By Matt Miller
October 29, 2010
From the vantage point of their 37th-floor offices, Mark Filippell and Ralph Della Ratta Jr., co-founders of investment bank Western Reserve Partners LLC, gesture to the Cleveland cityscape below. They point slightly northwest, where barges unload iron ore from Lake Erie. They then walk to another office facing the opposite direction, where the old Republic Steel plant, now owned by ArcelorMittal, continues to light up the night sky. Moving from room to room, Filippell proudly demonstrates remarkably detailed working models of bridges he has constructed. Real-life expanses frame parts of the view in the distance.
“You’re seeing the vestiges of the American industrial heartland,” says Della Ratta. “At one time Cleveland was the richest city in America,” he adds, pride mixed with regret. “It was like the Silicon Valley of the 1920s.”
The purpose of the brief tour isn’t just to acclimate a visitor to the city, but to help explain both Western Reserve’s own manufacturing-dominant advisory business and the origins of Cleveland’s deal infrastructure. That community is surprisingly large and self-sufficient, with an array of both national and regional players. “It’s amazingly dynamic,” he says. “It’s the full spectrum of dealmaking.”
Cleveland is a stellar example of how most deals get done in America. For all its troubles, the city remains the vibrant center of a regional network, with national and international outgrowths, consisting of banks, nonbank lenders, accounting and law firms, private equity shops, some venture capital. “I think we have all the pieces, all the parts. There’s nothing you have to leave our market for,” says Gregory Skoda, chairman and co-founder of accounting firm Skoda, Minotti & Co., based in the Cleveland suburb of Mayfield Village. “So saying, more and more and more, we all have to play on a national or an international stage.” (See “Candlewood looks abroad.“)
Mention deal-related financial clusters and New York easily leads the pack. Chicago, Los Angeles and Boston follow. When it comes to technology, the San Francisco Bay area dominates. Less obvious to outsiders are other cities — Pittsburgh, Houston, Milwaukee, Atlanta, Minneapolis — that host their own, smaller deal communities. They vary in number and reach, although most cater to local and regional businesses and exhibit a decidedly middle-market emphasis.
Perhaps none, however, boast Cleveland’s outsized numbers. “Cleveland has a disproportionately strong deal community,” says John Mino, a partner at Cleveland-based law firm Calfee, Halter & Griswold LLP. “It has a disproportionately large service provider community.”
“Blame it on history,” says John Gherlein, Cleveland-based head of the national business group of law firm Baker and Hostetler LLP, whose offices are a few blocks east of those of Western Reserve. Gherlein rattles off three storied Cleveland business names: Diamond Shamrock, TRW, Sohio. (At one time in the early 1900s, more Fortune 500 companies were based in Cleveland than any other city save New York, according to some accounts.) Services developed to cater to these large corporations. While most of them have moved on, been acquired or are out of business, the service providers remain. Some, such as legal powerhouse Jones Day and what began in Cleveland as accounting firm Ernst & Ernst (now Ernst & Young LLP), boast stellar names and global reach. Others are known only in and around Cleveland.
Stewart Kohl serves as co-CEO for Cleveland-based Riverside Co., one of America’s largest middle-market private equity players. An understanding of the city’s industrial past, he says, helps explain what Cleveland has to offer: “In the 1920s, Cleveland led in the growth industries. It was Seattle, Palo Alto, Austin, all rolled into one.” But, he adds, “unlike Detroit and Pittsburgh, where wealth and industry were concentrated on a very few companies,” which quickly outgrew their local roots, Cleveland companies “used Cleveland banks, used Cleveland law firms, used Cleveland accounting firms. Cleveland had this kind of cluster of intellectual capital that continues to this day.”
The numbers are impressive. In Cleveland, that deal community, including some leading legal and audit advisories, encompasses almost 60 firms, according to a survey compiled by The Deal.
Private equity alone has 21 entries, which means Cleveland ranks perhaps fifth nationally, behind New York, Chicago, Los Angeles and Boston. Cleveland’s private equity heft far outweighs the local business scene. Riverside heads the list, but the lineup also includes nationally known shops such as Blue Point Capital Partners, Linsalata Capital Partners Inc., Kirtland Capital Partners and Primus Capital Funds. Key Principal Partners Corp., 50% funded by KeyCorp, has established itself in the top ranks nationally of mezzanine lender/noncontrolling investors.
