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Case studies: How to learn from success of others

It is an axiom of investing that the larger a portfolio, the more its returns must mimic those of the markets in which it invests. Indeed, if a portfolio were to grow fast enough, it would gobble up its investment market and then its returns would have to be identical to those of that market.

Argosy Partners, a Toronto-based investment management company that specializes in replacing partners in closely held private corporations, has found a space of its own. Founding partner Richard Reid was a Bay Street heavyweight when he wheeled and dealed for investment bank Gordon Capital. Today, he perches where big investment funds don't bother to go, where he can operate faster than competing specialty lenders such as GE Capital and where his instincts for dealing can flourish.

With $75-million under management, Argosy Partners is doing much better than the average Canadian equity fund.

Argosy's Shotgun Fund, for example, has returned 20 per cent a year since its inception in January, 2000.

In the past three years, by way of comparison, the S&P/TSX composite index has had a compound annual return of minus 12.6 per cent.

The Shotgun Fund has run a very different race than the broad S&P/TSX, however.

As Reid notes, the entry point for the fund is when partnerships threaten to break down. At that time, the frequently used "shotgun clause" in partnership agreements that lets either partner buy the other out or be bought out and to give notice of same within 30 days sets in process a valuation race.

"It happens when the birds of a feather syndrome pops up," Reid explains.

"When both partners do the same thing, conflicts arise. There may be a lack of a partnership agreement that covers the disagreement. There may be a lack of outside mediators to advise the partners. When the breakup is inevitable, we step in."

Other things can propel small companies into the arms of the Shotgun Fund. It can be the ill health of one partner or a strong need for cash by a partner, Reid adds. "When there is at least $1-million of equity, and if after our own due diligence we are satisfied, then we can provide an answer. We can act within 48 hours."

Selling half of a small corporation to a couple of investment professionals may not be every entrepreneur's idea of destiny, but, as Reid notes, Argosy only takes a seat on the board. It exercises no operating control, seeks none and establishes an exit strategy so either party can shed the other in time.

To date, Reid says, Argosy has done deals and taken a piece of partnerships that control a hotel in Toronto, a steel business in Hamilton, a high-tech manufacturer in Burlington, Ont., a uniform maker in Montreal and a waterbed maker in Toronto.

A related fund, the Succession Fund, gives partners a way to get liquidity without incurring more debt. Finally, Argosy's Bridge Fund makes enterprise value loans to businesses in tough but transitory situations for periods of six months to two years.

Will success spoil Argosy? Reid thinks not. Any merchant bank can do these deals, but few can do them as fast as the two-day turnaround time Argosy sets for its clients, he says.

Major investment dealers and big specialty lenders tend to be slower and, in any case, would tend to walk away from deals as small as Argosy handles. Partnership buyouts are not hedge funds' stock in trade; they are not within the mandate of mutual funds, and they are not the mandate of commercial factors such as GE Capital that advance funds on inventory or cash flow.

Sometimes, a small nest is the best perch on the block.

© The Globe and Mail

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