Ted J. Bender III
Managing Director
Croft & Bender
Mr. Bender is a co-founder of Croft & Bender, an investment banking firm focused on middle market M&A and private equity transactions. Since its founding in 1996, Croft & Bender has completed over $2.5 billion in M&A advisory transactions and over $700 million in private equity capital raises. In addition, the firm manages two private equity/venture capital funds totaling $44 million.
Prior to co-founding Croft & Bender in 1996, Mr. Bender was a Managing Director of the Corporate Finance Department at The Robinson-Humphrey Company, Inc. and was a member of its Board of Directors. Mr. Bender joined Robinson-Humphrey in 1976, and during his tenure he founded and led several industry practice groups. Mr. Bender has been involved in many industries, including general manufacturing, healthcare, software, life sciences, insurance, banking, building materials and business services. Mr. Bender has served and continues to serve on the Boards of several corporations. Mr. Bender received a B.S. from the University of Alabama in 1971.
Q: To set the stage for our discussion, would you please give an overview of how investment banks fit into the process of raising capital?
A: Investment banks are expected to be experts at all aspects of the process of raising capital or selling a company. This process usually begins with some sort of valuation and moves forward to include evaluating the company’s capital markets or strategic alternatives, preparing the company for going to market, and then taking the lead in executing the sales process. This sales or marketing process should be managed so as to generate significant "demand" or interest in the transaction so that the client can be presented with several favorable alternatives. A banker should have experience in both the type transaction being considered and the client’s industry sector.
Q: We're hearing the phrase "private equity" more now. For the entrepreneurs reading this book, would you provide your definition for what that means and how you differentiate private equity from venture capital?
A: The broadest differentiation is that Venture Capital funds invest in early stage companies and Private Equity funds invest in more established companies. Today most venture funds are looking for companies with a "proven business model." Typically, that is a company with some level of customers and revenue. Such companies need capital but they are not able to go to a commercial bank and borrow the money because they are not sufficiently profitable. These companies are willing to incur the higher cost of equity capital and need to share the risk with a venture capital fund. We use the term "private equity" fund primarily to refer to equity funds that are investing in companies that have grown beyond the venture stage. Most of these funds are focused on investing in leveraged change of control transactions and are also referred to as LBO funds. There are also a limited number of private equity funds which will invest in non-leveraged and non-change of control transactions but, again, they are interested in relatively well established companies.
Q: What about hedge funds? Are they a factor in the capital raising process that we are discussing here?
A: Hedge funds have become a major factor in the overall capital markets, but they are not yet a big factor in the venture capital or long-term private equity markets. Hedge funds generally have a relatively short time line for holding investments, so they like to invest in companies that are, or soon will be, either public or acquired. Most venture stage investments are highly illiquid and likely to remain so for three to five years. We are occasionally seeing a venture stage company merged into a public shell and then raising capital from hedge funds; however, liquidity is still an issue. Such complex transactions are very limited in numbers and I doubt they will reach significant volume in the near future. I have not seen a lot of hedge fund activity in the private equity market for the same reason – lack of liquidity. No doubt a large secondary market of sorts will develop for private equity or even venture capital deals but I am not yet aware of one efficient enough to attract large volumes.
Q: Let's step back and have you describe the climate for raising capital in today's market. How do you view the market?
A: If we are referring to companies that have good growth rates and have been consistently profitable, whether they want to raise growth capital, recapitalize or complete a change of control -- this is an extremely good time. The private equity funds, the banks, and the mezzanine funds are all currently aggressive. There are billions of dollars that have been raised by the middle market LBO funds, and they are looking for transactions. I do not think prices being paid for well performing companies have been higher in the last 20 or 30 years. We are in a good economy with unusually aggressive lenders. Even with the overdue credit tightening occurring at this time (August 07) there is still plenty of leverage available to middle market transactions. These smaller transactions never had access to the higher flying public debt markets in the first place. For them, very little has changed. venture capital market is also quite favorable, but not as aggressive as private equity. Venture capital valuations have improved since the bursting of the tech bubble, but not as much as in the LBO market. Although there is still plenty of capital for good venture stage companies, the bursting of the tech bubble destroyed total returns for lots of venture capital funds so this sector has not been able to raise enough capital to set off another competitive streak. LBO transaction volume has increased tenfold since 2001 and venture capital transaction volume is at about the same level as it was then.
