Locally owned and operated businesses are a unique asset to West Michigan’s economy, but that dynamic is changing as more owners opt to sell to private equity firms that have increasingly targeted the region for deals.
Many locally operated businesses in the region have 100 or fewer employees, yet they still provide 65 percent of jobs and an estimated $25.8 billion in output in the region, according to The Right Place Inc. The recent “erosion” of local ownership is an issue the organization plans to focus on in the coming years, according to The Right Place President and CEO Birgit Klohs.
“We have become a hotbed for the PE industry,” Klohs said during the organization’s annual economic outlook last month. “It changes the makeup of our community to some degree.”
Private equity firms have capital to spend, and they’re attracted to the region by fiscally conservative, well-managed companies in their target markets, especially in manufacturing. This shift in ownership from local individuals to private equity funds has the potential to affect the longevity of the company within the region and changes conversations surrounding retention and expansion, according to Klohs. Next month when The Right Place plans to introduce a new three-year strategic plan, it expects to include preserving local ownership as one of its main pillars.
“I have no doubt that if we identify a problem in this community, we will figure out how to tackle it, because that is what we do,” Klohs said, adding that the plan will take a “serious look” at how to stimulate local buyers.
One of the main drivers of the issue is that many of the local owners who are selling their businesses are Baby Boomers who do not have a succession plan in place but are ready to retire.
“You can’t keep someone from selling a business if there is nobody to run it,” Klohs said.
That’s resulted in a rush of West Michigan companies hitting the market at a time when private equity firms from large metro areas are starting to look down market, according to Eric Seifert, principal of Muskegon-based Left Coast Capital Resources LLC.
“The PE groups have raised a lot of money in the last several years and now they need to deploy it, so they’re really beating the bush to find deals,” Seifert told MiBiz.
Private equity firms generally receive a return on their investments through a recapitalization or flipping the company in another sale, which can have a “bad effect” on local employees and communities, according to Seifert.
“In the private equity companies, they have to really scrimp down on expenses,” he said. “While all firms would probably benefit from becoming more efficient, a lot of times the private equity group is so leveraged and has such high debt, it has to make a lot of cuts and sell assets to make payments.”
Experts also worry about the fate of highly leveraged private equity-backed companies when the next downturn hits.
“We’re going to see some failures with the private equity deals because they use so much debt in the acquisition that they have to come up with funds to service that debt,” Seifert said. “If the revenues aren’t rising and the profits aren’t rising, they’ve got to figure out what to do.”
Seifert pointed to one example of an unnamed company in Grand Haven that was founded by a local owner and operator about 30 years ago and then was sold to an out-of-state private equity firm.
“The private equity group wanted to build the bottom line profits so then they could flip it again, and they have indeed since flipped it maybe six months ago,” he said. “Now, the new private equity people are in there trying to crimp down expenses even more, which is tearing at the fabric of the company.”
The company also divested from all civic engagement and local philanthropic activity, according to Seifert.
That’s a common theme among transactions involving local companies and outside capital, according to Joy Gaasch, president of the Chamber of Commerce for Grand Haven, Spring Lake, and Ferrysburg.
“In a number of cases, (when) you lose local ownership, you lose that individual that lives here in the community, supports philanthropy, and encourages people to volunteer and give back to the community,” Gaasch told MiBiz. “Some private equity firms will continue that, but many don’t.”
Finding an upside
Even when ownership transfers to an out-of-state private equity firm that decides to maintain membership in the local chamber of commerce or continue with charitable workplace campaigns, they often peter out within a couple of years, according to Gaasch. Oftentimes, the practice coincides with the final departure of local management.
“In a number of cases, the folks that were there when the firm was purchased were kept on for two to three years and then they were moved on,” she said.
Then, the company may be ready to be sold again and enter a cycle of changing hands, which poses a “challenge” for those trying to keep the local ties in place, Gaasch said.
However, one “upside” is that private equity firms usually continue to provide local employment and support the manufacturing base of the community, she added. While they may not give back in the same ways or at the same level, employees of the affected companies will continue to buy local services and contribute to the local economy.
According to the Washington, D.C.-based American Investment Council, private equity-backed companies employ 242,000 people in Michigan, while private equity firms have invested $69.69 billion in in-state businesses from 2013 to 2018.
Some 653 private equity-backed companies operated in Michigan during the same period, according to data from the American Investment Council, an advocacy group for the private equity sector.
“It is what it is, and you figure out how to deal with it,” Gaasch said of private equity-backed companies in West Michigan. “We’re just glad that people are employed.”
For their part, local private equity execs say the industry stereotype often doesn’t live up to reality.
Case in point: Grand Rapids-based Auxo Investment Partners has been able to leverage its local connections in multiple recent deals, according to co-founder and Managing Partner Jeff Helminski. In one example, the firm closed on a deal for Warren-based manufacturer Prestige Stamping Inc. even though it was not the highest financial bidder by impressing on the family owners that they care about legacy and culture.
“The family that owned it and had founded it have multiple generations of family in the company and they care deeply about their employees and about the legacy of that business,” Helminski said. “Even though they had higher financial offers from strategic buyers and other bigger private equity firms than Auxo, they felt like we were the right fit.”
It was a “unique” transaction, Helminski said, noting the parties focused on collaborating to come up with a deal that would be good for the business as well as the community and the people it supported.
“That was a very interesting and enjoyable process to go through because we had picked each other in this process and then determined to figure out how to get a deal done that we could all feel great about,” Helminski said.