Despite Advantages, Family Offices Won’t Put Us Out of Business

By Rob McCreary

The Wall Street Journal recently focused on the rise of family offices as significant disrupters of the private equity model. In an interesting article by Anupreeta Das and Juliet Chung entitled “New Force on Wall Street: The Family Office” the authors confirm a trend we have been seeing for the last 10 years. Increasingly, wealthy families are collaborating for advantage. That advantage may be direct investments where fees and carried interest are side stepped completely or it may take a form of uncompensated side car investments where the important family uses its networks, wealth and access to assist private equity sponsors. In return for the extra help, these families are often allowed to invest in “friends and family” vehicles or directly into a specific portfolio company without paying management fees or carried interest. As Ms. Das and Chung observed:

“Wealthy families have always found ways to protect and build their money, and the savvier among them have pursued their own business deals, from acquiring farmland to seeding hedge funds to buying companies. Today their ranks are ballooning, and many, put off by the high fees and sometimes weak performances of Wall Street money managers, are shifting to investments they can pursue directly through family offices.”

In October 2014 I wrote a blog entitled “Family Offices Are a Protected Species” about another advantage a family office has; exemption from SEC registration.  As you may recall Dodd Frank requires private equity firms and hedge funds with more than $150 million under management to register with the SEC. This almost always triggers an audit where manager compensation, cybersecurity, valuation of portfolio companies, record keeping practices, governance and self-dealing are scrutinized. The same registration burden, however, does not apply to family offices with a common ancestor even if they hire internal managers who are paid performance compensation. As long as the managers do not own and control the fund they are managing, they can be incented with performance compensation. I guess the logic is that a single investor family office is sophisticated enough to fend for itself and, more importantly, no ERISA governed assets are at risk.

The scale of these disrupters is what caught my attention.  According to the authors, the family assets rival the managed wealth within the entire PE asset class:

“Research shows family offices hold assets of more than $4 trillion. That approaches the cumulative $5.7 trillion of private-equity firms and hedge funds, as estimated by data provider Preqin, though there is overlap because family offices sometimes invest in private-equity and hedge funds.”

Secrecy May Be the Biggest Advantage

The authors also note a big advantage family offices bring to the investment world – SECRECY. Many private or public company management teams do not want the world to know who owns them or if; in fact, there has been a change in ownership at all. In addition, we have seen that certain families like the Koch Brothers have become political targets for their activism. Secrecy about where they are investing removes one less possible objection. It also helps disguise investment themes or strategies. I have always believed that the Wizard of Omaha, Warren Buffet, often shares investment wisdom when he is conditioning the market. For example, he’s often quite bullish on investments like U.S. Air and Salomon Brothers while he is an owner but more whimsical once he has exited.

Family Offices Are Not a Real Threat

However, even with these advantages, the family office has yet to dominate private equity. There may be five big reasons:

  1. Taxation of carried interest
  2. Career path for younger employees
  3. Total compensation
  4. Lack of owner urgency
  5. Alignment for portfolio company managers and rollover owners

No Carry

On the first point it is typically hard to compensate family office managers with anything other than phantom equity because a good company may be owned for multiple generations. Without an exit to set value and create a capital transaction the inside manager may settle for the equivalent of stock appreciation rights. Typically, this phantom equity is treated as ordinary income.

Lateral Employment

On the second point, the family office will never provide the same lateral employment opportunity as a private equity firm in a city with a vibrant practice. For example, Cleveland has a robust PE community where the breakup of a PE firm can lead to multiple new entrants with opportunity to own their own management company, raise capital and recruit managers who are blocked at other firms. That entrepreneurial pull is strong.

Total Compensation

The third disadvantage is total compensation. If the family is supplying the capital, the managers may command a much smaller share of the upside.


The fourth disadvantage is urgency. In the PE model in order to raise successive funds you must demonstrate an ability to realize returns in all markets. This means deploying capital, growing companies and having successful exits in all markets. Many PE firms have proven they can repeat the formula over 50 years and as many as 9-10 funds. The family office already has uber wealth and often does not have to deploy capital for self-preservation.

No Second Bite

While a family office can offer immortality for a patriarchal business and continuing employment for loyal employees, it struggles to provide long term gain opportunities for management that has not had a “pay day” as well as owners who want a “second bite” of the apple. The alignment of managers and former owners is a powerful inducement as well as an important risk mitigant that you are buying a business that is running out of gas.

In short, I really don’t know any PE managers who would quit their job to work for a family office. Until that happens the private equity firms will win the recruitment war.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC
March 22, 2017

Rob McCrearyDespite Advantages, Family Offices Won’t Put Us Out of Business

$30 Trillion of Debt Doesn’t Worry Anyone

By Rob McCreary

Every year the US Government releases its Annual Report to its citizens. It is always interesting to see where we stand. Chart 4 below shows a 2016 balance sheet for the U.S. government. The assets are $3.4 trillion comprised mostly of student loans. The liabilities are $22.75 trillion comprised of two thirds federal debt (principal and accrued interest) and one third federal employee and veterans’ benefits. If I were Secretary of Treasury, Jacob Lew, I might have discounted that student loan asset inasmuch as most of that receivable is either in arrears or non-performing. I also wonder why the government does not treat Medicare, Medicaid and Social Security Benefits as a debt net of the corresponding trust fund asset. The explanation is that $5.5 trillion trust fund liabilities are off the “big balance sheet” because they are offset by assets on Agency balance sheets. I guess they wash which means that all these programs are fully funded?  In fact, agency debt is de facto guaranteed by the taxpayers.  So I don’t understand why they don’t just consolidate into the US balance sheet and round it up to $30 trillion?