“We’re all hiding in plain sight in Cleveland,” notes John Sinnenberg, Key Principal’s chairman.
The legal community also boasts marquee names. Jones Day prides itself on its Cleveland roots. Squire, Sanders & Dempsey LLP has also gone global from its Cleveland base. Baker and Hostetler has national reach. Calfee; Benesch, Friedlander, Coplan & Aronoff LLP; Thompson Hine LLP; and Taft Stettinius & Hollister LLP are strong regional players. “The legal talent in this market is so deep, you can’t go wrong,” says Andrew Petryk, managing director at local investment bank Brown Gibbons Lang & Co. LLC. Petryk adds that because of a cheaper cost structure, “our legal community is able to export its services to other markets.”
Accounting and due diligence include the Big Four as well as second-tier stalwarts Grant Thornton LLP and RSM McGladrey Inc. Skoda Minotti is the largest local accounting firm but is also part of the BDO Seidman LLP alliance.
“There’s a big supporting cast that allows deals to get done,” says James Doyle, Cleveland-based senior vice president and national business development manager for asset-based finance at Minneapolis’ U.S. Bancorp. “A lot of firms grew up here and stayed.”
There are gaps in Cleveland’s finance-related ecosystem. Most notably, venture capital is only now beginning to gain traction after a long hiatus. Cleveland’s alternative investment history actually begins with venture capital, when David Morgenthaler, now 90, founded a small family-funded firm in 1968. He began to attract institutional capital in the 1980s. While Morgenthaler Ventures maintains an administrative and buyout office in Cleveland, its venture work has for years been sourced from offices in Silicon Valley, Boston and Boulder, Colo.
Venture capital is now being more actively sought, thanks to government initiatives over the past eight years. These require a physical office in Ohio to qualify for government funds, in which the state plays the role of limited partner. (See “Can venture capital thrive along the Cuyahoga?“)
Yet, so far, Early Stage Partners is the only Cleveland-based venture firm of any size. “I think you’ll see more venture coming in,” says Mark Brandt, who heads business development for McGladrey. “This area is ripe for it.”
For a city in the heart of America’s Rust Belt, distressed financing isn’t as strong as it should be. One big exception: Resilience Capital Partners, a distressed buyout fund whose 17 investments totaling $125 million since its 2001 inception is one-third Ohio-based. Because of Resilience’s success, other distressed shops may follow, a few believe.
According to some in the local deal community, homegrown senior lending is getting tougher, especially after the takeover two years ago of National City Corp. by Pittsburgh-based PNC Financial Services Group Inc. Bad mortgages had pummeled National City, which was weakened to the point where it couldn’t survive on its own. It was Northeast Ohio’s largest bank. However, in the aftermath of the merger, PNC reduced lending. Deposits dropped, and the bank’s influence has waned. “People liked banking with National City,” says Howard Bobrow, a Cleveland-based partner at Taft Stettinius. “PNC isn’t local, so it doesn’t support the same philanthropic organizations. Its criteria for borrowers are different. [The loss] was a very powerful blow.”
KeyCorp is now the city’s biggest commercial bank and the last remaining major Cleveland-based financial institution. National institutions with a Cleveland signage such as U.S. Bank are beating the streets. U.S. Bank’s asset-based lending operations are based in Cleveland, which helps. And Akron, Ohio-based FirstMerit Corp., which avoided the subprime lending fiasco, has moved aggressively into lending in Cleveland’s environs over the past few years. After the sale to PNC, FirstMerit grabbed some top National City executives, who know the local marketplace and its players.
“We’ve been able to reach out to other financing partners” including FirstMerit, says Stephen Perry, a senior managing director at Linsalata, who says recent consolidation hasn’t hurt his firm’s financing needs. “PNC has a presence here,” he adds, so the takeover of National City by PNC “isn’t a total loss.”
Although Cleveland’s high-net-worth individuals once seeded many of the city’s original private equity players, it’s a limited source of fundraising for private equity and venture capital. While some of these families may still inhabit Cleveland and environs, institutional money is usually sourced elsewhere. Cleveland lacks life insurance companies and locally based pension funds. No major fund-of-funds calls Cleveland home, although a subsidiary of Key Principal, Key Capital Corp., does make investments in other private equity funds. Fundraising at least involves a 2.5 hour drive down Interstate 71 to Ohio state capital Columbus.
