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  • Brien Davis | Investing in e-Commerce in a Post-Pandemic Market
    POSTED 6.29.21 M&A Masters Podcast

    On this week’s episode of the M&A Masters Podcast, we are joined by Brien Davis, Founder of Altacrest Capital. Altacrest is a private investment firm focused on consumer brands with enthusiast customer bases and centered mainly on e-commerce. 

    Giving clients the experience of an institutional sized team at the boutique level, Altacrest Capital’s focus on e-commerce has been even more fine-tuned in the virtual world of COVID.

    We chat with Brien about his journey from big companies to lower middle markets, as well as:

    • Building an investment thesis around e-commerce
    • Flexibility and strengths of being an independent sponsor 
    • Growth in the e-commerce industry
    • Risk and cost in transactions
    • The e-commerce markets that will continue to grow 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 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 Brien Davis, founder of Altacrest Capital. Altacrest is a Dallas based private investment firm focused on investing in consumer brands with enthusiast customer bases, largely through e-commerce. Brien it’s a pleasure to have you. Welcome to the show.

    Brien Davis: Thank you for having me, it’s a joy to be on.

    Patrick: Now, we’re going to get into Altacrest and where you’re dealing with all the cool kids with the enthusiast customer, right, all that stuff. But before we get into that, let’s start with you. What brought you to this point in your career?

    Brien: Sure, no, it’s been a bit of an entrepreneurial journey for myself, you know, which has been fun, because we get to work with a lot of founders of these young brands that are kind of going to the next level. But I have a similar background to my two partners, we both came, or all three of us came from large financial institutions. And, you know, I worked at Prudential Private Capital for about 15 years. Wonderful group, wonderful, people really enjoyed it. However, you know, the transaction sizes were getting bigger and bigger. 

    And I frankly, wanted to do something where I could be a little more hands on and have a bigger impact on helping to grow, you know, smaller, middle market companies. And so, for me, it was a great fit to make the transition and make the leap from the big firm. And then, you know, head up into Altacrest Capital, which we did about three years ago. And my two partners were in a similar state of mind. One of them is Tim Laczkowski. He and I has worked together at Prudential for about 15 years. And then Rick Sukkar, who was at JP Morgan for for quite a while as well. So it’s been a good fit for all of us.

    Patrick: Well, now you didn’t name it after after the founders, which is what, you know, your I would say, the less creative law firms and insurance firms are, they just named things after their founders? And I like I like getting an insight for a company, their culture and their background, a lot of it comes down to how they were named. So we’ll start with Altacrest, and how would you name and it, then we’ll talk about Altacrest.

    Brien: Sure. It’s actually the ancient Roman god of no, I’m just kidding. Nothing to do with that. We actually do have a little bit of a family connection to it. So Tim, who I mentioned earlier, was actually the first one to leave the big institution. And he went out on his own, and originally came up with the name Altacrest. And it’s an acronym of his family’s name. It goes wife, Amy, and his sons, Luke, Tate, and Andrew and that’s the alta. 

    And then they loved to vacation and Crested Butte. And I’ve done it for years and years. And it’s a beautiful place. When Rick and I joined, it was interesting is like, well, that’s a pretty personal sounding name for for Tim. And we were all coming in as equal partners. But we liked the vibe, you know, frankly, because we’re three of us all been married long time, we’ve all got multiple kids, and, you know, very family oriented. And so it just, it seemed like a great fit. And so we stuck with it. 

    Patrick: Well, I think and Tim’s last name, pronounced it again for me.

    Brien: Laczkowski.

    Patrick: Okay, if you see the spelling of it, that’s a real tricky way. If you started using that same formula, put everybody’s name in there, I think it would have been even more duck soup. So, I think you took the path of least resistance. And you did that. One of the things you mentioned is how you had been in in the larger institutional capital. 

    And we’ll find out in a future episode, actually about your firm Prudential capital where they are not as institutional as you might think. But you were up there in the deals were getting bigger and bigger. And that’s been the trend for a lot of private equity firms, as things get bigger and bigger over time. But you’re committed to the lower middle market like we are. Talk about that a little bit. Why there? Why do you want to get your hands dirty?

    Brien: I love it, you know, we’re dealing with mainly companies from about 2 million of EBITDA up to call it 10. And quite frankly, at that point, you oftentimes it’s a founder, who had a wonderful idea, and is great at getting the company launched, and gets to a certain point where, you know, he or she wants a little help, you know, taking it to the next level. And it’s, it’s a situation where, you know, they’ve got really good management teams, and they’re, they’re beginning to build those out. But there’s still a lot of room for, for growth. 

    And the nice thing about, you know, coming from a place like Prudential where we provide capital from larger companies, we’ve seen the roadmap, you know, so we know what those companies look like at that size, and we’ve got a good sense for how to help these businesses get there. And it’s great. I mean, there’s a lot of them at the lower middle market just in terms of the volume of types of companies that are there. 

    But it’s also just, you know, there’s just more help that they need and more kind of value add they can do you get into the consumer products side, there’s been some unique things with ecommerce and things like that, that have even driven even more need for and more development of some of these younger companies that are growing rapidly and have really taken advantage of the changing and consumer behavior.

    Patrick: Yeah, I think what’s exciting about this is, first of all, there’s a large marketplace out there, when you look at the lower middle market. So there’s, I would almost say, idyllically, there’s plenty for everybody. But this segment of the market is really underserved. And what’s fantastic is, you know, you get these owner founders, and you’re right, they can take from nothing and create something, but they can’t scale it and get to a point of inflection where, okay, we’re, you know, we’re not really small, but we’re not big, what do we do. 

    And a lot of times, if they’re not informed, they may default to a strategic that may or may not have their best interests at heart. And so if they don’t do that, they go to an institution that maybe can’t meet all of their needs, but we’ll charge them a lot more money. And and that’s not serve them better. So it’s great that we can go ahead and put Altacrest capital out there and really highlight you as a destination, particularly for consumer brands. In ecommerce, that’s a nice niche, where, hey, here’s a place to turn because, you know, they’re getting the benefits of experience from an institutional sized team, but at the boutique level. 

    And so I think that’s fantastic. So I was thrilled to be able to have you there and spotlight a firm like Altacrest Capital. When you’re looking at this class of business, why this this line of business, the consumer products and the e-commerce? Why not just consumer products or whatever? Tell me about that.

    Brien: Yeah, it’s been fun. So one of my partners, Rick Sukkar, he’s been in consumer products for 20 plus years. Yeah, he did the big JPMorgan, institutional M&A, investment banking thing. And then about, you know, 10 years ago or more now, he went out on the operating side. And so he’s been an operations on some of these smaller consumer brands that are growing. And in his instance, it was more omni channel. And by that we mean brick and mortar, ecommerce, any type of channel you can think of to sell your your widgets, and, but where he saw a lot of growth, and where they had a lot of success was was on the the e-commerce side. 

    You know, Tim, and I come from a more of a background with a strong focus on free cash flow, generation, margin, etc, etc, a lot of the great things that we learned through our investing time at Prudential. And when you took the experiences that the three of us had had, and this was early in our formation, like I said, we’ve been together for about three years, we fine tuned around this investment thesis around ecommerce. And the reason for that is a couple things. One, you’ve got a massive tailwind behind you. 

    And this year, we obviously came up with this thesis before COVID. But obviously, that’s helped it as well. But you’ve got the shift of people going from brick and mortar to e-commerce. And so that’s a nice tailwind. The other aspect of it is the ability to grow a young brand can be very cash efficient. You can outsource the manufacturing, you can do the product design in house. So you can keep from a capital expenditure standpoint, from a working capital standpoint, you can keep it relatively manageable, too. 

    And so it’s a great little free cash flow generation model. And so you take some of the industry aspects, some of the business model aspects of it were like this, this makes a lot of sense. Yeah, we really want to focus on this. And so we bought our first company, Barton Watch Bands, in November of 2018. And it’s been a great ride. I mean, we’re seeing just a lot of those things. play out now, we did not anticipate, you know, a global pandemic. That wasn’t part of the investment thesis.

    Patrick: Neither do the the people from Zoom. But they’re doing ok.

    Brien: Exactly, exactly. So, um, but, but now, we’ve been fine tuning that since then. And the other part of it that that made sense for us to focus on this niche is really our network. And we call it our Altacrest ecosystem, if you will. But it’s, we’re pretty hands on. Yeah, we we help out a lot if with anything from operations, whether it’s, you know, bringing in a consultant we’ve worked with for a long period of time to help refine things to hiring COOs. 

    On the marketing side, we get, you know, involved in terms of helping out on digital marketing strategies, different agencies to work with different particular people to work with. PR, etc, there’s a lot of different ways that we try to bring resources to bear to these small companies that that didn’t have them before, in an effort to accelerate growth. And so that’s, you know, sort of our experience level coupled with what’s going on in the industry seemed like a good fit for us. And so and it’s been fun. We’ve done three acquisitions now and hoping to do do more as we keep going.

    Patrick: And with this, what you’re bringing to the table is, now you’ve got the experience in that particular space. So you’re not just doing financial engineering, you’ve got hands on operations, and we’ll talk about a layer but you’re also dealing with a human element, that gets, you know, can be vexing, quite frankly, for owners and founders. Particularly in e-commerce and consumer brands. Because their, their their focus is elsewhere. 

    And that’s a big blind spot, or can be a tragic blind spot for them. With your structure, okay, as an investment firm, you’re not a you know, big fund, private equity firm. Let’s talk about your setup. Why did you structure as otherwise known as an independent sponsor? What flexibility, or what strengths does it derive from that, as opposed to, you know, having a big fund behind you?

    Brien: We like it for a number of reasons. You know, one, you know, capital availability hasn’t been the biggest hindrance to doing deals for for a while, and that does ebb and flow depending on what’s going on the the economy and things like that. But for attractive investments, capital’s generally generally available. You know, it’s been harder to find is,you know, attractive deals and in sectors that are in something that we wanted to be in. And so, you know, two things led to, you know, doing the independent sponsor model. 

    One, frankly, just being honest, is a lack of history of the three of us investing together within this investment strategy. And so that’s something that is typically desirable in terms of pulling together a committed fund is a track record of investing in the same strategy with the same people for over a period of time. You know, the, the other part of it is the fact that we just like it, we like the flexibility, we have a lot of relationships, both institutional and high net worth, if you look at the capital that we’ve put into our acquisitions, it’s it’s some of our own capital, in addition to a mixture of high net worth individuals and institutions. 

    Most of those high net worth individuals, frankly, are our former private equity guys and women of some ilk. And so we like that, too, because it’s a nice value added base that, frankly, we use to, you know, bounce questions off from time to time, as well, in some of our portfolio companies.

    Patrick: And I would think, for sustainability, long term, you’re having this experience with these investors, and you’re, you know, having a track record of success. Should something change in the future, and you need to pivot, you can turn to them with a real great track record, if you did have to make a fund set up a fund, well, then you’ve got that source, I think that you’re keeping all of your options open. And you’re looking out for, obviously, what’s best for the companies that you’re investing you’re partnering with. And so why don’t we talk about that? What’s your profile of a target? What’s your ideal profile?

    Brien: Sure, I mean, I think the best way to answer that might be just giving you an example of a recent transaction that we did. So in September of last year, so you know, right in the middle of COVID, we closed on a transaction with a company called Big Dot of Happiness. Big Dot of Happiness, makes party supplies. So think of things that you’re going to hand out at a bridal shower, or a birthday party or a 50th, you know, celebration of whatever graduation celebration. And right there, you may think we’re absolutely insane that we’re buying a company that is built around the gathering of people in the middle of a pandemic, when you can’t gather people. 

    But that’s a we, you know, the process started before COVID began in terms of us having conversations and it got it admittedly got stalled for a while as we all digested what was going on in the world. But but this is a great example of a of a management team and a founder, who were just really impressive and they successfully pivoted from doing, you know, a paper invitation that says come to my party to uninvitations. Hey, you’re not invited to my party because I can’t have one. And the beauty of that business and this is part of the beauty of e commerce is you know, they have in house creative. They have in house manufacturing. And they have the logistics to get the product out the door very quickly. 

    So they can go from idea to in a customer’s you know, home in about 48 hours. Which is what allowed them to pivot as quickly as they did. And so it’s a really nice business. We think that they’ve done a great job pivoting through the transition that we had, we think, obviously, as gathering start to come back together, and, you know, vaccinations, increase, etc, that it’s a great business to be in. But the rationale for the transaction was this is the founder that built the business over 20 years. 

    She wanted a partner to help her take it to the to the next level, you know, she is, you know, incredibly talented at what she does, but she’s been doing that particular work for for 20 years. We’ve got some other experiences, obviously, that we’ve had in our careers. And I’ve tried to bring some of those experiences to bear. You know, one of the things right now we’re working on is the operation side, you know, we recently hired a new CEO, we’re super excited to have him on board. And we think that we can create even more of these wonderful little products and even more efficient way with with somebody like that. 

    And so they wanted to partner help in growing and things like that. But they also saw upside of the business going forward. So that’s another common thing that we see in our transaction is a degree of rollover equity. So the founder typically owns call it 15 to 30%, post deal, and kind of gets that proverbial second bite of the apple. And so we don’t we don’t require that. But it seems to be all three deals that we’ve done, have had that element, which has been been interesting.

    Patrick: Yeah, I don’t imagine your type of target looking for an exit at closing right now. They want to bring it to the next level.

    Brien: Most do. I mean, like I said, there’s there’s pretty good tailwind in the industry. You know, and COVID has done nothing but accelerate that. I mean, there’s some interesting trends that we could talk about in consumer products, where, you know, not all things are created equal depends on what product categories you’re in as to how COVID has impacted you and how you’re likely to perform coming out of it. But yes, we we believe that there’s still a lot of runway to go and a lot of great growth, and we’re excited to partner with them and help them achieve that.

