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Alan Clark | Why This Major 2023 Prediction is Wrong
POSTED 1.18.23 M&A, Podcast

When your small business owner client is in a room full of MBAs, they can feel out of their depths…

So how do you keep your client’s emotions in check during a high-stakes sale?

Alan Clark is here to share his perspective as a sell-side advisor helping clients exit their businesses.
Alan also reveals why he thinks a common 2023 M&A prediction is wrong—and weighs in on a new sell-side reps & warranties product.

Mentioned in this episode:
● https://www.hatterasgroup.com
● https://www.linkedin.com/in/alaneclark/

Transcript

Patrick Stroth: Hello there. I’m Patrick Stroth, trusted authority in executive and transactional liability and founder of Rubicon M&A Insurance Services, now a proud member of the Liberty Company Insurance Broker Network. Welcome to M&A Masters where I speak with 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 Alan Clark, Founder and Managing Partner of the Hatteras Group. Based in North Carolina, the Hatteras Group is a collaborative team of M&A advisors, professional intermediaries, leading business owners and entrepreneurs as they navigate the complex and often emotional process of selling or buying a business and we’re gonna get into emotions today here. Alan it’s great to have you. Thanks for joining me today.

Alan Clark: I appreciate you having me, Patrick. I’m looking forward to this.

Patrick: Yeah, now before we get in into Hatteras Group, let’s talk about you. What brought you to this point in your career?

Alan: Well, it all started selling goat’s milk and goat manure when I was probably 10 or 12 years old. So that was the start of my entrepreneurial career. But yeah, so honestly, that’s how I got started as an entrepreneur. I wound up going to college and got an engineering degree, but found my way right back to entrepreneurship by buying a small business in Atlanta probably 30 years ago. And then, about 20, it’s 24 years because that’s how my daughter, my oldest daughter is, she was born and I needed to change jobs.

I was traveling, I had started a business, in the adhesive business with a partner. So I was traveling, my wife was traveling, we had a daughter, so I needed to be home more. So I sold my half of the business to my partner on an earn out and that gave me a little, a little cash flow to get into dealmaking. So I went to work for a Sunbelt business broker firm in Atlanta, Georgia. I started doing selling ice cream stores and candy shops, and just over the years kind of worked my way up the food chain, teaching myself to business and doing a little bit larger deals a little more complicated deals.

And so now we do, it’s all business to business. You know, we don’t do retail, there’s things we don’t do. We’re what do you call industry agnostic? Which I, I could, I could argue there’s some benefit to that as an advisor. But yeah, so now we do deals that range from probably two to $22 million in in transaction size. Some smaller, some a little bit larger, but it tends to be the market that’s too small for the investment banker, but probably too large or maybe a little too complicated. Not a typical business broker sort of deal.

Patrick: Is that outside the realm of like the SBA lending and things like that?

Alan: No, that’s right. That’s in our sweet spot. I mean, SBA loans go up to like $5 million now. So yeah,

Patrick: So let’s move on to how to Hatteras Group. Okay. Before you tell us about that, how’d you come up with the name because you didn’t name it Clark.

Alan: No, I’d never did appreciate just that, that was a little too easy, you know, Clark Advisors, or Clark, Brokers, or whatever that might be. You know, and I like to think I had greater aspirations. But to be honest, when I had pets and things I lived in Georgia, but my roots were in

North Carolina. So I would name my pets and such to some North Carolina connection. And so I just kind of thought about places that I had been and visited or lived. And I go to Ocracoke Island, which is on the Outer Banks of North Carolina every year, but that’s a tongue twister, very unique, but a little too hard to say.

And then so I just started thinking about that and Hatteras, Hatteras lighthouse and Cape Hatteras is a, you know, it’s a well-known spot in North Carolina. And then the lighthouse kind of gave some symbol symbolism of direction and lost in the fog. Every now and then I come up with all kinds of, you know, analogies to being lost in the fog and giving you some direction. And that’s why I’m here.