As funds increase in size, they source their limited partners all over the U.S. and globally, although many say state investments remain pivotal. “We’ve been involved with Ohio pension funds from the beginning,” says Primus managing director Jonathan Dick. “We have Canadian pension funds, national insurance companies, but Ohio pension funds remain our backbone.”
Caveats aside, the infrastructure surrounding deals is extensive. “If anything, it’s a more thriving deal community than ever before,” says Perry.
That doesn’t mean this community is focused on servicing only Cleveland or Northeast Ohio. For many major players, a relatively small percentage of deals have a connection that’s local. In a current fund that reaches close to $300 million, Primus has invested between $40 million and $50 million in Ohio. “We invest nationally. Part of our strategy is broad geographic representation,” says William McMaster, a Primus principal. “If we can invest locally, all the better.”
That local percentage isn’t likely to grow. Primus has moved away from manufacturing — “we haven’t done a manufacturing company in probably 15 years,” says Dick — and toward growth industries. At Riverside, more than 25% of the firm’s 190 employees call Cleveland home, but it boasts 19 offices in 13 countries and 71 current portfolio companies that span Europe and Asia as well as North America. “We tend to give more attention, more time when we find [a prospective company] in Northeast Ohio,” says Cheryl Strom, associate director for Riverside’s origination operations. However, she adds, “[w]e don’t see an outsized proportion in Northeast Ohio.”
Brown Gibbons’ Petryk says that when it comes to his firm, the proportion of regional deals fluctuates with the times. In a more buoyant market, “maybe one-third of our deals take place within a four-hour drive of here,” he says. “Now, it’s probably 50 to 60%.” Brown Gibbons focuses on companies with valuations from $25 million to $150 million.
Cleveland isn’t a closed deal shop. Chicago financiers, Boston venture capital and New York private equity all participate. Bulge-bracket firms such as Goldman, Sachs & Co. and Morgan Stanley call on major companies, although they’re often dismissed by locals as giving the city short shrift. A group of KeyBanc Capital Markets executives is asked where the out-of-towners are usually spotted. “They’re in for a certain meeting and then out again,” says Andrew Vollmer, a KeyBanc managing director who heads the financial sponsors group. “We physically see them at the airport.”
A number of deal-related professionals in Cleveland maintain that some New York investment banks have garnered a less-than-sterling reputation. “Whether reality or not, there’s a perception that one Wall Street team comes in to make the pitch and the actual transaction is handled by a more junior team,” says Petryk, adding “most people here want to deal with those in the community.”
That extends to private equity, Sinnenberg argues. “There’s a healthy disrespect for New York private equity that comes to the Midwest,” he says. “Midwesterners don’t want kids with M.B.A.s telling them how to do their business.”
Several big corporations such as Eaton Corp., Sherwin-Williams Co. and Parker Hannifin Corp. maintain headquarters in Cleveland. Aircraft components manufacturer TransDigm Group Inc., whose offices occupy one of Cleveland’s most distinctive downtown office buildings, is on something of an acquisition tear, most recently announcing in September that it will pay $1.27 billion in cash for McKechnie Aerospace Holdings Inc. National real estate powerhouse Forest City Enterprises Inc. is based downtown, while Developers Diversified Realty Corp. has its headquarters in suburban Beachwood.
“There are a shocking number of larger corporations,” says Lyle Ganske, Jones Day’s partner in charge of the Cleveland office. “The number of public companies within 50 miles of where we’re sitting blows us away.” Adds Bobrow, “There are a lot of formidable companies here in town,” but the city and its environs have become a decidedly middle-market economy, “both in numbers [of companies] and in jobs.”
Cleveland’s deal infrastructure is tilted to that middle market. “We chose Cleveland because the Midwest is great and we love midmarket companies,” says Key Principal’s Sinnenberg. Even KeyBanc Capital Markets, by far the dominant investment bank in the city, prides itself on being “very focused on the middle market,” says Andrew Paine III, executive vice president and head of corporate and investment banking. “The region is full of middle-market companies. Many of them were spun out of the Fortune 500.”
