Private Equity Dealmaking in the Hospitality Sector

EMS:

Hi Mark. Thank you so much for being with me today.

Mark Leavitt:

Good morning, Elana. Nice to see you as always.

EMS:

So, Mark, to kick off the conversation, tell us a little about yourself and how you got to where you are today.

ML:

So, after spending more than 30 years in investment banking, mainly running tech, media, telecom groups, I noticed that in the telecom space, sorry, the technology space, there was increased interest and in the hospitality area and over a dinner one night nine summers ago with my college roommate, Danny Meyer, we started talking about wouldn't it be interesting to put our complementary strengths together to try to build an investment platform, which is how we did it. We raised our first fund about eight years ago. It was a $220 million fund. We've made 15 investments there. We raised our second fund almost three years ago. That was a $330 million fund, and half the fund is technology mainly focused around the pain points in the hospitality space with the rest of the fund, a mix of fast casual restaurant brands, consumer packaged goods companies, and health, beauty and wellness is an area we've made several investments and continue to have interest. And we're also doing some things in the entertainment space. We just made an investment in Five Iron, the golf simulator entertainment space. So, that's what we're doing and how it got started. I think one of the more interesting things about our fund is that two thirds of the companies we've invested in have female or other underrepresented founders and CEOs, and we have an equally diverse investment team, which we think is critical for competing and winning in what's an increasingly complex and diverse world.

EMS:

Great. Mark, love your journey of how you got to where you are today and your firm's story. So, I'd like to dive a little deeper into the transaction, some of them that you completed, specifically Culture POP and Goldbelly. I would love to hear the story from start to finish on how you completed those.

ML:

So, Goldbelly was done a little over five years ago. It was done in Fund 1. We made the investment in Goldbelly, which for those that don't know is a food marketplace. They really have the monopoly on iconic food brands from around the country, and within the next week or two, they're going to start shipping to Canada as well. So, international expansion is coming for Goldbelly, but Goldbelly is really a marketplace that ships iconic food brands. And what we liked about it, we made the investment, and this was obviously done pre-COVID, was that we thought it was a way for restaurants to increase the revenues outside of the four walls of a restaurant because they could create additional food and ship it and it was an additional revenue stream. What we didn't know was that when COVID came, it was going to keep a lot of restaurants alive because restaurants couldn't open. There were not customers going out and going to restaurants. In a lot of places, it was illegal for the restaurants to be open and Goldbelly was a vehicle where companies could basically use their restaurant as their factory, create stuff and ship it around the country. We spent a lot of time early in COVID saying, is hospitality dead? Do people care? And if they care, how has it changed? And we thought Goldbelly checked a lot of the boxes and understand this was not the investment theory coming in. We didn't know there was going to be a pandemic that was going to shut restaurants down, but we thought Goldbelly was going to increase 100% the second year we were in it, and they were up about 500% during COVID because it touched a couple really important themes around hospitality. We thought that what people cared about during hospitality was the feeling of being around family and friends and being able to travel, none of which you could do. Well, you could be around family and friends, but you couldn’t travel. So, this let you order some of the iconic foods from places you had traveled that brought back that memory. We said to the Goldbelly management team that you've made it when the name of your company becomes a verb. And much like early in my career as a tech banker, when Google was getting started and people would say I Googled something to get information, we suddenly heard people that were foodies talking about, Goldbelly ribs and various other barbecue things or cakes or ice cream from around the country from their favorite places to have dinner parties. And when we made the investment, the average customer was purchasing through Goldbelly about one-and-a-half times a year, which meant they were basically using it for gifting around the holidays. And we thought one of the opportunities was to increase the frequency that the average customer was using Goldbelly and that came across in a really big way during COVID, so they were up 500% during COVID. They were then down about 30% two years ago, which for companies we saw that had big COVID bumps, they held on to a much higher percentage of their customers than pretty much anyone else we saw. And then they spent about six to nine months flattening out from the 30% drop off the 500% increase, and now they're starting double digit growth again, which has gone on for a little over a year. So, we continue to be really excited about the company and the brand and what it does.

EMS:

Mark, on the other hand, what are some of the greatest challenges that you faced with those transactions and how have you tried to overcome those challenges?

ML:

I guess the biggest challenge was early COVID, not knowing with restaurants closing what was going to happen. But what we found was, in particular, the tech businesses we invested in grew much more rapidly than we'd anticipated. And I think it was because there was a need for restaurants to operate more efficiently, to reach more consumers, to get in front of pickup and delivery. And we have been to be fortunate to have had four companies, five companies that were focused around this space from a tech side who grew more dramatically than we could have reasonably anticipated when we made the investment. So, in terms of specific challenges, in a lot of ways COVID brought a different set of challenges and skillsets you needed from an operational standpoint, and it was helping the management team build out their capabilities, helping them focus on customer acquisition costs. They had traditionally done all their advertising through social media and what they had kind of everyone else that did that found was that probably the last, I don't know, 20% of the dollars you spent on social media were not that effective. So, they've been able to use television, radio, other vehicles as a way to promote the brand, which has also been pretty effective. So, it is really having a management team that's skilled enough and adaptable enough to go with the flow and figure out where the world was going and stay ahead of it and the Goldbelly team did that really well.

