Author Archives: carpedia76539

G.W. Anglin Manufacturing Expands Into Quebec Market

gwaCarpedia Capital is pleased to announce an expansion to the business of G.W. Anglin Manufacturing (“GWA”) following the completion of two acquisitions this year. The second and more significant of these acquisitions was concluded September 15, 2015 to cement GWA’s initial market position in the province of Quebec that was acquired April 22, 2015. Together with GWA’s existing operations, the combined business will now be the best-in-class, one-stop-shop vehicle upfitter for large commercial fleets in Ontario and Quebec. The acquisition also adds a talented entrepreneur to GWA’s management team. After an integration period, we are looking forward to additional acquisitions to further expand GWA’s national platform.

GWA is a leading upfitter in Canada for large scale, high performance commercial fleets – particularly for the complex vehicles primarily utilized by large natural gas utility, electric utility and telecommunication customers. As one of Canada’s few vertically integrated commercial vehicle upfitters, GWA designs, manufactures and installs a majority of the product it integrates into vehicles – providing customers with turn‐key work vehicle solutions. GWA is also a Tier 1 supplier of low volume, light metal fabrications incorporated into heavy equipment vehicles and a Tier 2 supplier of low volume automotive parts. Carpedia Capital completed its initial investment in GWA on November 1, 2011.

To read more about this transaction, please review the Press Announcements and the article on PE Hub Canada.

For more information on this transaction please contact Glen Ampleford at ampleford@carpediacapital.com or 416-364-8842.

Picking the Right Financial Partner

When considering liquidity options for their business, many entrepreneurs seek out deal structures that allow them to sell most of their ownership to a financial investor while remaining in a management capacity and retaining a stake to get the proverbial “second bite at the apple.” Having been exposed to many such deals, as both buyer and seller, our experience has shaped our perspective on the key considerations for entrepreneurs to ensure they select the right financial partner and avoid the shortcomings of capital raising processes.

Selecting a Financial Partner is an Opportunity Fraught with Risks: Typically, a structured capital raising process introduces the entrepreneur to a limited number of financial investors in the course of a few weeks in the investment banking equivalent of “speed dating.” From these heavily-orchestrated meetings and the resulting indications of price and other deal parameters, entrepreneurs are expected to select their preferred financial partner with which to “go exclusive.” The importance of this relatively early decision point is not to be underestimated, as it starts a time-consuming and expensive diligence process prior to attempting to consummate an investment transaction – and it is very difficult to change the selection at a later point without badly impacting the entrepreneur’s negotiating position or waiting an extended period of time to restart the process.

We have observed that this process of partner selection tends to over-emphasize raw cash price and likelihood of expedient closing rather than a more balanced assessment of total value and alignment to the needs of the entrepreneur, typically for three reasons:

  • Limited awareness by the entrepreneur about the investors. While much information will have been given to the investors about the business and entrepreneur, there typically has been much less reverse dialog in regards to the financial partner and its people – making it hard for the entrepreneur to make a decision other than by intuition based upon limited interactions and perspective from key influencers. In comparison, we have seen entrepreneurs invest more personal time and effort into selecting key employees than into the selection of an investor to become their financial partner.
  • Basic motivations of key influencers around the entrepreneur, such as the financial advisor, lawyer or accountant. They tend to be price-focused by the commission or success nature of how they are primarily paid and have personality types to match. They are the primary interface with the investors and typically prepare and lead the discussion of the entrepreneur’s options, thereby giving substantial weight in the entrepreneur’s decision process to the key influencer’s perspective. If the key influencer works as part of a larger institution, they may also have secondary objectives related to their employer’s other product lines which can influence their actions and recommendations.
  • Structure of the process itself, often with a linear schedule geared around milestones and timeframes designed to move the selection and diligence process forward expeditiously and manage the large number of people involved in the working groups.

While these factors help drive the momentum required to get a deal closed, the pressures they create in the crush to “get the deal done” make it easy for the entrepreneur to lose sight of the fact that they are going to have to spend the next 5 to 10 years of their life in a potentially hastily-made partnership selected primarily on the basis of price rather than other and equally important long-term criteria. Only after the transaction is done and the euphoria fades does the realization set in that the deal’s finish line is really only the starting point from which the entrepreneur must then develop a meaningful partnership with the often relatively unknown, and now in control, financial investor.

