Private Markets 360° | Episode 45: Understanding Success in the Evolving PE Landscape

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Jocelyn Lewis [00:00:01]:

Welcome to Private Markets 360 where we delve into the evolving landscape of private markets and the insights that shape investment strategies. In this episode, we're excited to welcome Bob Belke, a distinguished leader with 26 years of experience at Lovell Minnick Partners. Bob joined Lovell Minnick in its early days in 2000, when the firm was just getting off the ground, and has since played a pivotal role in its growth and success. As the current managing partner, Bob has specialized focus on private equity, asset management and wealth management. His journey began at TIAA where he was part of a direct equity investing group. But he found a unique opportunity at Lovell Minnick to adopt a more specialized approach, particularly in the financial services sector. Lovell Minnick is known for being one of the first outside institutional investors in companies, particularly in the lower middle market where they excel in identifying and nurturing growth opportunities. In this episode, Bob will discuss the unique aspects of lower middle market buyouts, the evolution of the private equity industry over the past two decades, and the critical importance of value creation in today's competitive landscape.

 

Jocelyn Lewis [00:01:24]:

He will also share his insights on the current market dynamics, the need for liquidity among investors, and Lovell Minnick's disciplined approach to investing during challenging times. Bob, welcome to Private Markets 360. It's a pleasure to have you with us today. How are you?

 

Bob Belke [00:01:42]:

I'm doing great, Jocelyn, thank you for having me.

 

Chris Sparenberg [00:01:46]:

We're thrilled to have you. Bob, I think there's no better way to start off this conversation than talking about your career evolution and your time at Lovell Minnick over the last 26 years.

 

Bob Belke [00:01:55]:

Great. Absolutely. So I joined Lovell Minnick in 2000. So 26 years ago. The vast majority of my career has really been spent at Lovell Minnick. Previous to that, I think, as Jocelyn, you mentioned in your intro, I was at TIAA-CREF, which is a large pension fund and I was doing direct private equity investing there for a few years, but really as a generalist. So we invested in, I mean I remember doing deals in. We bought a paper company, we bought a semiconductor manufacturer, we bought multiple consumer products companies.

 

Bob Belke [00:02:32]:

It was an amazing experience for me. But I also realized sort of very early on that as a generalist in the sector you really don't bring much to the table except really money. And I think I got kind of an early glimpse at what the specialist model could really could really do. So I met the founders of Lovell Minick at that time, Jeff Lovell and Jim Minick. And they were really coming at it from the far other end of the spectrum. Extreme specialization in financial Services. They actually came from operating backgrounds in the asset management sector. And I had some prior experience at Wilshire Associates where I worked with a number of asset management firms as my clients.

 

Bob Belke [00:03:26]:

And I saw an opportunity to become a real expert investing in that specialized sector. And it seemed very logical to me that the private equity industry would evolve that way over time, particularly for complex sectors such as financial services. So we raised our first institutional fund that year in 2000. It was a hundred million dollar fund and we're now investing our six funds. So my career evolution really the first 15 years or so at Lovell Minick, I led and executed many deals in our early funds and then the last almost coming up on 10 years or so. I've been a managing partner of the business. I chair our investment committee and, and so today I spend most of my time really working on the portfolio, sort of thinking through the key decisions on buying companies, selling companies, critical things that we might have going on within our portfolio. We own about 25 companies today, maybe just some background on our firm.

 

Bob Belke [00:04:40]:

So we're deep sector specialists in financial services. Our current fund is just over a billion dollars with co investment. We'll invest over 2 billion with this fund. In fact, we've actually closed down almost a billion dollars of co investment with our current fund. Typical deal size for us is going to be EBITDA in sort of the 10 to 30 million range. I really like the low end of that range. And we've been operating there for a very long time. I find that we can really kind of do the most with companies of this size.

 

Bob Belke [00:05:19]:

There's a lot of low hanging fruit. You can institutionalize the platforms, you can expand products and services, you can expand geographies, you can introduce formalize M and A programs. Most of our companies do that. We're also almost always the first outside institutional capital in our businesses. I'd say that's a major differentiator. We will rarely buy from other sponsors. I would say we would typically sell our companies to other larger sponsors. And we've really kind of stayed true to our strategy over many funds.