    Patrick: Well, I think this is a great opportunity for this particular organization. Because I’d say just from personal experience, if you’re planning parties for a nine or 10 year old girl is amazing how quickly their tastes change, may have one theme one week, and then a week later, and quite frankly, this happened. I’m dating myself, but the movie, Peabody and Sherman came out. And my daughter automatically went from a princess type theme party to she wanted Peabody and Sherman in a week.

    Brien: Right. Right.

    Patrick: And as you know, scramble for my wife who wants to please her and everything and be you know, good mom.

    Brien: Absolutely. Really competitive moms. That’s a good thing.

    Patrick: I think that’s, I think that’s outstanding. One of the things that, you know, what I mentioned earlier on this is that, you know, the target your your, you’re coming for our new owners and founders, because you’re, you’re the lower middle market, these these organizations are just getting up off the ground. And you cannot remove the human element from these deals. And as fun and exciting as these deals are, they don’t happen in a vacuum, there’s risk. And what’s dangerous is where you have an experienced buyer, like you and your team that is working with an inexperienced, they’re not, you know, any lack of anything else, they just don’t do M&A every day. 

    And so for a lot of things that are familiar routine for you through the process, and they’re not familiar with the process, which can, you know, cause some stress. And, you know, going through the diligence process is one example. And once they’ve gone through that, they have the talk with their attorney about indemnification and how, what they hear in this and they’re not experienced, but you know, they hear the buyers essentially telling them, look, I know, we just went through this whole due diligence, but hey, in case we missed anything, we’re going to leave you on the hook to pay any of our losses for X number of years down the road. 

    But you know what, this is routine, there’s probably nothing out there. But you know what, you’re on the hook. And then the sellers looking, again, not experienced thinking. Wait a minute, I just told you everything I know. You can’t hold me responsible, financially responsible for something that I didn’t know about. And the buyer who’s experienced is going to have the immediate responses is wait a minute, I’m betting maybe 10s of millions of dollars that your memory is perfect. And I’m sorry, we just can’t do that. And so you have this, what started as a collaborative process through all this wear and tear, you’re at risk of it descending to an acrimonious, almost adversarial situation. 

    And you know, all of a sudden you’ve injected distrust into this and is part of the process and you know, the the seller eventually win the deal closes, the dust settles, they may forgive the process. But they don’t forget it. And the tragedy about that is all that can be avoided. And what’s very exciting with us in the insurance industry is, you know, we just come in, and we’re going to insure these deals. And so we will take through this product called rep and warranty insurance. We take the indemnity obligation away from the seller, and we take it to the insurance company. 

    So we just look at what the buyers diligence was on the seller reps, if they checked them out, hey, if those reps later get breached, come to us buyer, we will pay you. You don’t have to go ahead and clawback anything from the seller. So buyer has certainty of return if anything happens. Seller, well, the insurance replaces some or all of the escrow. So they get more cash at closing, so don’t have as much withheld. But even better, they get the peace of mind knowing that, hey, if something does blow up, you know what they get to keep all their money because the insurance company’s gonna take care of. And the tragedy is that if that isn’t brought in, then you risk this kind of acrimony happening. 

    And if it’s done, right, for the buyer, all they do is offer this coverage to the seller, the cost is so low, the seller will gladly pay the premium on this. So it’s cost free to the buyer to the buyer, arguably, a lot of times they split the cost, but it’s out there. And you know, it’s just a nice elegant solution, it was not available, this insurance was not available for, for deals under 100 million a couple years ago. It has now fallen down where companies that are transactional value of 10 million, as low as $10 million are now eligible. And so, you know, that’s a great thing that we can now bring to the lower middle market that wasn’t there. Now, but you know, don’t take my word for it. You know, Brien, good, bad or indifferent, what experience have you and your team had with with rep and warranty insurance?

    Brien: Now, I’m a fan. I mean, I’ve I’ve been doing, you know, transactions long enough to have been on both sides of it back when there wasn’t insurance that was offered. I remember back when we you had to be really big transactions for our RWI insurance to to be in play. And I think it’s great to see it come down. It is for the reasons you talk about it, because, you know, you go through these transactions, and everybody does a ton of diligence, and you think that you’ve uncovered everything. 

    And I’ve especially in situations where where we are where we’re typically buying it from a founder, and, you know, they typically are still owning a chunk of the company going forward. And so, in, and I’ve had situations where, you know, unknowingly there’s a breach of the rep, you know, there was something out there that they didn’t realize, and you know, there’s either litigation coming in, or it’s a problem in it. And I’ve been in a situation where it’s material. And so it’s enough to where you’re gonna have to, you know, discuss and negotiate, you know, a reasonable outcome. 

    And that is, it’s a really hard place to be, it’s a hard place to be if they’re your partner, and they own part of the business, it’s an extremely hard place to be, if they’re still running that business. So that’s a, that’s a part of it, as well, that that occurs. And so we prefer to use rep and warranty insurance in our transactions for those reasons. You know, there is a little bit more diligence on the upside, but frankly, on the front side, that’s that’s a good thing. You know, I think figuring out more things before the deal happens, as opposed to after is always a good thing. 

    And and I would say I mean, you know, the cost is, you know, is fine. I mean, there’s these transactions are not, you know, we’re super cheap in terms of transaction expenses, and we all too are tied to our part to keep them keep them down and that sort of thing. But, you know, in my mind, it’s not an area to skimp in and it can really improve the relationship, you know, post deal.

    Patrick: Yeah, I’m almost borderline on the part. Let’s, rep and warranty isn’t for every deal, there are some deals that just aren’t going to, you know, be eligible for. Where’s available, particularly if the seller number one and buy a lot of sellers and seller advisors and the investment bankers to get the pricing upfront. But, you know, if they’re willing to pay for it, I would almost think it’s just an act of good faith on the part of the buyer to say look, if you’re if you’re gonna pay for fine, let’s let’s move forward.

    Where we see situations which are unfortunate or where you’ve got some buyer that, you know, 400 times the size of the target company, and they’re just gonna use leverage because they can’t, and and that that’s tragic, but you know, then again, hey, another reason why a firm like Altacrest Capital would be a lot more desirable because they’re gonna have good faith and work with you.

    Brien: Yeah, yeah. No, and I think it’s a I mean, it’s a selling point, as buyer, if you say, yeah, we’re happy to do a rep and warranty policy as opposed to a big escrow, you know, it’s generally very advantageous to the seller. And so that’s a good thing. And I would say when it when, when rep and warranty insurance first came out, I would say there’s a little bit of trepidation of, you know, if you go, if you have a breach, and you’re going against the policy to get, you know, made a hole, what’s the likelihood of getting the claim, you know, relative to getting it out of an escrow for the seller. 

    And there was no concern when this was a more nascent industry. I, I personally have not had a claim. So I have to give that caveat. Right, I guess, insurance provider for reps and warranties. But I have been counseled by people that are very involved in including legal counsel and others that, frankly, they’re seeing it every bit as good, if not even better recoveries from an insurance provider, as opposed to trying to get it out of escrow.

    Patrick: We just like, you know faster, cheaper, happier, is how we go on those. So no, but great, great response there, Brien. Now, as we’re coming coming through this year, now, we’re, I think, confidently looking at the beginning of the end of the pandemic. And you had referenced earlier that you’re aware of trends in the consumer products area. So COVID, no, COVID. Give us give us your perspective on what do you see down the road?

    Brien: Yeah, I think it’s fascinating. I mean, I think M&A activity is, definitely picking up. You know, the second and third quarter of last year was pretty, you know, dead. And fourth quarter, first quarter, second quarter of you know, the last three quarters have definitely been picking up. Just in general, within the consumer space. I would say it’s been picking up more as well. But it’s interesting to see which companies are coming to market. And so within consumer world, you’ve got to think about okay, and in a COVID world, what has worked really well, anything tied to the home. 

    You know, we’re because people are spending more time at home, and then they ever have and home furnishings all that type of thing that’s been an interesting area of of growth. Yeah, how sustainable is that, you know, you could argue that everybody’s gonna go back to work, and that, you know, that, you know, ride is over. But but most people and I’m one of them, I think there’s some legs to, to some, you know, ongoing, you know, growth within the home industry, because I don’t know that people are going to go to the back to the office five days a week, you know, there’s going to be more home offices, there’s going to be more people working from home than than ever, ever before. 

    So that’s an interesting category to think about. And almost on the flip side of that would be apparel, especially apparel we use for work. You know, I mean, if you’re, you know, belts or something like that, where, you know, if you’re Lulu Lemon, I’m sure they’re killing it. Or, you know, anything like that sweat pants, anything, we’re outside of being on a Zoom call, you’re not not being seen day to day, those those categories are so well, but but apparel in general is definitely down. And so it’s part of the fun part of our job. 

    And part of the difficult part is figuring out, okay, we’re coming out of COVID I agree with you seemed like we’re starting to come out of COVID. And more and more people are getting active and doing things. But what is it going to mean for the next 2, 3, 5 years? And we don’t underwrite to, you know, six months or 12 months, or trying to think about 5, 7, 10 years down the road. But it’s, it’s gonna be a fun ride, as we figure this out. And there’s, you know, stimulus checks coming in that influence things. And, you know, there’s all sorts of factors going on.

    Patrick: Yeah, I just found and again, I hate to, you know, make this about me, but I just from a personal experience, we’re seeing that, you know, what, we may not be getting home furnishings yet, but because of all the wear and tear on everybody being home, you know, last year, day in and day out, I have a feeling we’ve got a lot of worn out furniture. So those upgrades. And then definitely the wardrobe, at least maybe temporarily, because a few of us might might have added a little bit of weight during this time. So some of those office wear may not fit today. We may need a bridge.

    Brien: Exactly, exactly. Yeah. No, it all kinds of, you know, unintended consequences. You’re not sure exactly how it’s gonna play out. But, but it’ll be fun to watch.

    Patrick: Yeah, it’ll be it’ll be a great seeing a comeback, which, which is always a lot more fun than then a shutdown or a slowdown. So Brien Davis of Altacrest Capital. How can our audience members find you? 

    Brien: Sure. There’s a couple ways to reach us. Our website. Feel free to take a look at us there. It’s altacrestcapital.com. That’s a l t a c r e s t c a p i t a l.com. If you want to reach out to me directly you can always find me at LinkedIn there Brien Davis and I spell it funny b r i e n Davis or feel free to reach out and shoot me an email at Brien, b r i e n @altacrestcapital.com

    Patrick: Yeah in our last conversation where you remember Brien’s name in the spelling is just think of the the Irish last name O’Brien. Drop off the O apostrophe br i e n. So I I’ve never forgotten that. Brien, absolute pleasure speaking with you fascinating with with the e commerce and consumer products because we’re usually seeing a lot of, you know, business to business stuff but real pleasure to meet you and I look forward to talking to you again soon.

    Brien: Thank you. It’s been great talking to you as well. I enjoyed it.

  • Domenic Rinaldi | The Number One Pitfall in M&A Transactions
    POSTED 6.22.21 M&A Masters Podcast

    On this week’s episode of the M&A Masters podcast, we sit down with Domenic Rinaldi, President and Managing Partner of Sun Acquisitions. Sun Acquisitions is an M&A advising firm specializing in both buy-side and sell-side advisory services. Domenic also hosts his own podcast, M&A Unplugged, ranked among the top M&A podcasts of 2021. 

    From a young age, Domenic had an itch to own his own business. In discussing why he chose the details of Sun Acquisitions, Domenic says, “Quite frankly, I love the lower middle market. They have more sophistication, more infrastructure, but they don’t necessarily have the money for the advisory groups…so they need firms like ours.”

    We chat with Domenic about his path to owning Sun Acquisitions, as well as: 

    • The ideal client both on the buy-side and sell-side
    • Encouraging empathy in M&A
    • Experiences with rep and warranty
    • The importance of preparation when it comes to transactions
    • Using podcasts to help spread information
    • 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, and that’s a clean exit for owners, founders and their investors. Today I’m joined by Domenic Rinaldi, President and Managing Partner of Sun Acquisitions. Sun Acquisitions is an M&A advisory firm based in Chicago that specializes in both buy side and sell side advisory services. Dom is also the host of the M&A Unplugged podcast, which was recently ranked among the top M&A podcasts for 2021. So we have both M&A, and podcasting in common. Dom, so great to have you. Thanks for joining me.

    Domenic Rinaldi: Hey, Patrick, thank you so much for having me such a pleasure.

    Patrick: Now, before we get into Sun Acquisitions, and M&A for 2021, let’s give our listeners some context here. Let’s talk about you. How did you get to this point in your career?

    Domenic: Yeah, so you remember that commercial a long time ago doesn’t look like you and I needed it. But the men’s hair club, you know, not only am I the owner, but I was a client. Very similar story. I, many years ago, was in transition and was trying to decide what I was going to do next, I launched a business search, I just I had always wanted to own a business from even a very young age, I was always very entrepreneurial, I had my own paper routes, I was, oh, have my own lawn mowing business. I loved to doing my own thing. And I think from a very young age, I really always wanted to own my own business. 

    But for many reasons we won’t get into, I launched a corporate career. Next thing, you know, you wake up 30 years later, and you’ve got you know, all this, you know, all these things you’ve done, but you’ve always had this itch to own your own business. And so I decided in my early 40s, that I really wanted to own my own business. And I had done the analysis of should I start something or should I buy something. And for me, the safer route was to buy something because I had what I call a train to pull. Meaning I had young kids, college education ahead of me, a mortgage. 

    So I wanted an ongoing concern with you know, ongoing cash flows and clients and, and so I initiated a business search, and I did it on my own. And the long the short story here is in doing all of this, I really got enamored with the M&A business. And lo and behold, as I’m doing my research and opportunity presented itself. It was a small little advisory firm that was for sale, did some diligence actually did a good number of months of diligence, and decided that this really was a path forward for me. And so I bought this business. And here I am, almost 20 years later, we’ve you know, 10, more than 10x, almost 20x the business since then. And it’s been a great ride.

