emerging markets such as China, where demand is strong but the ability to pay new-phone prices is not. Phobio, with its own auction house in place there, is on track to process 2 million trades this year, according to Vice President of Partner Development Korey Klugman.

“China buys everything,” Stephen Wakeling says.

“They buy everything that we are throwing away, and the new stuff too.”

Phobio mainly takes in iPhones and other smartphones, the majority from store trade-ins but also from bulk deals, including retail overstocks.

In the U.S., he says, smartphone users hang on to their devices for about 18 months, but that number is decreasing as device makers launch upgrades more quickly and tradein programs such as Phobio’s take hold.

Traded-in phones are valued in stores by Phobio’s software, with retailers typically getting commissions of 2 percent to 20 percent of the estimated resale value of each trade-in.

Once the used phones make it to Hong Kong, Matt Wakeling sells them to mainland China. Some are also resold in the United States, but U.S. sales account for only about 20 percent of the phones Phobio resells.

Phobio initially used a model similar to that of online trade-in service Gazelle.com, allowing consumers to sell used phones and other electronic devices on the Internet in exchange for cash.

But the company changed course when a small retailer in New Orleans read about it in a local paper and asked the Phobio team to set up a system directly in their shop.

“Before us, they weren’t really operating a service. They were doing what we are doing, but a ramshackle version of it,” Stephen Wakeling says, adding that the sales staff was looking up phones on eBay to guess trade-in values.

“We were able to provide this service en masse that legitimized (the trade-in program) and made it a part of day-to-day sales.”

Phobio has since expanded into 6,500 stores belonging to 250 retailers in the United States, 1,100 stores in Germany, 600 in Australia and 160 in Italy.

A ‘FRIENDS & FAMILY’ PLAN Though the revised model works around the world, Stephen Wakeling says Phobio picks geographies carefully. A country must have a vibrant market for new phones and phone service contracts to support trade-ins as opposed to pay-as-you-go programs.

When considering new countries, Phobio relies heavily on the founders’ trusted friends and family. The Wakelings’ parents are from Australia, for example, and the brothers spent a lot of time there as kids (their father Philip Wakeling is a member of Phobio’s advisory board).

The founders have all worked or lived overseas.

“We have an attitude of cultural flexibility, and you know, you can solve a lot of problems with technology,” says Stephen Wakeling.

“WE HAVE AN ATTITUDE OF CULTURAL FLEXIBILITY, AND YOU KNOW, YOU CAN SOLVE A LOT OF PROBLEMS WITH TECHNOLOGY.” Stephen Wakeling CEO, Phobio

USED PHONES // A never-ending supply.

For example, in Australia, a law designed to allow time for stolen goods to be tracked down in pawn shops states that retailers must keep tradedin phones in the store for two weeks before they are shipped for resale. So Phobio sets the inventory software to keep track of when the phone can be sent.

Phobio Advisory Board Member Terry Hulce, a life and business coach and CEO of DNA Coaching LLC, says management has the right attitude for working internationally.

“Business is about people,” he says. “The most important thing you can build is a culture of courage and creativity.” He adds that “screw-ups” will happen, especially working internationally.

To mitigate risk, all of Phobio’s development work happens in the United States, where it maintains 45 employees, including software engineers and a marketing team to provide advertising collateral for stores. It has just five employees overseas.

When expanding into a new market, management enlists its trusted connections to find attorneys “skilled to deal with the mountain of paperwork” involved in setting up business in another country.

‘DAVID AND TWO GOLIATHS’ “Hong Kong is a city-state designed for businesses,” Stephen Wakeling says of Phobio’s first and most necessary foreign venture. “We found it easy to get things going, which fueled our naiveté on how easy it would be” to link up with international retailers.

While phone trade-ins are increasing, the company has far from cornered the market. Phobio’s main competitors are Brightstar Corp. and HYLA Mobile, both significantly larger companies with ample marketing resources.

That’s why Phobio plans to expand into new retail markets, specifically in Britain and possibly Brazil, and to continue to develop software updates and service additions that benefit retailers and make Phobio a more beneficial partner. The company says its software is the easiest to use and the most reliable for pricing trade-ins, with a 98 percent accuracy rate.

“BUSINESS IS ABOUT PEOPLE. THE MOST IMPORTANT THING YOU CAN BUILD IS A CULTURE OF COURAGE AND CREATIVITY.” Terry Hulce Phobio Advisory Board Member and CEO, DNA Coaching LLC

POISED TO EXPLODE // The secondhand phone market is growing rapidly, and Phobio is on track to increase revenue by 50 percent this year.

“We are the David and we have two Goliaths,” Stephen Wakeling says.

“But we have smooth stones and sharp aim, so we’re OK.” At a trade show this fall, the company will unveil new software that helps retailers communicate with their sales associates—again, for free.

“Anything we do is based on listening to our retailers from the beginning,” says Co-founder Yeaton, who now serves as Chief Technology Officer. “We get feedback, see what works, what they like and don’t, and we constantly sharpen that axe.”

And for now, even if it means very streamlined growth, Phobio plans to steer clear of ceding control of the business to outside investors.

“Equity investment could certainly accelerate our go-to-market strategy, but we’re confident in our current course,” CMO Juge says. // Susan Nadeau is a Hartford, Wis.-based business writer.

PHOBIO’S PHONE TRADE-INS // Phobio’s custom software makes the trade-in process seamless, from receiving used phones in-store to shipping them abroad for resale.

1 TRADE IN YOUR OLD OR BROKEN PHONE

2

PHONE IS REFURBISHED

BY PHOBIO

4 PHONE IS THEN RESOLD

3 REFURBISHED PHONE IS SHIPPED TO CHINA

Groundbreaking regulatory changes in Mexico are opening up the market for investment in the country’s booming energy sector.

Unlocking the

Mexican Potential

BY AINSLIE CHANDLER, Privcap Media

T

o get a sense of the excitement surrounding the opportunity now presented by Mexican energy, have a conversation with one of the few people to have actually completed a private equity deal in the space.