 

Bob Belke [00:05:58]:

We really like the lower middle market. And I'd say while we've grown as a firm, our typical deal profile hasn't really changed. It's easy to stray and we haven't really done that. And then I maybe just mention some other just signatures to our style as investors. We're highly collaborative, we're known for that. In fact, our sort of, our slogan that we've used now for quite some time is industry experts Collaborative partners. So if you think about our end sectors, we really, we only invest in, in people, businesses and it just requires a very different style of investing right into those types of companies. Culture is critical.

 

Bob Belke [00:06:45]:

We really only do buyouts. It's all B2B, not B2C. We don't really do anything that's directly consumer facing and we don't really do balance sheet heavy businesses. So things like banks, specialty finance, et cetera. Our companies tend to be high margin, high cash flow, low capex. So that should give you a pretty good snapshot of sort of my history and my firm.

 

Jocelyn Lewis [00:07:14]:

Wow, Bob. Well, thank you for walking us through that journey. There's a lot to unpack there and it's really a great context for understanding how both you and Lovell Minnick really evolved together. Hearing that the firm grew from its early days into a highly specialized financial services investor really sets the stage for exploring one of the themes that you've consistently emphasize, which is that power of specialization. So with that foundation in mind, let's shift into how this specialization translates into real value creation across your portfolio companies. So throughout your time at lnp, you've often highlighted that importance with specialization. And could you elaborate on how that enhances value creation within the portfolio companies, particularly in the lower middle market, and what strategies you've found to be most effective in driving growth and operational improvements post acquisition?

 

Bob Belke [00:08:23]:

Yeah, sure. Jocelyn. Happy, happy to address that. Appreciate the question. So yeah, I mentioned at the very beginning, right. We've been deep specialists from the beginning and that's a big advantage because the market has absolutely moved that way and like being a specialist, it just helps in, in so many areas. Right. One, one is just, this is winning the deal, right? It's you need to speak management's language.

 

Bob Belke [00:08:47]:

You really need to understand as much about the sectors and the subsectors that that the companies, the management teams actually understand themselves. Right. You have to speak their language and you can't do that unless really you're truly an expert. Right. Unless you spend all of your time doing it so referenced at the beginning, my experience at TI cref, which was amazing as a young new investor to have that kind of exposure, but. Right. I wasn't gonna become an expert in semiconductor manufacturing and paper manufacturing at the same time. Management is going to pick the party that can help them to grow the most.

 

Bob Belke [00:09:25]:

It won't necessarily be the highest price, sort of depending on who the seller is. It's all about what you can build together going forward. And you know, the industry has just gotten so much More competitive over the years. So today, I mean you can't really win as a generalist. I mean even generalist firms, right, they've scrambled to become multi sector specialists. I don't think anyone today would really even sort of call themselves a generalist, right. They picked verticals, they assign and you know, a major advantage though for us today is really more around how long we've been doing it, right. We have the fortunate history of being early investors in our sectors.

 

Bob Belke [00:10:03]:

And when I look at several of our subsectors, things like wealth management or specialty consulting firms or insurance brokerage, like we were just there very early. And while there might be a number of other firms, you know, playing there today, being there early was helpful. Another area, and you referenced this, right? Value creation, where specialization really matters is what are you going to do with the company once you own it? So we have an advisory council that consists of 30 members today. Nine of those 30 are what we call functional experts. And the other 21 of the 30 are really what we call industry experts, ex CEOs in specific verticals. So when I look at our functional experts, these are people that we can apply across the full portfolio. So we have a, we have an individual who focuses exclusively on human capital for us. And I know that's a topic I think we're going to talk about later.

 

Bob Belke [00:11:08]:

We have an individual exclusively in operations, go to market, in sales, M and a finance and accounting and then a number of folks in tech. Obviously we have an increased AI focus both at our firm and across the portfolio. We have an individual, for instance, that is exclusively focused in cybersecurity across the portfolio. He manages all the threats very close to each of the companies. On that topic, our industry folks, they're all experts in their subsectors. Most are ex CEOs and you just sort of can't build something like that unless you're a specialist. We also recently hired a value we call the role of value creation quarterback. It's an internal role at our firm.

