On this week’s episode of M&A Masters, we speak with Skip Maner.
Skip is a General Partner of NewSpring Capital and founder of the firm’s dedicated buyout strategy, NewSpring Holdings, and was recently featured in Mergers & Acquisitions Magazine.
For over 20 years, NewSpring Capital has been seizing compelling opportunities and offering a fresh approach to building businesses in the lower middle market. There’s a lot more to them than meets the eye and we have just the right person to walk us through it, so listen and discover:
Patrick Stroth: Hello there, I’m Patrick Stroth, trusted authority on executive and transactional liability, and 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 Skip Maner, general partner of NewSpring Capital. Based in Pennsylvania, NewSpring Capital for 20 years, has partnered with high performing lower middle market companies and dynamic industries to catalyze new growth, and seize compelling opportunities. Recently featured in Mergers and Acquisitions magazine, Skip is the founder of NewSpring’s dedicated buyout strategy NewSpring Holdings. And so then there, you’re going to find there’s going to be a lot more to NewSpring than meets the eye. And we have just the person to walk us through this. So Skip, thanks for joining me today.
Skip Maner: Thanks, Patrick. Happy to be here. Thanks for having me.
Patrick: Now, before we dive into all things, new spring, let’s give our audience a little bit of context. And we’ll start with you. What led you to this point in your career?
Skip: Well, it’s I guess, I’ve been in private equity for about 26 years now. So it’s been quite a ride. And I guess I think I started when I started my private equity journey when I was in college, when I started two companies. I wasn’t I wasn’t the Elon Musk of the time, but it was enough money to pay for beer and a couple of books, maybe. But, uh, you know, after I graduated from college, I started two additional companies. And I really think, again, that’s where I started in private equity, because I’ve always, you know, really, I think, taken a highly operational approach to the companies that I’ve ultimately invested in, in my, in my career. I was 23 years old, when the bank called me and told me, I wasn’t making payroll. And I had to figure it out. So I’ve sat on that, that entrepreneurial, and that founder side of the table. I went back to business school after selling two of the companies.
And, and really, part of the reason I went back to business school was to, you know, you know, small business owner oftentimes feels like the world, you know, the world revolves around them. And it really, it was far from the truth. And there were things happening in the macro environment that I really wanted to understand. And so graduated from Wharton in 95. And got into private equity, really in the in the mid 90s. So I’ve seen a lot of the the cycle and a lot of the maturation of the industry. I think when I graduated from Wharton, you know, probably less than 10, 5% of us went into private equity. You know, that’s probably closer to 25-30% now. So it’s, you know, it’s been, it’s been a great ride, again, seeing many, many cycles, and, you know, thankfully around to talk about the cycles.
Patrick: Well, contrary to its name, okay, NewSpring I mentioned in the intro is not new to private equity, you’re one of the rare firms out there that been around now for two decades. So, as we get in, we talk about NewSpring, let’s kind of open it up with I always like finding out, you know, the culture of a company or the insight, if you figure out, you know, how they came up with their name, specifically, because it’s not named Maner Capital. So we’ll start with the name. Tell me about NewSpring.
Skip: Yeah, well, I think it’s all about, you know, we’re all about growth, and we’re all about formation. And I think, you know, just the combination of really that, you know, ideas springing forth. And, and, and, you know, and surrounding them with, you know, with this idea of how to take companies to the next level. NewSpring seemed like an appropriate name, I can’t take credit for it. Some of my partners and predecessors yeah, could have been, again, I think the the culture around again, we focus on the lower middle market, and again, so that could be companies in our definition, between 10 and 100 million in size. Those are even at 100 million. It’s still very small companies in the whole scheme of the world. And I think that the notion of NewSpring really helps. We want to take a fresh approach to, you know, the company building experience.
Patrick: Right, and it sounds like you’re on the beginning of a cycle, you’re not at the end of a cycle. So, you know, you’ve got that emphasis and as being, you know, experienced at 20 years ago, is really impressive, but 20 years in this space, you’re not doing just one thing, NewSpring is a series of a number of silos. Let’s talk about those for a moment.
Skip: Yeah, and it’s look, it’s it’s a fun story to talk about because again, the longevity of the firm, you know, again, I can’t take credit for it is really really Impressive. So, you know, when I guess I’m you know, proud to be a part of it. We just invested our $2 billion over that 20, 22 years that we’ve been involved in 184 companies. And what’s really interesting, and this is, you know, talks a little bit about the maturation of private equity, it took us 17 years to invest the first billion. And then it took us five years to invest the next billion. And we do that through we have five investment strategies, again, each focus on a different segment of what a lower middle market company might need.
So I’ll get to my my segment last, but we have a growth strategy that invests in software and tech enabled services companies. They just closed their their fifth fund, and they do minority capital, minority equity capital, onto the balance sheet of companies that really need a last round of capital to get them to profitability. They’re averaging, I think company investments such as maybe 20 million in revenues. Our health care fund, which they’re closing their third fund right now, is focused on again, similar growth stage companies with tech enabled services companies all around the healthcare space, especially pharma, and niche clinical providers. And then we have a mezzanine fund. Our mezzanine fund is closing their fourth fund, and that is focused on subordinated debt, and really supporting other private equity sponsors into buyout transactions. And then we recently founded what we call NewSpring Franchise.
NewSpring Franchise is a group started to really buy into compelling and interesting franchise and multi unit businesses, consumer oriented businesses. And then what I run is what we call NewSpring Holdings. NewSpring Holdings is is our buyout function that we started in 2015. And what we do is, do control buyouts into founder and family run businesses. We really like to find companies that have, you know, been on a journey for, you know, five to 20 years, but, you know, may have a transition issue or a desire to grow to the next level, and want a partner to do so. So again, it’s with those those five strategies that we kind of look at the lower end of the market. And, again, it’s a nice broad horizontal approach, where really, you know, a lot of the you know, the need that a middle market company might have a lower middle market company might have, you know, we can solve in this building.
Patrick: Well, that’s something because, and I’ve got a real soft spot for the lower middle market, particularly because you’ve got owners and founders that started with nothing and created tremendous value where like I said, nothing existed before. And they don’t know how to get past that inflection point, there’s some their content to stay where they are, but there are others are wanting, you know, the they either, you know, by just their success, they’re a victim of their success. So they either get to the inflection point by becoming, you know, they’re too small for enterprise, but they’re too big to be small. And they, they need some outside force, outside assistance to help them. And if there aren’t, you know, experienced owners that have gone through that process multiple times.
They don’t know where to turn. And but you know, and if they don’t know anybody, they get by default, they go to an institution or a brand name, or something is out there. And they really are left short. And what happens is, unfortunately, they’re they’re underserved. But they’re overcharged. And that’s why it’s helpful to have firms like NewSpring out there that are really committed to this segment. Talk to me about the issue where you’ve been around again, I keep hammering on this, but you’ve been around for over 20 years, and you did not scale upstream in terms of deal size. Why is that?
Skip: Well, you know, I think it’s because we love the opportunity at the lower middle market. I mean, again, you have, that’s where most of the companies are, and if you look at where, you know, where we are in, you know, in the in the cycle, you know, the oldest baby boomer right now is 75 years old. And we’re in the midst of what’s going to be as the baby boomers age, you know, the largest transfer of wealth in the history of the world. That’s something like $10 trillion is tied up in, you know, family run businesses. And you know, we want to be we wanted to be a part of that. So that’s why NewSpring chose to stay and keep our fund sizes small, so that we could continue to to really be experts and build a preeminent firm that focuses on these lower middle market companies. And you’re right that you know, the needs or the needs are very different.
You know, I Patrick, you hit the nail on the head, which you know, when you we find a business owner that’s, you know, as a $40 million business and they’re making $5 million in EBITDA a year, you know, and and they had their, they’re at a point of inflection and what in order to grow the business, they may have to take the EBITDA backwards or you know, go on a hiring spree or do things they haven’t done like go international. What we’ve done is build our firm to serve all those needs. And really what, you know, it starts with being able to apply a different risk profile. An owner, all their eggs are in one basket. And when we do a transit transaction with an owner, you know, we’ll go in and we’ll say, look, we’re going to provide you with a with an ample amount of liquidity today.
So you can diversify your wealth. But then we’ll ask the owner to, to roll in 20 to 40% of the of the ongoing transaction. And, you know, frankly, as an owner, that’s like having a, you know, a, you know, somebody manage your wealth for you. But it’s just in your private equity asset, because what we’re going to do is apply our approach and what we’ve done at NewSpring Holdings is really build this go to market strategy, where we’ve surrounded us, ourselves and our eco sphere with very senior executives who have built businesses. Again, we’re not former investment bankers we’re former operators. My partner, one of my partners, ran a two and a half billion dollar business that he built organically and through 100 acquisitions over over a 30 year career.
And we’ve surrounded that team were of functional operating experts where we can go in and if we get involved, these are experts that help, you know, take a company and position it then for different organic means that we might bring to the table or a significant amount of M&A. We’ve done we have four companies in our in my portfolio today, we’ve done close to 30 acquisitions in the last five years into those four companies. And we really think you can create an exponential outcome by by doing both organic and acquisitive tactics.
Patrick: I think it’s just a competitive advantage that I hear you have one of the questions I asked was, you know, what do you bring to the table. But I think, clearly, this operational approach and grow through operation is a huge advantage over other firms or investors out there that are more financially guided. And I think that by doing this, I can’t imagine just putting myself in the in the shoes of an owner. I want to grow, I want to change, I want to do this, but I don’t want to bet the company on it. And there’s no margin for error. And so you not only need the expertise from somebody outside, and that cares and wants to partner with you, but you want to be able to diversify, you know your wealth so that you aren’t betting your entire future on a change that you need to do anyway. And so I think it makes it a lot easier.
Skip: Yeah, we call it we call it a different lens of ownership. Again, you know, it’s an owner is gonna make a certain decision that we would all make a rational decision, you know, if they own 100% of one. And, you know, this really allows you to expand and put a different lens of ownership on. Again, we’re, you know, we’re not an ATM, you know, money isn’t free. But again, if an owner is able to diversify their wealth, they could make different decisions. And then then again, by sitting next to us, you’ve got the former CEO of $3 billion company, you’ve got, you know, we’re gonna put board members on the company that are industry experts here. And on our, on our boards today, we have the former CIO of Comcast and the former chairman of NASDAQ, and other really preeminent individuals that are going to be the industry guides. And then we’ve got the functional guides that can fill in holes, if there’s holes at the companies. Or that can be strategic advisors to those companies as they embark on what is, you know, what is a new kind of op tempo and a new kind of way of looking at the business.
Patrick: The other advantage I see for private equity over strategics, and other you know, M&A investors out there is that you mentioned this with the role of equity is the opting for a second bite at the apple for owners and founders, which I think is great, where they go ahead and agree to, you know, a hold on to a 30% minority stake in their company. And that 30% in five years could be worth more than the 70% that that they that they got to closing originally. And I think that’s a formula for success. How could anybody turn away from that?
Skip: Well, and I can promise you that we work every day to make sure that happens, because that’s the way that we’re going to make money. And, you know, look at the example is this that if you know, the four companies we own today, the aggregated revenues, when we got involved in them were about $50 million dollars. Today, they’re over 700 million in revenues, and about, you know, close to 60 million of EBITDA. So, you know, those owners and the stake that they’ve rolled in and retained is you know, is benefiting from that. And for me, you know, losing sleep every night over how we’re going to make them all successful.
Patrick: And of course we put it in a disclaimer right now that past performance is not an indication of future results and all that good stuff. I mean, you’re seeing this, because you’ve got a lot of, you know, very smart people. And they’re all committed, which, which I really appreciate too and then part of the passion with the lower middle market, is that trust, that you’re all kind of pulling in the same direction. And that’s outstanding. As great as all this sounds, I’m sure, you know, some listeners are sitting there saying, how do we get in on this. Give us a a profile of your ideal target. What is NewSpring Holdings looking for?
Skip: Yeah, so again, this is the NewSpring Holding segment of NewSpring, but we look for companies, let’s say between 10 and 15 million in revenues. What we do is like to get started with, again, it’s a term everybody uses with a platform, and what we will have done prior to that is really, you know, try to take a deep look at an industry where we believe there’s a decent amount of fragmentation, the companies that we target are all profitable. And because we do use a small amount of debt, you know, in all of our transactions, you know, we’ll come in, again, when we get involved, we buy a majority stake, give an owner a nice payday today, but let us, you know, move into the driver’s seat with that owner as a partner, that, you know, we can create the best outcome together.
And so then what we’ll do is, we’ll we’ll launch into a, you know, a program where we, again, if we got involved with, we think there’s a lot of fragmentation, and then we will try to aggressively not only work the 100 day plan, where we’re putting the organic growth tactics in place, but then, you know, do a significant amount of M&A around that. And so, you know, really, it’s, it’s an owner is who would want to get involved with us. It’s an owner, that’s saying to themselves, my gosh, I know, there’s something better out there, but I don’t want to do it, as we talked about. I don’t want to take that risk, but it’s its owner like that, it’s an owner, that they may have, you know, may not have a way to you know, trans transition the business may not be like, you know, stated succession plan. And so, you know, those are places that we can, you know, that we find that we can, you know, really, really maximize.
Patrick: Gotcha. with and in terms of industry, because you got a healthcare group, and you’ve got the franchising. Industries, geographies, any kind of limitations or anything?
Skip: Yeah, primarily US based. And then, you know, we tend to look at the world through a horizontal view. And that means we look for tech enabled services companies. And so we look for a type of company. And that puts us in different vertical markets. In our four companies today, we’re in FinTech, government services, last mile logistics, commerce, etc. And, and then cloud. So again, different vertical markets, but you know, the types of dynamics, we find that our companies really pervade the vertical market. Again, what we’re usually find when we go into a company is that they, they haven’t, they don’t have a big salesforce.
They haven’t focused on marketing. The finance organization is usually used as a way to, you know, how much cash they have in the bank and and how much their taxes are. And so what we try to do is turn each one of those functional groups into a strategic weapon, and really help position for growth, that again, when we deliver the company, you know, to the to the next level, it’s, you know, we’ve scaled it, we’ve de risked it because a lot of times companies have customer concentration or supplier concentration or owner concentration. So what we would have done is diversified all that and that that should mean that we deliver to more than the middle market, that a company that is significantly less risk attached to it.
Patrick: Well and I would think on the exit side for this, you know, the firms out there are getting bigger and bigger and you’ve got SPACs, and so they’re all these bigger entities that are buyers out there for your lower middle market that when they’re ready to graduate, there’s there’s a whole you know, very eager marketplace looking looking to make the acquisitions. You, you sparked the thought that I had, tell me about a an epiphany that you witnessed with one of your portfolio companies where you mentioned the 100 days where you come in, you do the analysis and you’ve got the game plan and you have laid out a plan of action. And tell me a time where in that in those early months, you just saw that owner and founder all of a sudden see the light bulb come on, say, I never thought I could pull this off. Anything like that?
Skip: Yeah, look, it’s and this is why I love what I do. Because we really think that we create fundamental value where, again, there’s a lot of ways to make money and, you know, financial engineering, and in levering companies up and cutting costs, that may be one way. The way we make money is through growth. And so it’s really fun. Again, a lot of the companies we get involved with, you know, I’ve not I’ve not been in growth mode, again, for the reasons we’ve talked about. And so, I think one of the most fun things is when we come in, and, you know, again, I’ve heard this many, many times, you know, from from founders, well, we tried to hire a sales force, I had a sales manager, you know, I went through three of them in two years, and it just wasn’t working out. So we just gave up.
Patrick: That’s painful, yes. Those are painful comments.
Skip: And, and so you know, it’s, it’s really hard to grow a company unless you, you know, again, turn sales into, you know, a real function with real strong people. And so I think one of the most fun things is, is to, again, you know, we have, we have the experts here to, you know, to start to bring in and build that sales function. And it starts with better defining the customers better defining who, you know, you don’t want to do business with as well as who you do want to do business with, because again, a lot of things we find are, you know, again, any revenue is good revenue. And that’s not always the case when you want when you want to, to grow. And so, you know, really the most fun epiphany is when you, you start to see the effect of bringing in an institutional quality sales team, and you start to see those growth numbers tip up, tick up, because organic growth is oftentimes, you know, far cheaper than then, you know, any other type.
Patrick: Okay, I just a lot of fun, particularly that because I think, you know, either labor, personnel, or sales marketing are those very nuanced types of types of practices that are really tough, and they’re very scary. And that’s, that’s something you bring on. Now, you’ve had over close to 200 acquisitions throughout this whole tenure. Let’s talk real quick about how that process has changed, because it’s gotten a lot easier for the whole M&A process. And one of the ways that it’s gotten easier is to reduce risk for the parties involved. And you know, that’s being done now by a product brought in by the insurance industry called reps and warranties insurance.
And the purpose of the product is essentially, it takes the indemnity obligation between seller to buyer, transfer that away from the seller for a couple bucks for premium to an insurance company. Therefore, if there’s a breach of the seller reps, rather than a major escrow or fear of a big clawback by the buyer who’s been financially harmed, because even though they did the diligence, something was missed. And in a perfect world, nothing would be missed, but that happens. And so this product has become a very elegant, elegant, elegant tool that’s now available for the lower middle market. But you know, don’t take my word for it, you know, Skip good, bad or indifferent. What’s been your experience with rep and warranty insurance?
Skip: Yeah, look, it’s for perspective. I remember the first time I used it was maybe 15-16 years ago, and trying to find somebody to underwrite, you know, rep and warranty insurance, you know, there was sagebrush rolling through the streets. It was a very different market. And, you know, so I think you’re right, it has increased the lubricity of getting a getting a transaction done today. So we use it in 80-85% of our transactions today. It really takes I mean, it works just like insurance instead of one owner, you know, basically having all of the risk of, again, having made a mistake, or having some warranty claim come up from, you know, five years ago, it’ll again, allows the pooled interest to underwrite to that and it’s only the exception where we don’t use it in in the trend, and again, in the significant amount of transactions we’ve closed in the last five years.
Patrick: Yeah, I think I think the nicest development, and the success of rep and warranty has been eligibility has increased, not tightened. The claims haven’t hurt the industry. And you know, very much at all, so rates have been low, they’re beginning to rise solely because the demand. Demand for the product has gone way up. And and that’s what’s driven it. One of the things I did want to point out because it’s just not broadcast that often is that rep and warranty was originally reserved for deals with a transaction value of $100 million plus. Pre COVID, just pre COVID, that threshold dropped by a couple of markets down to deals as low as $20 million in transaction value. There is now as of July 2021, a market out there that has a product that can insure M&A deals with transactions from 1 million transaction value up to 10 million and insure the entire transaction.
Slightly different product it is for sell side deals. But what we think is important is that as you know, the market grows, that there are just different options available out there. And what we like is just the sheer number of add ons that are happening. And so there may be preferred destinations for platform investments, there are going to be way more add ons. And if you have tools that are now available for those add ons, all the better. Skip as we record this right now, you know, we’re passing through the pandemic, and now we’re dealing as Californians would almost call the aftershocks with the Delta variants. So things are kind of hanging on. But we’re coming in now we’re racing into end of 21, looking at 2022 what trends do you see going forward? Either, you know, macro or just NewSpring yourself?
Skip: Well, it’s I mean, first of all, you know, again, the dealing with COVID. I think we all know that, you know, we thought the vaccine was a total panacea. I think it’s definitely helping but I think, you know, COVID is now becoming more, you know, perhaps a longer term part of our overall lives. And so, you know, that op tempo that COVID has created, there’s no, it’s not going to go away anytime soon. So I think we’re, you know, we’re, we think we’re going to deal with an economy economy that is, is, you know, is affected by that. You know, at the same time, you know, there’s a lot of dollars sloshing around in the economy.
You know, with what the Fed has done, and what the tray and Treasury slash Congress has done at the same time, you know, there’s, there’s a, there’s a lot of capital out there. And, you know, thankfully, you know, the quick action, you know, that the the government and Fed did, back in March, April, May last year, I, you know, served its purpose. You know, I think 2022 is gonna be a great year. It’s, you know, I do worry about, you know, going further out that, you know, we’re going to see, you know, some issues in the economy, you know, our companies are already seeing wage inflation, you know, you can take price hikes away, but, you know, you don’t take wages back.
Patrick: No. Yeah, that’s true.
