Private Markets 360° | Episode 36: The Human Factor in Investing

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Jocelyn Lewis [00:00:00]:

Welcome to Private Markets 360, your insider's guide to the world of private investments. Today we're joined by David Fann, Partner, Senior Managing Director and Head of Investor Relations at VSS Capital Partners. David brings over three decades of executive leadership experience across private equity, private credit, real assets and real estate, having helped organizations invest more than 50 billion for institutional clients and limited partners. From his early days at Citibank to leading roles at apigem Capital, Axia LLC and Tory Cove Capital Partners, David's career has been defined by his ability to navigate evolving markets and build value for investors and entrepreneurs alike. With a deep understanding of structured capital, an innovative niche between private credit and private equity, David has shaped investment strategies that balance risk and reward, empower entrepreneurs and unlock growth in lower middle market businesses. His commitment to partnership, transparency and creative capital solutions sets VSS apart in today's challenging market. Today, David will share his insights into the evolution of structured capital, the changing landscape of private markets, and the critical lessons he's learned in helping businesses grow through uncertainty. We're excited to hear his perspective on building resilient companies, adapting to economic and geopolitical challenges, and the future of investor relations.

 

Jocelyn Lewis [00:01:31]:

David, welcome to Private Markets 360. It's a pleasure to have you with us today. How are you?

 

David Fann [00:01:37]:

I'm doing great Jocelyn, and thank you for that brilliant introduction. I really feel validated now, so thank you for that.

 

Jocelyn Lewis [00:01:46]:

Absolutely thrilled to dive into the conversation.

 

Chris Sparenberg [00:01:49]:

I couldn't agree more. David, we're so happy to have you here. We want to start things off by talking about you and your career journey. You've held leadership roles at several major investment firms. Now you're the head of Investor Relations at vss. You've had so many experiences across the LP and GP spectrum. We'd love to just start by having you walk us through your career journey. And what led you to focus on structured capital and IR at vss?

 

David Fann [00:02:15]:

Chris, that's such a great question. None of us ever anticipate being where we are when we're younger. I started my career at Citicorp Venture Capital which is now CVC today doing buyout transactions and venture capital. And then I was given a leadership role at a large wealth manager where I got to build venture capital, private equity fund of funds, co investment programs and business development companies. And then I was recruited to lead a job at a consulting firm that was doing all aspects of private equity, everything from limited partnership investing to co investing secondaries and so forth. And as you mentioned, a large life insurance company where I had to do some leadership roles as well. I always had the entrepreneurial bug of building something, and so built a couple consulting firms and now given a role at VSS where I could help take the firm from where it's at today to maybe a different level five years from now. So very excited to be at VSS in the investor relations role, I think, is an interesting one today, as you all know, fundraising just become very difficult.

 

David Fann [00:03:29]:

Maybe the hardest fundraising environment since the very beginnings of the private equity industry. It's a strategic imperative for most firms to be able to raise capital. It's existential in many ways. You can't have a firm if you can't raise the money for it to make the investments. I think what limited partners are looking for today are more strategic relationships. And the investor relations role now, I think, really is more nuanced than it's ever been before. Cultivating relationships with limited partners so that they do feel like you're partners with the firm as opposed to just being a passive investor.

 

Jocelyn Lewis [00:04:09]:

Partnership is definitely key and one of the themes that we hear about over and over again with our client base. David. So we couldn't agree more, so really appreciate that perspective. We'd like to have you discuss a little bit about structured capital and how we describe it as a niche between private credit and private equity involving complex deal structures. But how do you define it and what advantages does it offer to entrepreneurs and investors compared to traditional PE or credit solutions?

 

David Fann [00:04:45]:

Excellent question. I describe it as the best of both worlds. The best of private credit and the best of private equity. We sit at this interesting intersection where using the credit elements of the structure, creating significant downside protection for our investors, the limited partners in our fund and having a significant equity ownership, we typically own somewhere between 30 to 60% of the companies we invest in creating the equity upside. So you end up with this asymmetric risk reward. Today's environment, this is compelling for a lot of investors who are looking for the downside protection, the equity upside. But along the way, we also have interest income that helps mitigate the J curve. For the entrepreneurs, it's a way for them to partner with private equity but not losing control of their business.

 

David Fann [00:05:42]:

And we're typically looking for the passionate entrepreneur who really believes in the business plan that they've set out on a piece of paper. And in our discussions, the conversation usually evolves to conviction and passion. If you, you know, the question we ask is if you truly believe in the business plan you just shown us, why would you sell control today when you could make a lot more money partnering with us five years from now with a better outcome. And it turns out to be self selecting. Those are entrepreneurs that don't truly believe in their business model, usually are opting to cash out with a traditional private equity solution. Whereas those that do believe in their business plan and their ability to achieve the numbers on the piece of paper, they're usually embracing the opportunity to work with us because they see how economically fruitful it could be in a few years for them. So I think that's how we position it and I think it's a win win for both the limited partner and the entrepreneur if we could. And creating that alignment is critical and.

