When founding partners Jeff Helminski and Jack Kolodny, formerly managing directors at mid-market firm Blackford Capital, and long-time industrial executive Fred Tedori were coming up with the structure for Auxo Investment Partners’ debut private equity fund, they drew on all the investor concerns they had heard over the years and put them front and centre.
“Investors in the marketplace felt there was a lack of alignment and transparency inherent in the traditional private equity model,” Helminski tells Private Equity International.
“We heard complaints around the fee structure, the lack of economic alignment where managers in our industry tend to have a relatively small amount of the overall capital that’s at risk, and where the investment perspective is often very short-term in nature. That never really aligns with the natural rhythms of a business and can often lead to sub-optimal decision-making, particularly around the exit timing.”
For family offices in particular, these concerns drove a desire for more direct control over their private equity investment, often through co-investment.
The result was a fund with no management fees and no set end date, with Auxo itself the largest investor, committing just over 25 percent of the capital. Not only that, to address the issue of transparency the trio carved out a slice of ownership of Auxo’s management company itself for all LPs in the fund. Auxo declined to share the size of the stake held by LPs, but said it’s a “small” slice primarily intended to strengthen the relationship rather than simply to boost economics for the investors.
‘Diversity of thought’
“Rather than them just being LPs in a fund and us just being managers, it really makes us partners,” Helminski says. “That alignment, that transparency and that partnership are really fundamental to Auxo’s DNA.”
The three founding partners retain complete authority over the operations of the firm, including capital allocation and investment decisions.
Helminski declined to disclose how many LPs are invested in the fund, but said there were “enough to give diversity of thought and geography and relationships and experience, but not so many it becomes unmanageable”.
Auxo Growth Holdings I held a final close on its $50 million hard-cap last week. Together with co-investment from limited partners and certain outside parties and leverage, the fund expects to deploy $150 million of equity into 10-15 companies. Having held a first close last August, the team has already invested more than $30 million of equity into four companies, of which around $7.5 million came from the fund.
“We set out to find people who were going to be aligned with our thinking and strategic to what we are building at Auxo”
The fund has a seven-year investment period and the founders expect the capital to be deployed over the next three years.
The fund is targeting 25 percent net internal rate of return and will charge 20 percent carry over an 8 percent preferred return threshold. While the fund will not charge its LPs management fees, portfolio companies will pay a closing fee and an annual management fee, the latter tied to company profitability.
The majority of the fund’s investors are family offices, with a few institutional investors. The Auxo founders had existing relationships with around a third of investors, with the remainder coming from a combination of referrals from that third, introductions from service providers working with the firm, referrals from new investors and incoming inquiries.
“We set out to find people who were going to be aligned with our thinking and strategic to what we are building at Auxo,” Helminski says, adding many of the family office investors created their wealth in the types of industries Auxo is investing in.
“Many of them are very active in the investment community so they see a lot of dealflow. That provides a tremendous resource for us.”
Auxo is targeting North America-based companies in the manufacturing, industrial, value-added distribution and business services industries with EBITDA of $1.5 million to $15 million, with a preference for majority-control investments. It is looking to partner with owner-operators seeking retirement or teams seeking capital for growth.
“Our investors know a lot about those industries and the processes those companies are involved in, and can be very, very helpful to us around diligence, around relationships, around connections to customers,” Helminski says.
The Auxo founders chose not to pursue a deal-by-deal strategy for several reasons. Firstly, competitors in that part of the market are often investing on a deal-by-deal basis, therefore having capital ready to go is a differentiator and helps to “instill confidence in a company owner or their advisors that we have the capital to close the deal”, Helminski says. Secondly, the founders are looking to build Auxo into a “significant player in the world of private equity”, and a fund-based structure is a better basis for that.
The longer-term nature of Auxo’s capital is also a positive factor for some potential sellers; while family offices are often able to provide such capital, it doesn’t come with the added operational skill set a private equity firm can bring, Helminski says.
“We’re focused on the business model and management team dynamics,” Kolodny says. “We’ve developed a thematic playbook we use to approach these companies.”
Auxo takes a hands-on approach to put in place the people, processes and infrastructure to create a platform for growth, Kolodny adds.
There has been little movement on the standard 2 percent management fee across private equity, which has been in place since the earliest days of the asset class, despite a significant reduction in returns. A recent report from law firm MJ Hudson found that more than 40 percent of funds this year are charging a management fee between 1.76 percent and 2 percent during their investment periods. However, 16.9 percent of 2018 funds are charging a management fee of less than 1 percent, up from 4.6 percent in 2017.