A Research-Driven Approach to Deals

Independent sponsors are increasingly prevalent in the middle and lower middle market today. We sat down with John Huhn, Managing Partner of St. Louis-based independent sponsor Compass Group Equity Partners, founded in 2014, to talk about the firm’s strategy and the benefits they see in their investment model. 

Compass Group Equity Partners invests in companies between $2 million and $10 million in EBITDA and will look at smaller opportunities for add-ons. Industries of interest include manufacturing, value-added distribution, and business services. 

Why did you decide to employ an independent sponsor model?

I come from a corporate development background and have experience doing deals for publicly traded companies all over the world. In those deals I often encountered private equity firms who were interested in exiting a platform that we were interested in acquiring. 

When I got to know that seller, I’d ask them, “Why are you selling this opportunity now? It seems to be gaining traction and things seem to be going well.” They’d inevitably say something like, “Well, it was just time for an exit.” In other words, they had to get a return for their investors. 

When we were starting Compass Group, we didn’t want to have those kinds of arbitrary time restraints. We were very deliberate about doing what’s right for the business. Our structure allows us to be more patient and more flexible. 

How do you arrive at your investment thesis?

Research is always a big part of our process. Rather than being opportunistic, we spend a lot of time looking at everything out there in the market from a macroeconomic perspective and then designing an investment plan from there. 

Right now we have four main platforms. The first one is our electronics manufactured services group — circuit boards, wire harnesses, cable assemblies. It’s a very fragmented industry that services industries like aerospace, consumer interactive kiosks, medical diagnostic equipment, and more. 

Our second platform is in industrial automation. We focus primarily on modular workstations that can be plugged in and utilize something called machine vision, which identifies exactly where in the production process things need to be bolted on or encapsulated. Let’s say at Procter & Gamble, a production line is shooting these detergent, liquid detergent bottles down, and they need the exact place where the cap needs to be put on and screwed on, at a certain tightness. 

Our third platform is in healthcare kitting — designing in-home test kits for patients on behalf of our customers, who tend to be physicians’ practices, hospitals, laboratories, or pharmaceutical companies. This is a great example of a mature industry which has a lot of inefficiencies where we can aid in lowering cost, which is one of our fundamental goals. 

Our last active platform right now is Care Vet, a small animal veterinarian practice rollout in the Midwest. CareVet is highly focused on medical outcomes and a vet-supportive environment. 

We have a few new things in the hopper that have followed long-time research in areas of interest. 

How do you secure funding for your deals?

We have a stable of 10 to 12 family offices mostly located in the middle portion of the U.S. who really like our thoughtful thematic approach. Because we’re not opportunistic, we’re able to go over our existing and prospective investment theses with our family offices in advance and gauge their interest and how much they want to be involved in each particular platform. They give us a sense not only of their level of interest, but also the size check they might want to commit to invest in a particular thesis, based on a research-intensive investor deck. We’re never just springing an idea on them — usually they’ve been engaged for months if not years about particular platform investment opportunities. 

We’ve seen a big change over the past 5 to 7 years in the way family offices look to invest. They really crave engagement and often look for holdings that either complement the way they made their own wealth or diversify away from it. 

How do you find deals?

It’s hard work. We visit a lot of trade shows, walk the floors to try to understand what’s happening within the industry — it’s often a lot different than what you read about. 

We get to know the players and try to strike up relationships. It takes time — often too much time for private equity funds to take this approach, which is why they often go through intermediaries to find deals. We do that too, to better understand particular sectors we’d like to penetrate. 

Another strategy is cold-calling industry professionals. Many small business owners in the lower middle market will put up walls when they hear you’re a private equity firm — they’re thinking, I don’t want to sell. This is my baby. And they don’t want to answer any questions about that. But our approach instead is to just see if they’re open to just talking about what they do. Most of these owners love what they do, and if you approach them in a non-confrontational way it’s pretty easy to get them to talk about something they love. While we may want to acquire some of these companies, the goal right now is to create personal relationships. 

What’s a lesson you’ve learned since starting the firm?

One thing that has really been evident over the years is that talent is just as important as a business model. Most of the time a management team needs to be augmented in some way. When we’re acquiring a lower middle market company, they usually don’t have the systems or processes or protocols that a more mature organization might have. And therefore, you’ve got to inject experienced talent to enable them to get to where we all believe they should be. One of the most important lessons we’ve learned is that if we align ourselves with extremely talented people — both existing leadership and the people we bring in — the businesses will succeed.