A private equity firm recently offered Inc. a rare inside look at the sale of an Inc. 5000 company. We expected brinkmanship, twists and turns, and white-knuckle tension. We were not disappointed.
Brendan Anderson and Jeff Kadlic opened the door to the storage room and stopped short. This was not what they were expecting to see.
A large blue plastic tarp was suspended like a tent from the ceiling. The tarp protected a set of blinking computer servers from water that trickled through the cracked ceiling whenever it rained. A small portable fan whirred away and oscillated, cooling the machines.
Anderson and Kadlic looked at each other. This was what they were going to spend millions to acquire?
The servers belonged to the Accurate Group, a mortgage-servicing firm in Charlotte, North Carolina. Sitting on the network was Accurate's most valuable asset, a powerful suite of mortgage-servicing software capable of managing thousands upon thousands of real estate transactions. Kadlic and Anderson--the co-founders of Evolution Capital, a small private equity firm in Cleveland--had a hunch that the software could be upgraded and marketed to banks nationwide. If they were right, they, their investors, and their young private equity firm would enjoy a very nice return.
That was in 2009. Three years later, Kadlic, Anderson, and a management co-owner had retooled, refurbished, and spit-shined Accurate, moved it to Cleveland, and--yes--brought the servers in out of the rain. A slew of major banks had signed on, and the company was in the black. But now came the ultimate proof of their business judgment. They had put Accurate on the market at a price tag of about $50 million. "What we needed," Kadlic says, "was a home run."
The sale of an entrepreneurial company tends to be a high-stakes drama, stamping a price tag on years or even a lifetime of obsessive work. It also tends to be a very secretive affair. So when Kadlic and Anderson offered Inc. a chance to observe the sale of the Accurate Group, we jumped at it. We wanted to see Kadlic and Anderson swing for the fences.
Though you probably think of private equity partners as Wall Street financial engineers, Kadlic and Anderson are, in fact, more akin to the entrepreneurs whose businesses they invest in. They launched Evolution Capital in 2006, with a fund of $75 million raised from wealthy local entrepreneurs. By 2009, when it acquired Accurate, the firm had invested most of that fund in three businesses. In each deal, the goal had been a return of at least 30 percent before fees, a typical target for private equity funds. They had missed that mark, returning from 15 percent to 20 percent. Their investors didn't particularly mind, but Kadlic and Anderson knew that Evolution would never get to the next level without a blockbuster. They needed this deal to work.
The two men learned about Accurate from an acquaintance, Paul Doman, a Cleveland title insurance executive. Doman had spent 20 years working in banking and mortgage services and knew the business well. Accurate seemed ripe to grow, but it was stuck in neutral: Revenue hovered at about $6 million, and its owner, Paul O'Connor, wanted to leave the business and spend more time on his 50-foot yacht. Doman proposed that he and Evolution team up to buy the company, which he would then manage.
In addition to inspecting the company's servers, Anderson and Kadlic took a hard look at Accurate's EBITDA--earnings before interest, taxes, depreciation, and amortization--the amount of cash generated by the company. This is a key metric in most private equity deals. Anderson and Kadlic usually seek cash flow of $500,000 to $2 million--which, as a rule, provides them enough cash to reinvest in the business without having to take on debt. Accurate had EBITDA of only $350,000, but with a profit margin of about 10 percent, the pair bet that sales growth could make up the shortfall. In February 2009, they and Doman bought the company for $4 million. The game was on.
During the first 12 months, long-overdue investment vacuumed up most of the company's cash flow. But by Year Two, the investments began paying off. By 2011, with new customers such as Royal Bank of Scotland and KeyBank, cash flow jumped to nearly $3 million, and the company landed at No. 1,153 on the Inc. 5000. By the end of 2012, it was No. 936 on the list, and Doman forecast EBITDA would close in on $7 million or even more.