 

Chris Sparenberg [00:06:49]:

You'Re doing that while focusing in the lower middle market segment. So a lot of entrepreneur backed companies, a lot of family owned companies, and certainly makes sense considering your own background in investment consulting. I know from my experience in investment consulting that has always been a sweet spot for numerous reasons. Can you talk about more of the unique challenges that some businesses in that segment face and some of the really specific actions that VSS takes to help them unlock value and scale?

 

David Fann [00:07:17]:

Great question, Chris. As the lower middle market tends to be inefficient, there are a lot of companies under $100 million. I think our account is roughly 300,000 companies in the United States. When we're looking at these situations, most of them have not had institutional capital flow into them, whether it be senior debt or equity partner. And so we're typically the first institutional capital into these situations. Management teams tend to be incomplete. They've typically not have done acquisitions before, although they want to. We think there's a lot more opportunity for a institutional investor, a private equity partner, to create value.

 

David Fann [00:08:05]:

I know value creation is a overused term in the industry today, but we truly believe that these entrepreneurs desire to have someone help them build out the management team, extend their product lines, expand their geographic coverage. And part of our business model is to help these entrepreneurs and management teams effectuate three, four or five acquisitions to build up bulk, expand strategically, and along the way increase their operating margin through the use of operating leverage. That typically exists when you're able to expand the revenue base and the product suite. So it's not just being money, I think money is a commodity, but actually being value add and truly value add to those that are seeking it and really have greater aspirations in making a bigger company.

 

Chris Sparenberg [00:09:00]:

And along those lines, could we dig into some of the mechanics? So when VSS is working with entrepreneurs who want to grow that capital, who've chosen you because they don't want to give up majority ownership in many cases. How are you structuring that investment to align interests and to help founders retain that meaningful upside for us?

 

David Fann [00:09:20]:

The founder is typically focused on equity ownership and some cases control. So we're trying to create a flexible capital solution that allows them to maintain ownership to the targets that they're looking for. Most of them are looking for at least 51% ownership where they have control. Our capital can come in as senior debt, junior debt, preferred equity and common equity as well. But typically most of our capital, 80 to 90% of it comes into some form of security that's senior to the common. When it has that downside protection, it usually has a lower cost associated with it. So our senior debt is typically priced at 12%. Our preferred equity is usually with a liquidation preference or a conversion feature.

 

David Fann [00:10:13]:

We're giving them lower cost of capital that participates in the upside. And so that's what creates that structural downside for us. The entrepreneur that is truly passionate about his business and believes in the ability to hit the business plan, the five year business plan, if you will, doesn't necessarily feel that the capital sitting on top of him is punitive. In fact, it is comparable to what he would otherwise borrows money from third parties. He just hasn't been able to do it before. And so it's maybe a lower cost of capital solution in their view. But I think the linchpin for us, the great appeal which causes the partnership to work is his or her belief in our ability to contribute to the team, to making sure he's able to achieve that business plan, helping him or her walk through the mechanics of an acquisition, teaching them how to do it so that they're able to do it on their own, and then giving them the confidence to hire and professionalize some other parts of the team. Usually recruiting a strong VP of sales or marketing or layering in financial controls in a financial system that allows them to generate objectives and manage to key performance indicators.

 

David Fann [00:11:34]:

So it's really helping the entrepreneur institutionalize their platform so they're ready for maybe a bigger event at some point in the future.

 

Jocelyn Lewis [00:11:46]:

David, those are some terrific insights on how you're structuring the flexible deals and keeping the founders engaged and aligned. And that partnership approach really seems important in the lower middle market where businesses often have unique growth challenges. And if we define the lower middle market with 5 to around $15 million of EBITDA, could you please share with us what makes this particular segment attractive and how you Go about identifying these motivated entrepreneurs to be your partners and who are that right fit for for your partnership model.

 

David Fann [00:12:29]:

There are a lot of companies in this segment. I think our guess and I think that various other data sources like the U.S. chamber of Commerce suggest that this is where this is the sweet spot of American business. There are literally hundreds of thousands of businesses between 5 and $15 million in EBITDA. We specifically try to focus on business related services, health care, education. And so that narrows the mix to maybe 100,000 actionable opportunities for us. We have invested in a business development organization whose sole job is to identify these opportunities. We go to a lot of trade shows, conferences, we meet with deal brokers, investment bankers, accountants, lawyers, anybody that might have some nexus to an entrepreneur that is looking for a capital solution.

