Evolution Capital Draws Companies to its Honeypot

Some companies that need funding to grow fall through the cracks between venture capital and larger, more traditional PE firms. Evolution Capital Partners was formed to catch some of these “second-stage companies,” says co-founder Jeffrey Kadlic.

There is a gap that exists between venture capital funding for start-ups and private equity funding for more mature, middle-market businesses. That gap is the reason that Evolution Capital Partners (ECP) exists.

The firm was founded in 2005 after its two co-founders recognized the funding gap and decided to help entrepreneurs that were past the start-up phase grow their businesses. Jeffrey Kadlic, managing partner, says his background and that of the other co-founder, Brendan Anderson are “from opposite ends of the spectrum.” He and his partner both went from commercial lending to small business, but then took diverging paths. Kadlic gravitated towards institutional private equity, while Anderson turned toward entrepreneurship before co-founding ECP.

“My background continued down the institutional path, worked at some larger PE funds, and I was seeing small companies that I just couldn’t pursue,” Kadlic says. “I couldn’t write the small checks I wanted to write.” There was a void, he continues, for companies that had been established, were profitable, had a track record, but were relatively undeveloped and would require more energy to work with than an unestablished company.

So ECP is focused on what it calls “second-stage companies”—those with 20 to 50 employees, have been around for five to 30 years, have regional recognition, and often rely on the founder for its success. “That market is largely untapped by institutional investors,” says Kadlic. “A lot of that had to do with the influx of large amounts of capital into the private equity space.” As capital flowed more and more into PE funds, they moved upmarket to put their money to work in a timely manner.

The businesses that ECP invests in don’t need the firm in order to survive on a day-to-day basis, he says, but they “need an extra kick in the pants to take it to the next level. Venture has moved away from what its traditional moorings were, and strategic buyers were looking at five to seven different criteria that don’t necessarily fit these [kinds of] companies. They’ve just fallen through the cracks.”

As for competition from PE firms looking at the same type of companies, Kadlic says it doesn’t really exist because “the competition is the entrepreneur deciding to do nothing. We’re not pursuing companies where the entrepreneur is desperate.” Often the company has underestimated the need for financial reporting and may not get along well with banks for financing needs. They also may be running too fast or too hard on a day-to-day basis to keep the business going, and haven’t thought about where they want to take it in the next month or even five years out, Kadlic adds. “They’re relying on the founder for success and have a lack of professionals who know what it should look like when [the business] gets bigger some day.”

ECP aims to hold its portfolio companies for five to seven years, but generally middle-market funds are “desperate for new product, scouring websites for bolt-on acquisitions,” he says. Often an exit is done in about four years via a platform acquisition to a larger fund or a bolt-on to one of their companies. “Plan B is to sell to a competitor or to the management team”

One major difference in how ECP operates compared to a more traditional—say middle market—PE firm that decides what kind of company it invests in, and then goes out to find it, is that they do the opposite. “Our website is a honey pot,” says Kadlic. “We have an enormous social media footprint. We have a radio show, we blog several times a week, we host conferences. These small companies are impossible to find. We want to be found.”