Skip: You know, with, you know, with a lot of the things that happened with COVID, which some of which are good, some are bad. Number one, you know, a lot of people decided to retire and are not coming back to the workforce. So that takes a significant pool away. You know, the lack of immigration over the last five years. You know, we need immigration to grow our economy. You know, on the good side, you know, a lot of, I think, the most business formation in the history of the country in the last year.
Skip: So that’s a good thing. So, look, you know, there’s a lot of good and bad, you know, I think the key to founders and other people in private equity is you always have to assume that the, you know, again, I’ve been doing this 25 years, I think this is my third downturn, you know, and, you know, I guess we’re in an upturn now, but, you know, things go in cycles. And so you have to, you have to invest and run your businesses thinking that, you know, you know, take advantage of what you can but but know that you’ve got to architect for the downside.
And, look, we’re doing the same things, you know, today that we were doing, you know, last year. It’s a seller’s market. It is not a buyer’s market, because there’s all those dollars out there. So it’s a great time to be a seller. We have to be disciplined. And, you know, I guess our thought is that if we do our the right things by picking the right companies, and then running our game plan, that we can create the growth dynamic, that, you know, that allows us to kind of, you know, succeed in upturns and downturns.
Patrick: Skip, how can our audience members find you? How can we find NewSpring Capital?
Patrick: Great, well Skip, a lot of fun. It was a pleasure speaking with you today. Thanks so much.
Skip: All right. Appreciate it, Patrick. Take care.
Our guest for this week’s episode of M&A Masters is Gus Marshall, Head of Transaction Liability at CFC Underwriting, Ltd. CFC is a specialist insurance provider, pioneer in emerging risk, and market leader in cyber and transactional liability.
Today we are talking with Gus about CFC’s exciting new product launch, Transaction Liability Private Enterprise (TLPE).Gus says, “Reps and warranties insurance is currently Wall Street and we want to make it Main Street with TLPE.” He’ll break this new product down for us and tell us:
Patrick Stroth: Hello there, I’m Patrick Stroth, trusted authority on executive and transactional liability, and 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 as a clean exit for owners, founders and their investors. Today I’m joined by Gus Marshall, head of transaction liability for CFC. CFC is a specialist insurance provider and pioneer in emerging risk and market leader in both cyber and transactional liability. Gus is here today to present CFCs newest transactional liability product, which was just launched and titled transaction liability, private enterprise or TLP.
Now on a personal note, M&A Masters has been doing podcast for over two years, Gus is the very first transaction liability insurance person to be here. And it’s a real key day for us because Gus is here to talk about a new product is the first time in rep a warranty for a long time that a new product has been launched. And this is a product that is designed specifically for an unserved market in the m&a community. These are trying transactions with enterprise value of 10 million and less. I’ll say that again, for you owners out there with companies 10 million or less investment bankers, Business Brokers, or buyers seeking companies at a value of 10 million 10 million or less. We now have a product that has not been around. Gus is a great pleasure to have you. Thanks for joining me today.
Angus Marshall: Thanks for joining Patrick, delighted to be here and flattered to be amongst such August company, m&a masters.
Patrick: Yeah. And before we get into the TLP, and CFC, let’s talk about you tell us personally, just what brought you to this point in your career.
Angus: So, you know, prior life, so to speak, I was a m&a attorney at Norton rose Fulbright, here in Sydney. And it probably would be remiss of me to not mention my background, which is somewhat unusual and dynein, from my parents in law’s house in Sydney, and I’m in the pottery studio. But I’ve converted it to a makeshift m&a Center. But ordinarily, I’m based in London, as you said CSC. Prior to my my joining CFC, I was head of m&a for the UK and London market at AIG. And I moved to CSC about two years before that. And as I mentioned, I was a an m&a attorney at Norton rose Fulbright in Sydney.
And I think might be interesting to your audience to know that the Australian m&a insurance market, it’s one of the most developed in the world. So in many ways I had the perfect market in which to learn the key skills of underwriting and advising underwriters as an attorney here in Australia, before moving to London, close to a decade ago now. So I’ve been knocking around the m&a insurance market for pretty much a decade. And it’s been an absolute pleasure to be involved in such a nascent, innovative and emerging type of insurance sector is to insurance has come to me.
Patrick: Yeah, and it was for our audience members to understand CFC is a long term player and rep award to actually just full disclosure, Rubicon just plays to a recent traditional rep and warranty policy list, CFC. So you guys have been around for a long time. And it was let’s talk about CFC and just the nature because it is very innovative. And you talk about the culture that created the opportunity where, you know, it came up with a new product like TLP.
Angus: Sure, so CSC, founded about 20 years ago by our founder and CEO, Dave Walsh, who, at that point, identified a real niche in the market with cyber insurance. Now cyber insurance back then was certainly nowhere near what it is today. And like all businesses, cc’s had to evolve and we got some things wrong, and we got some things very right. But about the name, you know, this sort of tells you a bit about about that story. And that is, cc stands for click for cover, not only more, but it did. And the original theory there was we wanted to be a web based insurer for cyber where you could literally click for cover.
Now things have evolved since then, and we’ve we’ve dropped the cliff we cover now just CFC and also expanded across a whole variety of different lines of business to being a pretty cool line and you are about and how do we come up with TLP. So it’s at the height of COVID. We were, I think it’s fair to say fairly concerned about the outlook for m&a, I think everyone was. And we wanted to try and create some opportunities and some positives from what was a fairly depressing blip on the overall m&a lifecycle. And CST, we do a lot of SME business. And I think the board at CSC myself got together and we identified, I think, something that we always knew for a long time. And that is there really isn’t a product for what is such a massive part of m&a. And that is for deals under $10 million enterprise value, the so called SME micro segment.
And for us, this was quite a neat pivot, both from a tail standpoint, but also from a CFC standpoint. So for TL in our, what I call our main market, we write deals in the low and mid market. And I said a sweet spot is deals with an enterprise value of about $200 million and under. And so what we thought of trpa is, it’s really just a natural extension. Beyond that lob in market into the SME micro segment and the pivot, I mentioned about CSCs, we are already a very key SME insurer, both on cyber and other lines. So now we’re always a little bit displaced in tail only writing that log in market without writing the SME. So it’s a nice, I guess, return to CSCs roots being a key SME insurer.
Patrick: Well, you had mentioned once when you were rolling out, DLP, what was the average deal size enterprise value were reppin warranties purchase?
Angus: So it sort of depends on who you ask. But I think it’s it’s probably fair to say across the market, it’s about $352 million.
Patrick: Yeah, $354 million, is your average deal that gets insurance. And they may only get, you know, 10 $15 million dollar policy. But I mean, and there are 1000s of those deals happening every quarter that blew me away when I first got into m&a was I didn’t realize how many of these things were happening man in typical for most people that are involved in m&a because they’re just looking at the Wall Street Journal, the news, and all they see are the multibillion dollar, you know, Whole Foods being bought by Amazon, you know, and so that’s, that’s their perspective.
And what really I found great was that, you know, as rep and warranty has been coming down market where they were, their threshold was $100 million dollar transaction value down to 15 million down to now they can do as low as 10, there’s been kind of that hard floor for the markets, they will make an exception from time to time to entertain a deal. But then you’ve got the converse issue. And the limitation with rep and warranty is the amount of diligence is required, in order in order for a deal to even become eligible, and you’ve removed all that. And so now we’ve talked about your thinking behind this vast market, and you’re ahead of everybody else, because I’m sure everybody else right now is busy with what they have.
I mean, that’s, that’s the interesting thing. And I appreciate the innovation of CFC is, rather than being, you know, having lack of bandwidth, let’s look at some other place where we can be real efficient. I think that was one of the focuses you hadn’t. Let’s talk about some of the things that are going to enable you not only to enter this market, but to sustain it because you talk about, you know, making sure that you have a real streamline application processes submission process. How are you going to do that? What are your plans that way?
Angus: Yeah. So, I mean, there’s, there’s a lot of Next question. Let me start by just trying to identify some of the things that we knew we had to get right in order for this product to work. And you’ve already mentioned a couple. But you know, this is the context, right? So reps and warranties is currently Wall Street, and we want to make it mainstream. And we did that by saying, Okay, so what are the pain points for current reps? And how do we change that four TLP pain points are, the process was too long, the cost was too high. And I’m talking in the context of SME, of course, the cost was too high for SME because of that minimum premium interaction.
The third point is, you know, it’s not just the cost of the policy, it’s also the cost of the additional diligence required in order to have a policy underwritten in a conventional sense. So if you if you read that altogether, it’s going to be a compelling price point. It’s got to be speedy in underwriting and the third point i think that’s that’s really key. It’s got to be simplistic and and that’s really because we’re talking to a much larger distribution community and there’s always been this I guess, this missing Stick around reps and warranties insurance that it’s insurance by name, but not really by nature. And where you go with that is, you know, there’s no application process, the underwriting is kind of inverted as compared to other insurance products.
There’s not a high volume, there’s this prevailing view that you have to be an m&a lawyer to understand it, and to be able to broker it. And so there’s always been this natural resistance from insurance brokers to want to even venture into the world of m&a. And what we’ve really tried to do is not just achieve the speed and the price points, we also wanted to simplify it so that we could have as broad a distribution community as possible, feel confident that they can both recommend this product to their clients, but also place it from a technical standpoint.
Patrick: Yeah, absolutely key because I can tell you the challenge that I see out there for brokers is brokers will not discuss a product or an offering with prospective clients unless they really are comfortable with it. Because I mean, human nature, they just don’t want to look uninformed. And they want to be able to answer client questions. So if they don’t understand they’re not going to talk about. But let’s talk about TLPE just in the basics, and we’ll talk about how it’s different. And most of our audience is familiar with the traditional rep a warranty policy. So let’s go step by step on a couple areas. Okay, how’s TLPE different number one? You know, let’s go over this and explain this. Okay. It is not a buy policy, this is a sell side policy exclusively? Talk about that Gus.
Angus: Yep. So the main reason why we can expedite underwriting and also reduce the underwriting costs is we’re relying a lot on the knowledge of the seller. And if you play that through, in the SME micro market, the seller is often the manager of the business. And this plays into what is the basis for pretty much every other insurance product, and that is your insured is telling you the truth. If they don’t, then, you know, coverage is far more limited. But we relying on their knowledge and their integrity in buying insurance. And what we do with an application process, which is really the pinnacle or the center of our underwriting. The application process captures that knowledge and tries to tease out some of the more material issues that might be relevant to a transaction. This is all in the context of our theory. And our philosophy when it comes to micro and SME is we need not apply the same underwriting process to this end of the market.
Because these businesses, there is some complexity, but it’s nowhere near as complex as your multi billion dollar deal that gets insured in the main market. So it was inappropriate for us to adopt the same very interventionist type of process that aims to kick every single, little tire. In company, we wanted to make an application based underwriting can be achieved in but we can get a policy to insert within three days. And another point I’d make is there’s no underwriting fee. The underwriting fee is often charged on the main market, we don’t have that and we don’t need it. And we didn’t want it because that was just another barrier to accessing this part of the market with a new product.
Patrick: Yeah, you just you just carved out 35 to $50,000 in costs off the top with that, I’ll comment on just on your application. Again, you can reach out to me or to Gus, but we can get you the application Rubicon M&A Insurance Services, has his application ready to set out on demand for anybody that asks for it. It is it is intimidating in terms of an application if you compare it to other insurance applications, but it is absolutely market for a due diligence checklist. Mirrors that. There are a lot of sections that don’t apply. But it is one of those things that is available out there. And it’s nowhere else in the market. Let’s talk about just because TLPE as great as it is not for everybody. Let’s talk about their particular industries that you like, let’s focus on the ones that aren’t eligible and why they’re not eligible.
Angus: Yeah. So some of the industries that are ineligible for TLPE would be U.S. healthcare, pharma, financial institutions, excluding insurance brokers. So that is inappetite, but everything else is out. Now.
Patrick: There’s a robust market for insurance brokers acquisition.
Angus: There absolutely is, which is why we carved that back into appetite because, well, there’s there’s various reasons we can go into on that, but, you know, just sort of thinking about those out of appetite industries. I would say that the one that is practically relevant, and therefore, I guess material to the market would be that there are a lot of healthcare deals on a 10 mil. And healthcare has its own, especially in the US has its own risks and exposures which generally don’t lend themselves to a streamlined underwriting process. Financial institutions that I mentioned as well, I consider that to be somewhat academic as a kind of exclusion, or out of appetite sector primarily because we don’t expect to see many financial institution businesses at under $10 million.
So look, we include it for completeness, but as I said, not not hugely relevant, perhaps the easiest way to think about it is, is trying to think about the quintessential or kind of target. In short, it’s mom and dad, entrepreneurs who build a livelihood through a business, or a variety of connected businesses, and they want to retire. That’s a really cool market currently. And it could be anything from a chain of restaurants to a consulting practice to a construction firm. As I said, it’s kind of you know, what’s on Main Street. And that’s it’s pretty much 99% of what’s on Main Street is in appetite.
Patrick: Let’s talk about a clarification you have for technology, because technology is all over the place. And then we’ll talk about a case study with a technology firm, but distinguish eligible tech from ineligible tech.
Angus: Yeah, so I think it broadly breaks down like this, that a technology being sold pursuant to an asset purchase agreement, we can get our arms around. I think when you’re dealing with a acquisition of shares of a tech company, that doesn’t mean that it’s out of appetite. But what we’ll often see with those deals is a very, very high, multiple evaluate. And when we can’t reconcile the economic basis for a business, we find it difficult to provide an insurance solution. Whereas when it’s an asset deal, you don’t have necessarily that EBITDA valuation issue that we often encounter on share deals.
Now, I know there’s I sort of refer to a don’t mean this to sound pejorative at all, but it’s kind of like the after after market. In California, for technology, where a lot of companies of use, a lot of companies have failed, but they still have valuable technology that they want to try and realize some value for, and they sell that as an asset. That to me is a perfect fit for TLPE. Along with, you know, the mom and dad entrepreneurs that I mentioned earlier.
Patrick: We can’t talk about TLPE without talking about cost. Okay, one major savings right now, there’s no, excuse me, there’s no underwriting fee, which is fantastic. Let’s talk about the pricing. And I because I’ve done this too is let’s compare, you know, a $5 million TLPE versus a $5 million limit, that’s to the full transaction, by the way, a TLPE versus a rep warranty policy.
Angus: Yep. So average rate online range is between one and two. But I think really, it ends up at 3%. So it’s between one and 3%. Now for the non insurance, audience rate online is just an expression of premium over total limit bought under the policy. So between one to 3% and just some of the factors that influence that rate. So a lot of it comes down to what the naic is the North American industry code of the target business is. That sets the initial rate. And then there are positives and negatives to that rate based on the responses to the application.
And also importantly, based on the percentage of the policy limit relative to the enterprise value. So the more limit you buy relative to EV, the cheaper the policy becomes as a rate online percentage. So let me just let me just bring that to life that if you’re buying 10% of the total enterprise value, you’re rate online for argument’s sake, maybe 2%. But if you’re going to buy 100% of the enterprise value as a policy, then you’re rate online, will probably come down to about 1.2% for illustrative purposes. So it gets cheaper, the more you buy is the bottom line there.
Patrick: But the bottom line is the price is determined not by the transaction value, but by how much insurance you buy. And then it’s a matter of, okay, well, you know, we’ve got a $5 million sale do we want to sell, you know, two and a half million dollars worth of insurance to insure you know, the full five, and then just you make a decision from there?
Angus: Yes. Yep. And so that’s certainly one factor. And I think, interestingly, for the reps market, certain responses in the application may reduce your premium. So to give you an example, if you use, say multi factor authorization to control your cyber network, well, that would be a credit to your premium. If you buy cyber insurance. Again, that’s a credit. So you know what we’ve constructed the application not just to try and elicit information, but it also informs what the total price is.
Patrick: The bottom line is, as you’ll see this, this can all be played out, you know, in a matter of a day or two with the application and so forth. When we get into this, and we remember now, as a sell side policy, unlike a buy side policy rep and warranty where a buyer experiences a breach, suffers a financial loss, they go right to the insurance company. Okay, with the sell side, what happens is that, in the event of a breach, the policy is specifically written so that it is triggered when the buyer comes back after the seller. Let’s talk about that real quick I just the dynamics of how this policy works.
Angus: Yep. The seller gives reps to the buyer, the buyer discovers an issue, that issue constitutes a breach of the rep, the buyer brings a claim under the terms of the agreement against the seller. At that point, the seller has a claim under the TLPE policy. And the insurance will indemnify the seller in respect of the buyer’s claim.
Patrick: I mean, it’s one extra step, where under rep and warranty buyer goes right to the insurance company, under TLPE, buyer approaches seller, which is no different than if there’s an escrow and the buyer is notifying the seller, hey, you know the funds in escrow, we’re gonna have to claw those back now we need to return. The difference is negligible. So this is a big departure. And so now you’ve got ask sellers, you have the protection that the rep and warranty policyholders have. So it is very helpful in that way.
Angus: And one on that is the buyer can know about the insurance. In fact, the buyer can recommend to the seller take out insurance. And the dynamic there that I think is is quite attractive is if the buyer ordinarily is demanding an escrow from the seller, the seller can come up and say well, I’m not going to give you an escrow. But I will have insurance, which should give buyer comfort that there’s something that backstops any type of potential issue that that comes up in the future.
Patrick: Yeah, I hate to interrupt but that mean, that’s the other issue that comes in here. Apologies, my lighting over here. But the other issue that comes up with in the micro market where rep and warranty is not available. The buyer’s major segue is a major escrow and they require the seller to carry a D&O tail, because there’s at least a policy and the buyer can say well, I’m gonna go make a demand because there was a misrepresentation. You know, is a contractual breach the D&O policy, we’re getting too into the weeds with insurance. But there are problems with that, but it’s better than nothing. Well, now you’ve got this product is designed specifically for these buyer clients.
Angus: Yeah. Look, it’s um, you’re absolutely right. And one of the questions that, you know, even though this product has only been been launched for just over a month now, one of the questions we often get is, well, why don’t I just buy D&O, run off? And this was to your point, Patrick? Yeah, I mean, up absolutely can but D&O genuinely excludes liabilities in relation to a breach of contract. So as much as it was the only thing available that gave a scintilla of peace of mind, it was so imperfect that I kind of questioned whether it was even worth the money. Yeah, if your objective in buying it is to protect yourself against a breach of rep in a contract. And TLPE fills that gap.
So it’s there exactly for that reason. And that’s why we think that it’s it’s such a neat solution for the sellers. I should probably say, you know, the other question I’ve received a lot is, so why is it the sell side only and not not the buy side? And it’s a good question, because for those familiar with reps and warranties insurance, 99% of policies now are issued to the buyer. The key reason is, as I said in my remarks earlier, we really want to capture the knowledge of the seller, and offer only to the seller means that the underwriting required can be so much faster and so much more efficient. If we were to underwrite on the buy side, the cost would be higher, the and there would be probably an underwriting fee.
And one of the reasons for that is we’d have to forensically go into every single warranty and rep and make sure that they’re market. Because the buyer, don’t forget has a direct recourse against the insurers and has the can leave the seller right out of it. So there’s that that kind of moral hazard that the seller doesn’t care, the buyer agrees, very favorable reps. And if we were to be so streamlined that we couldn’t pick up on that, well, you know, I don’t think we’d have a product very long.
Patrick: You wouldn’t be around. I mean, and this hasn’t happened in a vacuum. TLPE is not in a vacuum. And I can tell you, because we’re very proud that, you know, we do have a case study to talk about where TLPE brought a deal from the grave, and close within two weeks, and the situation is going to be one where we have a SaaS company. And a small $5 million transaction, they reached out to Rubicon and said, hey, you know, we just had our deal, you know, taken off the table, because we have a disagreement with the buyer and is specifically this, in the event of a breach of the IP reps, the buyer was going to go and pursue the seller, say, hey, you’re going to pay us any loss or damages as a result of IP reps. But we, the buyer, are going to retain full control of defense counsel.
So if an IP rep does get breached, we’re gonna get our attorneys on and defended vigorously, and you’re gonna pay the bill. Okay, it was a very large Silicon Valley based buyer that was doing this. And the seller, quite frankly said, Look, that’s a blank check to you guys, for your attorneys fees, there’s no way and that was a line in the sand that both sides had, and the deal was dead. All sudden, TLPE is announced. We said wait a minute, there’s another way. We could insure the intellectual property reps in the agreement. In the event the the buyer suffered a loss, they had control on their attorney that they were going to go ahead and do because that’s their loss up to the policy limit. So they could spend as much as they want to it. But you know, the, you know, there’s only so much out there.
