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  • Brooke Ansel | The Benefits of Mezzanine Financing
    POSTED 5.25.21 M&A Masters Podcast

    On this week’s episode of the M&A Masters Podcast, we are joined by Brooke Ansel, Vice President of Prudential Private Capital. She runs a Prudential team focused in the southern United States, but her career path to the investment company was unconventional – it started with the Neiman Marcus buying team. 

    Brooke tells us about how Prudential is more than just a bank – it has a commitment to the lower middle market that might surprise some listeners. Prudential Private Capital focuses more on debt and minority equity, and acts as the private capital arm of the larger Prudential institution. 

    We chat with Brooke about what Prudential Private Capital brings to the table, as well as:

    • Minority equity and mezzanine debt 
    • The Prudential Private Capital ideal client 
    • Investing in growth and being there for the long-term relationship
    • Important misunderstandings to avoid 
    • Optimism for the M&A world Post-COVID 
    • And more

    Listen now…

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Service. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Brooke Ansel, Vice President of Prudential Private Capital, in their Dallas office. Brooke it’s great to have you. Thanks for joining me today.

    Brooke Ansel: Patrick, thank you for having me. Thrilled to be on today.

    Patrick: This is unique. Usually, we’re talking with either private equity firms or other capital providers in the lower middle market. At the first blush, you think Prudential big institution, large cap, you know, interest only, not the case. So it’s a pleasure to have you. So before we get into that, though, let’s talk about you. How did you get to this point in your career?

    Brooke: Yeah. So as of the beginning of May, I’ll be with Prudential for about seven years. It’s gone by very quickly. Like Patrick, like you mentioned, I’m a Vice President. And I run a team here in Dallas and focused really in the southern part of the United States. But I have what I would call a fairly untraditional career path to where I am today, actually started out of undergrad at Neiman Marcus in their handbag buying office. 

    So after getting a finance degree, that’s what I chose to do. And it was a fantastic experience, I got to learn about a lot of different parts of business, including marketing and finance and inventory management. Among other things, it was great experience, but decided to then pivot and pursue more what I would call traditional corporate finance opportunities, including an opportunity at a large hedge fund here in Dallas, and then at Deloitte. So like I said, kind of untraditional, I think to the role I’m in now, but all great experience. And I would say just a great journey. And a lot of that experience I leverage in my in my role today.

    Patrick: I can say, you can’t understate the importance of experience. And it’s great because you go from school right into where you’re an operations and working on something on a large scale. And and so you get to see a lot of little things, rather than being in some boutique where you’re just narrow in one area. So that’s excellent. Now, as I mentioned before, people don’t necessarily think of an institution like Prudential being active in in investing like this or more of just like a bank. Okay, not the case. Talk to me about this, and how Prudential Private Capital how it’s different from, you know, just a regular bank. And also, its commitment to the lower middle market, which again, complete surprise. And I’m glad you’re here to tell us about that. 

    Brooke: Yeah, I’m so glad to have this conversation, because like you alluded to, a lot of people hear the name Prudential. And they either think of, you know, oh, they’re only investing in public securities, or they just think of our retirement and retirement products, life insurance products. So Prudential Private Capital, we’re a part of that broader Prudential. And we actually have about 100, I think we’re close to 100 years, in terms of our history as the private investing arm for Prudential. And we largely focus on on the debt side, but we do provide minority equity as well. So really think of us in terms of all types of private, private capital. And that’s what we’re doing on behalf of Prudential. So it’s great and that we have, you know, this large balance sheet that we’re investing on. 

    But we have, we can get into this a little bit more, as we talk further. But we have these smaller regional deal teams and regional offices that allow us to get to know management teams, get to know sponsors in our territories. And that allows us to invest, you know, private capital in the lower middle market and middle market space. So we’ve been around for a long time, but I feel like a lot of people aren’t as familiar with kind of what what we do on the private capital side.

    Patrick: Connection we have with Prudential is they start off as a life insurance company. So you got you gotta like that little connection with with the legacy there of insurance and then broadening out into other financial areas. So you’ve got this large institution, and you referenced this real quick as you got a deal team. So you’re a lot more nimble than people think. Why don’t you talk about what the what are the elements that Prudential Private Capital brings to the table? 

    Brooke: Yeah, this is such a great question. And I know you know, one of your prior guests I know alluded to the fact that all capitals and saying no money is greater than any other money, one of my good friends, Heather Hubbard, but you know, I think in terms of our secret sauce, and what we bring to the table is really this idea of our network. And it’s our internal network as well as our external network. So the culture of just our organization, I work with a lot of people who’ve worked together for literally decades and just know each other very well, we can be nimble, make decisions quickly, just because our senior management team has been together for so long and through cycles. 

    Not only that, you know, myself and the other team leaders, my peers, we’ve all been with Prudential for years and know each other well. So we’re able to network be nimble, get smart on different situations, different industries, really quickly through just our internal network within our group. But beyond that, you know, we talked a little bit about our regional office network, you know, I am very focused on really sponsors and companies in my backyard. So I know what’s going on in the market dynamics in my region. And as well, as you know, my colleagues across the country in the world, actually, very similar model, they just get to know people and their markets really well. 

    And then beyond that, I mentioned our global footprint, you know, I have they’re individuals like me who are based in our London office, or Frankfurt office or Sydney office. So we have this global network and and global client base team base, that we’re able just to pull a lot of knowledge from leverage relationships, and help not only kind of our colleagues, but also are the companies and sponsors that we back in terms of the institutional knowledge that we can bring to the table. And then really, the last thing I’d mentioned, separate from just our network, both internally and externally, would be our ability to really bring capital solutions to bear. We do have, you know, a lot of capital to invest, which is helpful, but not only that, we have the ability to invest across the capital structure. So senior debt, mezzanine debt equity, so a lot of flexibility that I really do sets us apart in terms of creating capital solutions to get deals done.

    Patrick: You know, and the other thing is, is, you know, I didn’t realize until we had met that, okay, Prudential, you know, may be a financial institution, but Prudential Private Capital is not a bank. So you got a lot more tools at your disposal. With regard to that, where, you know, your basis of lending or basis of investing is slightly more flexible. Talk about that real quick.

    Brooke: Yeah, you know, um, a lot of our underwriting or really all of our underwriting is more cashflow based, yeah. And so instead of looking at asset values, or we’re frequently really underwriting to cash flows, so that in itself, I think creates some more flexibility in terms of the capital structures that we can look to provide. So while we also partner with a lot of banks to in terms of, you know, oftentimes there’s a senior facility and either we’re providing fixed rate long term debt along that big facility, or we’re providing mezzanine and junior capital, so, so just, I like it really an apple and an orange in terms of my commercial bank, banker friends, but great ways that we can partner together to get to get transactions done.

    Patrick: Yeah. And the other thing that works out pretty well as you don’t have the regulatory constrictions or constraints that banks have, you can get out there. And the other thing I think, is appealing, particularly and we can talk about this with independent sponsors, which is an emerging class of equity out there is that you’re not interested in majority investments, you want to stay minority, which is very helpful. I mean, there are those that want an exit, there are others that hey they want to come in, they want to make an acquisition, they want to be the majority. And that fits right in with your appetite.

    Brooke: Yeah, absolutely. A lot of what we do, at least on the equity side is minority equity. But also in situations where you can stretch the balance sheet a little and provide mezzanine, a lot of people will either call it an expensive debt or cheap equity. Okay, so yeah, so in certain situations, there really is the ability to provide mezzanine, it’s less dilutive to owners, or there may be situations where, you know, the owner doesn’t really want to give up control, but they need to whether it’s take some chips off the table, they want to make a big acquisition, they need to buy out a shareholder. There are a lot of other reasons why, you know, junior capital is important.

    Patrick: When you bring it you bring it that way. Now, we brought up the topic of independent sponsors, which is kind of a segue into, you know, your ideal client. Why don’t you give us a profile on who does Prudential Private Capital best serve? 

    Brooke: Yeah, so you know, it’s really across the board, Patrick. We, we work with a lot of sponsors, both small and larger funds just because of, you know, our minimum check size starts really at 15 million, and then we have the ability to invest up to a couple 100 million. So we do work with smaller, kind of first time funds, some of the larger private equity funds, but then we also work a lot with management teams on a direct basis with companies. So our, I would say, you know, it’s a pretty broad, a broad range of clients that we work with consistently, though, it’s, it’s people that really value relationships, and value potential and what we bring to the table and really want a long term partner that they can trust, build a relationship with, which I think you know, a lot of our clients definitely saw the benefit of that during COVID. 

    Any potential client that I’m talking to, I would say, call some of my clients that we worked with during COVID. And they can talk about how we were patient, we listened a lot of dialogue during very, you know, very challenging time for many of our clients. So that’s a long way to answer your question. But, you know, we work with a lot of different types of firms, different sizes of firms and companies, but consistently, it’s folks that really value relationships.

