Private Equity Spotlight: A conversation with Chris Baddon of Pacific Avenue Capital

In the first of our Private Equity Spotlight series, Brian Murchie, senior client development advisor at Reed Smith, welcomes Chris Baddon, a principal and the head of business development at Pacific Avenue Capital, to discuss trends in the private equity industry in 2023 and what to look forward to this year.

Transcript:

Intro: Hello, welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content through this series please contact our speakers. 

Brian: Welcome back to Dealmaker Insights. We are excited with a new series spotlighting the private equity industry. My name is Brian Murchie. I'm the client development advisor at Reed Smith. Excited to welcome our first guest, Chris Badden with Pacific Avenue Capital. I'm personally excited to welcome Chris, given I have a background like his. I spent seven years on the business development team with Platinum Equity. And then from there, I went into a sponsor coverage role with Stifel and then Raymond James. So, you know, welcome Chris, excited to have you and looking forward to your insights here with our podcast. 

Chris: Thanks, Brian. Look, I really appreciate you having us on and, and uh looking forward to the discussion today. Personal background on myself, local kid in Southern California. So I grew up in, in Orange County in Huntington Beach specifically, I found my way to, to USD for college down in San Diego. And uh actually got some private equity experience during a college internship with JMI Equity. They're a software and tech focused private equity firm down in, down in San Diego. And I came up to LA for my first role professionally with Open Gate Capital uh back in 2010, which certainly exposed me to the industry. And I started as a, as an entry level uh business development associate. Most of my coverage was specifically uh industrial focused and chemicals and building products and source a number of platforms for, for the firm. There was there for about 7.5 years, went to Transom Capital for three years and help them build out the business development approach and then came here to Pacific about 2.5 years ago, almost three years ago now uh to lead the business development effort uh for Pacific Avenue. 

Brian: Thanks Chris. So what would you say were your biggest challenges in 2023? And kind of how do you see these evolving in the year ahead? 

Chris: Yeah, it's a really good question and, and maybe um maybe I'll start with just a quick background and an overview on Pacific as a firm that will help kind of segue into how we look at the world and and how we think about opportunity sets within the, the M&A environment and, and you know, just raising our first fund here. So, so Pacific Avenue was founded uh about seven years ago. Now, our founder, Chris Sznewajs um came out of The Gores Group. We have two other partners, uh Jason Lee, who came out of Platinum Equity and Sun Capital and, and James Oh who joined us recently, uh who came out of Transom and worked at uh Gores with uh with Chris. So, you know, we were founded on the premise that a lot of the, you know, firms that we, we all came from, you know, have moved up market uh when, when they look at these corporate divestiture and carve out opportunities and, and there's sort of a, a void or a hole for people with experience and, and credibility and understanding how to navigate these sorts of transactions in, in the lower middle market. So, you know, we were very successful as a pre fund firm. We, we did a number of transactions, you know, four different carve outs here and, and, and a few and one found a roll up opportunity prior to raising our first uh institutional capital pool and we did that successfully last year.

So in, in, in 2023 our, our fund closed officially uh just over 500 million and, and we, we raised the capital to really specialize in, in a few types of transactions. So the first being, corporate divestiture is certainly our, our number one bucket. Um and then businesses with unnatural ownership and, and what that means to us is, is carve outs are, are obviously somewhat self explanatory and, and, and we're buying businesses from, from larger organizations and, and uh fixing them operationally uh to, to end up returning capital to our investors. And we, we specialize in, in a number of categories, but we're, we're generalist um overall from an industry threshold and perspective. So we, we love industrials, um you know, business services, healthcare, consumer tech, broadly defined to name some of the larger sectors. But we're really, we're really more transaction focused than we are subsector experts. So we like deals and, and sit that we think we can be good partners for the Corporates in, in separating these businesses with our, our senior team. We, we've done over uh over 40 carve outs as, as a senior team here. So there are very few things that we haven't seen from transaction dynamic perspectives. And we, when we raise our first fund, we, we have two platforms already closed in the fund. One is a uh chemicals carve out that we bought from TotalEnergies uh that close uh in ’23 and we bought uh an ingredient processor from SunOpta uh as well in the, in the food and beverage space. So, uh we're based in, in Los Angeles. So most of the team sits there. We have a few folks that one sits in, in Dallas and two in Florida. But the, the majority of the team sits out of the L A office and uh we are growing very fast to keep up with uh internal demand and expectations on, on our side. 

