Middle Market Private Equity Outlook

MOMENTUM 2016

Middle MarketPrivate Equity

OutlookA 2016 CohnReznick LLP Report

mo • men • tumnoun: impetus and driving force gained by the development of a process or course of events

Regulatory Issues ...6

A CohnReznick Report 3

Industry Overview ........................................................................1

Strategies for Success in 2016 .....................................................2• Deal Strategies ...................................................................................... 2• Digital Strategies ................................................................................... 7• Regulatory Strategies ........................................................................... 9• Diligence Strategies ............................................................................ 10

Conclusion .................................................................................13

Regulatory Issues ...6

Table ofContents

As we move forward into 2016, there are many unknown factors ahead for the private equity industry. How will interest rate hikes impact the markets/economy and how many more times will the Fed raise rates? How will the buildup to, and outcome of, the presidential election infl uence the fi nancial markets? What does an economic slowdown in China or other nations mean for investment opportunities both at home and abroad?

These ever-changing dynamics will present private equity players with both challenges to navigate and opportunities to seize over the next 12 months.

CohnReznick’s 2016 Middle Market Private Equity Outlook analyzes the key issues and activity drivers that will most likely impact the private equity industry in the coming year. Driven in part by fresh perspectives on longstanding issues, as well as new insights into game changing developments, this report identifi es the emerging trends, opportunities, and challenges on the horizon that will inspire private equity fi rms to embrace new strategies and compete more effectively.

Although it is impossible to predict precisely what the year ahead will bring, we expect to see increased momentum in the private equity sector. This report highlights the issues that will gain traction in 2016, and provides strategic ideas to assist middle market private equity fi rms as they adapt to a constantly evolving business environment.

Jeremy SwanPrincipalNational Director, Private Equity and Venture Capital Industry Practice

Preface

January 2016

Jeremy Swan


William Shakespeare said it best: “What’s past is prologue.” The past helps defi ne the present and sets the stage for the future. So, to assess what may happen in the private equity industry in 2016, it is fi rst necessary to understand what transpired in 2015.

Beyond a doubt, the story of the year in private equity was soaring valuations. Fueled by a potent mix of ultra-low fi nancing costs and a highly competitive M&A market, valuations climbed to new heights in 2015, reaching record levels of 16 times EBITDA in the U.S., according to Thomson Reuters. In fact, the valuation story for private companies is in stark contrast to what is happening in the public markets, where prices are softening. Some companies, like mobile payments provider Square, even saw their valuations plummet once they went public. Square’s initial IPO share price of $9 put its valuation at $2.9 billion—half of where the company was priced at an earlier private-fi nancing round. Shares ultimately closed at $13.07 on the fi rst trading day.

While many middle market private equity investors had a diffi cult time justifying the towering multiples, the same could not be said for cash-rich strategic acquirers who pushed deal prices beyond the reach of many PE buyers. Home Depot, for instance, recently outbid several PE fi rms in its $1.63 billion acquisition of Interline Brands, Inc.

The fi erce competition from strategic acquirers resulted in a steep decline in overall private equity deal activity. Just 5% of the $2.6 trillion in deals announced as of August 2015 were private equity backed, down from 9% over the same period in 2014, and the lowest percentage for any similar period in 14 years, according to data from Dealogic.

But that is not to say that middle market PE fi rms sat idle last year. Instead of buying companies, many PE shops were busy taking advantage of the seller’s market and preparing their portfolio companies for exit.

“PE fi rms were selling everything that was not nailed down,” said Jeremy Swan, National Director of CohnReznick’s Private Equity and Venture Capital Industry Practice. “If you look at our transaction business, historically it has been 50% buy side and 50% sell side, and as high as 75% buy side and 25% sell side in some years. But last year, the majority of our work was sell side. We saw a real shift in the market. So while it is a tough time for PE fi rms to get deals done, it is an opportune time for them to exit portfolio companies.”

