Penta Mezzanine Fund: A True Partnership Approach with CEOs

GrowthCap speaks with Seth Ellis whose series of business successes makes him a unique investor and partner to CEOs

RJ: Seth, thank you so much for taking the time. Perhaps we could kick off with your background?

Seth: After finishing at the University of Florida on the GI Bill, I was very fortunate to get a job at Ernst & Whinney, now Ernst & Young. I spent 10 years in public accounting and then left to become the CFO of a hospital. It was a rural hospital and losing money. In about two and a half years we turned it around and merged it with Adventist Health Systems. Subsequently, the CEO and I purchased the hospital-based ambulance management company from the hospital. We grew it into four states, and sold it to American Medical Response. Then I took a little time to figure out what I wanted to do next. It was late 1998 when everything was going crazy in the dot com world, when my mentor said, “Hey, there’s a company that does infrared thermal cameras, I think they’ll go public, I’d go look at it and invest in it.” It was a father and two sons who didn’t even have a product. I thought, “Well, I don’t think this is going to work.” But my wife said, “You need to do something, so get out of the house, go invest in this thing.” So I did and then 9/11 happened. Homeland defense became a very intense industry and as a result the company grew very fast.

The folks at Wexford Capital invested in us. They had a vision of buying up multiple homeland defense companies, so I helped them buy 18 companies and then we went public. Around 2007, I was tired of really extensive travel around the world and wanted to do something else, when learned about mezzanine investing. John Morgan, a long-time friend from college who is founder of one of the largest personal injury law firms in the country (Morgan and Morgan) , decided to start a fund and did so with a friends and family raise of approximately $30 million. As we were launching our fund, the 2008 crash happened. We held off on making any investments that year, which proved to be a good decision, but we still waived that year’s management fees. We didn’t really start investing until late 2009 in Florida Mezzanine Fund.

Florida Mezz has had 27 straight quarters of returning cash distributions of approximately 12% or better to its investors with a net IRR of about 15%. We only have really three major holdings left in that fund. When nearing the end of Florida Mezz, Penta came together with John Morgan again, myself, and we brought Rebecca Irish in who worked with me at Ernst & Young and as part of the team doing the Florida Mezz investments. She has an extensive background in M&A and had run several companies as CFO or President. We also brought in a guy named Jeff Black, who became a partner and really helped us fundraise and then of course Grant Hill was very instrumental in helping us. Grant wanted to get involved in the fund industry to complement his extensive real estate investment experience. We formed Penta Mezzanine Fund and made our first investment in late 2012. And here it is 2016 and we’ll be fully invested by sometime late summer or early fall so we’re considering starting another fund. Penta is hitting the same net IRRs of about 16%, a little better with a gross of about 27%. It seems we have found a niche – in all of these investments we’ve done, all but one were originated by the owners/managers of the borrower rather than through an equity sponsor.

RJ: Can you give me a sense of the size of the firm?

Seth: In Penta we raised a little more than $80 million and our deal sizes ranged between $5 and $10 million, so we’re somewhere around the $7.5 million check on average.

RJ: You mentioned your theme of really working and partnering with CEOs and management teams.

Seth: In Florida Mezz, there were seven CEOs, three of them became investors in Penta because they really appreciated our involvement with their company. It was a little different probably than other mezz funds. They look at us differently – Rebecca and I function as the day-to-day partners of the Fund but we have run businesses and know what they’re going through. They appreciate our input, insights and empathy.

There have been some tough times where we’ve rolled up our sleeves and helped the company because we looked at the situation and decided, “Hey, look, it’s easier and more valuable to Penta to help fix the company than it is to sell the desk and the chairs.” We know everyone can experience periodic glitches when you run a company. We’ve never panicked – we just sit down and work with the CEOs when they need us. We’ve had good results so the CEOs look at us as a partner rather than just a lender.

RJ: Are there certain sectors that you focus on?

Seth: We are agnostic; I mean we’ve done businesses ranging from nutraceuticals, distribution, prosthetics, an oil tank manufacturer, a company that sells remnant MRI time, to a water supplier to the fracking industry. It really depends on the management team, on how well we like the management team and how strong they are. That’s really where we do most of our due diligence – how good is that CEO and the management team? Every CEO may have trouble, but it’s how you deal with problems that counts. We also ask ourselves if they are good guys to work with and do they have good personal track records.

RJ: Any bright lines in terms of key parameters for you to be interested in an opportunity?

Seth: I keep it very simple. My simple question is will your current earnings pay my current interest and can your organic growth refinance me out. I don’t want to count on a sale, I don’t want to count on an IPO. I want to count on your earnings and growth basically financing me out. And I have to believe in your model.

RJ: You have a really unique offering in that you’re a former operator. You must have a sixth sense when spending time with CEO you’re about to invest in.

Seth: When we submit a final term sheet we very rarely lose that opportunity, because by then we’ve spent a lot of time with the CEO who understands that there’s a financial value obviously that we’re providing, but there’s also an intangible quality or value that we’re bringing to the company. So our deal flow has grown tremendously, each year we see about 500 to 600 deals. What we’re really proud of is our geographic diversity despite being an Orlando-based fund. Only 36% of our deal flow comes from the Southeast, 21% comes from the Northeast, 17% from the West, 12% from the Midwest and 12% from the Southwest approximately.

I’ll give you an example, one of the CEO’s in our portfolio went to Bank of America for additional capital but he wasn’t able to get financing he needed. We were the only guys to go visit him, so even though our rate might not have been the cheapest, we were the only people to actually go and see him and try to learn about his organization. We’ve had a great, great relationship, and his growth has been tremendous. But that’s kind of the model for us; I’d rather get on a plane and go visit somebody that we think is really interesting and walk the floor with them, see what kind of manager they are, see ways to interact with them, just see what kind of company they have from a culture standpoint too, and if it’s something we like.

RJ: What do you look for in a CEO? When do you know if a CEO is someone you want to back and conversely are there some telltale signs to the negative?

Seth: Some of it is the way he interacts with his team, the way he interacts with his employees. Is this a one-man shop or does he truly have a team? For example, when someone walks the floor and the rank and file employees are all nervous, that means that (a) he doesn’t do that very often or (b) he’s pretty hard on them when he comes out there. So we look at the way he interacts and also how he treats the CFO. What does he think of the CFO, is it an overhead position or is it a revenue position? A good CFO should make you money, not just be an overhead. The CFO should be not only giving you good financial information but providing you other information that can help save the company money or make money in certain areas. So it’s important to us how the CEO views the team, relates to the team and empowers the team.

RJ: What’s next for Penta Mezzanine?

We are exploring forming another fund that will probably be larger than the last one. An analogy that I like to make is that we fish in a lake where there are not a lot of boats, not a lot of funds are interested in doing the non-sponsored deals under $10 million. But we get usually 12% interest plus additional upside and shoot for a 20% gross return. We’ve been north of that hurdle in each fund, especially in Penta right now, we’re at 26% on realized investments. So we’re significantly above it. If we move out into the ocean, try and become a BDC or something similar, we would be playing a different game and I may not get my target return because now my rates go to 11% – 12% all in at that range. And second, the type of companies that we interact really well with and have a good track record with — why change the formula?   It benefits our investors if we stay with what we do well. And that’s what we’re trying to do.

RJ: Thanks again Seth.



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