At $7 million in EBITDA, a company crosses an important threshold in private equity's particular calculus. At that point, large private equity buyers begin to enter the picture, because they can purchase the company with borrowed money and use the company's own cash flow to service the debt. In other words, Kadlic and Anderson thought it was time to put Accurate back on the market. With any luck, they figured, the company could fetch $50 million. They were about to find out how smart they really were.
Kadlic and Anderson hired Edgeview Partners, a Charlotte-based investment bank, to find potential buyers. The bankers spent three months wooing the firms in their database with details about Accurate's financials and found serious interest from 12 private equity groups, all of them far larger than Evolution. The custom in such deals is for potential buyers to sign a nonbinding letter of intent and a nondisclosure agreement with estimates of what they would pay to acquire a company. The estimates were better than the Evolution partners had dared hope--from $48 million to $75 million.
But they were still a long way from a signed deal. Over the next few months, managing partners from all 12 tire-kickers came to Cleveland. They would gather with Doman and his team in a Marriott Hotel conference room decorated with flowery wallpaper. The meetings, which Kadlic and Anderson chose not to attend, often looked like negotiations between representatives of two vastly different kingdoms. On one side of the table, Ohio: bear-shaped, Van Heusen-shirted, blue-blazered. On the other, Wall Street: gym-buff, Prada-suited, and French-cuffed.
Two months later, the competition narrowed to three apparently serious bidders.
But the three finalists' finances weren't always as buttoned up as their representatives' expensive suits. One would-be buyer, a private equity firm from New York City, said it lacked the funds to buy the company. Kadlic and Anderson realized the well-dressed bankers had been bluffing all along. Though it isn't unusual for investors to pretend to be buyers in order to gain inside knowledge about the finances of particular businesses or industries, Kadlic and Anderson were angry that the firm had wasted so much of their time.
Now only two firms were left--one from Boston, the other from Baltimore. Both came in with encouraging offers at the top third of the price range. Then the Boston team asked the Accurate team to a dinner, at which it dropped a bombshell of its own: Rather than buying Accurate, it proposed co-investing in the business. Kadlic and Anderson figured the firm was using the acquisition of Accurate as a way to market itself to potential investors. "We'd been played," says Kadlic. No way, they said.
That left ABS Capital, a 23-year-old firm from Baltimore. Composed of seven funds, with a total of $2.5 billion under management, ABS is basically a larger version of Evolution. To Doman, who hoped to continue running the company after the sale, it seemed like a good potential match. But after being whipsawed by the other two firms, Kadlic and Anderson were counting on nothing.
Adding to the tension, Anderson and Kadlic were determined to complete the sale by the end of the year. That was because capital gains taxes were set to rise in early 2013--a hike that would cut Evolution's windfall as much as 5 percent.
To Anderson and Kadlic's relief, ABS laid out its terms in a clear and straightforward manner. And then the firm asked for another round of due diligence, triple checking Accurate's books and quizzing the company's key customers. Finally--with just three weeks left before Kadlic and Anderson's tax deadline--ABS agreed to acquire Accurate for $55 million in equity, plus an undisclosed amount in debt.
The sale of Accurate wound up returning more than 100 percent to Evolution's investors and boosted the fund's overall return to more than 31 percent. That performance, not surprisingly, has significantly boosted Evolution's cred in the eyes of its customers, institutional investors and rich individuals. "Getting a significant win and an exit like this propels you light years forward," Kadlic says. He and Anderson recently raised $50 million for Evolution's second fund.
Accurate, too, has been on the fast track. Doman remains CEO, and revenue is expected to hit $70 million in 2013. In August, the company made an acquisition of its own, snatching up, for an undisclosed amount, Preferred Appraisal, creator of ValueNet, the mortgage industry's leading desktop appraisal system. ABS's next milestone for Accurate: revenue of $200 million. Says ABS managing general partner Phil Clough: "What we saw in Accurate was a technology platform that allows a relatively small centralized team to manage activity, whether it's the size it is now or will be in 2017." That latter date, as it happens, is about when ABS plans to put the company back on the market.
See related story: Preparing your Company for a Big Sale