ValueStreet vs. Traditional Private Equity Firms in San Diego

    Jim Moran

    The private equity industry is vast. Although the media (for better or worse) tends to lump all of private equity into one basket, the truth is that firms vary greatly in size and strategy. In this article I’ll discuss some of the ways private equity firms differ, and in particular, how our small San Diego private equity firm – ValueStreet – operates relative to other firms in our industry.  This is not meant to be a comprehensive evaluation, but rather a high-level analysis of the things to consider if you’re selling a small business or taking investment from us or anyone else.

    Difference #1 – Fund Timelines

    The vast majority of private equity firms’ funds – nearly all, in fact – operate with ‘fund timelines’. These timelines are like calendars detailing when the fund will raise money, when it will invest its funds, and when the investments will be exited (sold). The typical private equity firm fund timeline is 5-7 years, meaning the fund typically has about 5 years from the moment of investment to create value in the business and sell the asset to another buyer.

    ValueStreet is one of the few private equity firms in San Diego that operates without any timeline. We’re able to operate this way because we are financially independent, and because we approach each investment expecting to own the company forever. To our knowledge, we are the only private equity firm in San Diego operating this way, and one of a select few across the country.

    Difference #2 – ‘Skin in the Game’

    Would you trust somebody to care for your business as much as you do if they didn’t share any of your risk? We wouldn’t either, but that’s exactly how most private equity firm funds are structured. In most cases, the GP (the manager of the private equity firm fund) only invests a few percentage points of the fund’s total capital, meaning that the managers you’re meeting have very little risk of loss if things go poorly. Some of private equity’s horror stories can be traced back to this strange lack of alignment.

    At ValueStreet, our small business private equity firm doesn’t suffer from these issues. Our managers are our largest shareholders, and it is likely to stay that way for the foreseeable future. This means that the people you’re negotiating with – and working to grow the business alongside – are the same people writing the check, and we wouldn’t want it any other way. We don’t think we would be very good partners to our companies if we shared only their hopes, rather than both their hopes and fears.

    Difference #3 – Management Incentives

    Depending on what you’re looking for from a small business investor the incentives being provided to a private equity firm’s managers could be the most important thing to understand in your evaluation of a partner. Why? Because most private equity firm managers are incentivized to ‘package and sell’ their portfolio companies for top dollar within a certain period of time (the fund ‘timeline’ as discussed earlier). It is only upon this sale that the majority of fees are delivered to the management team, often in the form of ‘carried interest’, a tax-friendly form of income that has made some private equity firm managers among the world’s richest.

    Here at ValueStreet, our San Diego private equity firm is more interested in long-term cash flows than short term sales. Since we’re primarily managing our own money, and since we have no desire to sell our companies, carried interest isn’t something we’ve ever thought about much. Rather, as a small business private equity firm we seek to re-invest as much money as prudently possible into our portfolio companies’ growth to increase the long-term trajectory of our investments. When growth isn’t available and our companies have excess cash, we receive distributions or dividends from the business the same way you do and pay normal tax rates on our income.

    Difference #4 – Let’s Talk Leverage

    Debt is a controversial topic in the private equity world, and for good reason. Too much debt can make a company vulnerable, increasing its odds of bankruptcy. Indeed, some of the media’s most vilified private equity transactions in recent memory – including the story of Toys ‘R Us and others – were accused of abusing debt markets to enrich investors at the expense of the stability of the business. The flip side to debt – and the reason debt is so often used in private equity – is that it increases fund returns. Thus, the majority of private equity firms use multiple ‘tranches’ of debt to maximize the returns on their funds (and collect more of that carried interest).

    Our small business private equity firm has yet to use any meaningful debt in a transaction. Although we recognize its utility, we simply haven’t needed it to produce the kinds of returns and outcomes that we desire. While the day may come where debt makes more sense for us, for now we’re enjoying sleeping soundly at night knowing that our investments won’t be exposed if our businesses hit an inevitable rough patch.

    Difference #5 – Local-First Private Equity Firm in San Diego County

    While operating locally isn’t a luxury of larger private equity firms (because there just aren’t enough big businesses for them to invest in), it’s one of our favorite aspects of being a small business private equity firm. This month, we expect to close our second small business acquisition of 2020 right here in the City of San Diego, and we couldn’t be happier about it. We know there will be more opportunities to expand our portfolio and provide more jobs in the city and region.

    The List Goes On

    The way we do things at our private equity firm in San Diego certainly isn’t for everyone, and most traditional private equity firms are run by ethical people and produce good outcomes for company operators. Still, we like managing our small private equity firm in San Diego and wouldn’t change the way we do business for anything or anyone. If you’re interested in talking about a business or learning more about how we operate, please drop us a line. We’d love to chat.