 

Bob Belke [00:11:58]:

It sits on top of all the resources that I just described to really ensure that we're optimizing the matching of the resources with the opportunities, whether it's new deals or whether it's existing portfolio companies. And maybe the last one I would mention on this specialization topic is just deal sourcing, right? It's just another area where being a specialist is a huge advantage. I previously mentioned winning the deal, right? This sort of relates to that. If you're only trafficking in a specific sector, you develop an industry reputation. You can spend all of your time sourcing. There's. We have a proprietary sourcing model that we developed about 10 to 15 years ago that we call our campaign process. It involves creating internal deal teams to develop and execute on these sourcing campaigns.

 

Bob Belke [00:12:53]:

It's a very specialized approach. And so, yeah, I mean I think the market has obviously come this way over all the years, as you would expect. And I think it's been proven generally in the industry that specialized firms do generate incremental alpha in private equity.

 

Chris Sparenberg [00:13:11]:

I'd love to follow that point and specifically about you're being early to investing in wealth management. Just to talk a little bit about what you saw about that segment that was unique, how your approach to investing in wealth management has evolved over time and certainly your outlook for that segment as the market continues to evolve.

 

Bob Belke [00:13:32]:

Yeah, no, thanks for that, Chris. Yeah, we've been early. We were very early in wealth management. We were either the first or certainly one of the first private equity firms to make investments there. It's like it's generally a great subsector within financial services. There certainly are some challenges worth probably talking about in this environment. But if you think about the sector, right, recurring revenues, sticky clients, you also get this natural lift to revenues and to profitability just based on the business model, right. Or if you think about it as tied to markets, overall markets over time do go up.

 

Bob Belke [00:14:09]:

So you get this general appreciation right in your profitability, which is great. Now there's some volatility to that clearly, but over time it's a really nice lift that you get. We've done many deals over the last 20 plus years in wealth management. I think we're certainly recognized as a strong brand name there among participants in the industry, which is an advantage. We invest in a lot of different types of companies here over the years. Fee only RIAs, independent broker dealers, retirement advisors. We had a firm that started as a tax advisor that evolved into financial planning, certainly traditional asset management firms, although we really have done a lot less there in more recent years for various reasons. And then just firms that provide infrastructure and services to the space, the whole ecosystem and the industries.

 

Bob Belke [00:15:10]:

That sector's really evolved, right. There's still a lot of pockets where you can do well. We really like fee based RIAs. Right. That's where the advisor needs to be, a true fiduciary. It's also the fastest growing area of that sector. You know, we currently have two firms that are fee based RIAs. In the portfolio we have a company called Pastone, which today may be the largest independently Owned ultra high net worth wealth management firm.

 

Bob Belke [00:15:43]:

So they focus really on the very large sort of family office market. That and that we did that, we made that investment about five years ago and we've grown it to a sizable company today. And then we have another company called Americana, which is an investment that we made just over a year ago, which is, which is smaller Texas based business. A I would say some of the challenges though in wealth management, I mean one, just the amount of private equity investment that the space has seen. A lot of firms that you might say were kind of generalists and just a lot of firms that made investments there because they viewed it, they recognize it's a very solid sector. And just the valuations today, right. I mean 20 times plus EBITDA multiples are commonplace in wealth management. So really high and it's a maturing industry.

 

Bob Belke [00:16:44]:

Right. Private equities recognize how attractive it is. So how do you play it given these concerns? It's not like it was 15 years ago. What we've done is the idea of starting small. So I mentioned the Americana investment, starting really small where if you're going to grow really fast, you can sort of get comfortable paying 20 times EBITDA. If let's just say you take a company that's 7 or 8 million dollars in EBITDA and you have confidence that in year one you can take it to 12 to 15, your 20 times multiple becomes closer to 10 times multiple very quickly. That's a lot easier to do than buying something that's 50 million in EBITDA where the big guys kind of need to play. And saying you're going to take that to a hundred in one year, you, you really almost can't do that.

 

Bob Belke [00:17:40]:

So it's a good way to play. We're doing some similar things in the insurance MGA space where we're actually, we're creating our own company there. As opposed to paying a high price per platform. We've sort of found a team and we're just acquiring a number of small businesses to build a platform. So that's a way to kind of, it's a way to approach a high priced sector that you have expertise in and still do well in an environment that's pretty challenging.