Consider, for example, a story told by George Osorio, managing partner of Conduit Capital Partners, an energyspecialist private equity firm that completed a hydroelectric investment in Mexico in 2002. The difficulty of that project convinced Osorio that investments in Mexico would always be characterized by complexity and pain. He relates encounters he had in the early 2000s with Mexican regulatory officials: “We would have discussions with (government regulatory entities) CRE and CFE…and we were trying to start the conversation about opening up the sector, opening it up for private investment and potentially privatization.

We would literally be laughed at. They said that would never happen in Mexico: ‘It’s too nationalistic. This is part of our national resource, and we don’t intend to ever open it up.’

Fifteen years later, look where we are—it’s happening.”

FACTS ABOUT MEXICO’S ENERGY MARKET • For the first time, foreign direct investment will be permitted in Mexico’s energy sector, including production-sharing contracts with Pemex.

• The reforms were badly needed: Mexico issued only three drilling permits in 2012 for its share of the Eagle Ford shale, to the U.S.’s 4,143 in the same shale north of the border.

• Required capital expenditure in Mexico’s energy sector could total $350 billion over five years.

• Demand for natural gas is expected to rise strongly as Mexico’s industrial and consumer energy usage grows.

What is happening in Mexico should indeed be energizing to private investors around the world, as well as to domestic advocates for Mexican growth. Most discussed are the amendments to the Mexican Constitution enacted by lawmakers late in 2013 that create several models for foreign investment in Mexican hydrocarbon. But Mexico’s domestic economy is growing such that demand for energy from across the border will also spell investment opportunity.

The groundbreaking reforms are a result “...NOW WE HAVE of amendments to the Mexican Constitution PRETTY MUCH ALL THE enacted last year. The changes end the longFRAMEWORK READY IN standing monopoly of the national petroleum CONGRESS. THE SENATE company, Pemex, and allow for several forms HAS STARTED TO of investment contracts in that market. The APPROVE THE POWER reforms continue to enjoy legislative support— LAWS, SO IT just this past August, Mexican lawmakers IS HAPPENING.” passed a new series of laws designed to bolster Oscar Lopez-Velarde the constitutional amendments and further Tax Partner at EY’s Latin American Business Center reorder the country’s energy industry.

BIG OPPORTUNITY The scope for investment is huge, with capital expenditure across the sector potentially reaching $350 billion, according to figures from the Binational Center Library at Texas A&M International University.

Oscar Lopez-Velarde, tax partner at EY’s Latin American Business Center, describes the reforms as a “game changer” and a huge opportunity for those looking to invest in upstream, midstream and downstream opportunities. The underdeveloped pipeline network through and to Mexico is just one area begging for outside investment, while there is also pressing need for new refineries.

In addition, a number of private equity firms are already starting to create joint ventures with Mexican partners to bid on tender offers for exploration and production projects. Lopez-Velarde says Mexico does not yet have the framework for master limited partnership investment, but the government and tax authorities are working on a similar framework to attract more capital. “A year ago, when the constitutional discussion was started in (Mexico’s) Congress, nobody believed that this was going to come into place. Now we have pretty much all the framework ready in Congress.

The Senate has started to approve the power laws, so it is happening.”

Osorio says he is optimistic that benefits of the reform will be obvious enough to policymakers that the reforms are likely to remain in place, whether or not there is a change of government. He believes Mexico will avoid some of the “growing pains” of countries like Argentina and Venezuela because of its strong ties with the United States and Canada. While the reforms do not yet promise “straight out privatization,” he says they do seem poised to deliver “creeping privatization.”

Commenting on the Comisión Federal de Electricidad (CFE, the state-owned power monopoly), Osorio notes that legal changes will allow producers to supply power to companies or municipalities in deals over which the CFE will have limited control, a change he says is “dramatic” and “profound.”

The suite of reforms is “the best thing that could happen, and I’m not just saying for Mexico—for the region, including the U.S, its neighbors, all of South America,” says Osorio.

“This has far-reaching effects, and I don’t think people appreciate it.”

PARTNERS GROUP One group that definitely appreciates the Mexican opportunity is global investment firm Partners Group. Based in Switzerland, Partners Group had been interested in the North American oil and gas market but was hesitant about getting involved in the U.S. space prowled by so many competitive MLPs, according to Maximiliano Del Vento, a vice president at the firm.

Instead, Partners Group looked farther south and struck a deal with Fermaca, Mexico’s second-largest gas pipeline company. The firm invested an initial $750 million into Fermaca. Noting Mexico’s share of the fertile Eagle Ford shale formation, Del Vento says Fermaca will be transporting “the same resources, the same shale gas…The only difference is that there is a line on the floor that separates Mexico from Texas. So we’ve found this amazing asset and incredible management team and we were able to work with management on a transaction that makes sense for everybody.”

“THE THING I WOULD SAY ABOUT MEXICO INVESTING IS THAT, UNLIKE ANY OTHER COUNTRY IN LATIN AMERICA, DEVELOPMENT MEANS YOU TALK TO THE COMMUNITY FIRST.” George Osorio Managing Partner, Conduit Capital Partners

Del Vento says his firm’s stake in Fermaca positions it well to enjoy an expected wave of growth as Mexico moves to increase its energy infrastructure. “We think there is a huge opportunity for the company to participate in the tenders that are coming to market,” he says. “There is a multi-billion dollar opportunity in the midstream to build the infrastructure in Mexico. If you look at the government plan, (legislators) expect to auction approximately 10,000 kilometers of traditional natural gas pipelines over the next few years.”

Del Vento further estimates that the legal reforms could help lift Mexican GDP by 1 percent to 1.5 percent, depending on how the laws are implemented. “We think that things (will) be implemented well and in a very market-friendly way,” he says, given the aim of the laws is to attract more foreign direct investment, create jobs, improve productivity and increase living standards.

“THERE IS A MULTIBILLION DOLLAR OPPORTUNITY IN THE MIDSTREAM TO BUILD THE INFRASTRUCTURE IN MEXICO.” Maximiliano Del Vento Vice President, Partners Group

EY’s Lopez-Velarde agrees that the scope of the opportunity is large and stresses there are prospects for players of different sizes and types: “You will find the big projects, the huge pipelines, but also smaller pipelines already being built. If you go to offshore, we know that the majors will probably get the first deep-sea water projects. We are also seeing Mexican companies operating in the onshore business. We are putting in place a couple of companies funded by private equity that are planning to do investments that range between $500 million and $1 billion…We see room for everybody, honestly. There will be room for the big guys, for the mid-size projects and also for a lot of the small things that need to be built in Mexico.”