When Will We See Profits from Operations

The U.S. Balance Sheet might be a little frightening but the trend line for receipts and disbursements should induce panic. The chart below is a little hard to interpret, but I can help. I have been looking at this report long enough that I actually get it now. The BLACK LINE is total receipts. The Color Bars add up to total non interest spending on categories like defense, Social Security, Medicare and Medicaid. The blue line is historical and projected total spending (which includes interest) from 1980 to 2090.  In a sleight of color, Mr. Lew shows the real problem in white hoping that it will be ignored.

Prior to the crash of 2008, receipts and non interest spending were pretty closely matched with a wonderful period prior to the dot com crash where receipts even exceeded total spending including interest! During the last 8 years receipts plunged and non interest spending hemorrhaged, Thank goodness we have the world’s reserve currency and were able to control interest costs. Of course, we see a projection that by 2020 we will be back in balance with no primary deficit.

If one of our managers gave us this kind of rosy projection, we might ask to see the historical trend line supporting that wonderful future and we might also ask what is the interest rate assumption underlying the growth in net interest expense.

 Look At the Net Operating Deficit

As shown below the government managers want us to believe they were on the right path for a believable turnaround until last year. The budget deficit fell from $1.089 trillion in 2012 to $438 billion in 2015. In 2016, however, the budget deficit spiked to $587 billion on the back of a 50% increase in net operating costs. In another interesting sleight of color, Mr. Lew portrays the budget deficit in red and the net operating deficit in white. In fact, the budgeting process for this management team is worthless and we as owners should just look at the net operating deficit. Our managers have overspent their income in every year since 2012 and they doubled the loss from 2015 to 2016. Since 2012 they have cumulative net operating losses of $4.45 trillion. So why would we believe anything in the projection from this management team about the future primary deficit and return to normalcy by 2020.

Interest Is Toxic

An even more important question is the cost of debt. Every year I look for the assumptions underlying the projected cost of capital and cannot find the assumption. This is a really important variable especially in a rising rate environment where the cost of funding accrued interest will keep rising. If we ever return to a 1980 environment where the cost of 10 year government debt was  close to 20%, our creditors will basically own America.

Why Don’t We Care?

When I talk to even the most sophisticated financial people about this debt trap I get a lot of eye rolling and yawns. It dawned on me that no one cares. Is it the law of large numbers? Is it a “kick the can down the road?” Is it confidence in our ability to reschedule the debt because the U.S. Dollar is the reserve currency? Is it because the politicians plan on swapping the Grand Canyon for Chinese debt? Or is it because we are all hooked on this heroin masquerading as legitimate finance? Maybe it is an intellectual recognition that $30 Trillion of debt is a problem – BUT NOT MY PROBLEM.

My finance teachers always taught there are only 3 things you can do with debt, default on it, render it worthless by printing money or hyper-inflating or rescheduling it. There is one thing for sure that distinguishes governments from its citizens, they will never pay it back!!!!

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

March 7, 2017

Rob McCreary$30 Trillion of Debt Doesn’t Worry Anyone

An Obituary for Democracy and Capitalism

By Rob McCreary

The Economist has an interesting journalistic twist. Several of its opinion columns like Schumpeter, Buttonwood and Bagehot are named for inflexion point economists, political theorists or iconic events. For example, Schumpeter is named for Joseph Schumpeter who published a 1942 best-seller called “Capitalism, Socialism and Democracy”. Mr. Schumpeter was not bullish on the capitalist model preferring the socialist model advocated by Karl Marx. He saw the end of capitalism coming when the intellectual class overpowered the “creative destruction” of entrepreneurs and capital risk takers. Buttonwood is a column that explores the dynamics of financial markets. It is named for the buttonwood tree on Wall Street where brokerage activity was once conducted. Bagehot is named for the man who was the editor of The Economist from 1861 to 1877 and it explores politics in Britain. In all three cases the reigning journalist is anonymous.

I normally don’t pay any attention to Schumpeter or Bagehot and often just surf through Buttonwood but the December 24, 2016 copy of The Economist drew me to the Schumpeter column because its anonymous author had announced he was delivering his last thoughts as Schumpeter.  He would be reincarnated as Bagehot in April. Figuring his last would be his best, I read with interest a pretty gloomy outlook for capitalism and democracy. The Economist must agree because they announced that “the Schumpeter column will return in 2017 with a new (and possibly more optimistic) author”. So here are the cliff notes in the form of excerpts from the column and the thesis for his sour outlook.

Schumpeter’s Doom Loop

  • “His biggest worry (the real Schumpeter) was that capitalism was producing its own gravediggers in the form of anti-capitalist intelligentsia. Today, that very elite, snug in Los Angeles canyons and University departments, has expanded… The liberal sort of academic (meaning the type that favors big government) far outnumbers the conservative kind by five to one according to one recent study.”
  • Government, regulations and big business are all growing and they force out entrepreneurs by creating “red tape” that favors incumbent big bureaucracies.
  • Business is now owned by institutions who hire safe managers “whose chief aim is to search for safe returns, not risky opportunities.”
  • Democracy is becoming more dysfunctional and endlessly content to allow governments to overspend their means.
  • Populism is ascendant “As economic stagnation breeds populism, so excessive regard for the popular will reinforce stagnation.”

