Tom Shattan and Greg Mendel helped form The Shattan Group five years ago this month. The New York-based independent placement agency is focused exclusively on assisting growth companies in the process of obtaining private equity and equity-related capital. Since its founding in 1996, The Shattan Group has raised more than $700 million for companies in a variety of businesses, including telecommunications, industrial services, information technology and financial services.
Shattan began his investment career with Goldman Sachs, then did stints at both Kidder, Peabody and Prudential Securities before launching his own firm. Mendel also hails from Prudential Securities but, previously, he was a managing director at Richter & Co. Inc. Together, they have a combined 40-plus years of finance and private equity experience.
Is the need for a placement agent greater now than ever before?
TS: Absolutely. First of all, we believe that our clients need the right partner. They don’t just need money, they need the right financial partner, and all funds are not created equal. Therefore, getting access to the right partner, and knowing which funds truly have the capital and the inclination to invest and will move quickly in this marketplace is very important.
We think it’s very dangerous for an entrepreneur who needs to raise capital to grow or to make an acquisition to just say I’ll use my lawyer or my accountant or my brother-in-law to introduce me to two or three funds out there. The likelihood of them getting that deal done will be too hard.
We also don’t believe in going to the world. We believe you need to go to a very carefully picked group of investors where we think the chemistry, the synergy and the industry knowledge will be there. More important than ever, where it’s definitely harder to find capital, you need someone who’s experienced in knowing who’s still investing and whether they like their industry.
The second thing is that terms are definitely changing in this marketplace. We are now seeing more interest on the part of both investors and companies in wanting to do more creative structuring work.
For example, there is much more usage today of ratchets, or “adjustable financing” features, where, if the company performs, they get the valuation that’s presented. If they don’t perform, then there is an adjustment feature, perhaps tied to either an increase or reduction in EBITDA and revenue over one or more years.
Knowing how to structure that, and getting the investor and the company to agree on them takes the skill set and the experience of an agent who’s done a lot of these. Not one who’s new to the business.
What does an agent do for a company in this market?
GM: Right now, every company is having challenges of some sort, given what’s going on out there. And an agent will minimize the distraction of this process. Raising private equity capital is both a distracting process and one that takes time. Entrepreneurs should be running their companies, should be focused on growing their business, period, and not wasting their precious time trying to get the capital raised. We’ve seen situations time and again where entrepreneurs take their eye off the ball, spend an inordinate amount of time trying to raise capital on their own and, as a result, their financial results and their underlying business suffered, which then creates a snowballing effect whereby they can’t get the capital raised because their financials [have gone south].
How has the nature of your business changed as companies have found it more difficult to raise financing?
TS: The marketplace that we are focused on has not been early-stage companies. The Shattan Group is pleased to say that we have financed no pure-play Internet companies or new economy companies over the last several years. It took a lot of discipline, and we were a little bit lucky and a little bit smart, but we did dodge a lot of bullets.
The companies that we have focused on – meaning those that have had real cash flow and real revenue – have not always had as difficult a time raising capital as earlier-stage companies that have a high cash burn rate.
In fact, we just finished doing a survey of a lot of the private equity funds, and we found that if a company has got substantial revenues and a proven business model and real cash flow, they’re going to be able to raise capital in this environment.
Will the valuation be down a little bit? Yes. Can you definitely say that all valuations are down 15% or 20%? No. But for high quality companies with proven management teams and good business models, there is plenty of money available today.
Where does valuation fit into that?
GM: What we tell entrepreneurs is that since the vast majority of our transactions represent minority interests where they’re selling 20%, 30%, 35% of their company, not 100%, don’t focus so much on valuation. If a company were looking to sell 100% we’d tell them just focus on valuation, because that’s the last opportunity you’re going to have to receive anything for your business. That’s the last bite of the apple.
If you’re selling a minority stake, valuations are important, but getting that partner who can bring more than just that money – contacts, relationships, know-how – to help that entrepreneur grow his business, is oftentimes as equal to or more important than valuation because it’s giving him a couple of bites of the apple. One bite right now, and a bigger bite down the road when there’s greater critical mass after having used that money and the value-add from that partner to grow the business.
How do you value companies?
GM: The days of valuing companies based on new metrics like the number of eyeballs or a variety of other, once-accepted metrics are gone. Investors are looking for real companies with real revenue, real customers and real cash flow. They’re coming back to more of the traditional valuation methodologies.
Generally, in the private equity institutional marketplace it’s multiples of EBITDA – earnings before interest, taxes, depreciation and amortization. In certain industries, they’re still using a revenue multiple, but some of the more esoteric valuation methodologies are no longer applicable today.
The institutions are using the public comparables as one benchmark of valuation. They’re looking at the company’s historical growth rate and its expected growth rate as a tool to determine valuation. They’re often times giving companies the benefit of the doubt for the company’s projected performance and saying, okay, if you hit these numbers or come in close proximity to these numbers, you deserve x valuation. If you exceed them, then maybe we give you x-plus something, a little bit better valuation. But if you’re short, and you miss them, then valuation will come down. It’s a partner-to-partner, putting your money where your mouth is valuation that’s being used more and more in this marketplace.
TS: I think you have to use several different valuation methods to arrive at an average. Our books actually go out with as many as three or more valuation methodologies to help an investor and, frankly, an entrepreneur, figure out what his company is worth.
Have term sheets changed drastically?
TS: Drastically, no. There is more interest these days in both companies and investors exploring redeemable preferred stock deals as opposed to convertible preferreds. It used to be that all equity was done as convertible preferreds.
Sometimes, to bridge valuation differences, or just for more mature companies that want to raise as close to an equity security as possible but don’t want to give up as much dilution, there are more investors suggesting let’s do this as redeemable, where they get their money back and then own a percentage of warrants in the company as opposed to a pure convertible.
We have also seen different investors have sometimes asked for liquidation preferences that are two, sometimes three times the liquidation, so they get twice or three times their money back in the event of a liquidation of a company. It hasn’t happened in one of our transactions yet, but we’ve heard of it.
GM: Because the general market has come down and, therefore, valuations across the board have come down a bit, certain companies are a little bit reluctant to issue a pure equity security because it’s a dilution, and more are turning to the mezzanine debt market, which is a quasi-equity security. That will be generally a subordinated debt instrument with a current coupon of 12% to 14%, plus some equity kickers to get the investors 18% to 22% or 23% returns.
For the issuer, it’s a way to get the growth capital, it’s subordinated with very few covenants, it’s long-term, and at the same time, you’re minimizing the dilution you would otherwise have with a more traditional equity security.
Has there ever been a time when you’ve looked at a deal and said to yourself, “The deal can’t possibly happen this way”? What do you do in that situation?
TS: We were working with a company in the janitorial services sector, and we were talking with an investor, and it kind of wasn’t happening. The investor had indicated some interest in the company, but it wasn’t really moving along and they weren’t clicking. Also, it looked like the deal might actually just not happen. The investor and the client were both beginning to express some concerns, and so we curtailed the discussion with them.
As it turned out, we ended up doing the transaction with another bigger, deep-pocketed institution, and it was probably very appropriate that the second fund be the one to finance the company than the first one because the needs of the company were a lot greater than perhaps was handleable by the first fund. It ultimately became a much larger deal and, in fact, the second fund later put in more money in a subsequent financing, so it really worked out well for everyone.
Robyn Kurdek can be contacted at Robyn.Kurdek@tfn.com