Patrick: And bringing people into a safe harbor. So I think that’s well done. You’ve been doing this for over, over 20 years, you haven’t gone up market, you found a nice little niche between the really tiny and the lower middle market, you know, to mid-market. Talk about that, why haven’t you expanded any larger and get into your commitment to this section of the of the industry.

Alan: I really think I’ll be honest, Patrick, I think it’s that’s the group of people, the group of business owners that need the most help. And it’s, it’s a little bit of, you know, could I make maybe more on a transaction if I went to $100 million deal, you know, maybe but I’m not the Harvard MBA. I’m your blue collar, past business owner, current business owner, I have two other companies outside of this. So I kind of, that’s the people I relate to, that’s the people who I feel like we can provide the most value to.

So, you know, it’s we can provide investment banker like services with 80%, or better of investment banker resources to the group that the investment banker can afford to pick up their pen, you know, what I’m saying? So, you know, instead of $100,000, check, we might have a 10, you know, 5, 10, $20,000 retainer, you know, built in. Our fee structure, you know, we have limited overhead, we’re essentially a virtual company, with five advisors working together now. And so that’s just what fits us better.

Patrick: And you’ve got all the experience.

Alan: Not trying to be something we’re not. We’re just, we’re transparent. Like I said, nobody in our group, actually, the guy I just brought on he has an MBA, so I got, I can’t use that tagline anymore.

Patrick: Okay. Well, that’s, well, I think this is this is ideal, and why I really appreciate you having you in the Hatteras Group here, because there are a lot of owners and founders that they’ve got to that point of inflection where they’re too big to be small, but they’re too small to be enterprise. They are just outside the realm of the business broker, or it’s a stretch for the business broker, although a lot of them are very professional, but it’s a little stretch on that side. And as you said, the investment bankers, if they were to come down, they’re going to overcharge and probably underserve them for no other reason, then they’re geared more for larger deals.

So this is great to have a solution that you can deliver. And I appreciate you being here. And we’re going to make sure we amplify Hatteras Group for this really large swath of people that are in need and have wonderful resources and can afford to benefit from what you deliver. And let’s talk about what you deliver. You’ve got the experience and you talk about how you’re, you know, shepherding people through not only the technical and logistical but the emotional part. What does the Hatteras Group bring to the table for your clients?

Alan: Well, so the bulk of the work we do is sell-side engagements. We offer, you know, we can

help people secure debt and equity funding, we can work on buy-side engagements and do exclusive proprietary searches on the buy side, but 90% of what we do, and we I feel like we do our best work when we’re engaged by an owner and take that business to market. So again, we’re using a process that looks like an investment banker, more than a business broker.

You know, in addition to putting it into the online classified ads, quote, unquote, you know, of businesses for sale, we’re also going to research for potential strategic buyers, potential add ons to portfolio companies, private equity firms. So in the end, about half the deals we do are with a new owner operators filling the role, and other half are with other existing companies or private equity-backed companies.

Patrick: Yeah, so you’re going to find where the thing I mean, that’s very helpful, is you have kind of the network and you know, actually who the good players are, and who are the ones that just want to kick the tires.

Alan: Yeah, and we really, so our initial contact with an owner is generally your real close to the person, you’re going to wind up leading the transaction to the end. I might be an initial point of contact, but then I’m going to bring in as we pitch an engagement to an owner, and go take that business to market, we’re gonna have one of my other advisors be the lead on that project. And then essentially, I back everybody up. So I’m familiar with all the projects, occasionally, we’ll get two advisors working on something for different reasons. You know, just bringing everybody strength to the table and doing the best work we can for a client.

Patrick: I can’t tell you one of the biggest skills that you have to have service wise is just have to be responsive, even if nothing is happening. And as you get more team members involved with a project, then you got responsiveness because that’s absolutely key.

Alan: Yeah. And communication is key. I think we’re translators, in a lot of ways. I was talking to somebody else today explaining, you know, you bring a blue collar business owner who’s built a great business. They’re at the table with, in a room with half a dozen MBAs from some private equity group. Those guys don’t necessarily speak the same language. And so we’re there to help make sure they understand each other.

