Falfurrias spreads the wealth with private equity

 In August 2019

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Hugh McColl Jr. made a lot of money as he expanded the old NCNB Corp. fiftyfold, earning about $4 million in salary and bonuses in 2000, his last full year as CEO of Bank of America Corp. But “retirement” has proved more lucrative for the iconic 84-year-old banker, thanks to the wonders of private equity. “I’ve made a lot more money in the few years I’ve been involved in Falfurrias [Capital Partners LLC] than I did in the 42 years I ran the bank,” he says.

The remuneration attests to the success enjoyed by Falfurrias, which was formed in 2006 by McColl, Marc Oken, a former BofA CFO, and managing partner Ed McMahan, to invest in a diverse portfolio of growth-oriented, middle-market companies. McColl says Falfurrias’ annual compound return has topped 20% since 2006, far outpacing median gains in the Standard & Poor’s 500 and various hedge-fund indices.

The trio believes that leveraging its skills in strategy and operations management and decades of business relationships can add value to portfolio companies and spark strong investment gains for limited partners. Over the last year, McColl and Oken, the firm’s 72-year-old chairman, have ceded day-to-day responsibility to McMahan, 44, who wants to ramp up the pace of deals and make Falfurrias much larger while continuing to produce outsized returns. But the veteran bankers remain closely involved in attracting business, raising funds and reviewing potential investments.

The opportunity to join McColl and Oken in his early 30s was irresistible, McMahan says. After earning bachelor’s degrees in economics and English from UNC Chapel Hill and an MBA from Northwestern University, he worked for two investment firms, Chicago Growth Partners and William Blair Capital Partners. He also was a financial analyst at Bowles Hollowell Conner & Co., a Charlotte-based investment bank bought by First Union Corp. in 1998.

“I had some industry experience about how to structure transactions, and I had a lot of thoughts about what a good private equity fund needed to be,” says McMahan, whose father, W. Edwin McMahan, formerly led Little & Associates, Charlotte’s biggest architecture firm, and served in the N.C. General Assembly. The younger McMahan joined Falfurrias as a partner at its founding and was named managing partner last year.

McColl and Oken initially didn’t think they needed help at Falfurrias, “but the people that we were raising money from thought we needed somebody that knew something about the [PE] business, and that led us to Ed,” McColl says. “We’re glad we got him, and we’re more than comfortable with him running our business day-to-day. [He’s] a really talented young man who has tremendous focus.”

Falfurrias uses a proprietary, theme-based approach to identify industries in which it can leverage its resources and relationships. The firm invests in companies with pretax operating earnings of $3 million to $25 million across sectors including retail, food and beverage, business services, financial services, manufacturing and health care. Valuations of prospective investments run as much as $300 million. Transactions don’t proceed without unanimous investment committee approval.

In February, Falfurrias closed its fourth fund, Falfurrias Capital Partners IV, with $500 million in total funding. That hefty pot of money enables the company to make larger investments. Falfurrias’ first three investment funds totaled $99 million, $124 million and $275 million, respectively.

The first two funds have had net internal rate of returns topping 23%, while details on the third fund are cloudy because Falfurrias still has stakes in some investments that will be eventually sold. “We don’t have any unhappy investors. I’m quite sure of that,” McColl says.

Falfurrias, which is named after a small Texas town near where McColl and Oken own hunting camps, has had some bumps. In 2007, shortly after its founding, the fund invested in a building materials company just as the real estate industry was collapsing. Falfurrias lost money on the deal and the recession slowed the firm’s ability to raise capital, McMahan says.

But many successful deals followed. In 2015, Falfurrias acquired Morrisville-based RegEd, which sold a platform helping many of the nation’s biggest financial services companies manage compliance, licensing and conflicts of interest. After overcoming initial software problems and changing management, the company attracted new customers willing to sign long-term contracts. Revenue grew at a 30% annual clip, while pretax earnings nearly doubled.

Last year, Falfurrias sold the company to Gryphon Investors, a San Francisco-based private equity company for “a staggering sum of money,” McColl says. Investment banker Michael Murr, an investor in Falfurrias’ funds, earned tens of millions on that deal, McColl says. Other limited partners include former Carolina Panthers owner Jerry Richardson and Charleston real estate investor Charles Way Jr., a former secretary of the South Carolina Department of Commerce.

In June, Falfurrias made one of its most high-profile investments, buying the food business assets of Richmond, Va.-based C.F. Sauer Co., which has made Duke’s Mayonnaise for many decades. Terms weren’t disclosed, but the deal includes Sauer’s manufacturing facilities in Mauldin, S.C.; New Century, Kan.; and San Luis Obispo, Calif. Conrad Sauer IV, the fourth generation of his family to lead the 860-employee company, is retiring as CEO but remains a director.

Bill Lovette, a 37-year food industry veteran with Tyson Foods Inc. and Pilgrim’s Pride Corp., was named interim CEO and executive chairman. Falfurrias principal Chip Johnson and partner Ken Walker will join the board.

The new owners have no intention to tinker with Duke’s recipe. “We don’t plan to mess with perfection,” Johnson told Virginia Business magazine.

Falfurrias’ previous food industry investments include the Charlotte-based Bojangles’ Inc. fast-food chain, which it bought in 2007 and sold four years later to another big private equity group, Advent International, for a significant gain. The private equity group installed veteran fast-food executive Randy Kibler as Bojangles’ CEO and boosted sales by 40% while adding more than 100 new sites.

“Private equity firms may, in general, have the reputation of achieving financial returns through financial maneuvering, leveraging up the companies, for example, putting minimum equity in,” Oken says. “We don’t do that. We’re investing other people’s capital in illiquid, longer-lived investments and trying to grow those investments, sell them and achieve a return for our investors.”

Sales of companies owned by private equity groups are declining amid concerns that the long U.S. economic expansion is nearing an end. The number of sales hit a six-year low in the second quarter this year, according to the Buyouts Insider trade publication. Meanwhile, U.S. buyout funds raised
$160 billion in the first half of this year, nearly double the amount during the same period last year.

“Money has really flowed into the private equity firms, and the biggest risk — and I’m sure my partners would agree with this — is a bigger fool with too much money and no place to put it,” McColl says. By focusing on smaller middle-market companies, he adds, “we’re avoiding fighting giants who have more money than sense.”

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