I can find great examples of each of these elements that Schumpeter sees as creating a death spiral: “The result of this toxic brew is a wave of populism that is rapidly destroying the foundations of the post-war international order and producing a far more unstable world.” Without suggesting any remedy The Economist then signs off. “These comforting thoughts are the last this columnist will offer you as Schumpeter.”

Smart, Compelling, But Anonymous

This guy is pretty smart and maybe he should not retire to write about Brexit. He is right about the smug elites, big bureaucracies, safe managers, dysfunctional politics and Trumpeteers. They are indeed a toxic brew and Trump is proving badly matched to more polished opponents. The more he blusters and attacks the more he creates uncertainty and polarization. That leads to status quo. While it is exciting to think the populist agenda can rally change, the new regime is quickly discovering that kind of dramatic, entrepreneurial, and permanent reordering may be stymied by incumbents that will deflect and distract; as Peggy Noonan has recited in her weekly column on Friday February 17, 2016 “a government within the government that hates the elected government”.

The two forces that may be able to break the doom loop are external threats/war and unbridled prosperity. These forces rarely co-exist. The stock market is signaling great confidence in the latter while North Korea, Iran and Russia are tilting the answer towards the former. In any event I simply can’t respect a genius journalist like Schumpeter who anonymously describes the American future as a toilet bowl and then quits his janitorial job to report on an even larger looming vortex in Britain.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

February 23, 2017

Rob McCrearyAn Obituary for Democracy and Capitalism

Why Do You Want Your Fridge To Be Smart?

By Rob McCreary

In a nation of chronically obese and out of shape citizens why does anyone want a smart refrigerator? Based on my superficial and uneducated experience with other smart devices like cellphones, autos, iPads, computers, and Fitbits I have formed an opinion that smart devices are way too needy.

Take the iPhone; I get a notice every day that my phone cannot be backed up in the cloud because I don’t have enough storage room in the cloud. What does that mean? I have tons of excess capacity on my iPhone because I have never been any good at taking pictures and because transferring my music library is hard. I don’t have any videos on my phone either. This supposedly smart device is smart enough to know that if you send me Message #1 “You know your iPhone has not been backed up since 2011” I will freak out and sign up for cloud storage at the cost of $1.00 per month. The only reason I have not done that yet is because I also get Message #2 that says I can back up my phone by entering my password, locking the phone and having it tied to a power source after 10pm. This smart phone understands that I have been dutifully trying to back up my phone via Message #2 without success and that Message #1 ( a revenue producer for Apple) will finally get me to sign up for a cloud subscription.

It is pretty ironic that I have enough storage capacity on my iPhone to download the Library of Congress but no storage in my cloud. Speaking of my cloud, I guess every device will have its own cloud so I should expect a message soon from Subaru or Fitbit that I have not backed up my info on their cloud? Why would I want to save info about the times I was slacking at the gym or speeding in my car? Why do I want a smart device at all?

Get Ready For National Food Lockdown

This is certainly true for refrigerators. Why do you want your celery and carrots to have equal rights with ice cream and bagels? I can envision the optimal diet getting downloaded into my fridge and facing a denial of service because I have 3 bags of Arugula wilting in the crisper drawer when I have exceeded my daily dose of red meat for 8 months in a row. How about the fridge that takes your vital signs and BMI (body mass index) when you grab the handle? America would be on immediate food lock down as smart refrigerators across the nation sensed a six sigma event. Everyone’s BMI would be at least 6 standard deviations worse than the norm. Getting a smart device that has any influence over your daily intake of food would be horrible.

Even worse would be the smart wine cooler or a smart beer fridge. As my son-in-law admitted when I got him a 2 year gift subscription to Wine Spectator, “I am certainly better at consuming than spectating”. Your little secrets about daily consumption would certainly end up in the cloud where they would be hacked or, more likely, transported to your children who are monitoring your intake and plotting an intervention. Pretty soon your family physician would know that “two drinks a day” really means polishing off several cases of beer and a few bottle of wine each week.

Graduating To a Nest

Just imagine when your cloud is so full you need a “nest” so the internet of things enables your smart devices to all talk to each other in the cloud. The human profile that emerges would be so frightening you probably would go off the grid and never return. The car tells the cloud that you exceeded the speed limit all day while also exceeding the allowed decibel levels on your car speakers because you kept replaying AC/DC songs  which in turn alerts your wife, children and doctor that you are probably going deaf and have a “failure to launch” problem. The fridge gives everyone your vital signs and a chart showing wintertime consumption of Ben and Jerry’s Chubby Hubby. The Fitbit doesn’t tell the cloud anything because you are not working out and your BMI is 45 and your blood pressure is 159 over 98, and your pulse is 95. Your car won’t start because the nest signals you are about to die. No more trips to the wine store even though both the beer and wine are gone. While the cloud might register that you have given up beer and wine, you have actually graduated to Jose Cuervo. You can’t eat because of fridge lockdown and the car won’t start. You have a bad profile with UBER from the nest. Meanwhile you are longing for that blissful anonymity before you migrated to the cloud for $1.00 a month just to get rid of those annoying messages from Apple. The Stones saw this coming in 1967 when they composed Get off My Cloud:

“Hey! You! Get off my cloud

Don’t hang around ‘cause two’s a crowd

on my cloud, baby”

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

February 2, 2017

Rob McCrearyWhy Do You Want Your Fridge To Be Smart?

