Capitalizing on Inefficiencies in Lower Middle Market Private Equity

8th April, 2021

Today we are joined by the Vice President of Townsend Street Capital, Charles Zalud, to talk about the opportunities of lower middle market investment and how his company is making the most of these in the current climate. In this punchy interview, Charles gives us some great insight into the way Townsend Street works, and what differentiates them from their competitors, highlighting their pool of human resources and active philosophy to longer-term hold periods. We also get into some important definitions, with our guest clarifying exactly what is meant by ‘lower middle market’ and ‘committed capital’ in the context of his business. We cover the changes we have seen through the last year, and some of the surprising stability that has been present despite the pandemic, before going on to cover ideal partners and investments from Townsend Street’s perspective. Our guest also shares their idea of sticking to the industries and sectors they know best, and drilling down with expertise and experience for the greatest returns. So for all this and a whole lot more, be sure to join us.

Key Points From This Episode:

  • Charles’ professional background, investment experience, and how he joined Townsend Street Capital.
  • Impacts of the pandemic on investment opportunities; what Charles has noticed.
  • Unpacking exactly what is meant by the term ‘lower middle market’.
  • How Townsend Street’s focus on the middle market segment allows them to be more selective with their investments.
  • Imbalances of supply and demand in the middle market that enhance Townsend Street’s ability to make good purchases.
  • Why Charles positions himself and the company on the side of active investment.
  • Thoughts on ideal investments from Charles; partnering, seller profiles, and equity.
  • The long-term investment approach that Townsend Street favors and their average hold periods.
  • Townsend Street’s focus on specific sectors and industries in which they are experienced.
  • Charles’ definition of ‘committed capital’ and the pros and cons of this model for investment.
  • The human resources at Townsend Street’s disposal while approaching the lower middle market.


[0:00:18.5] JM: Hi, I’m Jenny Merchant, co-founder of PitchBoard and welcome to The Pitch Podcast. We’re here to have thoughtful discussions with forward thinking managers who are taking unique approaches to professionally investing capital. Through these conversations, we hope to introduce you to new ideas and strategies that will help you better manage your own portfolios.


Before we begin, we want to remind our listeners that everything in this podcast is for educational purposes only. Nothing here is tax, legal or investment advice. We don’t endorse any products, services or opinions made by our speakers. Some statements in this podcast may contain forward looking projections. These projections do not guarantee future performance and any past performance does not guarantee future result. Finally, nothing in this podcast is an offer to buy or sell securities. Speak to your own advisor before making any financial decision.


[0:01:21.8] AH: Hi everyone, this is Andrew Hepburn from PitchBoard. It’s my pleasure today to welcome Charlie Zalud, vice-president of Townsend Street Capital to the podcast today. Townsend Street is an emerging private equity firm based in Birmingham, Michigan and focused in the lower middle market. Charlie has over 10 years of direct investing and investment advisory experience. He is a CFA charter holder.

I’ll just start Charlie by saying that I admire anyone who can get through the CFA process. I’ve never done it myself but I have friends who did and it sounds like a grueling experience, to say the least.

[0:01:53.1] CZ: I appreciate that intro and yeah, it was many long nights and hours spent studying and then let’s just say that I’m glad I did it before having kids because I could not imagined doing it now.

[0:02:05.2] AH: Tell me about yourself, your investing background and then we’ll get to your firm as well.

[0:02:09.6] CZ: Yeah, for sure. I joined, you mentioned Townsend Street Capital shortly after they commenced operations upon holding their successful first close and prior to that, I spent about five years in a direct investing, private equity style investing law for a rather large family office in the metro Detroit area called SI Capital and it was there that I really cut my teeth in the private equity world.

Worked on a variety of transactions, essentially ran the day-to-day deal execution and operations for the firm’s private equity mandate. It was interesting to operate in more of the middle market but it was sort of where I realized that there’s a little bit more of an opportunity to enact a value-oriented investing strategy in this lower end of the middle market.