Osorio, a pan-Latin American investor, is enthused about Mexico as a destination for his firm’s investment activities. “Mexico is actually our No. 1 target by far out of all the countries in the region as a whole,” he says.

As someone who has completed three deals in Mexico, however, Osorio cautions that energy projects in particular need to begin with community buy-in—a cultural factor that the reforms do not overcome. “The thing I would say about Mexico investing is that, unlike any other country in Latin America, development means you talk to the community first,” he says. “Forget the feasibility studies, forget your energy research, forget your legal structures. You need to talk to the community first.”

COMPETITION International investors are indeed coming to Mexico and creating an inevitable dynamic in an attractive market: competition. As the government’s stranglehold on the markets loosens, Osorio says the number of participants investing in the sector, including financial institutions, pension funds and others from around the world, will increase. But he sees this as a positive development for established private equity investors because exit markets will open up. “When we first invested we didn’t know whether we were going to exit or not,” he says. “With so many participants going into an investmentgrade country, it just changes everything.”

Osorio says a big issue for new entrants will be finding management teams with deep expertise, given the lack of private investment in the sector up until now.

Del Vento adds that private equity firms’ movement into the Mexican energy market is similar to how PE firms operated during the real estate boom of the 1990s, deploying both Mexican and foreign management to make sure they have the expertise needed to operate in the sector.

Mexico’s energy reforms are also inspiring investment in ancillary industries expected to benefit from the growth of Mexican energy. According to EY’s Lopez-Velarde, “We are also starting to see a lot of private equity firms investing in construction companies, or in companies that would be rendering services. We’re starting to see it in Mexican shipping companies…all over the areas that are being opened for private investors. It’s a very positive outcome.”

Much remains to be seen in the way the reforms are implemented in Mexico, but the savviest energy investors in the private equity market seem to agree: The changes in Mexico are real, and the moves to participate in a new market opportunity are emphatic. // Ainslie Chandler, Senior Journalist, Privcap Media

Click here to register for Privcap’s Energy Game Change 2014 conference.

Click here to view a recording of Privcap’s webinar, “Mexican Energy: The Private Equity Opportunity.”

A QUALIFIED OPINION TORBEN LUTH // Partner, JZ International

T

orben Luth is a partner with JZ International, a London-based investment group. The firm, which also has a Madrid office, has completed over 35 transactions in Europe since 2002, primarily with familyowned businesses. Luth is responsible for sourcing deals and building relationships with target companies and brokers prior to transactions and after closing.

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WHAT HAVE YOU FOUND IS THE GREATEST CHALLENGE TO CROSS-BORDER INVESTMENT?

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t’s getting to know the ideal target. When entering a new country, either through proprietary research or with an intermediary such as a banker, firms will find that potential targets often fall into one of three categories: 1. The “eager beaver,” which is either in financial trouble, believes a foreign buyer will pay above market price or is not attractive to local buyers for other reasons.

2. The “information collector,” which is not interested in selling but will not disclose that as it gathers as much business intelligence as possible.

3. The “thinker,” which is an ideal target. The company is not in a rush, preferring to collect information in order to make the correct choice with the future in mind.

The challenge for buyers is first identifying the “thinker,” then finding the best way to approach the seller while keeping a lookout for cultural issues that could derail a deal.

Photo by Matthew Gilson

A QUALIFIED OPINION TORBEN LUTH // Partner, JZ International

T

orben Luth is a partner with JZ International, a London-based investment group. The firm, which also has a Madrid office, has completed over 35 transactions in Europe since 2002, primarily with familyowned businesses. Luth is responsible for sourcing deals and building relationships with target companies and brokers prior to transactions and after closing.

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WHICH FACTORS SHOULD INVESTORS CONSIDER WHEN DECIDING WHETHER TO TAKE A PORTFOLIO COMPANY INTO A NEW GEOGRAPHIC MARKET?

G

eographic expansion can be a very attractive way to grow a company. The easiest strategy is to follow an important client from the company’s home market—depending, of course, on the relationship the company has with the client. The client can be a valuable source for information as well as a potential client in a new market.

The first decision is which strategy to follow for expansion: joint venture, greenfield startup or acquisition. Each option has the usual pitfalls, from legal and cultural challenges to foreign currency exposure and tax structure.

Often overlooked is the impact such a move will have on the portfolio company itself. Internal challenges range from diverting resources, which are needed in the home market, to territorial fights over who should oversee the new venture and how to handle compensation.

Photo by Matthew Gilson

A QUALIFIED OPINION TORBEN LUTH // Partner, JZ International

T

orben Luth is a partner with JZ International, a London-based investment group. The firm, which also has a Madrid office, has completed over 35 transactions in Europe since 2002, primarily with familyowned businesses. Luth is responsible for sourcing deals and building relationships with target companies and brokers prior to transactions and after closing.

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HOW WAS JZ INTERNATIONAL ABLE TO HELP ITS EUROPEAN PORTFOLIO COMPANIES WEATHER THE GREAT RECESSION OVER THE PAST SIX YEARS?

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ome of our portfolio companies were positioned so they benefited from banks pulling out of their traditional business lines; JZI’s role was to help these firms finance new opportunities to claim market share.

Other portfolio companies were hurt by the crisis. One example is a firm that focused exclusively on assisting banks with the documentation process for mortgage loans. Initially JZI helped the company shift its focus toward handling the refinancing of troubled mortgages and distressed loans.

After the first six months, when mortgages had settled at their new low market volume, JZI helped management expand its client list in both traditional and refinanced mortgages, growing the company’s market share from 7 percent to over 30 percent, albeit in a much smaller marketplace.

Additional legal services, including documentation for probate, were also introduced to the company’s clientele. As the traditional mortgage market slowly recovers, the firm is performing extremely well with more clients and service offerings than ever before.

