Monday morning, Riverside

Sitting at his desk in New York’s Rockefeller Center on a recent Monday morning, Bela Szigethy, co-chief executive officer of private equity firm The Riverside Company, concentrates on the banter taking place on the large video monitor in front of him. On the screen is a slide puzzle of camera shots labeled by city: Budapest, Madrid, Warsaw, Prague, Munich. Szigethy tries to joins the conversation as infrequently as possible, because it is a conversation that is supposed to produce results without meddling from the boss.

Szigethy is in the middle of the first hour of a nearly day-long journey called the “MoM”, or “Meeting of Minds”. It is a weekly deal-screening ritual, attended in person and via videoconference by every member of the firm’s several investment committees, as well as by the deal teams, consultants and potential management teams that have information to share with committee members. Riverside, like most private equity firms, regards these meetings as the veritable command-and-control of its investment business. And just as every private equity firm is unique, every investment committee process is unique. A look at Riverside’s MoMs reveals a firm with a prowess for vetting a huge number of small companies in search of attractive investment opportunities, and an ambition to duplicate its trademark small-deal strategy across the world.

Investment committee meetings: 'Command-and-control'

On the day of my visit in late November, Szigethy’s MoM journey would take him from the Western European auto accessories industry, through the Eastern European energy technology scene, onto a Mediterranean island-based business, then across the Atlantic and into the nitty-gritty of a medical supplies franchise, through a household products deal before he pauses for a brief lunch at his desk. That is followed by another series of meetings focused on “micro-cap” opportunities – deals that are even smaller than the small-deal-biased Riverside can pursue from its main fund.

During the Riverside Europe session, held first thing Monday morning, Szigethy refers to a stack of print-outs in front of him – the details of various investment opportunities that come up for review (see “The Riverside deal path” for a guide to how Riverside deals get approved). Although Szigethy is mostly a silent observer, between bites of his breakfast, he refers me to salient traits of several businesses under review. “Look at that crazy cap ex,” he says, pointing to a line item in the financial statement of a deal being discussed. “Look at those crazy margins,” he says of the deal that comes up next.

I get the feeling that the “crazy” capital expenditures and margins of these two particular companies have been discussed before, and at great length.

That neither Szigethy nor the firm’s other co-chief executive officer, Stewart Kohl – who joins in from the Cleveland office – dominate the discussion during the MoM is a reflection of the confidence they have in the broader Riverside team to arrive at sound investment decisions, as well as a reflection of their actual influence over these decisions, which is, by design, limited. Riverside has structured its deal-vetting process to include three main hurdles. For a deal to make it over each hurdle and through to a final approval, it needs to receive a majority vote from the members of the investment committee, with the two founders granted just one vote each. Szigethy and Kohl do reserve the right to veto deals, but, as in US presidential politics, these vetoes are deployed in extraordinary circumstances only.

The rules and customs of Riverside’s investment committee meeting present a telling microcosm of the firm’s overall culture. MoMs are rigorous and designed to process many, many investment opportunities, but are relatively democratic, with many voices chiming in extemporaneously. It is also, for the first time, open to the observation of a journalist, reflecting a longstanding priority of Riverside’s founders to be transparent and eager to tell both their own story and the story of private equity to the outside world.

Bela Szigethy

To put this level of access in context, I have never in my 12 years covering private equity been invited to attend an investment committee meeting. Most GPs would sooner invite the Hells Angels to their daughter’s wedding than invite a journalist to this highly confidential discussion. Among the sensitive information exchanged at MoMs are frank appraisals of management teams, profitability reports, competitor analysis, proprietary valuation metrics, tough assessments of deal intermediaries, and jokes that potential sellers might or might not find funny.