But that provided that way that the two sides could bridge their disagreement. Deal closed. I mean, it actually took longer to get the bankers back in, get the finance realigned than it is to get the insurance. And that’s, you know, our role here, we want to be the conduits that are going to go and help deals close successfully. Because we got these owners and founders of these lower middle market companies, they create a great value from nothing. And they’ve got these small issues that you know, that can bridge that are a reasonable risk to take and, and that’s been, just a great, great avenue. And we see this happening more and more particularly out here in Silicon Valley. But you know, Gus, you know, you know, this deal. It was the first one you guys did any comments you have on it?
Angus: Yeah, I think just to pick you up on some of the remarks you made Patrick, what was pleasing is, you know, we pitched TLPE and we still could shoot as peace of mind to kind of mom and dad sellers. Not that, in this instance, our mom and dad sellers, it was a sophisticated company. But you know, it’s it’s originally pitched as peace of mind. But what was so pleasing about this deal is it can be a deal facilitator, so much more than we thought it would end up being, both from avoiding the need for escrow, but also unlocking or bridging the gap between negotiation expectations.
So it’s, you know, it’s pleasing to know that a deal got done that otherwise wouldn’t have done and that’s because of insurance. And I often joke, you know, people say the hardest thing about insurance is telling your parents you got into the insurance industry, but we’ve, I gotta say I’m to the market, we’ve done a great job, I think of creating a very valuable product for deal facilitation, risk transfer, and overall, M&A efficiencies. And, you know, I gotta say I’m chuffed to be part of it and chuffed to have brought this TLPE product and excited that you were the first broker to place the first policy.
Patrick: Yeah, we’re looking forward to a lot, a lot more. The hardest, the first one is always the hardest one to get, and so forth. Give us your projections. I always ask my guests, you know, what trends that they see going forward? You know, what do you see going forward for for this, at least in 2021? And then from there?
Angus: Yeah. So what I’d say first of all, is, with any new product, it inevitably evolves. And there’s also inevitably competition. I mean, that, you know, there’ll be another insurer that comes out with a similar product. And that’s great. I mean, we welcome. We welcome that. That’s a market operating as it should. But, you know, in terms of projections, I think we’re going to see some pretty consistent demand for the next six months whilst brokers who probably aren’t familiar with with M&A insurance, understand that there’s a product now that services that lower end of the market. And then, we see consistent growth thereafter. I think an interesting point to note, from an M&A perspective is there’s far less of a cycle in the the SME market than there is in any other part of the market.
And we like that, because we generally don’t have asset bubbles that affects risk in the main market for M&A insurance. And also, it allows us I mean, one of the big issues as you would no doubt have experienced Patrick, in the current M&A market is one of underwriter capacity, we are in the biggest M&A boom in modern history. And there just aren’t enough underwriters out there to service all the deals. So we think we’re TLPE we can have a fast, smoother resource allocation to service these deals. And, you know, what helps is CFCs long history in servicing 1000s of policies every single year that also renew every single year with a tech enabled platform. So that’s something that that we we bring to this product as well.
Patrick: What was the number of prospective businesses out there? Transactions like 230,000?
Angus: Yeah, that’s right. I mean, it’s it’s hard to accurately project or sort of private market addressable market, especially in the US with a lack of public disclosures required, unlike, say, the UK where some of your US listeners might be outraged to know that company accounts, even small companies are disclosed and available for free to everyone. That’s not the case in the US. And so it is hard to to assess the target addressable market, but based on various data points, we think there are about 230,000 transactions in the sub $10 million market taking to the US alone, that is so and there’s so much to draw from that right. But even if we’re only 10%, right, or we only get 5% of that market, that’s still easily more than what the the main market of reps and warranties insurance currently services.
Patrick: Yeah, it’s just a it’s a great, great opportunity. Gus, how can our audience members find you, find CFC, questions about TLPE?
Angus: Sure. So I think one of the key points would be, we have a webinar that was recorded, and then you attend it. And that’s quite a good point, just to run through some of the key parts of TLPE that’s available on CFC’s website. Look, I want to be found, I’m on LinkedIn, we’re on the CFC website, if you just jump on the CFC website, you’ll find my email address. Shoot any questions you have delighted to, to help, you know any M&A practitioners and lawyers and the like, understand what this product can do. But you know, equally we only engage and transact via an insurance broker. So Patrick, you’re you’re the first one to do it. That’s that’s worth a a deal tombstone, which aren’t often given away. But I think this warrants it. So I recommend that they get in touch with you first and foremost.
Patrick: I would say that that insurance is a regulated product, it can only be placed through an insurance broker and and this is circle slides is just another layer of complexity in regulatory stuff. So I would stress if anybody wanted information or the application just have a look at this. Reach out to me at firstname.lastname@example.org. You can look up Rubiconins.com, the M&A Masters podcast, you can check there and ping us and we’d be happy to go in and respond. We’ve got to get get a couple more things up and running on the site. But absolutely, I’m walking me out. Anybody for this. It’s great because this is where we’ve wanted to live is to really serve the entrepreneur. We really look forward to it. Gus, you came up with, you know, the better mousetrap that’s out there and I hope the world beats the path to both our respective doors.
Angus: Likewise, Patrick.
Patrick: Thank you very much for joining us, and we’re gonna be talking to you again.
Angus: Been a pleasure. Thanks, Patrick.
On this week’s episode of M&A Masters, we speak with Jordan Tate, Managing Partner at Montage Partners. Montage Partners, based in Arizona, is a people-first private equity firm. For 17 years they have invested in established companies across North America, helping them reach transformative growth.
Jordan tells us about his path to Montage Partners, the interesting meaning behind their company name, and how it reflects both who they are and the companies they seek to invest in, as well as:
Patrick Stroth: Hello there, I’m Patrick Stroth, trusted authority in executive and transactional liability, and 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 Jordan Tate, managing partner of Montage Partners. Montage Partners is an Arizona based private equity firm founded in 2004. They manage $70 million in capital and invest in established successful companies across North America. Jordan is great to have you here. Welcome to the show.
Jordan Tate: Thanks, Patrick. Good to speak with you again.
Patrick: Now, we don’t see a lot of private equity activity here in Arizona. So you really caught our attention. Before we get into Montage Partners, let’s let’s start with you. How did you get to this point in your career, and then maybe trace, you know how you landed in Arizona?
Jordan: Sure. So a little bit of background, I’m 40 years old, I started my career as an investment banking analyst at Merrill Lynch, working on mergers and acquisitions, primarily with consumer and industrial companies, and what now seems like a lifetime ago. And then in 2004, I moved back home to Arizona to co found Montage Partners. And it’s been a fun 17 year journey. Over that time, we’ve now invested in 17 companies, having successfully exited our investments in eight of those companies. So we’re active investors in nine companies today, and have a ton of fun working with our partners and still view ourselves, in spite of the 17 year history, as being in the early innings of building, the leading lower middle market private equity firm in the US.
Patrick: Excellent. Now when we turn to Montage Partners, I credit you guys a private equity, that you’re not boring, you’re a little more creative in the way you name your company, as opposed to law firms and insurance firms, that name them after the owners and the founders. But what’s the story at how you came up with the name and tell us about Montage Partners.
Jordan: Yeah, thanks for asking not a question that we get all that often. But you’re right, we intentionally didn’t name the firm after any one individual. That is a reflection of our culture. So we’re very team oriented. And collaborative. The firm’s not about any one individual, it’s certainly not about me. And so the name montage comes from the fact that a montage is a picture of pictures with each of those individual pictures, being self sufficient, and unique and standing on its own. And that’s a reflection of how we think about the companies that we invest in.
So each of those companies is unique, self sufficient, successful in its own right. And together, those companies comprise the overall picture of what forms our firm Montage Partners. And then maybe the last thing I’ll share is on the partner side, that was intentional as well. So we look for a true win win relationships where it really is a partnership with the leadership teams that were backing and or the founders if it’s a majority recap situation. And while the founders cashing out significant liquidity may stay involved and continue to be an owner, what we’re looking for, are those true partners with people that we like and trust. And so that’s reflective of the name as well.
Patrick: And the the size area that you’re looking at for your investments, I would consider that the lower middle market, correct.
Jordan: That’s right. So in terms of size, we’re investing in established successful companies with one to 5 million of EBITDA. So no startups, no distressed situations. You mentioned across the US, we focus on four industry verticals. So business services, consumer products and services, industrials and technology. So one to 5 million of EBITDA, no startups, those four industry verticals. And then in terms of the catalyst for the transaction, there’s really three situations that capture all 17 companies we’ve invested in today. And those three are founder liquidity event. So whether that’s a founder seeking a full sale of the company, or a founder seeking a majority recap, where the founder may want to continue in the CEO role and or continue to be involved from an ownership perspective or a board perspective. That would be scenario one, and that’s very core to who we are. The second one is the management buyout.
So backing leadership teams with capital to buy their business from a larger organization. And there’s two examples there would be Equity Methods and Metal FX, both of which were actively investors in today, Equity Methods was prior to our transaction, a wholly owned subsidiary of Bank of America. And Metal FX was majority owned by a publicly traded utility called a VISTA Corporation. And both of those cases, we provided the capital to back the leadership teams of those companies to buy their business. So that’s number two. And then lastly, the third scenario is backing operators or independent sponsors, who have a thesis within a particular industry and or have identified a particular company and need an equity partner to support them.
Patrick: I’m just curious real quick with with the independent sponsors your your third point there, have you seen that activity grow?
Jordan: Absolutely. So definitely a trend, we think back over the past 17 years, there’s a growing universe of independent sponsors, for sure. And I think from if I put myself in a founder’s seat who’s seeking liquidity, I think that’s both a good thing and a bad thing, I think it’s a good thing because it provides another option. And there’s very high quality people out there in the independent sponsor universe. And then maybe on the on the challenging side, or something to look out for as a founder is not everyone’s created equally, right. And it’s difficult. When you’re getting to know somebody who doesn’t have a track record, they don’t have a portfolio of companies where they’ve been through the transaction process many times.
And if this is the first time they’re going through a transaction, there’s a lot of getting to know one another. And so there’s some work that goes in on the founder side to get to know the people involved, make sure that everyone understands the source of capital, and that the person sort of can successfully navigate the transaction process so that a founder who’s built a successful company, over 20, 30 years, is going to have a relatively smooth positive experience with highly emotional once in a lifetime opportunity. So growing universe, and lots of variety in terms of the folks that are competing within that space. But certainly for us, we’re very interested in doing more deals where we’re providing equity, to independent sponsors to help them close transactions.
Patrick: I think is fantastic. It’s a nice matchup with the pooled resources, like you said, if you’ve got an independent sponsor, you’re just looking at that individuals, the owner or founder of an organization with a track record, like you have, you know, backing them up all sudden, it gives a lot more credibility to the the opportunity for success.
Jordan: Absolutely great. So there’s a good compliment there, particularly when that independent sponsor plans to step in and take an operational role in the business. So sometimes, if I’m a founder, I’ve built a successful company, I don’t have necessarily a successor internally. But I’m seeking liquidity. I need both a capital provider to provide the liquidity but I also need a solution in terms of who’s going to step into that leadership role. And in a scenario where there’s an independent sponsor involved, who plans to step into that leadership role. And there’s good rapport between the founder and that individual. And then we can step in with the capital. So solving for the capital that’s going to provide liquidity as well as support growth initiatives, also speak to the track record, and then bring the shared services resources from our team. That’s a good combination, and it sort of rounds out the solution for the the founder who’s got a lot at stake.
Patrick: You haven’t done this yesterday. So I mean, the number of private equity firms, you know, when when Montage Partners started was a lot smaller than that universe now. And I’m just curious as you’ve got this long track record, how are you having gone up market for bigger and bigger deals? Explain explain your preferences, staying in the lower middle market?
Jordan: Yeah. So you’re right, we have stuck to our lane, there’s not much that’s changed with respect to our investment strategy, or size, or the qualities that we look for in companies or people that we’re going to invest in, over the past 17 years. So we haven’t drifted up market that’s been intentional. One of the reasons is, we have a lot of fun doing what we’re doing. So we like this category. It’s large, there’s a lot to do. And we love the founder transition story. We think where a founder is willing to invest the time to get to know the people and where the founder knows what market is in terms of purchase price or multiple.
And so there’s confidence going into the transaction that they’re going to be paid that price, regardless of who the buyer is. And once that box is checked, that they’re getting the liquidity they’re looking for, they’re getting a full fair purchase price for the business, then other things matter a lot. So for founders who really care about the integrity of the people Who’s going to be involved? Who’s going to represent the company on the board from that private equity firm? What’s the post close plan? And what resources can that private equity firm bring to bear? What’s the track record of that firm, and we’re the founder can jump on reference calls from other folks who had sat in their seat before. Hugely important, hugely powerful. And we like this this size, and the dynamic changes as you go up market, it gets a little less personal.
Patrick: Yeah, well, I think that when owners and founders, they get to an inflection point, and they’re looking for an exit, or they’re looking for, you know, that next step, because they are either, you know, and they’re, they’re too too big for being small, but they’re too small to be enterprise. And, you know, they’re at that point, they have to make some kind of change. And if they don’t know any better, a lot of these owners and founders just default to an institution or to have some brand name out there, or they fall over to a strategic that may not have their their interests, you know, at heart. And that’s why it’s very important that we highlight organizations like montage partners, because you offer a way out that is a real positive. And the more choice they have, particularly for these people who have, you know, taken started with nothing, and then develop, you know, build great value is great to know that there’s organizations like yours out there that can get them to that next chapter.
Jordan: As you know very well, if there’s a great strategic buyer, that is a great fit for the particular company, that could be a good option for the founder, if that’s not the case, or they’re concerned about competitive sensitivity with sharing information during a diligence process, or there’s not a great cultural fit with the organization that they’ve built. And that potential acquire, and or the founder cares deeply about that leadership team. And the folks that are going to carry the torch after they start to step out of a day to day role. aligning with a private equity firm can solve for all of those things.
Because if you’re doing your homework, getting to know the people at that private equity firm, and you’re partnering with high integrity, high quality people, and you can do those reference calls, the culture at your company is not going to change, there shouldn’t be renewed energy, but the fundamental culture is not going to change. Now you’ve got stronger balance sheet capital to support growth initiatives, potentially help upgrading finance and accounting infrastructure, help standing up pull based marketing initiatives. Help recruiting to round out the leadership team, if that’s helpful. And then uniquely one differentiator for a founder and choosing private equity as a path towards liquidity versus a strategic buyer is the ability to roll equity, if they’re interested in maintaining a stake in the business.
So for a lot of founders, you built a business 20, 25, 30 years of sacrifice, blood, sweat, and tears, and you want to take substantial cash out of the business. But at a certain threshold, once you’ve met some certain dollar amounts of liquidity, it’s oftentimes very appealing to maintain a stake in the company through that next phase of growth over the next 5, 6, 7 years. And that usually that opportunity doesn’t exist most often with a strategic buyer. But with the right private equity firm, that opportunity to maintain a stake in the business and accomplish the upfront liquidity objective is sometimes very attractive.
Patrick: Yeah, one and also that rollover, that can happen, you could end up that rollover ends up being worth more than the original liquidity event as possible, as possible. Yeah. So that I mean, what a great way, you’ve just, you’ve just gone through just all the types of things that you bring to bear. When you come into the company, you’re showing them how to scale, bring in new talent, improve processes, probably get economies of scale, in terms of costs, and so forth. The four areas that you like to invest where you have business services, consumer products, light manufacturing, and technology. Give us on each one of those buckets. Could you give us a brief profile on your ideal target note in those fields, other than other than just size?
Jordan: Sure. So maybe what I’ll do to try to be succinct and in the interest of time is this talk about the common threads that that we would look for that apply across all four of those verticals. So even though we’re investing in companies that might compete in very different industries, there are kind of fundamental common threads that we’re looking for. And so those include things like customer retention. So we’ll go back in time and we’ll review spend patterns and understand when customers were lost. What happened there? When new customers were won? How did that happen? How sticky are those relationships, so both on dollar revenue retention, and then the retention of the relationship that’s really important, regardless of which of those four verticals, we’re looking at.
Margin stability. So there certainly has to be an actionable growth opportunity, we’re not the right fit. But we’re also not chasing sort of the shiny object, the next new thing, we’re looking for companies that have a fundamental value proposition, they have high revenue retention, sticky customer relationships, ability to generate consistent a consistent margin profile. So that means when say for a manufacturing company material prices, right now are going up across the board, the ability for that company, on balance to pass through those price increases to their customer shows up in gross margins, right, and it says a lot about the value add of that company and the relationships they have with the customer base. So those things are important things like competitive position within the industry.
But then at the end of the day, past all those quantitative metrics, ultimately, the biggest driver of our decisions to wire funds that close are the people we want to work with people we like and trust. High integrity is high integrity, whether we’re talking about a manufacturing company, a consumer products company, a professional services company, or a software company. So at the end of the day, there are quantitative metrics that we look for. And they’re common threads across those four verticals. But ultimately, it’s it’s the the integrity and the personal fit the culture of the company and the enjoyment working together that should be there for both sides. Otherwise, it’s probably not the right solution.
Patrick: Well, you touch on one area, on that key thing with the integrity that I consistently see with everybody I speak with, and that’s you cannot eliminate the human element in mergers and acquisitions. Okay, there, there is not, you know, the news where Amazon buys Whole Foods. It’s not Company A, Company B. It is a group of people choosing to partner with another group of people. And if everything works, you know, one plus one equals six. And so that’s something that resonates for everybody I’ve spoken with it, that’s the determining, determining factor is the people.
Jordan: 100% agree. And I think the best outcomes are those where both parties spend sufficient time, which doesn’t mean a transaction needs to drag on for months on end, but spend sufficient time getting to know one another, beyond walking through the line items on an income statement, but really getting to know one another, getting to know one another’s goals, and confirming that if it’s a founder that’s seeking a full exit, I’ve poured a lot of cases my entire life into building this company. Are these the stewards of my business that I’m going to be proud to hand the keys over to? Or if if somebody who’s doing a majority recap and is going to stay involved?
Do I like these people? Do I enjoy working with these people? Am I gonna have fun at board meetings, it’s just gonna be a fun process over the coming years, or am I just looking for liquidity at close, and I’m going to dread every conversation with my new partner post close. In those situations, we’re typically not going to be interested. So we really do want there to be a good two way fit. And that sets up a win win partnership. And the most attractive opportunities for us are those where the seller is spending as much time being selective, doing reverse due diligence during those reference calls getting to know us, and vice versa. And we confirm that there’s just great alignment, and it’s going to be a fun partnership post close.
Patrick: One of the things that struck me, you’d mentioned through the process as your research, I would just think as your owner and founder, in most cases, your attention all your focus is on your company and getting out there just day to day, getting sales done serving customers, things like that. But then you get through go through the diligence process. And you’ve got the opportunity where somebody else is looking at your numbers and looking at him with a different perspective. And I’m just curious, when you’re talking about customer retention and things like that. I imagine if I were going through that process, I would probably have an epiphany or two about my firm, and by somebody else coming in as a partner with me, say, hey, here’s some areas for you of opportunity. Did you know this and they could be right in front of me, but I didn’t see him. I’m just curious. Have you experienced that with your investments where you just created these aha moments with with your targets and all of a sudden they were just really excited because oh, I didn’t even see this. We can do this tomorrow.
Jordan: Absolutely, it does happen. So there are situations during the due diligence process, when that post goes plan is starting to be formulated, and everyone’s collaborating on for the areas of focus and where the investment is going to go post close. And it’s fairly common for. So we’ll do playback sessions where we’ll take our analysis, we’ve cut up the data, and we’ll play back our conclusions. Hey, here’s what we think we’re seeing in the information. Here’s our conclusions we’re drawing, tell us where we’re right, tell us where we’re off. And that’s part of our process of getting educated on the business during due diligence. But I think as a byproduct of that, what you’re describing absolutely plays out where the founders saying, well, intuitively, I knew that, but I’ve never seen it sort of quantified. I’ve never seen it presented that way. And that then leads to additional ideas. And it’s a fun collaborative process.
Patrick: I just think that hits the ground running where and outside of M&A they’re the people say, well, somebody’s got a big liquidity event. So they’re probably just going to kick back now and stay, you know, run out their time. But I think this is just invigorates management, saying here are these new options, we never realized, and they’re right at our fingertips.