So that mixed with the relationship that I had with the few of the partners at Townsend Street Capital, ultimately led to my joining the firm middle of 2020 and yeah, excited to be here. You know, we’re seeing a lot of activity and it’s exciting to sort of watch this thesis play out as we sort of position our fund and capital for what we believe to be rather exciting time to invest in the lower-middle market.

[0:03:31.1] AH: You joined it at an interesting time, during a pandemic. Has that presented more opportunities or is that in more of a hindrance to opportunities when you look back on your time so far, what would you say?

[0:03:41.6] CZ: Yeah, I say it’s been a little bit of both. When we closed in June of last year amidst a pandemic, we thought, there would be a – where we saw this tremendous opportunity for business owners and firms in this lower end of the middle market that would be looking actively for a capital partner. A, to de-risk a little bit. B for additional capital support and then C to sort of weather the storm with the partners as supposed to going it alone.

While we have certainly seen that play out to some extent, the vast amount of capital that had been pumped into the system has provided an interesting dynamic in that there’s a lot of dollars out there, right? We still see that businesses are looking for a partner, those businesses that’s truly need a partner, it’s harder to underwrite those businesses and obtain traditional bank financing when we’re looking for a change of control transaction.

Whereas the businesses that are easily financeable and makes for solid growth-oriented acquisition targets are the businesses that have weathered the storm and aren’t as actively looking for a capital partner. To answer your question, it certainly provided for a little bit of both but I think to put simply, we still feel that the pandemic and some of the fallout from the election and then the pending structural changes therein lie or make for what attractive environment in this lower end of the middle market as you like to build out an attractive portfolio.

[0:05:16.1] AH: Right, for those at home who hear the term ‘lower middle market’, do you want to give a sense of just what that is sort of from a numbers perspective?

[0:05:24.4] CZ: Yeah, absolutely. You might hear the term middle market, lower middle market used quite often and we define the lower-middle market for us as businesses with five to 15 million in revenue and one to seven million of [inaudible].

Broadly speaking, the middle market can be defined for the businesses as little as let’s call it five million in revenue to upwards of 500 million in revenue. We are very much focused on that lower end of the middle market. So think businesses that are not publicly traded. Privately held enterprises in the lower middle market, those tend to be founder-led, family-owned businesses. Maybe it’s a second-generation ownership of businesses that have typically never had institutional capital or investors in their business, right?

In addition to size, the ownership dynamics for us provide for a little bit of delineation between the middle market and the lower middle market in terms of how we’re looking at it.

[0:06:28.5] AH: Would you say that there’s sort of an analogy to be made between what you guys are doing and let’s say a small cap investment fund might do in a public markets that you’re looking outside of the big guys but you’re finding what you guys think are better opportunities because of that?

[0:06:45.0] CZ: Yeah, similar to a small cap public equity fund, we feel that the greater supply of businesses that our target sized profile, allow us to be more buy-in at a better valuation than the middle market or businesses that accuse the public equity now like GDS and S&P 500, right? There are one estimate as there’s north of 300,000 businesses that fit our revenue profile five to 50 million, which compares to roughly 20,000 businesses that more of the middle market sized criteria so that allows us to, we feel, be a little bit more picky when it comes to looking for acquisition targets.

And secondarily, this end of the market is rather untapped from a capital provider buyer perspective. We think some of the larger private equity funds and you know, small cap publicly traded companies, they’re not really going to be interested in businesses that are on this lower end of the middle market, right? It’s just not going to move the needle. Whether it be from a public market’s perspective or a revenue or EBITDA perspective. They will typically not have much of an interest for businesses with the 50 million dollars in revenue.

[0:08:08.6] AH: Right. It’s really interesting because there’s always this debate about whether capital markets are efficient and I think that this is one more example of when they’re not efficient that if they were totally efficient, you probably wouldn’t see the opportunity you see. Because the bigger guys would snap up these opportunities and I guess that’s probably true of small cap equities as well.