    Patrick: You and I are both right around the same age. But we were just coming out of where everybody’s joining big corporations. And the idea of going out and starting your own little firm out there was daunting, because it was still it was there on the periphery. But if you grew up in a city or in a metropolitan area, you just had all the big companies around, so completely understandable. So now we go on to Sun Acquisitions. And let’s talk about that real quick. You bought it as an existing business. So tell me about you know, where the name came from? Why didn’t you name it Rinaldi and and just give us a description of Sun Acquisitions.

    Domenic: Yeah, so actually, I wound up rebranding the business, but only slightly. And what I thought was important in in talking to our webmasters, and our and our social media people is that our name should be descriptive, that the more descriptive it was, the better we would show up in search engine rankings and things like that. So really, I did it. We named it Sun Acquisitions, because we wanted acquisitions in the name. We wanted people to know that this is what we did. So when they came to us, there’s no mystery and from a search engine perspective, looking back now, it’s really worked out for us.

    Patrick: And then your your focus is more toward the lower middle market as opposed to the larger deals. So give us a context size and why the lower middle market as opposed to other you know, larger size.

    Domenic: Yeah, so when I was going back again to when I first bought the business, actually, it was really focused on the small business market, mom and pops and smaller businesses and, and so over the years, we’ve left that market and we’ve gravitated to lower middle market. Quite frankly, I love the lower middle market. It they have a little more sophistication than the small businesses mom and pops, they have more infrastructure. 

    And but they they don’t necessarily have the budget for the advisory groups that the big, the big boys do, right. And so they really need firms like ours, at at sort of price points that we’re at, that can help them both get their arms around what the value of their businesses are, if they’re if they’re selling or understand what the market’s like if they’re buying and then go out and help them get those acquisitions or those sales done.

    Patrick: Yeah, well, I, what I what I love about the lower middle market is, you know, it’s vast. And it’s established to a point where you know, that these companies, they’re, they’re too big to be small, but they’re too small to the enterprise. And, you know, they’re not aware of all the services that are available to them that are not at that retail higher price. And that’s why I love having having you on here just to spite the spotlight while you’re doing because if if they don’t know about you, and Sun Acquisitions, what happens is a lot of owners and founders that are looking at exit, they default to either a strategic acquire that may not have their best interests at heart. 

    Or they may go to some institution that, you know, they’re going to be overcharged and underserved. And really, there’s great value that you’re going to bring because you’re doing not only, you know, sell side advisory you’re doing buy side. So distinguish the two types of services for us, because you can bring, you know, a prospective seller buyers to the table or attract them and, and vice versa. So talk about one side of the table and the other side.

    Domenic: Yeah, so the sell side, we are representing owners of privately held companies who want to understand the value and the market timing and whether or not now is the right time. And if they are ready, we’ll represent them and take them out to the market confidentially and represent them throughout the entire process. On the buy side, there are buyers who want professional representation. They want firms like ours that will go out and essentially make a market. And on the buy side, what we’re doing there is bringing discreet proprietary deal flow to our clients. So we’re not bringing them deals that are on the marketplace, which right now, if it’s a decent quality deal is probably getting a lot of action, we’re going into the marketplace. 

    And we’re trying to uncover opportunities with owners in businesses that are not on the market for sale, and see if they’d have an appetite to talk to our buyside client who is also paying our fee. And so that’s how we distinguish between the two and right now that the buy side part of our practice is exploding, because there just are so many buyers out there in the marketplace.

    Patrick: And I can imagine these are largely strategics or do you have smaller private equity firms that work with you?

    Domenic: So largely strategics. But we do have some private equity groups that have retained us to go out and do this work for them as well.

    Patrick: Oh, I would think for private equity is an ideal fit to have Sun Acquisitions help them because when you’re you know, looking for proprietary deal flow, that’s a fancy way of saying you’re cold calling. And you’re you’re going out reaching out to owners and founders that may not be in the mindset to take those types of calls yet, and they come around, but at the time, that’s as a real tough slog and have a professional like you that can bring those to them, I think is a great value add that you bring.

    Domenic: Well, and the other thing that we hear from owners who have been contacted directly by private equity groups, because for a lot of private equity groups do this work themselves. But the things that we hear time and time, again from owners that have been contacted directly is they didn’t want to go down that path. They felt like they were overmatched. They were in over their heads. And they felt like they needed professional representation. So if a private equity group outsources to us, even though we represent the private equity group, we’re much less intimidating to the owner of that business. When we do that outreach, and we try to make that match.

    Patrick: Talk about the ideal profile for Sun Acquisition. Give me a profile of your ideal client both on the buy side and sell side.

    Domenic: You know, so I’d say on the sell side, we’re, you know, we’re largely working with companies that are a couple of million dollars of enterprise value up to $40 million. That’s usually our sweet spot. We’re fairly industry agnostic, although I admit we don’t do deals in energy and agriculture. We tend to steer steer away from retail, and restaurants. Those are just not places that we tend to focus on. 

    On the buy side. We’ll do transactions from you know, a million dollars up to a couple of 100 million depending on what our client wants, we represent both international and domestic clients. And we’ll do it in any industry they want. And we’ll even do international searches, which we’ve done a couple of for some clients. So the deal sizes there can be can be much different.

    Patrick: And geography is not a problem for you.

    Domenic: Geography is not a problem, we have our own in house Business Development Group. So we insource, all of that. So we’re not, we’re not outsourcing anybody, we control all of that outbound effort on behalf of our clients. And these are people that are trained on our industry. So when they get an owner on the phone, they understand the sensitivities, they understand what the dialogue should look like. And they’re very professional, and quick about it. So we can really exercise and implement these engagements in a very time efficient manner.

    Patrick: Well, I think one of the things is important about what you’ve mentioned a couple times on this, it just shows the empathy that you and Sun Acquisitions has for for target companies, for sellers out there prospective sellers, because, you know, they’re not doing M&A every day. And you know, so they’re inexperienced, or not naive, they’re just inexperienced. And so, there can be a little bit of a intimidation factor there, as they go into this, you know, what I consider, in some cases, a life changing transaction for that. And so, there, there is some fear out there. And, you know, one of the great developments has been out here now, mergers and acquisitions was, has been the development of reps and warranties insurance. 

    Where a seller has their representations of their disclosures with their company outline in the purchase and sale agreement. And to a buyer this is standard operating procedures. These reps are there, the buyer performs diligence. But then the buyer says, well, we’ve got this thing called an indemnification clause. So in the event we miss anything in the diligence is with the seller, if we missed anything, this provision allows us to come and claw back money from you for something that you didn’t tell us about may not have known about it, but you know, that’s what it is. And that scenario, particularly for someone who’s inexperienced, and as, as these owners, and founders are, they, you know, have the situation, fall from a collaborative conversation to a confrontational, almost adversarial. Because all of a sudden, you enter a little distrust there. 

    Because, you know, on one side, the seller is like, you can’t keep me responsible for something I didn’t know about. And the buyers is saying, well, that’s true. But at the same time, you got to understand, I’m betting 10s of millions of dollars, that your memory is perfect, okay. And so you’ve got that natural tension. The beautiful thing is by ensuring a deal with reps and warranties, that indemnity obligation is transferred away from the seller, to an insurance company, buyer benefits because they got certainty that if there is a breach, and they suffer financially, they can collect from the insurance company without having to, you know, attack the seller. The seller benefits, because the attachment points on these policies is usually lower than most escrows. So less money is held back at the transaction, seller gets more cash at closing. 

    Better yet, they have peace of mind knowing that even with that additional money they have, they’re not at risk of any more clawbacks coming back so they can go ahead and exit cleanly. And we’ve just seen this just you cannot understate the tension as released, when when this is brought into the deal. And happily deals now in the lower middle market as low as 10 million to $15 million transactions are eligible for rep and warranty. It wasn’t the case pre COVID. Now it is and so the more we can get that out, the better. But you know, you don’t take my word for it. Dom, what experience have you had good, bad or indifferent with rep and warranty?

    Domenic: Yeah, not a lot. Because it like, as you pointed out, it hasn’t really been available down to the, you know, deal sizes that we’re focused on. Right. And so we’ve been learning about it over the last couple of years, we’ve presented it in a couple of situations where we thought we could bridge a gap. But now that it’s coming down market and the price points are, you know, to the point where people can, you know, it really makes a lot of sense for a 10, 15 $20 million deal. We’ll be promoting this a lot more. And I think, especially with post COVID. With all of the new deal structures that we’re starting to see, with all of the uncertainty about is the business recovering. If it’s going to recover, what’s it going to recover to? 

    And I know there are some limitations around will it cover earn outs or not and things like that, but there are all sorts of new deal structures because of COVID. And I think if we can fit reps and warranties insurance into that, even in some small way, it will go a long way to bridging bridging gaps between buyers and sellers.

    Patrick: Fantastic. Now let’s talk about M&A Unplugged. And just as one podcaster to another I’d love for you to share your story on, okay why did you decide to become a podcaster? And what types of tell us about the content and so forth? How we can find it? I mean, I will comment on one thing for my audience about M&A Unplugged. As of today in post first quarter 2021. There are over 1 million podcast series out there right now. Okay. But the average podcast series is only six episodes doesn’t go more than that. Dom as a you and I talked before you’re approaching episode number 100. So you definitely got some sustainable messaging out there. There’s some great stuff. So tell us about M&A Unplugged.

    Domenic: Yeah, you know, I didn’t set out to actually do a podcast, we were trying to figure out how we can help people that do transactions with the number one pitfall that we see, over our 20 years of experience. And over, we’ve got over 400 completed transactions under our belt. And the number one pitfall is people don’t properly prepare. Whether you’re acquiring a business and you don’t put all the pieces together, and you’re not strategic, and you don’t really figure out the finance. Like if you don’t put all those things together ahead of time, you’re bound to hit some speed bumps, and you can lose deals are not met, not meet your returns. 

    On the owner side, we see it almost 100% of the time, they haven’t properly prepared, they haven’t put their house their their personal house in order their personal financial situation order, they haven’t put their business in order. And then sometimes they’re not even emotionally ready. And so we wanted a way to help people understand what preparation looked like, whether you’re looking to buy or sell, and what goes into getting a deal done so that when they are ready for their own transaction, at least maybe we’ve played some small role in helping getting you know, helping them to get smart, so that they can maximize their returns and minimize their risks. And when we thought about how can we do this, you know, could we blog? Can we do webinars? 

    Podcasting, back we did, we launched in 2019 was already taking off, but not even like it is today. I mean, it’s exploded since I started doing it. And the more I learned about it, the more I thought, wow, this is a great way to create content that’s evergreen people can consume it, they can go back to episode number one or two or whatever, you know, episode topic may fit fit them, and they can consume it. And they can consume it at regular speed, fast speed, like you know, I just me like it was a really flexible way. And and we captured video early on. So we also knew we could put this information up on YouTube. 

    And YouTube’s become a tremendous way for people to get content. And so the more I thought about it, and the more My team and I researched it, we arrived at the conclusion that podcasting was the way to go. And our mission has been simple from day one. We just want to help people avoid the number one pitfall of not being prepared. And hopefully we do that hopefully we you know, our episodes and our content deliver on that mission.

    Patrick: I can tell yours are nice and tight. And you know, they don’t ramble on very long but very informative. But that’s what you need is you need those kind of bite sized data points and talking points to kind of get you familiar with some of these unfamiliar, which has been a boon. I think also what’s been great is just the, you know, the silver lining COVID was just the evolution of Zoom with being you know, being able to have have these meetings, and so forth, then record them and get them out. So I think that’s just a wave of the future we’re not going to go away from we will do more in person as as as the as COVID wanes. But I’ll tell you, this is a tool that we’re going to leverage quite a bit.

    Domenic: I believe that.

    Patrick: Yeah. Now as we’re getting into, you know, we’re now a good chunk into 2021. Dom, share with us your perspective, what do you see for the rest of the year? Either be it M&A in general, or Sun Acquisitions in particular or M&A Unplugged?

    Domenic: Yeah. You know, so from what we would what we can see in the M&A market at this point in time, there continue to be more buyers than sellers. The buyer market has exploded for a number of reasons. Private Equity pre COVID had raised almost $2 trillion pre COVID. And that money is earmarked for private equity go out and make acquisitions. So you had all that money that was raised pre COVID. You also have all these strategics who are out there trying to grow their businesses. And what we hear time and time, again, is that organic growth has become very hard for people. And acquisitions, if you have a healthy balance sheet has become an easy way, a much easier way than going out and spending money on R&D or starting up a new division. 

    Let’s go buy something somebody else somebody else has already built. So you’ve got all these strategics in the marketplace. And then you’ve got this third level of investor groups that have popped up people with a good amount of money, who have decided that they’re done with corporate America. They’ve had two or three people pull, you know, a couple of million dollars together, and they’re out in the marketplace, and they’re looking for acquisitions. And we’ve seen that part of the market explode. So you have all these buyers with lots of money supported by a lending environment with very low interest rates. 

    And it’s, you know, it’s a lot of fuel for acquisitions. The piece that continues to be a little bit missing in action are the owners. We have good quality businesses, but not nearly enough to meet the demand of the buyers that are out there, which is why you see multiples being you know, as high as they are in the marketplace right now. So owners who are selling are getting very good multiples for their, for their businesses. And I’m also sort of surprised that the looming tax changes, even though there isn’t a decision on them. But there’s lots of talk about capital gains taxes going up, I’ve been a little surprised that that hasn’t moved more market and more owners into the market to sell their businesses. 

    So I’m a little uncertain at this point in time as to where the sellers are going to shake out. I’m still hopeful that before the end of the year, we’re going to see a flood of owners decide that 2021 is the year to get out. They’ve recovered from COVID. And all the buyers are still there to you know, to make those acquisitions. So I think it’s still going to be a very strong year. I think it’s going to be stronger in the second half than it has been in the first half.