In fact, Riverside has asked me to keep the details of this meeting very vague. But the flow of the meetings, the way that the Riverside team members needle each other for important details and analysis, and the way the firm arrives at decisions on whether or not to invest in a company, all offer a fascinating insight into Riverside as a franchise. These also offer insights into private equity as a distinct asset class. A final “yes” vote from the Riverside investment committee, three of which I witnessed, comes after a mighty intellectual struggle that one would expect of a firm about to put its capital at risk over a long and illiquid stretch of time. Most firms wouldn’t spend as much time or resources on a decision to buy a stock, for example.

INVESTMENT COMMITTEES

You might say that investment committees are the “souls” of private investment firms, because in them you can see the collective culture, personality and priorities of the partners. You also learn a great deal about the people who control the firm by studying the investment committees they have created, and this is manifest largely in the degree of control that founders have over deal approval.

On the far end of the spectrum is what one investment consultant told me he likes to call the “Hugo Chavez model” of investment committee – an institution with ostensible rules and procedures that nevertheless get overridden whenever el Presidente has a whim. Many successful private equity firms operate investment committees where the committees act more as sounding boards for the founders, who then make all final decisions. In some cases, however, this “founder rules” structure has had disastrous consequences when the founder becomes the sole champion for a risky or off-strategy deal.

On the other end of the spectrum are firms that require total consensus among investment committee members before deals can move forward, in the form of unanimous votes.

Then there are firms like Riverside, which allow deals to move forward with even a slim majority of investment committee member support. Szigethy says he and Kohl established this model because the investment business is about taking prudent risks, and the fact that many otherwise promising deals usually have detractors in the vetting process means that unanimity shouldn’t be a prerequisite for an investment.

Not that Riverside hasn’t had some investment disasters, like nearly all private equity firms. These green-lit bloopers have been carefully studied and their lessons hang framed in Riverside’s restrooms.

LONG WAY TO A ‘YES’

Uncharacteristically for Riverside’s MoMs, today’s session will include three opportunities put up for a final vote: two from Europe and one from the US. Once over this final hurdle, actual cash changes hands, as does control of the targeted corporate entity. The session also includes many other discussions and datapoints at various stages along the way to one of three critical “yes” votes or a good-bye “no” vote.

The day starts with a mild disappointment – Riverside’s Swedish team reveals that a strategic buyer has swooped in to buy up an attractive target company for  “a very full price”. The broader European MoM discusses reasons behind the loss and the role played by the deal intermediary, but soon the talk moves on. As Szigethy tosses the lost deal’s print-out into the trash he mutters, “Well that’s a shame.”

Another potential deal, this one sourced out of the Warsaw office, is reviewed. Although the pricing is richer than Riverside typically likes to pay, the Warsaw team is excited about the business, as the extensive screening memo indicates. “Our recommendation is to pursue this deal aggressively,” says a team member. The investment committee agrees and the deal is given a green light.

At 8:30 am, the European investment committee takes up the discussion of two deals that have made it all the way to “the final”.  With serious money at stake, the talk becomes slightly more formal and an air of seriousness permeates the videoconference. It is rare that two European deals are up for final approval in a single session. “This is the busiest European meeting ever,” notes Szigethy.

The first deal up for a vote is a management “buy-in” where a key to success will be a chief investment officer and his team who have not previously run the company. Joining the meeting from Europe are the senior members of this management team. The executives express their excitement at potentially partnering with Riverside to get the company to its next stage of success. They are quizzed by the MoMers about a few details having to do with the selling shareholder and regional expansion plans for the company, and then the buy-in team leave the virtual meeting.

It is now time for the individual investment committee members to say “yes” or “no”. No one offers a casual answer. All votes come with carefully considered statements about the merits of the deal, and two come with carefully worded concerns. From Cleveland, Stewart Kohl raises a concern that has not previously been discussed at length, but hears an answer from a deal team member that satisfies him. He’s a “yes”. After voicing his own “very strong yes” to the deal, Szigethy says: “I’m eager to really blow this thing out and make it a big player. We should be trying to make this one of the best deals in the history of Riverside Europe.”