Photo by Matthew Gilson

A QUALIFIED OPINION TORBEN LUTH // Partner, JZ International

T

orben Luth is a partner with JZ International, a London-based investment group. The firm, which also has a Madrid office, has completed over 35 transactions in Europe since 2002, primarily with familyowned businesses. Luth is responsible for sourcing deals and building relationships with target companies and brokers prior to transactions and after closing.

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AS THE ECONOMIC OUTLOOK IMPROVES IN EUROPE, WHERE DO YOU SEE THE MOST OPPORTUNITY FOR INVESTORS?

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isregarding the obvious directive for distressed investors to look to Southern and Eastern Europe, I believe the answer hinges on sector. The crisis has created opportunities for investors across the continent. Companies that survived have been battle-tested: The difficult task of trimming excess cost has been taken care of, production and/or services have been optimized and owners are realizing that a sustainable, profitable company is the most important thing.

For example, One World Packaging, a packing company in Spain in which JZI recently invested, operates at significantly lower costs than most of its global competitors, using an innovative biodegradable package that it developed to survive the recession. We are looking at several Eastern European service companies which, after suffering during the downturn, now have very low costs and owners with more reasonable price expectations than they had before the crisis. So opportunity is not strictly a matter of geography, but rather where you’ll find the “thinker” target referenced previously.

Photo by Matthew Gilson

A QUALIFIED OPINION TORBEN LUTH // Partner, JZ International

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orben Luth is a partner with JZ International, a London-based investment group. The firm, which also has a Madrid office, has completed over 35 transactions in Europe since 2002, primarily with familyowned businesses. Luth is responsible for sourcing deals and building relationships with target companies and brokers prior to transactions and after closing.

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AS U.S.-BASED PRIVATE EQUITY GROUPS LOOK INCREASINGLY TO EUROPE FOR DEALS, ARE THERE PARTICULAR RISKS OR CHALLENGES THEY SHOULD CONSIDER BEFORE INVESTING?

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ne of the persistent challenges in Europe versus the United States is the availability of financing. In the Scandinavian countries, for example, a firm can get up to three times EBITDA in financing for a deal; however, most deals are priced at an EBITDA multiple two to three times higher than the rest of Europe.

Meanwhile, the U.K. finance market is returning rapidly, in part due to an influx of American-based alternative lenders, while securing financing in the Benelux and German markets remains very challenging at best. And once you go to Spain and Italy, financing is still not readily available. As you consider crossing the pond, evaluate the lending environment in the target country and determine how you will finance the acquisition before you make a move.

Photo by Matthew Gilson

ACG@WORK CHAPTER NEWS FROM AROUND THE GLOBE

EDMONTON DETROIT BOSTON MARYLAND

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ACG EDMONTON

Edmonton Forms Stand-Alone ACG Chapter The ACG Edmonton Network, founded in 2012 as an affiliate of ACG Calgary, in August transitioned to an independent chapter, bolstering support for the energy-rich province of Alberta, a fast-growing economy within Canada.

ACG’s 57th chapter will represent the Edmonton region, home to the core of Alberta’s burgeoning oil and gas industry. Growth in Edmonton, the so-called “gateway to the North,” is closely tied to the development of Alberta’s oil sands.

ACG Edmonton’s move to become a stand-alone chapter followed a vote by the separate boards of Calgary and Edmonton. ACG Global voted in favor of the change in September.

Ron Dersch, Edmonton Network co-founder and president, will continue to run ACG Edmonton. The chapter will use an approval membership model. It has more than 90 members, up from 70 at the end its 2013 fiscal year ended in May. ACG Calgary will continue to represent middle-market industry in the southern region of Alberta, which besides the city of Calgary includes Banff, Lethbridge and Medicine Hat. //

LEADERSHIP // Chapter Co-founder and President Ron Dersch will run ACG Edmonton.

ACG@WORK CHAPTER NEWS FROM AROUND THE GLOBE TOP HONORS // ACG Detroit President Rob Dutkiewicz (left) presents the chapter’s Lifetime Achievement Award to Don Clayton (right).

ACG DETROIT

ACG Detroit Turns 30 This year marks ACG Detroit’s 30th anniversary as a chapter. To commemorate the milestone, it hosted a celebratory reception and presented its first Lifetime Achievement Award during the chapter’s annual conference.

In March, ACG Detroit hosted an evening reception at the Detroit Institute of Arts to celebrate its anniversary. Over 200 people attended to recognize the chapter’s success hosting events and bringing together M&A executives over the past three decades.

During ACG Detroit’s 7th Annual M&A Conference in June at the Detroit Athletic Club, the chapter presented member Don Clayton with a Lifetime Achievement Award.

He was acknowledged for his role in growing and shaping the organization through active participation and leadership and his exemplary role within Detroit’s middle-market community. Clayton, chairman of the accounting and tax advisory firm Clayton & McKervey P.C., has been a member of ACG Detroit since 1996. He has served as chapter president, vice president of membership and on the program committee. //

ACG@WORK CHAPTER NEWS FROM AROUND THE GLOBE ATTENDEE NETWORKING // Nigel Howard, RLJ Equity Partners (left), and Kevin Cunningham, Leeds Novamark Capital, grab time to talk during Deal Forum.

ACG MARYLAND

Baseball and More at Deal Forum 2014 In June, ACG Maryland hosted its third annual Deal Forum conference. Building on the success of the past two years, the event featured fun, unconventional networking opportunities and valuable programming.

More than 300 dealmakers focused on the lower middle market attended the conference at the picturesque Baltimore Inner Harbor. Attendees were treated to a number of novel networking events, including a reception and ballgame at Oriole Park at Camden Yards, the Extra Innings after-party at a local ale house and Deal Forum’s inaugural Bloody Mary event on the morning of the second day.

In addition to social events, the conference included a lineup of topical panels and a keynote address from war hero 1st Sgt. Matthew Eversmann, whose life story was immortalized in the book and epic film “Black Hawk Down.” Two thought leadership sessions addressed topics relevant to today’s business environment: “Reshoring: Trends and Opportunities in U.S. Manufacturing” and “Health Care IT: Population Health Management.” //

ACG@WORK CHAPTER NEWS FROM AROUND THE GLOBE SOUTH END SETTING // DealFest Northeast was held at Boston’s Cyclorama venue.