    Patrick: Yeah, well, I’m stealing from a prior guest. But one of the things that, you know, people overlooked with COVID was, you had all that dry powder. But not only that, you know, time didn’t stop. And so the people that were thinking of an expert that are getting a little bit older, those owners and founders, they’re not getting any younger that time has come on. So I have a feeling that there’s going to be you know, not a surge, but you’re going to see quite a bit more movement. I think as as everybody kind of gets back to work. 

    I think there are a lot of owners that, you know, they want to dig out of the whatever lag they have from COVID and get back on their feet, because they don’t want the earnouts they want to go ahead and see if they can build up a bit. Yeah, and you know, more power to them. But I think as as you and I both agree that it probably you know, the in the foreseeable future M&A activities, definitely not going to be going away.

    Domenic: Yeah. Yeah. No, I think it’s, I think next couple of years, as long as interest rates stay relatively low and the capital markets remain open. It’s it’s going to be a robust M&A market.

    Patrick: I mean, just look at look at a SPACs are out there. And that’s on the high end, and they’re doing 100 million dollar deals. Hundreds of those from out of nowhere. So there’s a very diverse community out there for for everybody. There’s enough for everybody, which is, which is a nice way to view life I guess.

    Domenic: Absolutely.

    Patrick: Dom this has been fantastic. How can our audience members find you either with M&A Unplugged as well as Sun Acquisitions?

    Domenic: Yeah, so M&A Unplugged is on all the major podcast platforms. We also post the episodes on our websites sunacquisitions.com. And you can always reach me directly at my email, which is drinaldi. drinaldi@sunacquisitions.com. And Patrick, thank you so much, and kudos to you too, with your show. You’re also up there in the top shows in 2021 for M&A. So it’s a pleasure to do a show with a fellow M&A compadre.

    Patrick: I totally appreciate it. I was thrilled. I didn’t even realize that there was a list out there. And then when I saw it, I was like, you know, I didn’t care if it was a 15 way tie for tenth. I didn’t care. The fact we got on the list. I was thrilled. But it was it was nice, because this is a great way to meet you. And I wish you all the success and let’s keep talking. Okay.

    Domenic: All right, Patrick. Thank you.

    Patrick: Thank you.

  • Ryan Milligan | Building a Business on Honesty and Transparency
    POSTED 6.15.21 M&A Masters Podcast

    On this week’s episode of M&A Masters, we are joined by Ryan Milligan, Partner of ParkerGale. Guided by their principle – “products that matter, cultures that last” – ParkerGale is a small private equity firm that focuses on profitable, lower middle market technology companies and the convergence of private equity and software. 

    “Let’s just be transparent, and let’s just give everyone the answers to the test,” Ryan says of the empathy he has learned in the market – take the competitive advantage off the table and make it about the people. 

    We chat with Ryan about his journey to building a successful company and culture in ParkerGale, as well as: 

    • The excitement of working in the lower middle market 
    • The importance and art of measuring culture
    • How a “Chief Worry Officer” can fit into risk decisions and dynamics
    • Buyer diligence and reps and warranties
    • The future of software post-pandemic 
    • 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 Ryan Milligan, partner of ParkerGale. ParkerGale, is a Chicago based private equity firm that focuses on lower middle market technology companies, and is guided by their principal: products that matter, cultures that last. And on a personal level, I’m especially pleased to have Ryan here today because it was ParkerGale’s podcast, which is entitled The Private Equity Funcast that opened the entire private equity world to me four and a half, five years ago. And I’m eternally grateful for that. So Ryan, welcome to the show.

    Ryan Milligan: Thank you so much, saying thank you so much for having me. It’s always fun to hear. Hear that. And we get in the history of that a little bit. But no, this is a treat. So thank you for having us.

    Patrick: Now, we’ll get we’ll get into the funcast and ParkerGale, and just a lot of groundbreaking things that you started doing years ago ahead ahead of other private equity firms on a lot of levels. So I’m really looking forward to it. But before we do that, let’s talk about you. What brought you to this point your career?

    Ryan: Yeah, good question. Um, yeah, a lot, a lot of a lot of things along the way. But no, I mean, I’ve always I had always, you know, for us for kind of software, or things are software and private equity, you know, in the in the convergence of those things. And, and then, you know with ParkerGale became more and more is becoming more and more the convergence of how do you run, having a perspective on how you run a small software company as well. So, you know, kind of the convergence of those things, I always had an interest in software and tech, I mean, back to, I went to Boston College, and I worked at the help desk. So my job and my job and in college, just to pay for, you know, for meals, I guess I’d call it was cleaning out antiviral and anti spyware and all that stuff from you know, unknowing, fellow students’ computers and things like that. 

    But then, I was a finance degree and went into went into investment banking blindly, you know, not really understanding what that was, and that was drinking from the firehose, but, you know, kind of horrible at the same time, so that had that cocktail for a couple couple years. But then I joined it, you know, a group that became the software team at, at a larger private equity firm, and we were having fun together, over really, for me eight years, was kind of my tenure at that spot. And that’s really when we decided that, you know, we like this thing, we’re doing these small software businesses and how you run them and, and having a perspective on that, and how you how you build a company, how you build a culture, you find people you want to work with, and live with for five, six years, and hopefully do good things. 

    And that manifested itself in forming ParkerGale, and then those are the things that you know, he referenced the funcast, but that’s those are the types of things that we spend every day talking about in our walls outside our walls publicly, privately. And now we feel like we’ve got something going on at ParkerGale, that we’re just trying to do things a little differently every day and be really good at the types of things that we’re looking for. So that’s that’s what led me to this in a nutshell.

    Patrick: Well, what really is striking is your first introduction with software is working on a help desk. So a lot of the goal of companies and folks both in and outside of technology, if you’re trying to help customers, you’re trying to solve problems. And you were at the granule granular level, then of solving people’s problems. And you’re, you know, a technologist dealing with non tech people. So that must have been real impressionable for you.

    Ryan: Yeah, I get you know, we talk a lot about empathy. So, yeah, it definitely helped me build empathy for for people’s problems. And then also the people trying to solve those problems and things like that. So for sure.

    Patrick: Well, let’s transition over at ParkerGale, and I always ask my guests, you know, to get a feel about culture of a firm and so for this kind of come up, find out why they came up with the name they came up with because unlike law firms and insurance firms that name their firm after their founder, there was no Parker and there has been no Gale at ParkerGale.

    Ryan: Yep, that’s correct. No, it’s funny, and I appreciate you asking us because it’s actually been it’s probably been three years since since we kind of told this. I’ve told this story. So takes us back. So a nice little trip down memory memory lane. But yeah, we did have a few rules. You kind of already went there. You know, we said no bodies of water, no ski, ski hills, no cross streets, you know, things like that. And we actually, you know, we had a lot of internal discussions. There’s, so story a little bit, but one of my partners so Jim Milberry, who you know, well, was the godfather of the PE funcast and and then Devin, he pulled Devin in and they kind of got that whole thing started. But Jim is a boxer. 

    So you know, we were, Jim is I was a professional boxer, I boxed on the amateur level. But you know, we were thrown around things like Dempsey Capital for Jack Dempsey, and lots of different names. But what actually exists in our bones is, you know, we do these personality tests, and actually a lot of us like in aesthetics, of all things, if you can believe that. And Devin, actually, my partner kind of came up with this idea, but it was based in Chicago, and Frank Lloyd Wright, the architect has Chicago roots. And he had a career that was going well, but he kind of saw what he was doing. He wanted to do more of it and do it independently. So he kind of branched off and started his own thing. 

    And we were looking at ways to kind of play off of that. And in Chicago, in the Chicagoland area, there’s a couple houses still even two are ones called the Parker House. And then there’s one called the Gale House. And those names kind of jelled off each other well enough, and ParkerGale.com was available. That’s always important to check before you solidify your name. But we kind of made that our thing. And it was it was a little bit of the attitude, a little bit of the aesthetics, a little bit of the Chicago roots. And all that kind of came together that said, this was something we came up with together, not on the backs of just one name, or one idea and things like that. And it’s kind of stuck with us ever since. So that’s that’s where we came in. That’s how ParkerGale was born.

    Patrick: You know, I think is a great iconic reference because is homage, to your area of Chicago. And also, I mean, I would tell you coming from California here that is the most trendy style of architecture now by state of California in the last maybe seven, eight years. So you went from, you know, the mission style to the Mediterranean style, you know, and and now it’s a Frank Lloyd Wright, which which is there and I would say that the little history note nugget for you on Frank Lloyd Wright is he designed the city hall for the city of San Rafael people outside of California called San Rafael but it’s San Rafael. So it was highlighted in the movie Gatica. So I know you guys like doing a lot of movie references in your thing. So that’s mine, to Jim Milberry is getting that good.

    Ryan: No it’s great. It actually and it paid off. So I’ll expand on the story a little bit. It’s already it’s already paid off. You know, you talk about karma and stuff like that. So I grew up in Iowa. I grew up in Des Moines, Iowa. I was born in Chicago grew up in Iowa, though, and we were looking at we own a company called DealerBuilt now. DealerBuilt  is based based in Mason City, Iowa. Like 10s of 1000s of people not very small town. Okay. My dad had a lake house in Clear Lake which is attached to Mason City. So I’ve been to Mason City. Nobody’s, been amazing city. Well, so I go to visit DealerBuilt, Jim and I drive to DeakerBuilt offices. Turns out the only hotel in town is the last Frank Lloyd Wright standing hotel in the country. So we’re meeting with the founder and the CEO. We breakfast in the restaurant at the last standing Frank Frank Lloyd Wright Hotel in the country. So that was like, we’re just everybody sitting there. Both sides like huh, okay, like this, this is probably supposed to happen. So anyway, it’s fun when things like that come together.

    Patrick: It is really nice how they circle around. Give me a little bit more background with regard to ParkerGale. You’ve got the passion and in capability and skills, and the appetite for technology, you can get a hardware software. Why the lower middle market avenue because you’ve been around for a few years, you haven’t ramped up, tell me about your commitment to the lower middle market and your targets there.

    Ryan: Yeah, it’s just yeah, we like again, it comes back to the convergence of software, which we like and we think that’s a trend that is just a good one, it’s a good space to be involved in. Obviously, the last 12 months has pushed the world to a place where we’re relying more and more on software every day, to do the work that we’re all trying to do. So that existed, you know, we do like getting involved in these, you know, it’s for us, it’s either a founder own situation where there’s a transition, or corporate carve outs, or maybe a consolidation and bringing things together. But for all of those there’s a certain level of business building and scaling and kind of work that needs to be done where there’s products you know, it’s products that matter cultures that last we’re kind of adding process sticks to that as well because we’ve been expanding our our ops team. 

    But we just like that work that we you know, we like we like the space we like companies that are doing well but need resource. And that’s what we bring to the table resource in a perspective. For companies that are succeeding, but to continue to succeed, there’s a certain either level of resource and some perspective that they need to continue on. And we’re looking for the convergence of those things. So we think we’ve built a firm that knows how to find those, how to engage in those conversations the right way, in a way that is received while on the other end. And people feel like, we care. And this is all we do. And this is what we’re looking for, that we have credibility, to get that deal done, we have credibility to make that transition the right way. And that gets into how you do it in the culture that you’re building and how you take care of people and things like that. 

    But then also, like harder skills, perspective about products and how products are built and what customers are looking for, and how you learn from your customers and build that back into the product and all those feedback loops. So we do come into this with an operational bend that we think is fun to engage in and and help and and bring all those things to the table. So and then for us, yeah, we it’s hard to do all that stuff. If you get too big, because there’s, you know, private equity firms, private equity, by its nature is kind of their the incentive is to get bigger and bigger and bigger, because there’s fees and things like that. So there’s kind of a gravitational pull out of this space. And we, because I think we’d a lot of conversations about it in the formation of our firm, are we ever religion to stay where we’re at, within reason, and keep doing just more of this thing better? That makes sense. So yeah, that’s kind of where we’re at why we operate where we do?

    Patrick: Well I appreciate how you fight that temptation to scale up as things get bigger. And I also appreciate the commitment you have to the lower middle market, because quite frankly, if you’re an owner and founder, you’re not doing this, I’m gonna we’ll talk about this over and over again. But they’re not experienced in doing M&A they’re experiencing experience in doing what they do. And when they come to some inflection point, they don’t know where to turn. And unfortunately, what will happen is, if they’re uninformed, they don’t know where to look, then they’re going to default to either a strategic that may not have their best interests at heart, or they’re going to look at an institution, and it’s just brand name, I heard about them, let’s go there. 

    And they will, you know, be underserved. They’ll get overlooked. And I think they’ll get overcharged. And the more that we can highlight organizations like yours, that it not only, you know, know what you’re doing, you can deliver on execution. But you’ve got the passion, you really want to do this. And you’ve had the experience, because I’ve heard this on your podcast, where you’ll have recommendations, you’re dealing with owner owners and founders that built something from nothing, but they did it their way. And that’s that whole learning curve and new experience they have as they bring in outsiders to come and get them to that next level. And you’re so experienced in that.

    Ryan: Yeah, I think and and that is yes, that’s and it’s finding that balance of understanding what got them there. And then Brent, how you how you bring your perspective to the table in that way. But even before that point, I mean, that is a good that you kind of just described why the funcast exists. And if you look at our website, we try to be we try to do a lot of writing. And when it really comes down to is transparency. So yeah, we do think our strategy, our approach to all that was, you know, I think private equity was getting to a point where it was trading, you said it, they haven’t done this before, they don’t understand what it is they don’t understand what they’re getting into, necessarily, because they haven’t been through it before. 

    And some private equity folks, I do think treat that information gap as a competitive advantage. Well, we kind of said, let’s just be transparent. And let’s give everybody the answers to the test. Like just put it out there. The lemons problem, the fact that you understand more than the person you’re selling to and all that like that, just put it out there, explain to them what it means explain to them what it how it’s going to be have, you know, forecast what a tough conversation looks like. Forecast what you’re trying to accomplish, and why. You know, the more people have heard exactly what the deal is, before a decision is made, the faster you can go because there’s no surprises and people know what they’re getting into. 