[0:08:29.0] CZ: Yeah, we feel as well that there is supply and demand imbalance in the lower middle market, allows for a firm like us to not only buy rights and buy it at an attractive valuation that can be as much as 50% of a discount to the middle market valuations but also, these businesses are in our view, more right for organic growth and lend themselves better to come in, provide operational support and really execute on a growth thesis, right?

If you think about it, you know, it’s easier to some respect to grow a business from 10 million in revenue to 20 million in revenue than it is to grow a business 500 million in revenue to a billion dollars in revenue, all else being equal just from a pure dollars perspective.

[0:09:16.8] AH: Sure, that totally makes sense.

[0:09:18.2] CZ: We feel that there’s many factors that sort of influence this thesis about targeting the lower middle market but certainly, the inefficiencies that are provided are what attract us to this space.

[0:09:29.5] AH: I was going to ask you but I think you maybe sort of already started to answer it. Whether you guys see yourself as a passive investor or one that is working directly alongside the management teams of the companies that you plan to acquire. I’m guessing, you’re probably leaning towards more the latter?

[0:09:45.7] CZ: Yeah, so we would very much consider ourselves to be more of the active investor. If you think about it, you know we are going to come in and we are going to acquire controlling equity stake in the business, we are going to utilize a typically utilize a conservative amount of debt to finance the acquisition and you know we are really going to get granular when it comes to due diligence working with the existing employee base and management teams.

Working in operating partners and strategic advisers in our network to truly understand the business and curl of levers behind the business. From there, during the due diligence process leading up to the day of close, we are going to work to create a robust growth thesis focusing in on three, four or five key levers that we feel provide for the biggest ROI. Post-close, we are going to come in, we are going to get granular, we are going to be actively involved in the business.

That may ultimately transition to more of a weekly, monthly, oversight role as we get more comfortable with the management teams but yes, we consider ourselves to be active investors in that. We want to roll up our sleeves and work alongside existing management teams as we work to grow the business as oppose to investing capital and checking in on a quarterly basis.

[0:11:10.6] AH: Right. What do you consider the ideal investment both from a company that you are looking at, it’s growth trajectory, and then also when to exit your investment?

[0:11:20.2] CZ: Yes, we are very much looking to partner with shareholders, management teams, founders, et cetera. So the preferred transaction for our fund is to come in and do what’s called a majority recap. So let’s say you own a business and you sell that business to us for $10 million. Out of those proceeds, we will have you reinvest a portion of those proceeds back into the business alongside of us resulting in somewhere along the lines of say a 25% post-transaction ownership.

We are looking to partner with management teams who are growth-oriented. Maybe it is a profile of a business owner who’s owned the business for let’s say 10 years. They’ve grown the business, they feel they’ve hatched either their expertise or their ability to finance growth or maybe they just don’t want to take on that added risk themselves for a myriad of reasons want to bring on a partner, tell the majority stake in their business and retain the proverbial second bite of the apple.

Those are the transactions and the seller profile that we’re looking to get involved with and you know it’s –

[0:12:31.4] AH: Yeah and would you prefer that they have some skin in the game at like post-transaction?

[0:12:36.1] CZ: Absolutely, yep. You hit the nail on the head, so the roll over equity is very much allows us to align incentives, right? You know, you are taking chips off the table, you deserve it, you know, you are monetizing the equity that you have built in the business over a number of years but that second bite of the apple, you know a lot of times ends up being much bigger than the first bit of the apple, which allows us to and that potential allows us to very much align incentives in ownership.

[0:13:02.2] AH: Right and then sort of on the – this sort of ideal exits scenario, how long would you like to hold stakes and companies for what sort of return might you be targeting.

[0:13:12.1] CZ: We consider ourselves to be long-term investors and for us that long-term specifically between three to seven years of a hold period. We go into every investment looking at a five year horizon, so we not looking to buy a business and flip it in six to 12 months’ time, right? We understand that it’s going to take a little bit of time to enact our growth thesis and really polish the business and position it for a more up-market sale to a middle market buyer.

From a timeframe perspective, it could be as soon as three years. It could take us as long as seven years but I would say, you know, that bell curve would certainly be between the three to seven year window for a hold period in our portfolio companies.

