Mark Gartner is head of investment development at private equity firm ClearLight Partners LLC, which is dedicated to the lower middle market.
Over his years in the industry, he’s seen a sea change in how PE firms go after potential targets, from “smiling and dialing” to using CRMs and data to guide their strategy.
He talks about other elements of his approach to potential acquisitions, including how he always has a value proposition in mind when making contact.
Part of that strategy derives from the fact that many of the ClearLight team have actually run companies and know the reality of operating a business – they’re not investors working in a vacuum.
We talk about that, as well as…
- Why 75% of companies utilize rep and warranty insurance
- The reason they focus on lower middle market companies
- The ideal target profile they’ve identified – and how it’s evolved over time
- Where he and his partners see the greatest opportunity right now
- And more
Mentioned in this episode:
Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here, that’s a clean exit for owners, founders and their investors. Today I’m joined by Mark Gartner, head of business development at ClearLight Partners.
Based in Newport Beach, California, ClearLight Partners is a long-established private equity firm dedicated to the lower middle market. And at the expense of showing my bias, I would say there are fewer places on this planet that are more beautiful than Newport Beach, California to have your office situated. So, Mark, I envy where you are. Welcome to the podcast. Thanks for joining me today.
Mark Gartner: Yeah, pleasure to be here. Thanks, Patrick.
Patrick: Now, before we get into ClearLight, let’s set the table. Tell us what led you to this point in your career?
How Mark Got to This Point in His Career
Mark: Yeah, good question. As I look back, I would point to a series of decisions that all seemed like good ideas at the time. I would say in most cases they were. But I started off in investment banking, like a lot of folks who get into private equity, first with a boutique out of Memphis, Tennessee, and really valued that experience working for a firm called Morgan Keegan, which a while ago now got bought by Raymond James. So fewer people are familiar with the Morgan Keegan name, but had a wonderful experience there. And that was really my exposure to the m&a process.
And then I joined a firm most people are not familiar with called Houlihan Lokey, their industrials group and focus on plastics and packaging transactions to kind of round out almost three years as an investment banking analyst. And then I was looking for a buy-side job and I interviewed with a lot of firms, mostly in Chicago, which was where I was at the time. And at one point, I think I’d cold emailed ClearLight, not knowing anything about the firm, not knowing anything about Newport Beach. I’m actually from Cincinnati, Ohio originally. And they responded, so every now and then a cold email works, or it did back in the day. This is back in 2007.
Patrick: It was meant to be.
Mark: It was meant to be, yeah. And they brought me in for an interview to be part of this proprietary deal sourcing program they wanted to develop. They were looking to recruit ex-investment banking analysts who could sort of eat what they killed and really be on the phones trying to source transactions by calling business owners directly and then work on those deals once you kind of brought them in house. And to me, that was very entrepreneurially exciting at that stage of my career to kind of live the full lifecycle of a private equity transaction.
And, frankly, everything that they promised that program would be for the most part became true. And so I was at ClearLight for four and a half years, was kind of romanced away to another fund up in the Bay Area for two and a half years to focus on building them a deal sourcing program, and then was welcomed back to ClearLight in 2014 for my second tour of duty, so to speak. And, you know, I’ve been focused since that time on building, you know, what we think is a high-functioning, you know, institutional-grade deal sourcing engine to bring in as many deals that fit our criteria as possible.
Patrick: Yeah, that’s part of the magic there is, you’ve got these great theories on what you can do with targets is identifying the targets, and then, you know, making a good enough case for that target to want to be acquired.
Mark: Yeah, that’s a really good point. And I think what that kind of touches on a little bit, or maybe I’ll just touch on it, is the evolution of how the sourcing strategy has changed. You know, we started out looking for proprietary deals, you know, just kind of smiling and dialing. And at that point, this is probably 13,14 years ago, you could do that because not as many funds were doing it. Then business owners started getting bombarded with calls and they just kind of stopped returning phone calls. So the strategy had to pivot.