    Patrick: Yeah, well let’s not gloss over this COVID thing you just you just referenced quickly is, you know, with Prudential Private Capital, your your capital is more patient, and you’re going to find ways to make make your investments and your clients successful. So your cut, you’re kind of, you know, aligned with them in the interest, and you’re not trying to just roll them out and get him get an exit, you’re, you’re invested in their growth. And I think being there for the long term really helps with relationships. 

    Brooke: Yeah, absolutely. I do think that our approach is it, like you said, more of a long term kind of approach, and with some of our clients, you know, we’ve been invested for a very long time and have had long standing relationships with them. And, you know, in periods of destructive of disruption and uncertainty, that just is so so important. And I think, you know, also think about just our regional office model, the fact that, you know, I’m either in the city or a short car ride away, and not sitting at a, you know, not in New York location, you know, I mean, it’s, I can’t, I’m really kind of in in their backyard. While we couldn’t necessarily always be with each other in person, I think there is this element of, you know, close by in a more normal world, being able to respond in person, if that’s what it requires, and just relationship oriented, not transactional oriented.

    Patrick: Well, and as you talk about relationships, I mean, you cannot disregard the human element, particularly when, when we’re involved with investing in mergers and acquisitions, and so forth, where, you know, it’s not Amazon, buying Whole Foods, this is a group of people choosing to work and partner with another group of people. And for an ongoing relationship. And, you know, ideally, one plus one equals six, and so is important to, you know, nurture those relationships. And one of the things that happens with mergers and acquisitions, where, you know, there’s there’s a recipe for failure is where you have an experienced party on one side of an M&A deal, usually the buyer, and an inexperienced party that are not naive, they’re just an inexperienced, that’s the owner and the founder that have gone through an M&A deal. 

    And things that are routine to the buyer, are scary, and, and, you know, disrupting to the, to the inexperienced player. And so there’s a recipe there for a lot of tension, a lot of unknown, just from a misunderstanding. And you know, one of the errors that comes in a lot as we see in mergers and acquisitions is where buyer goes through a very invasive due diligence process, and then following that says to the seller, okay, well, we’ve got this thing called an indemnification clause, where, and this is what the seller buyer saying, just in case we missed anything. This this clause says that I can claw back money from you if there’s a thing that blows up post closing that you didn’t tell me about, and I might have missed intelligence. And also the seller is like, wait a minute. I’ve just shared everything with you. I’ve answered all your questions. 

    How can you hold me responsible for something that I didn’t know about? To where the experienced buyers as well, I’m making a bet 10s of millions of dollars that your memory is perfect, and that you’ve told me everything. And you can get through that a bit and the seller will eventually you know the deal gets closed and the seller will forgive the process but they’ll never forget the feeling they had and something like that situations completely avoidable because the deal can be insured, there’s an insurance product called rep and warranty insurance where it steps in the shoes of the seller and says essentially, look, if any of the seller reps get breached the reps that the buyer performed diligence on, didn’t find anything. 

    And those breaches cost the buyer money, the insurance company, not the seller will go ahead and make the buyer whole buyer has certainty of collection. So that’s all good, they’re set to go sell, I guess, clean exit. And usually, not only did they get more cash at closing, because the policy attaches at a lower point. So there’s little or no need for an escrow. But like a peace of mind that, hey, I get to keep all the money that I got fantastic, let’s move forward. And what was pre COVID, rep and warranty insurance was restricted to deals north of $100 million in transaction value. And then just prior to COVID, the threshold, the rules for eligibility dropped all the way down. 

    So deals as low as $10 million are eligible for insurance now. And so it’s a great way for, you know, even minority players to have their interest covered on this as well. And so it’s been just a boon for the M&A in the lower middle market space, which is why we were trying to get that word out. But as a reliable tool, don’t listen to me, Brooke, good, bad or indifferent, tell us about your experience with rep and warranty for your clients.

    Brooke: Yeah, I mean, I would say that it is really just become the norm and a part of the natural conversation to at least talk about is this something that is necessary in the transaction or not. And, and I would say just consistently, like you mentioned, there, there are benefits to both the buyer and the seller. But more importantly, it can just help the speed up the timeline of the transaction, and help the buyer and the seller, get the deal done. So I just think that it is becoming more mainstream and and definitely a product that is, you know, a few years ago, you know, people were talking about, but now it’s just I feel like it is just a part of the M&A world now. Very interested to hear that now then the threshold for deal sizes has come down. So that’s, that’s exciting to hear.

    Patrick: As we’re going through this year, right? At this point, we’re recording, I just mentioned to you in the pre recording talk that I just got, my daughter got 16 year old got her first COVID shot. So we’re I’m confident that we’re at the beginning of the end of the pandemic here and bring it back to work. And, Brooke, from your perspective, what do you see going forward for the rest of the year be it M&A, Prudential?

    Brooke: Yeah, I’m, I’m with you, I am very optimistic about the outlook. For the balance of the year, I just got my second shot. And I really think that things are opening up. So definitely optimistic for the balance of the year. But as it relates to M&A, I mean, what I’m hearing from my network for people that are really involved more on the front end of the process in terms of sell side and investment banks, that they are very active. And it sounds like there are a lot of companies that, you know, maybe were in market pre COVID, or because of COVID had decided has decided that they want to explore strategic alternatives. And really, their focus was, you know, let’s get through kind of 12 months with really good trend lines, good performance, good, trailing 12 month kind of performance. 

    And then let’s go to market. So I’m really optimistic that it’s going to be a busy second half of the year for M&A. And clearly the capital markets, there’s still a ton of capital available, whether it’s in the public markets or the or the private markets, and Prudential actually, we just raised our sixth mezzanine fund. So we have more junior capital to put to work which we’re very excited about. So I think that you know, q4 of 2020 was extremely busy and people have kind of taken a taken a little bit of a breath either they’ve been closing deals that didn’t get closed by the end of last year, or they haven’t taken a deep breath and I’m I’m certainly gearing up for a busy second half of the year.

    Patrick: You know, I think that a couple things that happened was the dry powder and private equity didn’t didn’t blow away during COVID the other the other issue is the other thing that didn’t stop all a lot of things in life stop time didn’t and so got a lot of owners and founders out though that everybody got a year older. I think I agree with you that there may not be just rushed to market because you know, there might be buyers taking advantage of trying to get a discount because you know past performance and you know relying on earnouts or something post closing calculation right? 

    I agree with you I think there are going to be a lot of companies that just they want to hold until they get that 12 month trend line and and get that get those our arrows pointing up into the up into the right and and it’ll improve their position a bit. So that’s a well noted. Brooke, tell our audience how they can find you and your group to learn more about Prudential Private Capital. 

    Brooke: Yeah, so the easiest way is just our website, which is pretty easy. It’s prudentialprivatecapital.com. And then me personally, I have a LinkedIn page there get it’s Brooke Ansel. And you can find me on LinkedIn and I try to post interesting content from Prudential and when you know welcome to connect with anyone to talk further or network regarding M&A and, and capital availability, so.

    Patrick: Yeah, I will vouch for Brooke also, the emerging independent sponsors that used to be called fundless sponsors, her relationships in that area if you’re if you’re an individual investor, I think the connections that Brooke has and the relationships and the resources she has available is ideally suited for that class. So definitely give give Brooke a call. Brooke, thanks again very much for for this it was a pleasure having you today.

    Brooke: This is a lot of fun. I’m a big fan and consumer of podcasts. So to be a part of one is was a lot of fun. So I appreciate it.

    Patrick: Now you can start your own.

  • Jon Finger | The Benefits of Building Relationships with Independent Sponsors
    POSTED 5.18.21 M&A Masters Podcast

    Our guest for this week’s episode of M&A Masters is Jon Finger. Jon is a Partner at McGuireWoods LLC in Dallas, and his practice focuses on private equity and corporate transactions. He and his partners were the first in the area of independent sponsors to create a private equity practice dedicated to independent sponsors. Jon and his partners also created “Deal-by-Deal”, a podcast that focuses on the independent sponsor community of the M&A market.

    Jon says, of this independent sponsor relationship, “Many of these sellers are selling their baby – this has been, and will be, their legacy. Finding independent sponsors who are really appreciative of that is a big part of what we look for in our network for the clients that we want to be working with.”

    We discuss the importance of building a network and prioritizing the independent sponsor relationships, as well as:

    • The difference between independent sponsors and other buyers
    • Perceptions of private equity
    • Finding creative ways and best practices to partner with independent sponsors
    • The ideal client of the independent sponsor community
    • Hybrid models of independent sponsors and private equity funds
    • And more

    Listen now

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Jon Finger, Partner and McGuireWoods. McGuireWoods is a full service law firm with over 1000 attorneys and 24 offices throughout the US and beyond. Jon’s practice focuses on private equity and corporate transactional matters from McGuireWoods, Dallas office. It is in the area of independent sponsors, where Jon and his partners were the first to create an M&A practice and ecosystem dedicated solely for this segment of private equity. So it’s a real great pleasure to have a true pioneer in a new class of business for private equity. Jon, thanks for joining me today.

