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Insight Newsletter
Twenty Years of Reflection
Much has changed, but not Zachary Scott's philosophy of working with clients.
"It was a dark and stormy night"... or so
every Snoopy story began. Although
admittedly there was some late night
soul searching at the beginning, Zachary
Scott opened its doors on a bright sunny day
in the middle of a Pacific Northwest summer
on August 1, 1991.
It would be a great story to tell that Zachary
Scott was born out of entrepreneurial inspiration
to field a "better mousetrap." The truth
is that the firm was born out of change.
The late 1980's was a heady time to work at
Bank of America's Pacific Northwest investment-
banking outpost (still known as Seafirst
Bank at the time). The combination of the
bank's dominant position as a middle-market
lender, a motivated team, and a dearth of direct
competition led to a string of client successes.
But, the business world is never static,
and in spite of great success in this small corner
of the BofA empire, we recognized that
our group was just the tip of the tail on a rather
large and growing dog.
.........
It would be a great story to
tell that Zachary Scott was
born out of entrepreneurial
inspiration to field a "better
moustrap." The truth is that the
firm was born out of change.
..........
In early 1991, BofA reorganized its investment
banking functions to tighten its focus
on large businesses as the wall separating
commercial and investment banking—the
Glass-Steagall Act—began to crumble.
Money-center banks were pushing hard for
deregulation, freeing them to compete with
Wall Street. The implication for the privatecompany
dominated Pacific Northwest was
that BofA would target only the very largest
businesses for investment banking services,
leaving the middle market to others. Zachary
Scott was created to be the "other". We designed
our service model to fit our expertise
and personalities — we are more financial engineers
than salesmen. Our advice to clients is
based on our opinion, after a thorough study
of the economics of each business and the
dynamics of its industry, of how to create the
most shareholder value.
.........
We designed our service
model to fit our expertise
and personalities — we are
more financial engineers
than salesmen. Our advice
to clients is based on our
opinion, after a thorough
study of the economics of each
business and the dynamics of its
industry, of how to create the
most shareholder value.
..........
We understood at the outset that the sales
cycle in our business would be long, but that
to be successful we must always put the client's
interests above our own. Twenty years
later, we are proud to say that we have been
true to that principle.
Our approach to business also provided
some clear guidelines that have become the
backbone to the firm’s culture. We don’t offer
advice in areas we don’t understand. Therefore,
certain areas of technology and early
stages of business development have escaped
our grasp. Intellectual honesty is a prerequisite
to all of our advice. Although not always
right, there must be specific reasoning behind
each recommendation. Our reputation depends
on it.
We should get this out of the way up
front. The name of the firm is rooted in family—
"Zachary" is the name of Mark Working's
oldest son, now 28, and "Scott" is the
"S" in William S. Hanneman. In much the
same way that a person's name can be inexorably
linked to a personality, Zachary Scott
has carved out its own unique identity, of
which we are quite proud.
The Evolving Landscape
Looking back over the past twenty years, the one universal
factor has been change. There are profound differences in the players, the markets, and even the way business
is done. As with our own situation, business conditions evolve as do the players, or they go by the wayside.
PUBLIC ACCOUNTING
Virtually every segment of the financial
services industry saw wrenching change. At
the zenith of the "Big is Beautiful" era, the
seemingly indissoluble "Big Eight" core of the
accounting industry briskly consolidated into
the Big Five to cater to the compliance needs
of public companies. The ignominious implosion
of Arthur Andersen, as the consequence
of the malfeasance at Enron, left just the Big
Four. Smaller national firms (Grant Thornton,
RSM McGladrey, and BDO Seidman), as well
as regional firms (Moss Adams, Clark Nuber,
Berntson Porter and others) blossomed to fill
the void left in the middle market as the “Big
Four” moved to cater to the compliance needs
of public companies.