ACG BOSTON

DealFest Northeast’s New Take on Networking On June 18, ACG Boston welcomed over 500 dealmakers from across the country to the historic Cyclorama in Boston’s South End for the inaugural DealFest Northeast, replete with new twists on classic ACG networking events.

In place of the traditional ACG Capital Connection® format, attendees enjoyed New England craft beers and select wines provided by the top Boston-based private equity and investment banking firms, which co-hosted the event. Surrounded by facades of famous landmarks like Fenway Park’s Green Monster, Mike’s Pastry, L Street Tavern and a replica Cheers bar, the high-energy event was a true Boston experience. Live Irish music and locally inspired food, including a roving seafood cart and Boston cream pies for dessert, enhanced the atmosphere.

The following day, the reinvented DealSource® Select was presented to private equity professionals, investment bankers, select lenders, limited partners and, for the first time, corporate development professionals. Participants used a new software tool that gave them greater control over their schedules and meeting requests. As a result, a record-setting 700 meetings were pre-arranged among nearly 300 participants.

For those interested in participating in DealFest Northeast 2015, please contact ACG Boston for an invitation. //

THE PORTFOLIO INSIGHT FROM THE EXPERTS SOUND DECISIONS

MID-MARKET TRENDS

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IN THIS ISSUE SOUND DECISIONS • To ensure cybersecurity is maintained, evaluating the resilience of third parties involved in M&A is a must.

MID-MARKET TRENDS • Middle-market private equitybacked firms differ in their approach to performance management compared to their non-PE-backed counterparts.

• To prevent organizational fraud, firms should strengthen their internal controls and utilize forensic audit tools.

COMING SOON

Check out the Portfolio section of the November/December issue for more on the latest middlemarket trends, written exclusively by our team of expert ACG Partners. To learn more about contributing to this section, please contact Meredith Rollins, (312) 957-4260.

These articles are brought to you by ACG’s Global Partners.

THE PORTFOLIO SOUND DECISIONS // Adam Pang, Regional Director, Merrill DataSite SOUND DECISIONS

MID-MARKET TRENDS

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Managing Data Risks: The Importance of Cybersecurity in Dealmaking

D Taking precautions around the people and systems involved in a deal is essential to data security.

ealmakers need to pay close attention to data security to mitigate the risk of competitors gaining an advantage from information disclosed during due diligence. Threats arise from an ever-increasing range of sources, including but not limited to individuals, organized crime networks, competitors, hackers, employees, contractors and even nation-states. When it comes to issues of data protection, the resilience of third parties has become as important as reviewing one’s own internal security standards.

Precautions can be administered during

without malicious intent. File-sharing

the M&A process to minimize and

platforms also need to be assessed

eliminate cybersecurity risks. During

carefully to ensure they’re a fit for the

deal preparation, it’s wise to limit the

purpose. Recent incidents involving

number of people brought into the

public and open availability of sensitive

inner circle. Firms can then map out

and personal data occurred not because

information and process flows, review

someone hacked and exposed the data,

current working practices and appoint

but because functionality created a

a third-party data room provider. When

loophole. The best course of action is to

engaging advisers, establish a shared

assess and select a secure virtual data

principal of governance, think about due

room solution in which multiple parties

diligence procedures and put in place an

can concurrently view information

incident plan.

within a protected online environment

Next, consider what information you will provide and how to share it with the

built to manage confidential data.

It’s also a good idea to have

parties involved in the transaction. We

confidentiality agreements with all

would never advise transferring data—

parties in place before sharing any data.

particularly sensitive data—via email

Firms should continually monitor who

between parties involved in an M&A

accesses information and when. Ideally,

transaction, as this is rife with security

firms should utilize a real-time report

risks. Servers can be accessed and emails

available in premier VDR solutions,

cloned or simply forwarded by accident

allowing sell-side teams engaged in

THE PORTFOLIO SOUND DECISIONS // Adam Pang, Regional Director, Merrill DataSite SOUND DECISIONS

MID-MARKET TRENDS

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a project to see which individual has

Adam Pang

Finally, upon completion continue

accessed what information down to page

to monitor information related to the

level, as well as when he or she viewed

transaction, transfer funds securely

it and for how long. This provides an

and be conscious that your organization

advantage: any suspicious activity

may be at increased risk of cyberattack.

would send up red flags without delay.

It is time to consider reviewing and

Importantly, during a deal negotiation it’s

strengthening security policies across

also easy to see who is interested in the

the post-merger organization and to

asset based on what data he or she has

determine how the combined entity will

reviewed and how much time was spent

manage information. It’s possible, for

viewing them. There really isn’t a better

example, to continue to use a VDR for

way both to monitor suspicious activity

secure purposes post-integration.

and move deal negotiations forward to achieve the best valuation.

It’s important to recognize, however,

To learn more about how to protect your next M&A transaction from cybersecurity risks, speak to one of our

that people are just as important as

industry experts and schedule a demo

technology when it comes to the issue

of Merrill DataSite. //

of cybersecurity. You can’t afford to be complacent in this area—all the

Adam Pang is a regional director with

employees at Merrill DataSite, for

Merrill DataSite in the firm’s London office

example, undergo extensive background

with a focus on the international sales effort

checks and must sign stringent non-

in the U.K. and emerging markets. He has

disclosure agreements. To meet the

over 10 years of experience in financial and

security standards required to guarantee

information solutions management.

a system is operated securely—the ISO 27001 security specification, for instance—over 200 internal security protocols need to be in place. These significantly reduce the security risks associated with any technology in use.

THE PORTFOLIO SOUND DECISIONS // Randall Wilson, Partner, RGL Forensics SOUND DECISIONS

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Enhancing Internal Control in the Fight Against Fraud

T Effective internal controls are the best weapons for fighting fraud within an organization.

he Association of Certified Fraud Examiners’ 2014 Report to the Nations estimates the cost of fraud to organizations around the world at $3.7 trillion. This equates to approximately 5 percent of the revenue of all domestic and international entities combined. And, surprisingly, fraud continues to rise. The ACFE’s international fraud survey shows that fraud has increased by nearly a trillion dollars since 2009.