Key Financial Partner Selection Criteria: For those entrepreneurs looking to get their “second bite at the apple,” and provided a reasonable and market-based price is offered, the following are important upfront considerations in selecting the right financial partner for a valuable and constructive long-term relationship:

  • Value-Add: A financial partner who contributes the most towards enabling the entrepreneur’s and the employees’ future success, with the highest degree of certainty. This is the most important consideration because the potential to recover the rolled-over equity stake and the new “value creation” is dependent upon future results. Therefore, the best financial partners contribute strongly to development and implementation of strategy, fostering the development of high quality people and the optimization of processes, systems and proactive behaviours.
  • Good Character: The constitutional qualities entrepreneurs must look for in their financial partners include high integrity, open-mindedness, humbleness, self-motivation and hard working. Great financial partners also need to be results-oriented, transparent and equitable – qualities which are essential to maintaining balance in the management-investor relationship. Actions always speak louder than words in this regard, and thetrue picture of character often emerges best through small anecdotes and stories about past deals and experiences that demonstrate integrity and consistency of approach – particularly in the face of adversity. Independent references are also a key final test, but should be used to confirm, rather than form, the entrepreneur’s view of a financial partner’s character.
  • Personal Fit and Consistency of Personnel: Personal chemistry is critical, as entrepreneurs will be spending large amounts of time with their new financial partners. From shared interests to a sense of humour, there must be more to the relationship than just the business. Also critical is whether the decision-makers involved in forging the deal with the entrepreneur will be the same as those overseeing the investment throughout its multi-year lifecycle – uncertainty in this regard is a significant issue.
  • Strategic Alignment: There are many ways to grow a business. Alignment enables the entrepreneur and his team to confidently deploy resources and execute plans to implement the agreed strategy. In contrast, a material mis-alignment in strategic intent will delay progress and waste time and resources while the business’ direction is debated. Furthermore, such a mis-alignment can even fracture the sought-after partnership as the investor exerts their control over the company and entrepreneur. Having a shared understanding of where, as partners, you collectively want to take the business and how you are going to do it over the next 3 to 5 years is an essential pre-condition to selecting the right financial partner.
  • Financial Alignment: Entrepreneurs should require the same strong degree of alignment with the financial partner’s decision-makers as they require of the entrepreneur – the surest sign of which is a substantial cash investment from their personal accounts that puts meaningful dollars at risk on the same terms as the entrepreneur.

Conclusion: Naturally, it is hard for entrepreneurs to avoid being swept up in the whirlwind of making a deal and to maintain focus on long-term criteria such as value-add, character, fit and alignment, when those around them may be focused on short-term factors such as cash price and speed to closing. However, such a long-term focus is essential to choosing a partner for a relationship meant to encompass much of the entrepreneur’s remaining professional career and have the best chance to realize the “second bite at the apple” the entrepreneur set out to achieve. Great financial partners are hard to find; focusing on the right selection factors throughout the process is the key to choosing the right partner.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.

Our Approach to Assessing Value

“What’s My Business Worth,” The Often Premature Question:
Most entrepreneurs we meet with, after the appropriate initial pleasantries, typically want to ‘cut to the chase’ and ask “so, what is my business worth?” At this early point, it is important to note that we are typically in possession of very little real information on which to form an investment grade view about the business – critical context which will meaningfully impact the value we perceive.

Framing the Transparent Process: Rather than prematurely set stakes in the ground without the necessary context, we instead engage the entrepreneur in describing the process of ‘how’ we go about becoming knowledgeable enough to give a serious view on value:

  1. Fundamentally Strong Business: Our approach gauges whether a company is actually a rare business that has inherent stability (consistent historical profits on an adjusted basis and strong returns on capital, entrenched position with attractive and diverse customers in non-cyclical end markets), is unique in its competitive advantage, business model and ability to innovate, while also offering growth potential through operational enhancement, organic expansion and follow-on acquisitions.
  2. Good People: We focus extensively on understanding the entrepreneur and their team in terms of their character, commitment to hard work, self-motivation and our ability to trust them. Actions speak louder than words in this regard, so we typically rely upon how people have lived their lives and independently-sourced references of their character. The continuity of good people with the business, particularly when the situation presents ‘key-man’ risk in respect of customer relationships and operational execution, makes this assessment of critical importance.
  3. Good Deal Dynamics: Positive dynamics that create strong alignment – such as the entrepreneur and management participating with their own funds (either by way of roll-over or with fresh capital) and recognition that the transaction is fundamentally an investment in the team to execute the business plan – are critical to a successful deal. Other factors include the ability to attract bank financing and the presence of performance-based price mechanisms that deliver additional value to the sellers over a multi-year horizon (‘earnout’ is a colloquial term, as these may be based on future revenues as often as they are on profits).

balanced_valueSumming it All Up (or, Boiling it All Down): After much good discussion with the entrepreneur and review of these key factors, we will then be in a position to translate all of that context into an investment grade view on the value we would offer for 100% of the business enterprise and the composition of that value between cash, shares and or performance-based price.

So what does this mean in terms of generalities? For a Canadian business producing between $2MM to $4MM in adjusted EBITDA – which has good people, which possesses many of the characteristics of a fundamentally strong business and which has positive deal dynamics – is most likely going to be worth, to Carpedia Capital, a value of 4X to 6X adjusted EBITDA. As most businesses will have some, but not all of these characteristics or will exhibit exaggerated critical risk factors, they may fall between the 4X and 5X range whereas those rare businesses which have most or all of these characteristics with no exaggerated critical risk factors will fall between 5X and 6X. Where a business has too few of the essential criteria we seek, we merely decline to pursue the transaction rather than express an artificially low view of value. In respect of larger businesses, such as those producing more than $5MM of EBITDA, an escalating size premium will often come on top of the above noted ranges.

Common Mis-Estimations, Made By Entrepreneurs, Regarding Business Risks & Value: This brings us back to the entrepreneur that wants to know the value of their business. We’ve met only a few entrepreneurs that already knew how certain critical risk factors would interplay with the value that a third party would perceive in their business – meaning that most entrepreneurs misperceive the value of their business to be higher, for a variety of reasons (ranging from anecdotes about what other people may have sold their businesses for in the past to visceral emotional attachment to a desire to merely end up with a certain dollar amount of money), than what an informed third-party would perceive. However, what most entrepreneurs often fail to account for is their closeness to the proverbial ‘trees’ causes them to blindly underestimate the risk a third party perceives to the overall business ‘forest’ from critical risk factors such as customer concentration, cyclicality and key man responsibility; higher risk ends up being reflected in a price that appears lower relative only to inappropriate expectations that ignored such risks. Our transparent and consistent approach seeks to address these issues upfront, so as to avoid any unforeseen differences in opinion regarding total value or the composition of value amongst cash, shares or performance-based price.

Often, without recent experience weighing upon them from these risk factors, only the weight of time and or a reduction in profitability stemming from one of these usually binary risks moving against them will bring the entrepreneur to the table. That is, unless, you offer a price that ignores the risk factors – of which the surest sign of this ‘winners curse’ is an entrepreneur running to embrace your offer with little pause or sign of uncertainty.

Conclusion: Most entrepreneurs try to ask for your conclusion on value before you have the necessary context required to put forth a bona fide view of value. While we do clearly discuss process upfront, we typically defer setting any stakes in the ground until a clear understanding of the business’ context is obtained. We always look for certain attributes in the businesses we evaluate – such as a fundamentally strong business, good people and good deal dynamics – and those which meet our requirements are ultimately presented with a fair value offer derived in a manner consistent with our process. Transparency and consistency has been our best approach to avoid late-in-the-game differences in opinion or surprises regarding value and have proven to be the most effective means to reach a fair value deal that will successfully transact.

This manner of transparency is even more essential when the entrepreneur is not only deciding if they should sell you their business, but also simultaneously evaluating whether you are someone with whom they want to partner in further building their business; the tone and approach you set upfront must carry through the entire relationship consistently.

What’s Next: Picking a financial partner versus picking the right financial partner.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.