Q: There is a tagline on your website that describes your firm as "Investment Bankers to the Southeast." How has that geographic focus served your firm?
A: Ed Croft and I formed the firm with the concept that the larger full service investment banks had become focused nationally along industry verticals and on companies with large, liquid market capitalizations. We observed that this left smaller growth companies without access to really experienced advisors. There was a bit of a vacuum. We grew up serving growth companies in the Southeast. Our then current employer had recently been sold to a large Wall Street firm. It was time to make a move. Being in Atlanta, which is one of the most robust business communities anywhere in the world, has served us well. We are part of the community, which I think represents a competitive advantage. When people understand that we are part of this community and that our reputation, personally and professionally, is behind every transaction, it makes a difference. We are not here from New York or Menlo Park just for this deal. We are in Atlanta and the Southeast for our career, and each client’s opinion about our performance is going to impact our reputation locally which in turn is critical to our continued success. I think that is very important in something like investment banking where business owners or managers may not be familiar with the role of investment bankers or how to differentiate between firms.
Q: So, from a geographic perspective, do you think areas outside of Silicon Valley and the Northeast have been underserved in the capital raising process?
A: Relatively speaking, yes. There is no question that most of the U.S. based institutional equity capital is domiciled in the Northeast and California. A large part of the services that we bring to entrepreneurs is our knowledge of this national marketplace. We take a company from the Southeast and help them raise capital from strategically focused funds that are based all over the country. We are bringing money to the Southeast as fast as we can.
The Southeast has always been relatively undercapitalized. Changing that is a gradual ongoing process. We may never catch up but the more important point is to try to accelerate our region’s positive momentum. As the Southeast continues to have success stories and to build the infrastructure necessary to attract and retain great companies, institutions will be more and more willing to allocate money to Southeast-based funds and companies. For example, RTP and Atlanta are recognized as thriving hotbeds for new innovative companies.
Q: From a capital raising process standpoint, would a company in Charlotte face a different path for funding than a company in Sunnyvale, CA assuming the underlying idea and business model were similar?
A: If it is a venture stage company, yes it would be easier, possibly much easier, to raise the money for the California-based entity. If you are from Sunnyvale, you could visit 20 funds that may have an interest in your company within a two hour's drive. If you are in Charlotte, there may just be just one fund there that would have deep knowledge of your space, and maybe three to five in the region. But there would be twenty or thirty spread throughout the Midwest and Eastern U.S. So, although not easily quantifiable, the Charlotte company is at a disadvantage. But again, our role is to minimize or eliminate that disadvantage by making sure good companies have full national exposure to appropriate capital sources.
If the Charlotte based company is a well established company with greater than $10 million to $20 million of EBITDA, it would be at no disadvantage to the California company. In fact, it may even have a slight advantage.
Q: After the internet bubble, have you seen a shift in the ability for idea companies or true start-ups to get funding? Has venture capital completely moved upstream to companies with revenue and market traction?
A: For the most part there is no meaningful institutional capital available for companies that are only at the idea stage. There are angel groups and individuals but not institutions. No matter how good the idea might be, the venture community wants to see a proven business model which, at minimum, means one with customers. To be fair, I would not say there are "0" funds interested in this category but it is definitely a needle in a haystack. Medical devices and pharmaceuticals are an exception due to the FDA approval process and definable nature of the potential market for such products.
Q: How much revenue are we talking about? What would a typical venture stage company look like that you would be comfortable presenting to a venture fund?
A: Typically, such a company would need to have a minimum of $3 million to $10 million of revenue. Such a company may or may not be profitable, but would have identified and proven a market niche, their growth potential would be significant and they would need capital to meet the demand for their products or services. That is the ideal candidate.
Q: Are there particular industry segments where you think you are more likely to find candidates that fit that profile?
A: There is opportunity in every industry. I don't see any segments that are absolutely on fire, but internet marketing is pretty hot. The internet is, I think, still in the backwoods trails days. We've only begun to see what we can do with it. Business services and outsourcing are trends which appear likely to continue, enhanced by the ability to provide services remotely via the internet. Software is increasingly important to everything we do so there are lots of opportunities in that sector. There are always opportunities in healthcare IT; businesses that are helping to speed up the process of treating patients, handling information, lowering costs and improving patient outcomes. Life sciences is another very interesting sector. Although these companies often do not fit the ideal profile described above, I personally think life sciences and alternative energy are the sectors which will present the biggest opportunities in this century. They are also the most technical and seem to present the highest risk.