Patrick: Well, there’s a dynamic there too. And if we could talk about this, because you and I, we didn’t do this in the pre show, but you know, there’s a human dynamic with that because you’ll have the blue collar professional and the owner operator and then a roomful of credentialed MBAs. And there’s almost like an intimidation factor there.

Alan: Absolutely.

Patrick: And there’s also a situation where the seller, they’re not naive or simple, they’re just inexperienced in the transaction process. And so you’ve got a very inexperienced person on one side who’d probably get it, but they’re on one side of the table and the other side of the table are very experienced people, and it’s really, it’s not their business at risk, as opposed to that. So could you give us some insight on the emotional side.

Alan: I think that’s, that’s a lot of the, that’s the big chunk of the value we bring to the table, you know, when they’re throwing out, you know, a 20-page due diligence list, you know, and the initial, you know, this business owner, he’s never seen anything like that. He hasn’t, he doesn’t understand why they need so much information.

So we have to coach them through that, educate them on that process, explain what’s, you know, customary, what’s not customary, you know, it’s our job to vet those buyers and bring the best possible fits to the table. But yeah, and it can be very emotional, because you’re a

business owner, you’re usually leading a group, you’re not, you’re not used to being vulnerable, and, and really opening up your kimono, so to speak, and let everybody see what’s in there

Patrick: And tell you what’s wrong with it.

Alan: Yeah, and tell you what’s wrong with it. So you got to keep help them keep their ego in check. And just keep those emotions in check. It is an emotional process, you know, most business owners we talked to, you know, especially in the early part of the process, they talk about taking care of their people as much as taking care of their money, right? Take care of, you know, we only want to sell it, if somebody’s gonna keep them here, keep them employed, take care of my people treat them well.

And so even that we have to help educate on the front end. It’s a preconceived notion that companies buy other companies to fire people and reorganize them. And so we have to educate the owners that the reason somebody is buying your business is probably because of your people. 99% is that because you’ve organized a great group of people that produce a great product and service and generates cash flow, and that’s why they want to buy it. So we don’t, you don’t want to let your employees know, because you don’t want to create a period of uncertainty in the three to six months that you’re trying to put a deal together.

And so sometimes we have to walk business owners through that, because they’re been so accustomed to being totally transparent. And they feel like they’re not being honest with their employees, and we have to educate them say, no, you’re looking out for him, just like a parent looking out for their kids. You don’t you know, you give them the information they need, and don’t create uncertainty without, you know, it being necessary.

Patrick: No, I, you hit the nail on the head. And I mean, particularly in the technology sector, you’re bringing over dev teams and coding teams, and all those folks and in this environment it’s even more critical, because you’ve got a lot of the kids that are doing that early retirement or great resignation. A lot of people that don’t want to go into work. And so those organizations that have teams that are in house, those are like gold.

And you got to do everything you can to protect them when you’re the buyer, because the last thing you need to do is once you get, grab that great team is all of a sudden have to start replacing people and they’re not prepared to do that, necessarily. And so that comes in. One of the questions I had about with this with your clients, the owners of founders, what percentage of them are exiting? And what percentage are rolling over and bringing the whole management team with them?

Alan: That’s a good question, Patrick. I’d say my gut would say 80% are selling to exit. Maybe, maybe upwards of 90. And I do think that the playbook to sell a business when your pre-retirement, you know, 10 years before retirement, I think that’s a great play to make. If you have a nice business, and you want to take some chips off the table. I pitch this to a lot of owners. The truth is, the majority of owners do not plan to sell their business. They do not plan for a proper exit. And they’re calling me or they’re responding to my phone call or email when they’re totally fed up and ready to get out.

So when I’d say hey, would you like another five or 10 years and a shot of turning a chunk of your business 20, 30% of it into a bigger pot of money? No, I just want out of it. My wife has been on my butt for, I’m not going fishing enough. She wants to stay at the beach more, you know, they’ve built a nice life. So you know, that’s, I see that quite a bit. But we do have, you know, if we do, and we’re not we’re not a high volume shop.