    So it’s kind of do that lead with our lead with our implied you know, competitive advantage. Just take that off the table. Talk about what we’re going to do and and then you got to be able to back it up and then do that do those things over five or six years and then you know, we’re now you know, we’ve been doing this for a while so then we can refer back to the people that heard it at the beginning. They’ve now been through a full cycle and a success story and say they call them. So that’s that’s kind of been our approach.

    Patrick: All now since you’ve opened ParkerGale. I learned about private equity and mergers and acquisitions. Well, I mean, the number of PE firms has just exploded. We’re we’re an account of north of 4000, private equity firms in the US. Majority of them are targeting middle and lower middle market. And so they’re as, as more competitors come into this space, what I like about a space filling up as it becomes sustainable, because you have to have innovation, and services, quality wise go up, costs go down, things get more efficient, a lot of good benefits come out, you know, for competitive advantage. And ParkerGale is unique in this and that you have made some innovations in focusing years ahead of the competition. I’d like you to talk about this, because in this modern era, now, people are talking about the importance of culture. 

    And they’ve been paying lip service to culture, you know, the last 10 years, but there’s a competitive advantage to it. And so now, people are talking about it more, but it’s still more art than science. And your organization, you’ve spoken about this. I invite you to go and take a look at private equity funcast episodes with you’re actively working to measure culture, and not only identify it, or define it, but measure it. And so why don’t you talk about that, because that’s something that you bring to the table that, you know, everybody’s all into closing a deal. But it’s it’s the it’s the post acquisition, you know, that’s where real magic needs to happen. And so talk about the efforts you have done in the strides you you’ve taken.

    Ryan: Sure, yeah, I think it for us, yeah, it comes down to yeah, it’s taking care of your people, which are really the assets of the company. And, you know, and we’ve we’ve invested in that we, you know, I talked about the the taglines that we come up with, you know, we have, you know, two full time resources basically just focused on the talent practices of our companies and bringing more of those talent practices into our companies. But, yeah, culture is kind of a stew that’s created from a whole list of things that we’re doing that wouldn’t you know, what it comes down to is, you know, within companies communication, you know, consistency, feedback, alignment, you know, all these different things. 

    But yeah, culture specifically, you know, the combination of communication and the consistency and then listening to your organization, I mean, that just comes down to a process that you put in place that goes out into the company on a regular basis, we use a tool called culture IQ, that full disclosure is a portfolio company of ours. So that’s fortuitous, you know, creating this listening organization, that you create a baseline, it basically comes through a survey process, that you go out into the company, and you invite them to respond to a bunch of different attributes and react perspectives and things like that about the company. And that ends up in scores that are baseline metrics for the company and how you’re doing on different parameters. 

    So that might be alignment, that might be communication, that might be innovation, you know, things like that. And you can look at it by team and by a group or manager and things like that direct reports. So if you open up that conversation, and you measure it, you’re listening, and then you look at it, and then usually the best practice for companies is to then look at where you’re strong look at where you want to be stronger. And then they basically commit, create committees to address those things. And a lot of times, we would recommend that the executive team, you know, not even make it it’s not like the CEO is the chair of each committee, you kind of push some of the control of those decisions further down in the organization. You got committees to give some of your star people some authority to work on how do we improve this thing? And what are the actionable insights that would come out of this to increase those scores? 

    And then you do follow up, you know, pulse, checks, from time to time, and you measure it. And our CEOs, actually, it’s kind of fun. Sometimes we’ll put, you know, line graphs of how they’re doing on different attributes, and you show them how they’re doing versus the other leaders of the companies and things like that. And it just turns out that turns out the CEOs tend to be a little competitive. And that’ll get their attention. But then you can ask yourself, Well, why is this one doing this? Why is this one doing this? And you can start to you know, apply pain medicine or things like that to, to each company situation. But yeah, that’s that’s, that is kind of like an overall management, or just measuring tool of the ether that exists in a company, I think. 

    Of all the things that we bring to the table, whether it’s leader, you know, org design or leadership development or manager training, or how you hire, you know, how you onboard all those things are in support of culture as much as the analytical side of measuring culture, I think. So that’s been something that and we’ve been doing this long enough where eventually, you know, I think, through time, then we can actually start to look at some harder data because we haven’t really gone through the exercise yet, but we will have, you look at a p&l and try to Is there any correlation between these improvements and how that performs or this margin or a top line or and things like that. So overall, that’s just kind of been our approach. And the nice thing about that is the intangible that I think is a tangible benefit. 

    But the intangible is that if you are focused on that, you’re actually making those companies a better place to work for the people that are in. So if that’s not, you know, if, as a backdrop, the rest of your career, if all these things that you’re doing to try to generate better returns for your investors, I also happen to make the 40, 60 hours a week that everybody takes away from their family to go spend it a company more enjoyable and better and more fulfilling. Then, you know, I don’t know what’s better than that. If we can kind of converge those two things. So that is a fun and nice thing that we kind of have in the back of our mind. And try to live to is we’re as we’re doing this work in private equity.

    Patrick: And I think with most of the target companies, you’re dealing with owners and founders, how, what percentage maybe, are just looking for an exit? And what percentage are rolling over and saying, hey, I want to I want to see this story play out. So I’m staying I’d like to stay what’s what’s the ratio? 

    Ryan: Yes, it’s it’s across the board, it’s probably seven, I’m going from gut 70. Like 75% are maintaining some participation, and to go forward. Oftentimes, an ongoing advisory board type role. In some instances, there’s either a family situation or just something going on where they want a clean break, and there’s a transition usually do an heir apparent that type of thing. But yeah, when we can, we try to at least maintain relationship and contact in contact with the founder. And that’s probably the split.

    Patrick: I think it’s just another value add that you’re you’re delivering, as it look, owner and founder you’re rolling over, we’re not changing your company, you know, ground wise, we’re gonna sit there and we’re going to watch as the culture, we’re going to maintain it, protect the good stuff, and just see how it evolves. And that’s gotta give them peace of mind. Gives you an advantage over other organizations that may be sitting there saying, oh, we’re the best we’re gonna get you big, you’re gonna make this kind of returning, you know, come on with us because we’re bigger, faster, wider, all that other stuff.

    Ryan: Yeah, we can’t we kind of, we relieve the burden of we caught. Somebody came up with this phrase, the chief worry officer. So there’s a point where you build a business and you’ve kind of done it, you lead the way you lead by example, you’re doing a couple different jobs, you’re now making 10, 15 million in revenue, and it’s profitable. And it’s a good thing, and you feel like you made it you did. But there’s a point where then you start every opportunity you chase feels like a risk to you, you know, every new hire giving up some control, and you start feeling like every of every, then every risk in your mind that you take is yours. 

    Like I’m taking this risk. So that’s the chief worry officer. And we come in and we say, well, let’s, what if you just took that, what if we took that burden on we’ll call it opportunity not risk. And, you know, companies at a point need a hand at their backs and keep going, keep going got to progress. Got to make that hire, make the wrong one, we’ll do it again. You know, that’s, yeah, try to push that train forward. Because if not, there’s somebody else hungry. That was where they were 10 years ago, they’re gonna try to get you know, get back to where you are. And if you’re not pushing that train forward, then then something’s gonna happen. 

    So, so yeah, that’s, that is a dynamic that we kind of sell into and say, hey, you want you wanna just go off into the sunset, we will, you will convince you that you’ve left it in good hands. If you want to maintain involvement. You can put the bag of worries down and ride along and do the stuff you enjoy doing, and have some fun with and not feel like every incremental investment we make is from your pocketbook, you know, that type of thing. So yeah, that’s that is a dynamic that we we often see. And then I think we built our firm well to work with.

    Patrick: I think, I think that that post integration focus that you have here is a real competitive advantage for. Profile wise, give me give me the profile of what your ideal target company is. What are you looking for?

    Ryan: Yeah, I mean, there’s, it’s, it’s kind of, you know, I mean, so software, right, so that’s tons of those that are out there. We’re control investors. So that just means we buy majority only. So that can be 51% in a buy out. Buying out a founder that’s a partial buy can be 80%, it could be 100%. So that’s kind of a buyout. The smaller ones are more but you know, it can be kind of a recap. We can do carve outs from you know, sometimes businesses get embedded in in lost in larger companies. We’ve done carve outs as well. But that’s kind of what we’re looking for. Size wise, you know, 10 to 30 million in revenue, you know, you reference the amount of private equity firms out there. 

    So we’ve started to think through more, hey, should we work with an executive and put a couple things together out of the gate, you know, starting to play play more in that regard and try to create a formidable companies, that might be a couple smaller ones, before they come together. And we’ve kind of built our ops team to be able to support that type of initiative. But anyway, those are the overall parameters for our business they are, they’re probably number in a lot of cash, or at least profitable, they can be loosely profitable. But we don’t want to have a big burn position. They’re nice products that are standing on their own. And there’s a situation where there’s some sort of transition needed transition from a fall founder transition to a CEO, passing it down to an heir apparent. 

    Transition, where somebody wants to step out and somebody else needs to come in. Transition to a carve out that needs a company stood up and needs a lot of resources brought to the table to then have that kind of operating on its own without constraints and doing its own thing. So at the end of the day, that’s what we’re looking for. And then we kind of do our thing with it. And, you know, hopefully have a fun next five or six years.

    Patrick: So and yeah, you’re based in Chicago, but you’re looking at things, opportunities all over the country.

    Ryan: Yeah, really North American. Our headquarters are all currently based in the US. But we do have a lot of satellite offices in either Canada or Europe today. And some effort, you know, there’ll be satellite things that could be overseas and things like that. But yes, really domestically focused for us.

    Patrick: Well, I want to circle around to something you’ve mentioned, where and what’s crazy, we’re talking about the transparency, which is really important to me, because for the longest time, private equity was a members only type of sector and the financial, institutional sections, because if you didn’t know about it, it was really hard to learn if you weren’t in the club, I mean, forget about learning, you couldn’t even reach out to people. And you could, you could demonstrate that by looking at websites and private equity firms where the old days, you couldn’t get any information about team members or anything. Now at least you’ve got not only pictures, but the contact information and stuff like that, which, you know, is a nice development out there. 

    But you also talk about transparency when you’re in negotiations with, you know, these inexperienced M&A counterparts. Yeah, you know, I, I believe that I mean, they’re not, they’re not naive, and, and just not experienced in doing deals, particularly when it’s their own, you know, their own firm, and you can’t remove the human element from M&A is not in a vacuum, there are risks out there. And, you know, you’ve got to lay those out. And there are a lot of times, if you can understand you’re dealing with an inexperienced owner and founder who’s just gone through a very rigorous due diligence process, we will call a thorough, but you know, they go through that process, and then they’re there through that. And then their attorney sits down with them, they have to talk about the indemnification provision, and not everybody explains to them upfront what that is and how it works. 

    But essentially, it’s in to be very simplistic is where the buyer tells the seller, I’ll tell you what, I know, we’ve done this due diligence, but in case we missed anything, and it costs us money, you got to pay that tip. And the response from you know, the very understandable responses. Well, wait a minute, I’m selling the company, you did the diligence, you can’t hold me responsible for something I didn’t know about, particularly years after this happens. And then the experienced buyer is going to have an immediate response is just going to say, yeah, well, I’m betting 10s of millions of dollars, that your memory is perfect. And you’ve told me everything, just not going to do that. And immediately that collaborative environment is at risk of becoming, you know, adversarial and worst case scenario. And the tragedy about that, is that all that can be avoided. 

    And the way you can avoid it is if there’s some risk out there, why don’t we put an insurance policy, the insurance industry came up with a product called reps and warranties insurance, which essentially looks at the diligence the buyer performed over the sellers reps. And for a couple bucks, the insurance company says I’ll tell you what, buyer, if you have if there’s a breach and you lose any money because of the breach, come to us we’ll give you a check. So the buyer has certainty that they can collect seller, two major benefits. Okay, first of all, the policy comes in and is going to replace it some if not all of an escrow. Those are the money that was going to be held back at purchase time, you know, and held for 12 to 18 months. Well now that’s released because you got an insurance policy there. So seller gets more cash at closing. Even better though, they get the peace of mind knowing that they get to keep all their cash because there’s no risk or variable Little risk of a clawback because if something bad happens, buyer goes to the insurance company, not to the seller, and that’s what we call a clean exit. 

    And I would tell you that if it’s done, right, this costs zero to a buyer, because the buyer simply offers this up, you know, this process rather than an escrow or reduced escrow. And the seller 99 times out of 100, in our experience, 99 times out of 100, they’ll go with it, and they’ll embrace it. And that speeds, you know, the process and negotiations, it lowers the temperature in the room, and you will avoid, you know, they may forgive the process, but they’ll never forget that feeling. And you can avoid all that, you know, but I you don’t take my my word for this. Ryan, good, bad or indifferent? What’s been your experience with rep and warranty on your deals?

    Ryan: Yeah, it’s been, you know, it’s a tool, it’s kind of part of the, you know, it’s it’s just part of the process at this point for us, honestly. And I would say overall, in a good way, for sure. It’s, I mean, you described it, well, I’ll kind of just take it from the top and give my perspective on it. Because yeah, I think, so much of the time, and attention and angst, in a negotiation does come through these reps and warranties. And my experience has always, they seem like a big deal. In the negotiation, you know, once you’re in the legal docs, and have spent 60, 70% of your time on them, and money, and worry. And just thinking through hypotheticals, and honestly, in our experience, outside of like, you know, certain taxes or things like that, that come up, they’re not ever really touched again, or used to, like, but at the time, it seemed like a really big deal. very stressful, and just gets a lot of time and attention and all that. 

    So yeah, I do think, you know, I was probably a little skeptical at the start when it came up, because I was a little worried about, you know, seller then not feeling like they have skin in the game or, you know, for what they’re saying or doing and that type of thing. But you know, it’s been around for five, six years now, pretty ubiquitous. And I’ve never had an issue. It’s not, I mean, it’s not something I think a lot about, you know, once the deal’s done, it’s part of our process and things like that, and it does exactly what I think you do. You’re talking about you want to if you want to have a tough conversation, let’s have it be about what’s your role is going to be what’s your compensation going to be? What’s this going to be? What’s that going to be? 

