An Operator-turned-PE Investor's Take on How to Originate More Deals, Playbook with Ted Clark

Sure. Let me start with a big picture and then kind of narrow it down. I think one of the things that we see generally as a trend in middle market private equity investing is more specialization. Firms are more specializing in markets or sectors. I think the benefit of that is trying to create some differentiation in terms of firm capabilities. Not everybody's a great generalist investor, but focusing on sectors where you have specific knowledge, background, and experience is likely to create more opportunities and helps frankly risk-mitigate investments by the firm. So one thing that we do in our case is we specialize around areas that we have experience in. We work through healthcare, life sciences, specialty chemicals, and materials. We believe there's a nexus between all of those. Healthcare is really more of a market where life sciences is focusing on med-tech healthcare, and especially chemicals and materials is a very broad market. But within especially chemicals and materials, there's really a nexus with life sciences, so you sometimes see opportunities that span both life sciences and specialty chemical type markets. In our case, we have one partner who is an investment professional over a couple of decades who has a lot of experience investing in this area. I'm more from the operating side, but I've got four decades of experience in both life sciences and specialty chemicals. Our third partner kind of spans both; he started as an investment professional and then was an operator for many years in life sciences. The reason I bring that out is I think being successful at deal origination comes from intent. We're very intentional about where we want to invest, and from there we spend a lot of time thinking through the process to narrow that down to actual opportunities. But I think fundamentally that's probably the most important thing: having a vision and a foundation around where you want to invest, and then from there crafting strategies and tactics to do the deal origination.

Yeah, so what we try to do is before we go out and go hard and wide trying to find opportunities, we'll develop a thesis. Even though we're specialized in this area, it's a very large market. If you consider specialty chemicals, it's a huge global market. So what we do is we try to focus on segments within those markets. Quite frankly, we look for things that we'd call active ingredients, things that are creating value for our customers. We tend to invest in B2B companies, and these companies tend to work with the biggest manufacturers in the world, whether they be in healthcare, med-tech, personal care, or industrial markets like automotive, electronics, etc. So what we're really looking at is sub-sectors within this broader frame. Once we identify them, we have a team that will spend time developing a thesis around each area that we think is attractive. We don't know until we do the work, but we'll develop a thesis around those. The thesis will look at exactly those kinds of things: what kind of value creation is that sector creating for the broader market, what kind of fragmentation is there, is it dominated by one or two large players, that sort of thing. Then we'll look at the underlying market trends. Are these sectors supported by long-term infrastructure growth or changing demographics in the healthcare market, things like that. Once we have a thesis, if we have already engaged with somebody, we'll tend to look at our networks. The other benefit of having a lot of experience in these markets is we also have a pretty big network of executives and others with expertise in the market that we can recruit in specifically to support a thesis. Part of what we really want to do is understand the market really well, try to network and add to our team, either as people that might potentially be board members or otherwise have an interest in investing in the thesis that we've put together. They will use their networks to help identify and originate deals. It's a sort of cascading thing, like a microscope. We start with a big picture and then dive down deep into the market sector, trying to identify the people that can help us with the investment thesis. That's where we've found success, because it's not about ad hoc, it's a strategic approach that allows us to really understand and then manage. We could look at public comps, we could look at trends within the industry. Sometimes we might have a thesis in which we don't do a deal for a year or 18 months. That whole time we're monitoring it, talking to lots of people. We think this is the way to invest our LPs' money properly. The other part of it is we do spend a lot of time once we have a portfolio company doing add-on acquisitions. When you're doing a thesis, it gives us the opportunity to see if buy-and-build is a good approach. Are we making this investment just because we feel the underlying organic growth is going to be exponentially higher than other investments? It allows us to either create a platform and from that platform, what's the next step? We can pre-think most of the steps through to an exit strategy and a value creation exit strategy.

Yeah, we do a couple things. We'll use our own networks, the people that we know. But obviously you're probably never going to have a complete network just with people that you know. So we do use sometimes third parties, people like yourself that may have a great deal of experience in certain market sectors with executives. We kind of look at it like you would sort of a recruitment assignment, if you were going to hire a CEO or a CFO or a chief technology officer. We sort of first look at who we know, but maybe to complete that picture or to really make sure that we're getting the best possible person to support our thesis, we'll go to third parties to help us introduce and begin to build and create a relationship, using people like yourselves that spent a lot of time thinking about great executives and what they do and what they know.

Yeah, we do both. Obviously, once we do the thesis, we work hard to try and build proprietary deals, but we also will share that thesis with investment bankers and let them know what we're doing, what our ultimate goal is, and the strategy. We cast a wide net. We're not kind of prideful about ownership here. If we have a relationship, we're obviously going to try to leverage that relationship. If an investment bank can help us get into processes that fit with our thesis, then obviously we want to make sure they know what we're trying to do and accomplish so that we can participate in those deals. Particularly on the platform companies, as we get into buy-and-build and add-ons, sometimes the add-ons are going to be relatively small, so almost by definition you need to generate those yourself. The investment banks have to be careful with their time and how they work with different size companies they're representing. But yeah, we cast a wide net. Frankly, with our fund, most of the initial deals we've done have been proprietary. We've had a couple of process deals, but we're kind of agnostic. The fit is more important than anything else. We want to cast a wide net and get as many swings at the bat as possible when we're driving one of our investment theses.