Brian: Thanks Chris for that. That's great to hear. And congrats on all the success you guys have had. Uh there, it's been, you know, it's been fun to watch you guys really grow. So, you know, with that being said, you know, what were some bright spots or specific trends that kind of excites you going into this year in 2024? 

Chris: Yeah, absolutely. And, and I'll, I'll, I'll address the challenges question as well. And I know we, we got to that at the end there. But, you know, I think in, in ’23 some of the challenges we face were similar to most funds that are looking to deploy capital is, is navigating a, a difficult financing market to get transactions closed. Um You know, we found that uh timeline to get deals closed was taking much longer than in previous years. And, and we tend to focus in a lot of complex and, and challenged uh corporate carve out situations that have, have a ton of moving pieces and, and they tend to, to take longer than, than they used to. You know, for, for us, you know, one of the challenges we didn't have was, was overall deal flow. You know, the market was, was down certainly across the board. And I think it obviously is relative to the types of transactions, each firm uh is independently looking at from either a sponsor back transaction perspective or um something like us where we spend more time in, in corporate carve outs. But we were actually up just over 30% in, in do year, over year uh compared to ’22. So we had, we had a good, good volume of opportunities on a regular basis. 

Brian: Wow, that's great. 

Chris: Yeah, it was. And I think that, you know, the market shifted, you know, towards us for sure. Uh the complexity in the, in the financing markets obviously kept a lot of, you know, normal regular way, private equity backed transactions on, on the sidelines that, you know, certainly as we'll get to, I think we see an expectation to pick up in ’24. But for us, you know, that led to a lot of complex situations and, and we find that, you know, the carve out market itself, it, it doesn't, it doesn't ebb and flow from a volume perspective as, as much as, as some other categories, but it shifts more from an industry perspective. So, you know, in certain years, we'll see a ton of auto or chemicals or packaging type transactions. And then a year later, we'll see, you know, food and bev and, and oil and gas services and it seems to, to flow more from an industry threshold than it does uh a specific volume or, or ebb and flow based on the the market dynamics. But, you know, we, we think um for ’24 that, that there's a lot of bright spots.

So as mentioned, you know, we raised a new fund. Um so we have plenty of available capital to put into, to new transaction opportunities that we're very excited about. And we're two deals into the fund already. You know, we also have a large co-invest program with our LPs and, and what that allows us to do and when we raise the fund is target, a larger and more sizable transactions and that may be perceived that we can, can complete out out of a $500 million fund. So we punch above our weight, I think from a sourcing perspective and we like deals that are, you know, large and complex from a general thesis and scale is, is really important to us when we look at the, the new set of opportunities that we can go target. Uh you know, how do we, how do we build this? So we, we built this strategically from a sourcing model perspective. So we, we have what we call a dual source coverage model internally Pacific. And what that means to us is we cover the uh corporations directly from a carve out perspective. And also the, you know, all the advisors, the middle market advisors, the bulge brackets and down to the boutique boutique advisors as well. So, you know, in a perfect world. We have uh relationships with one or one or the other party that allow us not to miss a transaction. So, you know, we cover over 2000 public companies. Um We split our business development team up amongst sectors. So we have one individual. Uh Drew Nicoletti who's covering the industrial sphere for us. We another one named Eugene Kim who covers health care, business services, tech and consumer and, and they are regularly reaching out and building relationships um with these corporate heads of M&A, heads of corporate development, the right folks internally that are making these decisions and, and creating these buyers list and, and well, the goal of that, excuse me, the goal of that is to be uh become a trusted partner for these corporate corporations and, and, and understand with credibility that we have to navigate these sorts of complex transactions and, and ultimately, you know, we are introduced to the, the advisors that they choose. And so it, it's, it allows us to have either uh one sided coverage or dual sided coverage. In perfect world you know, we, we talk to a large corporation and they're gonna choose Goldman Sachs as their advisor, for example. And you know, we, we are covered on the golden side and we are covered on the corporate side and uh in, in a less perfect world we're covered on one of them and we don't miss the opportunity set either way. 

