H.I.G.'s Growth Tests Firm's Quest to Stay True to Its Roots

May 5, 2016 | The Wall Street Journal

Known to some as the Blackstone Group of the midmarket, H.I.G. Capital wants to seal its position as one of the biggest names in a highly competitive space.

In the past half decade, the Miami firm, which built its reputation backing small and midsize companies, more than doubled the capital it has managed since inception to $19 billion from $8.5 billion.

Along the way, the firm has expanded beyond its North American lower-midmarket buyout roots into strategies that span European and Latin American private equity, direct lending and syndicated products as well as real estate and life sciences.

The growth story of H.I.G. epitomizes the burgeoning ranks of private-equity firms that in recent years have transformed themselves into multiasset managers.

As H.I.G makes that transition, it has seen turnover in its investment ranks. At least a dozen managing directors – roughly a fifth of the firm’s some 60 managing directors today – were either squeezed out or departed in the last five years, people said. Some joined competitors or launched businesses of their own, giving them more control over their share of firm economics than when they were at H.I.G., where ownership is concentrated among the firm’s two founders, Sami Mnaymneh, 54, and Tony Tamer, 58.

H.I.G. Capital faces a test of whether it can retain its brightest minds and reputation for value-oriented deal making as it grows. As H.I.G.’s alumni network expands, visit the link below to see a selection of its dealmakers who have taken on founding or key roles at other firms.

H.I.G.’s evolution puts the firm at an inflection point: While some industry observers and limited partners fear team shifts and asset expansion could hamper H.I.G.’s ability to repeat its past successes, others say a refreshed slate of senior deal makers and its asset growth have boosted its competitive edge through its exposure to other markets.

And despite its growing pains, H.I.G. has been able to continue to draw investor support following a streak of strong returns.

As with many fast-growing firms, H.I.G. must prove it can continue to deliver stellar performance and retain its brightest minds as it gets bigger – all the while staying true to its midmarket roots.

‘Product Proliferation’

H.I.G.’s roots date back to 1993, when it launched a lower-midmarket fund focused on North American control deals, a strategy that has become the firm’s crown jewel.

The flagship strategy’s focus on the small-cap market – companies with earnings before interest, taxes, depreciation and amortization of up to $40 million – has made its performance less correlated to cycles of credit and equity markets than its megabuyout brethren. The firm’s $750 million flagship fund, raised in 2006, delivered 4.5 times its invested capital at the end of 2015 on a gross basis, outpacing its 2002 predecessor, said a person familiar with the matter.

Investors clamored to get into the next flagship pool, which attracted more demand than it could accommodate and closed with $1 billion in 2013.

H.I.G. relies on a labor-intensive model, with some 300 investment professionals working on a varied range of companies – from a health-care provider for jail inmates, to a seller of personal background data, to the California franchisee of Australian-themed Outback Steakhouse. Individual funds can have between 30 and 40 positions.

The personalities of the founders are intertwined with the firm’s culture, according to people who have worked with them. They describe Mr. Tamer, a former partner at Bain & Co., as an adept negotiator, and Mr. Mnaymneh, who specialized in financial advisory services at Blackstone before H.I.G., as a hands-on manager and a direct communicator.

To build on its success, H.I.G. moved people from its private-equity group to start new business lines and gave itself space to make slightly larger deals with the launch of a dedicated midmarket fund. The firm has fanned out in all directions in what pension fund investor Texas Municipal Retirement System described as “product proliferation” in a February investment report. H.I.G. launched distressed-debt unit Bayside Capital in 2004, bought WhiteHorse Capital in 2011 to grow its syndicated products and direct lending platform, and sprouted new strategies that span real estate, biotechnology and growth capital.

As H.I.G.’s performance with lower-midmarket buyouts has attracted return backers and allowed it to get larger, some private-equity investors question whether it will get harder for the firm to sustain its success buying and improving the value of smaller companies, as its funds increase in size.

The horizontal expansion may have kept in check rapid growth between successive funds. H.I.G.’s assets under management for its private-equity funds and Bayside credit pools have grown at an annualized rate of less than 10% each, one person with direct knowledge of the firm said.

“What allows successful firms to diversify is the ability to develop investment capabilities that can be scaled and deliver long-term client value, as opposed to simply executing a short-term trade,” said Kevin Quirk, chairman and partner at management consultancy Casey Quirk, speaking broadly on the industry and not about any specific manager.
Not all of H.I.G.’s products have thrived. About four years ago, H.I.G. started winding down Brightpoint Capital, a hedge-fund division launched in 2006, said a person familiar with the matter.