IndustryOverview

Momentum 2016: Middle Market Private Equity Outlook2

Strong strategic planning is critical to success in the private equity industry. Here are a number of strategies that forward-thinking PE fi rms should consider implementing to help ensure they remain at the top of their game in 2016.

Deal Strategies

Strategies for Success

in 2016

Become the Buyer of Choice

In 2016, middle market private equity fi rms will need to hone their origination and acquisition skills. With piles of dry powder—or uninvested capital— still waiting to be put to work, it is reasonable to expect an overall increase in deal activity in 2016. However, to win more deals, PE fi rms should focus less on the auction process and more on driving their own proprietary deal fl ow. And, if they are involved in the auction process, they must develop strategies to position themselves as the “buyer of choice” to win those deals.

“In today’s active M&A market, you have a lot of different parties looking at the same assets,” said Swan. “To compete, PE fi rms really need to

differentiate themselves and become the buyer of choice, even if they are not fi nancially the highest bidder.”

For PE fi rms, differentiation can mean developing and executing with deep expertise in several key industries, and staffi ng their fi rms with experienced personnel with deep industry knowledge who understand those markets inside and out. These fi rms can potentially uncover superior opportunities, generate proprietary deal fl ow, and provide more effective advice and connections to portfolio companies, especially compared to their non-specialized competitors.


Specialization is particularly important to sellers that plan to retain an ownership stake in the business and want to partner with a private equity fi rm that can add the most value post-transaction. Entrepreneurs and business owners are increasingly eager to team with PE fi rms that can quickly leverage their industry knowledge and make an immediate impact on the portfolio company.

“PE fi rms will need to differentiate themselves in 2016 by showing they are not just bringing capital to the table, but are also bringing value-add from a strategic perspective,” said Swan. “To position themselves as the buyer of choice, PE fi rms must bring a laser-like focus to a particular industry or sector, and they must take a more operational role to drive the growth of their portfolio companies, involving themselves like never before.”

Hunt for Proprietary Deal Flow

PE fi rms that want to be successful in 2016 should not only focus on differentiation, but also on sourcing deals outside of the auction process. “With valuations at or near record levels, it’s more important than ever for PE fi rms to really focus on driving proprietary deal fl ow,” said Swan.

Sourcing new and proprietary deals will continue to be one of the industry’s most signifi cant challenges in 2016, attributable in large part to the massive amounts of capital chasing a smaller number of quality opportunities. As a result, savvy PE fi rms are increasingly networking with industry leaders and building relationships with target companies that may not yet be ready for an investment today, but could be looking for a private equity partner several years down the road.

Additionally, the best fi rms are building up their internal business development and deal sourcing functions in an effort to leave no stone unturned. “Five years ago, only about 10% of the top quartile funds had an internal deal origination function,” said Swan. “Instead, they relied on referrals from investment bankers and on auctions. Today, more than 40% of those top fi rms have a formalized process for deal sourcing. They have seen the need to spend time and money developing that function in-house.”

He adds that PE fi rms will continue to feel pressure from limited partners (LPs) to fi nd proprietary deals and put money to work at reasonable valuations. “The LPs want to invest in fi rms that have an internal deal-generation engine and are uncovering their own deal fl ow,” said Swan. “LPs are often less interested in fi rms that solely compete in auctions and overpay to win deals.”

JEREMY SWAN, Principal, National Director, Private Equity and Venture Capital

Industry Practice

”

With valuations at or near record levels,

it’s more important than ever for PE fi rms

to really focus on driving proprietary

deal fl ow.

“


Target the Baby Boomers

Baby boomers are turning 65 en masse. Every day, 10,000 boomers hit the typical retirement age of 65. That is four million a year. Many retiring baby boomers are business owners. In fact, boomers are a generation of entrepreneurs. More businesses were founded by people born in the years 1946-1964 than any generation ever. A whopping two-thirds of all businesses with employees are owned by baby boomers.