 

Jocelyn Lewis [00:18:12]:

That's really a great breakdown of how Lovell Minnick approached the wealth management sector and the dynamics shaping the evolution. The opportunities and challenges that you highlighted really underscore how quickly this landscape is shifting not just in wealth management but across financial services more broadly. And Bob, building on that, just wanting to widen the lens and Talk about the broader deal environment with which you're operating in. So what are some of the key factors shaping investment decisions today and how have you adapted the strategy to address the challenges and opportunities that are present in today's market?

 

Bob Belke [00:18:59]:

Yeah, great, great question. It's a really interesting deal environment today. I'm sure you probably had a lot of episodes around this topic, right? I mean, capital flows into the industry are down materially.

 

Chris Sparenberg [00:19:16]:

Right.

 

Bob Belke [00:19:16]:

Fundraising is well off the pace from really the spike of 2021. Now my view is actually that today's environment is actually much more normal when you compare it to the years prior to 2020. I think the outlier was really that boom that happened in starting post Covid. Right late 20, all the way into 2021, into 2022. That period, frankly, it was abnormal and it was not good for the industry. Many GPs raised and invested funds in a really compressed timeframe, one to two years in some cases, instead of maybe the typical cycle of call it three to five years. Many of the deals that were done in that time period were at peak valuations. Massive amounts of capital were deployed and like, it's just, it's a challenge for the industries, can take years to work through it.

 

Bob Belke [00:20:13]:

There were. The leverage on those deals was also just really high because financing was cheap. You know, rates were so low and that's just no longer so to the extent that you had floating rates debt on those companies, that's now a pretty expensive debt. So firms that over deployed during that period are just, they're going to struggle more than those that haven't. I have to put in a little plug for my firm on this one. I think we stayed pretty true to our history. Our vintage years were 2015, that was our fund for 2019, that was our fund five and then 2023 was our fund six. So we had four years in between, which was consistent with our history.

 

Bob Belke [00:21:03]:

We did very few deals in 2021. We really struggled to get things done and in retrospect I'm really happy about that. We stayed disciplined on valuation. That meant our hit rate was just low and we just weren't comfortable with the due diligence cycle that compressed to. It was literally weeks. You had to get something done in weeks instead of months. You couldn't run your process. If you didn't agree to, you know, closing on all the sellers terms in this compressed period of time, someone else would.

 

Bob Belke [00:21:38]:

So it shut us out, I'd say. So relative to that period, the deal market today is. It's just much healthier though most people don't describe it that way. The other side of the coin is it's the realization pace. Right? So there's deployment and then there's realization. Right. Returning money. And you alluded to this, Jocelyn.

 

Bob Belke [00:22:00]:

Institutional investors, they need money back. They're overallocated today, they're demanding money back. If you haven't been consistently doing it over the last several years, frankly it's too late now. It's just much harder in this environment. So dpi, the percentage of your fund that you've returned to investors really is the new IRR. I think we've done this pretty well. The DPIs on our most recent funds are they're really strong actually relative to peers and to benchmarks. So firms that stayed true to their deployment pace during the boom and didn't get caught up in the frenzy, they're going to outperform those that consistently return capital during that same period.

 

Bob Belke [00:22:45]:

They're going to outperform and. But it takes years. It takes years for the sort of the stats to play out. But ultimately DPI doesn't lie is an interesting phrase that I heard a few other stats that I thought were kind of interesting that I'd maybe like to share with your listeners. So the three year return on buyout deals in the US is now high single digits. That's 8.7%. That's the Cambridge number for US buyouts. That's the three year number.

 

Bob Belke [00:23:20]:

Right. Which is. So it's well below the long term industry average, which depending on how you measure all that's pretty consistently, you're going to say it's low to mid teens is the net IRR for US private equity buyouts. So the three year number is like 500 basis points below the longer term average and the five year number is still over 14%. And why is that? It's because it includes all of 2021 and 2022, which were just, they were huge return periods. But what you're going to see when those periods roll off, which is going to be in the next two years, is the industry's probably going to be looking at five year buyout returns, I think in the high single digits because when I look at the next two years, I think it's unlikely that they're going to be these high performing years because you still have a lot of unrealized kind of marks that the industry needs to work through. So if you're talking high single digits for five years, investors are really going to start, I think paying attention to that five years is a pretty long time. And that could have some impact on things like the retail market or the industries counting on those types of those flows.

