Patient Capital from Professional Investors: River Cities Works with Management to Find an Optimal Exit

Carter McNabb, Managing Director of River Cities Capital Funds, explains his firm’s history and evolution into a leading growth equity investment firm for the healthcare and software industries.

RJ: Carter, thank you again for taking the time here.  Could we kick off with a little background on River Cities?

Carter: Absolutely, the firm’s roots start back as early as 1978 when the two founders, Glen Mayfield and Ted Robinson, were doing business advisory work and merchant banking.  In the early 90’s they were tired of rounding up money from their friends for deals that they found interesting, so they institutionalized the business under the River Cities Capital Funds moniker. At that time it was a small venture-oriented fund.  Over time, as they raised subsequent funds and hired people like me and others, the focus of the firm hardened and became less generalist. We started focusing more on healthcare and software.  And at the same time, we matriculated from a pretty early stage venture orientation into what you’d call growth equity orientation, and that’s where we are today.  We’re investing out of our fifth fund, a $200 million vehicle.  We’re in the early phases of putting that money to work, and we’re looking to write $7 million to $15 million checks initially.  With our LPs we can syndicate deals as large as $25 million or $30 million.  We like to invest in multiple rounds over time.  We’re minority investors, and we like the bulk of our dollars to go to sales and marketing to drive growth.

RJ: What’s interesting about River Cities, at least from our perspective, is that most investors we speak with are typically located on one of the coasts. Your home office is in Cincinnati and you have another one in Raleigh.  Can you talk about the regions that you focus on, and if there is an advantage to being where you are geographically?

Carter:. We are in Cincinnati and Raleigh because that’s where the partners live and have roots. What River Cities was doing in the 90’s was local and early stage. What we’ve become is later-stage focused and geography agnostic. We have partners from all over the world, from Seattle to Miami and LA to Tel Aviv. The advantage is that we’re not where 90% of the money is. I think money will travel to find good deals, but the nature of the business is inherently local. You get to know communities where you spend your time. For our type of medical tech and B2B software orientation it is easier to find good deals where there’s less money. I think that’s pretty obvious. Still, our last two deals have been in Orange County.  So we’re not avoiding the major metropolitan area, and we’re not focused necessarily in our backyard.

RJ: Can you just spend a couple of minutes on your background and what you specifically focus on?

Carter: I run the healthcare portfolio here. I grew up in Nashville, which has a pretty robust healthcare services economy, and I worked for a private equity backed healthcare services company.  Then I went to school at Vanderbilt and eventually worked in research for a local investment bank called JC Bradford & Company, an entity that was acquired by PaineWebber, which was eventually acquired by UBS. But my orientation has always been in healthcare.  When I started working for River Cities, I gravitated to that arena because it’s what I knew.  I come from a family of doctors, so I was able to leverage clinical perspectives for our med tech investing through my family. And I was able to get diligence performed and have a perspective on the services industry just through having worked there and having grown up in Nashville.  So I really cut my teeth starting in the 90’s with River Cities and formed the strategy for our healthcare practice in the early 2000’s. Today, healthcare is over 50% of our fund in terms of allocation.

RJ: Fantastic. Are there certain key areas that you like to hone in on right off the bat? Can you quickly tell whether or not the opportunity is going to be a fit for you?

Carter:  In general terms, we are no different from any other longstanding investor in that we back management teams first and foremost. The rest of the thesis has to hold together, but the team is key.  What might set us apart is our maniacal focus on sales and marketing execution.  We want to take something working in a microcosm and partner with teams to take it national or, even better, global. We want the return on sales and marketing dollars (as measured in gross profit) to be eye popping. In health care services, we are typically looking for some type of technology enablement so that we can leverage our expertise in software. When you move into devices, we are extremely focused on clinical validation and a strong economics for the providers and payors, basically the triple aim in effect.  We have a large number of strategic healthcare limited partners.  We like to be able to leverage those relationships in the diligence process, as well.

RJ: Could you highlight one example where you had a particularly successful outcome partnering with a CEO to give a sense of the value that River Cities was able to provide?

Carter: Certainly. We spend a ton of our time on governance, making sure that the closets are clean, and making sure the company is going to look ready to sell or go public. We spend a lot of time in sales and marketing, benchmarking against over 100 portfolio companies that we’ve had over time, whether they be staffing companies, medical device companies or services companies. There’s always a robust grouping of companies that have performed well that we can benchmark against.  And then we spend a lot of time hiring.  That’s where our management teams really rely on us a lot.

I would say at the end of the day, you help the companies the most by helping them get business. About 80% of our portfolio has started some type of contractual or business relationship with one of our strategic LPs over time.  And that’s not because the LPs are doing us a favor.  It’s because we have researched the company, we’ve researched the products, we think their value proposition fits well for these groups, and we’re making the introduction.  The other thing I think highlights us relative to other growth equity companies is that we can be patient.  We have a very overlapping LP base across our funds, and while we’re targeting a great IRR and to sell companies in a short period of time, I could put you in touch with five or six CEOs where we have been involved with the company for 10 years and it just wasn’t time to sell.  We waited with them, we helped them change strategy and we found the time where the rate of value creation was at its peak.

RJ: That’s very helpful.  You don’t always find that longer term horizon with growth equity projects. When we speak with many CEOs, it’s a point of concern for them if they’re not decided on definitely exiting within the three to five year timeframe. So that’s a great point.

Carter: The only other thing that I would add is that in the pantheon of growth equity, our venture heritage has made us more comfortable with a P&L profile that I think most growth equity firms aren’t attracted to.  The bulk of growth equity is “I want to write a $15 million to $50 million check for a company that’s at least breaking even. I’d really like to have $3 million to $10 million of EBITDA, and I want to take it to $30 million of EBITDA.”  We are finding companies that we think have similar risk profiles that are choosing growth over profitability in the near term, and so a lot of the companies that we end up investing $10 million to $15 million into are losing money and are going to continue to lose money for 12 to 24 months while their growth rate remains at 40% or higher. Sometimes we’ll write a smaller check, which I also think puts us in a bit of a different camp than the rest of growth equity market.

RJ: Certainly.  I think that is a good differentiator given that some of these entrepreneurs may disqualify themselves from growth equity when they may not know that some firms out there can have a venture component. Thank you for this, we really appreciate your time.

Carter: Thanks for having me, talk to you soon.


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