    Jon Finger: Thank you, Patrick. Pleasure to be here.

    Patrick: Now, before we get into the practice of with independent sponsors, which literally did not exist until you guys came along, let’s start with you. Tell us how you got to this point in your career. 

    Jon: Sure. Really appreciate appreciate you giving me the opportunity to join you today. So I’ve been I’ve been practicing for about about 20 years. And about halfway through my career, which had predominantly been representing lower middle market, committed private equity fund clients, we saw a lot of activity within that independent sponsor community. And at that time, it was still evolving. The models obviously been around for some time, but it was really, I think, evolving into what has become today. And it just happened to be around the same time that myself and a few of my partners were changing law firms. And around that time, what we dedicated ourselves to was building our network. And so we had this network of capital partners, family offices, private equity mez funds, etc. 

    And as we built that network, what we found was, there was an incredible intersection with the independent sponsor community. And so as we were building the network, and our practice was evolving, what we like to think was our secret sauce was our ability to introduce investment opportunities to our network of capital partners. And so we were going to trade shows, we were calling on companies, we were doing all these different things. And we saw a lot of great success out of that. The reality is, it’s very time consuming. And so ultimately, what the a bit of a lightbulb moment was, the independent sponsor in our network can be doing a lot of that spadework if you will, for us. So as we started to see, okay, if we spent more time harvesting our independent sponsor relationships, and really finding opportunities that they had, that we could then introduce to our capital partner network, it really made what we were doing much more efficient. 

    And so we weren’t having to necessarily go out there, find those investment opportunities, we were leveraging the independent sponsor community. And so what really led to where we are today, I hearken back to that where it was a situation that we were at the intersection of capital partner, and deal opportunity. And so it really allowed us to differentiate ourselves with our network. And we we continue to do it today, with I think, really good results. And that that was probably the biggest pillar of what led to where I am in my practice today, where a lot of my work is, is with independent sponsors.

    Patrick: And let’s get a little bit more detail with the independent sponsors. How are they different from private equity or other other investors or acquirers out there?

    Jon: Sure. So lots of different ways, no doubt. I think the first thing I tell you is, of course, you know, every independent sponsor is different. That’s the beauty of it. That’s the fun of it. But as a general matter, right, independent sponsors don’t have a committed fund that stands behind them that they’re able to draw down capital for each deal. So you know, the independent sponsor, let’s say they’re putting in 500 grand sometimes seven figures. The reality is, most videos we work on me independent sponsor is putting that level of capital. And there’s another, you know, $10-20 million in equity capital and obviously lender coming in. 

    So the biggest difference right is they don’t have that committed fund behind them. What that also means is, it allows the independent sponsor to really identify the capital partner that makes the most sense for each opportunity and each situation. And so, you know, use the word the scope bespoke if you want. Luckily, I got the right on the second try there, but so it allows them to bring more of a bespoke nature to each opportunity that gives them that flexibility and differentiates them from a traditional private equity fund. Another I think area that I would want to really highlight with the independent sponsor is it’s a segment of private equity. But there is a perception out there with some sellers, that it’s, you know, big, bad private equity, right? And what does this mean for my business, and so a lot of our independent sponsors, really had the ability to play off that, and, and just, you know, many of them are entrepreneurs, many of them sold their business, and now they’re looking to acquire a business. 

    And just that ability, I think, that they demonstrate to relate to those sellers is another way that they’ve been able, I think, to differentiate themselves from more institutional, private equity. And, and it’s, it’s really something where I think the independent sponsor has also capitalized on these market dynamics, if you will, where you have the sellers, and you know, it’s it’s definitely a robust M&A environment, as you know, but there are a lot of other things that it allows the independent sponsor to come to the capital partner, and also have a situation where you can really be creative with the economics that the independent sponsor is, is receiving on each different deal. And so, you know, maybe it’s not a two and 20 structure, right. And so there are a lot of those different optionality, if you will, that the independent sponsor brings brings to the table, I’m sure we’ll, we’ll talk more about some of those things. But I think high level, those are probably some of the bigger differentiators.

    Patrick: Well, I the perception out there. And this is why it’s so important, I’m so happy to have you here in the lower middle market with with sellers that need to know about all these different options out there on alternatives is where to go. Unfortunately, a lot of organizations, they, the owners, and founders who aren’t in M&A every day, if they don’t know any better, they default to, you know, a strategic, which may not have their best interests at heart, they may default to an institution, or you know, they may be fearful of private equity, and just shut the door on that completely. And that’s, that’s not at their advantage. And so it’s very important to understand that there are these great options out there. 

    And you know, quite frankly, until I learned more about your practice, I had a notion about independent sponsors where they were the sole source of capital, and so they only targeted smaller deals, they didn’t have the, you know, the reserves. No, they tap on that, and then they can leverage that to their interest, which is also I think their interest is is aligned with with the sellers. Explain how you guys develop this practice, just from the ground up. I mean, it because, and we’ll get into this a little bit more, but I mean, this is a pretty fragmented sector.

    Jon: That’s the beauty of the sector. From my perspective, it is it is an endless ocean of opportunities for us to develop relationships, and add value to be independent sponsors. I think, as I look back on how the practice developed, you know, again, the reality is this model has been out there for a long time, back when it was, you know, a guy or gal with a deal who just, you know, was raising capital from his neighbors. And then it was called fundless sponsor, right, which I’ve really tried to push hard to get away from that one, because, you know, it does have a bit of a pejorative nature, but the reality is, it’s not true. I mean, these independent sponsors, yeah, they don’t have a $300 million fund behind them, but they’re writing meaningful checks on these deals. 

    So, you know, I think that evolution of, you know, bringing helping bring credibility to the market was something that really helped us develop the practice, but I think a few things I would point out kind of getting back to what I was talking about before. What we have the ability to do is, is really eliminate a lot of the friction in the system where, you know, independent sponsors may have the need to hire a placement agent sometimes right? For a given situation. And there may be instances where, look, what we’re trying to do is connect our capital partner relationships with our independent sponsor relationships. To be abundantly clear. We’re lawyers, we’re not bankers, we can’t get paid introductions, introductory fees, placement fees, so that friction’s gone, right, we’re just trying to put the right groups together to get deals done. 

    And so that was a really, I think, powerful message and continues to be. But of course, one of the things that independent sponsors always struggle with is dead deal risk, right? That’s part of the equation that they don’t have the ability to just have $100,000 dead deal expense and just draw down from a fund to pay it. And so, for us, it was being selective around developing relationships, that we really wanted to have 5, 10, 20 years down the road, and be creative with ways that we could truly partner with those independent sponsors. And so whether it’s discounting fees or finding other creative solutions, where it’s not okay, just write me a check. That ability, I think, to be shoulder to shoulder with the independent sponsor was was really powerful. What we did with our network was, as we found different opportunities to connect our networks, we created essentially YPO for independent sponsors, which are regional chapters of independent sponsors that get together, share best practices, and and ultimately find opportunities to connect people with deals. 

    Those chapters led to us developing our independent sponsor conference a few years ago, which in 2019, we had over 800, solely independent sponsors, and capital partners. And it was a great opportunity to get everyone together. And it was all people who wanted to be there because of who was there. Right. And, and that obviously had great benefit to us, not from a charging registration fees, but from a developing our network and our client base. And so that has really, I think, allowed us to take a leadership position in the independent sponsor community, and develop that practice, where I do think we’re regarded as the preeminent firm with independent sponsor transactions, either on the capital partner side, the independent sponsor side, and really just knowing what’s market, right. And that’s a critical component to all of these deals. We’re in the middle of our latest deal survey. 

    So we’re leveraging both our expertise, but now we’re taking that opportunity to get input from our network of what’s market on all different sorts of components of the deal. And so that’ll be coming out down the road. And then I think the last thing I would tell you about really being a true partner to the independent sponsor is, in the next few months, we’re going to be launching independentsponsorforum.com, which is our, I think, what we’re trying to do is find that next way to develop a true platform for the independent sponsors and the capital partners, that has a lot of great content, and really allows us to demonstrate, again, that leadership position within the community. And so that’s kind of, you know, starting from day one to where we are today, I think some of the, the hallmarks along the way that have really allowed us to grow the practice.