Brian: Chris, with that being said, with, with, you know, your firm's experience in corporate uh divestitures and, you know, your, your area focused on that part. How do you view the corporate divestiture, you know, market coming for this year? 

Chris: Yeah, I think we expect it to be pretty strong, you know, we from the conversations we have, you know, I think there's a lot of activity that we expect to see uh from both both the advisory network and specifically from, from the Corporates and in thinking about strategic alternatives. So I think we expect it to be pretty strong, you know, we also expect that the private equity back assets in the market will, will increase dramatically right there, there were, there was a pretty big slowdown in that piece of, of the M&A uh cycle last year and going forward, we expect that that is going to be a big wave of opportunities. You know, we talked to all the advisers and most of them have extremely strong backlogs uh and are just waiting to hit go frankly for the right market conditions for new sets of opportunities. Uh And, and I think the third, the third way is we look at transactions is is unnatural ownership. So, you know, in, in that very much fits in, in a corporate situation where there's a non core nonstrategic business unit that is being carved out for, for a variety of reasons. But it also fits into, um, a founder own business that is in transition and, and maybe there's no succession plan uh in that organization. And they, they look for uh a private equity partner that can help, uh, take them to the next level. Maybe they haven't had any institutional capital invested in the business before it, it could be a, private equity backed business that sits in a, in a prior fund or maybe even two or three funds ago. And, and there's sort of a need to move on from the asset. I think we'll see a little bit of that in ’24 with, with the fundraising dynamics of, of LPs obviously looking to get to get capital returned. I think uh sponsors will, will certainly need to sell businesses that they may have held on to longer uh in, in normal, normal course. But, you know, maybe they are looking at a new fundraise and they need to return capital um to do so. So I think we'll see more of those kind of must be sold, dynamic transactions and then there's, there's other situations where uh the lenders may have taken over the business and it may not be a broken business per se, but it's certainly one that has operational complexity and an unnatural current owner. So we, we look at those as well and I think that's a bigger piece of what we'll see in ’24 but we, we generally expect the market to be pretty active for, for Pacific Avenue. 

Brian: Thanks. That's excellent background on, on that. And you, you touched on a little bit of this Chris, but could you just kind of give a overview of the market with what you saw in 2023 and kind of what your challenges were and kinda, you know, even those challenges, how you were able to also find opportunities in 2023? 

Chris: Yeah, of course, you know, I think for, for, for us 2023 was a, was a good year. Um You know, we raised our debut fund, which is, is a big accomplishment. It's tough financing environment uh has been, you know, publicly documented. It's challenging to get that over the finish line. So we were able to have very good success with that, which is, is a testament to, to the team here. You know, I think from a, from a new platform perspective, you know, we completed one new platform which was a cross border divestiture of a very complex carve out from TotalEnergies. Uh There's three different product lines basically where we had to insert some, some management as part of the transaction and it was, it was extremely complicated. So getting that one over the finish line is, is a good testament to our team and our ability to, to succeed and, and actually transact in in those types of situations. For where we see opportunities and we were able to find them, you know, I, I touched on it a little bit but our, our model is, is dual, dual covered. But, you know, I think we, we inherit, we specifically spend a lot of time with the, the larger uh bolt bracket advisors and, and, and what we find and it's a fair question to say, you know, we are a $500 million fund. How much overlap is there with the, you know, the Goldman Sachs and the JP Morgan of the world. Uh You know, I think that there's quite a bit actually and, and what we find is, you know, those those advisors will, will regularly take on these, you know, larger revenue scale but more complicated corporate divestiture and carve out transactions. And, you know, that allows for an interesting um deal dynamic for a firm like us because generally they're, they're probably smaller processes than some and you know, that they are looking for a buyer who has credibility and can navigate a carve out and, and has proven the track record of doing so. So, you know, we spend a lot of time building relationships with, with the industry advisor, specifically industry coverage uh along with sponsor coverage at these larger banks because, you know, they tend to be smaller processes and, and knowing them personally um across the sectors that we like to play and allows us to get access to some of those opportunities that may be harder to navigate in, in other form. And I think that that's also true of, of the carve out uh and corporate relationship directly. We find that we get unique access to smaller, more bespoke deal processes. Uh Or maybe it's a, it's a boutique advisor that uh spun out of a big bank and, and they have a relationship so that they, they win that mandate. So we, we find a lot of success in that model. And as as mentioned, we were, you know, up just over 30% on deal for a year, over year. So we, we navigated the, the, the markets in ’23 fairly well from, from a sourcing model, but it's, it's still tough and, and look, we, we have a long way to go from a sourcing perspective, but we, we're starting to make headway in the relationships on, on both fronts. 