And then we switched to kind of intermediary coverage, you know, getting to know all the relevant investment bankers that were producing deal flow that we found interesting, and there’s over 1000 of those entities out there. And so that was a very real process to get up to speed on the population of intermediaries out there, and, you know, adopting a CRM and using data to help, you know, guide our activities. So that was a very interesting exercise. And then, you know, other funds adopted that strategy as well. And so one of the things you alluded to is making the case for a company or an industry.
And I think one of the really exciting strategies that’s working today is defining a thesis for a given industry, sort of calling your shot, if you will, and then going out and approaching companies in a more intelligent way, in a very purposeful way, given that you’ve already said I want to be in this space. You’re a company whose door I’m knocking on quite intentionally. Would you like to talk about a deal? And we’ve discovered that actually works pretty well.
Patrick: At the risk of getting ahead of ourselves here, let’s back up a little bit and let’s talk about ClearLight. And then we can go into that. You know, with ClearLight, tell me how it was founded and then describe the focus that they have and you have because we’re both in the same area here. We’re looking at the lower middle market as opposed to middle market.
ClearLight Partners’ Unique Origin Story
Mark: Yeah, great. Yeah, so ClearLight’s origin story is pretty unique, I think. You know, we actually grew out of an operating company, there’s only so many funds that can lay claim to that. This is about 20 years ago, our founder, was running a residential security business on behalf of a Japanese publicly-traded company who had bought the security company in Orange County, as it turns out, and it was effectively a turnaround situation.
Our founder had advised the parent company previously, as an attorney, incidentally, had learned to speak fluent Japanese in his spare time in between undergrad and law school and actually studied, I believe, in Tokyo and was able to nurture on that proficiency in the Japanese language.
And so he earned the trust of this Japanese entity to run their US operation. And so I think at the ripe age of 31, despite a career in law, he was installed as CEO of this home security company called Westech, Westech Security Group, which, if I understand correctly, was around 35 million of revenue, was on the verge of losing money and it was his task to turn it around. And over a 15-year period through a combination of organic growth and acquisition, he got it up to maybe 250 million of revenue.
And it’s sold to a strategic buyer for about $300 million. And rather than send the money, the proceeds money, back to Tokyo, he was entrusted with that capital to continue investing in other US-based businesses via a private equity structure. And so ClearLight was established in the year 2000, with that inaugural fund of 300 million, and we’ve subsequently raised a second and a third fund, each 300 million, with every dollar we’ve invested to date coming from that Japanese entity.
And so having this sort of single LP structure, kind of, in a sense, makes us a hybrid between, say, a family office and a private equity fund in the sense that we can invest over a longer time horizon if need be because we’re not subjected to the fundraising cycle. Yet we are staffed, motivated, incentivized, structured, to deploy capital routinely, you know, not by hobby, which is, unfortunately, how family offices have developed a reputation. So it’s been really the best of both worlds. And they’ve been an amazing partner, you know, for now, over 20 years.
Patrick: Well, and it speaks to the success because there’s just the trust and, you know, and that’s how these successful funds create lead to other funds is you’ve got very happy investors that are, you know, they trusted you with a little bit of money and now they can trust you with more money and they just keep rolling it over.
Mark: Yep. That’s a great way to think about it.
Patrick: Yeah. And so tell me about the targeting the lower middle market. The reason why I ask is that I personally believe that the lower middle market owners and founders there are the real entrepreneurs that are in a space where they’ve created value from nothing and just need to get to that next step. And the unfortunate thing is, I think a lot of lower middle market founders are underserved because they don’t know channels and access points that organizations like ClearLight Partners provides.
Mark: Yeah, it’s a good question. I think, as an investor, what you’re really looking for is inefficiency, you know, in the market, and as funds get larger enough to chase larger and larger deals, that market, the competition for those deals creates a very high level of efficiency. And so you have to ask yourself, Is that where there is the most opportunity?