At that, a senior partner from the Riverside Europe team chimes in: “Hopefully Bela is right and this thing goes all the way to Mars.”

The deal is approved with a unanimous vote – not even necessary for final approval, and therefore a sign that the meeting minds are all strongly behind this one.

Next up is a deal with more hair on it, so to speak. It is in a sector and location with which Riverside is not as familiar, but the economic and demographic trends behind its business model make it an especially compelling story. Again and again, different members of the investment committee bring up key “threshold issues” that prior meetings have identified as being key to success. At one point, Kohl asks a sector specialist consultant who has joined the call whether she would recommend the company’s products to her own daughter. The consultant says “yes”, but offers some further nuance around that “yes”.

Not a question is asked that the deal team assigned to this opportunity do not seemingly have data for. They can be seen on the video monitor handing sheets of paper to each other containing the requested information – real estate holdings, tax statuses, seller information, regulatory information … you name it.

At 10:10 am, the screen freezes and the global Riverside videoconference comes to a technical halt. Szigethy lets out a long and low “ooooh”.  Two minutes later the screen flickers back into action. Hiccups like these come with the territory of being a hyper-communicative global firm.

It now comes time for the second final vote, which ends with unanimous “yeses”, a repeat feat that one partner calls “amazing”. However, as with the prior vote, the complexity of the deal compels each member to add a lengthy preamble with concerns and offsetting enthusiasms. For his vote, Kohl begins, “Unfortunately, my comments will be a long way to a yes. This deal seems to engender a lot of comment.”

But deal two is approved, and at 10:30 am it is time for the US investment committee meeting, part of the Riverside Capital Appreciation investment platform. Szigethy stands up from his desk and walks into a large conference room down the hall, where some 10 New York-based professionals are waiting for him, along with videoconferenced offices in San Francisco, Dallas, Los Angeles, Chicago and Atlanta. Kohl and the Cleveland team are also waiting.

This meeting will put one deal up for a final vote, allow the presentation of a “mid-course review” for a deal in post-letter of intent due diligence, and review several other deals that have only recently been sourced.

As with the European deals up for a final vote, the discussion around the US deal is centred on only a couple of threshold issues. All other matters seem to be understood and agreed upon. It is an opportunity that requires a deep understanding of a market niche. However, the deal team members seem to have “gone native” with the due diligence and display a fluency in sector jargon and micro-trends.

A question is raised as to how vulnerable its products are to international competition. “When we sell this company in five years, will China be an opportunity or a threat?” asks one member.

A vote is taken, and this time there is a “no”. The detractor doesn’t like the price. Says another investment committee member with a raised eyebrow: “We hope you’re wrong and we’re all right.”

The mid-course review includes a long discussion on a regulatory matter that could affect the future profitability of the target company. A partner from San Francisco brings up a past Riverside disappointment and wonders whether there are lessons from that to be applied to the deal under review. Kohl asks whether a person known to the firm who used to work for the seller can be located and quizzed about an important question that is raised in the course of the discussion.

It is clear that Riverside, predisposed to prudently embrace risk, nevertheless does not like surprises. The mid-course deal under review has been vetted with the help of nine separate consultants in the fields of accounting, law, market sector, regulations, IT, insurance, human resources, environmental impact and management assessment, as listed by the internal discussion memo.

At 12:50 pm, a senior partner in the conference room glances at his watch and says he thought the meeting would be done by noon. But there are several more rapid-fire updates ahead – deals recently sourced that need the green-light to go any further. One of them is quickly dismissed because of its size. “That would lap up a ton of equity,” says one member.

The meeting ends with a brief pep talk from Kohl, who reminds the Riverside troops of the several “events” that need to take place before the end of 2010, including several investments and exits. “It’s going to be a crazy end of the year,” he says.

With the global markets poised for greater activity in 2011, it is likely that team Riverside will experience even more craziness as the market recovers and the firm grows, putting its meticulously crafted deal-vetting machine to the test.