 

David Fann [00:13:30]:

And so that's what generates the deal flow for us. This last year we saw over 750 investment opportunities. So I think there's a target rich environment for us to operate in as it relates to the entrepreneur and shaping it. I think it's all about the conversation and being a good listener to to in order to figure out whether we're going to be good partners with that entrepreneur. Most are looking for help. Most do have ambitious plans for the business. Being static is hard and, and want having a partner to help navigate through what could be a minefield really important for these entrepreneurs. So in many ways we believe being a partner with the right entrepreneur to craft the right outcomes for them is, is maybe the most important part of our job.

 

David Fann [00:14:31]:

And I think for us it's a matter of not just the psychology of the entrepreneur, but really helping them be a better entrepreneur, creating greater success, such a comprehensive approach.

 

Chris Sparenberg [00:14:45]:

I wonder if you could take us through a few examples from the portfolio past and present where this playbook has been able to fully play out.

 

David Fann [00:14:53]:

There's a real life example that talk about frequently in our organization. It's a company called HFW in the architectural design engineering space. And three entrepreneurs came to us five years ago and said we have a vision to build out a regional architectural engineering design firm focused on large infrastructure projects. So these projects might be a water treatment facility or where the design for a tunnel or a bridge or very large scale opportunities. Maybe one of the tailwinds for this is the decaying US infrastructure. The infrastructure bill that was meant to help the reconstruction of these mission critical activities that state and municipal and federal government was, was funding and continue to fund. We've helped this company acquire over 12 businesses today. It's been able to scale significantly, I would say orders of magnitude.

 

David Fann [00:16:02]:

It's now 50 times larger today than it was when we partnered with them initially. Cash flows have grown commensurate with the revenue growth and that's an example of where we worked with an entrepreneurial team that really had a well defined vision. We worked with them to help identify and execute on an acquisition strategy. They themselves knew a lot of the players that they wanted to acquire and we helped them do that and so many ways, institutionalizing platform, creating scale and really enabling the entrepreneurs to realize their vision of what their company could be.

 

Jocelyn Lewis [00:16:47]:

Thank you for sharing that. David. Looking ahead in today's challenging market, which is really marked by economic uncertainty, compressed valuations compared to maybe a few years ago, and demographic shifts, what are some of the biggest obstacles and opportunities you're seeing for middle market businesses?

 

David Fann [00:17:10]:

It's constantly changing, Jocelyn. We are in a dynamic environment for sure. Obviously we need to have a situation where there's maybe a more stable investment environment. I think that's starting to happen now. Some of the events that happened earlier this year vis a vis shifts in government budget and maybe some of the tariff discussions created a lot of noise in the marketplace and I think to little to some extent paralyzed the marketplace from an M and A perspective. Clearly mergers and acquisitions volume fell considerably this year, a continuation of what's happened last couple years, in fact, and a lot of that is driven by maybe a less favorable interest rate environment. I think if I'm reading what you're reading, interest rates look like they're potentially coming down further, which will be a boon to both private credit and private equity. So I'm quite optimistic about what 2026 will bring.

 

David Fann [00:18:10]:

I think a more favorable interest rate environment, coupled with the amount of dry powder out there on both the private equity and private credit side, will celebrate. Deal activity in 20 relates to structured capital. I think there are certainly more entrants today. The idea of rescue capital or structured equity or Tunis credit funds, I think a lot of them overlap with structured capital. The way we execute upon it. Most of those pools are much larger. But I do feel like structured capital is becoming an asset class unto itself. I know one investment consultant has actually created a whole research team focused on structured capital solutions as it relates to a subset of private credit.

 

David Fann [00:19:03]:

So I think it's becoming a legitimate segment of the market. Obviously that suggests that there's going to be more entrants and it's going to get crowded. But I think the niche we sit in, the lower middle market, non sponsored transactions still relatively unique and most likely most entrants don't necessarily want to go down that deep because it's really hard to find these businesses and requires quite a bit of resources to help smaller businesses get larger. So I think we're sitting in a defensible niche with some moats, but I think structured capital becomes a more legitimate, institutionalized place for other funds to operate.

 

Chris Sparenberg [00:19:49]:

We want to shift gears here and talk about your role in investor relations. And I have to say the two things are so deeply interlinked. I imagine you spend a lot of time talking to current and prospective investors about vss, your strategy, your portfolio companies. So we'll frame this question a little bit differently. Can you talk to us about how VSS is evolving its IR function and reporting practices? You're likely seeing greater demands for transparency. Data driven insights from LPs. What are you doing within the firm to address those?