Jordan: They can go both ways. Yeah, depending on the founder’s objective there, we have certainly invested in companies where the founder was very transparent that my goal is 100% liquidity. And I want to step away from the business as soon as possible. And depending on the composition of the leadership team that’s there, we can come up with a plan, whether it’s immediately at close or over some transition period for the founder to do that. But there are a lot of other cases where the founders objective is to take out a significant amount of liquidity.
But they are energized about the future, they do want to help scale the company to the next level, they want to partner to support the company with capital, but they also want a partner who’s going to be value add and roll up their sleeves and help execute on that roadmap. And both situations are fine. But certainly that situation where the founder is checking the box on the liquidity objective, but is re energized in the business about taking it through its next phase of growth. Those are really fun situations. And that’s part of why we love doing what we’re doing.
Patrick: I can imagine, you probably have a case or two where owner was going to check out after 24 months and things are going so much funny, just you know, I’m gonna stick around a little longer.
Jordan: That can happen.
Patrick: Okay, great. With with deals down the lower middle market, you’re dealing with owners and founders, and I mentioned the human element in mergers and acquisitions. And one of the things that comes up is, is fear. And it happens to there’s a lot of stress and a lot of drama, in mergers and acquisitions, because you get a lot of money at stake. And also this is, you know, a once in a lifetime or generational event for these owners and founders. And there’s a conflict there and is created not because there’s anything bad, it’s just you have one experienced party, which is the buyer who’s going through these events many times. And then the seller where this is their first this is their first time and it’s with their own money it’s their own, you know, business online.
So there’s a lot of tension to make sure that things go smoothly. And just things start coming up that probably the the owner founder didn’t expect. And that creates stress and you go through the diligence process. And then you get to this area called the indemnification conversation where what the with the buyer says is look, you know, we’re making a bet on this, we just need to protect ourselves. You know, if if something goes wrong post closing that we didn’t know about, we need some way to get remedy we need some way to just you know, limit our exposure on this this is market this happens everywhere. It also we need to go through this process.
But what the seller hears is okay after I told you everything I know, I cooperated in diligence. And now you’re telling me that even though I told you everything I know, I can be on the hook for something I didn’t know about? Why should I pay for something you missed? So you can get attention in their what’s been nice as the development in the insurance industry of what’s called rep and warranty insurance. And it’s an insurance policy, it literally steps in the shoes of the seller that says okay, based on the buyer’s diligence of the seller reps, if any of those reps end up, you know not being accurate and that inaccuracy costs the buyer buyer instead of going to the seller to pull back escrow funds or get remedy come to the insurance company, the insurance company will come in there and pay your loss.
Buyers like this because they get certainty of collection if there is a breach without you know, much, much waiting time. Sellers love it because they get a clean exit. They don’t have to worry about a clawback. They don’t have to worry about a large escrow the insurance policy covers most of the action escrow or if not, you know, there’s not gonna be a further clawback beyond that. And so it’s been a nice, elegant solution that removes the tension and removes the conflict, particularly when you want to start transitioning into integration, you know, post closing, and so forth. So it doesn’t step in in that way. And so it’s been nice.
The news is, in the last year, this product rep and warranty insurance is available for deals as low as $15 million in transaction value. It was usually reserved for nine figure deals. And the more that parties are aware of the availability of this, the more active they can get it and engage in the perception now pre COVID was only for the big guys it’ss not for our lower middle market. Not the case. And this is right, right in your area, Jordan. I’m not sure you know, good, bad or indifferent. I mean, don’t listen to me, good, bad or indifferent. What experience have you had with rep and warranty?
Jordan: That well, you summarized it well. And we can empathize with being on both sides of the table. Because we as a seller, we’ve been in that seat before. And certainly as a buyer, that’s what we do every day. So fully appreciate the value that reps and warranties policy brings to the seller in particular, but both parties in terms of smoothing the way to not wrangling too much within the reps and warranties section of the purchase agreement, which is where absent of reps and warranties policy, the majority of the time is often spent negotiating specific wording within that reps and warranties section.
So going back, so we’ve been investing 17 years now, going back 10 1215 years ago, the introduction of reps and warranties coverage was really suited towards transactions that were significantly upmarket, from where we’re investing. And so more recently, like you mentioned, it’s become more common. And it’s also become more common in our internal dialogue. So we have not purchased a policy yet. But it’s, it’s becoming increasingly common for that to be part of the discussion. And I suspect as reps and warranties policies become more widely available for the size of transactions that we’re investing in, which generally are in the five to $30 million enterprise value transactions. It’s only a matter of time before we’ll introduce that, as a solution.
Patrick: Jordan, as we’re going through, we’re recording this right about midpoint of 2021. And I it’s safe to say we’re probably at the beginning of the end of the pandemic, and there’s activity going on and everything. From your perspective, what do you see either M&A in general or Montage Partners in particular on, you know, what are your thoughts on trends going into end of year 2021?
Jordan: Yeah, interesting. So a couple things. One, high valuations is a very widely covered topic right now. So it’s a good time to sell if you’re a founder. But I’m not going to focus on that one. Because I think that’s pretty, pretty widely covered out there in the media, the potential likelihood of a capital gains increase is also pretty widely covered and expected. So many more, two more interesting trends that I’ll comment on are one you touched on earlier, which is the growing universe of independent sponsors. So like we talked about, that creates another option for a founder seeking liquidity, but it also creates some homework in the sense that you got to be careful. There are folks within that universe who aren’t as experienced as others who compete in that universe.
So you got to get to know the people and understand the source of funds. And that takes time to invest. And then the other interesting trend is, I would say, over the past 17 years, since the inception of our firm, within the lower middle market, sellers have become more sophisticated. And what I mean by that is looking beyond price. So when when a seller truly has a good sense for what’s market, how the transaction process works, whether that’s because they’ve done their own homework independently, or whether that’s because they have a great M&A attorney or an investment banker involved, somebody who’s giving him good advice. They know where companies like there’s trade on a multiple basis, they know where purchase price should be.
And so as long as they’re checking that box and accomplishing their liquidity goal and getting a full fair purchase price, becoming more sophisticated about that next layer of getting to know the people like we talked about earlier, so we see founders increasingly spending more time getting to know us as buyers, which is great. Doing reference calls asking for introductions to other founders who have entrusted us with their baby that they’ve built. And devoting a lot of time to talking about the post close plan, evaluating things like is there a good cultural fit so even though as a investor, we’re different from a strategic buyer that’s going to come in and integrate the company.
We have our own culture at our firm, and the founder who is concerned about making sure that there’s a good cultural fit among the people who are going to be on the board representing that private equity firm at their company, that that meshes well with the culture of the people who are at their company that they care deeply about, in most cases. That’s time well spent. And we’re seeing that become increasingly common. So beyond high valuations, the potential for increasing capital gains. The two things that come to mind there that are maybe more interesting are sophistication of sellers and the time spent evaluating the people who are involved, and then also the growing universe of independent sponsors.
Patrick: That’s real interesting. This is the first time I’ve heard that with, you know, the sophistication, the education of sellers. And I think that’s probably their sophistication of their knowledge base growth is leading to more successful mergers now.
Jordan: I think that’s right, I think there’s better information out there, it’s more easily accessed. And therefore, relative to 15 years ago, if I’m a founder who’s built a successful company in my industry, but I’ve never been through an M&A transaction before, I can learn much faster today than I think was easy to do 15 years ago, because of the prevalence of information that’s out there.
Patrick: And also news gets out within the M&A community, if you’re an organization is making acquisitions, and they and you’re, you’re not as good at integrating post closing, that word gets around, people learn about that. And so sellers aren’t necessarily looking at the top number on on the LOI. They’re they’re looking deeper, which that’s very, very encouraging.
Jordan: Absolutely, you hit the nail on the head, I mean, one of those areas to be cautious for as a seller is sure you get that indication of interest, you get the indicative terms, you get the LOI. And headline, enterprise value says this, you’re comparing one against another. Look at the structure, and then also get to know the people involved. And back to that integrity point. And the track record point. Does the firm you’re talking to have a history of retracing or changing purchase price or really grinding later during the purchase agreement. And some firms do and some firms don’t.
And some firms like we pride ourselves on taking a long term relationship oriented approach where we can serve up reference calls with anyone we’ve bought a business from before, because we pride ourselves on doing what we said we’re going to do treating people well. And 5, 6, 7 years post closing, we want to have a positive relationship with that founder. Because we take very seriously the fact that it is an emotional once in a lifetime event. And we take our stewardship of that company very seriously. Not everyone does. And so spending the time to investigate that I think will it’ll end up paying off in the long term because of the importance of the event and ultimately be worthwhile and make for a smoother transaction and a better partnership post flows for everybody.
Patrick: Well, that’s no surprise that Montage Partners has been doing this for 17 years. Very, very clear. Jordan, you’ve got a great story. Montage Partners has a great story. How can our audience members find you?
Jordan: Sure. So it’d be firstly on our website, which is montagepartners.com. So that’s www.m o n t a g e p a r t n e r s dot com. www.montagepartners.com. There’s a contact form there. We have team bios there so it’s easy to find contact details for anyone on our team and reach out directly. You can also find us on social media. So LinkedIn, Twitter, Facebook, and reach out that way as well.
Patrick: Well, Jordan Tate of Montage Partners in Arizona is our first private equity firm in Arizona that we’ve met. Real pleasure having you Jordan, and I wish you all the success as we go forward.
Jordan: Thanks, Patrick. Appreciate you having me on, and good to speak again.
Our guest for this week’s episode of M&A Masters is Tom Wells, Managing Partner and Co-Founder of 10 Point Capital in Atlanta. 10 Point Capital partners with visionary founders and operating executives to build dominant franchise brands. A foodie who loves hospitality, Tom found a way to combine those by investing in such companies as Walk-On’s and Slim Chickens.
We chat with Tom about the inspiration behind 10 Point Capital, and the meaning behind their brand name, as well as:
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 Tom wells, managing partner of 10 Point Capital. Based in Atlanta, 10 Point Capital is an independent sponsor that specializes in a very interesting class of business, franchises. In particular franchise restaurants, which I’ve seen quite a bit of action in the last 18 months. So I’m excited to get into this. Tom, thanks for joining me today.
Tom Wells: Thank you for having me.
Patrick: Now, Tom before we get into 10 Point Capital and the work in the franchise restaurant area, let’s start with you. Give our audience a little context. How did you get to this point in your career?
Tom: Yeah, so as you mentioned, I’m based in Atlanta, I actually grew up in Atlanta. But lefting left for a while, a long time and came back here. And I’ll give you that sort of path of how I got back here. After college up in the northeast of Boston College, moved out to California had always wanted to live out there. I was fortunate to work for a great investment bank out there called Harris Williams and company. Learned a lot about just middle market transactions, first exposure to private equity. And what that was prior to that had no idea. After spending a couple of years doing sort of the standard banking thing landed at a private equity group down in LA called century Park capital. Nice, very nice shop down there.
Spent a few years there, got an MBA in Chicago, and sort of came out of that first part of my career going you know, I really enjoy working with sort of founder led companies. Really enjoy high growth businesses as opposed to getting in and having to deal with turnarounds or any sort of challenges. And that actually led me to what was a bit of a hybrid venture capital and growth equity world down in Atlanta. Came to work for a firm called VIP capital, a great venture capital and healthcare investor in Atlanta, where my current partner was, had been a founder of in spent a handful of years they’re really doing a lot of growth equity deals. But it led to the forming of 10 Point Capital.
I know we’re gonna talk a little about that. But my founder, my my partner in 10 Point Capital, he had been a founder of VIP capital, but he was really passionate about the franchise space. That had been the bulk of his career. He had worked for franchise brands at points in his career, he had been a franchise investor back to being a work capital, which is a big firm in the space. In a few years ago, probably four years ago. Now he and I just started decided to form 10 Point Capital to focus on one thing, which is just investing in franchisors. And so we decided a few years ago to spin out and go go do that. And that sort of got me to where I am right now, I don’t know that I ever expected to be investing in franchisors.
I think that this sort of consistent thinking about what I was passionate about from early on, and I always had the desire to go figure out something that I could be an expert in. And that was something that I just wanted to do for fun. One is just this, this intersection of just being a growth investor. I love working with companies that are growing, it’s certainly much more fun to be growing and adding locations and hiring people. And that’s just much more exciting. But secondarily, like, I’m a huge foodie. And I love hospitality. And it has always been something that was just more like a hobby or an interest and sort of to be able to mix those two things together and work on restaurants and branded concepts and things that are tangible to people is super fun to me.
Patrick: Well, when we turn our attention to 10 Point, and I always made the mistake of saying 10 points, it’s 10 Point Capital, and you didn’t name it Wells Capital. So you have more imagination than most insurance firms, law firms out there. So before we get into 10 Point, why don’t you tell us how you came up with a name because it’s not good insight into the culture of a firm.
Tom: Yeah, it’s funny. I mean, it is fitting when I people try to brand stuff, it’s really hard to come up with a name, it seems like every name or in particular, every domain name for websites taken. But as we were working on coming up with a name and starting the firm dedicated to this. We one of the things we’re big on is culture, is people. And so we had sat in a room and we had talked about obviously the types of deals we were going to do and the criteria, what they were going to look like. But we talked about who we wanted to be as a firm and what our culture, what sort of culture we wanted to set. And we came up we had 10 values, that we created at the firm.
And so what was what was fun, and I could go through them all but I generally hit on the big ones like the ones that stand apart from me or like creativity and that’s we approach deals in a very flexible, creative manner. Relationships being another core value of our firm, it sort of ripples, all the way from the obviously the leadership and management teams we partner with but franchising is an industry and I’m sure we’ll talk about this too. Franchising is a very relationship driven industry. I’m not sure there are many industries that are more relationship driven. And then there were a couple other values integrity, and just doing the right way.
And determination, I mean, we are, we do not like to ever give up, we are very determined gritty people. But there were 10 values. And so we sit in a room and this took, I don’t know, it must have taken a month or two. I mean, seriously, we’d spent hours and hours trying to think of a name. And finally, one of our operating partners, who’s Charles Watson, he’s the CEO of Tropical Smoothie Café, which we used to own. Charles sat there and was like, you know, what, we have 10 values. Why don’t we just be 10 Point Capital?
That’s like a great name for the firm. And you Google you like sit there and go Google the domain name. And oh, yeah, that’s, that’s available. And it’s just, it’s funny, it fit. It’s a brand like if we’re you think about the segment, we’re in with consumer brands that stand for something. And we felt like picking our names was kind of a cop out, we wanted to have a real brand behind it. Later on, I noticed the benefit. We didn’t even think about it at the time. But the benefit is at any conference or event you’re at, 10 Point Capital shows up first on the list, because it’s in number.
Patrick: Digit. Yeah.
Tom: Secondary benefit is everybody sees us first. But but that’s where the name originated from.
Patrick: Okay. And now in when we spoke earlier, okay, you made a conscious decision. 10 Point Capital is not a private equity firm it’s an independent sponsor. So let’s talk about what you bring to the table as an independent sponsor, and then segue into the focus on franchises because that’s very, very interesting.
Tom: Yeah, so it’s interesting, we formed 10 Point is an independent sponsor, which means we raise capital deal by deal, we don’t have a committed fund, we’ve certainly had that in the past where we’ve had committed capital. But for us, we like the flexibility that being an independent sponsor allows. There’s a few things we like that are really unique about it. One, we’re able to, sort of, we don’t have a set pace, we have to go deals that we don’t have a bunch of committed capital, that we have to go find deals and put capital to work our. Our approaches, we’re going to go spend a lot of time in the industry, getting to know founders and entrepreneurs, and ultimately, hopefully find a deal that we like, and we want to invest our own capital.
And so when we get to that point, then we’re gonna, then we’re gonna go get a deal set up with the founders and go talk to our investor base in what’s interesting is, and we find, it forces you to underwrite those deals more deeply than if you were out of a committed fund where you had total discretion. One of the things I really enjoy is you go put this on paper, you work through your thesis internally, and how it all makes sense, you’ve got to sort of figure out how to convey to your investor base. But then you go talk to 100, smart people, or however many people about this deal, inevitably three, or five, or 10, really interesting insights are going to pop out.
There’s going to be risks that you didn’t even process or think about, for whatever reason that pop out from some of your investors. And so having to on the front end, just apply that amount of rigor to it, we really, really enjoy. I think the other thing we like is, we do one deal at a time, and I’ll get into 10 point of what we do. But we’re never gonna have a ton of deals, we may have three to five companies at a time. And we’re deeply involved in them. And so the approach lets us keep our core team very lean and focused, but also just do the deals we want to do with the people we want to partner with and enjoy working with. And so that that’s worked really well for us.
We have wait, generally we’re trying to do one deal a year, and so you can be very methodical about it. And we like that sort of one deal at a time. I tell investors of ours when we do a deal, they’ll always ask what do you think the next deal is, and I generally always say, I have no idea. I’m not even thinking about it. I’m gonna do this deal. I’m going to spend six months or a year or whatever it takes to feel really confident in the deal. And then I’ll think about the next deal. And I think our investors enjoy and appreciate that that like, we just go heads down and try to work with the companies to get them. Get them going.
Patrick: I think I’m sorry to interrupt, but I can imagine some of these investors because you’ve been successful, that you’re at this nice slow pace. Do they ever get anxious saying, wait a minute, yeah, this was really good, get going, find another one. Or do they say call me first?
Tom: Yeah, it’s interesting. I, they certainly appreciate being on like, we go out to our existing investors and talk to them first. And really, it’s it’s a little unique right now, like, especially where the economy is, I mean, we get more inbound from our investors going, hey, what’s next for us? And we’re we closed on a deal. And we’ll talk about it a closed on a deal six, seven months ago. I’m just starting to think about what’s next. And I sort of joke with investors, like I told you, I wasn’t going to think about anything else. And now I’m starting to think about it. So maybe this year, we’ll have something for you. Maybe we won’t. We feel good about our companies. But that’s it.
So yeah, it’s um, we definitely get some inbound, but we just we go at our own pace. And we feel like we can get good opportunities that way. And I guess I we haven’t really dove in, but diving into what we do at 10 Point Capital, because you asked that also. So we are really simple people as I talked about. So we invest in one area, which is franchisors, and oh, spend a second talking about what a franchisor is, because not everyone fully appreciates it.
Patrick: So I think this is really helpful because this isn’t the procession everybody has is a couple of brands that they know and you’re not picking up into the individual units. So get into that because that’s very helpful.
Tom: Yeah, so we don’t we generally aren’t gonna own many units and so at the franchisor level is the way it works in franchising is founder goes and creates a brand they generally open the first few restaurants or if it’s services, we there are a lot of things you can franchise. They go get their first few open and they start franchising. And what that means they’ll go find franchisees who will come and they’ll pay them some sort of fee to sign up for the system, and then they’ll pay them an ongoing royalty to go open and build their own units. I think what people naturally go to is McDonald’s or Taco Bell.
But there’s a hotel franchisors, their services franchisors like roto rooter and Mr. Sparky, so you can sort of franchise anything that’s replicable and process driven. And so we like investing in the brand, the parent company who’s going to collect the royalties and run marketing and sales and training. And our skill set is more tied to how do you go scale these branded concepts. And so we will invest in franchisors, they have a bunch of sort of similar criteria, because they all look a little bit the same in our mind. In terms of when we want to get involved. Generally 30 to 300 units.
They’re, they have past the point where they can prove that it’s one thing to be the coolest restaurant in Atlanta, or Nashville, or Los Angeles or whatever. It’s another thing to have open 30 or 40 of these things across a bunch of markets and gone, well, when I go to Birmingham, Alabama, I learned I need to be in this real estate or I need to have this type of franchisee or, or this is how I get customers in the door. And so we’re looking for those proof points and multiple markets at that point. We want the franchise infrastructure to be set and we want them to have sold franchises that sort of shows that they can go put it together, get people interested and get that pipeline going.
Patrick: So sustainability.
Tom: Exactly sustainability. The other thing that’s really important to us and you start to see it at this point, and I think it gets glossed over occasionally in franchising it the unit economics have to work for the franchisee. That really just means they got to make money. And they have to make a good return on their investment. And it five units or two units or 10 units kind of hard to see that. But you hit 30 and 50 and 100 units, they might not all work, there’s some painful lessons that get learned along the way. But you know, you figured out if it works and what it generally needs to look like. And then finally, for us people like yeah, at the end of the day, people drive every outcome in probably every investment industry.