So we’re going to do five or 10 deals, you know, maybe 12 deals in a year between, has been

four of us. You know, maybe one or two of those are situations where they’re doing that roll back. One of the ones we have right now, eight plus million dollar deal. They’ve agreed to take 20% back, roll that back across and reinvest, and I think it’s gonna be a great, great outcome for them.

Patrick: Okay, great. Well, one of the things that’s facilitating a lot of these transactions, because we’re at an all time high in the last couple of years, is that the insurance industry came in and found a way to transfer a great large amount of the risk in M&A away from the parties and over to a third party, an insurance company. And that’s in the identification section where in the event, the seller disclosures or the seller reps are inaccurate, and they slip through the buyer’s diligence, and then post closing those incorrect reps cost the buyer money, then the buyer has a chance to either absorb the escrow that they held out there, or they clawback proceeds from the seller.

And that possibility can create a great amount of tension. I can imagine, you know, when you’re with your client that comes up at the latter part of the negotiations where they’re kind of there, they see the end there. And then also you have the identification conversation. What’s great is there’s a product called reps and warranties insurance, which for the buyer can go ahead and step in the shoes of the seller.

And in the event the buyer suffers a financial loss as a result of the breach, buyer rather than pursuing seller, goes up and just goes to the insurance policy. There is now a new program out there for deals that are even smaller than the traditional buy-side rep. But, you know, before I get into too much, you know, Alan good, bad or indifferent, what experience have you guys had with rep and warranty insurance?

Alan: No, I appreciate that. I think we talked about that before, we’ve had not a lot of experience with that type of insurance. I think it’s like, just like we’re trying to bring investment banker like services to the lower end of the market. You’re bringing that insurance product down to that lower end of the market. And you’ve been a great resource to educate me on some of these things. So I don’t think we’ve, in my experience, we’ve not had a deal blow up yet because of it.

But it has been, those are contentious times when you’re negotiating those reps and warrants and I can absolutely see it tearing a deal up. So I’m glad to have that in my quiver now as another tool. And I imagine it won’t be long before we will bring that to the table and be using that to make sure a deal closes or closes a little more smooth.

Patrick: What we’re referencing to is a new product. It’s a sell-side policy as opposed to a traditional buy-side rep and warranty policy. Under a sell-side policy the seller not the buyer is the policyholder. The policy is triggered when the seller receives a demand notice from the buyer advising there’s been a breach, it’s cost this much, pay us. And so what the seller does is simply takes that demand letter or email, sends it up to their insurance carrier. The insurance carrier contacts the buyer and they negotiate a settlement and get it taken care of. So then the seller’s funds aren’t at risk, the seller gets that clean exit.

What’s been great about this is is a policy that is built specifically for deals that are priced between $1,000,000 and $30,000,000 in enterprise value. That’s the blind spot for the buy side rep and warranty. They prefer doing the much larger deals which will require extensive diligence and extensive expenses. The sell-side policy is priced at 15 to $20,000 per million dollars in coverage. So it doesn’t matter the size of the deal, it’s just how much insurance you’re going to buy. Okay. Unlike a buy-side policy, which has an underwriting fee that’s paid upfront, which is between 40 and $50,000, sell-side policy has no fee, okay.

They rely on an insurance application just like 99% of every other insurance policy out there.

And when you consider the savings and costs, the ability to provide protection for the seller, that lowers the temperature in the room. All of a sudden, now these potentially contentious negotiations go away. And for the buyer, they have you know, the peace of mind that look, there’s a pot of money from an insurance company that they can collect so they don’t have to pursue the seller for clawback, number one. And number two, in most cases, it’s free to the buyer.

Alan: That’s right. Under the right circumstances, Patrick, that sounds like a no brainer to me.

Patrick: That’s how we like to think about it.

Alan: And each industry has different risk profiles and risk issues. And so in certain industries, it’s gonna make more sense than others. But yeah, definitely keeping our eyes out for that.

Patrick: So we’re built in for that. But it’s one of the things that by, you know, speaking to you and other professionals in the lower middle market, a lot of people did not know this product existed. And up until a year ago, it didn’t. But we’re pleased to have it out here. And it’s been one that quite frankly, even if the buyer wanted to get rep and warranty insurance and, you know, cooperate with their counterparty.

