Opportunities for small pension plans in Canada’s lower, middle private-equity market
BY Yaelle Gang | March 31, 2020
For smaller pension funds looking to access private equity opportunities, the lower and middle part of the Canadian market should be very attractive, says Tracey McVicar, a partner at CAI Capital Partners, referring to businesses with $3 million to $10 million in earnings before interest, taxes, depreciation and amortization.
Institutional investors with bigger pools of capital haven’t found a way to access this part of the market, McVicar says. “It’s very interesting, but not big enough individually or even fund-wise, so that the bigger pools can really move the needle with an investment. That’s what I think the big opportunity is for larger family offices and smaller pension plans.”
McVicar highlights that almost 47,000 Canadian private companies have between 50 and 600 employees.
As well, with current equity markets melting, a lot of opportunities exist on the private side, she says, noting that the entire North American public equity market is barely 6,000 investable names, but almost 50,000 private companies are investable targets in Canada alone. “. . . If you really step back and look at the evolution of the North American public markets over the last 10 years, the number of public issues is down by half; the nature of the companies that are listed has really changed.”
Pension funds that buy into an index aren’t getting exposure to a cross-section of industry in North America anymore, she adds. “They’re getting the [Facebook, Amazon, Apple, Netflix and Googles], they’re getting a little bit of smaller tech and biotech, but they’re missing the heart — what used to be the real heart of the market.”
Referring specifically to CAI, McVicar says she doesn’t focus on specific industries, but rather looks for companies that have a founder who may be aging and has hit a wall growing their business. “It’s probably taken them their whole working life to build their business to, let’s say, $5 million in cash flow. They know that there’s an opportunity to grow beyond that. But as you age, it becomes very challenging to bet the company the way you did when you were young. And you just don’t want to. You’re much more averse to risk.”
Plenty of companies in Canada may be in this situation. In fact, according to a 2017 study by the Business Development Bank of Canada, almost 60 per cent of Canadian small and mid-sized business owners are aged 50 or older and more than 40 per cent of Canadian entrepreneurs will exit their business to retire in the next five years.
This offers a big opportunity, yet many large pools of pension capital in Canada are more than $100 billion dollars. And, while these funds are likely to have high private market allocations, they may have minimum cheque sizes for the amount they want to invest in a fund, says McVicar, referring to one large pension fund that doesn’t want to write cheques for less than $200 million. “And that’s because they don’t have the manpower to manage a whole bunch of $20-million positions.”
Further, smaller private equity funds like CAI wouldn’t want a single investor to be above $20 million at a time and dominate a fund, she notes, and that investor, on the flip side, also wouldn’t want to dominate a fund. “They all go out of their way to put limits on what percentage of a fund they can be.”
But smaller pension funds can take advantage of opportunities with smaller cheque sizes, adds McVicar. This space also has less competition for deals, meaning firms like CAI don’t have to pay the double-digit multiples that are common for larger deals.
“The smaller pension funds don’t often have an advantage over the big guys, and I think this is really the place they have an advantage. Because of the size of their pools, they can access a part of the market that is pretty much off limits to the big guys, and it’s a part of the market that has really good returns.”
The advantages of private equity during coronavirus
In the first few months of a market downturn like the one caused by the coronavirus pandemic, there isn’t a lot for sale, McVicar adds.
“I’ve been through this in ‘08 and I’ve been through it again in ’11, a little bit, and [in] ‘14 with the energy sector, but really what happens in these times is, everyone who’s . . . looking across the entire economy says it must be a great time to buy businesses.”
In reality, however, the really good businesses don’t want to trade in a down market and so investors are left with businesses that are forced to sell.
That said, with the coronavirus top of mind, McVicar highlights the advantages for private equity-owned firms in navigating the current market.
For example, she says CAI is spending a lot of time trying to manage its portfolio companies through the crisis, so they can focus on their operations. “We’re spearheading the negotiations on lease cost, on bank principal and interest where we need it. We’re just helping them to really focus on cash and collections and managing the downsizing of their business temporarily.”
This differs from public market management teams that are forced to adjust to the major change in the spotlight of the public market, she adds. “Being able to make all these adjustments and manage through this crisis without the glare of the public spotlight gives our [chief executive officers] more time to fix their problems.”
Further, the levers that a public equity manager can pull during this time are to either sell or hold. However, private equity managers can be more active and help manage companies more aggressively through a downturn, says McVicar. For example, she has people dedicated to looking at government programs, 13-week cash-flow modelling for each company and talking to all lenders and landlords.“And then my CEOs can focus on operations.”
One of CAI’s portfolio companies, Canadian Heating Products Inc., can attest to how helpful it is to have a general partner. The company, which has 127 employees, has operations in British Columbia and Washington.
Jonathan Burke, its president and CEO, says it’s been helpful to have a partner navigating the various government measures announced across jurisdictions. “It’s been fantastic having a private equity partner that’s doing it on behalf of a whole bunch of portfolio companies, and [being] able to summarize what’s out there in terms of support programs, in terms of regulatory loosening, things like that. It’s just been fantastic.”