And so, for us, we want a founder that’s going to be involved and we our pitch to founders as we help create dominant national brands, we’re going to help you take a great concept and take it national and scale it out. And so we’re looking for that you don’t need the whole management team. But we do want a core leadership team that we can work around. And so those are those are the ideal situation for us. And then I think we’re very flexible. I mentioned this being an independent independent sponsor. My pitch to founders is like a funny pitch, which is you really founder you don’t need us, like you’ve built this great franchisor and they take a long time to build. But you’ve built a great franchisor over 10 or 15 or 20 years, you’re cashflow positive, now you can look five years out and go holy cow, this thing’s gonna grow from 5 million EBITDA 30 or 40 or 50 million of EBITDA.
But we think we can help you grow faster. And oh, by the way, you’ve probably never taken any liquidity. So why don’t we give you a little bit of liquidity now we’ll take a minority position, we won’t, we don’t need to control your business. We’re partnering with you. And we’re backing you as a founder. And that’s resonated really nicely and oh, by the way we can if you need money for growth, too, because you want to invest here and there that works for us. And it’s funny because we do get the question a lot from investors coming in it’s like okay, you gave these founders some capital what is what are they going to show up for work?
Does that how does that motivate them going forward? And the types of brands that we’re partnered with that the founder they’re all in on this this is who they are. They’re here to fight it out every day till the end of this thing and that’s really a consistent across the leadership of our teams. Is that this is they’re not going anywhere. But it is strange it is it is to give them that liquidity gives them comfort. Like they can go home to their family and say, you know, if anything ever happened to me, you’re my family’s taken care of. And oh, by the way, I have a little money in the bank now not enough that I’m going to be happy long term but enough in the bank that yeah, if you if I need to go invest in scaling the business or take a little risk because the upside is huge. I’m comfortable doing that. It’s not like my bag could fail.
Patrick: Well, I think you’re I think your message is is different from some others out there because I really like that genuine approach where hey, you don’t really need us. But we’re here. I can imagine because this this does happen in a lot of professional services too. I can tell you an insurance it will happen where you’ll have somebody from a larger institution going up to a prospective target saying you know what, you’re never gonna get over the hump unless we can carry you. And it’s just absolutely tone deaf and I like the the approach you have and also just the concept that you have. You’re looking for people that want to stay in the business. They’re not looking to exit out as in other cases. And so, by the way your model is set up. I mean, you’re kind of strapped to the to the masthead with them, which is got it got to help with the rapport.
Tom: Yeah, it’s interesting. The other thing we talked to, I would spend a lot of time on is like, you’ve built your culture, you’ve built your brand, and the restaurant, like you sell X, Y, and Z product. I don’t want to touch that the lease like that works all day long. So like, my job is to protect that, like I and it’s important to founders, like, I want to protect your culture, because ultimately, going from 100 units to 1000 units, culture is probably the biggest thing of date that will dictate success for them. It is good is that is it a lot of ways and so telling the founders, look, we’re not here to tell you what to do, we’re here to help you grow faster.
And oh, by the way, you’re there’s probably 10 mistakes you can make between now and then and hopefully, we’ll help you eliminate, prevent some of those mistakes in you know, and not only that we bring a network of companies that we have leadership that just sort of the best practices across the portfolio. And so it’s resonated really well with founders. And we, we get excited about the potential. And usually most of the founders are used to, to your point, the big PE groups come in and go, this is great, you built a great business, I would love to buy all the business.
The founder is sitting there going, but if I just wait to get more like I, I’m not ready to get off, and I get to control it. And I have a ton of upside. And so it’s been, we sort of approach it and I talked about relationships earlier. It’s a partnership industry, it has to work for everybody. And so we try to come with flexibility and creativity to create deals that work for for both sides. And we haven’t really touched on the brands. And that’s probably cool, too. So I can I can tell you a little about that.
Patrick: We’ll get into brands. One of the things as great as when we talked before, I think one of the you’ve mastered a great way of building rapport because of your experience with this. And also as a foodie, you know, the attraction you have to toward the restaurants. But one of the things you’ll ask them or just in conversation is every one of these organizations has a has a you know, troubled stepchild unit talk about that.
Tom: Yeah, it’s what’s fun is so you get these dialogues, and I’m never going to go, what’s your EBITDA? How fast you’re growing? What’s your unit count, that’s like every other person in the segment. And we know the businesses well enough to sort of have a good proxy for what it looks like. What we spend a lot of time on is talking to them like an operator, because that’s how we view the world. And so a lot of the times I get in and go, you have what how you dealing with with, I’m sure you got a couple of operators that are causing you headaches, right now, they probably don’t listen, they probably do whatever, you know, what, which ones are those how you feel about that.
And in it, it really takes their guard down. And I do it in a way that’s like, hey, we’ve got these other brands, I could tell you which ones don’t, you know, mistakes we’ve made or who the operator that we have some challenges with are and how we’ve worked to resolve it and create a partnership with them. And I think acknowledging that there’s always challenges and issues is just it’s such an interesting way to approach it with them. Because it’s not like, okay, these guys are gonna come in and tell me what to do. It’s like, I know, they’re gonna get in the business. And they’ve seen everything.
And they’re going to get alongside me and try to think about it the same way as I do. The other thing we really spend a lot of time trying to do is is getting into your point is like, okay, what problems do you have as a brand? Where are you? Where are you running? Where are you stuck right now, like, chances are, I can get that pert that get the team connected to a leadership team at a different brand. That’s that solved that problem where I’ve got a vendor in the space that can be helpful. And those are things we do before doing the deal.
And partially because we like seeing the transparency from the teams and getting to know the teams, but it’s an industry that likes to help each other. And it’s one of the things I love about it is generally even though that yes, I’ve heard there’s competitors within a segment. People work together in the franchise space. And it’s a really special unique thing. And I think you see people in restaurants in particular, like, they don’t view the restaurant down the street is their competitor. There’s a real community around the restaurant operators. And so we like to take that approach to these deals.
Patrick: Now, before we get into we’ll talk about trends, you know, later on, but just as interest for my audience right now, everybody wants to know, okay, of the restaurant sector, you know, and you were involved with restaurants, you had this desire pre COVID. Why don’t you talk about just the sector right now pre and now we’re mid top, you know, approaching post COVID.
Tom: Yeah, and just I think it’s helpful for reference like where we sit. So with three, three, really two restaurant concepts today and a third concept is non restaurant. So right now we have investments in Slim Chickens, which is like a Zaxby’s type competitor for people who know that chicken tenders segment. But drive through sort of premium chicken tenders. So sort of I would call QSR quick service brands. We have walk ons, which is we just invested in walk ons and now it’s a sports restaurant. There are about 50 of them in the southeast and middle of the country. Their big boxes are full service, sit down boxes. I joke and I know we’re talking pandemic a little bit it’ll naturally come up but we invested in October in the middle of the pandemic, a few months ago.
And then we have a non restaurant brand called Phoenix Salon Suites, which is like a we work for beauty professionals. The professionals are able to come into a strip center and rent a space out in our locations and run their own business sort of fully independently. The other brand was a restaurant brand we just exited last year was called Tropical Smoothie Café. All different scale, the smallest brand being Walk Ons with 50 locations. Tropical Smoothie was about 900 locations when we exited. The others are in the 100 to 300 unit range. But really runs the gamut of type of brand. But in terms of industry trends, and where we spend our time I think what’s what’s interesting to us in the restaurant space and COVID had a bit of an impact.
But we had a we have a heavy convenience focus so the consumer and really look at what the consumer wants over time that we order with our phones. Now we we like drive throughs we like things that are sort of convenient to our lifestyle. It’s interesting, we did a casual dining deal because that’s natural with with Slim Chickens. It’s a drive thru. It’s the most convenient thing in the world. You look at like a Walk Ons, which is a full service sit down restaurant. You can go haven’t that doing the pandemic, and how does that do with, you know, consumers not going to full sit down stuff anymore, and you look at, you’ve got to supplement with third party and carry out. And just create reasons for that customer to come in the restaurant. And so, yeah, then you’ve got to have a convenience component to your business with takeout and third party delivery.
But also, you’ve got to give consumers other things, you’ve got to use technology to engage with them. And to get them to come to you versus other people, you definitely in the restaurant space, have to innovate, I think what’s what’s fun to us is, if you stop innovating as a restaurant, there are very few chains that keep their menu the same forever. And like you can think about McDonald’s or I don’t know, whatever it is, but you look at if people go like Taco Bell changes its menu all the time. You look at just sort of anything else in the franchise space or the restaurant space, you’ve always kind of got to go to what’s next and innovate.
And so we spend a lot of time thinking about just the trends and what could happen over time in restaurants. And so like for us, we when we get involved at the core, we’re like data and analytics driven focus. So we’re going to spend a lot of time helping put technology in place to go figure out what works and doesn’t work and what the analytics are and how to how do how are the customer trends going over time? And what can we do to impact that. But we’re gonna spend a lot of time on consumer facing technology too. I want my I want the consumer to be able to pick up the phone and order it as seamlessly as possible and come by and get it regardless of the restaurant type in I think I probably would have said pre COVID you know, look, you look at drive thru concepts, maybe you don’t need as much technology.
But chick fil a has a great, incredibly good app, our chicken brand ton of the orders are coming now through technology through order ahead and through third party delivery. And so I think you just have to stay aligned with where the trends are going. I think if you step back like we when we like to invest we also look at the industry trends.
So Slim Chickens like people love chicken that segments growing like crazy. I look at like the Phoenix salon suites business salon suites is an industry segment are growing 15% year and that brand is the number two player in the market. It’s it we have natural talent, you look at walk ons, and I think people go well, casual dining is you know, people don’t go out as much. But if you go into secondary and tertiary markets, which is our bias, so not not the big cities, not New York, Chicago, LA. But you go to like Birmingham and Toledo and Tulsa, Oklahoma, just great markets with a lot of people.
And you put a really high quality restaurant in there that’s consistent and treats them with great service and great food and a cool culture around it. People come back all day long. And so I think it, it can surprise people that are in big cities that brands like Olive Garden, Texas Roadhouse, it just do incredibly well in these markets. But it’s a great growing segment. And so then our goal is okay great brand great culture, like let’s think about what the brand what it looks like, in five years, how’s that consumer going to evolve? And what are the trends going on? It’s very fun.
Patrick: I think that’s what you’re that’s the real value you’re bringing in is you’ve got that that broader perspective as owner founder, they’re, they’re busy running the units, menus and the day to day stuff, and maybe looking for new alternative opportunity here or there. And you come in with big picture, particularly with the technology view, I think is very, very helpful. Because you could just see it, I mean, Silicon Valley learned that that you know, brands would live and die based on the user experience on the website. And you know.
Tom: It what’s interesting is like in the technology world has figured out there’s a lot of restaurants and a lot of franchised restaurants. So the amount of technology coming into our in our segment is, is interesting. And you have you talk about restaurants and like it traditionally has been a buyer that’s not as sophisticated on technology, right? You’re like, I’m gonna fry chicken or i’m gonna I’m going to make hamburgers or I’m going to do whatever I do, and I’m going to replicate it over and over again. In technology is very limited impact in that. And that’s changed a lot over how you advertise over how you run all the systems within your restaurant over how you integrate into third party.
And so it’s been really interesting to see the amount of kind of SaaS base products that come into the space selling. And you have the restaurant operators going, I can’t even parse this together in the brands, that evolution and five years later, over the last five years, if you had told me our brands would have Chief Technology Officers five years ago, I go in, that’s kind of crazy. Having a little bit of a technology investing background, I go, Hey, we don’t need those. Every brand needs a technology Chief Technology Officer now. And that’s been a huge evolution here. I think the other thing I would say, and so helping them focus on like, alright, how do we get the right partners in place, and you can, what’s great is the flip side of having all this technology coming into our industry is you don’t have to custom build anything anymore.
So you can go off the shelf, and you can piece it together. And everything integrates with API’s. And so it is nice that you don’t have to, you don’t have to custom build software, but you do need someone who knows how to integrate and sort of deal with data management to be your technology lead. I think the other thing we spent a lot of time on with these companies is just focus, like a for those who deal with entrepreneurs every day, part of why you’re an entrepreneur is you have a lot of ideas, and you’re always running around trying new stuff. And I could never do it. I just that’s not my personality. And I have tremendous admiration for someone who can start a business from scratch, especially in the franchise or the restaurant segment and grow it.
But there’s a point where it helps them to have focus. And so a lot of what we come in and if building out the team is like what do you not like to do as a founder? Well, let us help you hire some people that go do the things you hate doing anyway. And two, how do we help you focus on what moves the needle? So founder, if you ask that we and we love doing there’s going to ask what are the big things you’re working on this year? Generally, you get a list of like, five to 25 items they’re trying to do to do in one year.
It’s like we’re going to we’re going to change this system, we’re going to do this we’re going to do the new menu, we’re going to add in should change our prototype, you know, it’s 50 things long, it’s just a ton of stuff. In helping that founder go, okay, it’s great. But you can probably only do three of those big things like your whole team has a day job. And so we’re gonna let them do their day job in but we’re gonna help you focus on let’s get three things and let’s do them well, in over a five year period or seven year period, if you do three things a year, you’ve transformed that whole business.
Patrick: Yep, 15 to 20, out of the 30 to 50 are done. Yeah.
Tom: Yeah. And so we spend a lot of time there, because I think it is being not so in the weeds, you can step back and help them have a framework around. Yeah, you need to do this. But oh, by the way, does it drive your revenue? Does it drive your franchisees profitability or does it help your brand? And there’s a lot of stuff that just gets pushed off that list?
Patrick: It’s not an issue of discipline with them, it’s just bandwidth. And so get getting the focus there works out really well, I think the other issue that’s, you know, critical for people to understand with that your structure as an independent sponsors, you don’t have a fund, so you can’t afford to have misses. If you’re making an investment or you’re, you know, investing diligence on on a target, okay. You can’t afford to have something in the margin. So you’re spending more time looking at these things. And, and you’re you’re, you know, tied to tied to that investment a lot more directly than somebody who has a fund, and this is one of 30 portfolios, so you got to get it right.
And I bring this around, because, you know, you had mentioned earlier that this with a franchise is a big relationship oriented business. You cannot remove the human element from mergers and acquisitions transactions and doing investment and so forth. And as you’re going forward, you know, these deals involve risk. And there there is risk, these don’t, don’t happen in a vacuum. And you’re dealing with owners and founders that haven’t gone through an M&A process before. And you’ve got a longer diligence period.
And there’s always the potential that some disruption or distrust can build up from beginning to end the process, because you’ve got the diligence, you then get to the indemnification wording in your purchase and sale agreement that what the seller hears when you’re talking to them about this, it’s essentially, look, I know, we put you through all that due diligence, but you know, just in case, we the buyer missed something, and it cost us money down the road. You have to pay us so but don’t worry about this standard business stuff. We’re used to that. Okay, that’s what the seller hears. And the seller’s response is gonna be, I answered all your questions. You can’t hold me responsible for something I didn’t know about.
To which an experienced buyer is gonna say, yeah, but we’re making a bet on you 10s of millions of dollars, that your memory is perfect. And this is the process of just go forward with us and trust us. And, you know, the seller can forgive the process over time, but they’re never going to forget that. And if the the tragedy of the situation is it’s not, you know, being taking advantage of somebody is just an experienced party versus a less experienced party. In the whole process, the beautiful thing is the insurance industry has a way that that process or that that inflection can be avoided. And that’s ensuring the deal.
Okay, the product out there is called reps and warranties insurance. And essentially, it’s designed to step in the shoes of the seller. And in terms of the indemnification obligation, just essentially they look at the reps that are in the agreement. They look at the buyers diligence to make sure that they looked over and vetted the reps. And essentially, they make a statement for a couple bucks. If a breach happens post closing buyer, you come to the insurance company we will pay your loss don’t go to the seller buyer come to us buyers like that because hey, they’ve now they’ve hedged the risk. And if there is a loss, they can have no guarantee that it’s going to get covered and they don’t have to pursue the seller, seller comes out with a clean exit.
They usually have very little money that’s held back in escrow because the policy attaches at a lower point than most escrow. So the escrow being lower means seller gets more cash at closing. More importantly, they get the peace of mind knowing that, hey, in the event, something does happen, I get to keep my money, there’s not going to be a clawback. Now, this product rep and warranty ensures is being used throughout private equity right now. However, it was pre pandemic, it was reserved only for $100 million plus transactions, okay had to be up on the big ones with the big diligence and the big firms and everything. So smaller targets like these franchise, franchisors weren’t eligible.
That’s changed. Now, because of competition in the insurance market deals. The rules for eligibility for deals to be insured have gone from $100 million threshold down to as low as $10 million threshold. You don’t need audited financials and extensive diligence. You do need diligence, but you need simplified stuff. And so the more we can get that word out to organizations, the better because I will tell you from personal experience, if a buyer gives the seller an option saying hey, well we can do an escrow and uninsured the deal or will insure the deal in your escrow is now a fraction we just move forward with that, how about that. 99 times out of 100, the seller is willing to pay the entire cost of the policy. Just to get that release.
Okay. So if you’re a buyer, I mean, this zero cost to you. And you know, we see this as a real positive effect. Because I mean, private equity is already in place it on the larger deals, it’s now down to the smaller ones. But you know, you don’t have to take my word for it. You know, Tom, good, bad or indifferent. What experiences have you had with rep and warranty?
Tom: Yeah, it’s funny, like you mentioned, it was harder to access on the smaller deals in the past. And so we have used it it generally, we want to grow these businesses and obviously sell them for a large amount of money. And so we’ve used them on it’s been in play on exits, and we’ve had it on the on the sell when we’ve been selling a portfolio company. It’s great to have it sort of to your point, it really simplifies that process on the back end, because you realize there’s really no or minimal exposure to you as a seller for to your point, things you didn’t know about or didn’t weren’t diligenced properly, or whatever.
For whatever reason. You know, we have not used them going into any transactions. I think is you talk about that where the you can get the policies is come way down market now to smaller deals. And some of the deals like we do, which typically are we’re a minority shareholder, I think about the types of deals we do. And it sounds incredibly interesting and helpful to those types of deals. So you like you put ourselves in our shoes. So we’re a minority partner, we come into your point, these are founders that we’re investing in, there are a couple things in the purchase agreement that actually matter in sort of this is one of the contentious issues that really matters when you’re giving a founder the first liquidity and they’re going, wait, you’ve come clawback 20%, or whatever he put up of the capital in and so that’s scary for them.
And then you think about it for us. So we’re a year into a deal. And this this happens from time to time. Things pop up. Maybe there’s some sort of basket or some sort of threshold you’ve got to meet before you can go collect. But you go okay, well, I’ve crossed that now. It’s like I got about $100,000 of claims. We might have invested $15 million. It might be or 20 or $30 million, you may have $100,000 or $500,000 worth of claims on stuff that you know matters, but it’s not a ton of money. Now I’ve got to go back to the founder. I’ve got to say I need that money out of your pocket.
Oh, but by the way, we’re still partners in this I promise you we’re still partners, and we’re going to be in this for a long time together. It’s a really uncomfortable situation to be in from us because we’re a minority shareholder, they’re still in the deal. The relationship is what drives these deals for us as minority shareholders and so that having the ability to go put something in place like that, that now that it’s sort of moved down market to where we’re investing, it’s something something we’re gonna look at on our deals.
Because it If you don’t have it, then you’re otherwise making a business decision, like, I’m going to chase this. I’m either going to chase for this money to get back from the founder that’s going to jeopardize and potentially ruin the relationship. Or I’m going to somehow have to give that money up. But hopefully that I can, you know, keep the relationship and that drives better returns, and it becomes really much more of a business decision for us. So yeah, being able to take that off the table would be really interesting and helpful in our deals.
Patrick: I’ve heard here in Silicon Valley, because we’ve got a lot of aqua hires in the tech sector, where the business doesn’t have very many assets, they’re just bringing over the team. And that’s a real dilemma that that the buyers face because all of a sudden, they bring in this coding team or programming team and great talent and everything, and they’re rock stars. And they’re waiting for their $2 million escrow return.
And the you know, the the buyers just sitting there saying, okay, how do we break it to them that, you know, we just had a $1.4 million loss? Yeah, that that’s a real tough pill to swallow on why he says business decision, if you’ve got an insurance company on their net, you report it. So, it makes it makes it a lot more elegant and say it’s it saves the sizzle relationship. Now, Tom, we mentioned before that, you know, as we’re recording this, we’re, you know, thankfully on the back end, I’m confident to say now on the, I guess the beginning of the end of the pandemic. What trends do you see for the rest of the year going into 2022?