As boomer business owners retire, they must decide what to do with the businesses they have built. In generations past, succession was straightforward. The majority of retiring owners simply handed off their business to the next generation. But baby boomers tend to have far fewer kids than their parents did. And many children of boomers are simply not interested in taking over the family business.

Still, boomers take great pride in their businesses. They want to ensure their companies are handed down to competent new owners who can continue the tradition of success. “Many middle market businesses have been in the same family for generations and the owners really care about the business ending up in the right hands,” said Swan. “They are concerned about bringing on the right partner from a fi nancial and strategic perspective. They want a buyer who will take the business to the next level, but who also cares about the employee base and is committed to keeping the business in the same geography and community.”

DAVID RUBIN, Principal, Risk and Business Advisory

National Director

”

Going forward into 2016, CFOs need to lead the charge as they transform the

fi nance department from a purely transactional role to one that is creating

tangible value for the business.

“PE fi rms should pay special attention to these boomer businesses in 2016 as they could prove to be a signifi cant source of deal fl ow. “Owners, of course, are focused on sale price, but they are also attaching value to the less quantitative and more qualitative benefi ts that PE fi rms can provide,” said Swan.

Focus on the CFO

In the current seller’s market, middle market PE fi rms are being forced to pay a premium for deals, or risk losing out. So how can they justify paying prices they know are exorbitant?

“To realize value in the face of higher multiples, you need to have greater effectiveness in the way you operate the business and draw value out of the business,” said David Rubin, a Principal with CohnReznick Advisory and National Director of the Firm’s Risk and Business Advisory Practice.

One way to achieve that is by demanding an enhanced level of support and service from the fi nance function. PE fi rms are expecting more from the CFOs of their portfolio companies. Specifi cally, they want fi nance departments that are not only skilled at accounting and bookkeeping, but can also partner with the C-suite and add strategic value to the business.

“Going forward into 2016, CFOs need to lead the charge as they transform the fi nance department from a purely transactional role to one that is creating tangible value for the business,” added Rubin. “This means that middle market PE fi rms should champion CFOs who really understand the cost drivers and revenue drivers of the organization and know how to leverage those drivers to create more effi ciencies.”

With a strong CFO function in place, PE fi rms can gain a higher degree of confi dence in their acquisitions, even if they are paying multiples that exceed their historical comfort zone. “We have seen PE fi rms shut out of deals because the high valuations did not conform to their fi nancial models,” explained Mario Pompeo, who leads CohnReznick’s CFO Advisory Practice. “But, in many ways, 2016 could be the year


of the CFO. With an effective fi nance and accounting organization led by a CFO focused on lowering costs, increasing revenue, managing risk, and creating value, PE fi rms can take on an adjusted level of risk and even justify a higher purchase price.”

Overcome Integration Issues

PE fi rms frequently acquire a platform company and then make numerous add-on acquisitions to quickly grow the business. Often, however, the integration of these companies is not well thought out, which could hurt operations down the road. “It’s not just private equity,” said Swan. “Across the spectrum, 50 to 80% of all acquisitions that fail do so because the companies are not well integrated.”

For example, it was previously common practice for private equity buyers to examine a target company’s IT infrastructure only after the deal closed. But this often led to unforeseen expenses as PE fi rms realized too late they would have to invest in new hardware, software, and services to scale the acquired business and make it more competitive in the marketplace.

“PE fi rms are advised to start thinking about the integration process very early on, well before they consummate an add-on acquisition,” said Swan. “As part of the diligence process, they should be planning how the company’s accounting systems, fi nance teams, and IT platforms will be consolidated.”

When conducting IT due diligence, private equity buyers should ensure that all business systems, including customer support, manufacturing, and HR applications, are modernized, well-implemented and integrated. “From the moment the deal closes, the business needs to be able to start running on a combined basis—including an integrated IT platform,” said Swan.

Portfolio companies that are well integrated will achieve the greatest level of success and, ultimately, generate the highest returns in 2016.

