Private equity buyouts can be bad, ugly or good

When Gene Smith, supervisor at Riverside Millwork (known as Rivco) for the past 30 years, first met the new managers from Boston area private equity firm JMC Venture Partners, which last winter took over the troubled Penacook firm, he was told they wouldn’t have much trouble turning the company around.

“You just have a little problem, but it’s like a dog with a lot of fleas,” he told Smith.

“Does he mean Rivco is the dog, and we, the workers, are the fleas?” Smith asked himself.

Whatever they meant, Rivco shed about 100 workers during the last few months of the year, closed down its manufacturing plant around Christmas, was set to auction off its equipment on Valentine’s Day, and now primarily distributes other companies’ products through a Nashua showroom under the name New England Millworks and Kitchens.

At 59, Smith is hoping to find other employment, and so are his fellow workers. Smith figures JMC wanted to make a “killing” by using Rivco’s customer base without the headache of carrying all those workers.

“We are just expendable,” he said.

The Rivco buyout follows on the heels of another private equity disaster, the bankruptcy and sudden layoffs of some 122 workers at Customized Structures Inc. in Claremont, also right before Christmas, after it was acquired by another Massachusetts equity firm, Watermill Ventures. The shutdown led the state attorney general to go to court in order to win severance pay for the workers.

Joe Landers, one of the former owners of the firm who sold the company to Watermill, said that the Massachusetts firm “didn’t have that personal closeness with the company’s history and customers. They were trying to manage it from afar without understanding the personality of the company.”

What happened to Rivco and CSI reinforce the worst image of private equity companies: that they are remote from their workers, don’t have a full understanding of the business they are buying, and are perfectly willing to strip a company and fire workers in order to “turn around” the firm or sell it off for a quick buck.

Small is better?

But for every Rivco and CSI there are companies like:

•Burgon Tool Steel, a Portsmouth tool and die firm purchased in 2006 by Boston-based Seacoast Capital, which grew 16 percent last year and has increased its workforce from 38 to 70 employees.

•Infusion Solutions Inc., a Bedford firm that specializes in home delivery of intravenous medications and other medical services in the home, which was sold last March to Critical Homecare Solutions, a Pennsylvania firm that has consolidated similar businesses and has announced its intention to file an initial public offering of common stock.

Whether good or bad, private equity buyouts are a growing economic force. Last year, for instance, transactions totaled $406 billion nationally, according to an estimate by Thomson Financial, a consulting firm. Private equity firms have more than twice that much to invest, according to Private Equity Intelligence, which covers the industry — and that number should more than double in the next five to seven years.

Much of that capital went into the buyout of large public companies, most notably the purchase last year of automaker Chrysler by Cerberus Capital Management, for $7.4 billion.

While the number of such large, high-profile public buyouts has diminished of late, thanks to the capital crunch, smaller buyouts of private companies – the most common transactions to begin with — have been holding relatively steady, and may even be increasing.

The reason is that mid-size firms may have more difficulty obtaining more traditional bank financing, but the other explanation may be generational, surmises John Hamilton, managing director of Concord-based investment fund Vested for Growth. Baby boomers, who started their businesses in the late 1980s, are ready to retire, and not everybody has a son or daughter who is willing to take over the business.

The question is whether these buyouts do more good then harm, and it is a question that’s almost impossible to quantify, since such buyouts are, well, private.

One recent large-scale study of 22,000 buyouts over a 27-year period showed that for the first few years after the buyout, firms average 7 percent fewer jobs than similar firms examined. But after that, there was no difference.

Private equity firms tend to hold on to their companies longer than originally thought. Almost 60 percent kept them for five years, and that duration has increased over the last few years. Finally, the bankruptcy rate of firms bought out by private equity firms tends to be slightly less than firms as a whole.

But such aggregate statistics could be misleading, as the numbers from larger leveraged buyouts could tend to swamp what is happening with smaller buyouts, such as those in New Hampshire.

On the other hand, anecdotes, like the ones you will read below, also can be misleading. Those buyouts that make the newspapers are usually more likely to be troubled, whereas those alluded to by those in the industry will tend to be success stories.

There also are many different types of private buyouts. Firms that are troubled in the first place are more likely to end up in trouble, while those that are healthy in the first place tend to continue to grow.

Failure and success

Rivco was definitely troubled in the first place. Rivco, which was founded 45 years ago, had already been sold off by its original founders some two decades ago. In 2005, a management company sold Rivco to a group of employees, which in turn, sold it to JMC.

JMC didn’t return phone calls but, according to its Web site, it invests anywhere from $500,000 to $3 million on industrial manufacturers with sales between $5 million and $50 million.

“We invest in companies that are producing strong and predictable cash flows and are mid to latter stages,” according to the site. JMC also tends to stick to companies in the Northeast because “it allows us to be a hands-on strategic partner to our portfolio companies.”

Smith, the former supervisor, said he knew that Rivco was in trouble, with some $3 million in outstanding debt before JMC came in. According to Smith, officials from JMC said that it had turned companies around, and that the workers needed to “keep up the good work and produce as much as we can.”