    Patrick: One of the things I really appreciate what you’re saying I’m I’m a marketing guy at heart, I really enjoy messaging and the importance of communication. But, you know, you built the practice, largely not on just the relationships, but just the trust that you’re going to execute. You’re not getting paid just to be around and do introductions, but you’re literally your interests are aligned with the independent sponsor, and you want the best for them and it’s a small community, so clearly you are doing something right, because all you have is your reputation and you deliver. And execution I think is is important, particularly for a lot of firms out there, where they may have a lot of resources, have a lot of other things to offer and make a lot of noise, but at the end of the day it’s execution. 

    And this is a class of private equity that cannot afford as you said, you know, misfires And so that I think is critically important that you’re coming in and you’re delivering that. And then just through that great reputation now, the community is expanding, and you’re not sitting back. McGuireWoods is finding more ways to add value through information and best practices so that more deals happen faster, smoother, cheaper, happier, and and that aligns a lot of specialty firms. And so it’s such a pleasure to have a firm like yours to highlight on that. Now, one thing I will say is I’m very proud of our platform here at M&A, M&A Masters Podcast. But we’re not the only podcast out there that is talking about mergers and acquisitions and everything. Jon will talk about your your show, because that’s actually how I found you, 

    Jon: Sure. No fantastic. So one of the I think ways that we’ve been trying to transition and continue to grow a lot of what we’re doing. A couple of my partners, Greg Hawver and Rebecca Brophy really are spearheading deal by deal. And so it’s a podcast that’s focused on the M&A environment, but in particular, the independent sponsor community. And so we’re really trying to, I think, highlight, a lot of best practices within the independent sponsor community, also highlight different independent sponsors and capital partners. But to your point, particularly with what’s been happening in the pandemic, having that ability to find different ways to connect with your network, they’ve done an incredible job. And it’s, it’s, it’s definitely something we’re super proud of.

    Patrick: Yeah, I consider the silver lining of the pandemic, the evolution of, you know, the the Zoom, and the podcast and the communication, because there are messages out there. And it’s just, you know, finding the right channel where there’s an area of interest. And I will tell you, there are over 1 million podcasts out there. And there wouldn’t be that many if there weren’t such a diverse amount of interest out there in need for information. And something that’s, you know, quite frankly, quite, quite easy to deliver. Jon, let’s talk about, you know, give me a kind of a profile of your ideal client with the independent sponsor. I know very similar to there are other things out there. If you’ve seen one independent sponsor, you’ve seen one independent sponsor. Is is there, you know, for others that are listening out there, give us an idea, what’s the ideal profile of a client from McGuireWoods with this practice?

    Jon: Sure. So to your point, is, is definitely spot on. So within the independent sponsor community, there’s no question that there’s no one size fits all for what the what the ideal client for us is, in the sense that a lot of our clients in the independent sponsor world spun out of blue chip, private equity firms, they have that pedigree of doing deals, and now they’re doing deals as independent sponsors, they have been, and I think, will continue to be a great client base for us. At the same time, a lot of our independent sponsor clients are entrepreneurs who founded and sold a business. And now they want to go out and do it again, maybe they’re looking at bigger deals, maybe they sold their business to private equity, and started to understand that model better. And frankly, a lot of our independent sponsor clients who’ve been wonderful, are true CEO level talent, that, you know, maybe they made a lot of money for private equity. 

    And they have a Rolodex within a market or within a segment to say, I want to go out and do a roll up in this space. And that allows them with that domain expertise to really be a powerful and successful independent sponsor, and a great client for us. I think, when I look at some of the, I think, common characteristics, I would look at the independent sponsor who really wants a different value proposition who isn’t just looking for a lawyer that can draft a document for them and, you know, get them to closing. We’re looking for the client that really wants us to be their partner. And so whether it’s to the point about helping them find capital, helping them find, build out that executive team, helping them find the right provider, I mean, frankly, for services they need in conjunction with a deal. 

    We’re doing a lot with our CPA network, as you know, and I’m sure we’ll probably get into later, the prevalence of rep and warranty insurance on basically all deal sizes is huge right now. And so, where they say okay, who are the right firms to talk to, to go out to get a policy, our ability to say, okay, we’ve seen Patrick in action on X number of deals, and he’s really the value add guy around what’s important in this policy? What’s your history? What’s the claims history with this insurance? So I guess what I would say is that ability for us to really help develop the ecosystem and find independent sponsors that value, that benefit that we can provide is always huge for us. 

    But building those long term relationships, right, it’s we want that client, that’s not just coming to us for one meal, that over the next 20 years, we’re going to do 3, 4, 10 deals with them, and develop that trust. And that relationship, that’s probably the most important thing. And then ultimately, right, just doing the right thing, just finding people who they’re going to treat people, well, in particular, these sellers, many of these sellers, right. They’re selling their baby, right? I mean, this has been, and will be their legacy. And I think finding independent sponsors that are really appreciative of that is a big part of what we look for in our network. For the clients that we want to be working with.

    Patrick: Well, there’s a couple of things you brought up there that we’re definitely going to segue into. And, one of them is, first of all, you cannot remove the human element with these transactions. You know, most people out on the street, they think M&A, they think Amazon buying Whole Foods. Company by company. This is people working with people. And you know, within that you got humans that are fallible, and there’s fear, there’s greed, there’s all these other emotions that come into these, you know, life changing in some cases, transactions. I mean, they’re they’re very, very big deals for people. And you cannot dismiss that. And so you’ve got that element where you met with reps and warranties insurance, the amount of risk, these deals do not happen in a vacuum, there is tremendous financial risk that can be out there for the seller, who is personally financially liable to their eventual buyers. 

    And when a business owner is not used to M&A, it comes a realization that it is they can’t hide behind their corporate veil, it is their personal assets, their wealth, their retirement, literally their house could be at risk. And that realization comes to them a lot of times after they’ve gone through due diligence, they’ve been trying to work with the other counterparty and work together. And all of a sudden, boom, I’m responsible for you with my wealth for something I may not have known about. And in the typical response for a real, savvy, educated, experienced buyer is, well wait a minute, I’m making, you know, 10s of millions of dollars bet that your memory is perfect. And I’m afraid I just can’t do that. And so you’ve got that conflict where you’ve got a buyer that doesn’t want to get stuck, you know, with a lemon, and the seller doesn’t want to be kept on the hook indefinitely, particularly for things they don’t know about. So you’ve got that natural tension that can devolve to being adversarial is really a danger out there. 

    And what’s been great is the insurance industry came in with an insurance policy that transfers that risk away from the deal parties over to the insurance company. And the benefit to a buyer is, hey, if you have a financial loss as a result of the breach of the reps, you have certainty of collection, and you’re not going to have to clawed back and have ill will toward your target company who is probably now partner of yours, okay, for the seller. The policy can replace 90% of an escrow. So less money from the purchase price is being set aside and goes right to the the seller’s pocket. So they get more cash at closing, even better to get the peace of mind that they’re going to keep more money because there’s not going to be the risk of a clawback and as you know, is a product that has stood the test of time and is being used, you know, quite a bit now throughout the M&A community. 

    The news that I want to share out this is that this product was reserved solely for deals that were $100 million transaction value and up, you had to have thorough diligence, you had to have, you know, audited financials, you know, do extensive third party diligence of which was very, very expensive, so it wasn’t a fit for the sub 100 million dollar deals. That’s changed, thanks to technology, thanks to competition, eligibility standards for rep and warranty insurance have never been simpler. The cost has never been lower. And the claims it’s been sustainable where the claims have not overwhelmed the industry so we can see these lower rates continuing for a very long time. And there may have been players in the M&A space that maybe thought about rep and warranty a year or two ago, and had a not so good experience. That’s not the case now. And the more people understand about that, the better. But again, you don’t have to take my word for it. Jon, good, bad or indifferent. share with me your experience with rep and warranty.

    Jon: Sure. Excellent. Give you you know, I won’t choose your word I’ll tell you mine, right. It’s been it’s been phenomenal. And I think what I would say you hit on it, but I think my biggest takeaway that what, what I appreciate, and frankly, what my clients appreciate, is, if you’re doing a $20 million enterprise value deal, you can get rep and warranty insurance. And frankly, I’m doing one right now, that’s about 14 million. Right. And so, I think that that’s definitely something that my clients have not really understood as well as they should have. It’s not just the 50, 75, $100 million deal, you can really get a policy on a $20 million deal. That, you know, frankly, a lot of the time, as you alluded to the sellers rolling over, right, maybe they’re the CEO, whatever they are, and the idea that there’s going to be some sort of friction, right, or post closing dispute is just, it’s heart wrenching. It’s difficult in whatever word you want to choose. And having that ability to, for lack of a better phrase offload the risk, right. 