Building Great Businesses That Are Worthy of a Higher Valuation

Building Great Businesses That Are Worthy of a Higher Valuation
When Carpedia Capital considers investment opportunities, we always frame the potential for returns against the magnitude of risk (recall our definition of risk as the likelihood actual realized returns are lower than those required over a reasonable time period and the potential for permanent loss of capital) we are taking to ensure this relationship is appropriately balanced.

Diamond_1-2-3In our opinion, the primary determinant of investment returns and risk in private equity deals is how “good” the business is today and how likely it is to become exceptional during our holding period than it is likely to become the converse. Consequently, we spend the bulk of our time assessing businesses against these two criteria when deciding which companies to seriously pursue. After making the investment, our attention hones in upon the “how likely” qualifier to ensure our odds of success are “highly probable” as opposed to something less certain – with strategic focus, capital allocation, management development and risk mitigation being key tools to ensure the likelihood of strong investment returns remains in our favour.

Building Great Businesses That Are Worthy of a Higher Valuation: Profit level and applicable valuation multiple are, in our opinion, the two primary drivers of business value. Each is of significant importance and changes in profit level often cause directionally similar shifts in valuation multiple. Given that our approach to operational improvement of profits is well-discussed in earlier thought pieces, this article addresses the means through which we contribute to investment returns by building great businesses that are worthy of a higher valuation multiple:

  • Strategic Focus (or, Why & Where Management is Focused): Businesses that consistently demonstrate growth and improving competitive advantage, each resulting from intentional action rather than mere serendipity, are highly valuable. We invest significant effort to develop, with management, a strategic plan to focus their time and effort upon the right initiatives that will grow the business with a return on capital in excess of capital cost, with good margins, while diversifying its customer base, expanding its market position and strengthening its competitive advantages in quality, delivery, cost and innovation. We also intentionally seek, as part of the strategy, to grow the outright scale of the business through both acquisition and organic means – as larger businesses, typically those with $5MM to $10MM of EBITDA, are inherently more valuable on a multiple basis than those with <$5MM of EBITDA.
  • Capital Allocation (or, Where Management Lays the Shareholders’ Chips): Businesses that earn strong returns on incremental capital invested are highly valuable, as they have materially more growth potential and, also likely, a higher degree of profit sustainability than do low return on capital businesses. We invest significant effort to develop and vet capital plans for material new opportunities – be they of equipment or software or the acquisition of an entire complementary business – that accelerate the strategic plan.
  • Management Development: The ability of a management team to execute growth and operating plans, on time and within budget, is highly coveted. Good, hard-working, intelligent, self-motivated but humble people are rare assets which must be further developed, trained, recognized and rewarded to bring about their maximum value. The team must also have depth to it and a well-defined succession plan, properly tied to development and training plans.
  • Risk Mitigation: Businesses with inherent stability are more valuable than those subject to the vagaries of significant external risks. Through various hedging and natural matching strategies, we mitigate exposures to input cost, interest rate and currency rate volatility. We also often seek to reduce inherent business risk by expanding activities within non-cyclical end markets and with blue chip customers, typically under long-term contractual agreements, as strong and expanding market positions in these areas are highly coveted and by themselves serve to mitigate risk.

Conclusion: While we never bank on multiple expansion as a premise upon which to make an investment, we do devote significant effort towards building great businesses that will ultimately be worthy of a higher valuation than we paid – because the returns enhancement and risk mitigation benefits of doing so allow us the opportunity to exceed the business case upon which an investment was premised.

What’s Next: The right and wrong way to approach determining the value of a business will be the subject of our next blog.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.

The Importance of Good Governance

The Importance of Good Governance and Why We Require Control in our Investments
When Carpedia Capital considers investment opportunities, we always frame the potential for returns against the magnitude of risk (recall our definition of risk as the likelihood actual realized returns are lower than those required over a reasonable time period and the potential for permanent loss of capital) we are taking to ensure this relationship is appropriately balanced.