Tom: Yeah, it’s really fun where we sit, so we get consumer data every day, right? We have consumer facing brands, and you see what the consumer is doing every day versus the prior year, and the years before that. And the week, and you can compare to past weeks. What’s crazy to us is over the last call it five, six weeks. So we’re coming out of the back end of the pandemic, there’s vaccines, there’s obviously with stimulus money that went out earlier this year. We are seeing record days across all our brands from from a spending perspective. And granted, our brands are concentrated more in, like I said, secondary tertiary markets. So we’re not in cab, we’re not heavy.
In California, we’re not in big cities, that still may be a little shut down. We’re in southeast middle of the country, smaller towns in there, our people are out spending. And that includes our walk ons, which is just sit down all the way through slim chickens, which is more of a fast food restaurant we have seen across the board. And I sort of expected going into this that we’d see from a consumer perspective, okay, restaurants are open, I’m going to stop going through the drive thru or picking stuff up or doing a pizza or whatever I’m going to do, I’m going to shift over to sit and back down on a restaurant. And they’re absolutely going to sit down on the restaurant, but they continue to order go through drive thru and do delivery pizza. And so I think the rest of this year, we are going to see a lot of consumer spending. And I think we’re already seeing that, right?
Like you’re seeing supply chain disruptions just with the amount of spending going on. But I’m really bullish on what the rest of the year looks like for people where we are. It’s really interesting on the franchisor side. So we spent a lot of time thinking about how do you go sell find good franchisees basically sign franchise agreements. And what we’ve seen at this point in the cycle where you get this, you had an economic disruption, people were a little nervous about where they their livelihoods came from and how much control they had over their own income. It’s actually great for franchising, people go say, you know, I’m gonna go into business for myself as a franchisee. And so what we saw sort of coming the last half of 2020. And we’ve seen that continue into this year, franchise, interest is way up. So all our brands sign more franchise agreements with new franchisees than ever it wild and last year.
So I think from our industry perspective, it things are really positive. I think from a consumer perspective, I would expect a lot of spending this year. You know, it’s it is a foodie, and someone who loves independent restaurants is really sad to see all the carnage that happened last year. I mean, there are a lot of independent restaurants and small businesses that didn’t make it. There is in the restaurant industry in particular, but all retail like a little bit of organized chaos, and that those in those failed, but now you’ll see a new wave of restaurants reopen, it may, we may all be eating a lot more chain food this year, until that they all get open.
But in about a year, you’ll see these restaurants open back up and in the cycle happen again. And what’s cool is okay, the local spot closed down and it’s it’s, it’s awful. And it’s really sad. But another chef is going to come around and go I’m going to raise a little bit capital from people I know. And I’m going to maybe I’ll get that second generation restaurant space cheaper. And I’ll go open my restaurant finally. And the landlord will cut me a deal because they need someone in there. And so you’ll see new stuff pop up and keep going and that and that’s when new concepts get created and new brands get created.
And so it’s unfortunate This is sort of how it happens. But on the on the back end of that I think we’ll see a lot of obviously economic growth and we’re already seeing that in the consumer spending. And then we’ll see new brands and new cool things grow. It did this the restaurants and retail that opens on the back end of any sort of economic hiccup. tend to be the best investments to get made. They just tend to cost wants to get into and they do really great volumes.
Patrick: Yeah, I that’s a great observation. I think that there are there’s a rumbling out that a lot of people in the labor force of at least the executive force and so forth, are not going to be as dependent on an employer for their livelihood, they’re going to take matters into their own hands. And I think that’s a great, you know, observation you have there because we’re seeing that another little, little things as well. But, you know, real real alpha Wolf. Tom Wells of 10 Point Capital. How can our audience members find you learn more about 10 Point?
Tom: Sure. Our website is 10pointcapital.com. It’s the number 10 point p o i n t.
Patrick: No s.
Tom: No s. 10 point capital, you could probably google it with the s and I bet you we show up still. Hopefully and or you know, I’m available. I’m always around via email. So, T for Tom Wells, w e l l s @ 10pointcapital.com. I always love hearing from people who like the space or new brands or and talk I can talk franchising all day.
Patrick: Look, you and I could talk restaurants and you combine two things I love which is sports and and fine dining. So it’s just too bad, too bad California may not be an ideal market for you at this time.
Tom: Yep, yep. No, but we’re the we’ll get them spread out. So when you’re on the road, you can go to one.
Patrick: Outstanding. Well, Tom Wells of 10 Point Capital. Thanks for being a guest. Really enjoyed the talk today.
Tom: Thanks for having me.
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:
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.
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.
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:
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.
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. email@example.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.
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:
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
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.
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.
On this week’s episode of the M&A Masters Podcast, we are joined by Brooke Ansel, Vice President of Prudential Private Capital. She runs a Prudential team focused in the southern United States, but her career path to the investment company was unconventional – it started with the Neiman Marcus buying team.
Brooke tells us about how Prudential is more than just a bank – it has a commitment to the lower middle market that might surprise some listeners. Prudential Private Capital focuses more on debt and minority equity, and acts as the private capital arm of the larger Prudential institution.
We chat with Brooke about what Prudential Private Capital brings to the table, as well as:
Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Service. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Brooke Ansel, Vice President of Prudential Private Capital, in their Dallas office. Brooke it’s great to have you. Thanks for joining me today.
Brooke Ansel: Patrick, thank you for having me. Thrilled to be on today.
Patrick: This is unique. Usually, we’re talking with either private equity firms or other capital providers in the lower middle market. At the first blush, you think Prudential big institution, large cap, you know, interest only, not the case. So it’s a pleasure to have you. So before we get into that, though, let’s talk about you. How did you get to this point in your career?
Brooke: Yeah. So as of the beginning of May, I’ll be with Prudential for about seven years. It’s gone by very quickly. Like Patrick, like you mentioned, I’m a Vice President. And I run a team here in Dallas and focused really in the southern part of the United States. But I have what I would call a fairly untraditional career path to where I am today, actually started out of undergrad at Neiman Marcus in their handbag buying office.
So after getting a finance degree, that’s what I chose to do. And it was a fantastic experience, I got to learn about a lot of different parts of business, including marketing and finance and inventory management. Among other things, it was great experience, but decided to then pivot and pursue more what I would call traditional corporate finance opportunities, including an opportunity at a large hedge fund here in Dallas, and then at Deloitte. So like I said, kind of untraditional, I think to the role I’m in now, but all great experience. And I would say just a great journey. And a lot of that experience I leverage in my in my role today.
Patrick: I can say, you can’t understate the importance of experience. And it’s great because you go from school right into where you’re an operations and working on something on a large scale. And and so you get to see a lot of little things, rather than being in some boutique where you’re just narrow in one area. So that’s excellent. Now, as I mentioned before, people don’t necessarily think of an institution like Prudential being active in in investing like this or more of just like a bank. Okay, not the case. Talk to me about this, and how Prudential Private Capital how it’s different from, you know, just a regular bank. And also, its commitment to the lower middle market, which again, complete surprise. And I’m glad you’re here to tell us about that.
Brooke: Yeah, I’m so glad to have this conversation, because like you alluded to, a lot of people hear the name Prudential. And they either think of, you know, oh, they’re only investing in public securities, or they just think of our retirement and retirement products, life insurance products. So Prudential Private Capital, we’re a part of that broader Prudential. And we actually have about 100, I think we’re close to 100 years, in terms of our history as the private investing arm for Prudential. And we largely focus on on the debt side, but we do provide minority equity as well. So really think of us in terms of all types of private, private capital. And that’s what we’re doing on behalf of Prudential. So it’s great and that we have, you know, this large balance sheet that we’re investing on.
But we have, we can get into this a little bit more, as we talk further. But we have these smaller regional deal teams and regional offices that allow us to get to know management teams, get to know sponsors in our territories. And that allows us to invest, you know, private capital in the lower middle market and middle market space. So we’ve been around for a long time, but I feel like a lot of people aren’t as familiar with kind of what what we do on the private capital side.
Patrick: Connection we have with Prudential is they start off as a life insurance company. So you got you gotta like that little connection with with the legacy there of insurance and then broadening out into other financial areas. So you’ve got this large institution, and you referenced this real quick as you got a deal team. So you’re a lot more nimble than people think. Why don’t you talk about what the what are the elements that Prudential Private Capital brings to the table?
Brooke: Yeah, this is such a great question. And I know you know, one of your prior guests I know alluded to the fact that all capitals and saying no money is greater than any other money, one of my good friends, Heather Hubbard, but you know, I think in terms of our secret sauce, and what we bring to the table is really this idea of our network. And it’s our internal network as well as our external network. So the culture of just our organization, I work with a lot of people who’ve worked together for literally decades and just know each other very well, we can be nimble, make decisions quickly, just because our senior management team has been together for so long and through cycles.
Not only that, you know, myself and the other team leaders, my peers, we’ve all been with Prudential for years and know each other well. So we’re able to network be nimble, get smart on different situations, different industries, really quickly through just our internal network within our group. But beyond that, you know, we talked a little bit about our regional office network, you know, I am very focused on really sponsors and companies in my backyard. So I know what’s going on in the market dynamics in my region. And as well, as you know, my colleagues across the country in the world, actually, very similar model, they just get to know people and their markets really well.
And then beyond that, I mentioned our global footprint, you know, I have they’re individuals like me who are based in our London office, or Frankfurt office or Sydney office. So we have this global network and and global client base team base, that we’re able just to pull a lot of knowledge from leverage relationships, and help not only kind of our colleagues, but also are the companies and sponsors that we back in terms of the institutional knowledge that we can bring to the table. And then really, the last thing I’d mentioned, separate from just our network, both internally and externally, would be our ability to really bring capital solutions to bear. We do have, you know, a lot of capital to invest, which is helpful, but not only that, we have the ability to invest across the capital structure. So senior debt, mezzanine debt equity, so a lot of flexibility that I really do sets us apart in terms of creating capital solutions to get deals done.
Patrick: You know, and the other thing is, is, you know, I didn’t realize until we had met that, okay, Prudential, you know, may be a financial institution, but Prudential Private Capital is not a bank. So you got a lot more tools at your disposal. With regard to that, where, you know, your basis of lending or basis of investing is slightly more flexible. Talk about that real quick.
Brooke: Yeah, you know, um, a lot of our underwriting or really all of our underwriting is more cashflow based, yeah. And so instead of looking at asset values, or we’re frequently really underwriting to cash flows, so that in itself, I think creates some more flexibility in terms of the capital structures that we can look to provide. So while we also partner with a lot of banks to in terms of, you know, oftentimes there’s a senior facility and either we’re providing fixed rate long term debt along that big facility, or we’re providing mezzanine and junior capital, so, so just, I like it really an apple and an orange in terms of my commercial bank, banker friends, but great ways that we can partner together to get to get transactions done.
Patrick: Yeah. And the other thing that works out pretty well as you don’t have the regulatory constrictions or constraints that banks have, you can get out there. And the other thing I think, is appealing, particularly and we can talk about this with independent sponsors, which is an emerging class of equity out there is that you’re not interested in majority investments, you want to stay minority, which is very helpful. I mean, there are those that want an exit, there are others that hey they want to come in, they want to make an acquisition, they want to be the majority. And that fits right in with your appetite.
Brooke: Yeah, absolutely. A lot of what we do, at least on the equity side is minority equity. But also in situations where you can stretch the balance sheet a little and provide mezzanine, a lot of people will either call it an expensive debt or cheap equity. Okay, so yeah, so in certain situations, there really is the ability to provide mezzanine, it’s less dilutive to owners, or there may be situations where, you know, the owner doesn’t really want to give up control, but they need to whether it’s take some chips off the table, they want to make a big acquisition, they need to buy out a shareholder. There are a lot of other reasons why, you know, junior capital is important.
Patrick: When you bring it you bring it that way. Now, we brought up the topic of independent sponsors, which is kind of a segue into, you know, your ideal client. Why don’t you give us a profile on who does Prudential Private Capital best serve?
Brooke: Yeah, so you know, it’s really across the board, Patrick. We, we work with a lot of sponsors, both small and larger funds just because of, you know, our minimum check size starts really at 15 million, and then we have the ability to invest up to a couple 100 million. So we do work with smaller, kind of first time funds, some of the larger private equity funds, but then we also work a lot with management teams on a direct basis with companies. So our, I would say, you know, it’s a pretty broad, a broad range of clients that we work with consistently, though, it’s, it’s people that really value relationships, and value potential and what we bring to the table and really want a long term partner that they can trust, build a relationship with, which I think you know, a lot of our clients definitely saw the benefit of that during COVID.
Any potential client that I’m talking to, I would say, call some of my clients that we worked with during COVID. And they can talk about how we were patient, we listened a lot of dialogue during very, you know, very challenging time for many of our clients. So that’s a long way to answer your question. But, you know, we work with a lot of different types of firms, different sizes of firms and companies, but consistently, it’s folks that really value relationships.
Patrick: Yeah, well let’s not gloss over this COVID thing you just you just referenced quickly is, you know, with Prudential Private Capital, your your capital is more patient, and you’re going to find ways to make make your investments and your clients successful. So your cut, you’re kind of, you know, aligned with them in the interest, and you’re not trying to just roll them out and get him get an exit, you’re, you’re invested in their growth. And I think being there for the long term really helps with relationships.
Brooke: Yeah, absolutely. I do think that our approach is it, like you said, more of a long term kind of approach, and with some of our clients, you know, we’ve been invested for a very long time and have had long standing relationships with them. And, you know, in periods of destructive of disruption and uncertainty, that just is so so important. And I think, you know, also think about just our regional office model, the fact that, you know, I’m either in the city or a short car ride away, and not sitting at a, you know, not in New York location, you know, I mean, it’s, I can’t, I’m really kind of in in their backyard. While we couldn’t necessarily always be with each other in person, I think there is this element of, you know, close by in a more normal world, being able to respond in person, if that’s what it requires, and just relationship oriented, not transactional oriented.
Patrick: Well, and as you talk about relationships, I mean, you cannot disregard the human element, particularly when, when we’re involved with investing in mergers and acquisitions, and so forth, where, you know, it’s not Amazon, buying Whole Foods, this is a group of people choosing to work and partner with another group of people. And for an ongoing relationship. And, you know, ideally, one plus one equals six, and so is important to, you know, nurture those relationships. And one of the things that happens with mergers and acquisitions, where, you know, there’s there’s a recipe for failure is where you have an experienced party on one side of an M&A deal, usually the buyer, and an inexperienced party that are not naive, they’re just an inexperienced, that’s the owner and the founder that have gone through an M&A deal.
And things that are routine to the buyer, are scary, and, and, you know, disrupting to the, to the inexperienced player. And so there’s a recipe there for a lot of tension, a lot of unknown, just from a misunderstanding. And you know, one of the errors that comes in a lot as we see in mergers and acquisitions is where buyer goes through a very invasive due diligence process, and then following that says to the seller, okay, well, we’ve got this thing called an indemnification clause, where, and this is what the seller buyer saying, just in case we missed anything. This this clause says that I can claw back money from you if there’s a thing that blows up post closing that you didn’t tell me about, and I might have missed intelligence. And also the seller is like, wait a minute. I’ve just shared everything with you. I’ve answered all your questions.
How can you hold me responsible for something that I didn’t know about? To where the experienced buyers as well, I’m making a bet 10s of millions of dollars that your memory is perfect, and that you’ve told me everything. And you can get through that a bit and the seller will eventually you know the deal gets closed and the seller will forgive the process but they’ll never forget the feeling they had and something like that situations completely avoidable because the deal can be insured, there’s an insurance product called rep and warranty insurance where it steps in the shoes of the seller and says essentially, look, if any of the seller reps get breached the reps that the buyer performed diligence on, didn’t find anything.
And those breaches cost the buyer money, the insurance company, not the seller will go ahead and make the buyer whole buyer has certainty of collection. So that’s all good, they’re set to go sell, I guess, clean exit. And usually, not only did they get more cash at closing, because the policy attaches at a lower point. So there’s little or no need for an escrow. But like a peace of mind that, hey, I get to keep all the money that I got fantastic, let’s move forward. And what was pre COVID, rep and warranty insurance was restricted to deals north of $100 million in transaction value. And then just prior to COVID, the threshold, the rules for eligibility dropped all the way down.
So deals as low as $10 million are eligible for insurance now. And so it’s a great way for, you know, even minority players to have their interest covered on this as well. And so it’s been just a boon for the M&A in the lower middle market space, which is why we were trying to get that word out. But as a reliable tool, don’t listen to me, Brooke, good, bad or indifferent, tell us about your experience with rep and warranty for your clients.
Brooke: Yeah, I mean, I would say that it is really just become the norm and a part of the natural conversation to at least talk about is this something that is necessary in the transaction or not. And, and I would say just consistently, like you mentioned, there, there are benefits to both the buyer and the seller. But more importantly, it can just help the speed up the timeline of the transaction, and help the buyer and the seller, get the deal done. So I just think that it is becoming more mainstream and and definitely a product that is, you know, a few years ago, you know, people were talking about, but now it’s just I feel like it is just a part of the M&A world now. Very interested to hear that now then the threshold for deal sizes has come down. So that’s, that’s exciting to hear.
Patrick: As we’re going through this year, right? At this point, we’re recording, I just mentioned to you in the pre recording talk that I just got, my daughter got 16 year old got her first COVID shot. So we’re I’m confident that we’re at the beginning of the end of the pandemic here and bring it back to work. And, Brooke, from your perspective, what do you see going forward for the rest of the year be it M&A, Prudential?
Brooke: Yeah, I’m, I’m with you, I am very optimistic about the outlook. For the balance of the year, I just got my second shot. And I really think that things are opening up. So definitely optimistic for the balance of the year. But as it relates to M&A, I mean, what I’m hearing from my network for people that are really involved more on the front end of the process in terms of sell side and investment banks, that they are very active. And it sounds like there are a lot of companies that, you know, maybe were in market pre COVID, or because of COVID had decided has decided that they want to explore strategic alternatives. And really, their focus was, you know, let’s get through kind of 12 months with really good trend lines, good performance, good, trailing 12 month kind of performance.
And then let’s go to market. So I’m really optimistic that it’s going to be a busy second half of the year for M&A. And clearly the capital markets, there’s still a ton of capital available, whether it’s in the public markets or the or the private markets, and Prudential actually, we just raised our sixth mezzanine fund. So we have more junior capital to put to work which we’re very excited about. So I think that you know, q4 of 2020 was extremely busy and people have kind of taken a taken a little bit of a breath either they’ve been closing deals that didn’t get closed by the end of last year, or they haven’t taken a deep breath and I’m I’m certainly gearing up for a busy second half of the year.
Patrick: You know, I think that a couple things that happened was the dry powder and private equity didn’t didn’t blow away during COVID the other the other issue is the other thing that didn’t stop all a lot of things in life stop time didn’t and so got a lot of owners and founders out though that everybody got a year older. I think I agree with you that there may not be just rushed to market because you know, there might be buyers taking advantage of trying to get a discount because you know past performance and you know relying on earnouts or something post closing calculation right?
I agree with you I think there are going to be a lot of companies that just they want to hold until they get that 12 month trend line and and get that get those our arrows pointing up into the up into the right and and it’ll improve their position a bit. So that’s a well noted. Brooke, tell our audience how they can find you and your group to learn more about Prudential Private Capital.
Brooke: Yeah, so the easiest way is just our website, which is pretty easy. It’s prudentialprivatecapital.com. And then me personally, I have a LinkedIn page there get it’s Brooke Ansel. And you can find me on LinkedIn and I try to post interesting content from Prudential and when you know welcome to connect with anyone to talk further or network regarding M&A and, and capital availability, so.
Patrick: Yeah, I will vouch for Brooke also, the emerging independent sponsors that used to be called fundless sponsors, her relationships in that area if you’re if you’re an individual investor, I think the connections that Brooke has and the relationships and the resources she has available is ideally suited for that class. So definitely give give Brooke a call. Brooke, thanks again very much for for this it was a pleasure having you today.
Brooke: This is a lot of fun. I’m a big fan and consumer of podcasts. So to be a part of one is was a lot of fun. So I appreciate it.
Patrick: Now you can start your own.