    But it’s, it’s to me, it’s less about offloading the risk. It’s offloading the friction, right? It’s, it’s having that ability to say, okay, let’s really focus on what’s best for the business going forward, let’s focus on growing the business. And if we ran into a issue with a customer, let’s not be focused on was there a breach of a rep, let’s focus on how do we make that relationship better. And so our experience with rep and warranty it with, if I look at my deals, it’s it’s probably two thirds of my deals, it’s probably maybe more, maybe less. But you know, two thirds of my deals have rep and warranty insurance. And it’s a great product. It’s it really has developed and mature, where it’s an incredible tool for all the reasons you stated, but I just can’t I can’t overstate the impact of having the ability post closing, not to have that immediate dispute, particularly when, as we all know, that first year that integration period, that can be the most difficult, challenging, time consuming. And frankly, it can it can really have a determination about how things and how relationships evolve. And again, just taking that out of the equation, to a, to a full extent, or a partial extent, is extremely helpful. 

    Patrick: Yeah, what’s real tragic, and, you know, these disagreements are all avoidable. Yeah, you know, insurance is not the magic bullet is gonna cure all ills, but just having that there lowers the temperature in the room. And then, you know, as we go on with life, I mean, there’s so much concern in M&A now about, you know, communication and culture and those types of areas that we didn’t think about 10-15 years ago. And so anything we can do to enhance the relationships, I think, is a definite net positive. Now, john, as we’re talking today, you know, we’re getting through the first half of 2021, we’re, you know, fingers crossed, we can see the end of the pandemic out there. I mean, it’s, it’s possible now, more so than before, you know, and in this, you know, circumstance, you know, what do you think, what trends do you see either for independent sponsors, specifically, or for M&A in general, for the balance of 2021? What trends do you see?

    Jon: Sure, I think that maybe I’ll think a bit of the easier one is this is a very robust M&A environment. And I don’t think anything on the horizon for the next nine months, leads me to believe that’s going to change anytime soon. There’s just so much in the way of tailwinds going on with the economy going on with the reopening trade, etc. So I think generally M&A, it would be very surprising if we didn’t have a very strong year. On the independent sponsor side. I think you’re going to continue to see a few things. One, the the attractiveness of the deal by deal model in the independent sponsor framework, I truly believe will continue to grow over the next however many months and years. And so much of that comes back to, there’s so much dry powder out there, people are desperately trying to find different opportunities to get capital to work. 

    There is undoubtedly on the capital partner side, an interest in diversifying their private equity dollar investments, right. And so maybe they’re not going into the next Apollo or BlackRock or whatever it is, and finding an opportunity to be have more discretion over where their money is going. You know, and maybe it’s understanding the be independent sponsor oftentimes brings more proprietary deals brings more attractive deals, but at the end of the day, brings deals with the capital partner can say, yeah, I want to put my money behind this one. And that’s a different construct than just putting money into a private equity fund. So I really do think you’re going to continue to see that demand side from the capital partners. And then the independent sponsor, there’s a lot of reasons of course, why the model is so attractive. And it’s going to continue to be so and I think you’re going to continue to see increased supply of independent sponsors out there. 

    And so those factors together, I think, will generate a lot more independent sponsor transaction activity. Another trend I tell you that we really see and have seen is a bit of a increased focus on what I would call hybrid structures. So there’s definitely some good things about the committed private equity fund model, there are some good things about the independent sponsor model. And a lot of our capital partner relationships and clients are looking for as well as independent sponsor relationships. And clients are looking for opportunities to bring the best of both to their structure. And so there are a lot of different hybrid structures that we’ve been working on, that both sides of the equation are very interested in. And I think that’s going to continue as we project forward. 

    The last thing I’d probably put out there around the independent sponsor community is I have seen as the proliferation of independent sponsors continues, I have seen a greater focus with our independent sponsor community on being a bit of a more of a domain expert, and focusing more of their attention on I’m not just looking for a deal in manufacturing, business services, consumer healthcare, technology, you know, I’m going to be a SaaS guy, or I’m going to be looking at opportunities where I can bring my manufacturing expertise to bear and so I do think that the generalist independent sponsor will always have value. But I also feel like we’re going to continue this see this trend of independent sponsors being more focused on certain industries, where it ultimately just I think, allows them to bring greater value to their capital partner relationships.

    Patrick: Well, I think the idea, first of all, that continuing innovation and iteration of the structures is is really encouraging because it’s not just one way or the other, let’s find a third way. And that seems to be prevalent. And I think that naturally, as you have more buyers coming into a space, you know, as with anything else, you’re going to have to differentiate yourself. And and I think that only as more value. More competition is always is always a real good thing. So great, great insights there. And we got to keep an eye out for that. Jon, how can our audience members find you and McGuireWoods, not only you know, for the McGuireWoods Dallas, but also for the upcoming conference that you’re going to be having? I believe it’s in October. And if you can restate again, the podcast.

    Jon: Sure. So the podcast is Deal by Deal. Those will be coming out on a very regular basis. Our conference will be late October, in Dallas at the Ritz Carlton again, we have some really neat improvements going on this year. For more information. Pretty simple, independentsponsorconference.com. And then also keep your eye out for independentsponsorforum.com. We’ll be rolling that out in the next couple months as well.

    Patrick: Jonathan Finger of McGuireWoods. It’s been an absolute pleasure. Thanks again for joining us today.

    Jon: You betcha. Thanks, Patrick. I appreciate you.

  • The “Dating Site” for Lower Middle Market M&A Deals
    POSTED 5.11.21 M&A

    Pre-pandemic, the M&A world was all about hitting the road, with companies meeting potential capital providers or Buyers personally in board rooms all over the country. That’s a lot of airline miles.

    But for the last year or so, the majority of business development has been done online. And an innovative online platform that facilitates these sorts of interactions has taken off in a big way.

    Axial makes it easier than ever for lower middle market companies looking to raise money or get bought to meet privately with PE firms, VCs, Independent Sponsors, and even Strategic Acquirers.

    I liken it to the Match.com of M&A. Companies that are looking to be bought, or are seeking capital, post a profile and what they are looking for. Buyers and investors do the same.

    Axial also provides “concierges” who help connect appropriate members on either side who could do business together.

    The platform has been widely adopted in the time of Covid. According to Axial, 5,000 companies with EBITDA between $1M and $5M privately marketed their deal on the platform last year.

    Lower middle market companies, many of whose founders and management teams are not well-versed in M&A, can also hire advisors through Axial to help them find potential deals and walk them through them.

    And here’s the thing: Even as travel resumes and we move towards business as normal in many parts of our lives… don’t expect in-person business development to go back to the old way. Firms have discovered just how much they saved on travel during the pandemic. And how effective the Axial platform is at facilitating relationships between Buyers and Sellers.

    Any attachment Acquirers and investors had to conferences and other face-to-face meetings at almost every step of the deal process is fading.

    As Mark Gartner of ClearLight Partners put it back in Sept. 2020:

    The game of staffing up one or more business development professionals to focus their energies on literally the exact same strategy every other private equity fund is employing is simply dead. The famous investor Sir John Templeton once said, ‘It is impossible to produce superior performance unless you do something different.’ This is sage advice as we usher in business development 3.0 and say farewell to the following activities that are sort of like rocking chairs – they give you something to do but don’t really get you anywhere.”

    Gartner cited the following strategies as “dead”:

    • The conference circuit
    • High volume/low value city visits
    • Book collecting

    These strategies, of course, still have some sort of place going forward in M&A, but it will be radically different. I think most PE firms will reserve travel for when deals are further along… and make first contact online. And Axial is ideal for this new strategy. They’ve more than proven they can handle these deals and facilitate them quite nicely.

    Take this example…

    Trinity Consultants is an air quality consulting firm out of Dallas that has made more than 20 acquisitions in the past 12 years. But most of those deals were in the air quality space. They turned to Axial to find deals in new industries and from new sources.

    As the company put it in a case study on the Axial website:

    “Axial brings deals to us and helps us think about the realm of possibilities that could make sense.” 

    Working with Axial, led Trinity to acquire ADVENT Engineering, a life sciences engineering consulting firm. Says the ADVENT CEO of the deal:

    “Without Axial, there’s no reason the company or their banker would have heard of us, and no reason we would have heard of them.”

    It’s deals like this that make Axial so powerful…and the leader in this space. Over the last 10 years, it’s grown into the largest online platform for buying, selling, and financing private companies.

    The Paradox of Choice

    Common wisdom is that the lower middle market is underserved… that these small companies are the redheaded stepchildren of the M&A world and all the services are geared towards bigger companies.

    Peter Lehrman, founder and CEO of Axial, has a different view. He says the problem is there are too many providers. There are all different types of investors and service providers who are vying to do business with lower middle market companies.

    The Buyer’s universe for lower middle market companies includes 4,000 PE firms, tens of thousands of Strategic Acquirers looking to grow inorganically, thousands of family offices looking to invest in something other than the stock market…and even Independent Sponsors, individuals who, backed by private equity, are looking for companies to run and take to the next level.