A lot of times they just can’t, you know, get over the cost or the eligibility requirements because there’s extensive due diligence, third-party diligence that the buy side policies require. And it’s just, it just isn’t affordable. So this is a real elegant solution for both of those. So we’re very pleased to get out there and be around the movers and shakers like Hatteras Group, and talk about that.

Alan: And those policies are they, I’m sure they have caps, they have buckets with caps or overall caps and that sort of thing.

Patrick: We can we can set it, we can ensure all the way up to the full purchase price, up to $20 million. We can do up to $30 million deal, but the maximum we can write right now is a $20 million dollar limit. And there is no deductible to the buyer for this. So if there’s a seller buyer deductible or basket within the agreement, that’s fine. This policy is intended to sit on top of them.

And so as we move forward, where we see it happening quite often are aware in technology deals, where IP reps, the buyer wants us to be fundamental, we would insure the IP reps up to the purchase price, up to $20 million. And that’s a source of comfort, because a lot of sellers usually, they usually only have a million dollar policy that will protect them. So this would sit above that.

Alan: Yeah. Wow.

Patrick: Well, I mean, let’s talk about that for going forward, Alan. We’re wrapping up the year, we’re looking at 2023. And you and I spoke earlier, you’ve got a nice flurry of deals at the end of the year, which is great. What trends do you see next year?

Alan: Trends that I see. I mean, I’ve seen it for a long time, I don’t think it’s anything new. But overall, just this, I call it the Walmart effect that every industry is consolidating, you can no longer be a small inefficient business. You have to be, you can be small, but you have to be highly efficient managing your cost, whether you’re a manufacturer or service provider. But almost every industry has, you know, movements to consolidate.

Whether it’s just into holding companies that still create some value in back office and things to

really make an acquisitions in lawn care or digital marketing or whatever it might be that they integrate those companies, you know. But I call that the Walmart effect. I’ve seen that for years, you don’t have small mom-and-pop machine shops and things anymore. And I think my in my head, it’s, I’ll tell you something that is going to, it’s against the grain. Everybody loves to talk about this silver tsunami, all these businesses that are getting ready to come to market because there are baby boomers own us.

That’s a total farce. Okay. My theory, my theory is that as many as 80% of those businesses are zombie businesses. That they have business owners that have paid the debts off, created lifestyle businesses, have not managed them over the last five to 10 years to grow. They’ve managed them to not create more risk, and they’re just they’re zombie companies that most buyers would not buy. So I’m gonna be a contrarian in that, and that’s, I’ll throw that out there. What do you think of that theory, Patrick?

Patrick: You just gave us our tagline. This has going to be clicking like crazy. We’re going to be sitting there, the zombie business, phenomenon. Great.

Alan: For search funders that think they’re getting into this pool, with a ton of great looking fish to catch, and they’ve got the perfect bait, they’re going to catch a bunch of zombies. They’re going to catch a bunch of suckers and things they’re going to throw back. So the world, a lot of those folks never changed.

They never caught up, they got a smartphone, but then they never really integrated new technology, new processes, new ideas in their business. So they have a little machine shop or they’ve got some service company that is just outdated and their cost structure is not in line with the rest of the industry. And nobody’s going to buy it.

Patrick: Alan, how can our audience members find you?

Alan: Yeah, I think I’m pretty easy to find. Basically, go to our website, it’s hatterasgroup.com. Hatteras is maybe hard to spell h a t t e r a s group.com. There’s a lighthouse off the coast of North Carolina, look it up, you can visit. And I’m actually in the opposite side of the state. So I get that lots of times. Folks think I’m thinking about sitting fishing in the beach, but I’m actually in the foothills of North Carolina. Excellent.

Patrick: Excellent, well let’s see if we can get a couple of couple more folks coming your way. But you guys have a great benefit you’re bringing in and I think that’s wonderful when my guests are just bringing tremendous value and we can highlight you. So Alan, really appreciate you. Thank you for the show today.

Alan: Thanks, Patrick. Appreciate you having me.