    How are we going to work together going forward, you know, tell us a lot of political capital on a knowledge rep for some mundane, you know, employment law, or exhaustive diligence around that this thing that I didn’t even know what it was until the lawyer explained it to me, and why this three page paragraph, you know, needs to be adhere to having that the risk of that spread across kind of every deal, which gets the cost of these things down pretty meaningfully and take all of that stickiness out of what is the deal, which is a lot of work and angsty and a big, emotional moment for a seller and a big commitment on a buyers part. 

    Yeah, yeah, removing all that, from the conversation, I think has been, you know, a nice enabler for M&A transactions in particular, in my sector of the market, for people that are learning about these things for the first time. 

    So anything you can, you know, it’s kind of like a big release valve on the pressure on a seller for sure. For all that type of thing. So now we have good experience, we use them pretty much pretty much in every deal. And and yeah, why would why should somebody have to let millions of dollars sit still for 12 or 18 months when, you know, is when when you look at I think the history of reps being paid out on the the actual risk is quite low. So that’s, that’s just kind of my general perspective on it’s been positive.

    Patrick: Yeah, I think the great development in why you’re really trying to speak about this from the rooftops is that rep and warranty was not available for deals under $100 million 18 to 20 months ago. And there are so many of these lower middle market deals, I mean, as low as $13 million, $12 million that are now eligible for rep and warranty and that’s a real big deal if you can save somebody a million dollars on a $15, $16 million deal and and the only way the word gets out about that is through the these kinds of conversations. And so I appreciate what you have there. And that’s the next you know, foray for us is not only just getting on the checklist for acquisitions, but for add ons and now it makes sense when not only you’re doing the big you know, platform but then you get the add ons and so that it you know, people don’t know about unless we put it out there. 

    So you know, I appreciate your perspective on this. Now Ryan, as we’re, you know, talking about now we’re getting I mean, we’re blinking it, we’re going to be in the mid part of 2021 where Clearly, I think at the beginning of the end of the pandemic, I probably won’t be eligible for a shot for another four months, the way things are going California, but, you know, give me a perspective on what trends do you see out there for the rest of the year? And this is technology, ParkerGale, what do you see?

    Ryan: Yeah, I think so I’ll start with just kind of the software side of things. Yeah, I think software has been a good place to be. You know, it’s more important than ever, for everybody to do their jobs, you know, at the end of the day, so. So that’s a good thing. And that’s gonna sustain. Now with that, there’s gonna be more competition, more capital, more firms and all that. So it’s a good time to be a seller of a software business, you know, as well. So that’s something that we need to get navigated. But underneath all that, just talking about what, what I think, is interesting, you know, people want data at their fingertips. 

    And that’s kind of right data at the right time. So I think there’s been more, we invest a lot in b2b enterprise software, those are a lot of there’s a lot of data and systems of record, and you have to go find it, things like that. But I do think just thinking about right data, right place, right time, and the efficiency and getting to that whatever it is, you need, you know, even in your even you can tell Microsoft even as Apple, you know, people use email and phone every day, when you see autofills and it guessing about things and stuff like that, like that, that all gets and that’s not easy stuff that’s going into long histories of databases and things like that, kind of bring it into the surface. So that’s that really is kind of an analytic trend.

    Patrick: Real helpful for passwords, though.

    Ryan: No passwords, that’s a whole other topic. Well, I’m gonna stop talking about passwords. Everybody needs to, yes, security is a big thing. Um, but um, that gets also into automation. So, machine learning, and AI is an overused term. But it is becoming much more practically important. I do think and necessary. So loosely speaking, automation, automating tasks, having things just happen in the background, things that happen again, and again, taking the human element out of it, and having a machine do something for you learn and then do it again. Building that into your technology, I think can really help a user and that’ll be all finished up with kind of my lap. But that that theme of a user is a big theme, I think for software as well. Dashboarding. So that’s another way of just saying like bringing to the surface. 

    So having one place to go to just see the things that you care about. That’s something that we’re trying to embed a lot into, into a lot of our software solutions, and things like that. So I think dashboarding is is a big topic around how you present data in an eloquent way. But really what all these things are, there’s a theme here, what it kind of comes down to, I think, is UI and UX. So you know, user interface, user experience, how it looks and feels, and the front end of that is just more and more important. And then so late, that’s where the pandemic really comes in. So, quick aside, my dad’s in his 60s, and he was one of those holdouts that he probably didn’t have his email on his phone until about two years ago, okay, like he fought it tooth and nail. 

    He had a flip phone, all that stuff. Well, he uses zoom now. Okay. So he’s familiar, and usability and that interface. And so it basically did a couple things. One that is becoming more and more important every year as people that are used to phones and how how easy that is to use, get graduated and, you know, leadership positions. At the same time, we just forced people that were less comfortable with technology to get comfortable. So I think there’s like this big convergence of people who care, we’re going to use more technology and care more about usability. So I’m less focused on like new uses of software, but more of the execution of the software that I bring into market and how users experience that software, if that makes sense.

    Patrick: So you’re going there going from can we do it to? How do we make the experience better?

    Ryan: Yeah, how do you do it? And we do like that, because that’s an that gets into an exit. So we don’t need to like recreate the world, or do sciency stuff, we can bring some science elements into it, but it’s really about understanding how that is how they want. It’s not creating new technology. It’s it’s changing the way people interact with it, which is less revolutionary, but it is, I think it is making people’s experience and their lives better and how they interact with that. So those bringing that into older spaces, or more tired spaces are ones that weren’t given attention. Because it’s kind of boring and stuff like that, I think is an interesting trend. 

    For us to go re examine and think about how the companies we own even that’s a big topic is how do we listen to our customers, learn from our customers, not guess what they want, or just let them figure it out? How do we create that feedback loop, filter that into our product owners and our developers and then give that back to them in a better way. I think that’ll be important. So those overall, those are the big trends. We like to space overall. You know, I wish there were less people like me looking at it. But we like where we are. And that’s how we’re kind of playing.

    Patrick: Well, there’s no shortage of opportunities out there, because there’s a lot out there. And there’s, you know, everything is easier. I mean, you see is the website and they were tracking that when you did, you know, ecommerce, and purchasing online and so forth. So yeah, that’s gonna keep evolving. So you know, very, very well done. Ryan Milligan of ParkerGale, our audience members find you. 

    Ryan: Yeah, we try to be easy to find. Yeah, I mean, anybody can send me an email to ryan@ParkerGale.com. Our website is ParkerGale.com. We do have blogs, and we publish on our LinkedIn, you know, our perspectives and thoughts and things like that. So we try to be open to receive people however they want to reach out. Don’t be a stranger. We tried it, we say, you know, karma, like we try to just be I’ll take any conversation, we try to be as helpful as we can to as many people as we can. Because we all view ourselves as having at least 20-30 year careers left and something I do today, might pay off in 15 years. So if we can be helpful down the road, even if it’s not, you, we’ll get introduced to somebody that helps us get introduced to somebody and that’ll be cool for us too. So happy to help, happy to listen, happy to engage and reach out anytime.

    Patrick: If anybody wanted to go in an anonymous low profile insight to really get a feel for this organization, its members, its culture and everything. Highly recommend Private Equity Funcast and is everywhere that the podcasts are available, but highly recommended great stuff. There’s no shortage.

    Ryan: Yeah, it’s on Apple, and Google Play and you know, all that stuff. And yeah, there’s a fun one going on right now. It’s that date this but the there’s a March Madness, business books edition, where our ops team are all debating the best business books and people can engage with that. So yeah, check us out. We try not to take ourselves too seriously and have some fun from time to time as well.

    Patrick: Fantastic. Well, Ryan, thanks again for joining us and best of luck to you guys the rest of the year.

    Ryan: Thank you. You know, I appreciate you being a listener and engaging with us. So best of luck to you.

  • Representations and Warranty Insurance Post-Pandemic Trends for 2021 and 2022, Part 1
    POSTED 6.8.21 M&A

    As vaccines roll out and COVID-related restrictions are lifted across the country, it’s time to look at the impact the pandemic has had on the use of Representations & Warranty (R&W) insurance to cover M&A deals… and what to expect in the near term.

    R&W insurance, of course, transfers all the indemnity risk to a third-party – the insurer. If there are any breaches of reps and warranties post-closing, the policyholder, usually the Buyer, simply files a claim and gets paid damages.

    The use of this specialized type of coverage had been steadily growing and becoming more widespread pre-pandemic. Even lower middle market deals were being covered.

    Just as M&A deal-making contracted, there was a reduction in the number of R&W policies being written in the first three quarters of 2020. But by the fourth quarter, it had rebounded and even surpassed 2019 levels. That trend continued into the first quarter of 2021.

    In fact, according to the BMS Group’s Private Equity, M&A and Tax 2021 Report:

    “As the initial challenges of operating amidst a lockdown were managed, deal volume rebounded strongly in Q3 and Q4 was the busiest quarter ever in the M&A insurance market. As we go to press, early indications are that M&A activity has levelled up somewhat but nonetheless we expect 2021 to be a record year for M&A insurance.”

    Thanks to a rush to get back to deal-making, as well as the previous pre-pandemic growth, I expect a rising trend to continue as more dealmakers – both Buyers and Sellers – realize the value of this coverage. I forecast that this rebound will continue into 2022.

    That doesn’t mean there won’t be key changes.

    First thing to mention – especially if you have been hesitant to use R&W insurance – you should know that it’s well established and popular.

    The BMS Group report highlighted that:

    • 90% of those who use it are either very satisfied or somewhat satisfied with their coverage.
    • More than 2/3 have a favorable opinion of how claims are paid.
    • 78% of respondents had used this type of insurance six or more times.
    • Four out of 5 PE firms use R&W coverage on a majority of their deals.

    Key Trends in R&W Insurance to Watch

    The pandemic is going to impact how R&W policies are written, cost, and other factors. But some of this would have happened anyway – without COVID – simply due to the increasing popularity of this coverage.

    The COVID Impact Is Limited

    While it’s still early to make a final judgement, it appears COVID hasn’t had a catastrophic impact on the R&W market.

    As it states in the BMS Group report: “Despite the increase in claims frequency and severity, premium pricing has remained relatively low whereas it has hardened across other lines of insurance.”

    Going forward, COVID will have zero impact because it’s “known.” R&W insurance covers the unknown. Underwriters won’t necessarily issue blanket exclusions for COVID-related issues, but they will take it into consideration.

    Limits on the Rise

    Another trend to watch for: Expect buyers of R&W insurance policies to buy more limits. In the last couple of years, Buyers have been securing policies at 5% to 10% of transaction value, which is largely to just cover the escrow. Problem is if you have a $100M deal and a $10M policy, what happens if you have an $18M loss?

    The eight million over the R&W policy is uninsured.

    As a result, Buyers are seeking to transfer more risk. So, look for them to buy more Policy limits, or select “hybrid” Excess Policy Limits only or Fundamental Reps (the cost of which are a fraction of the R&W pricing). Because there’s no remedy for anything uninsured, as the Seller is off the hook.

    In the event there is a breach, and the amount of loss is significantly higher than the amount covered by R&W insurance, Buyers are beginning to make claims of fraud or misrepresentation against the Seller… because they know the Seller has a D&O policy.

    If there is a loss that exceeds the R&W policy, Buyers are looking to recoup some costs through the Seller’s D&O policy. So it’s no surprise there has been an increase in fraud lawsuits.

    D&O policies don’t pay for fraud. However, that exclusion only happens if fraud has been proven in court. The defendant has to admit they knew of fraud in court, or there must be a final judicial finding that fraud existed.

    Up until then, the insurance company pays defense costs. If they settle, which is often the most cost-effective option, the insurance company pays the settlement. As part of the settlement, Sellers don’t have to admit fraud was committed.

    This is why Sellers are being required to secure a D&O tail policy (if they don’t already have D&O in place) – Buyers should insist on it – and why they also need a R&W policy.

    Costs Are Going Up

    As more R&W policies are purchased, the cost will go up.

    The rate will go from high 2% to mid 3%. And it’s already beginning to happen. On a minimum premium deal like I do, it’s already at 3%. A $5M policy is $150,000 to $175,000. But on a $20M limit policy it’s going to be at $600,000 whereas last year it was closer to $500,000.

    PE Firms

    There was a serious contraction of M&A activity in 2020 and the early part of 2021 – no surprise there. PE firms were holding back – not willing to commit their money. Plus, it’s a natural result of meetings moving online, workplaces going virtual, and the like. Many industries slowed down over the last year and lost productivity.

    But now, PE firms, who’ve been sitting on all this cash for a year or more, are ready to start deal-making again. They – and their investors – are looking to start adding value to their portfolios again and rebuilding their balance sheets.

    Since PE firms are so committed to R&W insurance, there was a natural dip in policies being written that mirrored the drop in M&A activity. But R&W has returned.

    SPACs

    Special purpose acquisition companies (SPACs) will also have a hand in this growth in R&W policies being written in the next year or more. There are more than 400 SPACs that must complete an acquisition by 2023 – at the farthest out. That’s deadline pressure.

    SPACs mostly target middle market companies – those $100M or more. As these so-called “blank check companies” start doing deals again, expect to see a spike in R&W policies written.

    The one purpose of a SPAC is to acquire or merge with an existing company – it makes going public easier, quicker, and cheaper than a traditional IPO. And R&W coverage is perfect for these deals because even in the best of times, SPAC founders face tremendous pressure to get deals done within a two-year window. Because R&W insurance hedges risk for both Buyer and Seller it facilitates fast mergers and acquisitions.

    Insurers Scramble for Qualified Underwriters

    A natural side effect of the increasing use of R&W insurance over the last few years is that insurers are seriously understaffed with experienced Underwriters compared to demand for their services.