Yeah, yes we do. There's really two ways. There's a thesis that we might develop just out of curiosity and interest. We'll develop a thesis scenario we think is important, and when we do that, we'll begin to go to our networks and say, 'Hey, do you know anybody who's working in this area?' We may go to people like yourselves and ask the same question. In that case, we share the thesis right up front. We'll share the thesis, gauge their interest to support from their side, but also from our side try to gauge the experience and how that executive might be able to help and accelerate the thesis. The other way is where we have executives that come to us with a thesis. That's the other part of these networks. Here are the areas Iron Path is investing in. If you've got ideas, bring them to us. Let's sit down and talk about them. This was very much the model that I used over 20 years ago when I started Royal Adhesives. I had a thesis, I had done the work, and then I brought it to the firm, trying to match the firm to the thesis, somebody who had previously invested in the space that I was interested in. So those are likely the two ways that we would work. We're again kind of agnostic on that too. We love it when people come to us and say, 'Hey, I've got an idea. I know you guys have spent time in specialty chemicals. Here's what I'm thinking.' We actually have a couple of good examples of that as well in our business. Originating deals, you can distill it down to partially science in terms of process, but the other part of it is innovation, luck, and relationship. It's a sort of balance between those two things.

Yeah, it's a great question. One of the things that I find is when you go to a management presentation or you're sitting in front of management and you're talking about investing in their company, if you know something about the challenges of actually running a middle market company and manufacturing, things don't always go perfectly. You're up one day, down a little bit. You might have a challenge from a regulator, you've got all kinds of approvals, you've got all the things that everybody's been faced with over the last few years like finding qualified labor to run your business. There's lots of challenges. Being able to look at a business and understand the underlying value creation activity while at the same time having some empathy with all the challenges that a management team has in executing a strategy is helpful. We like to align ourselves with partners. We're not coming in to run the business; we're really coming in to help support the business with capital and advice, which are the two things that we have that can help a management team. It's been very useful for us in the sense of being able to recruit executives to work with us on theses, and also as we're meeting with potential sellers, it helps to differentiate our firm a little bit, given we've got this level of operating experience at the partner level.

I would say the first thing is really having a good balance between the operator, the investor, and the investment professional. I do make a distinction here. The thing I have to watch for myself is I look at a company and think, 'Geez, they have these problems, I think I could fix it.' But that's not going to be my role to fix it. My role is going to be to provide advice and evaluate the management teams and determine if they are capable to beat the challenges and drive the execution of the strategy. I would say that the investment team has to understand their own strengths, weaknesses, and potential biases as they're looking at investments. When you're looking, you want to find two things: you want to know and understand why this business is creating value, you want to know what the underlying trends are that will position it for growth, and you want to know how experienced the team is, what their appetite for growth is, and what their appetite for risk is. The one question that people normally have with private equity, particularly if it's a family company that's going to recapitalize, is that it gets capitalized with debt on the balance sheet. Now you've got a company that probably had zero debt that's going to have some debt. We try not to put too much debt on it, but it's more debt than they were used to. That's where the operator side comes in. You can help them understand, 'Look, I've done this before. I've operated a private equity company for over 20 years. Here's how this all works.' But we're in the business of investing, so it's about the returns we can generate and how they're going to be generated. We could have ideas that are great, but if in the end that's not really the management's vision for the business, then you've got a disconnect. You're there to understand management's vision and how they're going to execute it, not to assume that we've got these great opportunities and all you guys have to do is figure out how to do it. We spend a lot of time thinking about culture when we evaluate a business. What kind of management culture is there? How do they think about growth? It's all about thinking about where they're at right now and where they want to be. Evaluating that is the catalyst for generating the growth they're potentially capable of delivering.

Yeah, we're very active in that. The other thing is I've been in the specialty chemical industry for a long time and life sciences, so over the years you get to know all the investment banks and the bankers. Developing relationships with those bankers is really important. These investment bankers that put out a process need to think through who potential buyers are going to be. They want to be able to know and trust the people that they're going to recommend to come into a process to their client. Part of this is building a relationship where they understand who you are, how you operate, what they can rely upon you for. Developing those relationships is really important. Many of the ones that I dealt with over the years are still there, and there are lots of newer ones, but they hear from the ones that are leaving about your reputation and then you build a new reputation. So we have a very active set of relationships with the key healthcare, chemical, and life science bankers that we talk to on a pretty regular basis, keeping them up to date on what we're doing and what we're interested in. In this business, you don't want to miss a deal, so you want to at least be considered or told about deals that are coming out in the market. Those relationships are really important for that.

Yeah, you can reach me at [email protected]. That's probably the easiest. And I'm on LinkedIn as well under Theodore Clark. I think there might be an 'M' in there, Theodore M. Clark. So you can also reach out to me through LinkedIn messaging.

My pleasure, Alex. It's always great to be with you. Thank you.