Excerpted from Merchants of Enterprise - Private Equity in Canada: The Colour and Controversy
Conversation with Jim Ambrose,
Partner, The Shotgun Fund
I was on the look out for a few PE firms that cater to small businesses. These businesses are more representative of the Canadian market and often struggle to find equity financing. One firm caught my attention: The Shotgun Fund. Unlike most PE firms which are generalists, The Shotgun Fund has found a niche, concentrates on difficult to find financing for small businesses ($5 million to $15 million in enterprise value) and has a rapid turnaround. It can often complete a deal in 30 days.
A ‘shotgun’ provision is part of a standard agreement when people go into business together. Its aim is to protect the partners if there is a falling out. The provision allows one partner to notify the others of his intention to purchase their shares, usually on short notice. The other partners must accept the offer or else turn around and agree to buy out the triggering partner on the same basis.
This clause is included with good intent; it allows either partner to back out of an unsatisfactory partnership. The problem is that it can be used against weaker partners at a particularly vulnerable time. To add to the distress, shotguns are usually fired on a Friday before a long holiday, such as between Christmas and New Years’, when it is difficult to muster the proper resources.
In 1999, an owner of a successful Ontario firm appeared at the office of Jim Ambrose, an investment professional who invested in small businesses. The owner was distraught because his partner had triggered a ‘shotgun’ at a low price. The adversarial partner knew the limited financial resources of his partner and saw a chance to acquire the business cheaply. Jim Ambrose’s firm stepped in with funding. Ambrose’s firm saw an opportunity and immediately registered the name: ‘The Shotgun Fund’.
At that time, private equity was not a buzz word. The hot tickets were technology and venture capital. Registering the name ‘The Shotgun Fund’ was fresh thinking. A professional (C.A. or lawyer), who typed the word ‘shotgun’ into his browser or saw the ads, knew instantly what it meant.
“One of our most successful deals,” brags Jim, “came around Christmas from a lawyer with a devastated client who was rejected by the bank. The client was on the verge of losing his business amidst the festivities. A Canadian lawyer did an Internet search and found the ‘Shotgun Fund’. Our firm was accessed and the deal was completed at the 11th hour. It was one of The Shotgun Fund’s largest and fastest deals, completed in only four days”.
Back then, this also seemed like an edgy/controversial business, because shotguns can be pulled when there is a dispute and generally at the most injurious time: over vacations, when there are medical problems or during divorce proceedings. Often shotguns are a sign of human greed, the more aggressive partner wants the whole business for himself and finds an opportunity to take advantage of a situation. Jim Ambrose feels that his fund helps even the score and do deals that protect the weaker party. The victim keeps his share and The Shotgun Fund generally replaces the departing shareholder.
The niche created by The Shotgun Fund gives it access to profitable businesses. What the firm likes about shotgun deals is that three things are known; that a transaction must happen, the price, and the closing date. In addition to shotguns, the firm focuses on any deal that requires prompt action. For example, a competitor goes into bankruptcy and a strategic buyer needs money immediately to buy the assets.
Jim claims that The Shotgun Fund can do the due diligence, check references and come to a proper decision. “The reason for the quick turnaround is that we deal directly with the principals, not agents or institutions. The Shotgun Fund’s clients didn’t inherit their business; they built the business and can continue running it after separating from a partner.” The direct nature of the model is The Shotgun Fund’s attraction, but it must be nimble. It does not get involved in competitions, or auctions. Conversely, most private equity financiers do not take an interest in The Shotgun Fund type deals.
I am curious to know if these shotguns, that are a result of an adversarial relationship, tend to be generally problematic. In other words, is there a higher failure rate to the deals done by The Shotgun Fund?
Jim says that is not the case, but they do make judgment calls about the individuals. “We study the motivation for pulling the shotgun. A person who pulls a shotgun may not be good partner material and may have a history of blowing away partners. Sometimes, the person firing the shotgun is not running the business on a day-to-day basis.” This is the case when a shotgun is fired by a financial partner with deep pockets of a competitor with a conflict of interest. “Our firm must feel confident that there is a legitimate dispute and that we are backing the right party”.
The firm has strict parameters for the businesses it backs. They must be profitable, have been in business for three years, be of a certain size (at least $20 million in sales) and be reasonably priced. To protect itself, The Shotgun Fund charges its due diligence and legal fees to the party seeking financing. This covers some of the fund’s costs if the deal falls through.
I press Jim on problems that The Shotgun Fund faces in such partnerships.
“Compensation can be a bone of contention.” Jim says, “The founding partners often cleaned out the till at the end of the year, whereas with The Shotgun Fund the remaining partner is paid an annual income until the business is sold. The salary is negotiated, but as time goes by the partner who is left may try to claim more.”
“Mainly, the original partners frustrated each other, because they managed jointly, often on a daily basis. In the case of The Shotgun Fund, the only fights over business decisions are board fights.” This is because The Shotgun Fund takes its ownership position seriously. It insists on equal representation on the board and an equal vote on important issues. Although its goal is to provide replacement capital so one party can keep the business and run with it, decisions must also be in the best interests of The Shotgun Fund.
“Initially when The Shotgun Fund steps in, the partner who stays can be mistrustful; with time he appreciates our professional experience and resources” Jim maintains.
Giving up equity is not a cheap form of financing. Sometimes the remaining partner might have been better off hunting for debt financing. Certainly, in the long run, if the business succeeds, debt would have been cheaper. However, many operating partners don’t like debt, because if they hit a short-term snag, the debt could put them under.
Jim ends by saying that The Shotgun Fund focuses on small, interesting deals in a niche market and his firm survives by sticking to its model. “One of our biggest frustrations is waiting for suitable transactions. Often we wait a long time for the right deal.”
As I found my way around the private equity community, Jim’s name came up a few times as a maverick. Niches or specialties, such as The Shotgun Fund, are a good sign, because they make the private equity industry efficient and more competitive. Particularly in Canada where PE firms tend to be both generalists and homogeneous, it is noteworthy to see firms that differentiate themselves.
For a copy of Merchants of Enterprise - Private Equity in Canada: The Colour and Controversy by Miriam