Our guest for this week’s episode of M&A Masters is Jon Finger. Jon is a Partner at McGuireWoods LLC in Dallas, and his practice focuses on private equity and corporate transactions. He and his partners were the first in the area of independent sponsors to create a private equity practice dedicated to independent sponsors. Jon and his partners also created “Deal-by-Deal”, a podcast that focuses on the independent sponsor community of the M&A market.
Jon says, of this independent sponsor relationship, “Many of these sellers are selling their baby – this has been, and will be, their legacy. Finding independent sponsors who are really appreciative of that is a big part of what we look for in our network for the clients that we want to be working with.”
We discuss the importance of building a network and prioritizing the independent sponsor relationships, as well as:
Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Jon Finger, Partner and McGuireWoods. McGuireWoods is a full service law firm with over 1000 attorneys and 24 offices throughout the US and beyond. Jon’s practice focuses on private equity and corporate transactional matters from McGuireWoods, Dallas office. It is in the area of independent sponsors, where Jon and his partners were the first to create an M&A practice and ecosystem dedicated solely for this segment of private equity. So it’s a real great pleasure to have a true pioneer in a new class of business for private equity. Jon, thanks for joining me today.
Jon Finger: Thank you, Patrick. Pleasure to be here.
Patrick: Now, before we get into the practice of with independent sponsors, which literally did not exist until you guys came along, let’s start with you. Tell us how you got to this point in your career.
Jon: Sure. Really appreciate appreciate you giving me the opportunity to join you today. So I’ve been I’ve been practicing for about about 20 years. And about halfway through my career, which had predominantly been representing lower middle market, committed private equity fund clients, we saw a lot of activity within that independent sponsor community. And at that time, it was still evolving. The models obviously been around for some time, but it was really, I think, evolving into what has become today. And it just happened to be around the same time that myself and a few of my partners were changing law firms. And around that time, what we dedicated ourselves to was building our network. And so we had this network of capital partners, family offices, private equity mez funds, etc.
And as we built that network, what we found was, there was an incredible intersection with the independent sponsor community. And so as we were building the network, and our practice was evolving, what we like to think was our secret sauce was our ability to introduce investment opportunities to our network of capital partners. And so we were going to trade shows, we were calling on companies, we were doing all these different things. And we saw a lot of great success out of that. The reality is, it’s very time consuming. And so ultimately, what the a bit of a lightbulb moment was, the independent sponsor in our network can be doing a lot of that spadework if you will, for us. So as we started to see, okay, if we spent more time harvesting our independent sponsor relationships, and really finding opportunities that they had, that we could then introduce to our capital partner network, it really made what we were doing much more efficient.
And so we weren’t having to necessarily go out there, find those investment opportunities, we were leveraging the independent sponsor community. And so what really led to where we are today, I hearken back to that where it was a situation that we were at the intersection of capital partner, and deal opportunity. And so it really allowed us to differentiate ourselves with our network. And we we continue to do it today, with I think, really good results. And that that was probably the biggest pillar of what led to where I am in my practice today, where a lot of my work is, is with independent sponsors.
Patrick: And let’s get a little bit more detail with the independent sponsors. How are they different from private equity or other other investors or acquirers out there?
Jon: Sure. So lots of different ways, no doubt. I think the first thing I tell you is, of course, you know, every independent sponsor is different. That’s the beauty of it. That’s the fun of it. But as a general matter, right, independent sponsors don’t have a committed fund that stands behind them that they’re able to draw down capital for each deal. So you know, the independent sponsor, let’s say they’re putting in 500 grand sometimes seven figures. The reality is, most videos we work on me independent sponsor is putting that level of capital. And there’s another, you know, $10-20 million in equity capital and obviously lender coming in.
So the biggest difference right is they don’t have that committed fund behind them. What that also means is, it allows the independent sponsor to really identify the capital partner that makes the most sense for each opportunity and each situation. And so, you know, use the word the scope bespoke if you want. Luckily, I got the right on the second try there, but so it allows them to bring more of a bespoke nature to each opportunity that gives them that flexibility and differentiates them from a traditional private equity fund. Another I think area that I would want to really highlight with the independent sponsor is it’s a segment of private equity. But there is a perception out there with some sellers, that it’s, you know, big, bad private equity, right? And what does this mean for my business, and so a lot of our independent sponsors, really had the ability to play off that, and, and just, you know, many of them are entrepreneurs, many of them sold their business, and now they’re looking to acquire a business.
And just that ability, I think, that they demonstrate to relate to those sellers is another way that they’ve been able, I think, to differentiate themselves from more institutional, private equity. And, and it’s, it’s really something where I think the independent sponsor has also capitalized on these market dynamics, if you will, where you have the sellers, and you know, it’s it’s definitely a robust M&A environment, as you know, but there are a lot of other things that it allows the independent sponsor to come to the capital partner, and also have a situation where you can really be creative with the economics that the independent sponsor is, is receiving on each different deal. And so, you know, maybe it’s not a two and 20 structure, right. And so there are a lot of those different optionality, if you will, that the independent sponsor brings brings to the table, I’m sure we’ll, we’ll talk more about some of those things. But I think high level, those are probably some of the bigger differentiators.
Patrick: Well, I the perception out there. And this is why it’s so important, I’m so happy to have you here in the lower middle market with with sellers that need to know about all these different options out there on alternatives is where to go. Unfortunately, a lot of organizations, they, the owners, and founders who aren’t in M&A every day, if they don’t know any better, they default to, you know, a strategic, which may not have their best interests at heart, they may default to an institution, or you know, they may be fearful of private equity, and just shut the door on that completely. And that’s, that’s not at their advantage. And so it’s very important to understand that there are these great options out there.
And you know, quite frankly, until I learned more about your practice, I had a notion about independent sponsors where they were the sole source of capital, and so they only targeted smaller deals, they didn’t have the, you know, the reserves. No, they tap on that, and then they can leverage that to their interest, which is also I think their interest is is aligned with with the sellers. Explain how you guys develop this practice, just from the ground up. I mean, it because, and we’ll get into this a little bit more, but I mean, this is a pretty fragmented sector.
Jon: That’s the beauty of the sector. From my perspective, it is it is an endless ocean of opportunities for us to develop relationships, and add value to be independent sponsors. I think, as I look back on how the practice developed, you know, again, the reality is this model has been out there for a long time, back when it was, you know, a guy or gal with a deal who just, you know, was raising capital from his neighbors. And then it was called fundless sponsor, right, which I’ve really tried to push hard to get away from that one, because, you know, it does have a bit of a pejorative nature, but the reality is, it’s not true. I mean, these independent sponsors, yeah, they don’t have a $300 million fund behind them, but they’re writing meaningful checks on these deals.
So, you know, I think that evolution of, you know, bringing helping bring credibility to the market was something that really helped us develop the practice, but I think a few things I would point out kind of getting back to what I was talking about before. What we have the ability to do is, is really eliminate a lot of the friction in the system where, you know, independent sponsors may have the need to hire a placement agent sometimes right? For a given situation. And there may be instances where, look, what we’re trying to do is connect our capital partner relationships with our independent sponsor relationships. To be abundantly clear. We’re lawyers, we’re not bankers, we can’t get paid introductions, introductory fees, placement fees, so that friction’s gone, right, we’re just trying to put the right groups together to get deals done.
And so that was a really, I think, powerful message and continues to be. But of course, one of the things that independent sponsors always struggle with is dead deal risk, right? That’s part of the equation that they don’t have the ability to just have $100,000 dead deal expense and just draw down from a fund to pay it. And so, for us, it was being selective around developing relationships, that we really wanted to have 5, 10, 20 years down the road, and be creative with ways that we could truly partner with those independent sponsors. And so whether it’s discounting fees or finding other creative solutions, where it’s not okay, just write me a check. That ability, I think, to be shoulder to shoulder with the independent sponsor was was really powerful. What we did with our network was, as we found different opportunities to connect our networks, we created essentially YPO for independent sponsors, which are regional chapters of independent sponsors that get together, share best practices, and and ultimately find opportunities to connect people with deals.
Those chapters led to us developing our independent sponsor conference a few years ago, which in 2019, we had over 800, solely independent sponsors, and capital partners. And it was a great opportunity to get everyone together. And it was all people who wanted to be there because of who was there. Right. And, and that obviously had great benefit to us, not from a charging registration fees, but from a developing our network and our client base. And so that has really, I think, allowed us to take a leadership position in the independent sponsor community, and develop that practice, where I do think we’re regarded as the preeminent firm with independent sponsor transactions, either on the capital partner side, the independent sponsor side, and really just knowing what’s market, right. And that’s a critical component to all of these deals. We’re in the middle of our latest deal survey.
So we’re leveraging both our expertise, but now we’re taking that opportunity to get input from our network of what’s market on all different sorts of components of the deal. And so that’ll be coming out down the road. And then I think the last thing I would tell you about really being a true partner to the independent sponsor is, in the next few months, we’re going to be launching independentsponsorforum.com, which is our, I think, what we’re trying to do is find that next way to develop a true platform for the independent sponsors and the capital partners, that has a lot of great content, and really allows us to demonstrate, again, that leadership position within the community. And so that’s kind of, you know, starting from day one to where we are today, I think some of the, the hallmarks along the way that have really allowed us to grow the practice.
Patrick: One of the things I really appreciate what you’re saying I’m I’m a marketing guy at heart, I really enjoy messaging and the importance of communication. But, you know, you built the practice, largely not on just the relationships, but just the trust that you’re going to execute. You’re not getting paid just to be around and do introductions, but you’re literally your interests are aligned with the independent sponsor, and you want the best for them and it’s a small community, so clearly you are doing something right, because all you have is your reputation and you deliver. And execution I think is is important, particularly for a lot of firms out there, where they may have a lot of resources, have a lot of other things to offer and make a lot of noise, but at the end of the day it’s execution.
And this is a class of private equity that cannot afford as you said, you know, misfires And so that I think is critically important that you’re coming in and you’re delivering that. And then just through that great reputation now, the community is expanding, and you’re not sitting back. McGuireWoods is finding more ways to add value through information and best practices so that more deals happen faster, smoother, cheaper, happier, and and that aligns a lot of specialty firms. And so it’s such a pleasure to have a firm like yours to highlight on that. Now, one thing I will say is I’m very proud of our platform here at M&A, M&A Masters Podcast. But we’re not the only podcast out there that is talking about mergers and acquisitions and everything. Jon will talk about your your show, because that’s actually how I found you,
Jon: Sure. No fantastic. So one of the I think ways that we’ve been trying to transition and continue to grow a lot of what we’re doing. A couple of my partners, Greg Hawver and Rebecca Brophy really are spearheading deal by deal. And so it’s a podcast that’s focused on the M&A environment, but in particular, the independent sponsor community. And so we’re really trying to, I think, highlight, a lot of best practices within the independent sponsor community, also highlight different independent sponsors and capital partners. But to your point, particularly with what’s been happening in the pandemic, having that ability to find different ways to connect with your network, they’ve done an incredible job. And it’s, it’s, it’s definitely something we’re super proud of.
Patrick: Yeah, I consider the silver lining of the pandemic, the evolution of, you know, the the Zoom, and the podcast and the communication, because there are messages out there. And it’s just, you know, finding the right channel where there’s an area of interest. And I will tell you, there are over 1 million podcasts out there. And there wouldn’t be that many if there weren’t such a diverse amount of interest out there in need for information. And something that’s, you know, quite frankly, quite, quite easy to deliver. Jon, let’s talk about, you know, give me a kind of a profile of your ideal client with the independent sponsor. I know very similar to there are other things out there. If you’ve seen one independent sponsor, you’ve seen one independent sponsor. Is is there, you know, for others that are listening out there, give us an idea, what’s the ideal profile of a client from McGuireWoods with this practice?
Jon: Sure. So to your point, is, is definitely spot on. So within the independent sponsor community, there’s no question that there’s no one size fits all for what the what the ideal client for us is, in the sense that a lot of our clients in the independent sponsor world spun out of blue chip, private equity firms, they have that pedigree of doing deals, and now they’re doing deals as independent sponsors, they have been, and I think, will continue to be a great client base for us. At the same time, a lot of our independent sponsor clients are entrepreneurs who founded and sold a business. And now they want to go out and do it again, maybe they’re looking at bigger deals, maybe they sold their business to private equity, and started to understand that model better. And frankly, a lot of our independent sponsor clients who’ve been wonderful, are true CEO level talent, that, you know, maybe they made a lot of money for private equity.
And they have a Rolodex within a market or within a segment to say, I want to go out and do a roll up in this space. And that allows them with that domain expertise to really be a powerful and successful independent sponsor, and a great client for us. I think, when I look at some of the, I think, common characteristics, I would look at the independent sponsor who really wants a different value proposition who isn’t just looking for a lawyer that can draft a document for them and, you know, get them to closing. We’re looking for the client that really wants us to be their partner. And so whether it’s to the point about helping them find capital, helping them find, build out that executive team, helping them find the right provider, I mean, frankly, for services they need in conjunction with a deal.
We’re doing a lot with our CPA network, as you know, and I’m sure we’ll probably get into later, the prevalence of rep and warranty insurance on basically all deal sizes is huge right now. And so, where they say okay, who are the right firms to talk to, to go out to get a policy, our ability to say, okay, we’ve seen Patrick in action on X number of deals, and he’s really the value add guy around what’s important in this policy? What’s your history? What’s the claims history with this insurance? So I guess what I would say is that ability for us to really help develop the ecosystem and find independent sponsors that value, that benefit that we can provide is always huge for us.
But building those long term relationships, right, it’s we want that client, that’s not just coming to us for one meal, that over the next 20 years, we’re going to do 3, 4, 10 deals with them, and develop that trust. And that relationship, that’s probably the most important thing. And then ultimately, right, just doing the right thing, just finding people who they’re going to treat people, well, in particular, these sellers, many of these sellers, right. They’re selling their baby, right? I mean, this has been, and will be their legacy. And I think finding independent sponsors that are really appreciative of that is a big part of what we look for in our network. For the clients that we want to be working with.
Patrick: Well, there’s a couple of things you brought up there that we’re definitely going to segue into. And, one of them is, first of all, you cannot remove the human element with these transactions. You know, most people out on the street, they think M&A, they think Amazon buying Whole Foods. Company by company. This is people working with people. And you know, within that you got humans that are fallible, and there’s fear, there’s greed, there’s all these other emotions that come into these, you know, life changing in some cases, transactions. I mean, they’re they’re very, very big deals for people. And you cannot dismiss that. And so you’ve got that element where you met with reps and warranties insurance, the amount of risk, these deals do not happen in a vacuum, there is tremendous financial risk that can be out there for the seller, who is personally financially liable to their eventual buyers.
And when a business owner is not used to M&A, it comes a realization that it is they can’t hide behind their corporate veil, it is their personal assets, their wealth, their retirement, literally their house could be at risk. And that realization comes to them a lot of times after they’ve gone through due diligence, they’ve been trying to work with the other counterparty and work together. And all of a sudden, boom, I’m responsible for you with my wealth for something I may not have known about. And in the typical response for a real, savvy, educated, experienced buyer is, well wait a minute, I’m making, you know, 10s of millions of dollars bet that your memory is perfect. And I’m afraid I just can’t do that. And so you’ve got that conflict where you’ve got a buyer that doesn’t want to get stuck, you know, with a lemon, and the seller doesn’t want to be kept on the hook indefinitely, particularly for things they don’t know about. So you’ve got that natural tension that can devolve to being adversarial is really a danger out there.
And what’s been great is the insurance industry came in with an insurance policy that transfers that risk away from the deal parties over to the insurance company. And the benefit to a buyer is, hey, if you have a financial loss as a result of the breach of the reps, you have certainty of collection, and you’re not going to have to clawed back and have ill will toward your target company who is probably now partner of yours, okay, for the seller. The policy can replace 90% of an escrow. So less money from the purchase price is being set aside and goes right to the the seller’s pocket. So they get more cash at closing, even better to get the peace of mind that they’re going to keep more money because there’s not going to be the risk of a clawback and as you know, is a product that has stood the test of time and is being used, you know, quite a bit now throughout the M&A community.
The news that I want to share out this is that this product was reserved solely for deals that were $100 million transaction value and up, you had to have thorough diligence, you had to have, you know, audited financials, you know, do extensive third party diligence of which was very, very expensive, so it wasn’t a fit for the sub 100 million dollar deals. That’s changed, thanks to technology, thanks to competition, eligibility standards for rep and warranty insurance have never been simpler. The cost has never been lower. And the claims it’s been sustainable where the claims have not overwhelmed the industry so we can see these lower rates continuing for a very long time. And there may have been players in the M&A space that maybe thought about rep and warranty a year or two ago, and had a not so good experience. That’s not the case now. And the more people understand about that, the better. But again, you don’t have to take my word for it. Jon, good, bad or indifferent. share with me your experience with rep and warranty.
Jon: Sure. Excellent. Give you you know, I won’t choose your word I’ll tell you mine, right. It’s been it’s been phenomenal. And I think what I would say you hit on it, but I think my biggest takeaway that what, what I appreciate, and frankly, what my clients appreciate, is, if you’re doing a $20 million enterprise value deal, you can get rep and warranty insurance. And frankly, I’m doing one right now, that’s about 14 million. Right. And so, I think that that’s definitely something that my clients have not really understood as well as they should have. It’s not just the 50, 75, $100 million deal, you can really get a policy on a $20 million deal. That, you know, frankly, a lot of the time, as you alluded to the sellers rolling over, right, maybe they’re the CEO, whatever they are, and the idea that there’s going to be some sort of friction, right, or post closing dispute is just, it’s heart wrenching. It’s difficult in whatever word you want to choose. And having that ability to, for lack of a better phrase offload the risk, right.
But it’s, it’s to me, it’s less about offloading the risk. It’s offloading the friction, right? It’s, it’s having that ability to say, okay, let’s really focus on what’s best for the business going forward, let’s focus on growing the business. And if we ran into a issue with a customer, let’s not be focused on was there a breach of a rep, let’s focus on how do we make that relationship better. And so our experience with rep and warranty it with, if I look at my deals, it’s it’s probably two thirds of my deals, it’s probably maybe more, maybe less. But you know, two thirds of my deals have rep and warranty insurance. And it’s a great product. It’s it really has developed and mature, where it’s an incredible tool for all the reasons you stated, but I just can’t I can’t overstate the impact of having the ability post closing, not to have that immediate dispute, particularly when, as we all know, that first year that integration period, that can be the most difficult, challenging, time consuming. And frankly, it can it can really have a determination about how things and how relationships evolve. And again, just taking that out of the equation, to a, to a full extent, or a partial extent, is extremely helpful.
Patrick: Yeah, what’s real tragic, and, you know, these disagreements are all avoidable. Yeah, you know, insurance is not the magic bullet is gonna cure all ills, but just having that there lowers the temperature in the room. And then, you know, as we go on with life, I mean, there’s so much concern in M&A now about, you know, communication and culture and those types of areas that we didn’t think about 10-15 years ago. And so anything we can do to enhance the relationships, I think, is a definite net positive. Now, john, as we’re talking today, you know, we’re getting through the first half of 2021, we’re, you know, fingers crossed, we can see the end of the pandemic out there. I mean, it’s, it’s possible now, more so than before, you know, and in this, you know, circumstance, you know, what do you think, what trends do you see either for independent sponsors, specifically, or for M&A in general, for the balance of 2021? What trends do you see?
Jon: Sure, I think that maybe I’ll think a bit of the easier one is this is a very robust M&A environment. And I don’t think anything on the horizon for the next nine months, leads me to believe that’s going to change anytime soon. There’s just so much in the way of tailwinds going on with the economy going on with the reopening trade, etc. So I think generally M&A, it would be very surprising if we didn’t have a very strong year. On the independent sponsor side. I think you’re going to continue to see a few things. One, the the attractiveness of the deal by deal model in the independent sponsor framework, I truly believe will continue to grow over the next however many months and years. And so much of that comes back to, there’s so much dry powder out there, people are desperately trying to find different opportunities to get capital to work.
There is undoubtedly on the capital partner side, an interest in diversifying their private equity dollar investments, right. And so maybe they’re not going into the next Apollo or BlackRock or whatever it is, and finding an opportunity to be have more discretion over where their money is going. You know, and maybe it’s understanding the be independent sponsor oftentimes brings more proprietary deals brings more attractive deals, but at the end of the day, brings deals with the capital partner can say, yeah, I want to put my money behind this one. And that’s a different construct than just putting money into a private equity fund. So I really do think you’re going to continue to see that demand side from the capital partners. And then the independent sponsor, there’s a lot of reasons of course, why the model is so attractive. And it’s going to continue to be so and I think you’re going to continue to see increased supply of independent sponsors out there.