 

Bob Belke [00:24:37]:

And you're seeing some of this in private credit where I know Jocelyn, you've got some expertise in all the news we're reading about now in private credit in the retail market. But at the end of the day, you know, investors are just becoming much more discerning on the institutional side. Just given the scarcity of capital. They're trying to figure out who the long term winners and losers are. They do remain very returns focused but they also really appreciate those that have returned capital. They just much more credibility to that. And then they're just heavily focused on the processes by which firms create returns, namely their sourcing models, their value creation strategies. And so firms that have stayed cutting edge in those areas are going to be more relevant for the future and those that fell behind will just be more challenged.

 

Jocelyn Lewis [00:25:29]:

I know it's not on the agenda, but one thing to ask you Bob, and we can cut that little statement out there. Need that. I find it really interesting that you mentioned some of those five year returns to be in the high single digits because traditionally that's the return that people would expect on senior secured loans. So do you have any commentary on how that's going to impact some of maybe the rebalancing that LPs then are going to maybe look to do with that being potentially part of the norm as we're looking over kind of the next five years or so?

 

Bob Belke [00:26:17]:

Yeah, I mean I think investors are going to pay a lot more attention to it now. High single digits. I mean I don't think that high single digits is going to be the long term sustainable like new private equity norm in buyouts. I do think it's ultimately higher than that. But I think the numbers are coming down and so invest. I think the retail investors will pay more attention to it because one that's more their experience. Most retail investors haven't been in the space. Right.

 

Bob Belke [00:26:51]:

For the length of time that the institutional investors have been in this space. I think the institutional investors will look through it a bit more. But one of the things you kind of have to keep in mind here is when you think about a long term industry average. Right. Let's say low to high teens. If you think about the investors that really sort of got that, it's the investors that have been in the industry the entire time. If you look at the more recent returns, not only are they a lot lower, most of the dollars actually came into the space in the last 10 years. So the real lived experience for most investors is actually it's at those lower numbers.

 

Bob Belke [00:27:36]:

So I don't project doom and gloom to the private equity industry and I don't want to sort of come off that way. But I do think we will see. Jocelyn A. We're going to see a sort of a RE rating, a bit of a shakeout where we are seeing that right now there are more firms in the industry today than there will be in five years. I'm highly confident in saying that. And you're seeing that shakeout happen. And one, you have to have continued to stay competitive returns wise, that's just critical. And then two, investors today are just so much more sophisticated on the institutional side.

 

Bob Belke [00:28:12]:

They're just going much deeper around. Firms are willing to underwrite and they're looking at things like your sourcing model, your value creation model, your playbooks, management turnover, all those kinds of things at the companies.

 

Chris Sparenberg [00:28:26]:

Also a considerable amount of research out there showing how lower middle market and especially specialist managers outperform larger generalists. So a lot of maybe a confluence of factors there shaping the landscape right now.

 

Bob Belke [00:28:40]:

Yeah, no, you're right, Chris. And when I look at. That's a great point and I know Cambridge has done some of that research. What's interesting about the industry and the evolution of the industry, like if you really take that long term perspective, things that were once innovative years ago, they're just now standard practice. It's like any evolving industry. So 20 years ago in private equity you could buy cheap, you could add leverage and you were going to get returns. At that time, eight times EBITDA as a valuation seemed expensive. I mean I was in the industry, right? I mean I remember turning things down at that time at 8 times EBITDA because they were expensive.

 

Bob Belke [00:29:26]:

Probably turned down some really good deals at that pricing. Ten years ago you had to do things like evolve your sourcing model if you wanted to get proprietary deals done. Ten years ago you had to have a pretty specialized focused sourcing engine as an example. Right? There were still really strong industry tailwinds. Multiples, deal multiples were still expanding at that time. You didn't know it at the time, but it turned out that was true. They were still expanding, margins were generally expanding. There were a lot of tailwinds in the industry and you were going to do well.