Maybe I’m biased because I’ve spent most of my time in the lower middle market but I think about how a lot of private equity funds for instance, don’t have dedicated deal sourcing teams, are not using CRMs, are not comprehensively canvassing the universe of intermediaries who produce the deals are looking for, are still establishing kind of EBITDA thresholds of 5 million when you can find really great companies kind of in that three or $4 million EBITDA range. And to me, that just really presents a lot of opportunity.
And to your point, business owners in that size range probably have been underserved by equity capital providers, or at least there hasn’t been a focus on them. And I really think that’s changing. And, you know, some of the best deals, or at least a couple of deals I could point to that we’ve done, that have produced really nice returns have started with a very small, very modest starting point.
So yes, there’s more risk to starting at a smaller scale and the companies might need to be invested in and have management teams built out and have proper systems kind of put in place. But if that’s all done correctly, it can produce a lot of opportunity. So I’m a huge fan of the lower middle market. You just have to know kind of what you’re getting into and, you know, learn the playbook, if you will, to create value. So I’m a big fan of it.
Patrick: Well, you started, ClearLight Partners started as an operating company. And so let’s talk about, and we referenced this earlier, where you have a value proposition to make to these target companies as you are actively going out there, talking to them. What’s the message that you deliver that’s different? What are you bringing this a little different?
Mark: Yeah, I mean, as it relates to our operating heritage, I think sometimes between, you know, operators and investors, there can be kind of a communication disconnect. You know, let’s say you’ve got investors who’ve only been investors, or who were investment bankers and then became private equity investors.
There’s a manner of speaking that might not be compatible, you know, with how operators kind of describe their world. And then there also can be a lack of empathy for what it takes to execute strategy. And so if you look at our firm, starting with the senior-most leadership, these are people that have had p&l expertise. And that story kind of ripples throughout several people on our team who have run companies before, in some cases, run companies for private equity funds, and in even some cases further started companies themselves.
So it just lends itself to, I think, a more productive discussion and kind of bridging that communication gap and really understanding what it takes to execute strategies. That’s a huge part of what we offer. When you couple that with kind of the single source of capital and the longer investment horizon, we think, you know, in a fairly commoditized private equity world right now, we think it makes us different, but it’s just all a matter of getting in front of those owners so we can actually tell the story.
Patrick: It’s important that you talk about the empathy that you have because there’s a danger if your investor only focused, you’re going to fall into that trap that cynical people describe private equity. And that cynical thing is for words, just buy low and sell high. And, you know, that’s not comforting for owner-founders out there. And so it’s great that you guys are stepping out, and that is different out there from a lot of other folks. Why don’t you give me an example, you know, one of the deals you’ve done, or one of the success stories you’ve had?
Mark: Yeah, I think one of my favorite stories involves us getting into the fitness industry, which is important for a couple of reasons. One, we had never done a deal in fitness previously. And this was a franchisee. And this is before franchising was as hot of a space as it has become. And so, you know, one of our partners, you know, really deserves a tremendous amount of credit for having the vision to get into the industry to get into this deal. And so this franchisee in question was a Planet Fitness franchisee, they had 12 locations in two markets, they were generating healthy EBITDA, the unit economics were very compelling.
And if you know anything about the Planet Fitness model, it’s all about value. So it’s the low-cost model. And this is also at a time, I think, before the world became so focused on recurring revenue, but fitness is yet another industry that is based upon recurring revenue that perhaps wasn’t appreciated for it in the way that say, a security company was, you know, back in the day or has been. And so, you know, we took a bet on this particular business and it just paid off so well.
You know, we got into a couple of additional markets, so bought new territories, opened up clubs organically, basically didn’t acquire a single club in our journey from 12 locations to north of 60. And this is over a five-year period. And there are some really great things that happened during that time. Built out a management team. You know, the president of the company was given the opportunity to assume the CEO role. So that transition was done effectively.
