Talking Top Quartile with Steve Burns of Quad-C Management

Quad-C Partners VIII LP, the vintage 2012 buyout fund from Quad-C Management, generated a net IRR of 29.5 percent as of Dec. 31, 2016, for Nevada Public Employees’ Retirement System. The performance outpaced the top-quartile IRR threshold of 23.4 percent based on an annual analysis of public-pension-fund data by Buyouts (see Sept. 11, 2017, issue). Steve Burns, managing partner of the Charlottesville, Virginia, firm, spoke about the fund’s performance.

How was fundraising for Fund VIII in 2011-2012?

It was actually a very challenging environment. We raised $672 million from third parties. What we experienced was re-upping by some of our long-term core investors. We brought in maybe four or five new investors but lost a number of endowments. The endowment market essentially dried up for us. A lot of pension funds (in many cases advised by key gatekeepers) that had known us for years really showed up. We did manage to bring in a couple of key new relationships that have been very beneficial. Overall, it was a longer process than we hoped for. It contrasted with the $1.1 billion we raised for Quad-C IX, which closed in late 2016 after a six-month effort.

In the years after the financial crisis, what did the firm learn?

What doesn’t kill you makes you better. We have never had a dud fund, but we improved our processes and raised the underwriting bar after the experience of 2008/2009. Starting in 2008, we moved more intentionally into a structured industry vertical strategy. Although we certainly focused on certain industries we had experience with prior to that, we were more of a generalist firm before. During the meltdown, based on our research, we felt we should specialize in certain sectors and modified our processes and the structure of our deal teams.

We had execution partners focused on one or two verticals. And they have teams made up of a principal or vice president and associates working with them. That gave us expertise in specific sectors and improved our deal flow, our understanding of industry risks and our ability to spot the potential upside of a situation quickly.

Did you add any new executives to Fund VIII or change focus?

No. We have seven partners and the average tenure is 19 years. The older guys have been through several cycles. We have a lot of experience and a way we like to look at things. And there’s a comfort level in trusting each other and coming to decisions. It’s almost boring.

Regarding our focus, we doubled down and recommitted to middle-market private equity. Our sweet spot is founder/owner recap transactions in targeted verticals. We know it’s a very competitive, highly intermediated market; our focus helps in this environment.

Out of the 13 deals in Fund VIII, in nine we were the first institutional equity. In all of the companies, the founder or owners made significant rollover investments. Our average equity rollover in VIII was almost 30 percent with a low of 12 percent and a high of 50 percent.

So what drove performance in the fund?

Out of Fund VIII, thus far we have exited four companies and have nine left. We have returned almost all of the invested capital to our LPs with less than half the portfolio exited. It’s a nice situation. The deals left in the fund are collectively doing quite well. We target in a base case a gross MOIC of 2x to 2.5x over five years. All four of the exits we’ve had thus far were over the high end of that range on a gross MOIC basis.

We have chosen to remain in the middle market because you can really impact companies this size, say, $15 million to $20 million of EBITDA. We partner with management to accelerate organic growth and frequently look at acquisitions or joint ventures as an expansion strategy. We look at each portfolio company as a corporate development project. We take a long view and we’re not afraid to make significant investments in personnel, R&D or capital assets, e.g., to make things grow.

Any specific deals you would like to highlight?

InterWrap was a building-products deal we did in 2013. It was founded and owned by two partners. They started out in industrial packaging and developed a synthetic roofing underlayment product to replace traditional tar-paper underlayment. The synthetic roofing product was the leading product in the space. It really changed the market because it performed materially better and was easier to install, lowering labor costs. They needed help with systems, accounting, organization, strategic planning, financial planning and analysis, etc.

The company was much more of a well-oiled machine when we left. We built up the team, including a new CFO and sales chief as well as a new head of IT, and we boosted their human resources function. We also helped with the CEO transition. EBITDA almost doubled. We were in and out of it in 2 1/2 years — although it took us nearly two years to close the deal — and realized significant value creation. We sold the company to Owens Corning and they’re doing very well with it.

Other strong performers from Fund VIII?

Another great story is Worldwide Express, a franchise-based asset-light 3PL investment we made in 2013. We bought a controlling interest in the company and the management team made a significant rollover investment with us. The company provided overnight small-parcel services and less-than-truckload and full-truckload brokerage services to the small-to-medium enterprise market. Our value-creation strategy was to ramp up the growth in the small-parcel side, continue the rapid growth of the brokerage services, and to roll up a significant portion of the franchisee system. The team that worked on the deal literally acquired 22 franchisees in less than two years. The company got materially bigger and sales and EBITDA grew significantly. We became the acquirer of choice among the franchisee community. We were able to sell the platform at a higher multiple than the franchisee acquisitions. It was a very good play in terms of multiple arbitrage.

What’s the firm’s view on leverage and purchase-price multiples?

In the Fund VIII portfolio, the weighted average leverage is 4.1x EBITDA. We pretty consistently take less leverage than the market offers. We’re growth investors. We want to capitalize our investments so they’re not stressed by debt-service obligations. In general, we capitalize things fairly conservatively.

With Worldwide Express, it was a pure free-cash-flow generator, so you could leverage it more than the average company, but we didn’t max out the leverage. We’ve always been like that.

EBITDA purchase-price multiples in Fund VIII were higher than in Fund VII, but the free-cash-flow multiples [i.e., EBITDA less capex] in Fund VIII were closer to our historical average. We focused more on high free-cash-flow generators; we feel those deals can typically withstand recessions better depending on the industry.

How did the fund contribute to the evolution of the firm?

It reinforced the lesson that if you adopt a strategy and refine how you invest, it can deliver strong returns if you stick to it. We’ve always done well, but we made improvements to our processes that the partners bought into. Looking back at the fund, we’re pleased we stuck to our strategy. We realize we’re only as good as our most recent fund. Hopefully Fund IX is in the top quartile in four or five years.

Steve Burns, managing partner, Quad-C Management. Photo courtesy of the firm.