Q: When you are looking at potential opportunities, what characteristics do you place the most emphasis on during the evaluation process?
A: It would be pretty much the same things anyone else would say: a proven business model and a proven management team. It is all about having a large market opportunity, reasonable barriers to entry and a management team capable of executing the business plan. Of these factors management is the most critical. Executing a business plan is a slippery ordeal. The obstacles, and even the opportunities, are always changing. New competitors surface, customers defect, capital markets contract, possibly violently. Investors are looking for managers who can adapt quickly and continually advance the ball, no matter what.
Q: Are entrepreneurs today more savvy about the capital raising process than they were 8 to 10 years ago?
A: Oh, yes. No question about it. However, if they have not been through it, they cannot really understand what the process involves; how complex raising capital has become. They often think that one investor is as good as another and that if they get a deal done, it is a good deal. If they "have done a few deals" they tend to assume they have seen it all. We estimate that the process we execute requires at least 1,500 hours of our time. It requires an enormous amount of specialized expertise that we continually build on, one deal at a time. Selling a company or raising capital is not about being introduced to a few funds. The optimal outcome requires a huge sales effort by someone who is well prepared and respected in the financial community. It is a very complex and time consuming process which is best accomplished by a very experienced and well organized team. Everything needs to be perfect and the process must be carefully orchestrated to create competition among investors or buyers. You can not do that while running a company.
Q: Although your firm is primarily an investment bank, you also have your own investment fund. Would you please describe the purpose behind your fund?
A: Our fund is a vehicle to enhance our capital raising transactions. It does not come into play when we are selling a company. Primarily our fund provides the opportunity to capitalize on the quality and quantity of our capital raising transaction deal flow. Secondarily, we reasoned that we should not raise money for a company unless we were willing to invest our own capital in the transaction. Our commitment gives the deal added credibility in the marketplace. For us, the capital raising process provides a unique perspective from which to make an investment decision. In a capital raising transaction, we and management typically meet with ten to fifteen selected funds having a high level of expertise in the company’s business. We get to see what they all think about the company as we manage the process. In addition, being able to think like both an agent and a principal makes us better advisors.
Q: Is it unusual for an investment banking firm to also have its own venture fund to tag along on deals?
A: It is somewhat unusual, but not unique. We manage it so as to be a complement to the transaction -- not a conflict. Clients and investors both like it. We usually do not take a board seat, we invest less than 10 percent of the total so we do not price the transaction or lead the syndicate. We are very comfortable paying market prices. At the end of the process it is the client’s call. The key is that we have a highly efficient and unique perspective from which to make an investment decision and it adds credibility to the deal in the marketplace. Everyone benefits.
Q: What is your investment time horizon?
A: Usually three to six years. The average fund’s active investment period is five years, so you are always trying to balance the remaining life of the fund with the stage of development of the investments. The average holding period has increased considerably since the 90’s.
Q: Do you see a time when the IPO market will open back up again as viable exit strategy for these companies, or is it your expectation that acquisition will be the exit for the foreseeable future?
A: The IPO market has always been a window for a very small percentage of successful companies. No one should ever count on it. When a management team says their exit plan is an IPO, they mark themselves as amateurs. There are a lot of exciting things happening with venture-backed companies, but rarely does one come along that is capable of breaking out to $100 million or $200 million in revenue on their own during the typical fund’s holding period. Most of them will need to be either acquired by another company or recapitalized in order to provide investors liquidity. However, one can still make 4 and 5 times his money with a successful sale of a company in 3 to 6 years. That generates a 30-50 percent IRR. That, in my opinion, is getting the job done.
Q: In closing, is there a common piece of advice that you give the entrepreneurs you work with?
A: The answer to that question could be very lengthy. There is no one suggestion but I can offer a few thoughts.
- Before embarking on a major transaction, go sit down with a couple of investment bankers. You do not have to hire one. Do not first go out and try to sell your company or securities to all known potentially interested parties as your banker may not then be able to correct the misconceptions you may have created in the marketplace by going to market prematurely.
- When selling your company, and particularly when raising capital, meet with as many qualified interested buyers or investors as possible. The marketing process offers a unique opportunity to get feedback from a large number of really smart, well connected people who otherwise would not be available to you.
- A properly executed process will result in the best possible valuation and terms. Unless your company is large, well established and has a consistent profitable track record, no other valuation methodology is reliable.
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