A former ClearLight employee was actually able to step in as the CFO of the company, which proved invaluable kind of given his understanding of kind of how we analyze businesses and just the strong rapport we had with him. And, you know, the business, the exit of that deal generated basically the best financial return in the firm’s history in a five-year period. It just exceeded all expectations. So it’s just one of those great success stories where everything lines up well and you make a huge difference in the lives of people at that company. And it was just a really rewarding journey to observe.
Patrick: Well, that breaks the stereotype of fitness centers being not the greatest investment in the world. So that’s really telling. I’m just thinking from personal experience, just seeing things in the bay area where his centers are coming and going. With this thing, were you dealing in just one geographic region? Are you regional, are you cross country?
Mark: In that case, we had pretty disparate locations. I believe we were in San Antonio initially and in Nashville, I want to say, and got into Sacramento and then Pittsburgh and then also Canada. And so literally all over the map. And I know there’s a strategy that people like to embrace of building kind of regional density and the view that that kind of enhances valuation or kind of positions you best to enhance valuation. But in this case, we benefited just fine from having disparate layers. And it was, again, it was a great run.
Patrick: Well, and let’s transition into just a little bit broader on the profile. What’s the ideal target profile that you’re looking for?
ClearLight’s Ideal Customer Profile
Mark: Yeah, and this has evolved over time. I mean, if you can believe it, back when ClearLight was getting started, we were trying to figure out a strategy. We even did a few venture deals, some of which that actually panned out okay. But then we pivoted to kind of traditional middle market, you know, LBO investing back when LBO is still a term that people used.
But I think, you know, we’ve done deals buying from other private equity funds, but our passion is to invest in founder family-owned companies. Has been for a while now. I think that presents a lot of opportunity for professionalization, for investment into the business that, you know, not to the fault of the business owner, it’s just many business owners, you know, get their business to a point where they’re generating three, four or five, 6 million of EBITDA, life is pretty good.
You know, why do I need to take the risk of over-investing in the business or taking risks with the business? And so we think that presents a lot of opportunity. We like situations where the business is in an industry that’s healthy and growing. So it’s very clear and easy to understand macro story, supporting the growth of the business.
We don’t really invest in story situations or turnarounds. It’s usually kind of up into the right, organic industry growth that’s beating GDP for some compelling and sustainable reason. And then from there, it’s underwriting the business and try to understand, you know, is this a company that we’re excited about where, you know, we can understand the risks and box those accordingly and, you know, proceed with the management team to hopefully, double, triple EBITDA.
Patrick: And that’s where you guys really add the value to because the skill set for owners and founders where they’re killing themselves to get to a point where they’re three, four million EBITDA, the skill set to go up to 10 million EBITDA is a completely separate set of skills. And oftentimes, you’ve got to bring out other people, and you can risk it by yourself and try to do it yourself or find partners, you know, in private equity who have not only done it before, they’ve done it in your industry before and they’ve got the roadmap and you’ve got the resources and the knowledge to bring to bear.
Mark: Yeah. And then the other point I should have made too is we certainly welcome the involvement as shareholders of the founders, insofar as they want to retain equity alongside us. That’s actually a better situation than buying 100% of someone’s company. And it’s that proverbial second bite of the apple, which everybody talks about. But when it works, well, it does exactly what it’s supposed to do. And the second bite of the apple can be extremely rewarding. So that’s when things go well. We like to see that happen.
Patrick: Yeah, to talk about rolling equity into future funds. Yeah, we came across our, we, a founder-owner sold his company for 20 million, retained, rolled 5,000,000, 25% into the new firm. And a few years later, they sold the, they sold the new company for 25, $30 million dollars. So his 25% actually was worth more than the entire amount of his company previously. And they took that and rolled it on in and I just, that’s a win-win-win, which I’m surprised more of those stories are out there right now.
Mark: Well, and it’s also a good vote of confidence, frankly, when the owners want to retain equity. It’s a little scary if someone wants to throw the keys at you and kind of disappear in the sunset. So
Patrick: In those cases of disappearance and so forth that, I do want to ask you, you know, in your involvement, both with ClearLight Partners and before, tell me about your experience with rep and warranty insurance. Good, bad or indifferent?
