Russ’s educational background specialized in both business and engineering - having earned his MBA from Harvard University and a B.S. in Electrical Engineering from Case Western Reserve University. His expertise in risk management issues involving the M&A market and middle market businesses arises from his extensive US and cross-border M&A experience, covering over 200 transactions and spanning nearly all manufacturing, distribution, and services sectors.
Please share a little bit about your life and journey and how you came to work in mergers and acquisitions.
Armed with curiosity, an engineering degree, a fresh MBA and a six-month stint as Private in the U. S. Army (a reality check if there ever was one), I settled in at Ernst & Whinney, auditing a range of mostly mid-size companies and learning about businesses and industries from the inside out. In the mid-1970s, I joined the firm’s nascent merger and acquisition (M&A) practice when the M&A market was robust, and the firm was still figuring out where and how to play. It was a chance to create a significant new business within a highly respected firm. I led the firm’s Merger and Acquisition Services for 10 years. Helping business owners with arguably the most important and risk-prone activities of their professional lives – transitioning their business to a new owner or making a major investment to acquire – has always been a satisfying way to spend my day.
M&A in a large firm was stimulating, with client engagements from Hollywood (for Sammy Davis Jr.) to Jamestown, NY (selling a Tier 1 supplier to Chrysler and Volvo) to Kuwait (for a diverse trading company). There was national and international travel, which was exciting at the time. A capstone engagement for me was an on-site engagement to improve venture capital access in Indonesia, Thailand, Malaysia, Pakistan and Sri Lanka, which we conducted for the Asian Development Bank, a large non-governmental organization. Our results included funding for three start-up venture capital firms and passage of recommended legislation by Thailand.
Weeks later, Ernst & Whinney moved its headquarters from Cleveland to New York, and I moved on to found a boutique Cleveland-based middle market M&A firm serving privately-owned and public businesses. With a former colleague, we ran and grew the firm, closing 75 transactions. In 2008, we sold to EdgePoint, a growing young firm with shared values and mission: to bring top quality professional M&A services to owners of middle market businesses. I was happy to trade my former CEO duties for the role of Managing Director, developing business and serving clients.
Looking back on your career, what professional values or principles are most important to you and how did these values influence your work?
The client’s interests come first, and are best served by honest advice – even if it costs you money in the short run. Reputation is the most important asset of any business or professional.
Understand the value of the client’s business thoroughly. Do your homework. Figure out who would find the business most compelling to own. Reduce the risk of a failed auction by valuing the business realistically and making sure the owner is willing to sell at that price before beginning the engagement. Using this straightforward method, our firm has a five-year closing rate approaching 90% – far exceeding the industry norm.
The second and third parts of our interview will focus in detail on risk management issues in M&A work and the operation of middle market businesses. What are some of the seminal moments in the development of the M&A field for the middle market?
Forty years ago, the market for businesses with revenues between $10 million and $100 million was inefficient and very thin. Such businesses were truly illiquid assets. Pricing of a profitable, low-growth manufacturing business, for example, was likely to be less than net book value on the balance sheet. Terms usually included a lot of seller financing as notes or an earn-out. Owners had the stark choice of selling to someone with ‘no money’ and financing the transaction themselves, or being acquired by a competitor likely to erase the company’s identity.
In the 1970s, Nick Wallner, who acquired a small business using a debt-based technique borrowed from the commercial real estate industry, published a thick soft-cover tome with the catchy title How to Do a Leveraged Buyout or Acquisition. The LBO was born, and the world changed. The new transaction revamped the right-hand side of the balance sheet from mostly equity to mostly debt.
The theory underlying an LBO is that Investment Risk (of the private equity firm) equals Business Risk (the stability of the operating company) plus Financing Risk (debt). The more consistent the operating company’s cash flows, the more debt the investment can service, and vice versa.
With the then-low pricing parameters and ample assets as collateral, a buyer needed very little equity (maybe 5% of the purchase price) to finance an acquisition. The operating plan after closing was simply to use the company’s cash flows to pay down debt, selling in about five years. Soon entrepreneurial buyers began to seek suitable ‘boring’ businesses and, if needed, pass the hat to their friends, deal by deal, to provide the needed equity. Presto! The owner could receive cash at closing and the business remained independent.
Private equity was not a glamorous business in its early days. I remember meeting with the pioneer firm Kohlberg Kravis Roberts & Co. in its mid-town Manhattan offices, which were definitely underwhelming. They had raised a first fund of $31 million in 1977 to fund smallish acquisitions. But soon, KKR left the middle market for loftier transactions, and in 2000 acquired RJR Nabisco, as chronicled in Barbarians at the Gate.