(The one notable exception to a middle-market tilt is probably Jones Day, which occupies a modernist glass building on the waterfront close to the Rock and Roll Hall of Fame and Museum. Jones Day is among the three largest law firms in the country, and while partner Charles Hardin Jr., who heads the firm’s private equity practice, maintains “the middle market is our bread and butter,” the firm plays in all fields.)
While old money and past corporate glory help explain the origins of Cleveland’s deal-related infrastructure, some modern developments can be traced to a few individuals still kicking around and to the foibles and machinations of large financial institutions.
Take Filippell and Della Ratta’s old employer, McDonald & Co. In 1998, KeyCorp bought the storied brokerage company, which became the core of KeyBanc Capital Markets. However, Filippell and Della Ratta, key personnel in McDonald’s investment bank operations, quit almost three years later to start up their own shop. A number of other employees left to start asset management companies, business brokerages and advisory services.
Then there’s Citibank, which during the 1980s, had a major Cleveland footprint, including the bank’s national leveraged finance group. Jim Petras, who headed that group, says he supervised offices on both coasts and in Atlanta from his Cleveland perch. However, Citi began to pull back after various offshore debt crises and the leveraged lending debacle of the late ’80s, and the Cleveland operations shut down in 1993. Citi alum now constitute an important component of the city’s deal community: Petras is a co-managing director of Early Stage Partners; John Kirby is a managing partner at Blue Point Capital; and Riverside’s Kohl. “They trained a whole cohort of us,” says Kohl, who jokingly says he couldn’t spell “Ebitda” when he first joined Citi.
In discussions of Cleveland-based private equity, the nod usually goes to Morgenthaler as well as to John Turben, who in 1977 founded a small buyout shop called Chagrin Valley Co. Ltd. That grew into Kirtland Capital Partners. Primus Capital and Linsalata Capital came soon after. They occupy the same floor of a building in an office park, just east of the near suburbs collectively known as the Heights.
In 1983, a group of executives, worried about Cleveland’s economic tailspin, launched a growth initiative called Cleveland Tomorrow. One of the cornerstones was a $30 million venture fund focusing on Northeast Ohio. They tapped Loyal Wilson, a First Chicago Corp. executive, to start Primus. Linsalata followed a year later when founder Frank Linsalata left his job as executive vice president at Midland-Ross Corp.
Cleveland, population 430,000, is less than half what it was at its peak in 1950. Its golden age is long gone. But so, too, are the years when the city was emblematic of America’s urban woes and a cruel national joke. Whites fled the city. Massive numbers of blue-collar workers lost their jobs. The Cuyahoga River caught fire. “The fire is out. It was out a long time ago,” says Jean Robertson, another Cleveland partner with Calfee, who, like many, bristles at the hard-scrabble reputation the city just can’t seem to wholly shake off. “Cleveland is one of the best-kept secrets in America.”
Conversations invariably turn to a welcome lifestyle, the lack of stress and the benefits of raising a family in any number of picturesque suburbs: “The cost of living is a joke. You can buy a palace here for $500,000,” says Della Ratta. “The quality of life is amazing.”
Cleveland is big enough to support three professional sports teams. (OK, the Indians were dreadful this year, the Browns are dreadful, and the Cavaliers are expected to be dreadful now that superstar LeBron James has decamped for warmer climes in Miami.) The Cleveland Orchestra and art museum are among the best in the country. The Rock and Roll Hall of Fame and Museum has become a landmark since its opening two decades back and is a huge draw.
For those in the dealmaking community, that doesn’t just mean box seats or invitations to galas, but numerous opportunities to work for civic good. “It’s not just housing and the commute. You can get involved,” says Ganske. “The expectations are you will get involved. It’s in the fabric of the place.”
Ganske, who grew up in Ohio, attended law school at Ohio State and was Jones Day’s first associate in its Columbus office, acknowledges there’s a kind of inferiority complex, which he says translates into a “very welcoming community.”
“We sometimes feel like Rodney Dangerfield,” says Baker and Hostetler’s Gherlein.