JEREMY SWAN, Principal, National Director, Private Equity and Venture Capital

Industry Practice

”

From themoment the deal closes,the business needs to beable to start running on

a combined basis—including an integrated

IT platform.

“


Make Valuations Transparent for LP Investors

LP investors are paying close attention as valuations are on the rise. They want to stay abreast of the value of the PE fi rm’s portfolio investments. In 2016, PE fi rms will need to be more transparent than ever regarding valuations and should follow a consistent portfolio valuation process.

“PE fi rms are gradually progressing to more rigorous portfolio valuation procedures as investors are depending on accurate full disclosure,” said John Bautista, a Principal with CohnReznick’s Valuation Advisory Services Practice.

Rigorous valuation procedures are critical for communicating clear and consistent information to LPs. Many PE fi rms handle portfolio valuations themselves. However, GPs are not necessarily in the best position to determine what a particular investment is worth. Implementing an objective portfolio valuation process often starts with an independent external valuation service provider that specializes in portfolio valuation who can help a PE fi rm devise clear and consistent portfolio valuation procedures.

A key benefi t to an external valuation is that it could eliminate certain biases of portraying the PE fi rm more attractive to potential investors. Additionally, the Securities and Exchange Commission (SEC) is taking a close look at how the PE industry values its portfolio companies, especially as fi rms raise new capital and market their funds to investors.

“In 2016, the onus will be on PE fi rms to provide a greater level of transparency, consistency, and rigor in their valuation processes and procedures as LPs and the SEC are depending on accurate full disclosure,” said Bautista.

Prepare for Non-Traditional Players

Competition for private equity transactions from non-traditional players such as family offi ces is on the rise. As these parties grow in size and power, they are searching for new opportunities that can earn ever-higher returns. In 2016, one of their preferred strategies will be direct investment in private equity deals.

Underscoring this trend was the acquisition of Keurig Green Mountain, maker of home and offi ce coffee brewing systems, by the Reimann family for $13.9 billion. The deal caught many by surprise, as did the price tag, which was a 78% premium over where the stock had traded. This secretive family has amassed a consumer products empire that includes such brands as Jimmy Choo shoes, Durex condoms, and Peet’s Coffee & Tea.

“Given the growing direct investment capabilities and desire for increased returns of these family offi ces, we expect to see increased competition for private equity deals in 2016,” said Swan.” Private equity fi rms will have to increase their fl exibility as they compete for new deals. However, the impact on the industry could be higher valuations as well as more money chasing fewer quality deals.”

JOHN BAUTISTA, Principal, Valuation Advisory Services Practice

”

PE fi rms are gradually progressing

to more rigorous portfolio valuation procedures

as investors are depending on accurate

full disclosure.

“


Digital Strategies

Drive Performance Through IT and Data Analytics

These days, every company is a technology company, and private equity fi rms are no different. It is increasingly imperative for middle market PE fi rms to explore and implement digital strategies that can dramatically improve business. That is why, in 2016, many private equity players will place a greater reliance on IT and data analytics—both within their own operations and those of portfolio companies—to enhance performance and generate higher returns.

“These days, PE managers are relying less on fi nancial engineering and focusing more on operational improvements to drive growth and create value,” said Dean Nelson, a Principal with CohnReznick Advisory and National Director of the Firm’s Technology and

Strategiesfor Success

in 2016

Digital Services Practice. “They are increasingly investing in data analytics to better understand their own business as well as to help their portfolio companies better understand customer behavior, control costs, and make smarter decisions.”

For instance, a PE fi rm that owns a large retail chain with thousands of locations can leverage analytics to learn which similarities are shared by the top 10 stores in that chain. What is the secret sauce? Which attributes do the best-performing stores possess and how can those attributes be instilled in other locations? Analytics can reveal patterns and behaviors that lead to game-changing performance.


“There is still a tremendous need at the fund level for better collection, coordination, and analysis of data coming up from the portfolio companies,” said Swan. “In 2016, the burden will be on private equity investors to make technology a priority and help portfolio companies turn their mountains of information into meaningful insights. That is how big data can lead to even bigger returns for private equity.”