This increase is astonishing given the heightened awareness of fraud by corporate executives in the wake of billion-dollar mega-Ponzi schemes; the

GROWTH IN OCCUPATIONAL FRAUD $4.0

$3.7 Trillion $3.5 Trillion

$3.5

expansion of domestic and international regulation designed to prevent fraud and

$3.0

$2.9 Trillion

punish perpetrators; and the explosion of professionals dedicated to the fight against fraud around the world. And yet seldom has a week gone by without a news story about embezzlement from an

$2.5 $2.0

2009

2011

2013

According to the ACFE “Report to the Nations” survey

organization or financial statement fraud by the owners or officers of an entity.

his or her actions, the employee will

Until corporations and their directors

too often find a way to misappropriate

get serious about fraud prevention, these

funds. Thus, the primary area of focus

troubling trends will continue.

for corporations is on employees’ opportunity to engage in fraud.

Conditions that Lead to Fraud

Limiting the opportunity to embezzle

The conditions that lead to fraud include

involves dedication to a system of

motive, opportunity and rationalization.

checks and balances, thus creating an

When an employee with access to assets

environment of control that includes the

has a motive—typically in the form

detection of irregularities in the normal

of need or greed—and can rationalize

course of business. It involves an attitude

THE PORTFOLIO SOUND DECISIONS // Randall Wilson, Partner, RGL Forensics SOUND DECISIONS

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Randall Wilson

of intolerance for the commission of

available are also those least utilized

fraud that is pervasive throughout

by entities. ACFE ranks the following

the leadership of the corporation. In

internal controls as highly effective:

designing these systems, the corporation

•• Surprise audits

must be cognizant that even a small

•• Fraud hotlines

seam in its internal control can lead to

•• Rewards for whistleblowers

opportunity for a motivated employee.

•• Communication of the company’s

For example, in a recent fraud investigation case the corporation

stance against fraud

A surprise audit would have detected

believed that it had a sound system

the unusual transactions occurring

of controls in place when the

in the customer accounts in the fraud

misappropriation was discovered;

investigation case referenced earlier.

however, no one realized that the

However, electronic controls in the

accounts receivable manager had the

receivables module could have been even

ability to manipulate customer account

more effective: By denying access to move

balances within the receivables module

balances between customer accounts

in order to conceal the misappropriation

without supervisor approval and

of payments on accounts. In addition,

implementing electronically generated

the company’s leaders never dreamed

exception reports triggered by such

that the receivables manager would

transactions, company leaders would

modify daily deposits on the way to

have discovered the scheme much sooner.

the bank by replacing currency in

Fraud investigators have a number

the deposit with the checks received

of tools at their disposal to forensically

from customers. The bank statements

audit the books and records of a

and ledgers balanced, and the scheme

corporation and to identify aberrations,

continued for several years while several

which may lead to the discovery of fraud

hundreds of thousands of dollars were

upon investigation. These are valuable

misappropriated before detection.

weapons to include in your arsenal for the ongoing fight against fraud. //

The Internal Control Environment There are many ways to improve the

Randall Wilson is a partner at RGL Foren-

effectiveness of the internal control

sics, a global forensic accounting and con-

environment. Interestingly, however, some

sulting firm, where he leads the firm’s global

of the most effective internal controls

fraud practice.

THE PORTFOLIO MID-MARKET TRENDS // Raymond Noe and Larry Inks, Department of Management and Human Resources, The Ohio State University Fisher College of Business

SOUND DECISIONS

MID-MARKET TRENDS

TAP BUTTONS TO NAVIGATE COLUMNS

Performance Management: Implications for Middle-Market Private Equity-Owned Firms

A

soon-to-be released study from the National Center for the Middle Market reinforces the value of performance management despite recent criticisms suggesting it is a burdensome administrative process that makes little, if any, contribution to a firm’s strategy, bottom line and manager-employee relationships.

Middlemarket firms differ in their approach to performance management and in their evaluation of existing programs.

The study provides insight into how

Highlights of the study for private equity-

middle-market C-suite executives view the

owned middle-market firms

role of performance management, rank

• Leaders of private equity-owned firms

practices and challenges, and how they

face challenges for which effective

evaluate the effectiveness of performance

performance management is critical,

management systems. Middle-market lead-

including selecting employees

ers also rated the extent to which the orga-

to promote, allocating rewards,

nizational culture and managers’ and em-

identifying growth opportunities and

ployees’ attitudes and behaviors contribute

recruiting employees with particular

to effective performance management.

skills. Approximately a quarter of

The results reveal important differences in

leaders surveyed say performance

performance management practices

management is important but admit

between firms with increasing revenue

that it is underutilized when dealing

and those with flat or declining revenue.

with poor performers, turnover of

These differences are apparent in company

key employees and during succession

practices and culture—for example, firms

planning discussions.

with growing revenue are more effective

• Sixty-four percent of private equity-

at implementing formal progress review

owned company leaders gave their com-

discussions and their managers are more

pany an ‘A’ or ‘B’ grade for performance

comfortable making tough decisions and

management, rating the overall effec-

holding employees accountable.

tiveness of their performance management practices higher than did respondents from the overall middle market (55 percent). For private equity-owned

THE PORTFOLIO MID-MARKET TRENDS // Raymond Noe and Larry Inks, Department of Management and Human Resources, The Ohio State University Fisher College of Business

SOUND DECISIONS

MID-MARKET TRENDS

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firms the biggest obstacles to getting a

and did not feel weaker performers

top grade include management indiffer-

were hearing the message that their

ence and an ineffective or inconsistent

performance needed to improve.

performance review process.

• Over 70 percent of private equity-owned Raymond Noe

Larry Inks

• Private equity-owned firm leaders reported that the greatest obstacle to

firm leaders reported that their perfor-

improving their performance manage-

mance management system was very

ment was managers’ discomfort with

or somewhat effective for many of the

making tough decisions and holding

important components of performance

employees accountable. Twenty-two

management, including goal setting and

percent of private equity-owned firm

awarding compensation based on em-

leaders reported that their managers

ployee performance.

resisted evaluating direct reports, more

• Almost two-thirds of private equityowned company leaders agreed or strongly agreed that managers effec-

than non-private equity-owned company executives (12 percent).