    The problem is, says Lehrman, is that potential acquisitions in this space actually have too many choices, and it’s tough to navigate them and find the right providers and potential acquirers. And that’s precisely why Axial focuses on this space.

    As he told me in a recent interview:

    “I think the lower middle market has a level of dynamism to it that makes it a market where information problems plague Buyers and Sellers, that make it harder for Buyers and Sellers to find one another, to be found by one another, and to assess one another as counterparties and partners.”

     “There are a lot of problems and challenges that are, I think, much more unique to the lower middle market than to really any other sort of ‘category’ of private capital markets.”

    This reminds me of some relatives of mine from Ireland who were visiting recently. They needed aspirin, so I sent them to the chain drug store down the street from my house. They came back empty-handed. Faced with 30+ different varieties of pain relievers they couldn’t make a choice.

    Adds Lehrman:

    “I don’t think [the lower middle market] is underserved. I just think it’s very, very hard, as a business owner, to know how to sort of assess all of these potential partners to work with. And I think that’s actually the bigger challenge. It’s not that there are not enough people serving the lower middle market.”

     “It’s about helping the owners and entrepreneurs navigate that huge list of choices. They’re looking at say 100 private equity firms, and they’re thinking ‘What am I going to do, go to every single one of their websites? They all sound the same and say the same thing, right? So how am I really going to figure this out?’”

     “So that’s what I think is actually the bigger challenge. It’s not that they’re underserved. It’s that there’s too much choice, and they need help slicing through those choices by getting their hands on good information and good resources.”

    The paradox of choice in action.

    Potential investors and acquirers of lower middle market companies also face difficulty. These small businesses are scatted around the country… and there are tens of thousands of them owned by private equity. And as some firms grow and enter into the middle market, new entrants come in. It’s a constant churn.

    It’s no wonder that a platform like Axial, which uses technology to connect potential partners, has become a go-to for savvy dealmakers.

    Next Steps

    Of course, no matter how Buyer and Seller came together, there is a unique insurance product, which has become available to lower middle market deals only in recent years, that is a must have for M&A transactions.

    Representations and Warranty (R&W) insurance, which transfers indemnity risk to a third party (the insurer), has been…

    • Recognized as advantageous for both Buyers and Sellers
    • Shown to speed up negotiations and eliminate potential bad feelings between the parties on each side of the table
    • Opened up to smaller deal sizes, especially to the lower middle market transactions
    • Reduced in price

    I specialize in this type of insurance, and I’d be glad to discuss how it can specifically benefit your deal. Please contact me, Patrick Stroth, at pstroth@rubiconins.com.

  • Scott MacLaren | The Keys to Longevity in Private Equity
    POSTED 5.4.21 M&A Masters Podcast

    Our guest for this week’s episode of M&A Masters is Scott MacLaren, Partner of The Sterling Group in Houston. The Sterling Group is a private equity firm, one of the oldest in the country, and currently has $4 billion of assets under management. 

    Scott did not start off in private equity – he studied at the United States Military Academy at West Point, started business school after serving in the Army, and then finally found his private equity calling after working as a consultant. He started recruiting heavily for the middle market, and has now been with Sterling for seven years making investments in the industrial sector. 

    We chat with Scott about his path to The Sterling Group, as well as: 

    • The competition of the private equity market
    • Establishing longevity in a growing industry
    • Finding excitement in investing in “unsexy” markets
    • Simplifying life-changing events
    • The predictions for industrial markets and partners after the pandemic
    • And more

    Listen Now…

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters, where I speak with the leading experts in mergers and acquisitions and we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Scott MacLaren, Partner of The Sterling Group. Based in Houston, Texas, The Sterling Group is a middle market private equity firm that builds winning businesses for customers, employees and investors, and Scott it’s just a real great pleasure to have you here. Welcome to the show.

    Scott MacLaren: Thanks, Patrick. Appreciate you having me on.

    Patrick: Now I’m looking for I’m looking forward to talking about Sterling and your approach to a lot of things, but before we get into that let’s set the table. Why don’t you talk about yourself. Tell us what got you to this point in your career.

    Scott: Yeah, no absolutely. And you know my path to private equity was fairly non traditional. So I did my undergrad at the United States Military Academy at West Point. I went there because I wanted to get a good a good education but also wanted to serve my country. And I entered before nine 911 so that definition of serving the country certainly evolved over time. I graduated went to US Army Ranger School and met my platoon. Served as a platoon leader, spent 15 months deployed to Iraq during the now famous Troop Surge. And while I enjoyed leading soldiers and I liked the Army, it wasn’t what I wanted to do forever. 

    So after completing company commander in the army I applied to business school and went to Wharton and you know to be honest entering business school, I didn’t really know exactly what private equity was. I went into business school with the intention of being a management consultant or an investment banker or one of those you know traditional jobs you would think about in business school. It was probably my second year before I fully grasped what private equity was and that’s when I really started to focus and shift my efforts that way. The tough part was getting hired in private equity straight out of business school when you have a military background and no banking or consulting experience, it was really difficult. 

    So I decided to go to BCG and do consulting immediately after business school and get some of those hard skills that I felt like I needed to make a transition into private equity. And you know I enjoyed working at BCG and I enjoyed the projects that I worked on. Most of my clients were Fortune 500 companies and I thought about staying but you know what I didn’t like was it there was no ownership. You know you you work a lot of clients that are Fortune 500 companies. You run into middle managers there who are very risk averse and a lot of them you know we’re just trying to continue their career, so they could get to that retirement point. Collect that pension or you know maybe they weren’t risk averse and they liked your proposal and you liked your ideas but as a consultant you’re just too expensive to keep off from implementation. 

    So you never get to see a finished product or even if you do get to see the finished product, you personally don’t have upside in that. And so as I was thinking through where I wanted my career to go I really focused back on private equity and started recruiting heavily for PE in the middle market where I felt that my skill set that I had developed both those soft skills that I learned leading in the military which I think are directly applicable to leading and driving improvement in the company. And then those hard skills that I picked up and consulting. And so after two years you know I started applying and started to talk to firms and fortunately for me Sterling Group took a bet on me and I’ve been here for over seven years now. Have closed almost 30 transactions, which a handful of which has been platform investments. And then the vast majority or a large portion have been add on acquisitions of various sizes.

    Patrick: Well I hope you never get tired of hearing this but first of all and from the bottom of my heart thank you very much for your service and good for you to see how you managed to progress through this from zero background into creating opportunities for yourself. And I completely understand if you get to a point where you want to have passion and you want to make a change or make a difference or at least have some kind of impact that you could feel. You just kept looking you didn’t just settle down on it so that brings you over to The Sterling Group and as you, let’s talk about Sterling Group from from what you and I gathered in our first conversation, it’s among, if not the oldest, private equity firm in the country so tell us about Sterling

    Scott: Sure so The Sterling Group we are a Houston, Texas based operationally focused middle market private equity firm. We make control investments in the industrial sector. We define industrial is manufacturing, distribution or services companies. We’re investing out of our fifth fund which is a $2 billion fund that we raised last year. A typical target for us is 100 million to 750 million total enterprise value company, and we primarily invest in founder or family owned businesses or corporate carve outs. We also occasionally buy assets from other institutional investors, but that is less prevalent compared to the other two types of companies. And we currently have 10 portfolio companies. Sterling was started in 1982, as you pointed out, one of the oldest private equity firms in the country. And the gentleman that started his name is Gordon Cain. 

    Gordon was an operator and he had run chemical plants for many years. And in his 70s, he decided he wanted to be an entrepreneur. So there’s there’s hope for all of us to be an entrepreneur eventually. So he started buying businesses in in spaces that he knew well. And, you know, this was the 1980s. So it was sort of a wild west era of leveraged buyouts. And it was a newer concept, the LBO was, you know, very new to a lot of folks. And there were certainly a lot less firms doing it versus today. And in 1987, Gordon acquired several chemical plants and grouped them together and called them Cain Chemical. He paid about a billion dollars at the time, got 97.5% leverage from bank on the deal. Something you could never do in today’s LBO market as things have progressed, but again, sort of the wild west era, and he put 25 million of equity on top of that, for the for the total purchase price. 

    They bought the companies. Gordon, obviously being an operator knew how to operate the companies. He implemented an esop an employee stock ownership program, so that the employees, 1300 of them, could participate in the upside of the investment and really got the employees together and on board with driving improvement in the company and increasing the profitability. Less than a year later, they sold the business for 2 billion to Occidental. So they made 44 times their original investment. More than 1000 employees made $100,000. 57 became millionaires. And keep in mind, that’s a 1988 dolllars, when when those amounts were were fairly significant. Not that they are not significant now, but but that’s big money, for sure. 

    Patrick: Yeah, that’s real money. Yes.

