Inside Wealth

In Private Equity, Seeking to Profit From Small-Time Deals

Paul Sullivan, The New York Times
Source: Menaji

Private equity investing is getting a lot of attention this presidential season. Now that Mitt Romney, whose fortune came from his private equity work at Bain Capital, is set to accept the Republican presidential nomination next week in Tampa, Fla., the industry will certainly spend the fall in the spotlight.

But what Mr. Romney did at Bain was on a grand scale. There is another variety of private equity investors gaining ground. Call them the do-it-yourself Romneys. Driven by low returns on public investments and a desire to have a direct say in how the investment performs, these people are stepping in to find, invest in and ultimately profit from small-time private equity deals.

Far removed from the glamour of Bain, this do-it-yourself band is driven by the same belief: that professional managers can take an entrepreneur’s idea and turn it into something much bigger. The difference is that their past experience may not be relevant to running a company.

I was interested in finding out more about what people expected going into these small deals — but also what they encountered once they were running someone else’s company with their money at stake.

So I was receptive when, on the commuter train home a few months ago, James A. Fisher started questioning me about the shaving cream I had in a bag on my lap. He and his wife, Pamela Viglielmo, along with a former banking colleague, Eric Groberg, had made an investment in a men’s grooming and cosmetics company, called Menaji, in 2010 and had been running it with the founder. Mr. Fisher said he had also made another investment in an expert witness company, ExpertiCas.

I set up a time to hear more. Mr. Fisher and Mr. Groberg had worked together at JPMorgan Chase, and later at a small asset management firm, before going off on their own in 2008. Ms. Viglielmo had been a consultant to the beauty industry since 1993. Their goal was to find companies to which they could add value.

When an intermediary told them about Menaji, Ms. Viglielmo said they thought the timing was right for men’s cosmetics. The taboos about men’s wearing makeup — known as color in the industry — were fading, she said. “You have older guys in the workplace and men dating at different ages,” she said. “These products are needed.”

To me, the bigger question was, What do a beauty consultant and two finance guys who spent most of their careers at a large firm know about running a company? I wanted to test their assumptions with more seasoned advisers while also identifying the common mistakes that such D.I.Y. private equity teams make.

SELECTING THE INVESTMENT Before investing in Menaji, Mr. Fisher said, the team spent almost a year doing due diligence. That was on top of the nearly two years the group had spent looking for a company in which to invest.

“We resisted the temptation to move quickly or else we would lose the opportunity,” he said. “We needed time to perform thorough due diligence and develop a comprehensive plan.”

When they were comfortable, the group put up 75 percent of the investment, with the other 25 percent coming from seven other investors. (They declined to disclose the amount.) They also took out a loan from the Bank of Fairfield, a community bank, after many others, including Chase, passed. To secure the loan, the group had to sign personal guarantees, further tying their financial futures to this investment.

Not all that money went into expanding the business. Michele Probst, who started Menaji in Nashville, said her ex-husband had been crucial in helping her run the company from its founding in 1999 to their divorce in 2006, so some of the investment went to buying him out.

But even if that had not been a consideration, she said, her business was growing and she knew she needed help. “Chemistry was important,” she said. “I went through four or five frogs before I kissed this prince.”

John P. Rompon, managing partner at McNally Capital, which advises very wealthy families on private equity, said the group was right to take its time and gather as much information as possible before investing.

“Whether it’s a family or a couple of guys pooling their capital, that kind of entrepreneur starts out at a disadvantage because they lack the resources of a big firm,” he said. “This isn’t inherently a bad thing. It just complicates things.”

The mistake that smaller investors make, he said, is to rush into a deal or to lack awareness of their limitations.

Michael Tiedemann, chief investment officer of Tiedemann Wealth Management, said he tried to dissuade clients from small-time private equity with two questions: Who brought you the deal, and why are they bringing it to you?

“You don’t want to offend the client’s judgment,” he said. “But those two questions reveal so much. You can minimize a lot of the risk in that exercise.”

MANAGING THE COMPANY Once an investment is made, the hard part starts: running the company. Mr. Fisher and Mr. Groberg said they did not know much about the cosmetics industry, so their plan was always to focus on the financial side.

This was more about Michele and Pamela and an industry they have a lot of experience in,” Mr. Fisher said of his team. “In putting together a portfolio of small businesses, it was never that we’d learn the industry. It was that we’d find people that we could back.”

Some advisers think this approach is fine. Alan M. Harter, managing director of Pactolus Private Wealth Management, said his firm was putting together private equity deals in many industries, with one or two families leading each.

He recently put two real estate families together to lead a $140 million deal that has 12 other silent investors.

An advantage to doing this is eliminating that extra layer of the traditional private equity fund. “The cons are you have to be very aware of the people you’re doing it with,” he said. “One bad egg could cause you a lot of problems.”

Other advisers say that not focusing on one industry limits the quality of deals that will come your way and means you will never acquire any independent expertise.

“The worst-kept secret in private equity is it’s a game of execution, not strategy,” Mr. Rompon said. “There has to be a subsector you focus on so you can develop some expertise and understanding.”

Either way, the group has realized that managing Menaji is a serious time commitment with no immediate payoff. While Ms. Probst receives a salary and commission on sales, the investors have not paid themselves any distributions or received any compensation for the time they have put in.

MAKING MONEY All private equity investments are done for a return. The questions are always how big and when.

The three main investors in Menaji and Ms. Probst say they are focused on an eventual sale. Mr. Groberg said they would like to increase the company’s sales 10 to 20 times before finding a buyer. He would not say what sales are now.

This could take some time. Menaji sells its products in a few stores, but most of its sales come from online outlets.

Mr. Tiedemann said the most important thing for investors in a small private equity deal is a plan to get their money out. “As you’re trying to do the competitive market analysis, you really need to ask yourself, ‘Who’s the exit to?’ ” he said. “Is this a cash flow business or can you sell it to someone? If so, who?”

Most private equity funds have a set time horizon. That is what Mr. Harter has built into the deals he is putting together. But on the smaller scale, the Menaji group has more freedom: they are the majority owners, so they alone will determine when and if they want to sell Menaji.

For now, they are showing no regrets. “As former bankers, we understand there can be risks beyond our control,” Mr. Groberg said. “Two years into it, we remain very confident that our initial investment thesis will prevail.”