In our opinion, the primary determinant of investment risk in private equity deals is how “good” the business is today and how likely it is to become exceptional during our holding period than it is likely to become the converse. Consequently, we spend the bulk of our time assessing businesses against these two criteria when deciding which companies to seriously pursue. After making the investment, our attention hones in upon the “how likely” qualifier to ensure our odds of success are “highly probable” as opposed to something less certain – with comprehensive governance being a key tool to ensure the likelihood of success remains in our favour.

Our Approach to Good Governance: Given that we provide our management teams with a great degree of autonomy and responsibility, it is essential to us, as owners, that we know our managers are making decisions (both small and big, on the front line as well as in the executive suite) through the same shareholder value framework they would if the owners directly oversaw day-to-day operations. Creating and sustaining this degree of partnership and alignment throughout the lifecycle of a private equity investment is a complex matter which evolves over time. It is, however, in our opinion, simplified and enhanced by having from an early stage the following comprehensive approach to governance to ensure a focused implementation of the company’s strategies to build an exceptional business that experiences sustained profit improvement:

Engaged Ownership: We are active, hands-on investors that have a passion for the businesses with which we partner. While we do not meddle in day-to-day operations, we are keenly interested and patiently observe to stay abreast of developments to ensure we have the context required to make considered decisions at key points – often on short notice. Our hard work and enthusiasm resonate with management and our willingness to contribute insightful analysis and commentary to issues makes us indispensable partners towards making the right decisions.
Alignment with Management: We spend a tremendous amount of time and effort sizing up those with which we partner to ensure they are cut from the same self-motivated, hard-working, humble-but-driven cloth which are we. For managers that have an ethos of doing only great work and which choose to work hard every day at building their business, we establish clearly communicated, transparently calculated reward systems to ensure they meaningfully share in the value creation over both the short and long term.
Clear Direction: Collaboratively with management, we set the agenda for the business’ future direction and define the areas of managerial focus and pacing necessary to achieve the required results. We are explicit in communication of our strategy and the requirements flowing therefrom.
Clear Expectations: Collaboratively with management, the Carpedia approach to operational excellence develops clear requirements for results, from the warehouse to production floor departments, sales, engineering and the executive suite – both operationally and financially. This establishes the baseline against which all departments and stakeholders can easily gauge ‘how we did’ relative to the requirements set by the strategy. We are explicit in communication of our expectations and requirements.
Tangible, Value-Added Tools: The Carpedia approach to operational excellence ensures that the processes, systems and behaviours of our partner businesses are optimized and that our management teams are empowered to produce improving results by utilizing the right information to make decisions. Actual results for each area are then measured versus requirements for hourly, daily, weekly, monthly, quarterly and annual periods.
Strong and Consistent Oversight: We regularly review actual results against requirements, understand the reasons for variance, the resulting action items necessary and persons responsible as well as the resources to be applied and time frame in which action will be taken. We follow-up on open action items in a structured manner until results meet requirements.
Outright Ownership Control: There is no substitute to the economic and legal right to set the agenda, define requirements and follow-up to ensure management is focused and effective.

Conclusion: Good governance is fundamentally about setting the business’ agenda, defining the requirements, clearly communicating these to management and following-up on progress and action. We have found that this approach results in the highest likelihood of success in building an exceptional business that experiences sustained profit improvement – thereby delivering the business case upon which the investment was premised. It is for these reasons that we choose to require control of the businesses in which we invest.

What’s Next: How we create value in ways other than through operational improvement will be the subject of our next blog.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.

Announcing Investment in G.W. Anglin Manufacturing Inc.

gwaGWA is a leading upfitter in Canada for large scale, high performance commercial fleets – particularly for the complex vehicles primarily utilized by large natural gas utility, electric utility and telecommunication customers. As one of Canada’s few vertically integrated commercial vehicle upfitters, GWA designs, manufactures and installs a majority of the product it integrates into vehicles – providing customers with turn-key work vehicle solutions. GWA is also a Tier 1 supplier of low volume, light metal fabrications incorporated primarily into heavy equipment vehicles and a Tier 2 supplier of low volume automotive parts. The President and CEO, Loris Boschin, will hold a sizable equity stake and continue to run the company.

To read more about this transaction, please review the Press Announcement and the article from the Globe & Mail.

pressrelease

For more information on this transaction please contact
Glen Ampleford at ampleford@carpediacapital.com or 416-364-8842.

