Backing a company that’s cooking the books, investing in an unpredicable market with low margins, waiting too long to sell and ending up in the red.
Co-CEOs of The Riverside Company Stewart Kohl and Béla Szigethy provide a rare glimpse into these and other mistakes it has committed in an article in the latest edition of sister magazine Buyouts. It’s a glass of cool water in an industry where nearly every firm claims to generate top-quartile returns but where investors increasingly value candor and humility.
That Riverside has had plenty of good deals is beyond dispute. In its 23 years the firm has exited 64 platforms and their corresponding 67 add-ons, realizing a 53% gross IRR and a 3.5x gross cash-on-cash return. The firm, which closed a $1.17 billion fund in 2009, has proudly posted profiles of more than 55 solid exits throughout its 20 offices.
But Riverside doesn’t repress memories of its bad deals; rather, it embraces them and the lessons they teach. In fact, it has a posters titled “Lessons from the Loo” posted—where else?—on the wall in its office restrooms around the world (see picture above). The article in Buyouts, picking up on the theme, includes six lessons, which you can see summaries of by clicking through to the slideshow.
The trap: A fast growing company with strong market share, an impressive CEO and new products in a burgeoning industry.
Warning signs: The CEO was charming, but Riverside uncovered “more than one example of litigation and sketchy ethics.” The second tier of management was “inexperienced yet highly compensated.” The partners also noted a high turnover in senior staff and lenders with “restrictions on talking to individuals throughout the organization during due diligence.”
The reality: The fraud was so sophisticated it took almost a year for Riverside to uncover. The partners discovered it had overstated its EBITDA by $15 million and its working capital by $14 million. What’s more, during the due diligence process, “conference rooms were bugged, customers and vendors were involved in the fraud, and documents were manipulated.”
Lesson learned: Now, for all potential deals at least three days are spent on site with access to all employee information, files and systems.
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