Don’t Let Your Business Get IPA’ed

By Rob McCreary

With a title like this you are probably thinking PE4Fams committed the cardinal sin of good journalism, a typo in the headline. Not so fast my proofreading friends, this blog is about disruptive technologies and the pervasive onslaught of India Pale Ales.

The Economist Editorial staff produced a really interesting history of IPA’s in its Dec 24, 2016 Double Holiday Issue: “A child of Britain’s industrial revolution and imperial expansion that rose to world-straddling greatness, IPA went on to be humbled by its upstart rival, lager. It had all but banished when plucky supporters restored it to life and once more put the world at its feet. Here is beer with a back story.”

I immediately thought about analogous banishments like suspenders, bell bottoms, and fondue pots but realized that these fashion and lifestyle faux pas could never have the rebound potential or manifest destiny of a product as seductive as India Pale Ale. How could an almost dormant taste morph into ales with seductive names like “Blind Pig”, “Hop, Drop and Roll”, a “Whiter Shade of Pale”, “Modus Hoperandi”,  “Effinguud” (phonetic) and “Kilt Lifter”? How can any 21st century discerning beer drinker go for monosyllabic offerings like Bud, Coors, Lite, and Pabst?  Maybe the mystery of a “PBR” offering should compete with the promise of “Elysian Space Dust”, “Hoppy Ending” or “Beard of Zeus”, but the competition stops when the alcohol content exceeds 8% and a double or triple IPA is named “Alimony Ale” with a tag line “The bitterest brew in town”

The Economist is right, however, about the back story. IPA monopolized the beer industry in the 18th century on the back of Britain’s Hogdon’s Bow Brewery and the miracle of coke fired ovens that imparted a pale and more consistent product which began to compete with darker porters and stouts. The heavy, bitter hops counteracted the sweeter malt and preserved flavor and punch over the long voyages to India where it became the tipple of the British Army in India. Hogdon’s monopoly based on generous credit terms to ship owners for promoting the brand eventually gave way to well-known British competitors like Bass, Worthington, Tennets and Charrington. As The Economist explains: “As IPA conquered taste buds in India it spread across the world turning up in America, Australia and Southeast Asia…Bass’s Ale (in style, an IPA) made it Britain’s biggest brewery and its red triangle logo appeared around the world- some call it the world’s first global brand.”

Like all monopolies, though, the dominant brands caught the attention of politicians who believed it was fair to impose an excise tax on strong alcohol content which was IPA’s hallmark. World War I also led to the commandeering of grains that supported the brews. The rout of IPA was so severe that the leading breweries in England were mothballed.  Taxes, war, prohibition in the U.S. and the growth of mixed drinks all conspired to end IPA hegemony.

For those of us who are baby boomers, the brands of our youth were national lagers like Budweiser, Miller and local brands like Stroh’s and Carling. With time, the dominant national brands in the U.S. began to consolidate all of the capital intensive, limited distribution local brands. New techniques for preserving quality brews and the onslaught of grocery stores and regional distribution all favored hub and spoke manufacturing and distribution models. The beer wars increasingly were won by publicly traded, well capitalized, marketing savvy national and international brands. Local beers, like Stroh’s and Carling, feeling the press of extinction, surrendered quicker than the France facing a Panzer division. Eventually, even Augie Busch sold out to In Bev. But just about the same moment I was burning my bell bottoms, hiding my suspenders and jettisoning Gordon Gecko hair gel, craft brewing began a quiet comeback.

Today when I travel, I routinely ask every bartender and waitress whether they serve a local IPA. Places like Mt Airy Virginia (Hoptimization”), Damariscotta Maine  (“Farmhouse” by Oxbow), Hartford Connecticut (“From The Ashes”), Springfield Missouri (“Gravel Bar”), Ft Wayne Indiana (“Funky Wild Ryed”)and Dayton Ohio (No brewery for 50 years – “Double or Nothing”) all have a local favorite and sometimes two or three. Cleveland now has three or four thriving local breweries with fantastic offerings. As The Economist also points out there is a subculture of inclusion that is driving these flavorful favorites. There are local hops growers, the second best “off the grid” cash crop that make the local hops in Mt Airy a little like terroir in Napa. There is an immediate camaraderie around eliciting local pride for their local favorites. You are united by hops in a way that national lite beers simply cannot. If you had to choose between being skinny or drinking IPA which would you choose? Effinguud (phonetic) or Hop, Drop and Roll?”

The business model implications for oligopolists like Miller and In Bev are frightening. The local barriers to entry for craft beers are low and often powered by hobbyists. Local pride and word of mouth provide free marketing. The cool factor fuels the craze and makes the brands travel. Most perverse is any craft brand that succeeds on a national scale has to be bought. So oligops pay twice for national insurgents like Lagunitas, once when Lagunitas takes your market share in bars and specialty stores and again when you have to buy them out at 12x to regain share and remove competition.  After In Bev has brought you into its family, it is really not cool any more to drink their brand. This happened to Sam Adams after it was sold to In Bev. Lagunitas makes great beer buy the suggestive pleasure of Hoppy Ending will always be worth a shot.

Remembering Porter’s five forces- barriers to entry must be sustainable. When an old world product that used to be a monopoly based on taste and punch is resurrected in an era of low capitalization, high quality craft brewing, watch the oligopolies fall. Can you think of one or two more business models that might be disrupted? How about print and television media? How about book publishing? How about Department Stores and Big Box retail?