Alignment to Achieve Sustainable Profit Improvement

Achieving Sustainable Profit Improvement: It’s About Alignment Not Creating Motivation

When Carpedia Capital considers investment opportunities, we always frame the potential for returns against the magnitude of risk (recall our definition of risk as the likelihood actual realized returns are lower than those required over a reasonable time period and the potential for permanent loss of capital) we are taking to ensure this relationship is appropriately balanced.

In our opinion, the primary determinant of investment risk in private equity deals is how “good” the business is today and how likely it is to become exceptional during our holding period than it is likely to become the converse. Consequently, we spend the bulk of our time assessing businesses against these two criteria when deciding which companies to seriously pursue – focusing extensively on ensuring our management partners are aligned with us to build an exceptional business that experiences sustained profit improvement.

Alignment to Achieve Sustainable Profit Improvement: As owners of businesses, we employ professional managers as our representatives to oversee operations on a day-to-day basis, execute the implementation of strategies and to generate ever-improving returns on capital for shareholders. Given that we provide our management teams with a great degree of autonomy and responsibility, it is essential to us, as owners, that we know our managers are making decisions (both small and big, on the front line as well as in the executive suite) through the same shareholder value framework they would if the owners directly oversaw day-to-day operations.

Creating and sustaining this degree of partnership and alignment throughout the lifecycle of a private equity investment is a complex matter which evolves over time. It is, however, in our opinion, simplified and enhanced by having or implementing the following from an early stage:

  • Open-Minded, Humble But Driven Managers that are Self-Motivated: A management team which is open-minded to a collaborative partnership that empowers and significantly rewards their success, while being humble but driven to improve are essential conditions to successfully build an exceptional business. Provided that the management team meets these basic requirements, we are cognizant that the most effective form of motivation to build an exceptional business is self-motivation. As such, we choose to partner with management teams which have an ethos of doing only great work and which choose to work hard every day at building their business – as these are attributes which match closely with the Carpedia organization’s own philosophy. We find that these individuals make this choice by virtue of being passionate about what they do and having the drive to be excellent at what they do right down to the details – the halo of which tends to rub off on those around them and attract other like-minded, enthusiastic and hard-working people to their organization – thereby creating the positive momentum essential to growing a business and driving positive change;
  • A Cash Investment Alongside of Us: There is no substitute for management putting actual dollars at risk from their personal account to invest on the same terms as we do – it focuses the mind and makes the transaction “real” for everyone involved. Therefore, we require a personally meaningful cash investment by each key manager that is large enough to make it permanently top-of-mind but not so outsized relative to individual net worth that its potential impairment could have you regularly sweating at night; and,
  • Results Oriented, Transparent and Equitable Compensation: A comprehensive rewards system that is focused on results, is transparent in its award and calculation and which is equitable across a range of scenarios is essential to achieving sustainable profit improvement. This rewards system meaningfully shares in value creation over the long-term (through ownership and options) and in the short-term (through cash-based incentive plans and dividends on shares owned). The rewards system includes special emphasis on integrating the achievement of results targets determined by the Carpedia operational improvement project and the terms of the investment transaction. While our approach to compensation ensures our managers are well compensated and that they feel taken care of, which we do so in spades, it is important to note that the type of people with which we look to partner do not need to be, and are not, coerced through compensation to get engaged – they already are – and, in our opinion, if we are trying to “motivate” management to get engaged using money then we have already failed as owners; that said, management universally likes to know that their efforts, merit and the company’s success appropriately rewards them commensurately for their hard work and the value they have created.

We have found that this approach, when matched with regular communication by the board regarding the potential value of management’s shares, options and incentive plans as determined through a transparent and clear framework (which allows the participants to directly observe how value evolves up and down with performance and how key factors over which they have control impact value) actually achieves the owners objective of causing management to think and act like owners themselves and reinforces their hard work to grow the business and its equity value – irrespective of whether these transparently determined estimates precisely capture the exact market value of the equity of the total business. We have also found that the ‘value’ placed by management upon their shareholdings and the motivational benefit of option and cash-based incentive plans decreases dramatically (almost to the point of being negligible) in the absence of clear communication and transparent calculation methodology; therefore, for the management team to ascribe value to it, and for the shareholders to actually benefit from what they are paying for in cash compensation and through dilution, the board must ensure value is transparent and well-communicated to those participating in the rewards and compensation programs.

