5 Questions With Stewart Kohl, Co-CEO, The Riverside Company

1) The acquisition of The Herbal Garden was The Riverside Company’s 30th buyout of 2008*. Given that some firms are struggling just to close one or two deals in this market, what’s motivating Riverside’s flurry of activity?

That’s the machine-like nature of The Riverside Company. It starts from having been around for 20 years and having 185 employees. Over 20 of our folks spend each and every day in the origination function—on the phone, on email, or on the street—looking for deals. And on top of that we have a large team of folks that can process and review and find the diamond in the rough that represents our next great acquisition. We just keep humming along.

*Riverside has since closed another deal, bringing its year-to-date deal count to 31 acquisitions.2) A number of firms are sitting on the sidelines because they believe valuations are still falling and that sellers have yet to come to terms with market realities. Is that sentiment not shared by The Riverside Company?

The short answer is no. There are some great deals that will be done in this environment, and we want to do more than our fair share of them. The challenge is it will be more work to find them—more work to negotiate and structure and close them. Creativity is also a necessity so we’re dusting off some of our old tools, like seller paper and earn-outs, that weren’t used much in the peak but will be used more now.

Our focus on the small end of the middle market gives us a big advantage in deal sourcing. Deals come to us because owners are getting divorced or they’re retiring or in some cases they’re dying. We also see opportunities in public companies trading at depressed valuations. Then there are healthy companies that are owned by troubled parents or else part of distressed portfolios.

3) How is the credit crunch affecting Riverside Company’s investment strategy in terms of the amount of leverage it uses?

The credit crunch is certainly affecting us. Generally we do deals with about two-thirds debt and one-third equity. Today that ratio is about 60/40 or even 50/50, depending on the size and nature of the deal.

Add-ons pose a particular challenge right now. We think it’s an excellent time to be building up our companies but if the company had a pre-market correction capital structure, it can be very hard to finance an add-on at post-correction terms.

A big benefit is our focus on companies that can be purchased for less than $150 million. In our size range, we don’t need to put together a whole syndicate, we need one to five banks to fall in love with our deal. So far, all of the deals we’ve closed this year have had a debt component. In many cases we’re borrowing less and paying more than we would like, but we are borrowing.

4) Are these smaller businesses being affected by the economic downturn in any unique way, and what opportunities do they present your firm?

The classic economic theory would tell you that smaller businesses are more susceptible to the downturn. However, we mitigate that risk by investing in niche businesses that are not highly cyclical. We also don’t over-leverage them. If you looked at our portfolio as a whole, it has less than 3x debt to EBITDA. And we have a team of 22 operating professionals who are available to help our companies. It could be as little as consulting advice or as much as taking over and running them as CEO. Therefore, when there is a problem, we can deal with it very effectively.

5) How do you think this current economic downturn compares to previous ones?

It feels like this one could be the worst, but we don’t know that. Unusually, we have been led into this downturn by the credit contraction and dislocations in the capital markets, while in the prior recessions we looked at those issues as being the consequences—not the causes—of the downturn. That might mean this one will be deeper and longer, and because I tend to be bearish, I lean toward that conclusion. But the severity of it could prompt a fix from government action—TARP and the like— and that could lead us out of the recession more quickly. So while it’s tempting to say the downturn will play out like a very long flat U, there’s a chance it could be more like a V.