 

David Fann [00:20:20]:

Chris Wonderful question. When I started building my investment consulting firm a few years ago, one of the key challenges that limited partners were facing was the degree of opaqueness in the private equity industry. They felt like they were investing in a blind pool and they truly were blind to what was happening in the portfolio. They just didn't have a sense of performance on a portfolio company basis. And then a couple of shocks happened to the system where some of us still remember the great financial crisis and some of us with more gray hair or no hair remember the dot com crisis. These shocks propel investors to think about risk management and how they quantify that risk, whether it's by sector exposure or geographic exposure, currency exposure, whatever, manageable risk and something that they just weren't able to quantify. Obviously there is this six sigma problem, the right tail problem, which none of us could really manage to but but a lot of the things that were happening in the portfolio, even constructing the portfolio, were important things to the limited partners that they are looking for information on that requires more transparency for the general partners, especially as private equity and private credit venture capital become larger parts of the institutional portfolio through the asset allocation. I think Once you exceeded 5% it took note LPs took notice on exposures.

 

David Fann [00:22:01]:

This requires a generation of reporting tools that provides limited partners transparency into the underlying portfolio. Companies I know you all have been working on some ideas around this. It is important for general partners to be responsive to limited partners and being able to provide insightful aspects of information typically aggregated to allow a limited partner who's maybe managing hundreds of positions to understand exactly what their exposures are to segments of the marketplace I think sometimes private equity reports get combined with public equity reports to assess things like exposure to consumer or exposure to financials or exposure to energy companies. I think when you're a CIO or a board of directors, you want to understand the aggregate risk. And so this is causing all of us in the general partner side to integrate better reporting tools that allow limited partners to have real time information so that they can make smarter decisions about their portfolios, whether it's strategic or tactical. So I think there's just going to be more pushed for private equity and private credit transparency.

 

Jocelyn Lewis [00:23:24]:

We couldn't agree more and definitely think that bringing transparency from the private markets really will drive some of that just knowledge sharing and better understanding, just like you mentioned, to drive decisions, but also have people understand what exactly are the private markets and what are the mechanics that are shaping some of these outcomes. Just allowing for people to get that information in their hands, I think will be a change that we'll see over the next few years. And David, we'd also love to know what trends shaping the future of structured capital and private markets investing in general, and how VSS is positioning itself to capitalize on these changes.

 

David Fann [00:24:14]:

One thing I've recognized in my career is innovation is constant. I think when the team at VSS began utilizing a structured capital approach to investing, they were relatively unique. Very few firms were doing this. I think we're going to obviously see the rise of more evergreen funds. That phenomenon is happening. The regulatory change allowing retail investors and 401ks to invest in private assets. That that clearly, if that takes hold, that will clearly create a new set of investors. But that will require product Design to allow 401k and IRA investors to participate.

 

David Fann [00:25:02]:

But I presume smart people are working on that because it is one of the holy grails of the investment world, unlocking retirement capital, not just public pension funds, but personal retirement capital to participate in private credit and private equity. For us, I think we'd love to defend our niche and keep everybody out, but recognize that that's probably not an achievable feat. Capital flows to where returns are and we've been good beneficiaries of attractive rates of return. So we fully expect to have more competition. With that said, I think private equity investors, private credit investors will pivot and maybe this becomes structured capital becomes more of a global phenomenon. Right now it's largely United States, but it may be expands internationally. I think the idea of lenders becoming more active is in my mind an interesting idea. Lenders have been historically largely passive and reliant on sponsors to help drive value.

 

David Fann [00:26:07]:

But I suspect more lenders are contemplating becoming more active. I think there's a lot of opportunity for structured capital to evolve into maybe a subset of growth equity. So I think the future is wide. I think it's a blank piece of paper and there's going to be a lot of innovation that takes hold in the next five, 10 years. I think there's no shortage of smart folks in the private equity private credit businesses and they're constantly tinkering with ideas and and so I'm just happy that I've been able to be a participant. In many ways I feel like I've been the for scum of the private equity and private credit businesses and being able to watch how the world unfolded over the last couple decades.

 

Chris Sparenberg [00:26:49]:

What a great way to frame it.

 

Jocelyn Lewis [00:26:51]:

Yeah, I love that. What a great front row seat to have.

 

David Fann [00:26:54]:

Thank you.

 

Chris Sparenberg [00:26:55]:

Thank you for joining us for this episode of Private Markets360 where we had the pleasure of speaking with David Fann, Partner, Senior Managing Director and Head of Investor Relations at vss. David shared invaluable insights into the evolution of structured capital, the unique needs of lower middle market businesses, and how VSS is helping entrepreneurs unlock value and scale through flexible creative capital solutions. We explored the challenges and opportunities facing the market today, from compressed valuations and economic uncertainty to the growing demand for transparency and data driven decision making. We hope you found this conversation as insightful as we did. Don't forget to subscribe to Private Markets 360 for more expert perspectives and trends shaping the world of private investments. Until next time.