[0:13:56.4] AH: Are there any particular sectors that you are targeting right now that you see is especially attractive in this market?

[0:14:02.7] CZ: Yeah, we’re looking to stick to the industries and sectors that we know best. Our team has vast operating in mergers and acquisitions experience in the industrials, business services, consumer products and food and beverage industries. We are again sticking to those industries that we know well, those industries where we have a vast network of both executives, financing providers, et cetera.

I would say business models within those sectors that we’re attracted to right now are very much those reoccurring revenue business models, those widget makers that make a bunch of different skews in exhibit below revenue volatility. Those tend to be the businesses that we’re attracted to for a variety of reasons. First and foremost, you know, they typically exhibit less cyclicality in downturns, which we all know can come –

[0:15:03.4] AH: Anytime, yeah. I do know.

[0:15:05.7] CZ: Like we have seen in the last year and outside of that they also lend themselves to typically a lower risk profile for our investor base. To use an example, it could be an emerging brand in the food and beverage sector where we can utilize our vast network of distributors, buyers, large retailers, et cetera and really you know help grow the business and sort of fuel on the fire to extend distributions, et cetera. Or it could be a niche manufacturing firm that is making the widgets and selling to a certain end market. We come in and introduce them to buyers and adjacent end markets and grow revenue two or three times over a hold period.

[0:15:46.7] AH: Can you give us a short explanation of what committed capital is?

[0:15:49.8] CZ: Yeah, for sure. I think the biggest delineation between a committed capital fund investment versus a mutual fund investment or an ETF rather is, you know if you invest a million dollars into an ETF, that money is only earmarked or gone out of your bank account. And that is very much 100% invested and your riding the ups and downs of that vehicle.

With a committed fund investment vehicle, you are essentially pledging or committing a certain dollar amount. We’ll use the million dollars in this example, but that million dollars is going to be pulled or invested over a period of time. In our example, you commit a million dollars. Initially, it is going to be a very small amount that you actually fund and that will be largely comprised of very small amount of operating expenses you know at the fund level and we essentially hold that capital when we employ a business.

Let’s say you commit a million dollars, six months from now, we acquire our first business and you know, we pull 20% of that or 200,000. That 200,000 is now invested that’s going out of your proverbial bank account and you’ve got 800,000 still committed to us.

[0:17:09.4] AH: Right.

[0:17:09.9] CZ: There is certainly pros and cons to that. The pro is that it doesn’t necessarily tie up your capital at the exact moment. The con to some extent is you certainly have to keep that committed amount liquid, as you know we could hold that amount within a rather short timeframe if we find anything attractive investment opportunity.

[0:17:29.1] AH: Is there anything else that you want to tell our listeners about Townsend Street Capital or your strategy?

[0:17:33.6] CZ: Yeah, I would just add that we are – we feel that we positioned ourselves in this attractive lower middle market and that we have a committed pool of capital. We are largely competing against individual buyers, investment firms, private equity firms with the one, two or three individuals. Whereas, we are coming at this lower or middle market with a team of six plus investment professionals and can really provide the resources of a much larger investment private equity firm to this lower middle market that is rather underserved. You know, if I think it’s the people on the resources that I could bring mixed with the opportunity that the lower middle market provide that really mix together to drive [inaudible] generation for our investors.

[0:18:24.9] AH: Right, okay that’s great but we’re out of time but thank you so much, Charlie Zalud. We really appreciate you being on the show with us today and thank you to our PitchBoard listeners for listening in and this is the second episode and we will be back with the third shortly.

Charlie, it was great to chat with you and have a great day.

[0:18:42.4] CZ: Thanks Andrew, appreciate your time.

[0:18:44.0] AH: Okay, take care. Bye.


[0:18:46.3] JM: Thanks for joining us on this episode of The Pitch Podcast. Make sure you check us out online at If you liked our podcast today, please make sure to subscribe to The Pitch Podcast so you don’t miss an episode.


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