    There are only so many Underwriters out there with the “know how” to underwrite M&A transactions. And as more insurance companies have entered the growing market, we’ve actually seen them “poach” underwriting teams from other insurers.

    Pressure on Underwriters

    R&W insurance is a complex line of coverage. Even if Underwriters outsource due diligence to an outside law firm, they are seriously stretched for time due to the sheer volume of policies being requested.

    Many policies are being delayed – even declined – due to an insurer’s lack of bandwidth.

    What does this mean for Buyers and Sellers?

    You can’t expect Underwriters to turnaround a policy to cover your deal in a week or even a couple of weeks. Insurtech has not reached the R&W world yet. Although it was possible in the past, waiting until the week before closing to begin the R&W process is as prudent as waiting until April 14th to call your CPA for tax assistance.

    If you’re interested in having this coverage for your deal, you need to start the Underwriting process at least four weeks out so there are no surprises. Don’t come in last minute and expect miracles. Underwriters are people too.

    You can’t push them to the brink without losing relationships. A good Underwriter wants to be your partner; they want to do it right and be as timely as possible. So, start the process sooner rather than later.

    A note of caution: Some insurers advertise faster processing, but they are prone to delays. Best case scenario – you’ll find an insurer to cover your deal on schedule but at exorbitant costs (2-3X the normal underwriting fee) that result in extra expense.

    What Underwriters Are Watching For

    The ideal situation for an Underwriter is to put as few limitations as possible on deal. Their objective is to have as few exclusions as possible because exclusions create friction. But they still need a sustainable product. They must protect the insurance company they work for.

    As a result, we’ll see Underwriters exercising more caution on wide open worded Reps. For example, if there is a Rep with the following wording “will continue to be” or “will continue” – which means post-closing – the Underwriter will read that out as if the wording doesn’t exist.

    In this market dynamic, Underwriters are also watching out for the definition of “damages”. They don’t want to explicitly cover multiplied or consequential damages, which are very problematic.

    But they have been known to strike a balance with policyholders. If, in the agreement the definition of damages is “silent” with regard to multiplied or consequential damages, the proposed policy will match the agreement with the intent that while the policy is not specifically covering consequential or multiplied damages, such damages are not specifically excluded either. This enables the parties to consider such damages in the event of a claim.

    It’s essential for the insurance broker to make clear with the Underwriter that silent doesn’t mean excluded. In other words, if it’s not there it doesn’t mean it’s excluded, it means it’s agreed.

    Where to Go From Here

    As with many things, COVID has had an impact on M&A and the specialized type of insurance that covers these deals: Representations and Warranty. Yet, I expect the true value of this coverage to shine through, and for its popularity and widespread use to not just continue, but to grow and expand.

    Here’s how they put it in the BMS Group report:

    “We remain optimistic about the outlook for M&A insurance and expect it to continue to play a vital role in M&A, especially given how ingrained it has become in the deal process and the part it plays in unlocking both capital and negotiations which have reached an impasse on M&A transactions.”

    In light of these trends, I wanted to offer you a free download of some best practices to consider going forward when it comes to incorporating Representations and Warranty insurance in your next M&A transaction.

    You can download it here.

    If you have a deal coming up or one closing between now and the end of the year, and are open to having a conversation on how R&W can work for your particular deal, you can contact me Patrick Stroth, at pstroth@rubiconins.com.

  • Todd Dauphinais | The Key to Setting Your Firm Apart
    POSTED 6.1.21 M&A Masters Podcast

    On this week’s episode of the M&A Masters Podcast, we sit down with Todd Dauphinais, Founding Principal and Managing Partner of Clavis Capital Partners in Dallas. Clavis Capital Partners realized that there was a better model and approach to private equity, and set out to create an investment firm focused on operations, the longer term, and on deploying capital in the most flexible and effective manner possible – the independent sponsor model. 

    We chat with Todd about what inspired him to build Clavis, and where the name Clavis even came from, as well as:

    • The successful effects of the independent sponsor model
    • The importance of strategy for growing businesses 
    • Building a company culture that sets you apart
    • How the rapid advancement of technology can be used for market benefit
    • Rep and warranty policies 
    • 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 Todd Dauphinais, Founding Principal and Managing Partner of Clavis Capital Partners. Based in Dallas, Clavis Capital Partners recognized that there was a better model and approach to private equity, and set out to build a different kind of investment firm. One that was more focused on the operations, on the longer term, and on deploying capital in the most flexible and effective manner possible. And that model would be the independent sponsor model. So, Todd, it’s going to be great to talk to you about this. I’m very excited. Thanks for joining me today.

    Todd Dauphinais: Yeah, thanks, Patrick. I really appreciate it. Thanks for having me on today.

    Patrick: Yeah, before we get into Clavis Capital Partners, let’s give our audience a little bit of context for you. How did you get to this point in your career?

    Todd: Oh, it’s a great question. Thanks for asking that, Patrick. So I started Clavis, eight years ago, I was 43 years old at the time. Up until that point, in my career, I’d spent most of my career in operations, I had been the CEO of a midsize manufacturing firm for a number of years, I had done the kind of the big corporate thing I’d worked for Schneider Electric, which is a European based industrial company. I ran a number of their business units in their M&A team for a while. And I started out my career at Deloitte Consulting, doing strategy and operations consulting. And you know, as I look back, all of that experience, that operations and strategy and even the consulting experience really, is beneficial to what I do today. 

    And when I started Clavis, eight years ago, I like most things, you know, I was looking for, I wanted to take my operational experience and apply it to more more of an investing type model I talked to, and frankly, when I was interviewing with a number of PE firms, and I was looking for that firm that had more than operational background, and then operational bent that that had that was similar to my background. And I really, I couldn’t find it, I mean, I kept running into the same type of person over and over again. And in groups that were really, the backgrounds were much more financial services, financial engineering, investment banking backgrounds. And so you know, I remember the time actually, I was I was at the office of a good friend of mine, and was bemoaning the fact that I couldn’t quite find the job that I was looking for. 

    And he’s the one that finally kind of said, well, then go create it yourself. And so I guess the short story is, I couldn’t find the job that I was looking for. So I had to, I had to invent it. Unfortunately, it didn’t pay well at the time. But, you know, I really had a vision at the time to start a group that was staffed by and lead by operational and strategic people, and really had a vision at that time to create this, and it takes a lot longer than you ever think it will. But, you know, fast forward now our team is all operating and strategic professionals. And you know, we’ve been successful thus far. So I guess it worked out. But in the early days, you never know if that’s if that’s gonna work or not.

    Patrick: Yeah, I was. That is what happens when you get to be our age, and you blink, and all of a sudden five years goes by so you slog it through and blink, and you know, it all be behind you. So that’ll be great. Yeah, that brings it Yeah. And that brings us to Clavis Capital. And obviously, you didn’t name name, the organization Dauphinais Capital, because yeah, you’re more creativity than us insurance, folks and the lawyers out there. So give us a story. Because that’s nice insight into the culture of the firm. You know, how did you come up with the name Clavis Capital?

    Todd: Yeah, no it is a it is a good. It’s a funny story. Um, so the story is that we had rented a house in Sun Valley, Idaho many years ago, my wife was seven and a half months pregnant, and I had a two and a half year old. And on a Sunday night, I took my family out to dinner and came back to the house and this was before Airbnb, and before any of that. I’d rented it from a friend of mine who had a rental service and, and as I get back on Sunday night, I realize I’ve locked myself out of the house. It is, it is locked up tight as a drum and I tried to find a way in the house, I can’t get in the house, and it’s later it’s getting late on Sunday. 

    And I was standing on the back porch, and I’m kind of looking down and just really ticked off at myself for doing this because I couldn’t blame anyone, I couldn’t blame my two and a half year old. And as I’m looking down, I happen to glance over in a flowerbed and in the flowerbed it, I picked up a glint of a metallic object in there. And so I reached down and lo and behold, there’s a key, it’s the, it’s the backup key, and it had been there for a long time. And so and it got us in the house. And and that key is always been significant to me. And there’s a lot you could, you know, there’s all kinds of different things, you could you could read into that, but I kept that key. 

    And so when I started my firm, I wanted to, I wanted to do something that that that involve that key. Well, clavis is Latin for key. Yeah. And, you know, everything key was not only generic, but all of the URLs were taken. And so I had to go to Latin to find, to find an available URL and something like that, that sort of sounded neat. And so that’s that really is the the story behind the name. And it, it really like you mentioned, it, it, it’s part of our culture, and it’s in culture is a big thing for us both in our firm, my firm and, and the companies we invest in, we pay a lot of attention to culture. And so that’s a, that’s a cool little story that we can tell to people, it has some meaning and it obviously, is very meaningful to us.

    Patrick: Yeah, I think that’s fantastic. And there’s a key is iconic for a lot of different different areas, and so forth. And you talk about culture, and there are a lot of people that they pay lip service to culture, but it is a real strength is something you got to focus on, particularly for the type of organization you are, because let’s face it, in the investment world, right now, you’ve got over 4000 private equity firms out there, and more coming every time. Add to that family offices. And then, you know, there are 1000s, I don’t know, it’s very fragmented the sector, but you’ve got independent sponsorship sponsors out there, too. 

    And you have to distinguish yourself from all the others out there. And and culture is a great way because it comes from the heart, you can’t fake it. And so, you know, you and I talked earlier, you mentioned that you made, you know, your website is as you recognize as a better model out there, but you intentionally went the independent sponsor route, and you’ve not outgrown into a fund. So let’s talk about that as a model, what it does for you what it enables you to do for your investments, and how that’s been successful.

    Todd: Yeah, in your right to bring up there, there’s a lot of there’s a lot of competition in this market. And it’s, it is really difficult to, certainly to differentiate yourself or to get that message out. And, and to get people to understand that the and there’s no barrier to entry to being an independent sponsor. That’s the thing that’s most frustrating to me in a lot of ways is there’s there’s no you know, anybody can hang their shingle up and, and just call themselves that, that term. And so I even struggle with a little bit of the what to call ourselves, we don’t call ourselves generally, PE, because we’re not a fund, nor do I have any interest whatsoever in raising a fund. And there’s some specific reasons for that. But what I do for a living, what really gets me jazzed in what gets me out of bed in the morning is not deploying capital, per se, it’s building businesses. 

    That’s where the operational background comes in. What me and the other members of my team are really good at and really, really like, is building businesses. And so the second you raise institutional fund, you are now in the asset deployment business. And your job now is to get that that those dollars out the door, the people who do that for a living, they’re great people, and they they have a lot of fun doing what they’re doing. But they spend their day differently than how I spend my day. I spend my day really working on with our leadership teams and our portfolio companies developing long term strategy, developing, you know, the the plans and the operational plans to really grow those businesses. 

    And so we spend a lot more of our time doing those operational and strategic things. If I have a fun, that’s not what I get to do on a day to day basis. I’m managing LPs. I’m raising money on deploying that capital and it causes you to do some things that you might not want to do. There are pros and cons to both models, no doubt but what gets me really excited is being able to spend dedicated time on our portfolio companies and working with the leadership teams, and sort of being that that right hand person to the CEO of our portfolio companies. So I get, I get the best job really, in my opinion, I have the best job in the world and get to be sort of Kwazii CEO and strategy guy. But without the day to day headaches that I used to have when I was running my own my own company.

    Patrick: You summarize that really well, where you say, look, the day you open up a fund, you become, you know, you move away from what you love doing, which is being company builder, and you go from company builder, to financial engineer, nothing wrong, but there are some people that love the engineering, there are other people that really love rolling up their sleeves. And, and doing that, I would think that would appeal to owners and founders looking at, you know, they’re at an inflection point, they want to move to the next level. And, you know, they want somebody who’s going to actually be with them side by side, and, and work with them. And I think under this model, there’s no dilution of your attention.

    Todd: Yeah, that’s right. And it does, it appeals to the person who is really looking for a partner, not just looking to sell their business to the highest bidder. And there are both types out there, and they’re there, they’re fine. But we are very selective in the types of things that we get involved in for a number of reasons. Number one, we can’t do a whole lot of deals, at the same time, we can only concentrate on so many deals. And that’s really how I want it. I mean, that allows me to get deeply involved in my team to get deeply involved in each individual deal. We also can’t afford to get any one of them wrong. In a fund structure, you know, you may invest in 10, 15 companies in a fund and you know that two or three or four of them are just not gonna go well, they’re gonna go bad, I can’t afford that I every single deal that we get involved in is its own deal. 

    And, and so I can’t afford to get it wrong. So we spend a lot of time really evaluating our opportunities. And that’s where you mentioned earlier culture, that’s where culture comes into this. And it’s not just lip service, because the you can tell a lot about how successful and investments going to be based on the company culture that the leadership of that company has built. And if you go into a place and they’ve got really great culture, you can feel it, it’s it’s not something that’s easy to see, necessarily, but you can feel it, those investments will do nine times out of 10 or 10 times out of 10, those those investments are going to do just fine because they’ve been built right from the ground up. Because the the leadership have focused on building that culture.

    Patrick: I’m curious when you talk about culture now. I mean, it’s one of those you can see it or you can feel it immediately. It doesn’t have to be translated, I mean. Is it that easy? Did you are you able to tune to recognize that real quick? 

    Todd: Yeah, we’ve gotten better at it. But yeah, you you can tell, you can tell. And there’s a couple things that are that are a little bit telltale, when you when you go to even before you go visit, you can usually get some sense of the culture. It’s amazing, you know, just what you can tell by going out to the internet and seeing, you know, how does the website present and what’s you know, what, what is that? Does that talk about culture? You know, we’ve we’ve seen, we’ve, we’ve gotten really intrigued with some companies where there were YouTube videos that the CEO had put out there that talked about culture, you know, if you can, a lot of times even before going out there, you can tell a little bit. 