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

January 26, 2017

Rob McCrearyDon’t Let Your Business Get IPA’ed

A New Year for Private Equity

By Rob McCreary

Turning the page on a great year is always bittersweet. While the future is exciting, the status quo is also mighty inviting. For private equity, 2016 will go down with Dickensian hyperbole as “The Best of Times”.

Our business model turns on six or seven main ingredients, the absence of any one of which can make a great cake unremarkable.

  • Low Interest Rates
  • Plentiful Liquidity
  • Low Tax Rates
  • Willing Sellers
  • Efficient M&A Markets
  • Favorable Taxation of Carried Interest
  • Stable Macro Economic Environment

Our industry has matured to a point where our bench of service providers, industry experts, operational consultants, and pricing specialists is prolific. By comparison, in 1999 when we founded CapitalWorks, the Christmas party was eight people, six of whom were creditors! The market for buying and selling was choppy. The providers of senior and mezzanine debt changed their appetite for providing liquidity more often than my teenage granddaughter changes outfits. While lawyers and accountants were skilled at most aspects of the M&A process, there were few diligence providers for mainstream services like Quality of Earnings, Environmental Due Diligence, Market Surveys, Customer Satisfaction Surveys, Operational Improvement, Pricing Analysis, HR Consultation, and Benefits and Insurance Review.

The employment multiplier from the Private Equity Business Model has become simply HUGE. You can prove it by attending any annual chapter meeting of the Association for Corporate Growth. What used to be 150 guys (very few women) swapping lies over beers and, sometimes, something a little stronger, now is close to 900-1100 men and women still swapping lies and drinking more prosperous brands.

The largest change from 1999 is  our industry now suffers from constant media and political injustice; I guess it is our fault. If you are not creating your own message in the marketplace, your competitors and detractors will do it for you. We should become less private about claiming GDP and employment credit. I regret that Mitt Romney had a perfect chance to educate and exonerate when he was running for President but he never delivered the counter punch. We are all the worse for his passivity.

The most interesting aspect of our industry’s poor image is we may simply be a business abstraction to most people in political life. If you ask most politicians what the private equity industry does, they will quickly confuse you with Venture Capital. My favorite insight about how politicians view us came years ago when I talked to one of our County Commissioners about engaging the private equity industry in a discussion of Cuyahoga County’s regional economic development plan for which he was responsible. He asked me with all seriousness “What is private equity?” I fear the political class has a similar abstract view of PE importance to GDP or our value added on important political subjects like jobs.

There is little recognition of how private equity has brought credit stability to the lower middle market of companies with less than $100 million in revenues. Formerly, many of these companies were owned by entrepreneurs who supplied personal guarantees to the banks, but were generally reluctant to invest fresh capital into the business, especially when it was in trouble. Today, most banks expect private equity owners to provide “support” when a company breaks covenants or uses bank funding to support cash losses. That support usually means additional equity in return for time to remedy the problem. There are a whole group of lower middle market lenders who want to bank PE owned firms for just this reason.

As we enter 2017 we remain bullish on our business model and our ability to make a meaningful contribution to the health and prosperity of businesses in the lower middle market, especially job preservation and creation. Now we have PE attribution for supporting a large and growing group of taxpayers and that is not an abstraction.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

January 11, 2017

Rob McCrearyA New Year for Private Equity

Build On What Unites Us

By Rob McCreary

You can get a pulse of America by paying attention to the TV shows acceptable for hospital waiting rooms where comfort, tranquility and hope are cultivated among those patients and family waiting for judgment or healing. Based on my recent pre election waiting room experiences there are only 4 acceptable channels:

  • Judge Judy
  • HGTV
  • The Cooking Channel
  • Weather Channel

As hopeless as this list sounds, I think we can build on all four.

Judge Judy is the easiest. She has a kind of frontier justice devoid of legal niceties and fancy Latin phrases that gets right down to who is right. She quickly undresses the fakers, the con artists, the family leaches and the liars. She dispenses an incontrovertible homeland justice just like Wyatt Earp and Andy Griffith. As such she recalls our roots in the rule of law and administers justice without regard to political sway. We can all get behind her kind of JUSTICE, right?

HGTV is a marvel. How Property Brothers, Flip or Flop, Love It or List It and Fixer Upper are uniting us is obvious. This country loves to buy homes and loves a deal. The concept of a makeover in life, looks, love or finances is part of the American Dream. I am absolutely smitten by Chip and Joana in Fixer Upper. He is the typical guy; broad shoulders, ex-jock, good with his hands, a problem solver, a little bit insensitive and always there in the pinch for Joana. For her part Joana is hot, creative, problem solving and communicative. She handles the goofy couples who are always making those stupid interior design decisions that are either unaffordable or unbuildable. Together they are awesome. If they are faking their genuine love and affection, then strike me down. Their kids are cool too along with the goats, chickens, dogs and cats. I admire mom and dad as self made entrepreneurs. Most of all I share their values even though the Bible is a little out of print for the PC crowd. They represent Family Values and Entrepreneurship.

The Cooking Channel is my North Star. “Chopped” is simply the best TV Show in America. It takes talented chefs who serve up great food and makes gladiators out of them, especially when they get a bad basket of say rattlesnake, brussel sprouts, fruit loops and seaweed. How someone could turn that into a yummy appetizer just blows my mind. The Chefs don’t mind telling you that they really need the money and want to beat the other chefs. This is not tee ball or all “participants are winners” but instead a pretty cut throat race for the crown and the cash. Sort of like real life and the pursuit of happiness. The quirky judges remind me of real life, too, where you encounter people with complete power over you who are difficult. What is refreshing about the interplay is radishes and rhubarb don’t have political views and can live together in a contestant’s basket. It seems to me the judges put professional palate above all else. There is an objective, higher standard. And they reach consensus despite differences and favorites. The chefs are the governed and the judges are those who govern. They are a metaphor for our REPUBLIC and its system of representative democracy.