Tech-savvy PE firms are also paying greater attention to the overall IT infrastructure of their portfolio companies. They understand that a solid information technology foundation is often the mark of a well- run business—and a signal that an investment will be successful.

“A cohesive IT strategy can help PE firms make better investments, grow their companies more effectively, and leverage strengths across the entire portfolio,” said Nelson. “For instance, if a PE firm has a portfolio company that still operates a data center, it should analyze whether it makes more sense to outsource that function to the cloud for a fraction of the cost.”

Take a Bite Out of Cybercrime

Cyber breaches are very likely to increase in size and scope, and PE firms and their portfolios should prepare for the worst in 2016. That’s because, when it comes to preventing cyber threats, private equity firms are generally well behind other companies. Though cyber breaches have a direct cost on business, many PE firms are not proactively combating these threats.

Ironically, the private equity industry has an enhanced cyber risk profile, making it low-hanging fruit for hackers. “Cyber risk is proportional to the value of data, and PE firms possess critical deal and investor information that makes them especially attractive to hackers,” explained Jim Ambrosini, Managing Director at CohnReznick Advisory who leads the Firm’s Cybersecurity Practice.

He noted that PE firms possess valuable data about their portfolio companies, as well as businesses they are thinking of buying or selling. All of this data is

very valuable not just to organized crime but to competitors and opportunistic hackers. “All it takes is one breach to ruin a firm’s reputation and lose future LP commitments,” added Ambrosini.

Indeed, breaches at the fund level can shake investor confidence and impact the firm’s ability to raise new funds. Ambrosini strongly advises that private equity firms make cybersecurity an ongoing process that becomes part of their business strategies and risk management policies, and that they weave it into the diligence process.

These actions will be vital in 2016, especially as the SEC embarks on a campaign to proactively assess the cybersecurity preparedness of PE firms and hedge funds. CohnReznick believes the SEC is poised to dramatically expand its scrutiny of PE firms and their security practices. In fact, one thing is very clear when looking at the cybersecurity guidance for registered funds and advisers issued by the SEC in April of 2015. The SEC means business and expects firms to have controls in place to protect, detect, and recover from cyber-attacks.

Still, despite being put on notice by the SEC, very few PE firms are taking concrete action. This could be a fatal mistake. “A breach at the fund level could have a catastrophic impact,” said Ambrosini “Firms really do need to rethink their approach to cyber and elevate it to the level of business risk that it deserves.”

As a first step toward cyber preparedness, firms should classify their data into categories of high, medium, and low risk. They should also set about understanding where each piece of data resides and who has access to it, and then put in place a series of checks to ensure that only approved personnel have access to sensitive data. They should also understand the many ways a hacker might try to gain access to that data.

“It is incumbent on firms to implement a comprehensive approach that can help them prevent and recover from potential threats,” said Ambrosini. “Cybercrime will only get worse in the months and years ahead.”


Regulatory Strategies

Prepare for the New Era of Compliance


in 2016

Now that the vast majority of PE fi rms must register with the SEC as registered investment advisers, the regulatory burdens are far greater than any time before. In fact, many LPs have introduced new processes to match the increased focus of the SEC on private equity investments. CalPERS, for instance, is now conducting on-site compliance visits, which it had never done before. Middle market PE fi rms can meet the challenges of increased scrutiny by ramping up their compliance procedures.

“For starters, PE professionals should consider developing robust internal controls and ensuring their limited partnership agreements are fully transparent regarding fees and expenses,” said Jay Levy, a CohnReznick Partner and Financial Services Industry Practice Leader. “Fund managers are advised to form an internal advisory group to review and approve specifi c fund-level activities in accordance with LP agreements.”