Brian: That's great to hear, you know, with that being said, I know a lot of these, the investment banks uh have this backlog that almost goes back to last September of 2023. But you know, what are your expectations in this year for 2024? And do you think that there'll be an uptick in deal activity this year? 

Chris: We, we do. And, and I agree, we, we hear that as well that the, the backlogs are extremely strong and that these, these things will come to market. Uh You know, I think we expected January to be a little busier than we found it to be in 2024. You know, I think there's a few of the big conferences and events early in the year that, you know, you have ICR and JP Morgan Health and, and, and Holiday as well. So, you know, we figured the back half of January was when the, the inboxes would start to flood with new opportunities and, and we've definitely seen our fair share, but I don't think we've seen that big wave that I think we expect to uh coming into the New Year. So my guess is it'll be pushed later into, uh you know, February and March and, but we, we feel there's going to be a strong activity level for, for M&A and deal flow overall in, in ’24. Uh And we, we think a lot of that will be driven by private equity backed assets, as mentioned earlier on, you know, sort of the need to sell, um need to return capital and need to raise capital. So I think we'll, we'll get a lot of those opportunities and, and that's fine for us because they can fit in that unnatural ownership bucket as, as we talked about. But I think we'll continue to see uh a heavy load of, of both sets of opportunities in ’24. 

Brian: And when this activity picks up this year, what sectors do you think will be busier than others in, in this coming year? 

Chris: Yeah, it's a great question, Brian. I it's difficult to say from a, a carve out perspective, you know, where to predict activity. You know, you can look at which sectors may be more challenged that may create carve out opportunities for Corporates to clean up um or reorganize their, their, their portfolio. Uh But I think the way we look at it is when we, when we circle back on, on ’23 and we look at where our our sourcing activity came from. You know, we have a few sectors of, of focus going into ’24 that we're excited to spend more time in. So industrial is, is a very big sector for, for us at Pacific, you know, represented nearly 50% of all deal flow that we we sourced last year. So I think there are, you know, a few sectors, health care, business services and, and broadly tech are our focus areas for us in addition to consumers. So we, we brought on a new partner, he joined us uh a few months back and his name is James Oh and he has a, a big consumer background from, from his prior firm. So, you know, we, we are gonna spend more and more time there than, than we did previously. And we're looking at several opportunities now that we're, we're fairly advanced on in that universe. So it, it's difficult to say exactly where it will come from. But I think our, our aim is to really focus in, in those sectors in addition to the industrial world uh to make sure we're, we're rounding out our, our, our level set of opportunity. 

Brian: Yeah, you know, that makes sense. And you know, with the cost of capital, you know, are, are funds kind of resetting their investment uh strategies just given like the volume of M&A deal flow being down, you know, the last couple years? 