Finally, there is The Weather Channel.  Who doesn’t like a Cat 5 Hurricane, a Tsunami, a tornado or 12 state ice storm that shuts down the interstate system? This channel is so popular that people in Florida convene for Northern Calamity Cocktails whenever an ice storm cripples the eastern seaboard or the upper Midwest. Without really acknowledging it we are all “channeling” a primal belief in that higher power. As such the weather channel is really our proxy for religion-GOD.

So what unites us is waiting room TV. The reason we like it is pretty much the reasons we love our country and our unique and exceptional experiment in representative democracy. Think about the unconscious waiting room consensus around these core values: JUSTICE, FAMILY VALUES, ENTREPRENEURSHIP, A REPUBLIC, A HIGHER POWER, CONSENT OF THE GOVERNED, PURSUIT OF HAPPINESS. Do these shows have an antecedent in anything faintly familiar?

We hold these truths to be self evident- that all men are created equal, that they are endowed by their Creator with certain inalienable Rights that among these are Life, Liberty and the pursuit of Happiness. That to secure these rights, Governments are instituted among men deriving their just powers from the consent of the governed

During this holiday season we should remember what unites us and bless this great country that alone among great civilizations is grounded in ascendant, revolutionary principles. Those who tell us otherwise are protecting jobs, careers, status or stock prices. They are not broadcasting in the waiting room of our hearts.

Merry Christmas, Happy Holidays and Have A Healthy and Prosperous New Year.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

December 21, 2016

Rob McCrearyBuild On What Unites Us

“The Economist” Weighs In On Private Equity

By Rob McCreary

It seems like the whole world is now fascinated by a business model that has been around for more than 40 years. In the October 22nd issue of The Economist an editorial panel took a look at Private Equity. Entitled “The Barbarian Establishment” the article is mostly complimentary: “Private Equity has prospered while almost every other approach to business has stumbled. That is both good and disturbing.” It reviews the ingredients for successful economic returns as a layer cake of available leverage, low interest rates, and tax shields from deductible interest, large uncommitted equity pools, long term capital commitments and lack of competition from the public markets. Interestingly, the stock market performance of the big four public PE firms – Blackstone (2007 IPO), KKR (2010), Apollo (2011) and Carlyle (2012) – have all lagged the S&P500. In fact, all four are trading at or below their IPO price. Those lackluster returns only apply to the stream of profits from the management companies, not the returns to the limited partners of the multiple underlying funds. It would be surprising, indeed, for Steve Schwarzman and Leon Black to have made a bad trade in monetizing their own profit stream. When they are sellers, the public should be wary.

The article reviews the paltry returns available today from almost every other asset class and concludes “private equity’s current appeal rests not on whether it can repeat the absolute returns achieved in the past…but on whether it has a plausible chance of doing better than lackluster alternatives”. It takes the authors several thousand words, however, to zero in on PE distinctiveness as being the freedom its managers have to ignore the pressures of “quarterly capitalism” meaning impatient investors.” There is recognition of less taxation, less legal vulnerability and fewer operating constraints that allow private equity managers to focus as owners on managing their assets to provide the greatest returns in a short period of time. By contrast, public companies face a mountain of often incomprehensible or conflicting regulatory demands that are not relevant to performance.

A great example is the agenda for our private equity meetings. We try to start (not end) with an executive session that often includes only the CEO of the portfolio company during which the advisory board members ask the CEO to focus on particular issues that are raised by the volumes of financial and operating statistics included in the board package. This allows the PE owners to prioritize and focus on value creation to the exclusion of all else. My public board experience, especially for the 2-3 years after Sarbanes Oxley was enacted, was exactly the opposite. We usually started with an excruciatingly boring review of Sarbanes Oxley compliance conducted by our general counsel or outside lawyers. Only after 50 pages of PowerPoint persuasion that we were, in fact, complying were we allowed to turn to the purpose of the meeting- creation of shareholder value. By that time you were eating lunch and quickly slipping into carbo overload from the cookies and potato chips. With all your blood in your stomach, the public shareholders often competed with the desperate need for a nap.

The authors are also enamored with an attribute that is lacking in the more constipated public company process, SPEED. Management can be changed quickly. Tuck in acquisitions can be accomplished in a matter of months. Divestitures of non performing units do not need lengthy and cumbersome public disclosure. My experience in the public markets with change in management was illustrative. The Governance Committee of the Board would often have “hypothetical” conversations about changing key managers because regulation FD required immediate disclosure if a serious discussion was joined or a real decision was made. It also always took at least two and sometimes three governance meetings to reach a conclusion that a private equity firm will accomplish in a week.

Speed is also important when a window of opportunity is about to close. I had a discussion with the CEO of a telecom company who feared that the “new economy” telecom bubble was about to burst and telecom valuations would soon crash. He said he knew the end was inevitable when in early 1999 all of his customers had infinity growth plans for their respective markets. He shared his concern with the large PE firm that owned his operation and was told they would have a plane pick him up that afternoon. Two weeks later a “Selling Memorandum” was on the street and eight weeks later the company was sold for cash to a large multi-national telecom company. One year later the telecom market was faltering and two years later industry stalwarts like Global Crossing and WorldCom were filing for bankruptcy. The acquirer is still alive but it never regained its mojo.