It is also critical for PE fi rms to set the regulatory tone from the top. This means putting in place a chief compliance offi cer who takes the role seriously and is not simply in the position by default. This person should be well versed in all the rules and regulations impacting PE and must have the power to ensure the fi rm is doing (and documenting) exactly what it says it is doing.

“A culture of compliance will be crucial in 2016,” said Chris Aroh, a CohnReznick Partner and a member of the fi rm’s Financial Services Industry Practice. “Private equity fi rms have spent years and years building their reputation by delivering solid returns to their investors. To have that taken away overnight because of a compliance breach—that would be devastating. It is one thing to hire smart and honest people, but it is quite another to have a tone and culture of compliance throughout the organization.”



in 2016

Diligence Strategies

Enhance the Diligence Process to Win Deals

Sharon Bromberg, a Partner in CohnReznick Advisory, has seen clients get very excited about winning a deal—only to see them lose it at the last moment. “Pricing keeps climbing and deals today are very competitive,” she said. “You think you are at the fi nish line and then someone else comes out with a higher bid. That has happened on many occasions recently.”

So how can PE fi rms win more deals in 2016? One way is through better diligence and preparation.

A component of this preparation includes a growing trend to eliminate escrow provisions in the sale purchase agreement and for the parties to take out rep and warranty insurance. Typically, the seller bears the cost of such insurance.

“Several investment banks, as part of their preparation process, are obtaining preliminary estimates and terms for rep and warranty insurance to make the overall closing process more effi cient” said Claudine Cohen, a Principal and member of CohnReznick’s Transactional Advisory Practice.

Buyers are advised to plan properly—including having their fi nancing in place, their diligence team organized, and their letter of intent (LOI) in order—or risk losing deals. “The LOI forms the backbone of the deal terms, so it needs to be as specifi c as possible,” said Cohen. “We are seeing letters of intent that are much more comprehensive than they have been in the past.”


“

Employ Sell-Side Diligence to Speed Up Deals

Sourcing new deals has become more challenging due to a larger amount of capital chasing a limited number of quality deals. As a result, PE fi rms are actively moving downstream and targeting smaller companies. Indeed, fi rms that once only looked at businesses with at least $10 million of EBITDA are now, in many cases, evaluating those with $5 million of EBITDA or less.

That is one reason why sell-side due diligence is gaining in popularity with middle market private equity fi rms. It can expedite the sales process by providing buyers with an in-depth report on the fi nancial and operational health of potential targets. This is especially important when acquiring a smaller company that may have under-invested in its own fi nance and accounting operations.

A sell-side diligence report is an opportunity to provide every potential buyer at the table with a set of information from which to move forward. It is a very useful document because it enables both the buyer and seller to avoid surprises, while minimizing disruptions and increasing the likelihood of a successful transaction.

“Our sell-side diligence practice has grown rapidly as middle market PE fi rms have come to realize there are signifi cant benefi ts here,” said Cohen. “We fully expect the momentum to continue into 2016.”

Private equity fi rms, in particular, are discovering the many advantages of sell-side diligence for their own portfolio companies. They are increasingly requiring portfolio companies to conduct their own internal diligence as a way to prepare management teams for the sale process and for the questions they will ultimately be asked by buyers.

“For private equity buyers, sell-side diligence offers greater insight to the business and its fi nancials and operations. This helps raise the trust level and willingness to do the deal,” added Margaret Shanley, a Principal at CohnReznick and National Director of the Firm’s Transactional Advisory Services Practice. “These reports can really make the process so much easier for the buyer and can actually lead to some deals closing in half the time.”

For privateequity buyers, sell-sidediligence offers greater

insight to the business and its fi nancials and operations. This helps raise the trust level and

willingness to do the deal.

MARGARET SHANLEY, Principal, Transactional Advisory

Services PracticeNational Director

”


Don’t Turn a Blind Eye to Corporate Crime

On September 9, 2015, the U.S. Department of Justice (DOJ) released the “Yates Memo” calling for a substantially increased focus on individual accountability for corporate wrongdoing. In other words, the DOJ is moving beyond handing out corporate fines and is now getting serious about putting white-collar criminals behind bars. The memo’s author, Deputy Attorney General Sally Q. Yates, has said that the DOJ’s mission is “not to recover the largest amount of money from the greatest number of corporations,” but rather, “to seek accountability from those who break our laws and victimize our citizens.”