Mark’s Experience With Rep and Warranty
Mark: Yeah, it’s a good question. I was reflecting on this a little bit because in my seat on dealer origination, it’s not a product that I’ve had as much exposure to. I’ve mostly been an observer of market trends and listening to it come up as a topic of discussion. And I was able to research on rep and warranty because I was interested about, you know, where the product came from, where it’s been.
Apparently, the product has been around since the late 90s. And it was created as you might expect, for fun, I wanted to free up money from escrow to get paid, you know, more at closing versus having some percentage of the purchase price being locked up for 12, 18 months, whatever it was.
And so it’s easy to understand why a product like that would be created. It wasn’t really embraced until maybe 2007, 2010. People were accustomed to doing things the way they’ve always done them with escrow being some set percentage of the purchase price and so forth. I’m told rep and warranty insurance really gained traction to a law firm, a fairly prominent law firm who got behind the product was really recommending it to their clients and like I said, Maybe 2000, 2010.
And I would say my extreme awareness of the product, you know, really started to come into view upon my return to ClearLight, maybe 2014 or so you just started hearing everybody wanting to talk about it. And if I understand statistics correctly, this is a little anecdotal, I’ve heard that in private equity-backed deals, maybe 75% of deals at this point are utilizing rep and warranty insurance. From my perspective, it has a couple of advantages, certainly to the seller. You know, you get more of your consideration paid to you at closing. From a buyer’s perspective, there’s also advantages.
You know, if you have to go after a claim, you know, you’re dealing with an insurance company, as opposed to your new partners in the deal, which I could imagine would create for some awkward conversations, as you’re, you know, in the early innings of a transaction trying to build a company together as friendly colleagues. So it’s very clear to me why the project has, you know, become increasingly in fashion. You know, certainly in the recent, some of the recent deals we’ve done, without citing any specific examples, I know that it has been something that’s been utilized and I would expect that trend to continue.
Patrick: Yeah, well, the biggest development out there is that rep and warranty initially was a product, the reason why I didn’t gain traction was it was prohibitively expensive and it was limited in what it covered and what it didn’t cover. In the technology sector, particularly for years, it would exclude any IP-related reps, which is is a deal-breaker in Silicon Valley.
But because of good success and good traction and a copycat industry, other insurance carriers would get into the mix. And with competition comes two things, a broader improved product and lower prices. Today, rep and warranty can now be brought to bear for a transaction as little as $10 million. Were the minimum price, you know, all in including underwriting fees and taxes and everything, a $5 million rep warranty policy is under $200,000 total costs.
I mean, rep and warranty is now available for add ons, where is it did make a lot of financial sense when the pricing was probably a multiple of where it is now. And it’s not only less expensive, it’s simpler to secure. And so that’s where we want to get the message out, particularly to the lower middle market, because two years ago, if you were under 100 million dollars transaction value, you probably wouldn’t be eligible for rep and warranty.
Now, that’s not the case. So it was great being able to have it out there where it really does make a difference. Now, Mark, from your perspective, and I want to go to an article you just posted not too long ago called Never Let a Good Crisis Go to Waste. You had as we’ve been mired in this COVID-19 pandemic settle in place on again off again in California, especially, but what do you see out there for m&a going forward? And you had a great piece, we’ll link it to our notes here, but tell us what you see.
Where M&A Might be Headed
Mark: Yeah, I know I wrote that piece, I was just tired of all the negative headlines. I mean, it really weighs on your consciousness. And so I said, What’s the contrarian thing to do here? Let’s talk about how the glass can be half full amidst all of it. I mean, one of the alarming statistics is now an estimated third of our population is suffering from anxiety and depression, if not both. I mean, that’s like 100 and 10 million people. You know, wandering around their house, you know, depressed or anxious because of COVID. It’s like, we all need a little bit of cheering up here.