You have to love an asset class that can move with this kind of speed in a world of red tape and numbing process.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

December 7, 2016

Rob McCreary“The Economist” Weighs In On Private Equity

Winners, Losers and Reigned Out

By Rob McCreary

The 2016 presidential election results were surprising and the aftermath is sure to bring more surprises. There appears to be premature celebration in many camps as business interprets the Trump victory in a most positive light. There are, however, a few bedrock changes coming that will set a business, legal and tax foundation for the next 20 years.

Effects on Private Equity

This election will have a positive effect on the PE asset class but may fall short of positive for its managers. The tsunami of regulation that occurred during President Obama’s last term was real and unprecedented. In our annual summit meeting last spring we brought in an expert on labor matters to speak to our portfolio company CEO’s and CFO’s. He painted a picture of Orwellian doom where the Department of Labor had become its own rule making body under the leadership of the ambitious Thomas Perez. Wage and hour rules including overtime pay and minimum wage were significant issues for our portfolio companies. The classification of workers as “employees” or “contractors” was also a significant risk to many business models that utilize part time or seasonal workers. An expansive “class action” right allowed workers, past and present, to jump into a single dispute and aggregate their grievances. In several cases a wage and hour dispute for less than $5,000.00 became magnified by contingent fee lawyers who earned 30% of their settlements for a class of workers who had nothing to do with the original dispute. In a few cases the settlements were 20x the original amount in controversy and covered hundreds of employees.

There appears to be a general consensus that President-Elect Donald Trump and U.S. Speaker Paul Ryan agree on rolling back government regulation, especially where there is a clear causal connection with small business. Maybe the “wolf pack” within DOL will stop taking down businessmen and capitalists in the name of protecting labor? Maybe harassing successful small business will no longer be the game.

Carried Interest at Risk

While our businesses may be able to breathe better and spend less time each day dealing with regulation and regulators, managers of PE firms may find Trump’s tax policies do not favor them. Both he and Hillary Clinton pledged to end the favorable taxation of carried interest. I have argued in the past about the PE asset class attracting talent because after-tax rewards on wealth creation are significantly greater than many other compensation regimes. For example, appreciated stock options, restricted stock, stock appreciation rights, deferred compensation and stock bonuses are almost always taxed as ordinary income while the gain sharing for PE managers is almost always a “capital transaction” with taxes at capital rather than ordinary income levels. The difference in taxes over a career is meaningful. I do not hear loud voices of protest from the leaders in our industry like Carlyle Partners, Blackstone or KKR. Maybe that is because they already converted their management fee and carried interest streams into a capital asset by going public over the last decade? Without an organized effort to protect our business model it is likely to change soon.

Losers Are Pretty Obvious

The biggest loser is the media. Their business model has changed in my lifetime from journalism based on fact finding (think Ben Bradlee and “All The President’s Men”) to sponsored political content based on celebrity status and inside access. I have noticed in the days after the Trump Trounce the media does not know what to do with itself. ABC, CBS, CNN, NBC news will all struggle for relevance and viewership as they are denied access to a Trump Whitehouse. With a press secretary like Laura Ingraham who is old school enough to expect the media to “do their work”, press conferences may be less like fraternity and sorority mixers and much more like a business of journalism. The big winner, of course, is FOX, especially if Laura Ingraham gets the top media job. Maybe the liberal media can rehabilitate itself with hard core journalism? I would take bet, however, that the taste of stardom and narcissistic fascination with their own reflection will make most of them bitter and mean and eventually cause them to drown in a pool of self-pity.

Reigned Out – It Is About Time

A trifecta is Hillary Clinton, Nancy Pelosi and Harry Reid all getting fired in the same year. There is a real good chance we will see this occur in the next 6 months. That ushers in Elizabeth Warren and Bernie Sanders as the opposition voice.  I doubt incumbent Democrats will see their socialist ideas as currency for a reelection campaign. There are 10 more Senate seats up in 2018 and they are mostly in states that went for Donald Trump. One thing you can count on in politics is self-interest. Democratic incumbents are going to ride whatever train drops them off at Union Station and I doubt it will have a conductor or engineer named Warren or Sanders.

A close second in my lifetime wish list for personnel change is Ruth Baeder Ginsberg. She will never quit the Supreme Court but her influence as a jurist is done. I actually believe that the Supreme Court is guided by principle and legal precedent. As a former lawyer, I have immense respect for the Supreme Court as an institution. It conserves the rule of law. In a smothering political climate where huge political pressure imperils the Court as an institution, the Justices will make sure the institution survives even if there is some bad law created from time to time. Now there is a chance for open and free dialogue around the nuances of legal precedent without the threat from Pennsylvania Avenue. A Justice who has already declared herself has neither the objectivity nor the dexterity to remain relevant in a minority position where persuasion, intellectual fortitude and collegiality matter.