“For divisions that aren’t really core, turnover is something to monitor,” said a long-time backer of H.I.G. funds.

Competition from direct lenders and unitranche investors has created a more challenging landscape for Bayside and the proliferation of new players has opened doors for some staffers to jump ship. Six of the deal makers listed as senior members of Bayside at the start of 2015 were removed from the firm’s website; the departures amounted to more than a fifth of the current 27 senior deal makers. Among them is Paul Triggiani, a managing director at Bayside who earlier this year joined the special-situations credit arm at W.L. Ross & Co.

Those departures took place as the firm has been raising $1 billion for H.I.G. Bayside Loan Opportunity Fund IV LP. The firm has been marketing the fund since at least the fall of 2014, regulatory filings show.

More recently, H.I.G. brought on Giuseppe Mirante, who headed distressed and loan research at BNP Paribas, as a new managing director at Bayside when Lionel Laurant left for Pacific Investment Management Co. It hired Stuart Aronson, who formerly headed GE Capital’s sponsor finance unit, along with a team of originators, to bolster WhiteHorse Capital.

At the same time, H.I.G. has taken a hands-on approach to shaping its teams. Executives will pull aside deal makers that don’t measure up to ask them to leave, said two people familiar with the matter, but not without ensuring their portfolio companies land in safe hands.

H.I.G takes the view that some degree of turnover helps an organization by allowing people rising within it to take on bigger roles – managing directors at H.I.G.’s private-equity division have an average tenure of 11 years at the firm, said a person familiar with the matter.

By contrast, at Boston midmarket firm Berkshire Partners, founded in 1984, managing directors have an average tenure of 16 years with the firm, while the managing directors at Chicago-based Madison Dearborn Partners, founded in 1992, have an average tenure of 20 years at the firm, according to their websites.

“Some offices want fresh blood and new thinking to come through, so higher turnover can be completely acceptable,” said Jeffrey Cohn, managing director for succession planning at recruiting firm DHR International Inc. “Turnover is simply a function of a firm’s culture and risk appetite.”

H.I.G.’s annual retention rate is close to 95% across the entire firm, if exits from those in its pre-M.B.A. associate program aren’t counted, said the person with knowledge of the firm. The firm hires 30 vice presidents and associates each year to build a deep bench.

Founders’ Firm?

Some industry players and former H.I.G. deal makers worry the departures are a symptom of a deeper issue: the concentration of control and economics in the hands of a few at the firm.

At least 10 new firms were formed in the past decade with former H.I.G. deal makers in founding or key leadership roles, some of whom said they sought greater control over fund economics.

At H.I.G., Messrs. Mnaymneh and Tamer, who have led the firm since its inception, make up the principal owners of the firm, regulatory filings show. The four executive managing directors of the firm – Douglas Berman, Rick Rosen and Brian Schwartz, who focus on private equity; and John Bolduc, who leads H.I.G.’s credit platform – have been at the firm since the 1990s. The quartet pockets a more concentrated share of carried interest from the funds they oversee than other managing directors – and their loyalty is sustained by a long-term vesting schedule.

“Even as the firm has grown quickly, there’s a sense the culture hasn’t evolved and it’s still a founders’ firm,” said a person familiar with the firm.

A recent study of private equity funds by Harvard Business School professors Victoria Ivashina and Josh Lerner found that partnerships with a more unequal distribution of profits and ownership are less stable, as individual senior partners with a smaller piece of pie were more likely to leave.

Some people said H.I.G’s structure has actually strengthened the firm. “The people who started the firm are running the firm. It adds stability to see all the people working together,” said a former H.I.G deal maker.

The true test of whether H.I.G. can stay on its path toward leadership in the midmarket will hinge on its ability to replicate past success while retaining its brightest deal makers and the favor of limited partners.

It may be too early to tell how well the firm’s more recent partnerships will fare over time, as funds such as H.I.G. Capital Partners V LP, H.I.G. Middle Market LBO Fund II LP and H.I.G. Europe Capital Partners II LP were launched less than five years ago. As long as H.I.G. can continue to deliver, investors will likely stick along for the ride.

“Turnover ensures that you have fresh blood coming into the equation, but companies need to balance that with maintaining continuity and what makes them unique,” said Mr. Cohn of DHR International. “More private equity firms will have to figure out how to get that mix right as they get bigger.”