    Scott: Yep. You know, the employees, it’s funny employees took out a full page ad in the Wall Street Journal thanking him a Harvard Business School case was written about his team. But that was really the most notable point beginning of Sterling Group. And they continue to operate and do deals all the way up until 2001, in sort of what I would call past the hat fashion. So you know, they would go talk to a company about buying them doing an LBO. And, you know, to get the equity, they would pass the hat around to friends, collect it up and get the deal done. And that worked for them. And they were quite successful with it for a number of years, until a point where the number of private equity firms had increased in the space. Competition was more significant. 

    And other private equity firms had raised institutional dollars in committed funds. And so then that pitch changed a little bit in the sense of, if you’re a seller, are you going to sell to the person says, don’t worry about it, I’m gonna pass the hat around and get the money or some of that has committed institutional dollars, saying no, my investors are contractually obligated, and we have this money. And so that is when Sterling started raising committed funds. Raised the first one in 2001. I joined in fund three, and it was an 825 million fund, we did fund four, which was a billion and a quarter, and now we’re on fund five, a $2 billion fund.

    Patrick: Clearly, you’ve got a track record of success, and you’ve got the longevity. You’re flexible, flexible enough to make a change as the market and, you know, keep keep a step ahead of the competition. So well done for you and Sterling. But Scott, as you know, there are over 4000 private equity firms out there today. You know, what does the Sterling Group bring other, you know, in addition to its legacy, what do they bring to the table that the others may not be doing?

    Scott: Yeah, in 4000 is the first time I’ve heard that number, but that is a big number. So I’m gonna tell you just in the seven years that I’ve been in the industry, the number of new firms that come every single year, it clearly is an industry that continues to grow. But you know, what we do, we have been around for nearly four decades. In the big three differentiators, I always point folks to one, we are operationally focused, and I’ll talk about that in a minute. Two, we push incentives deep within an organization, and we are a true partner. I’ll talk about that a little bit more in a minute. And then lastly, we have 40 years, almost 40 years of experience. And through those 40 years, we’ve interacted with a variety of different companies on a variety of different initiatives. 

    And we have a playbook that we can bring to the table that we know helps to generate and create value. Just on that first point operationally focused. I think a lot of private equity firms like to say they’re operationally focused. And you know, folks say, Well, what does that mean? In you know, the firm saying, are they actually truly operationally focused? And I’ll tell you what that means to us at Sterling. And look, we invest in industries that that are inherently not sexy. And we find that exciting. I mean, we we own companies that make trailer axles that that make bathtubs, I mean, things that you just don’t think about, but we all love it. We’re all operators at heart. We roll up our sleeves and we get to work right alongside our management team. You know, just an example of this, we have a program that we call The Year Away. And this is a little unique compared to all of our peers. I don’t know anybody else that does it. But every, every investment professional that joins us out of their MBA program, we send a portfolio company for a year, where they embed with a management team. And they work on the most important initiatives at the company, and report to that CEO at the management team. 

    And we do this for a variety of reasons. But we think it’s a very invaluable experience, because allows our people to learn how to drive change, improve an organization and create value at a middle market industrial company, which is an environment, I can tell you, as I spent my year away, it is different than the Army, it is different than certainly working in investment bank in New York, it is different than being a consultant for a Fortune 500 company. And it’s an experience as an investor, if you’re out there looking and partnering with middle market, industrial companies, you ought to have that on your resume in order to be really a true partner, and understand the companies and the way they function. And what is feasible to get done with those companies, when you invest in partner with them.

    Patrick: I think before you get to the next part I clearly operational is in your DNA just from the founder story, okay, and to incorporate and inculcate your investment executives in there, where you’re embedding them for a year, that only, you know, builds familiarity for the professionals in there that get familiarity from the management team that’s working with them. And it just shows you’re going to some additional loyalty and commitment that’s in there, both sides because of that year away. So I would picture you know, the the physician being sent off to Alaska, you know, once once he got his degree, and he stuck there for a year, but I think is a very, very positive and unique way, and you’re walking the walk with your own people. So I think that’s fantastic.

    Scott: Agree. No, it’s everybody that’s done the year away comes back, I think with a completely different perspective about what is feasible, and you’ll never look at investment the same way. You’ll never look at a middle market company the same way. And we’ve never had a CEO turn down the opportunity to have a you know, post MBA quality investment professional join their team and report to him for a year. Could be because we pay for it. But it also could be because they know that person’s driving value. But it’s been a really successful program for us in developing our folks here at Sterling.

    Patrick: Great. Now your next point, the second one.

    Scott: Yeah. So we push incentives deep within the organization, because we want to be a true partner, you know, just like Gordon did in the 80s, with the esop. And of course, we don’t do esop’s now there’s some tax implications to that. But one of our big tenants is to push options and equity, deep in our portfolio company so the employees can participate in the upside. We think managers who are owners operate with a different mentality, and they’re able to embrace improvement initiatives, and incentivize to grow profitability. And option payouts at our companies can be, you know, quite large, how to deal that, that we exited recently that I was involved in, we had over 80 option holders, in those 80 option holders made more than $30 million in option proceeds. 

    And so, you know, for some of these managers, it could be a life changing amount of money, it can pay off mortgages. And you see people understand that at the beginning of your investment, and they will work hard and drive toward that goal of an exit of growing the business of improving the business to get an exit in order to achieve that. And it’s a that is probably one of my favorite parts of the job, to be honest.

    Patrick: I think it’s also real generous move. I mean, it’s it’s strategically brilliant. Because if you’ve got buy in from the rank and file, okay, and you’re all going in the same direction, you’ve got, you know, communists of purpose, what better way to do it, and then you get the the outcome. I think the other thing that you touch on this, and I sincerely believe this is that mergers and acquisitions represent the most exciting business event out there. Some people would argue it’s IPOs. I think nothing has a greater chance of being a life changing or even generational change than a M&A transaction. I’ll tell you, you know, Scott, if you and I are doing our jobs, these life changing events happen. They happen faster, they happen cheaper, they happen simpler, and they’re happier. And who wouldn’t want to be part of that?

    Scott: Agreed. Couldn’t agree more, Patrick. Absolutely. And then just lastly, so 40 years of experience, here at Sterling in it’s certainly what we have what’s called our seven levers, which are the seven areas over the last 35 to 40 years where we’ve learned there are opportunities to drive value creation. And so we sit down with the companies that we partner with, and we go through an entire strategic plan and layout when we’re gonna pull each one of these seven levers throughout the lifecycle of that investment, and get the employees and the managers on board with doing that. And we have experience from other companies where we’ve done this and can leverage that experience from the past, to help the companies that we’re working with now, to increase the probability of success on pulling each one of those levers successfully and growing the business. And so for me, those are the three big areas where I think we differentiate ourselves. You talk to other people, they may have different opinions, but those are the three that we certainly focus on. 

    Patrick: Well, tell me, you know, as we talk about mergers and acquisitions, usually, you know, the folks on the outside of M&A think they think of M&A as what they read in the newspaper, where you have Amazon buys Whole Foods. And in reality, it is a group of people choosing to work with another group of people. And the objective is one plus one equals five or six. However, these deals don’t happen in a vacuum, there’s risk. And when you got human beings involved, you got you know, fear, greed, worry, a lot of a lot of these elements out there that that the outside world doesn’t know about. And you know, quite frankly, a lot of the target owners and founders who don’t go through M&A day in and day out, they get surprised when they go through a due diligence process. And then at the end of that they get informed by their attorney. 

    Well, here’s this indemnification provision we need to talk about. And then they learn, wait a minute, I’m personally liable financially to my buyer, if something I have no idea about, and they didn’t find in diligence, will cost them money post deal. Wait a minute. You know, and all of a sudden, you get that injection, that you’re not able to hide behind a corporate veil. Your future, your wealth is at risk. And that can create not only worry and fear, but some distrust. And the tragedy is, you know, these types of interruptions and so forth. You know, they’re they’re reasonable, but they’re avoidable. I mean, on the buyer side, look, they don’t want to be stuck holding a lemon. 

    And on the seller side, they want to be, you know, on the hook indefinitely for things that are out of their control. And they’ll they’ll protest, but an experienced buyer is going to say, well, you know, you’re asking me to bet 10s of millions of dollars that your memory is perfect. And I just can’t do that. Well, what’s been nice is that the insurance industry came in a few years ago, and introduced a product called reps and warranties insurance. And what it does is it looks at the seller reps in the purchase sale agreement, polls the buyer to find out what diligence the buyer did to make sure those reps was accurate as possible. And then they say, hey, for a couple bucks. If something blows up, and buyer you suffer financially, don’t go to the seller come to us, we will give you a check. Just show us the loss. And we will go in. Buyer has certainty of recovery. 