The least likely reign out will be James Comey. Trump may owe him a few years in office. However, like Loretta Lynch, the Clintons have soiled him and he cannot have any support from anyone inside the FBI who actually cares about the rule of law. He will go soon on his own.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

November 21, 2016

Rob McCrearyWinners, Losers and Reigned Out

Indians in Six Because…

By Rob McCreary

Writing a blog about The World Series when your home team is a participant would seem as natural as blonde hair at a hair dressers convention. But I was resisting (jinx concerns) until I read a column by Jared Diamond in Monday’s edition of the Wall Street Journal “How the Cubs Overpowered October”.  Like most of the media, Mr. Diamond is certainly not an Indians fan. While he acknowledges that the October prize often goes to the team with momentum (the Indians are 7-1 in post season), he goes on to state; “Cubs President Theo Epstein- already enshrined in baseball lore for his curse-breaking stint with the Boston Red Sox- has built a roster so loaded with talent that it transcends the crapshoot nature of October.” Well, it is not just about October anymore and there is a real chance that the Champs will emerge from the gales of November off Lake Erie on either November 1st or November 2nd this year. More importantly, I can remember a team that was so loaded with talent that it should have transcended any crapshoot, the 1995 Cleveland Indians. Guess what? They lost.

’95 Tribe and ’16 Cubbies Are Loaded

Mr. Diamond is really enamored with the Cubbies winning 103 games in a 162 game season pronouncing the feat as “rarified air”. Maybe Mr. Diamond should recall that the 1995 Indians won 100 games in a strike shortened season of only 144 games. So the Cubs 63% winning percentage may be rare but the 1995 Indians with a 69% percentage must certainly be Olympian. If the ’95 Tribe had just won half of their remaining games they would have had 109 victories. If he wants blood rare he might bite into the 2001 Seattle Mariners who won 116 games and lost in the first round of the playoffs to the Yankees 4-1.

That 1995 Tribe team certainly matches up well with the Cubbies at the plate. Remember who the #7 hitter was? That would be a right fielder by the name of Manny Ramirez who at age 23 had 31 home runs and 107 RBI’s in a season with 18 less games than the Cubbies just completed. He had 119 fewer at bats than Kris Bryant! By comparison Kris Brant who plays 3B and bats 4th hit 39 home runs with 107 RBI’s in 603 At bats. Manny had 484 Abs. On top of Manny being a better hitter than Bryant the Club also had Albert Belle who at age 28 in 546 plate appearances had 52 home runs, 50 doubles and 126 RBI’s. I guess you have to compare him to Cub’s Anthony Rizzo age 26 who has 583 at bats with 32 dingers and 102 RBI’s. You are left with the rest of the mighty Cubbies getting 95 RBI’s from Addison Russell and 76 from Ben Zobrist. In my book “Rarefied” should mean Baerga with 90, Eddie Murray with 82, Thome with 73, Vizquel with 56, Lofton with 53 and Sandy Alomar with 35. In stark relief, the new WSJ boys of November did not have another hitter with more than 50 RBI’s. By the way the Cubbies strike out a ton and the starters only had 47 stolen bases. Kenny Lofton alone had 54 and the Cleveland starters in 1995 had 117 swipes.

There might be a slight advantage to the Cubs in the pitching department. Lester was 19-5, Arieta was 18-8 and Kyle Hendricks was 16-8. Dennis Martinez for the Tribe was 12-5, Charlie Nagy was 16-6 and Orel Hershiser was 16-6 but all with four fewer starts. The Cubs have a flamer in Aroldis Chapman who routinely throws over 100 MPH and the Tribe had (break my heart) Jose Mesa who lost his way in ‘95 but lost the World Series in 1997 to the Marlins. His name is not spoken in our home.

To keep the comparison going, the 1995 Indians never lost more than 3 games in a row. The 2016 Cubs had a swoon and lost 15-20 games midway through the season. The Cubs skipper is Joe Maddon who has a lifetime 103-58 record while the Tribe in 1995 was skippered by Mike Hargrove who was 100-44. The ‘95 Tribe and the ‘16 Cubs seem to me pretty equal.

Lake Erie Breezes Blow In a Championship

So I have an idea for why the Tribe will win in 6. It will be the weather. Game time is 8pm. Two of the nights will likely have rain. The game time temp for game 1 and game 2 is said to be 45 and 46 respectively followed by 56, 49, 49, 50 and 53. A team built for home runs with lots of strike outs will be feeling it in batting practice. Getting a grip on the baseball will be like trying to hold onto a greased watermelon. Trevor Bauer’s pinkie will be frozen and no blood will flow. A team of mutts that gets on base and advances the runners will have an edge. Tribe stole 2x the bases and neither Lester nor Arieta can hold runners. In fact, Lester has the yips about throwing to first base. Good defense will trump hitting (Indians ranked 11th and Cubs 22nd) and managerial experience will tip it in favor of the Tribe.

I consulted a definitive source on the matter of cold weather outcomes, The Hardball Times. In an article by Chris Constancio written October 2006, Mr. Constancio dropped a few pearls of wisdom.

  1. Pitchers strike out a higher proportion of batters in cold weather and stay warmer on the mound
  2. Pitchers also walk more batters in cold weather
  3. Home runs are relatively rare in cold weather
  4. Batted balls in play are less likely to be hits in cold weather
  5. Patient hitting teams have an edge
  6. Teams that are built on fast balls have an edge over teams with breaking balls

Not all of these factors favor the Tribe. Kluber, Tomlin, Merrit, Shaw and Miller rely on nasty breaking balls for their “out” pitches. In the post season the Tribe has also grabbed leads off the long ball. However, I do like the patient hitting edge and the legion of guys the Tribe can throw at you from the bullpen. Am I am sounding like a Yankees fan or a BoSox fan to you? I am still humble but practicing to become en-“titled” just like them.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

October 25, 2016

Rob McCrearyIndians in Six Because…