The Yates Memo is an eye-opener not just for the C-suite, but for PE firms as well. After all, if the DOJ is now targeting individual wrong-doers, PE firms have to be more vigilant about the companies they acquire. “If the leadership of a portfolio company comes under increased DOJ scrutiny in light of the Yates memo, portfolio value could be negatively impacted,” said William Monks, a Director with CohnReznick Advisory focusing on corporate investigation and anti-corruption services. Monks is also a former Special Agent of the Federal Bureau of Investigation specializing in white-collar crime.

Monks believes the Yates Memo will cause the U.S. government to ramp up prosecutions of individuals for violations of white collar statutes including the Foreign Corrupt Practices Act (FCPA). One of the FCPA’s main goals is to stamp out corporate bribes. Specifically, the Act prohibits any U.S. person or firm from paying, or promising to pay, any money or item of value to any foreign government official or political party for the purpose of obtaining business or any improper advantage.

“The DOJ has made it clear, under the theory of Successor Liability, that you buy the problems of your acquired target,” said Monks. “So do your full vetting and factor the results into your pricing. If you do find something of serious concern, a PE firm may consider bringing the matter to the DOJ to get an opinion on the activity prior to closing the deal. PE firms do not want to acquire FCPA-related liabilities, which could sum to hundreds of millions of dollars.”

For example, in February 2010, Kraft Food Groups, Inc., acquired U.K.-based Cadbury Ltd. and has faced regulatory scrutiny related to allegedly improper payments that Cadbury previously made to establish a facility in Baddi, India. According to a Kraft SEC filing in 2011, the company received a subpoena from the SEC and launched an investigation into the payments. Similarly, the SEC investigated U.S.-based Dialogic on a successor liability theory after its purchase of Veraz Networks, Inc., another U.S.-based company. In that case, Veraz Networks was already subject to the FCPA before its acquisition. In the case of U.S.-based Watts Water Technologies, the failure to swiftly set up compliance controls after Watts’ acquisition of a Chinese manufacturer led to a 2011 SEC enforcement action levying hundreds of thousands of dollars in fines and millions in disgorgement after the subsidiary engaged in corrupt activity.

So, what should PE firms do in 2016 to protect their investments and ensure their portfolio companies are not in violation of the FCPA? Before acquiring any company, Monks advises conducting a risk assessment that includes evaluating the parts of the world where a target company does business, analyzing the degree of sales to foreign governments and state owned entities, and examining other target company and/or third party touch points with foreign government officials.

“You also want to see if the company has an anti-corruption compliance program in place,” said Monks. “Do they have anti-corruption language built into their contracts? Do they train their people on FCPA and other anti-bribery regulations? Depending on the risk profile and any red flags which may emerge, a PE firm may also wish to examine records of selected accounts that could contain bribes or suspicious transactions. The U.S. government expects you to do your due diligence. You never want to discover a liability that can drastically decrease the value of a recent or pending acquisition.”


Conclusion

Abraham Lincoln once said, “The best way to predict your future is to create it.” Middle market private equity fi rms are shaping the future by creating value for the companies in which they invest, creating jobs in communities throughout the globe, and creating a culture of innovation across all industry sectors. That will never change.

Despite the challenges outlined in this report—including soaring valuations, increased regulatory scrutiny, and stiff competition for deals—the overall outlook for middle market private equity remains bright. The next 12 months will be replete with new opportunities for PE investors. But there will undoubtedly be challenges.

It is our hope that CohnReznick’s effort to pair solutions with the issues identifi ed in this report will better equip middle market PE fi rms to successfully compete in the dynamic business environment that stretches ahead.