• Eighty-seven percent of executives sur-

tively communicate to high performers

veyed said performance management is

that they’re valued. However, giving

a top or important priority for the com-

negative feedback to weak performers

ing year. Reflecting their assessment of

was less likely, perhaps explaining why

current evaluation practices, some of

only about half of surveyed leaders

the most common goals leaders noted

agreed or strongly agreed that perfor-

were improving team and individual

mance management was part of their

goal setting while emphasizing both

firms’ culture.

informal and formal feedback. //

• There were notable differences in the evaluation of performance management practices at private equity-owned firms compared to firms not backed by private equity. Leaders of private equity-owned firms were more likely to use technology to streamline the performance management process; however, they rated several aspects of the process less favorably than their non-private equity backed counterparts

Raymond Noe and Larry Inks are faculty members in the Department of Management and Human Resources at The Ohio State University Fisher College of Business.

The National Center for the Middle Market is a collaboration between GE Capital and The Ohio State University Fisher College of Business. Visit middlemarketcenter.org to view the performance management report when it becomes available.

THE LADDER ACG MEMBERS ON THE MOVE Audax, a middle-market

Dennis Roberts, a longtime

private equity firm, announced

member of ACG National Capital

the completion of its 400th

and chairman of The McLean

acquisition after its portfolio

Group, was presented with

company Phillips & Temro

the Thomas R. Porter Lifetime

Industries bought Idle Free

Keith Denham

Dennis Roberts

Achievement Award by the

Systems. To date, Audax has

National Association of Certified

acquired 77 platforms and made

Valuators and Analysts for his

323 add-on acquisitions.

contribution to the industry.

CohnReznick, an accounting,

The Keystone Group, a man-

tax and advisory firm, said Keith

agement consulting firm work-

Denham joined as managing

ing with mid-market manu-

principal and national director

facturing, distribution and

of the CohnReznick Advisory

transportation companies, has

Group in the firm’s Boston office.

expanded its Atlanta office.

Three long-term associates

Ari Markenson, a member of

have transferred from the firm’s

ACG New York, recently joined

Chicago headquarters to focus

the law firm Duane Morris as

on the Southeast market.

partner in its New York office.

Ari Markenson

Markenson was listed in 2014 as

Todd Kinney, a relationship

a top health care attorney by rat-

director for the national private

ing service Super Lawyers and

equity practice of BDO USA,

Best Lawyers in America.

an accounting and consulting group, was named executive

Sean Murphy, a member and

Todd Kinney

vice president of ACG New York.

past chairman of ACG Orlando,

He will support governance and

has joined Nperspective LLC, a

strategic planning for the chapter.

Florida-based CFO services firm, as strategy and operations prinSean Murphy

cipal. Murphy will help to grow Nperspective’s operations services offerings.

To submit your promotions, job changes and other accomplishments, please send information and a color photo (hi-res 300 dpi or above) to Associate Editor Kathryn Mulligan.

B-SIDE BRAUN JONES // Managing Director, Stonehaven Capital

PAYING ATTENTION TO...

Technology and services companies with high-growth potential serving large markets—security, data analytics, Internet, mobile, and communications companies—businesses that clearly leverage new information and communications paradigms.

“I SEE MORE INVESTING AND LESS BANKING IN MY NEAR FUTURE…”

INSPIRATIONAL FIGURE...

BRAUN JONES // A banker, entrepreneur, investor and fixer of broken things, Jones has provided advisory services for mergers and acquisitions and debt and equity private placements. He is also a veteran entrepreneur, having founded and successfully exited several tech and finance companies.

ON MUSIC...

I like just about everything from classic rock to Sinatra. I don’t like death metal, hard-core rap or Justin Bieber.

FAVORITE FILM...

“The Outlaw Josey Wales”—Clint Eastwood is at his best in this film.

As is typical of Eastwood, he portrays a somewhat sinister and vengeful character—but also one that in the end is seeking peace and to be left alone, which he finally finds with a little help from others.

My father—he influenced me to embrace entrepreneurship, dealmaking and investing. He started off as a very successful IBM salesman and then started a company. He started several other successful companies and was an early investor in AOL, among others. For the last 15 years he has captained his own boat and continually circumnavigates the globe—he is currently in the Baltic Sea. He’s a modern-day Magellan.

“IT’S REALLY ABOUT TIMING—TIMING IN HOW THINGS BECOME A SUCCESS AND WHY.”

GO-TO COCKTAIL...

I prefer vodka in the summer and bourbon in the winter.

I’m pretty simple.

INSPIRED READING...

Malcolm Gladwell. One of his main themes is timing and debunking common, accepted and intuitive explanations. Things are not always what they seem to be and good ideas don’t work when markets are not ready. Whether it’s leveraged buyouts, online learning, biometrics or vertical social networking, many early entrants fail only to give way to successful, yet similar incarnations when the market later matures.

IT’S THE SMALL THINGS WORLD TRENDS // The Middle Market is All Over the Map

1

BLOWING THE BRIC HOUSE DOWN PE is shifting gears from Brazil, Russia, India and China (the BRICs) to other emerging markets, including sub-Saharan Africa, Southeast Asia and Latin America (outside of Brazil).

6

OVERHANG HANGOVER Capital overhang in the global private investment industry is 23% higher than usual with U.S. private equity, European PE and global real estate together accounting for $655 billion, or 72% of the total.

2

MAKING A RUN FOR THE BORDER While domestic acquisitions remain the focus of acquisitive growth, cross-border M&A has increased by 56% since 2008 and 18% in 2013 alone.

7

3

HERE’S A RESHORING THOUGHT FOR THE U.S. If the trend of rising wages and shipping costs continues, 20% to 25% of products sent offshore will eventually return to the U.S.

UNITRANCHE PUSHING MEZZANINE TO THE BALCONY One of the biggest threats to mezzanine financing right now is the increasing popularity of unitranche lending—the strategy of combining senior and subordinated debt into one package with a blended interest rate— especially in the lower middle market.