 

Bob Belke [00:29:59]:

It was just much more competitive. But today, today it's extremely competitive. And it's really, it's just, it's all about what you do when you Own the company. If you think about where you're gonna get the returns today, you're not gonna get it from traditional multiple expansion. That's now going in the other direction. Multiples, overall industry wide multiples are coming down certainly from the peak. So you can get multiple expansion if you're the first outside institutional capital. You're building a platform, you're accelerating growth, building a bigger business, and you can sell it on the other side with those characteristics.

 

Bob Belke [00:30:39]:

Someone will give you multiple expansion for that. It's not because the overall market has gone that way, it's because of what you've done with the business. But you certainly can't count on it as a general tailwind. And then you say, so what about leverage? Can you get it from leverage? Well, you can get a little bit from leverage, but it's much harder in today's rate environment, right? The cheap leverage is gone. So you might be able to get a little bit of a lift, but you're also, you're taking on a lot more risk with the rates in today's environment. So it has to be about growth and what you do with the company when you own it. And that's. So that's why the value creation discussion that we had earlier now is so important.

 

Jocelyn Lewis [00:31:21]:

Bob, your perspective on how the deal environment evolved and the discipline required to navigate today's volatility really highlights just how much this industry have changed. And what really stands out is that even as firms adapt strategies, sourcing capital differently and leaning more heavily into value value creation, one constant remains is that none of this is possible without the right people. And with that context in mind, let's shift to a topic that you've emphasized throughout your career. And that's the critical role of human capital in driving a firm's long term success. So what do you believe is essential for attracting and retaining top talent in this competitive industry?

 

Bob Belke [00:32:14]:

Yeah, no, that's spot on. I mean, obviously culture is critical, right? We, I think we all know that. But it's amazing how many private equity firms there are today. I referenced it earlier. I think they'll probably be less in five years than there are today. But there's a lot of firms, but also how different they all are in their styles and their approach. So I talked earlier about our style, right? Highly collaborative, very management centric. And that's something that at our firm has really emanated from our original founders.

 

Bob Belke [00:32:51]:

It's been carried forward by myself and the next generation of leaders. But if you want to attract and keep top talent, you Must you have to have a strong organizational culture. So as we only invest in human capital driven businesses, so for our companies, compensation expense is by far the largest P and L line item. So it's, it's doubly critical that we get this right at the portfolio company level. So one of our advisory council members, Ron Garrow. So Ron leads our efforts in this area. He's deeply connected into the chief people officers at all of our approximately 25 portfolio companies. An example of this is we just had a few weeks ago our Chro Summit that took place in Charleston was our second annual Chro Summit.

 

Bob Belke [00:34:00]:

And it's an event where so it's all the chief human resource officers, Chro, I like to call them chief people officers. But in all of our companies they get together, they meet for a couple of days of presentations, networking, social events, they explore best practices on talent, recruiting, retention, compensation, et cetera. And, and Ron leaves that event for us. And it's a great example, I think, of what you need to do to stay relevant and competitive in, in private equity in today's environment. As a side note, we're not only doing those summits in the human capital area, we also just had our first technology summit with the ctos in our space. We're, we've got one that we're planning for the finance accounting function for the CFOs and back to sort of just the industry evolution. Right. Ten years ago I think this would have been pretty unheard of to do something like that.

 

Bob Belke [00:35:02]:

But if you think if you look five years forward, these kinds of things are just sort of table stakes for those firms that are leading in and evolving the industry. But to just sort of wrap on that human capital question. It is the pillar. It's the pillar to what? Certainly what we do as financial services investors.

 

Chris Sparenberg [00:35:23]:

Thank you for joining us for this episode of Private Markets 360, where we had the pleasure of speaking to Bob Belke, Managing partner at Lovell Minnick. Bob shared invaluable insights into the evolving landscape of private equity, emphasizing the critical role of specialization and value creation in achieving investment success. We delved into the unique challenges faced by emerging private equity managers today, including the competitive environment and the importance of adapting strategies to meet changing market dynamics. Bob's extensive experience and perspective truly shed light on the complexities and opportunities present in the private equity space. We appreciate you tuning in and hope you found this discussion as enlightening as we did. Don't forget to subscribe to Private Markets 360 for more expert insights and trends in the world of private investment. Until next time.