Members of CohnReznick’s Private Equity and Venture Capital Industry Practice contributing to the 2016 Middle Market Private Equity Outlook include:

Jeremy Swan Principal, National 646-625-5716 [email protected] Director, Private Equity and Venture Capital Industry Practice Jim Ambrosini Managing Director 973-618-6251 [email protected] Aroh Partner 959-200-7284 [email protected] Bautista Principal 646-762-3434 [email protected] Bromberg Partner 732-635-3128 [email protected] M. Cohen Principal 646-625-5717 [email protected] Collett Partner 959-200-7228 [email protected] Jay Levy Partner 646-254-7412 [email protected] William Monks Director 732-590-3948 [email protected] Nelson Principal 857-264-3875 [email protected] Pompeo Partner 862-245-5097 [email protected] David Rubin Principal 973-871-4021 [email protected] Margaret Shanley Principal 310-598-1669 [email protected] Matthew Teadore Director 646-625-5742 [email protected]

About CohnReznick’s Private Equity and Venture Capital Industry PracticeAs one of the leading accounting, tax, and advisory firms in the United States, CohnReznick provides private equity and venture capital firms, family offices, small business investment companies (SBICs), and other investment groups with technical skills grounded in deep industry expertise. With partner-level involvement at all stages, CohnReznick’s PE and venture capital professionals offer fully coordinated delivery of services for every transaction—from acquisition to exit.

Our PE and venture capital clients rely on our professionals to help them maximize the value of their investments. Services to PE and venture capital clients include:

• Transaction Services including due diligence and purchase price dispute services grounded in industry insight;

• Value Enhancement Services to improve EBITDA and increase cash flow. Our Business Discovery Boot Camps lead management through a collaborative process that looks beyond functional boundaries to root out opportunities to eliminate waste and add value;

• Portfolio Company Compliance including audit, tax, and consulting services that culminate with a management report, as a by-product of our audit services, that summarizes our preliminary observations regarding EBITDA and working capital improvements that we discuss with both the portfolio company senior management and the outside investors; and

• Fund Compliance solutions.

About CohnReznick’s Private Equity Practice


CohnReznick Advantage for Private Equity and Venture Capital Industry

Industry Insights, Optimized Solutions

• Our understanding of private equity and venture capital industry drivers, combined with consistent client service teams, translates to thoughtful, well-prepared transaction advisory, compliance, and value enhancement services.

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• We have the institutional credibility necessary to connect private investors and their portfolio companies with acquisition opportunities, liquidity events, and other capital-raising needs.

Proactive, Resourceful Services

• Partner-led service teams introduce opportunities, initiate critical discussions, and ensure that client expectations are documented and met through customized Client Service Plans.

• As advisers to the private equity and venture capital community, we connect clients to our vast resources, including educational events, regulatory updates, and business opportunities.

National with Global Reach

• With offices in the leading financial centers, we are geographically situated to perform local fund-level and portfolio company services.

• As an independent member of Nexia International, we assist clients with acquisitions, dispositions, compliance, tax, and advisory services in 590 offices in more than 100 countries.

About CohnReznick LLP

CohnReznick LLP is one of the top accounting, tax, and advisory firms in the United States, combining the resources and technical expertise of a national firm with the hands-on, entrepreneurial approach that today’s dynamic business environment demands. Headquartered in New York, NY, and with offices nationwide, CohnReznick serves a large number of diverse industries and offers specialized services for middle market and Fortune 1000 companies, private equity and financial services firms, government contractors, government agencies, and not-for-profit organizations. The Firm, with origins dating back to 1919, has more than 2,700 employees including nearly 300 partners and is a member of Nexia International, a global network of independent accountancy, tax, and business advisors. For more information, visit www.cohnreznick.com.

1301 Avenue of the Americas New York, NY 10036 212-297-0400

www.cohnreznick.comCohnReznick is an independent member of Nexia International

CohnReznick LLP © 2016Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

Middle Market Private Equity Outlook

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