EMS:

Mark, that segues nicely into the follow-up question I had for you about the due diligence process. I would love to hear your thoughts on the due diligence process you executed it when it came to the Goldbelly transaction.

ML:

So, we spend a lot of time looking at returns on capital, and when you're investing in a four-wall business, you look and say, what does it cost to build that box and how quickly do you recoup the cost? We've got investments in ice cream and coffee. We've got investments in health and beauty. What we like about those, it's less expensive to open the box. You don't need the venting and everything else that you need for a fast casual restaurant where they're doing cooking on premise. You basically need an outlet so you can have a freezer for your ice cream, you need a box where you can sell. We're investors in STUDS, which is an ear-piercing company we’re really excited about with numbers that are kind of off the charts in terms of returns on capital. So, we look at that kind of thing. For a business that's a direct-to-consumer business like a Goldbelly, the analysis we spent a lot of time looking at is lifetime value of a customer divided by customer acquisition cost.

So, we found during COVID with some of the inefficient advertising spend that pretty much everyone in the direct-to-consumer base experienced, we found that CAC, customer acquisition costs, got too high. They've done a really good job bringing them down. When we invested CAC for Goldbelly were somewhere around, I think $26-$27 per customer. It got as high during COVID as $75-$80 and now they're operating under $20. And at the same time, the lifetime value of a customer has increased pretty dramatically because the customer is buying more frequently. It's become more of a habit, which is great.

EMS:

Mark, as a follow-up question, what are you looking for in the buy-side process to ensure that a mutually beneficial and efficient transaction can be consummated in today's economic and transaction market?

ML:

So, I wish I could tell you that when we started this, we had this all perfectly mapped out. One of the things that we spend more, there's a couple of things we spend more time on now than we used to. One of them is tied to what kind of outside board do they have, and do they want to have and are they open to other voices? You have some people that are so concerned with preserving really management founders so focused on preserving their control, that that can inhibit growth. So, we look for people that are open to a broader group of advisors to help them grow the business. We think that's an important thing that's got to happen. I guess the other thing that we look at that we hadn't focused on as much initially is to make sure we're aligned from a timeframe standpoint.

We're managing outside capital. We've got sort of a three-to-six or seven-year hold at which point we need to exit the companies. Our approach is we are almost never a control investor, meaning we're almost never buying more than 51% of the company because what we found is within the hospitality space, we feel like we see everything, if not first, then pretty close to first and get offered better pricing because people want the Union Square Enlightened Hospitality Investment brand. The downside to that, and everyone, when you talk to anyone who's running a process, they'll say, of course we want a strategic like you because we've got a handful of LPs that are active in the food and hospitality and technology spaces and the international licensing spaces that are, it's kind of a unique ecosystem we have within our community, both the companies we've invested in and our LP base.

But as a result of that, we need to spend time to make sure that from a timeframe we're in sync as to what the right period of time is before we're going to try to maximize value and sell. Of course, it's an inexact science and there's bumps like a pandemic that get in the way that kind of slow your exit down sometimes. On the other hand, some of the tech companies that expedited the timing of the exits. So, you need people that are open-minded, flexible, but you need to have some reasonable expectations as to what the time is for exit. One of the things that we started doing, I would say probably halfway through Fund 1, and we're pretty much getting it in almost all our investments in Fund 2, is the right to force a sale after generally six-to-seven years. So, if we're in something and it looks like we're at odds with management about timing, even though we don't have control, we have enough cloud and have a big enough stake and have a, I guess, respected enough voice that companies are giving us the right to force that sale. And we're doing that with almost 100$ of the time now.

EMS:

Mark, we've covered a lot of ground today and wanted to see if there are any final thoughts you'd like to share with us.

ML:

Let me just give you the one highlight. We talked about Culture POP, which we're really excited about. We've only been in this one five months, but this was a bet on management. In this case, the guy that started Culture POP, this guy named Tom First who started Nantucket Nectars. So, he had successfully built a company, sold it for a high price to a big CPG business. He started this business as we got into this, which was news to me, not news to the young diverse team of talented employees that work with us, is that no one really drinks soda anymore of a younger generation. It's all-purpose driven drinks. So, it's either an energy drink, it does something for you besides taste good. This was a soda that we thought tasted good. They were No. 3 in the space between Olipop and Poppi, who had both wrote really rapidly. This is a prebiotic drink. This is basically a drink that's healthier for your gut but tastes great. And we liked backing a talented management team that was doing it. Of the three competing in the space are the only one that doesn't use Stevia. It's not as sweet as the others. We think it tastes better. The flavors are fantastic. So, we're really high on this one and on this management team.

EMS:

Mark, I wanted to thank you so much for sharing your perspective with our listeners.

ML:

It's my pleasure. It's always great to see you and happy to come back and keep you posted on how these things evolve over time.

EMS:

Absolutely. And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.