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Why private equity likes mid-sized companies such as Town Shoes

From left, Sophia Tolias, Guy Berman and Michael Akkawi of Torys LLP in Toronto.

Kevin Van Paassen/The Globe and Mail

A series looking at the unique challenges facing Canada's midmarket companies and how they innovate, stay competitive and grow. This piece starts with the Canadian shoe retailer that started with one store in a strip mall and grew to a 116-outlet chain. But then the question was: How to take it to the next level? Private equity was the answer.

Canadians who wander by a Town Shoes store might see a nice pair of boots or heels in the window. Private equity investors might see something different – an example of a mid-market company that's a good investment target.

Private equity funds, both Canadian and international, have become increasingly interested in Canada's mid-market sector. The interest can be mutually beneficial – profitable for the private equity investors and helpful for growth to mid-sized firms, which typically have between 50 and 500 employees and at least $5-million a year in revenue.

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Town Shoes is a good example, explains Michael Akkawi, a partner at Torys LLP in Toronto and head of the firm's Private Equity Group. The chain, now a giant, got started in 1952 by then-22-year-old Leonard Simpson, who was persuaded to open a store in what turned out to be Canada's first strip mall, at Bayview and Eglinton avenues in Toronto.

By 2012, the chain had grown to 116 stores across Canada, with good positions in both high-end retail markets because of its locations in fashionable areas, and in the discount sector because it also owned The Shoe Company stores.

As a strong, viable business, its only real limits were: how to make the transition from a family-founded mid-sized company into a big firm; and how to have access to the capital needed to do so.

In 2012, the founders sold controlling interest to Alberta Investment Management Corp. (AIMCO) and Callisto Capital, the latter a Toronto private equity firm, with the Simpsons' management team continuing to run the company.

This type of private equity deal is a win-win situation for both the buyer and the seller, Mr. Akkawi says.

"It's a great example of how private equity works," he explains. The buyers acquired a well-run business that had room to grow, while "from the owner's side, they made a good return on the sale and retained some of their equity."

The story didn't end there. By this year, the chain had 182 stores under both brands, with annual sales last year of $291-million. Earlier this year, U.S. giant DSW Inc. bought a 44-per-cent stake in Town Shoes for $62-million (U.S.), with options to buy the rest of the company after four years.

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Private equity firms are looking more eagerly at Canadian mid-sized firms of all types for investment opportunities, says Sophia Tolias, an associate at Torys who has worked on similar private equity transactions.

"It's partly because of changing Canadian demographics. The population is aging. Baby boomers are retiring in the next few years, and they're looking to transition their businesses. The private equity firms see opportunities, which, in turn, creates more opportunities," she says.

Together with Torys partner Guy Berman, Ms. Tolias and Mr. Akkawi published a review of Canada's private equity market in 2012. (They are updating their data and publishing a new review soon.) They found that mid-market transactions were rich territory for private equity firms in 2012.

"The vast majority of private equity transactions in Canada in 2012 remained in the low- to mid-market, with deals of less than $500-million accounting for 80 per cent of the disclosed deal values, similar to the experience in U.S. private equity markets. Canadian transactions were predominantly less than $100-million," their review said.

Among trends the experts are seeing now in the Canadian transaction market are that private equity firms are searching for and buying more mid-market companies now than they were two years ago. In 2012 there was more selling than buying, as private equity firms sought to realize returns on their investment.

Now there's more interest in finding good Canadian mid-sized businesses and investing, Mr. Berman says. "Everybody's all over them," he explains.

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The understanding of the strengths of Canadian mid-sized companies has changed, he adds. A few years ago, funds saw Canadian mid-sized firms as a way to gain a toehold in the Canadian economy without too much risk; now they want a bigger perch.

"The funds aren't looking at [these companies] as just a Canadian play any more, they're looking at it as a North American play," Mr. Berman says.

Investors are sharpening their business strategies, too, Mr. Akkawi adds. "One of the big focuses that we're seeing from our clients in their investment strategies is to focus on platform assets," he says.

By this he means that private equity investors are trying to build businesses, rather than simply parking money in the hope of a large profit later.

Town Shoes is an example, Mr. Akkawi says.

"They [private equity firms] will buy a shoe retailer and acquire a good solid base by building a national chain. Typically, our clients are real experts in a select number of industries. They have the expertise, they're looking for the platform investment and then they'll build on that," he says.

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Pros and cons

Taking on private equity can have upsides and downsides for mid-sized businesses.

Pros and cons include:

Control – Dynamic mid-sized firms usually draw their energy from entrepreneurs. Private equity investment can take this energy away, unless the investors reach a deal to keep the founders as managers or co-owners for a while.

Transition – Private equity can help owners build their business methodically, and it can eliminate family feuds that often spring up when it's time to pass on the company or make it bigger.

Editor's Note: This updated version of this article changes attribution for certain quotes made by Michael Akkawi and Guy Berman, partners at Torys LLP, who were interviewed by conference call.

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