But something wasn’t right. The company kept on running out of inventory, and was shifting into distribution of other products rather than producing its own. Managers were laid off and replaced with people from JMC, Smith said

“They didn’t display knowledge of production, and they didn’t take time to look at the mill,” Smith said.

Private equity firms also can have success with troubled firms. Foss Manufacturing, for, instance was picked up at bankruptcy sale in 2006 for $39 million by Alinian Capital Group LLC, a private equity firm based in Fort Lauderdale, Fla.

In this case, it wasn’t the equity firm, but Stephen Foss, the former CEO, who was charged by creditors with looting the company while it was insolvent. The outside firm wound up adding workers during the first months after its acquisition, and it has since developed a germ-resistant fabric for the medical market. Before that, Foss had primarily been marketing to the troubled automobile industry.

‘Lost touch with CSI’

It isn’t only troubled companies that fail under private equity.

When Joe Landers and his partner sold Customized Structures to Watermill Ventures in 2003 for an undisclosed sum, the modular home business was booming.

“It was the best year the company had,” he said.

Landers, who co-founded the company, knew that the industry was cyclical and knew it was a good time to get out. But, he said, he never really got that across to the new owners, even while he continued on as president for the next two years.

While both shared a vision for growth, neither he nor his partner were willing to invest additional capital.

“I don’t think they fully analyzed the risk,” said Landers. “The reason we survived this business was that we were so damn conservative.”

The company expanded and bought a facility three times its then-current size and then sold it at a quick profit, Landers said, locking itself into a costly lease-back arrangement.

“Although I was still the CEO, it wasn’t my decision,” said Landers. “I didn’t oppose it. I just advocated caution.”

Landers stepped down, staying on longer than he intended. At the same time, the partner at the firm that the company dealt with – and who most understood the business – left, and the company “lost touch with CSI,” according to Landers.

The inevitable downturn in the housing market came with unexpected fury. Watermill, said Landers, knew the company was in trouble, but was hoping to unload it, and kept the situation from its workers.

“I understand what they were trying to do,” said Landers. “They didn’t want to jeopardize their chances.”

As at was, the company closed its doors before Christmas, giving no notice to its workers.

Would the company have survived if it had been sold?

“I have no idea,” said Landers. “But I would have handled it differently. It’s different when the people working day-to-day are owners — and they weren’t.”

Does Landers have any regrets?

“I ask myself that every day now,” he said. “My wife, she’s happy that I got out. She has seen the ups and downs over the years,” he said.

‘Fair for everybody’

“I heard all the stories about private equity too,” said J. Patrick Dulany, former chief operating officer and founding partner of Infusion Solutions.

Dulany and his partners had built up a successful home medical model and grew it to a staff of 50 employees. As hospital and medical costs grew, so did the company. Ironically, that was one of the reasons the Dulany and his partners decided to sell the company. It was getting too expensive for a small company to offer health coverage to their workers.

Still, they never thought of selling the business until Critical Home Care Solutions Inc., a firm based near Philadelphia, offered to buy it.

Robert Cucuel was leading a private equity group that was cobbling together numerous similar firms that have been springing up around the country. Cucuel, betting on the national move to more expanded coverage, is now taking public a home health services firm that covers the entire eastern part of the nation.

Dulany won’t get a piece of the IPO action. He accepted an undisclosed amount of cash for the company last March, but “it was fair for everybody. We are pleased. It was very difficult for me, because this is the first time personally that I wasn’t working. But it has been wonderful for everybody. They have been fair and honest with the workers, and they have grown, they haven’t laid off. “

Using private equity to consolidate existing business is one result of a private equity buyout. Another is for an entrepreneur to use a private equity firm to set himself up as CEO of another company.

David Hughes had run companies before and learned from a business associate that Eric Burgon, who had inherited Burgon Tool Steel from his father, was looking to expand it, and wanted additional capital. So Hughes offered to supply the management and some of the capital, and went shopping on weekends and evenings for a private equity firm to get the rest. He eventually settled on Seacoast Capital, because it was small, local, understood the business and saw eye-to-eye on the objectives. Burgon remains the president, while Hughes is the CEO.

The company, located at Pease International Tradeport, grew slowly at first, but in 2007 its sales increased by 16 percent. It also purchased a 20,000-square-foot distribution center in Nashville, Tenn., and on Jan. 17 announced that it was acquiring Kloster Steel Corp., a similar company in Chicago, to serve the Midwest.

Because of the expansion, Hughes expects the company will grow by 25 percent this year.

Hughes also was aware of private equity stories, and some of them were true. And although he is the CEO and a substantial shareholder, Seacoast Capital, which owns the majority of the stock, controls the company, not him.

“You have to be very careful about picking your partner, just like any other business partner,” Hughes said.

“Private equity gets a bad rap,” said Tom Gorman, managing director of Seacoast Capital. “And sometimes they deserve it. But most of the time, it works out, for the manager and employees, the customers and the investors.”