We have also observed that the payment of regular distributions to shareholders, which fluctuate directly with the observable performance of the business, has a tremendous impact upon the perceived value of shares owned by management shareholders – particularly when management can influence the factors driving performance; the impact of initiating distributions is often an inflection point in management’s perceptions of the value as are changes in the direction of distribution growth, both upwards and downwards. As such, as part of our compensation philosophy to achieve alignment with management, we seek to pay distributions to shareholders as soon as is practical within the context of banking agreements and when it is value-added relative to available capital investment opportunities.

Conclusion: Creating alignment with management is essential to increase value and minimize risk. We believe this is best accomplished by partnering with self-motivated managers that share our philosophy, having them invest alongside us on similar terms and then providing them with transparent, results-driven compensation which rewards them commensurately for their hard work and the value they create. The combination of these three strategies aligns management to think and act like the owners they have become and rewards management for sustainably increasing profits as part of building a great business.

What’s Next: How we create value in ways other than through operational improvement will be the subject of our next blog.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.

Sustainable Profit Improvement

Sustainable Profit Improvement: Building Great Businesses
When Carpedia Capital considers investment opportunities, we always frame the potential for returns against the magnitude of risk (recall our definition of risk as the likelihood actual realized returns are lower than those required over a reasonable time period and the potential for permanent loss of capital) we are taking to ensure this relationship is appropriately balanced.

In our opinion, the primary determinant of investment risk in private equity deals is how “good” the business is today and how likely it is to become exceptional during our holding period than it is likely to become the converse. Consequently, we spend the bulk of our time assessing businesses against these two criteria when deciding which companies to seriously pursue.

But how do you know if a “good” business can become something more? While there are many theories and paradigms on this subject from all manner of authors and pundits, Carpedia International’s experience through 16 years consulting across more than 300 North American organizations through approximately 250,000 hours of real-time observations is that companies with the potential to sustainably close the gap between actual and potential profit performance – and thereby become exceptional businesses – share the following attributes:

  1. A management team which is open-minded to a collaborative partnership that empowers and significantly rewards their success, while being humble but driven to improve the business;
  2. Identifiable productivity improvement opportunities which can be achieved in a timely basis through tangible changes in processes, products, planning systems, and management’s behaviours, focus and discipline;
  3. A substantial backlog whose delivery can be accelerated as increased productivity expands the company’s available capacity to handle orders; and,
  4. A sales organization which can be invigorated to exploit the newly freed capacity and capitalize upon shorter lead times, improved quality and delivery to generate additional revenues and increase the company’s profit growth rate.

The presence of numerous of these attributes contributes to our ability to believe in the Company’s potential to sustainably improve their profitability.

The absence of any one of these attributes is a cautionary note requiring particular attention to understand, while the absence of two or more of these attributes is a red flag.

Conclusion: The degree to which a “good” business can become exceptional, as demonstrated by sustainable profit improvement beyond base levels, is strongly correlated with how favourable private equity investment returns prove to be and the actual degree of investment risk. Therefore, we focus our investing efforts on fundamentally strong businesses which can achieve sustainable profit improvement through the Carpedia approach to building great businesses.

What’s Next: How we create alignment and incentive to achieve the goal of sustainable profit improvement will be the subject of our next blog.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.

Fundamentally Strong Businesses

Fundamentally Strong Businesses: How do you know one when you see one?
When Carpedia Capital considers investment opportunities, we always frame the potential for returns against the magnitude of risk (recall our definition of risk as the likelihood actual realized returns are lower than those required over a reasonable time period and the potential for permanent loss of capital) we are taking to ensure this relationship is appropriately balanced.

In our opinion, the primary determinant of investment risk in private equity deals is how “good” the business is today and how likely it is to become great during our holding period than it is likely to become the converse. Consequently, we spend the bulk of our time assessing businesses against these two criteria when deciding which companies to seriously pursue.