CORPORATE LAW
The practice of corporate law was also reshuffled
in this time. Preston Thorgrimson Ellis
& Holman and Shidler McBroom Gates and
Lucas merged and eventually merged again
with Kirkpatrick & Lockhart to form K&L
Gates. Riddell Williams became part of Graham
& James and then returned to its previous
state. Bogle and Gates disbanded, and Heller
Ehrman followed suit some years later. Reed
McClure split apart, with one part creating the
Seattle office of Portland based Miller Nash in
the model of how Jones Grey & Bayley became
the northern outpost of Stoel Rives a few years
earlier. In the late 1990's, a number of new firms
set up shop in the Pacific Northwest to serve
technology startups.
BANKING
We take great interest in the Pacific
Northwest bank market, particularly the big
national banks, the regional players, and the
asset-based lenders. For many of our clients,
these institutions are the primary external
capital providers and, therefore, are of enormous
importance. The banking landscape has
been completely redefined by consolidation.
Many familiar names have faded into history.
At the inception of Zachary Scott, there were
nearly 12,000 banks chartered in the U.S. Today,
there are just 6,300 banks and the top 25
institutions hold 56% of total bank assets.
PRIVATE EQUITY
Important new capital providers arrived
on the scene. In 1991, the private equity industry
was in its infancy, with only one firm,
the Northern Group, headquartered in the
Pacific Northwest. But, as we were just getting
our feet wet, a new private-equity firm
emerged in Portland, Endeavour Capital,
with the princely sum of $25 million to invest.
Close on Endeavour's heels, a new $13 million
fund known as Capstan, set up shop in Seattle.
Neither the Northern Group nor Capstan
endured, while Endeavour has flourished, today,
managing over $1.75 billion. Other private
equity firms have successfully followed in Endeavour's
wake. Blue Point Capital, Evergreen
Pacific Partners, and Northwest Capital
Appreciation have collectively deployed
more than a billion dollars in Northwest
businesses. By our last count, in excess of 300
Pacific Northwest companies have private
equity investors.
INVESTMENT BANKS
Seafirst/BofA, Security Pacific, Dain Bosworth,
Ragen McKenzie, and firms outside the
region, including Robertson Stephens (San
Francisco), Houlihan Lokey (Los Angeles),
and Piper Jaffray (Minneapolis), served the
middle market in the early 1990's. Over the
succeeding twenty years there has been significant
churn in the participants, with a host of
firms entering and subsequently departing. In
contrast, Zachary Scott has been an island of
stability, where no principal has felt the urge
to move on. This is our turf.
INDUSTRY
Twenty years of change within bedrock
Northwest industries - such as aerospace, forest
products, agriculture, seafood, transportation,
technology and building products — are simply
too extensive to catalogue in this space. The
privately held, middle-market firms, which
form the core of this economy and our business,
were not immune to shifting industry dynamics.
These forces have served as a catalyst
for a number of our assignments.
Transformative Relationships
Our success is the consequence of having great clients.
Many of our assignments have resulted in cherished, long-lasting relationships. With each client and engagement,
we learned valuable lessons. A few relationships illustrate the ways in which clients have benefited from
our range of capabilities.
CELLO BAG
Cello was an early client that reflected the
breadth of needs a business and its owners
might experience over time. The company
produced flexible packaging in Tukwila,
Washington. It extruded film, applied print,
and created bags as packaging for diapers.
They did it in a major way, supplying companies
such as Proctor and Gamble and its ubiquitous
Pampers brand. Cello was owned by a
group of individuals that relished the benefits
of the steady dividends it generated. Given
its demanding global customers, this led to a
conflict between the capital needs of a growing
business and the requirements of owners
for income. We had the good fortune to assist
the management in structuring a buyout
and recapitalization of the business to resolve
that issue. This, in turn, set the stage for the
construction of a new state-of-the-art production
facility in the eastern U.S. With that
expansion accomplished, we then led a series
of recapitalizations; first, to buy out the private
equity partner, and then to refinance the
mezzanine debt with senior credit. As P&G
sought global, rather than regional, suppliers,
we ultimately engineered the sale of a minority
interest to a large Australian packaging
company. After several years, the next logical
step was a complete merger, and we were
there to help make it happen. The end result
was a great deal of wealth for the group of talented
managers who pointed the way.
