The vintage 2006 Brentwood Associates Private Equity IV fund delivered an IRR of 15.6 percent as of March 31, 2015, for Indiana Public Retirement System, according to data from the pension fund. That’s ahead of the 14.4 percent top-quartile threshold for that vintage year, according to an annual analysis of public pension fund data by Buyouts. The median IRR from that year is 8.7 percent. Bill Barnum, partner with Brentwood Associates, talked about the fund in a meeting with Buyouts.
How did fundraising for Fund IV go?
2006 was a pretty vibrant time in the market. It took about a year to get it done. So we hit our target of $450 million. We added a lot of new LPs because historically we’d had a lot of commercial banks in our LP base. We had to change a lot of them. That was sort of the old mode — all the banks would come into your funds. That kind of changed.
What did you do with the fund?
We got out the gates very quickly on that fund. A couple of our early deals were Paper Source and Zoe’s Kitchen. Those closed almost contemporaneously with closing the fund. We had those in the pipeline as we were going. Paper Source is a store that sells specialty papers, crafts, fun stuff. It’s got a really loyal customer base, which is part of our investment strategy, to find concepts that have loyal customers.
So while you were fundraising for Fund IV, you lined up Zoe’s Kitchen and Paper Source? You were telling LPs, ‘‘Hey, we want to buy these two great companies. You should invest in our fund.’’?
Yes. We were telling them all about what we had. We had a third one as well, called Teaching Co, that was ready to close. So we had a number of investments that we wanted to get done, fortunately with entrepreneurs who weren’t really in a hurry. With Paper Source, we had a year-and-a-half relationship with the entrepreneur. We were actually helping her change her manufacturing facility, her warehouse, her accounting system. We sort of wanted to get all that stuff done before we invested.
How did you navigate the financial crisis?
Both Zoe’s Kitchen and Paper Source were deals structured without any debt, as growth companies. The year 2007 was good one. We added some stores at each company. And then 2008 came and it was a little bit of a wild ride for a little while.
We basically tried to do a lot of interesting things in 2008 and 2009, but we didn’t see a lot come to completion. We did one deal during that period. … The things we looked at needed co-investment dollars and the liquidity crisis made it more difficult.
We dabbled with the idea of distressed debt and other things that some private equity firms did in those times. We decided that’s not our mission in life. Our mission is to find these really special businesses that have great customer loyalty. We found a couple, but we couldn’t get them done. The crisis was horrible. There was no debt available.
But your first two investments from Fund IV ended up doing well?
The good news was because the companies had great capital structures, we had lots of operating leverage. We didn’t have any financial leverage, so we didn’t have to worry about anything. We slowed the growth down a little bit. And then as soon as the recession ended in 2010, we sped it up again. They both turned out to be very successful investments. Zoe’s went public and Paper Source we sold to Investcorp.
How do you source deals?
About 70 percent of our deals are with entrepreneurs and founders of companies. Generally, we recommend that we buy about 80 percent of the business and that they keep 20 percent. We try to make them as much on the 20 percent after five years that they made on the 80 percent.
We get a number of people that like to do that. They like to stay with the company. They frequently are not in the management by that point. But still it’s their baby. It’s their life’s work and they don’t like to go cold turkey. A lot of times they’ll stay on the board. And they’ll offer advice. They’re the people who were there for the beginning so they have a lot of good insights to add.
Then, over our ownership period, we’ll generally bring in some key management hires — frequently, a marketing person who understands digital marketing, who understands marketing at a higher level. Then we’ll really start to grow the business by investing in acquiring more customers.
In terms of the skill set at your firm, do you have more people with operating experience to work closely with entrepreneurs?
Interesting question. We do have a lot of people we partner with who are on the operating side. But they’re not operating partners. We have one operating principal … a former GE executive, who is really good at distribution centers, manufacturing, he’s good with IT, he’s good with accounting systems.
Our businesses are not that operationally intensive. The real value that we bring to the party is in increasing the sophistication of the marketing. Our goal is to take single-channel businesses and make them multi-channel, or omni-channel. So if we find a retailer like Paper Source, we’ll introduce a website and a catalog. We’ll make it more sophisticated. We’ll make the real estate selection and the store design more sophisticated. Or we may buy a pure direct-marketing business and take it into bricks-and-mortar retail.
What deals drove performance in Fund IV?
Zoe’s Kitchen; Paper Source; Ariat, which is a Western and English footwear business; Teaching Co, which we’ve recapped a couple of times —it’s also known as The Great Courses.
How did the fund contribute to the evolution of the firm?
It was shortly after Sept 11, 2001, the mini-recession we had in 2002, that we really began to focus on controlling our destiny by investing in companies that have a one-to-one relationship with their customer. The strategy has evolved and gotten more sophisticated since then. We’ve had exactly the same team. So we’re now 15 years into executing this strategy. Fund IV contributed to that.
They’re few and far between, but when we find what we like, we know how to increase the value and grow the Ebitda faster than it’s been growing in the past.
Anything else you’d like to point out about Fund IV?
This fund was sort of a fund of two different economies. Half of it was invested before the recession and the other half after. Most of the pre-recession companies have been sold and the post-recession ones, we continue to look for opportunities to gain liquidity. We’re pursuing the same strategies we used in Fund IV.
Photo of Bill Barnum courtesy of Brentwood Associates