    Then definitely when you go out on site, and you meet with the leadership team, and you meet with the management, how they talk, how they talk about their company, you can always tell what’s the level of pride in the company, both how they talk, how does the how does the business present. If you walk around the plant, in our case, we do a lot of manufacturing stuff and the plants really clean and people are wearing the logo and stuff that tells you a lot about the pride of the people that the people have in the firm and the culture that they have. If you go there and nobody talks about the employees and it’s a dark and you know really, really

    Patrick: Gritty.

    Todd: Gritty place. Usually that kind of tells you a little bit as well. So it’s more art than science. But if you’ve got a little bit of a trained eye to it and you’re looking if you’re looking for it you can you can see.

    Patrick: Yeah, why now and we know not to focus on numbers or anything but you’re usually going from majority interest and then you prefer having the the owner founder remain with you or are how many others deals happen where the owner just wants an exit?

    Todd: You know, in in every case that we’ve actually done the deal, the owner has stayed with the business. But having said that, because of our operational background, it doesn’t scare us to have situations where an owner might be looking for an for an exit, not only a financial exit, but but you know, he’s looking to retire or to step back or whatever. I tell owners all the time, I’d rather know what your intentions are, I can work around those. And we’ve had a situation we’ve had two situations in our portfolio where the owner wanted to stick around for a transition period a year or two. 

    And they wanted to retire. And, and we were fine with that. And, and we, in both cases, honored that that wish and worked with the owner to find the right leader for that business after the owner stepped away. And we’re not scared of that at all. But in most cases, we’re looking for somebody who’s looking for a partner. And if if they’re looking for a partner, then they’re usually not looking to just sell 100% and go sit on the beach, because that’s, that’s, that that doesn’t work with our model very well.

    Patrick: Gotcha. And, and your focus is on the industrial sector, which before I started this podcast, being quite admittedly, based in Silicon Valley, our view of manufacturing is pretty much limited to the tech sector sector, where you’ve got clean rooms and all these spotless, little germ free environments and everything. And, you know, you’re in that nice, gritty, you know, sector there where the where the real work happens. And I’m surprised to see how, you know, manufacturing and industrials are actually thriving right now. So, you know, you gotta share with me, why did you pick that sector? Is it just your background? Or, you know, other reasons? 

    Todd: Yeah, it’s it’s, a lot of it came from my background to start with, it’s something that I know a little bit about having having run manufacturing businesses before. So I, you know, I was trained in LEAN manufacturing, and six sigma, all of those fancy words that came out of the 80s, 90s and 2000s. But really, our focus is in industrial and manufacturing, not as much because we know something about it. But we really believe in that sector. And in particular, the Renaissance that we believe is, is kind of happening in this country in manufacturing, some people call it manufacturing 4.0, or whatever you want to call it. But we have a specific thesis about what is going on in manufacturing. And what we’re seeing in the reshoring of manufacturing back to the US the kind of undoing of what happened over the last 30 years, when manufacturing, when supply chains got very disaggregated and and placed globally. 

    And that worked for a long time. What we’re seeing now is the market has evolved such that speed to market, rapid prototyping, mass customization, all of these things that are now trends in the market. And it really starts with the consumer, the consumer has gotten really used to having something delivered custom made instantaneously to their door, you can’t do that if you’re manufacturing everything in China. So we and then throw on top of that the world has just gotten a lot more complex and complicated. And you throw in, you know, trade wars and things like that. China, Asia in particular has gotten a lot less interesting and a lot less advantageous. It’s a lot that China has gotten more costly over the last decade or two. And so we’re seeing a lot of people come back reshoring but the manufacturing that is coming back is looks a lot different than the manufacturing they left. 

    And this is where it looks a lot more like your Silicon Valley and your tech oriented businesses then it certainly did in the you know, industrial age when you were talking big plants and and a lot of people there’s a lot of technology now involved in producing goods and prototyping goods and speed the market. There’s a lot more high tech stuff that is is is being invested in and put into ground here in the United States. And so even though, you know, our orientation is manufacturing and industrial, that doesn’t mean that we don’t pay a lot of attention to the technology and the the very rapid advancement of technology that’s occurring in our space. And, and that’s really where we like to invest. We’re looking to invest in more tech enabled manufacturing, and you’re seeing that across the board, it’s it’s really an exciting place to be right now.

    Patrick: Now with and with your, your targets, your investments, you’re usually the first institutional capital coming.

    Todd: Yep.

    Patrick: Okay. So a unique aspects to what you’re doing as an independent sponsor, you had mentioned, you can’t get these these deals wrong, you don’t have that margin for error as you’re going forward. And in mergers and acquisitions, there are a couple things that happen, you touched on with culture is, you know, you cannot remove the human element. This isn’t, you know, Company A and Company B, you know, coming together. This is one group of people agreeing to partner with another group of people. And so, you know, you’ve got that human element. And a lot of times what happens, and I imagine this happens every time in your case is that you have, you’re on one side of the table and you’re an experienced buyer, and your counterparty, the seller is inexperienced. 

    It’s not that they’re naive, they just don’t do this all the time. As they go through the process, you know, particularly when you’re going through diligence, which you’ve got to be thorough, because you can’t afford to miss. They’re not used to that. And then following that process, okay, they come through the diligence, then you sit down, you’re, you know, bringing out the purchase and sale agreement. And then there’s this indemnification clause, and what the seller hears who’s not experienced when when their lawyers reading the indemnification clause, they hear buyer saying to them, okay, I know we just went through this invasive diligence process, but just in case we the buyer missed anything. And that miss leaves us suffering financially, we’re gonna hold you to pay us for any losses we have. It’s just, you know, if we couldn’t find something, we don’t want to be out of pocket with a lemon. So, you know, that’s just part of the business is standard procedure will have an escrow and you’re all set, probably nothing’s there. 

    So don’t worry about it. And for seller that’s not used to hearing that they their response is. Wait a minute, I told you everything. You can’t hold me responsible for something I didn’t know about. Experienced buyers as well, yeah, but I’m making a bet of 10s of millions of dollars, that your memory is perfect. This, this happens in all the deals, it’s just part of the process. And right there, you’ve taken a collaborative situation, and all sudden, there’s this potential for distrust to come in stress, fear of the unknown. And, you know, it’s a real challenging thing, and sometimes derails deals. And the tragedy is that that whole process can can be avoided. And the way that happens is now the insurance industry in the last several years came through with an insurance policy, it’s called reps and warranties, it essentially takes the reps that the seller outlined, that the buyer vetted with due diligence, and the insurance industry simply says like, buyer, if if there’s a breach of at least a financial loss, come to us don’t go to the seller come to us. 

    Buyer has certainty of collection, they avoid the very, you know, tentious part of probably having to clawback money from the seller. And so they’re taking care of. Seller gets a clean exit. A policy attachment point is lower than most escrows. So they don’t have as much money held back in escrow. So they have more cash at closing. Better yet, they get peace of mind. Because if there is a loss, you know, they don’t have to pay it, they’re not going to lose any of their money. And so it just seems to smooth the process over. And the beautiful thing for us is in concept, this was great. But in practice, it wasn’t very useful because rep and warranty was reserved for deals at $100 million transaction value and up. They had very strict eligibility standards. You had to have audited financials, a battery of third party diligence reports and everything. And so it just wasn’t feasible for the smaller deals. 

    Competition has come into the insurance market since the pandemic. And now eligibility for rep and warranty has now fallen to deals as low as 10 to $12 million. And you don’t need audited financials now to qualify. And so that’s the purpose of our conversation with a lot of people out there is to make them aware that this thing that used to not be available is now available for the lower middle market where I really believe it makes a huge impact. Because if you can save somebody a million bucks or 2 million that’s that’s huge. You know, but don’t take my word for it, you know, Todd good, bad or indifferent. What experience have you had with rep and warranty?

    Todd: Yeah, now you it’s a great point, Patrick. The biggest thing for me is it removes a potentially contentious item out of the process at a critical time in the in the process. And you described it well that you know, you get through a due diligence process and now you got this. This this additional thing and to a to a seller who doesn’t do this for living, you know, that feels very bad faith. Yeah, bad faith or whatever. And so the rep and warranty product, kind of smooths that over quite a bit. And, and so we have utilized rep and warranty insurance in pretty much every deal that we’ve done for the last two, maybe three years, I believe. 

    And it does, it does smooth that over. The statistics I’ve seen is it’s that that part of the insurance market has really exploded because it’s for exactly the reason it’s, it’s good for all, you know, both parties involved in the process. And as an M&A professional, I want as little friction in the processes as I can get. And that’s that’s, that’s great. It’s gonna be interesting to me to see, I’ve seen a lot of statistics about the the implementation of rep and warranty policies. I haven’t seen a lot of statistics around the claims against those policies, and how often those policies or those claims get, get paid out. 

    Luckily, we haven’t had any any issues with with with any of our policies and you know, knock on wood, hopefully that is that that remains, that remains the case, that’s not something I want to be an expert in. So it’s a great product, it’s something that just makes the deal process work a lot better on our part. And, you know, I think it’s, it’s something that has been a real boon, actually, to the to the to the insurance carriers who develop this, and it’s become a lot more competitive. In the early days, there were two carriers that were that were that were that had 90% of the market. Now, you got a lot of other options there, which is good for competition.

    Patrick: Yeah, I think it helps because the more carriers are out there, there’s just more variety, where a couple carriers will will specifically target an industry or transaction size, and treat it more favorably, they’re just more familiar, they’re more comfortable with it. And then I would say on the claims side, so far, we haven’t heard anything industry wide reports are coming on, you know what the impact of COVID has been on rep and warranty policies. By and large, though, less than, you know, 10% of the policies out there, maybe 15 to 20% of the policies incur a breach reported, hasn’t been paid, but they just notify the carrier that actually paying this is very small as a very profitable line of coverage. 

    Even with consultation, we only they will see that because the demand is getting bigger, I would just say for 2021, we could probably see insurance carriers, maybe raising their retentions a little and maybe bringing the pricing up just by a little like a point or two, just because the demand is so high. Not because of losses. Which is a nice signal that is going to be sustainable. So we’re very, very happy with that. And now we’re able to do not only platform deals, but add ons. And so I think that’s just the more out there that we can be available, the better the better for everybody. Todd with, you know, where we are right now with, hopefully we’re at the beginning of the end of the pandemic. Now, as we move forward, and people are beginning to move out and get out and do site visits and everything like that. What trends do you see for the rest of the year into 2022? Either industrial, Clavis Capital? What do you see out there?

    Todd: Yeah, the market is is extremely competitive, and I think will remain so. There’s so much capital that’s out there, chasing deals, you know, in a lot of ways, COVID took a lot of what would otherwise be transactable companies off the market for whatever, you know, people were busy dealing with, with COVID related things, certainly industries that were heavily impacted. But it didn’t change the amount of capital chasing those deals. And so we’re seeing all kinds of just perverse behavior in the market, we’re seeing people that have come that traditionally would be more upper middle to large cap buyers come in to come down into the middle market, and even in the lower middle market space, it’s gotten a lot more competitive. 

    And I don’t see that changing. I really don’t the I think that’s going to be with us for a long period of time. The debt markets still remain very, very liquid. And so I you know, I and I don’t see a big correction to that coming anytime soon. So it’s gonna, it’s going to remain very difficult. It’s going to remain a seller’s market. And, you know, I think that’s going to be with us for quite some time. I think the industrial space will continue to be a good space to be in, but I think, you know, a lot of spaces are going to be good spaces to be in.

    Patrick: Yeah, don’t see any shrinkage in the industrial sector, particularly with logistics. So many people don’t realize how to get a good, you know, product from point A to point Point B. And as you said, that’s evolving as we speak now. And there’s plenty of room out there for that kind of stuff.

    Todd: Yeah, absolutely.

    Patrick: Do you think, one of the things I wanted to ask you. Do you think because of COVID, there are a number of companies that may have been out on the market and they they, you know, pull their pulled their chips off the table, they pulled their horns in, and then weathered the storm. And they may want to wait to get 12 months of performance post pandemic, on the books to kind of show where they are to improve their status before they go back out?

    Todd: Yeah, absolutely. We’re, what we’re seeing, and also hearing anecdotally in the market is that the second and third quarter of this year, you know, we talked to a lot of financial advisors and investment bankers and people that represent sellers. And what they’re telling us is towards the end of q2, and into q3 this year, there’s going to be a lot that comes on the market, because you’re going to have gotten that q1 and q2, really q2 of 2020, off the off the trailing 12. And I think that that will continue into q3, and q4 and even into 2022. And so I think you’re gonna see a lot of that, as people have recovered, that you’re gonna just see. 

    And you know, if you think about it, if you have a, a business owner, that’s call it, that’s in their, in their late 50s, early 60s, they’ve now been through three major financial disruptions in their, in their career between, you know, this, and 2008. And even even going back to bite off. At some point people go, you know, what, I don’t want to go through another one of those major disruptions and so and you’ve got baby boomers that are retiring, and the transfer of wealth, the generational wealth transfer, a lot of those in family owned companies is going to happen. It’s just going to the next, I think through the remainder of my career, honestly, is going to remain a heightened amount of activity, both on the on the supply of deals and on the demand for deals out there.

    Patrick: Man I hope you’re right. I really hope you’re right. Todd Dauhpinais with Clavis Capital, really appreciate having you here today. How can our audience members find you?

    Todd: Yeah, um, so a couple different ways. Our website is, is claviscp.com. So www.claviscp c l a v i s. C as in Charlie P is in partners.com. And then on there is all of our contact information, my phone number, my cell number is on there and email address. So that’s probably the easiest way to get us. And we would love to hear from anybody out there that certainly that that is looking to transact. But even somebody that’s looking for, you know, some advice and counsel on what to do we take those phone calls as well.

    Patrick: I think I think that’s a great value to people out there is, you know, there may not be a deal happening right tomorrow. But, you know, having those initial conversations goes a long way. So I really do appreciate you offering that out to the community. Todd Dauphinais, thank you very much. Really appreciate you. We’re going to talk again soon.

    Todd: That sounds good. Thanks, Patrick. Appreciate it.