He has a point. With national reach, many members of Cleveland’s deal community could locate anywhere. They’re in Cleveland because they choose to be, and while many are Ohio natives, a good number are transplants. Many say they have actively resisted relocation. “The reason I left Citi is because they tried to move me back to New York. I walked,” says Kirby. Notes Jones Day’s Ganske, who for years was co-head of global M&A for the firm, “They asked me to move a hundred times.” Ganske says he actively recruits from big New York firms with this pitch: “You can have the same practice and you can have a life.”
The dealmaking community may be far bigger than Cleveland’s numbers warrant, but that doesn’t mean the city exhibits a Manhattan vibe. “Cleveland’s a small town. Everybody knows everybody,” says Gherlein.
Collegiality rules. “I could give you a whole list of companies we’ve got done because we’re here,” says Kirby. “We know their accountant. We know their lawyer.”
That’s not necessarily hard. There’s physical proximity between so many of the players. Take maybe a half dozen downtown skyscrapers. Add the modernistic North Point Office Building and Tower that hugs the waterfront a couple blocks away. Throw in a few office parks in the suburbs east of the city and that’s about it.
Just about everyone along this deal-related food chain believes a shared Midwestern identity gives them an advantage over competition from either coast. Some anecdotal evidence supports this view. Take the case of Daniel Zelman, who owned Packers Holdings LLC, the country’s biggest cleaning service of meatpackers, based in Twinsburg, Ohio. In 2007, Zelman says, he decided to sell, but wanted to control the process. (He’s a former Arthur Andersen CPA who acquired Packers in a 1998 buyout.) He approached three private equity firms, Riverside, Blue Point and one in Chicago. Blue Point won out for a deal valued at $90 million. Zelman stayed on as president and minority stakeholder. With Blue Point’s support, Packers acquired in August Kaiser Contract Cleaning Specialists Inc., a Wisconsin-based competitor, for an undisclosed price.
Zelman talks of Blue Point’s “Midwestern values.” He says he “went to Cleveland firms because I knew them” and that “Cleveland has everything needed to execute these kinds of transactions.” But he’s quick to add: “If I didn’t feel I was getting good value, I could have gone elsewhere.”
Cleveland has labored hard to retool while sprucing up the city itself. At best, this is a work in progress. Its poverty rate remains disturbingly high. The city’s public schools consistently rank near the bottom nationally. Unemployment exceeds the national average. The auto industry downturn hit the city hard.
With a $1.8 billion endowment, the Cleveland Foundation is one of America’s largest city foundations. Just shy of a century, it’s the oldest. CEO and president Ronald Richard, who arrived in Cleveland seven years ago and initiated economic development, stresses that Cleveland’s cultural treasures are in jeopardy if the economy doesn’t thrive. “If we don’t think about funding economic development, we’re not going to have a museum to give to,” he says. “The Cleveland Orchestra can’t remain the country’s greatest orchestra if there’s no audience.”
Some counter that the economy hasn’t necessarily declined, just moved. “A lot of that economic evolution has taken place out of the city and into the suburbs,” says Skoda. He cites his own suburban office neighborhood, which is dominated by Progressive Casualty Insurance Co., now one of the biggest private-sector employers in the region. “From our offices, look in every direction, throw a stone, and you’ll hit a Progressive building.”
Greater Cleveland exhibits many of the traits that defined the American city in the past half-century, a time when suburbs pretty much sucked the energy out of most urban cores. Urban Cleveland is gaining strength, but slowly. While East Fourth Street and the Warehouse District offer a growing list of restaurants and bars, while professional stadiums flank downtown, while a few old buildings are being transformed into condos and lofts, pretty much everywhere else in the city center empties out after dark.
According to Jeffrey Wild, a real estate lawyer with Benesch, the outlook for commercial real estate downtown is, at best, mixed. “No one is doing development here,” he says. “The suburban office market is healthier than downtown” and older downtown buildings will face even tougher times in years ahead. Both Eaton and local Huntington Bancshares Inc. are relocating corporate offices to the suburbs, he says. “It’s going to be tough to re-lease that space.”
Wild says the biggest exception to a lack of real estate development is in healthcare — Cleveland’s real economic savior. “If it weren’t for healthcare, Cleveland would be in trouble,” says Della Ratta.