Chris: So we, we are not, you know, it's been a tough environment, you know, as we, we started this off with the financing markets have created challenges to get transactions complete. You know, I think we, we certainly haven't reset our strategy. You know, we like businesses in transition and, and complex situations that we spend time on. But I think what it, what it does is it changes, you know, sort of valuation perspectives specifically in more cyclical and or challenging industries. So, you know, things that you, you may have looked at one way um are, are either more expensive or uh more uncertain in terms of navigating how you're gonna uh get that deal over the finish line from a financing and overall valuation perspective. So, you know, look, it's a really competitive market where we play and similar to most, we are, we're constantly adjusting, you know, our approach to, to find ways to, to win transactions. You know, one of the things we, we spent a lot of time recently doing is is linking up with uh buys site advisors in specific sectors that we may not have as much uh specific expertise. So, you know, we are at Pacific are, are, are really aiming to build the firm as um you know, a mutual partner to obviously the the companies we're buying, but also the advisors that we work with to uh to acquire businesses and and regularly engaging them on the buy side. So that when we look at a new asset that we may understand the carve out dynamics um expertly, well, you know, we may not understand the subsector uh dynamics as well. So we, we look to lean on them and, and partner with them and, and bring them alongside as an engaged uh advisor. And then we're also spending a lot of time building out and operating partner network and really leaning on those folks as well that we can uh tap in for, you know, potential CEO roles or, or board seats. But really help us navigate, you know, the, the market dynamics of a specific niche industry that, you know, we may not be as familiar with outside the, the, the carve out and the transaction dynamics. So, you know, we think overall that ’24 it's gonna be a pretty transformational year for Pacific and, and we're working on a number of transactions now that we're very close to getting announced. So we're hopeful that uh those will all come to fruition. 

Brian: That's exciting. Congrats. 

Chris: Yeah, thank you very much. Now, we're, we're, we built a really good team and we're continuing to invest in, in the team here at Pacific to grow and, and, and make sure we don't have any bandwidth concerns from an execution perspective. So, you know, we've really executed well on that, on that. And um you know, we're, we're continuing to look for folks that, you know, fit, fit the Pacific Avenue culture and, you know, want to be a part of a kind of a growing winning team. 

Brian: And I know, you know, last year, there was kind of a gap between valuation expectations I mean, are you seeing valuations, have they reset? I'm just curious how you're seeing that. 

Chris: Yeah, I think they've certainly reset from, you know, 18, 24 months ago. You know, I think the bigger challenge that we saw in, in ’23 was, you know, just the financing markets and, and, you know, what, and, and sustainability of EDITDA, right? I think that's the other point as businesses had had rebounded on the backside of COVID, obviously that was, you know, a number of years ago now, but as businesses have continued to perform, you know, some have have changed completely, some, you know, declined and, and some, it's really understanding, you know, what current sustainability of EBITDA looks like and, and how to navigate that for, for a go forward transaction. 

Brian: You know, in, given the market that we're in, are you guys changing your target returns? I mean, I've talked to a number of sponsors where, and they told me kind of like the first time they're modeling in and they're forecasting lower returns just to provide some liquidity back to their LP. So I was just curious how, how you're viewing, you know, this current environment and if you're, if you're changing your target returns. 

Chris: You know, we certainly haven't. Um You know, we're a young fund in, in, in our uh in our cycle right now, you know, we raised it last year, it closed. So, you know, we're pretty focused on, on the strategy that we have that, that we raised the capital with and, and, and looking at these carve outs and, and divestitures and unlocking value as part of our operational thesis. So we, we certainly haven't, but obviously, we're, we're a different place than some, you know, we're, we're a new fund and, and, and recently raised. So can, can understand, you know, if we weren't that, that could be the case, but for us, we, we certainly haven't. 

Brian: Thanks. That's, that's great to hear. Well, Chris, that's all the questions that I had. And thank you so much for our podcast with Dealmaker Insights. We wish you and Pacific Avenue all the success in 2024. And thanks again for your time here. 

Chris: Yeah. Thank you very much, Brian. Appreciate you having having me on and, and it was great to, to discuss with you and share a little bit about Pacific and, and how we see the world and, and we look forward to 2024 with you guys. 

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