U.S. Lower Middle Market Investing
June 02, 2021
In this episode of Engaging Alternatives Spotlight, Elana Margulies-Snyderman, Senior Manager, Publications, EisnerAmper, speaks with Brett Hickey, Founder and CEO of Star Mountain Capital, a New York-based asset management firm focused on the U.S. lower middle market.
He shares with us his views on the U.S. lower middle market, and the various opportunities he sees in making direct investments, investing in credit fund managers and finally, secondary investments in smaller private credit funds. Also, with ESG and social impact top of mind for investors, he discusses how the firm is embedding those into its culture.
Note from Star Mountain Capital: This interview does not constitute an offer to sell or a solicitation of an offer to purchase interests in any fund, note, separately managed account or other product managed. This interview may contain certain forward looking statements, including those relating to future financial expectations. Due to uncertainties related to economic, competitive, governmental, regulatory, or other factors, actual results may differ materially from projected results.
EMS: So Brett, tell us a little about your firm and how you got to where you are today.
BH: We started Star Mountain to try to bring a specialized investment capability to private, small and medium-sized businesses with the view that there are many high quality companies that we could bring large market expertise down to, to create value both for the companies that we're investing in, as well as for our investors that we look to provide institutional quality access into the large fragmented private business marketplace. We are proud to have been in business for 11 years at this point, manage approximately $2 billion in capital as a 100% employee-owned firm, and we have people local in over 20 cities across the United States. Our firm was built really with the idea of the demographics and the market dynamics creating compelling opportunities for private businesses who really are looking for strategic and flexible capital partners where it's not a one size fits all dynamic. And so we've leveraged our experience from investment banking, private equity, private lending and operating experience to bring a packaged capital solution to these businesses.
EMS:Brett, what you're focused on, the US lower middle market, is an extremely hot area right now for investing. I thought you could start off and share your outlook for direct investing currently.
BH:It's a great question. The marketplace, as everybody knows right now, is filled with a lot of question marks. What we really like to focus on, our investment opportunities where we believe there is a strong probability of being able to achieve target objectives. In the larger markets right now, valuations for example, are very high that can make it harder to generate attractive returns and can make it harder to protect capital. As many of us remember the post 2000 market downturn, where markets like the NASDAQ dropped approximately 65% and took nearly a decade for people to get their capital back in various public market strategies. Perhaps today's valuations could have a similar challenge associated with them. And so what we like about the less efficient, harder to access and more complex private lower middle market is that there is a lot less competition and that allows us to target better valued investments, which we think is important when we think about both capital protection and the desires to create attractive, absolute, and risk-adjusted returns.
EMS: And Brett, what about the opportunities you specifically see in secondary investments and smaller private credit funds?
BH:Secondary investing is a strategy where we acquire assets and portfolios of assets at a targeted discount rate where other investors are looking for early liquidity in an e-liquid market. Given that we have approximately 80 people at Star Mountain, over 45 full-time people supported by 35 additional senior advisors and operating partners and have somebody local, we're 20 cities across the United States. It really gives us an edge in evaluating assets and finding private assets. So on a secondary basis, we're able to look in at assets and evaluate what somebody is looking to sell and try to determine if we believe that can be an attractive investment opportunity. And some of the trends that are positive within that include an aging demographic. You have many family offices and other types of investors that might be looking for estate planning, early liquidity and that can often be a compelling dynamic where you have motivated sellers of assets.
And just like everybody I'm sure understands the real estate market and looks at the housing market today as we speak and values are pretty high. Many things are often a function of supply and demand. And so where Star Mountain likes to focus its efforts is where there is a lot of supply of opportunities, but the demand, as far as the capital coming in, is much less competitive because it's so much harder to find these investments, time-consuming to evaluate them and then if you can bring a third angle, which Star Mountain targets, which is to be an active strategic partner, that often creates for a more positive supply demand dynamic, which the aging demographic in the US is helpful for. So that in connection with the fact that the private credit and private equity markets have expanded dramatically over the last 20 or 30 years means you have more investors, more assets, more opportunities to buy assets.
EMS:And Brett, what about some of the biggest challenges you face with respect to your investment strategy?