    So their downside is now been hedged. They also avoid the real uncomfortable situation of having to claw back funds from their their seller. On the sell side. Number one, they have more cash at closing because rather than having a large chunk of funds being set aside in an escrow account for cash on hand, the insurance policy covers 90% of that. So not only does the seller get 90, 90 plus percent cash at closing, they’ve got the peace of mind when they get to keep it because that risk of a clawback is now gone. It’s out with the insurance industry. And it’s it’s revolutionized mergers and acquisitions to the point where well your targets are in for your platforms are 100 million dollar transaction value and up, you’ve been very, very active in add ons, deals that are way under 100 million probably isn’t as low as 15 to 20 million. This product rep and warranty wasn’t available for those until now. 

    That’s now been something that’s been coming along now, in the same benefits for the larger transactions are now being available to the smaller ones. Which is great because saving two or $3 million for an owner and founder on a small deal. That’s a huge, huge difference. You know, but you don’t have to take my word for it. You know, Scott, good, bad or indifferent, tell us about your experience with rep and warranty.

    Scott: Yeah, so over the past seven years, it was funny when I started in private equity, you know, rep and warranty insurance. It wasn’t it wasn’t that prevalent, you know, certainly it’s existed. It was used on select deals. But over the past, you know, five or so years, it’s really evolved. And I’ll tell you now, we’re at a point where I can’t think of the last deal I did where we didn’t have a rep and warranty policy. And as you mentioned, even on the smaller deals, it used to be you would have difficulty finding underwriters, to quote the smaller deals. People would say 20 million TV was kind of the mark, and now we’re at a point we quoted, we had, you know, put one out to market a bit ago and we have four different underwriters quote a deal that was under $20 million of TV, which is just really impressive and tells you how far this market has come. 

    But to your point in terms of what it’s allowed us to do, it creates doing a deal, particularly with um, I wouldn’t say it’s sellers, who aren’t normal sellers. So, you know, founder and family of businesses, they may only do one transaction in their entire life. And that transaction they’re looking at, and they’re looking at that, you know, the the purchase agreement, which is 100, you know, 120 page document. And lawyers, and I love lawyers, and we can’t do our job without lawyers, but they’re very good about making you think about that 1% scenario. And so you’ll get founders and family owned businesses that think of that purchase agreement, talk to the lawyer, and just get so petrified of, well, okay, I’m gonna sell the business and you’re gonna give me money. 

    But if there’s a clawback scenario, or a large portion of my money is going to get put in this escrow account, which earns, you know, very little to no interest and we don’t have access to it, it creates friction. In thinking back to before rep and warranty was as prevalent as it is, the conversations that we would have with sellers at that point in time. We’re fortunate to not have those conversations anymore, in the sense that we can have an insurance policy that backs them up on that it says, look, you were on define how much you were on the hook for you are on the hook for an ordinary rep amount of X. And anything beyond that the insurance company is going to pick up. And oh, by the way, your escrow is only going to be this many dollars versus in the past, you saw escrows that were 5%, maybe 10% total enterprise value. 

    Patrick: Yeah. 10% we saw.

    Scott: Yeah, really big numbers that you when you’re thinking about calculating your proceeds, in your mind as all sellers do. Especially if they’re rolling in the deal and putting equity in incremental deal go for that was a large portion of the proceeds that we’re going to take off the table, right. And so the progression of rep and warranty insurance has alleviated a lot of those burdens. And like I said, I don’t see it going away. If anything, I just see it becoming more and more prevalent, more and more underwriters out there. And it continuing to be a part of of every single M&A transaction. 

    Patrick: Yeah, I mean, we’ve been really striving to get this on the checklist, if you got rep and warranty, at least is on the checklist. Now it’s something that you know, can get addressed on each deal. May not be a perfect fit for every particular deal. But the fact that it’s there is something to look up look at and and quite frankly, I mean, it is a tragedy if you’ve got avoidable situations where you’re taking wear and tear on people’s soul, because they get so fearful. It can be avoided. And here’s how it goes. And I would say on this on the on the buyer side, my goodness, the in a lot of cases, particularly where the buyer has leverage reps and warranties at no cost because 99 out of 100 sellers will pay the entire cost just to get the benefit of the of the indemnity indemnity transfer. They really really do appreciate it. Scott, now tell me because I had referenced this slightly, but we are talking about industrials, because you’re in Houston. So you’ve got the energy sector over there. 

    Scott: Sure.

    Patrick: Give me give me a profile of your ideal client. What is Sterling Group looking for now?

    Scott: And be very clear. We don’t we don’t touch anything in energy. So it’s odd to be done here in Houston, and be one of the few private equity firms that that doesn’t touch the energy space, we touch the downstream a little bit but midstream, upstream, different types of investing different firms. It’s just, you know, Houston’s where the firm started. And we’ve stayed here, but the vast majority of our companies are outside of Houston, and certainly you know, most outside the state of Texas. But an ideal partner for us and ideal company, that would be a target is a good business. In a consistent industry. Typically, like I said earlier, usually not a sexy industry, usually an industry that folks don’t typically think about, that has a management team, whether it’s a founder or a family of corporate carve out management team that wants a partner that can help make a step change in their business and work with them to make that step change. 

    Or that has a you know, an industry that they know well that wants to partner with someone and go out. And can you continue to acquire competitors continue to grow through acquisition, we do many buy and builds. And oftentimes we’ll bump into founders in industries that think that they’ve created the best mousetrap. And oftentimes they have, and that allows them to go out there and swallow up competitors, or get the competitors to join the team. And then continue to grow and get the benefits of scale. And we’d like that playbook just as well. And we’ve partnered with with many folks in doing that.

    Patrick: So they the partners, you’re looking for our management teams where they’re looking to, you know, they’ve reached perhaps an inflection point. And they want to stay on and see this through or do you have other situations where owner, founder, they just want out?

    Scott: Yeah, we have we see both, probably equally as much. There are certain situations where you have bounders that have run the business for forever, and we’re looking for retirement. And and that’s fine. And oftentimes we’ll have those individuals sit on a board of directors and continue to help and advise and find a CEO that we all trust can run and grow business. But equally as much we see folks out there management teams that have gotten their business and grown it to a point where they know that that next level is a complexity that they’re uncomfortable with, and they want some help navigating that and growing the business. Or that next level requires capital that they may not have access to. Like I gave the example of out there doing a buy and build in an industry and that’s something that we can help them with and put in place a program that helps them do those add on acquisitions in an efficient manner. You know we’ll have portfolio companies that have made 12 13 14 acquisitions in their lifecycle with us.

    Patrick: It’s just I can imagine the inflection point for them is they’re they’re too big to be small but they’re too small to be enterprise.

    Scott: That’s a good way to put it. Agreed. Agreed. In looking at enterprise it can be daunting sometimes.

    Patrick: And that’s the resource the private equity provides on that so that that’s fantastic not to mention the second bite of the apple for owners and founders. So there’s a real great value proposition which is why you’ve got the big growth in these PE firms by numbers so forth. Scott we’re well into 2021 right now we can see only the beginning of the end of the pandemic. Give me your thoughts or what trends do you see for manufacturers or for the industrials for Sterling Group as we go through into the next year or two. What do you see down the road?

    Scott: Yeah, no it’s a good question. Yeah we’ll see I can make some predictions who knows if we’ll be right. I would say in the deal making environment first, I think we see a return to in person meetings. You know we have been doing deals throughout the pandemic, closed a couple last year, we’ve closed a couple of the beginning of this year. And started off a lot of Zoom meetings and folks but it’s really hard to get to know management team over zoom and it’s there’s not a replacement for an in person meeting when you’re getting to know a management team and getting to know a partner that’s going to be a significant partner for the next 5, 6, 7 years of your company’s of your company’s life. 

    So I see us returning back to these in person management meetings and we’ll see how that goes. I think there are other folks who disagree, but we’ll see. And I think the pace of deals right now it’s already back to I think pre pandemic levels. The number of deals out in the market right now it’s been surprising. From a more macro perspective um I can tell you what I’d really like to see. I really like to see us get an infrastructure bill done investment in infrastructure would be very beneficial to some our companies that we own in the space and I think much needed for us. So we’ll see how that turns out but it would be a nice tailwind to the the current environment we’re seeing with our businesses.

    Patrick: For any of you out there that are in the industrial sector and you’re looking for some way to partner up and get past that inflection point really should look at The Sterling Group. Scott MacLaren how can our audience members reach you? How can they find you?

    Scott: Yeah so our web pages www.sterling-group.com and I’m on there. My email’s on there. Feel free to reach out. Happy to talk to anybody and certainly always happy to talk to any potential companies out there thinking of partnership.

    Patrick: Yeah let me highlight that also with the website because there’s more than one Sterling out there in the financial sector so it is sterling-group.com. And Scott absolute pleasure meeting you. Great to hear about the story. Again thanks for your service, and we wish you all the best going forward okay. Thank you.

    Scott: Thank you. You, too, Patrick. Take care.