How Private Equity Firms Select Investment Targets and Build Capital: Insights for Entrepreneurs – Procopio

Q&A with Procopio partner Paul Johnson and HCAP Partners partner Stefan Okhuysen

What do private equity and growth capital investors look for when they add new companies to their portfolios, and what strategies do they employ to help those companies optimize their capital? Procopio Partner and Mergers & Acquisitions and Strategic Joint Ventures co-leader Paul Johnson delved into that topic in a Q&A with Stefan Okhuysen, partner of HCAP Partners. They covered the current private equity landscape, value creation strategies, industry trends, different investment structures and more.

Paul Johnson (PJ): Thank you for agreeing to this conversation with me, Stefan. Let’s take a look at the current private equity/growth capital investing landscape. Where do you see this currently, especially in light of recent economic conditions and market volatility?

Stefan Okhuysen (SO): You’re welcome, Paul. As for the market, it has been slow for the first half of 2024 in terms of buyout or majority recap transactions. There is a lot of uncertainty in the market, mainly caused by the Fed’s unclear position on future interest rates, in addition to a lot of geopolitical noise and a very important election coming up. The consensus on what we’ve heard from colleagues, and on what we’re seeing, is that this year is going even slower than last year. That said, we have seen relatively stable transaction flow in healthcare, one of our key sectors of interest.

On the other hand, we have seen a lot of volume on the junior debt side. The delta between senior loans and junior loans has narrowed, and companies that need capital for growth or event financing are seeing the value of more flexibility in the structure of a loan at a marginally higher price. We expect this trend to continue as banks appear to be more conservative in their lending activities.

PJ: What strategies does a private equity firm use to create value within portfolio companies? Are there specific operational improvements or efficiencies that you are prioritizing?

SO: The strategy varies from case to case because all companies are different and have different needs. Nevertheless, some of the most important things we do are surround the existing management team with key experts and additional resources, financial and technical, to help them professionalize, grow and institutionalize their businesses. We have built an incredible list of operating partners, most of whom have been CEOs, CFOs, CMOs, etc. at successful companies that have gone through similar growth processes, and work with them to create and implement value creation roadmaps that will help the business achieve his goals and go to the next level. These may include organic growth initiatives, technology implementation plans, financial discipline and reporting improvements, operational efficiencies, among others.

PJ: Given the current economic climate, what is a sensible course of action to optimize working capital within portfolio companies? What metrics should be tracked to ensure efficient capital management?

SO: Again, this varies from company to company because not all companies are the same and their cash cycles can be very different. That said, we pay close attention to collections and payment cycles, industry or macro events that could impact them, such as supply chain disruptions, interest rates, industry-specific issues, etc. We work closely with companies to ensure that they are adequately capitalized, and we emphasize that we are conservative on leverage ratios. We keep a close eye on key debt indicators and help our companies monitor them to ensure that the companies are financially healthy and continue on their path to success.

PJ: Have you observed consolidation trends within specific industries or sectors? How would a private equity firm position itself to take advantage of consolidation opportunities?

SO: We continue to see a pretty big trend towards consolidating various services within the home and facility maintenance space, especially in the HVAC services space. While we look at these types of companies, we are aware that valuation ratios have increased significantly as a result of this consolidation. For this reason, we try to look at other sectors that have not received as much attention and where there is still room to create meaningful platforms while staying within reasonable valuations.

PJ: What does a typical investment structure look like for one of your investments? Percentage of debt versus equity? Warrants?

SO: We are a little different from many companies in that we can cut across the capital structure and tailor a transaction that provides a solution for each specific situation. Most of our transactions consist of a combination of debt and equity, or equity-like instruments such as warrants. We can take minority or majority ownership positions.

PJ: Can you describe the typical portfolio company you are looking for based on sector and size, and any other factors such as the experience of the management team or the stage of growth?

SO: Our general parameters are $3 million to $15 million in EBITDA, growing and established businesses and experienced management teams. Our main sectors of interest are healthcare, business services, SaaS and niche manufacturing.

PJ: You mentioned healthcare. What types of companies in that sector do you currently consider worth investigating? How do you assess risk and return in this area?

SO: One of the reasons we like the sector is that it is not as sensitive to economic fluctuations, and that has been a factor in us developing a lot of expertise in healthcare over the last twenty years. Nevertheless, it is not a sector to invest in without significant expertise, due to its complexity and heavy regulatory burden. When concluding a transaction, we take all these factors into account and include them in the return expectations.

We are actively exploring patient-centered healthcare services, especially those that are technology-enabled and have an established model that can be expanded and grown. We are also interested in services that help reduce costs and improve patient outcomes, which is a big trend in the industry.

PJ: This was very informative, Stefan. Turning to my final question, what advice would you give to business leaders when talking to interested growth capital partners?

SO: Thanks for the invite, and that’s a great question to end on. I would say it is important to interview and research the company you will be working with. All companies are very different and offer different solutions, including different levels of involvement in operations and value creation, as well as different types of capital solutions and structures. In general, most companies are open to potential portfolio companies talking to existing and former portfolio company executives for reference checks.