Brett Hickey: The primary challenge that we think about really comes down to execution. And for me, that's a risk that we like. As you know, I'm not afraid to work hard and growing up in Northwestern Canada, working on the oil drilling rigs for a year to pay for college, then speed skating on the national training team, I'm not afraid to work. One of the things I do find difficult is timing the markets. So for Star Mountain, our focus is less around attempting to time the markets, which most people have found to be very difficult if you look back overtime, and instead really focus on more labor-intensive investment strategies, more required specialization. And that's what brought us into the private marketplace of established small and medium-sized businesses, where the challenge is really about building a great team, making sure that your process and procedures are tight, having strong shareholder alignment of interest. At Star Mountain, the star on our mountain, which is the north star includes shareholder alignment.
A few examples of that include us being 100% employee-owned. 100% of our employees sharing the profits and everybody who is a director and more senior having personal capital invested in our funds so that when our team is out looking at opportunities and managing investments, it's with their own personal capital in mind. And we think that is really a critical part of risk management. In addition to having a large investment in technology, which we've embraced at Star Mountain with a full-time chief technology officer, we're in the process of hiring our ninth full-time person in India and we really believe that having a technology-driven and data-supported information is important to have competitive advantages and evaluating assets. All of which comes down to really building a great team, focusing on culture because at the end of the day, we are a team-centric business.
EMS:And Brett, that leads nicely into the next question I wanted to ask you. With ESG and social impact top of mind for investors, I was hoping you might be able to elaborate on how you embed those two things into the culture.
BH: ESG, as you mentioned, Elana has been something always important to us. And I think now people are starting to more and more understand the benefit of it as well as diversity and inclusion. When we started Star Mountain Capital over 11 years ago, we also quickly launched the Star Mountain Charitable Foundation, which is a nonprofit that's focused on various aspects in the community including assisting mothers and former athletes and veterans building their careers. And one of the things we really love about the for-profit side of Star Mountain is that building better companies, helping create jobs and helping build stronger boards has a natural alignment with the environmental, social, and governance aspects of what I’ll call impact investing - where it's not just about returns, but where one can drive incremental value to society and humanity with it. And then as we get into diversity inclusion, one of the things that has been important for us is really developing talent.
So for example, when we talk about bringing women into the finance industry, 20 years ago it was less the case that certain people were more invigorated to be in private equity. It was harder for them, fewer of their friends were in it and so naturally that's more challenging. So what we found is that in order to really create change, you have to develop and build it and take a long-term approach. So we're pleased to present or report today that over 40% of our team does fall within a diversity metric. And on top of that, we just hired five more full-time junior people through our year-round internship program where we're training and developing talent, and out of those five people, four of them are women and minorities.
And ultimately we think that's the way to drive change, is leading by example, not just hoping there's a quick fix because you also have to run great businesses. And so that's what we think is really critical from that aspect and the same thing from an environmental aspect, and the social, and the governance, when we're telling the businesses that we're investing in, "Here's all the benefits you can have." We believe that leading by example is the right way to really drive change and help them be an enabler, help educate and assist them along their path, which is part of the fun in helping grow high-quality passionate businesses.
EMS:Brett, we've covered a lot of ground today so I wanted to see if you have any final thoughts you'd like to share with us.
BH:Appreciate that, Elana. I think that the main thing that we like to share is that Star Mountain is here as a specialized investment firm to work with privately-owned businesses. So for all the businesses out there, if you have questions around options you have with your business and ways you might be able to strategically grow it, what kind of solutions might there be, you can check out some of our content, including our YouTube channel and our podcasts, as well as reach out to us at firstname.lastname@example.org. We'd be delighted to have somebody speak with you and figure out if there's any ways that we might be able to be helpful, at a minimum, sharing some thoughts and advice with you along with the type of experience that EisnerAmper brings to the clients as well. We think that groups like that, capital partners and strategic accounting and consulting partners like yourselves make for good partnerships with private businesses.
EMS:Brett, thanks for sharing your perspective with our listeners.
BH:My pleasure. Pleasure to be here today.
EMS:Elana Margulies-Snyderman: And thank you for listening to the EisnerAmper podcast series, visit eisneramper.com for more information on this and a host of other topics, and join us for our next EisnerAmper podcast when we get down to business.
Transcribed by Rev.com