MIKRON INDUSTRIES
A bit farther south of Cello in the Kent
Valley was a little company, Mikron Industries,
founded by two entrepreneurs, Mike
and Ron. Over time, Ron Sandwith assumed
control of Mikron and pioneered the extrusion
of vinyl profiles (framing material) for the
residential-window industry. This was a major
leap forward in window energy efficiency and,
as vinyl supplanted aluminum, the business
grew. Powered by Ron's unstinting passion,
Mikron cultivated an exceptional team of
people, invested heavily in technology (much
of it developed in-house), applied the principles
of W. Edward Deming and Lean Manufacturing,
and maintained a laser focus on
serving its customers. Mikron was renowned
for leading-edge window-frame design, just-intime
product deliveries, and tight inventory
control. All of this led to Mikron becoming
the sole-source supplier of vinyl profiles
to most of the window companies in North
America. The business grew tenfold from the
time of our initial acquaintance with Ron.
Similar to Cello Bag, the company required
capital to meet its customers' expanding
needs. Again, it was our good fortune to
help it through a string of refinancings to fund
new plants and acquisitions. Unfortunately,
Ron contracted a terminal illness and left us.
His able management team, which included
three of his sons, continued on. Eventually, as
the industry matured, it became apparent that
Mikron needed to broaden its product offerings.
Rather than take on that stage of expansion,
the company was sold, with our help, to
Quanex Corporation.
RABANCO
Unlike corporations, individuals have investment
horizons, which at times are driven
by unforeseen events. And, so it was with
Rabanco, the largest independent waste collection
and landfill operator in the country.
When the principal owner and CEO, Warren
Razore, fell ill and was no longer able to lead
the family business, the decision was made
to sell. Warren was an industry icon and had
hosted every waste industry CEO for dinner
in his home at one time or another. All he
needed to do was pick up the phone and buyers
would be on the next plane.
Warren's advisors convinced the family to
engage professional assistance and, although
pursued by every bulge bracket investment
bank in the country, the owners opted for the
local presence and personal service model of
Zachary Scott. At that time, the industry was
in the midst of intensive consolidation and
Rabanco represented a coveted opportunity
in the state of Washington. Competition for
Rabanco’s market position and local reputation
was intense. The transaction result still
stands as the valuation high-water mark for a
waste-industry transaction. The buyer, Allied
Waste, followed by swallowing another industry
giant, Browning Ferris, and then in turn
was swallowed by Republic Services. Since
that time, industry valuations have settled,
pointing out that the strategic importance of
a business is not permanent. While an unfortunate
illness served as the catalyst, the transaction
confirmed the importance of market
dynamics, where strategic value can abruptly
change as industries are reconfigured.
The reality that significant shareholder
value can be created during periods of industry
transition has been proven time and again
in engagements for the owners of Seabird
Electronics, Nile Spice, Davinci Gourmet,
SeaCoast Foods, Sun Media, Working Solutions,
MacGregor Publishing, and many others.
The owners of each of these companies
were able to recognize an inflection point
in their industries and had the presence of
mind to exit at or very near the peak of value.
When it comes to strategic value, it turns out
that timing really does matter.
Along the way, some owners waited too
long or the changing dynamics were not apparent
until too late. Our distress situations
practice has, over the years, been fueled by
many of those unfortunate situations.
UNIVERSAL TRUTHS
Through observation and experience,
several "truths" have repeatedly been proven
and form the core of our thinking about the
way the world works.
1: Investment bankers don't create value.
Value is created by the owners and managers
who direct strategy and capital deployment,
and by the seasoned employees that carry out
the blocking and tackling. That being said,
investment bankers play a critical role in assisting
managers to consider business and financial
strategy, arranging capital to grow the
business, and, ultimately, helping to unlock
the value that has been created.
.........
Through observation and experience,
several "truths" have
repeatedly been proven and
form the core of our thinking
about the way the world works.
..........
2: Trust is earned. Certain advisors, whether
they are investment bankers, lawyers, board
members, or caring friends, often provide
valuable input on company strategy and direction.
However, advice is only "heard" from an
advisor who has earned the right to speak.