8

RUSSIA MAY BE ‘PUTIN’ ITSELF IN THE RED In Russia, private capital outflows exceeded 5% of GDP in 2013 and remain a persistent problem, compounded by recent political actions.

4

OIL AND GAS ENERGIZED BY PE The oil and gas industry is experiencing significant capital investment with $700 billion slated for projects under development.

5

M&A MEANS THE WORLD TO GLOBAL DEALMAKING Not since 2007 has the volume of global corporate deals been so high for the first four months of the year, tracking at over $1.2 trillion.

—Larry Guthrie, manager, communications and marketing, ACG Global

THE LEADERSHIP ACG DIRECTORS ACG BOARD OF DIRECTORS //

CHAPTER REPRESENTATIVE DIRECTORS //

DIRECTORS AT LARGE //

Chairman Doug Tatum* Newport Board Group ACG Atlanta Term expires 8/31/2015

Brent Baxter Clayton Capital Partners ACG St. Louis Term expires 8/31/2017

Jason Brown Victory Park Capital ACG Los Angeles Term expires 8/31/2016

Bradford Adams TM Capital ACG Boston Term expires 8/31/2015

Jason Byrd The Charter Group ACG Western Michigan Term expires 8/31/2017

Robert Brighton Shutts & Bowen, LLP ACG South Florida Term expires 8/31/2017

Greg Cinnamon Kilpatrick Townsend & Stockton LLP ACG Atlanta Term expires 8/31/2015

Roy Graham Corporate Finance Associates ACG Central Texas Term expires 8/31/2015

Mike Ehlert Capital One Leverage Finance Corp.

ACG Dallas/Fort Worth Term expires 8/31/2015

Karen Grexa KeyBank Business Capital ACG New Jersey Term expires 8/31/2017

Brian Gilbreath Merrill Corporation ACG Nebraska Term expires 8/31/2015

Jay Hansen O2 Investment Partners ACG Detroit Term expires 8/31/2017

Ramsey Goodrich Carter Morse & Mathias ACG Connecticut Term expires 8/31/2016

Patricia King Bank of America Merrill Lynch ACG Tennessee Term expires 8/31/2015

Don Lipari McGladrey ACG New York Term expires 8/31/2017

Robert Napoli First West Capital ACG British Columbia Term expires 8/31/2015

Angie MacPhee RGL Forensics ACG Denver Term expires 8/31/2016

Walter O’Haire Valuation Research Corp.

ACG San Francisco Term expires 8/31/2017

Gretchen Perkins Huron Capital Partners ACG Detroit Term expires 8/31/2016

Steve Peterson Brass Ring Capital, Inc. ACG Wisconsin Term expires 8/31/2015

Karen Tuleta Morgenthaler ACG Cleveland Term expires 8/31/2017

Hans-Josef Vogel Beiten Burkhardt ACG Germany Term expires 8/31/2015

Tom Washbush Bricker & Eckler LLP ACG Columbus Term expires 8/31/2015

Vice Chairman Richard Jaffe* Duane Morris LLP ACG Philadelphia Term expires 8/31/2015 Chairman of Finance Stephen Prostor* Citi Private Bank ACG New York Term expires 8/31/2015 Secretary J.B. Dollison* Crutchfield Capital Corporation ACG Houston Term expires 8/31/2015 Immediate Past Chairman Pamela Hendrickson* The Riverside Company ACG New York Term expires 8/31/2015 President & Chief Executive Officer Gary A. LaBranche, FASAE, CAE* ACG Global

ACG HONORARY DIRECTORS // Robert G. Coffey Alan B. Gelband *denotes member of Executive Committee

ACG NEAR YOU ACG CHAPTERS ACG 101 Corridor acg.org/101

ACG Detroit acg.org/detroit

ACG Orlando acg.org/orlando

ACG Arizona acg.org/arizona

ACG Edmonton acg.org/edmontonnetwork

ACG Philadelphia acg.org/philadelphia

ACG Atlanta acg.org/atlanta

ACG France acg.org/paris

ACG Pittsburgh acg.org/pittsburgh

ACG Austria acg.org/austria

ACG Germany acg.org/germany

ACG Portland acg.org/portland

ACG Barcelona acg.org/spain

ACG Holland acg.org/holland

ACG Raleigh Durham acg.org/raleighdurham

ACG Boston acgboston.org

ACG Houston acg.org/houston

ACG Richmond acg.org/richmond

ACG Brasil acg.org/brazil

ACG Indiana acg.org/indiana

ACG San Diego acg.org/sandiego

ACG British Columbia acg.org/bc

ACG Kansas City acg.org/kc

ACG San Francisco acg.org/sanfrancisco

ACG Calgary acg.org/calgary

ACG Kentucky acg.org/kentucky

ACG Seattle acg.org/seattle

ACG Central Texas acg.org/centraltexas

ACG Los Angeles acgla.org

ACG Silicon Valley acg.org/sv

ACG Charlotte acg.org/charlotte

ACG Louisiana acg.org/louisiana

ACG South Florida acg.org/southflorida

ACG Chicago acgchicago.com

ACG Maryland acg.org/maryland

ACG St. Louis acg.org/stlouis

ACG China acg.org/china

ACG Minnesota acg.org/minnesota

ACG Tampa Bay acg.org/tampabay

ACG Cincinnati acg.org/cincinnati

ACG National Capital acgcapital.org

ACG Tennessee acg.org/tennessee

ACG Cleveland acg.org/cleveland

ACG Nebraska acg.org/nebraska

ACG Toronto acg.org/toronto

ACG Columbus acg.org/columbus

ACG New Jersey acg.org/newjersey

ACG UK acg.org/uk

ACG Connecticut acg.org/connecticut

ACG New York acg.org/nyc

ACG Utah acg.org/utah

ACG Dallas/Fort Worth acg.org/dfw

ACG North Florida acg.org/northflorida

ACG Western Michigan acg.org/wmich

ACG Denver acg.org/denver

ACG Orange County acg.org/occ

ACG Wisconsin acg.org/wisconsin