Private Equity Grows Up

Private Equity Grows Up

Boards need to meet the challenge of helping to grow business, create value.

You might say that Charles Holznecht has discovered the secret to success in private equity investing.

Holznecht is a mergers and acquisition expert at Kansas City-based George K. Baum Capital Advisors, which acquired Goettl Air Conditioning last summer. Goettl services some 50,000 homes in the Las Vegas, Phoenix, Tucson and Los Angeles markets, but Baum wants to make it the biggest player in HVAC in the Southwest. So Holznecht has focused on Goettl’s day-to-day performance, assuring next-day appointments (customers with heating/plumbing/AC problems are usually in crisis), with friendly, highly trained techs.

“The trucks look nice, the techs look nice,” he says. “People want to have them in their home. It’s about creating a high-level service that people expect, and then are willing to pay for.” It’s also about a maintenance plan that puts Goettl in customers’ homes again and again, and that becomes its own advertising. If it all seems incredibly simple, that’s exactly the point — Holznecht is drilling down into the most basic tenets of customer care and satisfaction, with great service as the basis of his investment’s push.

It’s a new model for private equity, and one being encouraged by forward-thinking private equity boards.

The old method of private equity investing — roar in, slash costs — is experiencing something of a sea change. Private equity is becoming more likely to invest in a business to build it, not cut, and to make it much more customer friendly rather than simply more efficient. This changing mindset presents a new challenge for private equity boards.

The old model had directors often culled from family and friends who had cachet names and token positions. Today, directors are effectively becoming part of the management team, and are expected to bring a concrete skill set to the table.

“You shouldn’t need to bring someone on the board just to teach management what private equity is. Now, it’s about looking for people whose capabilities and experiences line up with what you need to create value in the first place,” wrote partner and co-head of Permira’s industrials sector, Richard Carey, in a blog last year. Board members now need to bring expertise in areas such as IT, cybersecurity, marketing and HR.

They also need familiarity with sectors once thought too odd, small or nontraditional to attract PE interest. “Competition is increasingly driving private equity to sectors that haven’t historically felt the love from investors,” explains Mark Gartner, head of investment development at California’s ClearLight Partners.

For example, the continued rise of private equity-backed retail healthcare. Gartner says he’s been contacted this year about investment possibilities in podiatry, pediatrics, ophthalmology, oral surgery and dermatology. What’s more, the market’s generally high valuations and abundant capital are leading creative investors to tap surprising new niche areas where they’ve previously been slow to see the possibilities of strong returns (HVAC, roofing, landscaping, even dry cleaning). If all these industries have in common a lack of sizzle, they also share something else, an abundant opportunity. And forward-thinking private equity board directors are noticing.

From 2012 to 2017, deals involving retail healthcare companies — freestanding outlets like dental clinics or urgent care facilities — have taken off, increasing at a compound annual rate of 34% in the U.S. market, according to Bain & Co.

This trend continued in 2018, says Nirad Jain, a partner at Bain. “The focus of PE in healthcare is growth investing, not, primarily, to be more cost efficient.”

The changing private equity ethos is in line with the Starbucks model: Create convenient locations, with consistent service and predictable pricing and scheduling.

“It’s a shift in that we’re investing in the customer, because we want repeat business,” Jain says.

Opportunity in the sector is there, certainly. Jain notes that only 11% of dentists nationwide have partnered with service organizations, which provide business and tech help. That leaves 89% of dentists in the U.S. operating on their own, ripe for collective management. The same goes for veterinary clinics — Only 18% are now part of a chain, leaving about 25,000 operating independently. In fact, most segments of retail healthcare remain largely fragmented. As Jain says, “The incentives are aligned.”

Roofing, landscaping (“That one surprises me a little, because of the seasonality”)and pest control are industries Hoznecht says he’s seen private equity make recent inroads. Lacking the traditional glamour of private equity sectors, these industries have traditionally kept investors looking elsewhere.

That’s probably still true to some extent, but “What I’ve seen is when folks look in undiscovered areas, you hear through the grapevine that they’re doing very well,” Holznecht says. It’s obvious there’s a building sophistication among private equity boards to make better, long-term decisions, and to have a plan for growth in industries like retail healthcare or HVAC, he adds.

It does feel like a fundamental change, a phenomenon that could be labeled: “PE grows up.”

That conclusion, Souter adds, is “spot-on.” Which may have more and more directors looking a bit more closely the next time they stop to pick up the dry cleaning.

Mark A. Mulvanerty leads the Private Equity Philadelphia-based practice at Diversified Search, one of Forbes magazine’s top ten executive search firms in the nation. He is also a member of the firm’s board of directors practice.