But what exactly is a “good” business and how would you know one if you saw one? While beauty is often in the eye of the beholder, we pay particular attention to the following attributes in gauging whether a business is fundamentally strong:

  1. Growing or stable in terms of end market demand, market share thereof, brand presence, customer loyalty, basis of competitive advantage, rate of change in products or services;
  2. Diverse in terms of customer base and geography; and,
  3. Consistent in terms of historical profit margins, low capital expenditures, growth in unit volumes, pricing, revenues and profits, ability to innovate new products and services.

The presence of numerous of these attributes contributes to our ability to believe in the sustainability of the Company’s base level of profitability through good times and tough times, and the likelihood that the base level of profitability will actually be sustainable.

The absence of any one of these attributes is a cautionary note requiring particular attention to understand, while the absence of two or more of these attributes is a red flag.

Similarly, there are several attributes which indicate to us that a business may not be fundamentally strong:

  1. Converse of the above factors, no raison d’etre, fads and things that seem too good to be true or are dependent upon government subsidy;
  2. Long sales cycles with low unit volumes;
  3. Strong labour unions with restrictive labour policies and or poor labour relations;
  4. Significant input cost risk, supplier dependency, inability to pass through raw material cost volatility or asymmetrical exposure to adverse C$/US$ exchange rate fluctuations; and,
  5. Displacement within end markets by new competitors, particularly offshore competition.

The presence of any one of these attributes is a cautionary note requiring particular attention to understand, while the presence of two or more of these attributes is a red flag.

Conclusion: The degree to which a business is “good” is strongly correlated with how favourable private equity investment returns prove to be and the actual degree of investment risk. Therefore, we focus our investing efforts on fundamentally strong businesses and eschew those which do not meet our preconditions.

What’s Next: How we assess the likelihood that a “good” business can become great during our holding period will be the subject of our next blog.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.

Investment Risk (Part 3/3): How We Mitigate Risk

Investment Risk (Part 3 of 3): Actual Versus Perceived Risk and How Risk Can Be Mitigated Over Time

When CarpediaCapital considers investment opportunities, we always frame the potential for returns against the magnitude of risk we are taking to ensure this relationship is appropriately balanced.

To describe our view of this concept and means of implementing it in our investment decision making, we are writing a three-part series on investment risk. The first part discusses our view of what risk is and how much of it to take, the second describes how we take risk and the third discusses the difference between perceived and actual risk and how we mitigate risk.

Below is the third part to our series on investment risk:

Actual versus perceived risk: All investments have some degree of risk associated with owning the asset, and it is the amount of such perceived risk a the time the investment decision is made that drives the returns expected by investors and therefore the price they are willing to pay for the asset. However, Carpedia Capital believes that the actual risk of an asset, as time passes, is not always equal to the risk perceived by investors at the time an investment is made. We have observed that this disconnect in markets, which is frequently the result of asymmetrical information amongst investors, creates opportunities to acquire attractive assets at prices not reflective of their true risk. Therefore, those with a unique understanding of the history, context and potential for accretive change of a business or investment are much better positioned to gauge its true risk and to act with certainty (or know not to act) when opportunity arises.

Can actual risk be mitigated? We believe the most effective means, over a period of time, of mitigating the actual risk of an investment is to ensure it (e.g. a business) is performing better when you want to exit than it was when you entered. In our experience, the most consistently strong performing investors, especially in private equity, are those able to repeat-ably deliver improvements above and beyond the trend in baseline results, typically through strong and proactive involvement to sustainably improve operational, and therefore financial, results. A proprietary view on the opportunity for such accretive change, above the baseline trend, and being able to actually implement such change is critically important to successfully mitigating risk (and therefore generating favourable returns).

Conclusion: Carpedia Capital’s investing strategy focuses on optimizing how we take actual risk – by emphasizing opportunities where, by virtue of our background we have unique expertise or are able to identify companies most likely to benefit from the Carpedia approach to building better businesses – in order to ensure a high likelihood that the actual risk of an investment can be mitigated over time from that perceived at inception. We believe this investing approach is most likely to generate consistently favourable returns relative to the risk we take when making investments.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.