The sector transcends the urban-suburban divide. While hospitals, medical centers, laboratories and allied activities dot the suburbs, healthcare-related businesses are anchored in the Cleveland Clinic and University Hospitals, both of which crowd up against Case Western University, a decidedly urban area about four miles east of downtown. With aggressive acquisition strategies, multibillion-dollar expansion programs and phenomenal, state-of-the-art facilities — Cleveland Clinic has on its sprawling campus three hotels to service visiting family members — it is not only a huge employers, but provides intellectual capital for everything from medical devices to biotech.
Northeast Ohio’s economy is changing and its industrial base has weakened. But that doesn’t mean manufacturing has disappeared. Cleveland’s deal community reflects this as well. “Our sweet spot is manufacturing companies, with highly engineered components sold to OEMs,” says Mark Mansour, managing director of the Cleveland-based private equity firm MCM Capital Partners, whose current $50 million fund is tilted toward Ohio. “The reality is, developed economies will continue to shed manufacturing jobs to low-cost countries. So saying, there are still a number of wonderful niche manufacturers here.”
Many Cleveland private equity players say they love to beat the heartland bushes looking for good investments. “The further from a regional airport, the better the deal,” says Key Principal’s Sinnenberg.
The landscape is dotted with private, family-owned manufacturers. Many proprietors are reaching retirement age. While a down economy has slowed the process, sales of these private companies to larger strategic players or private equity shops should accelerate, and the region’s deal-oriented community is gearing up. “I sense it’s coming,” says U.S. Bank’s Doyle.
Quality Synthetic Rubber Inc., for example, inhabits a low-slung building around the corner from Packers Holdings. Its factory lies almost midway between Cleveland and Akron, once considered the “rubber capital of the world,” until many of the leading players either merged or decamped. The 44-year-old QSR produced rubber — now synthetic rubber — connectors primarily for car industry electronics, but also for heavy industrial equipment. The two original owners wanted to retire. Blue Point Capital first made contact with the company in 2002, acquired it five years later and pumped in new capital.
Blue Point stresses this is no old-guard rubber company. “They’re a true market leader in what they do,” says Kirby. “They’re at the intersection of polymer chemistry expertise and rubber molding expertise.” Shortly after the acquisition, however, the car industry imploded.
QSR CEO and president Randy Ross walks through the plant. He talks proudly about the added value in proprietary compounds. “Our secret recipe,” he says. He points to molds the company crafts for clients, which allow millions of pieces to be made to exacting standards. He shows off visual inspection machines built internally. It’s one area of the plant that Ross says is a must-stop on the tour. “We’re leaving the area of the 20th century and moving into the 21st century,” he says as he enters a section of the plant that includes three clean rooms.
This division makes silicone medical devices such as stents and feeding tubes. For Quality Synthetic, medical devices have grown from nothing to some 20% of total business over the past few years. “This is our No. 1 focus of growth,” he says. “This is our future.”
With the assistance of Blue Point, which has an office in Shanghai, QSR is beginning to make some products in China and sell aggressively into the rapidly growing Chinese auto industry. But Ross says that doesn’t mean QSR will turn its back on homegrown manufacturing. “I’ve been in a lot of companies where they’d give up on a plant like this and put everything in China,” says Ross. “For this little company in Ohio, survival means innovation.”
“They rebounded very nicely,” says Kirby. “They weathered the storm.”
Cleveland exhibits this kind of tough resilience, which is blended with a widespread, sometimes oddly self-deprecating persona. Call it Midwestern vice. As one local resident says, “We’re not as bad as you thought we were, are we?”
About Key Principal Partners
Key Principal Partners (KPP) is a $1 billion private investment firm that provides expansion capital to profitable middle-market companies with at least $30 million in revenue. The firm has the flexibility to provide any combination of subordinated debt, preferred equity and/or common equity in either non-control (minority ownership) or control (majority ownership) positions. KPP can invest between $10 million and $40 million to facilitate the growth, acquisition, refinancing, deleveraging or liquidity needs of private company owners and their management teams. Affiliated with KeyCorp, KPP is headquartered in Cleveland, and has additional offices in Greenwich, and San Francisco.
Cleveland–based KeyCorp is one of the nation’s largest bank–based financial services companies, with assets of approximately $97 billion. Key companies provide investment management, retail and commercial banking, consumer finance, and investment banking products and services to individuals and companies throughout the United States and, for certain businesses, internationally. For more information, visit www.Key.com.