So I tried to sprinkle a little bit that optimism through the article. And one of the quotes that I love that I just discovered in writing the article was something John F. Kennedy apparently said. And he said, When written in Chinese word crisis is composed of two characters. The first character represents danger, which is pretty easy to understand, but the second represents opportunity. And I think, therein lies the opportunity to find the silver lining amidst all this.
And so, you know, I was reflecting o,n you know, what are some of the sectors or themes that are surviving if not thriving, you know, kind of amidst COVID? Because there are some green shoots, if you will, or some very nice signs of life amidst all of this. I think it’s important to focus on those. So I just kind of talked about a couple of them. I mean, recurring revenue is an easy one to point to. That’s interesting in its own right, has been for a while. Not a new idea, but recurring revenue-generating businesses are doing, for the most part, you know, pretty well right now.
Similarly, and I’m saying this having just invested in an IT services company, companies with remote monitoring capabilities where you don’t have to be physically present to deliver some good or service are doing great as well because you can do what you need to do from the safety of whatever coronavirus-free location you happen to be in. Those companies are doing well. You know, I look at companies like our ice cream business, and I pointed things that I’m calling small consumable luxuries where there’s like a high ROI on happiness.
You know, you buy a $6 milkshake or whatever it is, and that’ll cheer you kids up, get you out of the house. You know, so there’s all sorts of things like that that I think are doing okay. I look at like, at-home convenience services, having your groceries delivered to you. All these things that have given rise because in large part our behaviors have changed to be well-positioned. So, you know, thinking about specific sectors that might be kind of interesting.
You know, I mentioned the depression and anxiety issues, I point to outpatient behavioral health, you know, sitting with a therapist and talking through your problems, there’s a lot of people who need help. And some of these issues often go untreated. And I think at the same time, some of the stigma around behavioral health is coming off. And I think there’s a lot of people that could benefit. So that feels like a classic do-well do-good industry that has been largely untapped by private equity for various reasons.
And it’s pretty interesting. Express car washes, fabulous industry, hiding in plain sight for way too long, you know, high margin recurring revenue, you don’t have to get out of your car, very COVID-friendly, you know, really nice business that kind of plays with our kind of multi-unit retail strategy. We’d love to do something there. We talked about fitness, there’s no way around it. Fitness is going through some hard times right now, for the obvious reasons, but as soon as people can get out of the house and feel comfortable exercising again, it’s just gonna go gangbusters, in my opinion.
And I think that it kind of correlates interestingly to the depression issue because fitness, you know, offsets, you know, kind of gloomy moods. You know, you get out there and you generate some baritone. And then I mentioned kind of IT and other tech-enabled services for the reasons I mentioned before, recurring revenue, remote monitoring. I think those businesses should do pretty well, too. So, you know, not an exhaustive list. There’s others. Some of the stuff is pretty obvious, but you know, trying to find, or trying to view the glass as half full, anyway.
Patrick: There has been that trend of pre-COVID to have fitness being brought from the outside into the home, particularly with peloton. We’ve only been in our home so much, I think that trend is going to go back. And just the desire of being around other people and being in another facility away from the home is a real good idea. Mark, how can our listeners find you?
Mark: Oh, gosh, yeah, so I’m on the ClearLight website. I’m, I think, reasonably easy to find there. But people are welcome to email me, call me anytime. Early often, we love hearing from people who want to chat about any of the topics we’ve discussed in this podcast. Or maybe they know a company or are running a company that could benefit from capital at this point. Even if it’s early, it’s always good to have those conversations to kind of get to know people. So feel free to visit our website. Email addresses on there, phone number, and give me a call anytime.
Patrick: And without showing any bias again toward ClearLight with our other guests and our other colleagues and partners out there. I will say though, if anybody is interested, have had a chat with ClearLight and see if you can swing a quick visit to their offices because like I said, there are fewer places on this planet that are as beautiful as Newport Beach. So Mark, an absolute pleasure being here. We’re going to talk again.
Mark: Alright, thanks, Patrick. Enjoyed it.