Fresh from becoming Key Capital Partners’ sole managing partner, James Hall sits down with Real Deals to discuss how the growth investor plans on refining its strategy in this new cycle.

As the new year begins with market conditions remaining tumultuous, one thing is certain for many investors – putting in the groundwork when dealflow quietens is key to continued success. That is certainly true for Key Capital Partners (Key). Its effort will be led by newly appointed managing partner James Hall. After becoming the firm’s sole managing partner in the summer of last year – having previously shared the title with Owen Trotter for three years – Hall is bringing a fresh perspective and seeking to put his mark on the firm.

As part of the leadership transition, Hall plans to hone in on the lower mid-market, echoing the statement that the investor can implement “real support and help” to businesses that are seeking their first institutional investor, especially in the tech-enabled, B2B services and healthcare sectors that Key favours: “We have a long and successful track record of supporting entrepreneurs in the lower mid-market, investing between £4m and £20m of equity in high-growth companies underpinned by deep sector experience.”

“They’re great businesses with strong propositions in really interesting and growing areas of the market,” he adds. “However, they’ve usually got a relatively thin management team, being led by an entrepreneur who needs some support. They reach a glass ceiling in essence, because they’re reluctant to recruit and trust others sometimes, and that can be a pretty lonely place. We have a proven track record of helping entrepreneurial businesses grow through investing in their people, systems and financial information, so they can increase the value of their stake.”

This value-add proposition is even more apt in the current environment, which Hall says should present interesting origination opportunities: “With costs on the rise and a number of other headwinds facing businesses, an entrepreneur has a lot to cope with on their own. Partnering with someone like us who can support management and help to develop and future-proof the business while partially de-risking the entrepreneur is an attractive route to go. We have numerous examples where our investment has accelerated growth and created significant value. So that should drive an element of deal flow.”

Refocusing the message

An area Hall has been keen to address is the firm’s messaging to the market: “We have an excellent track record but I think we need to be clearer on where we operate and how we deliver our returns.” The firm’s new website and brand was recently unveiled and seeks to address this.

Also included within the market positioning process has been setting out Key’s position on ESG. Hall says: “We support high growth businesses and have created thousands of jobs over the years. Our ethos is to support the long-term prosperity of our investments. We want them to thrive long after we have exited. Our track record supports this.” The managing partner adds that the firm is a recent signatory of the UN PRI and has ingrained its position on ESG throughout the investment and portfolio monitoring process.

Investment in the team, in addition to a new brand, and internal process developments have led to strong deal flow during the past 12 months, according to Hall: “Despite the headwinds, our deal flow is stronger than ever, with entrepreneurs motivated to identify supportive investment partners. Our job is to remain focused on quality, given the macro challenges present.”

Key makes both majority and minority investments, and intends to continue doing so going forward. However, unlike many larger contemporaries, a large proportion of Key’s investments are minority stakes. This remains a relatively unique investment strategy, Hall says: “We believe our market is well suited to minority investments. We are typically the first institutional investor in the businesses we back. By acquiring a significant minority, we enable founders and owner-managers to realise part of their value. However, we want them to feel that it remains their business, supported by us as an engaged and additive investment partner. We can provide the support, expertise and knowhow that will help the business maximise its potential.”

While this message resonates with Key’s target market, it can provide challenges in the LP community. “Some LPs do not particularly like minority investments. They do not necessarily understand that we are still in a position to drive change and value, and essentially have the same controls as we do on a majority investment; in truth, our track record suggests that they are our best-performing deals.”

Patient capital

With a recession on the horizon, portfolio management is likely to be equally important. But although record returns will arguably be harder to achieve in the coming years, Key’s focus on value creation and long-term growth (especially when compared to 2021 figures) through investment in the professionalisation of a business will be key, Hall says. For example, industrialising sales processes to remove the reliance on key individuals and moving away from initiatives that rely on“gut feelings” into data-led strategies is its most dependable tool for achieving growth.

This undoubtedly involves an element of patience. “We will put a significant amount of overhead into the business. Year one, we’re happy even if the business doesn’t necessarily grow from an Ebitda perspective, as you’ve got to remain patient and invest ahead of the curve to deliver that growth. That leads to quite aggressive but sustainable growth by the time you get to years three and four,” Hall says.

With its focus on smaller investments, Key is keen to remain cautious on leverage, ensuring businesses have the breathing space to grow. “We don’t tend to put a lot of debt in our structures initially,” Hall notes. “Given where the debt market currently is, and looking at how that’s likely to develop in the next six to 12 months, we want to continue to be light on leverage. I appreciate it can help drive the returns but our focus is much more on the growth and maximising value over our investment period. If you look at the returns we’ve generated over the last 10 years and more, profit growth and multiple arbitrage deliver the vast majority of the return, which is markedly different to the mid-market.”

And despite the rocky market conditions, Hall says Key has delivered strong returns in recent months. The firm has exited five investments from its 2016 institutional fund, delivering a gross return of 3.3x to investors (increasing to 4.3x including elements of value rolled over). These returns have led to the firm being identified as one of the top-performing global small-cap investors, according to recent independent research by Dow Jones (where Key was ranked the top-performing fund globally managing less than $150m).

Returns in recent months include the sale of Avantis Systems, a virtual reality edtech business to LDC (return undisclosed), and the sale of York Test Laboratories to NVM (1.1x return). These exits follow the sales of Sparta Global, a technology and training services business, to Inflexion for 6.8x; the partial exit of digital builders merchant CMO Group (a 6.3x return, 3.3x returned on IPO and 2.9x rolled over based on float price); and domiciliary care provider Routes Healthcare to Palatine.

Future-proofing

Origination is one area where changes could be afoot with Hall at the helm. As a small business, Key has an ‘all hands on deck’ approach to finding deals, as both teams in Leeds and London take responsibility for identifying opportunities and pitching them to the investment committee.

“We’re looking to complete perhaps two or three deals a year, but we’re reviewing 200 potential investments a year,” Hall explains. Continued professionalisation and investment in the origination function is likely to continue under Hall’s leadership.

Looking at what else is to come in 2023, Key’s focus could soon turn to fundraising. In 2022, the firm completed three exits and two new investments, and believes if it successfully invests at a sensible rate then a fundraise could begin as early as the fourth quarter.