3: People do business with people. The
strongest business relationships develop as a
result of people helping other people. In every
industry there are firms that can compete on
price and volume, but those who prove to be
worthy of trust and are consistently reliable
are the most valuable.
4: What's good for the owners isn't always
what's good for the business. The strategic
value of a business is time sensitive and
perishable with the changing dynamics of an
industry. Rarely does the timing of industry
restructuring or the peak of value coincide
with the retirement age of the owners.
5: There is no free lunch. Enduring economic
value is only created from new or
better ways to fulfill an economic need, combined
with hard work and persistent effort.
The reward for meeting that economic need
is profit, which ultimately is the sole determinant
of value.
Next Twenty Years?
It has been a heck of a ride so far.
We have experienced long periods of robust economic growth punctuated
by bursting asset bubbles and painful retrenchment.
While we don't pretend to be economists,
just interested observers, we can't help but
note a couple of financial market trends that
we think will be important in the future:
1. The use of leverage in the economy as a
whole has spiraled up relentlessly. Businesses
and consumers have only recently begun to
deleverage in the aftermath of the financial
crisis. Much of today's economic policy discourse
has addressed redirecting this trend,
yet governments here and around the world
continue to borrow heavily. As the eminent
economist Herb Stein once observed, "Trends
that can't continue, won't." When the painful
process of deleveraging does gather momentum,
it is likely to heighten uncertainty
and the perception of business risk. The prudent
business decision is to reduce financial
risk by employing more conservative capital
structures.
.........
As businesses adjust to changing
conditions, so have we
changed our approaches,
learned new skills, and adopted
new processes in an effort to
meet the new rhythms of a
global market. The same will be
true over the next twenty years.
..........
2. Private equity has steadily evolved from
its slim beginnings in the 1980's to a maturing
market, deep with capital and a diverse
set of investors. Today, it is estimated that
private equity accounts for roughly one-third
of the ownership of privately held U.S. businesses.
Some half a trillion dollars of capital
is currently queued up to pursue new opportunities.
As the use of leverage is tempered,
private equity is destined to become an even
more important capital source. To compete,
family-owned businesses will need to polish
and refine management, systems and strategic
decision-making.
As businesses adjust to changing conditions,
so have we changed our approaches,
learned new skills, and adopted new processes
in an effort to meet the new rhythms of a
global market. The same will be true over the
next twenty years. Yet, some things won't
change for us. Zachary Scott began with and
adheres to the simple objective of providing
our very best advice to owners, whether
or not they want to hear it. This shouldn't
be construed as arrogance, but rather as a
commitment to remain objective as honest
brokers of the merits of competing alternatives.
Sometimes, that has created conflict
with a potential client’s desire to hear only
good news, and can mean pulling away from a
transaction because the economics aren't favorable,
or undertaking initiatives to improve
the business before pursuing a transaction.
Many clients and their advisors have appreciated
hearing an unvarnished perspective.
As experience, knowledge, and talent have
been added to our team, we have more to offer
our clients. We will continue to grow and
improve, and look forward to continuing to
build on this legacy with future clients.
INSIGHT
This publication has become our trademark
connection with the market. After
experimenting for several years with different
forms of newsletters, we settled on this quarterly
format where, in each issue, we attempt
to address a few topics relevant to business
owners and their advisors and capital providers.
Readers have suggested some of our subject
matter and we appreciate those who take
the time to provide constructive thoughts
and ideas on each issue. Articles from more
than ten years are available on our website.
The work of crafting each article tends to be
a process of untold internal debate and strife.
But, we prevail as, like it or not, it's only us.
.........
Many clients and their
advisors have appreciated
hearing an unvarnished
perspective. As experience,
knowledge, and talent has been
added to our team, we have
more to offer our clients.
..........
THANK YOU!
To our great pleasure, the vast majority of
our clients over these past twenty years continue
to be close friends and our most ardent
supporters and references. Likewise, many
professional advisors have graciously brought
us into their confidence and shared their
clients. To each of you we offer our sincere
gratitude. We are humbled by your trust and
support and look forward to continued professional
collaboration and friendship.
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