With competition, of course, valuation multiples for suitable businesses began to rise, and private equity firms had to hone a distinctive strategy to find a competitive edge. Many began to differentiate themselves. For example, Wingate Partners sought ‘buy and fix’ situations, and other private equity firms began to work with experienced operating executives having deep operating experience in niche target markets. Riverside opened offices on four continents to help portfolio companies, and add foreign companies to their portfolio. The concept of bringing more to the table than money was born of necessity.
Another result of rising prices was the need to grow the business, organically or by add-on acquisitions, to achieve higher earnings and a possible multiple expansion, to hit target investor returns.
Private equity firms’ interest in diverse targets, and more financing options, meant that other types of businesses, like distribution, transportation and services, saw a wider range of financial suitors. Recently, with interest rates on fixed income investments at historic lows and stock market multiples sometimes frothy, family offices have added direct acquisitions of private companies to their portfolio mix, to boost overall returns. Usually, they buy and hold a business, making them an attractive alternative in the eyes of many company owners concerned about a ‘quick flip’ by a private equity firm.
As richer acquisition multiples became commonplace, the need increased for nuanced financing structures to make acquirers’ financial return models work. Banks’ willingness to lend senior debt (least costly financing) into a “highly leveraged transaction” (as defined by the Comptroller of the Currency, The Federal Reserve Bank and the FDIC) is limited by concerns of a recession, rising interest rates, a company’s track record and regulatory pressures. Accordingly, in the 1980s insurance companies, savings and loan associations and eventually limited partnerships formed available pools of risk capital, such as subordinated notes and preferred stock, with characteristics straddling debt and equity. ‘Mezz’, as it is affectionately called, is midway between senior debt and equity in cost and rights.
Louis Kelso, a visionary economist and merchant banker (Kelso & Company) who thought everyone should own a piece of the action, invented the Employee Stock Ownership Plan, a unique device for selling a company to its employees. Kelso created the ESOP in 1956. For years, he worked with Senate Finance Committee Chairman Russell Long, to build into the 1974 ERISA legislation generous tax advantages for both the ESOP company and the owner who sold to an ESOP. Sometimes misused (as in a failing steel company), the ESOP used as intended has created many millionaires on the factory floor and at steel desks. I knew and presented a series of seminars with the impassioned Mr. (and Mrs.) Kelso. It was a near-religious experience.
Your career has included over 200 transactions spanning nearly all manufacturing, distribution and services sectors. What are some of your favorite memories?
Closing a transaction. Every time we achieve a client’s objective is a satisfying occasion. Each closing has a story to be celebrated. But, some transactions are more fondly recalled than others – because of issues overcome or the people involved. We’ve had sellers die during the process and businesses lose a key customer, but we manage the situation and de-stress it for the client (or widow). Most rewarding, a number of former clients have become good friends.
Learning first-hand about different industries and businesses. There is no Groundhog Day in our work. Founding The TransAction Group. Running a small firm, the highs were higher, and the lows were lower. The experience helps me relate better to our clients’ founders and CEOs.
I also learned the value of loyal friendships. For example, our M&A team at Ernst & Whinney advised Bob Elman, a good friend, on his management buyout of DESA International, and when I left the firm, he was seeking acquisitions. Bob said, “We’ll be your first client,” even before I formed my legal entity. Allen Ford, retired CFO of Standard Oil (Ohio), and Allen Holmes, retired Managing Partner of Jones Day, were friends from the Case Western Reserve University Board of Trustees. They planned to share offices and a secretary, and invited me to join them. I immediately said “Yes.” Now I had a client and some credibility. My new venture was off to a strong start!
Joining EdgePoint. After a successful 21-year run at The TransAction Group, my business partner wanted to slow down and I wanted to continue, but I was getting tired of spending time on administrative bumf. I thought, ‘OK, figure out an end game so you can do what you want.’ We sold the firm to EdgePoint, which shares the same values and culture. To me, it’s my most successful transaction. The firm has grown from six people on 2008 to 20 today. I enjoy my colleagues and love what I do.
Giving back. Starting with encouragement from Ernst, I’ve served on a variety of non-profit boards and find them very rewarding. My wife and I make our charitable contributions where we invest our time and energy.
What three or four books would you recommend that every business leader should be familiar with?
A good library or book store entices yet frustrates me because there is only time to read a small portion of what is worthwhile. So, your question is laden with responsibility to recommend well.
To me, Stephen Covey’s The 7 Habits of Highly Effective People is worth re-reading every ten or 15 years. It is more than about business, it’s about the business of life.
Business leaders and risk managers had better understand strategy, and I know of nothing better than Michael Porter’s books, Competitive Strategy and Competitive Advantage. (snippet: “The essence of strategy is choosing what not to do.”)
Jim Collins is worth a read or re-read: Built to Last and Good to Great.
I enjoyed Walter Isaacson’s history of the digital age, The Innovators. It’s well worth your time.