And so those factors together, I think, will generate a lot more independent sponsor transaction activity. Another trend I tell you that we really see and have seen is a bit of a increased focus on what I would call hybrid structures. So there’s definitely some good things about the committed private equity fund model, there are some good things about the independent sponsor model. And a lot of our capital partner relationships and clients are looking for as well as independent sponsor relationships. And clients are looking for opportunities to bring the best of both to their structure. And so there are a lot of different hybrid structures that we’ve been working on, that both sides of the equation are very interested in. And I think that’s going to continue as we project forward.
The last thing I’d probably put out there around the independent sponsor community is I have seen as the proliferation of independent sponsors continues, I have seen a greater focus with our independent sponsor community on being a bit of a more of a domain expert, and focusing more of their attention on I’m not just looking for a deal in manufacturing, business services, consumer healthcare, technology, you know, I’m going to be a SaaS guy, or I’m going to be looking at opportunities where I can bring my manufacturing expertise to bear and so I do think that the generalist independent sponsor will always have value. But I also feel like we’re going to continue this see this trend of independent sponsors being more focused on certain industries, where it ultimately just I think, allows them to bring greater value to their capital partner relationships.
Patrick: Well, I think the idea, first of all, that continuing innovation and iteration of the structures is is really encouraging because it’s not just one way or the other, let’s find a third way. And that seems to be prevalent. And I think that naturally, as you have more buyers coming into a space, you know, as with anything else, you’re going to have to differentiate yourself. And and I think that only as more value. More competition is always is always a real good thing. So great, great insights there. And we got to keep an eye out for that. Jon, how can our audience members find you and McGuireWoods, not only you know, for the McGuireWoods Dallas, but also for the upcoming conference that you’re going to be having? I believe it’s in October. And if you can restate again, the podcast.
Jon: Sure. So the podcast is Deal by Deal. Those will be coming out on a very regular basis. Our conference will be late October, in Dallas at the Ritz Carlton again, we have some really neat improvements going on this year. For more information. Pretty simple, independentsponsorconference.com. And then also keep your eye out for independentsponsorforum.com. We’ll be rolling that out in the next couple months as well.
Patrick: Jonathan Finger of McGuireWoods. It’s been an absolute pleasure. Thanks again for joining us today.
Jon: You betcha. Thanks, Patrick. I appreciate you.
Our guest for this week’s episode of M&A Masters is Scott MacLaren, Partner of The Sterling Group in Houston. The Sterling Group is a private equity firm, one of the oldest in the country, and currently has $4 billion of assets under management.
Scott did not start off in private equity – he studied at the United States Military Academy at West Point, started business school after serving in the Army, and then finally found his private equity calling after working as a consultant. He started recruiting heavily for the middle market, and has now been with Sterling for seven years making investments in the industrial sector.
We chat with Scott about his path to The Sterling Group, as well as:
Patrick Stroth: Hello there I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters, where I speak with the leading experts in mergers and acquisitions and we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Scott MacLaren, Partner of The Sterling Group. Based in Houston, Texas, The Sterling Group is a middle market private equity firm that builds winning businesses for customers, employees and investors, and Scott it’s just a real great pleasure to have you here. Welcome to the show.
Scott MacLaren: Thanks, Patrick. Appreciate you having me on.
Patrick: Now I’m looking for I’m looking forward to talking about Sterling and your approach to a lot of things, but before we get into that let’s set the table. Why don’t you talk about yourself. Tell us what got you to this point in your career.
Scott: Yeah, no absolutely. And you know my path to private equity was fairly non traditional. So I did my undergrad at the United States Military Academy at West Point. I went there because I wanted to get a good a good education but also wanted to serve my country. And I entered before nine 911 so that definition of serving the country certainly evolved over time. I graduated went to US Army Ranger School and met my platoon. Served as a platoon leader, spent 15 months deployed to Iraq during the now famous Troop Surge. And while I enjoyed leading soldiers and I liked the Army, it wasn’t what I wanted to do forever.
So after completing company commander in the army I applied to business school and went to Wharton and you know to be honest entering business school, I didn’t really know exactly what private equity was. I went into business school with the intention of being a management consultant or an investment banker or one of those you know traditional jobs you would think about in business school. It was probably my second year before I fully grasped what private equity was and that’s when I really started to focus and shift my efforts that way. The tough part was getting hired in private equity straight out of business school when you have a military background and no banking or consulting experience, it was really difficult.
So I decided to go to BCG and do consulting immediately after business school and get some of those hard skills that I felt like I needed to make a transition into private equity. And you know I enjoyed working at BCG and I enjoyed the projects that I worked on. Most of my clients were Fortune 500 companies and I thought about staying but you know what I didn’t like was it there was no ownership. You know you you work a lot of clients that are Fortune 500 companies. You run into middle managers there who are very risk averse and a lot of them you know we’re just trying to continue their career, so they could get to that retirement point. Collect that pension or you know maybe they weren’t risk averse and they liked your proposal and you liked your ideas but as a consultant you’re just too expensive to keep off from implementation.
So you never get to see a finished product or even if you do get to see the finished product, you personally don’t have upside in that. And so as I was thinking through where I wanted my career to go I really focused back on private equity and started recruiting heavily for PE in the middle market where I felt that my skill set that I had developed both those soft skills that I learned leading in the military which I think are directly applicable to leading and driving improvement in the company. And then those hard skills that I picked up and consulting. And so after two years you know I started applying and started to talk to firms and fortunately for me Sterling Group took a bet on me and I’ve been here for over seven years now. Have closed almost 30 transactions, which a handful of which has been platform investments. And then the vast majority or a large portion have been add on acquisitions of various sizes.
Patrick: Well I hope you never get tired of hearing this but first of all and from the bottom of my heart thank you very much for your service and good for you to see how you managed to progress through this from zero background into creating opportunities for yourself. And I completely understand if you get to a point where you want to have passion and you want to make a change or make a difference or at least have some kind of impact that you could feel. You just kept looking you didn’t just settle down on it so that brings you over to The Sterling Group and as you, let’s talk about Sterling Group from from what you and I gathered in our first conversation, it’s among, if not the oldest, private equity firm in the country so tell us about Sterling
Scott: Sure so The Sterling Group we are a Houston, Texas based operationally focused middle market private equity firm. We make control investments in the industrial sector. We define industrial is manufacturing, distribution or services companies. We’re investing out of our fifth fund which is a $2 billion fund that we raised last year. A typical target for us is 100 million to 750 million total enterprise value company, and we primarily invest in founder or family owned businesses or corporate carve outs. We also occasionally buy assets from other institutional investors, but that is less prevalent compared to the other two types of companies. And we currently have 10 portfolio companies. Sterling was started in 1982, as you pointed out, one of the oldest private equity firms in the country. And the gentleman that started his name is Gordon Cain.
Gordon was an operator and he had run chemical plants for many years. And in his 70s, he decided he wanted to be an entrepreneur. So there’s there’s hope for all of us to be an entrepreneur eventually. So he started buying businesses in in spaces that he knew well. And, you know, this was the 1980s. So it was sort of a wild west era of leveraged buyouts. And it was a newer concept, the LBO was, you know, very new to a lot of folks. And there were certainly a lot less firms doing it versus today. And in 1987, Gordon acquired several chemical plants and grouped them together and called them Cain Chemical. He paid about a billion dollars at the time, got 97.5% leverage from bank on the deal. Something you could never do in today’s LBO market as things have progressed, but again, sort of the wild west era, and he put 25 million of equity on top of that, for the for the total purchase price.
They bought the companies. Gordon, obviously being an operator knew how to operate the companies. He implemented an esop an employee stock ownership program, so that the employees, 1300 of them, could participate in the upside of the investment and really got the employees together and on board with driving improvement in the company and increasing the profitability. Less than a year later, they sold the business for 2 billion to Occidental. So they made 44 times their original investment. More than 1000 employees made $100,000. 57 became millionaires. And keep in mind, that’s a 1988 dolllars, when when those amounts were were fairly significant. Not that they are not significant now, but but that’s big money, for sure.
Patrick: Yeah, that’s real money. Yes.
Scott: Yep. You know, the employees, it’s funny employees took out a full page ad in the Wall Street Journal thanking him a Harvard Business School case was written about his team. But that was really the most notable point beginning of Sterling Group. And they continue to operate and do deals all the way up until 2001, in sort of what I would call past the hat fashion. So you know, they would go talk to a company about buying them doing an LBO. And, you know, to get the equity, they would pass the hat around to friends, collect it up and get the deal done. And that worked for them. And they were quite successful with it for a number of years, until a point where the number of private equity firms had increased in the space. Competition was more significant.
And other private equity firms had raised institutional dollars in committed funds. And so then that pitch changed a little bit in the sense of, if you’re a seller, are you going to sell to the person says, don’t worry about it, I’m gonna pass the hat around and get the money or some of that has committed institutional dollars, saying no, my investors are contractually obligated, and we have this money. And so that is when Sterling started raising committed funds. Raised the first one in 2001. I joined in fund three, and it was an 825 million fund, we did fund four, which was a billion and a quarter, and now we’re on fund five, a $2 billion fund.
Patrick: Clearly, you’ve got a track record of success, and you’ve got the longevity. You’re flexible, flexible enough to make a change as the market and, you know, keep keep a step ahead of the competition. So well done for you and Sterling. But Scott, as you know, there are over 4000 private equity firms out there today. You know, what does the Sterling Group bring other, you know, in addition to its legacy, what do they bring to the table that the others may not be doing?
Scott: Yeah, in 4000 is the first time I’ve heard that number, but that is a big number. So I’m gonna tell you just in the seven years that I’ve been in the industry, the number of new firms that come every single year, it clearly is an industry that continues to grow. But you know, what we do, we have been around for nearly four decades. In the big three differentiators, I always point folks to one, we are operationally focused, and I’ll talk about that in a minute. Two, we push incentives deep within an organization, and we are a true partner. I’ll talk about that a little bit more in a minute. And then lastly, we have 40 years, almost 40 years of experience. And through those 40 years, we’ve interacted with a variety of different companies on a variety of different initiatives.
And we have a playbook that we can bring to the table that we know helps to generate and create value. Just on that first point operationally focused. I think a lot of private equity firms like to say they’re operationally focused. And you know, folks say, Well, what does that mean? In you know, the firm saying, are they actually truly operationally focused? And I’ll tell you what that means to us at Sterling. And look, we invest in industries that that are inherently not sexy. And we find that exciting. I mean, we we own companies that make trailer axles that that make bathtubs, I mean, things that you just don’t think about, but we all love it. We’re all operators at heart. We roll up our sleeves and we get to work right alongside our management team. You know, just an example of this, we have a program that we call The Year Away. And this is a little unique compared to all of our peers. I don’t know anybody else that does it. But every, every investment professional that joins us out of their MBA program, we send a portfolio company for a year, where they embed with a management team. And they work on the most important initiatives at the company, and report to that CEO at the management team.
And we do this for a variety of reasons. But we think it’s a very invaluable experience, because allows our people to learn how to drive change, improve an organization and create value at a middle market industrial company, which is an environment, I can tell you, as I spent my year away, it is different than the Army, it is different than certainly working in investment bank in New York, it is different than being a consultant for a Fortune 500 company. And it’s an experience as an investor, if you’re out there looking and partnering with middle market, industrial companies, you ought to have that on your resume in order to be really a true partner, and understand the companies and the way they function. And what is feasible to get done with those companies, when you invest in partner with them.
Patrick: I think before you get to the next part I clearly operational is in your DNA just from the founder story, okay, and to incorporate and inculcate your investment executives in there, where you’re embedding them for a year, that only, you know, builds familiarity for the professionals in there that get familiarity from the management team that’s working with them. And it just shows you’re going to some additional loyalty and commitment that’s in there, both sides because of that year away. So I would picture you know, the the physician being sent off to Alaska, you know, once once he got his degree, and he stuck there for a year, but I think is a very, very positive and unique way, and you’re walking the walk with your own people. So I think that’s fantastic.
Scott: Agree. No, it’s everybody that’s done the year away comes back, I think with a completely different perspective about what is feasible, and you’ll never look at investment the same way. You’ll never look at a middle market company the same way. And we’ve never had a CEO turn down the opportunity to have a you know, post MBA quality investment professional join their team and report to him for a year. Could be because we pay for it. But it also could be because they know that person’s driving value. But it’s been a really successful program for us in developing our folks here at Sterling.
Patrick: Great. Now your next point, the second one.
Scott: Yeah. So we push incentives deep within the organization, because we want to be a true partner, you know, just like Gordon did in the 80s, with the esop. And of course, we don’t do esop’s now there’s some tax implications to that. But one of our big tenants is to push options and equity, deep in our portfolio company so the employees can participate in the upside. We think managers who are owners operate with a different mentality, and they’re able to embrace improvement initiatives, and incentivize to grow profitability. And option payouts at our companies can be, you know, quite large, how to deal that, that we exited recently that I was involved in, we had over 80 option holders, in those 80 option holders made more than $30 million in option proceeds.
And so, you know, for some of these managers, it could be a life changing amount of money, it can pay off mortgages. And you see people understand that at the beginning of your investment, and they will work hard and drive toward that goal of an exit of growing the business of improving the business to get an exit in order to achieve that. And it’s a that is probably one of my favorite parts of the job, to be honest.
Patrick: I think it’s also real generous move. I mean, it’s it’s strategically brilliant. Because if you’ve got buy in from the rank and file, okay, and you’re all going in the same direction, you’ve got, you know, communists of purpose, what better way to do it, and then you get the the outcome. I think the other thing that you touch on this, and I sincerely believe this is that mergers and acquisitions represent the most exciting business event out there. Some people would argue it’s IPOs. I think nothing has a greater chance of being a life changing or even generational change than a M&A transaction. I’ll tell you, you know, Scott, if you and I are doing our jobs, these life changing events happen. They happen faster, they happen cheaper, they happen simpler, and they’re happier. And who wouldn’t want to be part of that?
Scott: Agreed. Couldn’t agree more, Patrick. Absolutely. And then just lastly, so 40 years of experience, here at Sterling in it’s certainly what we have what’s called our seven levers, which are the seven areas over the last 35 to 40 years where we’ve learned there are opportunities to drive value creation. And so we sit down with the companies that we partner with, and we go through an entire strategic plan and layout when we’re gonna pull each one of these seven levers throughout the lifecycle of that investment, and get the employees and the managers on board with doing that. And we have experience from other companies where we’ve done this and can leverage that experience from the past, to help the companies that we’re working with now, to increase the probability of success on pulling each one of those levers successfully and growing the business. And so for me, those are the three big areas where I think we differentiate ourselves. You talk to other people, they may have different opinions, but those are the three that we certainly focus on.
Patrick: Well, tell me, you know, as we talk about mergers and acquisitions, usually, you know, the folks on the outside of M&A think they think of M&A as what they read in the newspaper, where you have Amazon buys Whole Foods. And in reality, it is a group of people choosing to work with another group of people. And the objective is one plus one equals five or six. However, these deals don’t happen in a vacuum, there’s risk. And when you got human beings involved, you got you know, fear, greed, worry, a lot of a lot of these elements out there that that the outside world doesn’t know about. And you know, quite frankly, a lot of the target owners and founders who don’t go through M&A day in and day out, they get surprised when they go through a due diligence process. And then at the end of that they get informed by their attorney.
Well, here’s this indemnification provision we need to talk about. And then they learn, wait a minute, I’m personally liable financially to my buyer, if something I have no idea about, and they didn’t find in diligence, will cost them money post deal. Wait a minute. You know, and all of a sudden, you get that injection, that you’re not able to hide behind a corporate veil. Your future, your wealth is at risk. And that can create not only worry and fear, but some distrust. And the tragedy is, you know, these types of interruptions and so forth. You know, they’re they’re reasonable, but they’re avoidable. I mean, on the buyer side, look, they don’t want to be stuck holding a lemon.
And on the seller side, they want to be, you know, on the hook indefinitely for things that are out of their control. And they’ll they’ll protest, but an experienced buyer is going to say, well, you know, you’re asking me to bet 10s of millions of dollars that your memory is perfect. And I just can’t do that. Well, what’s been nice is that the insurance industry came in a few years ago, and introduced a product called reps and warranties insurance. And what it does is it looks at the seller reps in the purchase sale agreement, polls the buyer to find out what diligence the buyer did to make sure those reps was accurate as possible. And then they say, hey, for a couple bucks. If something blows up, and buyer you suffer financially, don’t go to the seller come to us, we will give you a check. Just show us the loss. And we will go in. Buyer has certainty of recovery.
So their downside is now been hedged. They also avoid the real uncomfortable situation of having to claw back funds from their their seller. On the sell side. Number one, they have more cash at closing because rather than having a large chunk of funds being set aside in an escrow account for cash on hand, the insurance policy covers 90% of that. So not only does the seller get 90, 90 plus percent cash at closing, they’ve got the peace of mind when they get to keep it because that risk of a clawback is now gone. It’s out with the insurance industry. And it’s it’s revolutionized mergers and acquisitions to the point where well your targets are in for your platforms are 100 million dollar transaction value and up, you’ve been very, very active in add ons, deals that are way under 100 million probably isn’t as low as 15 to 20 million. This product rep and warranty wasn’t available for those until now.
That’s now been something that’s been coming along now, in the same benefits for the larger transactions are now being available to the smaller ones. Which is great because saving two or $3 million for an owner and founder on a small deal. That’s a huge, huge difference. You know, but you don’t have to take my word for it. You know, Scott, good, bad or indifferent, tell us about your experience with rep and warranty.
Scott: Yeah, so over the past seven years, it was funny when I started in private equity, you know, rep and warranty insurance. It wasn’t it wasn’t that prevalent, you know, certainly it’s existed. It was used on select deals. But over the past, you know, five or so years, it’s really evolved. And I’ll tell you now, we’re at a point where I can’t think of the last deal I did where we didn’t have a rep and warranty policy. And as you mentioned, even on the smaller deals, it used to be you would have difficulty finding underwriters, to quote the smaller deals. People would say 20 million TV was kind of the mark, and now we’re at a point we quoted, we had, you know, put one out to market a bit ago and we have four different underwriters quote a deal that was under $20 million of TV, which is just really impressive and tells you how far this market has come.
But to your point in terms of what it’s allowed us to do, it creates doing a deal, particularly with um, I wouldn’t say it’s sellers, who aren’t normal sellers. So, you know, founder and family of businesses, they may only do one transaction in their entire life. And that transaction they’re looking at, and they’re looking at that, you know, the the purchase agreement, which is 100, you know, 120 page document. And lawyers, and I love lawyers, and we can’t do our job without lawyers, but they’re very good about making you think about that 1% scenario. And so you’ll get founders and family owned businesses that think of that purchase agreement, talk to the lawyer, and just get so petrified of, well, okay, I’m gonna sell the business and you’re gonna give me money.
But if there’s a clawback scenario, or a large portion of my money is going to get put in this escrow account, which earns, you know, very little to no interest and we don’t have access to it, it creates friction. In thinking back to before rep and warranty was as prevalent as it is, the conversations that we would have with sellers at that point in time. We’re fortunate to not have those conversations anymore, in the sense that we can have an insurance policy that backs them up on that it says, look, you were on define how much you were on the hook for you are on the hook for an ordinary rep amount of X. And anything beyond that the insurance company is going to pick up. And oh, by the way, your escrow is only going to be this many dollars versus in the past, you saw escrows that were 5%, maybe 10% total enterprise value.
Patrick: Yeah. 10% we saw.
Scott: Yeah, really big numbers that you when you’re thinking about calculating your proceeds, in your mind as all sellers do. Especially if they’re rolling in the deal and putting equity in incremental deal go for that was a large portion of the proceeds that we’re going to take off the table, right. And so the progression of rep and warranty insurance has alleviated a lot of those burdens. And like I said, I don’t see it going away. If anything, I just see it becoming more and more prevalent, more and more underwriters out there. And it continuing to be a part of of every single M&A transaction.
Patrick: Yeah, I mean, we’ve been really striving to get this on the checklist, if you got rep and warranty, at least is on the checklist. Now it’s something that you know, can get addressed on each deal. May not be a perfect fit for every particular deal. But the fact that it’s there is something to look up look at and and quite frankly, I mean, it is a tragedy if you’ve got avoidable situations where you’re taking wear and tear on people’s soul, because they get so fearful. It can be avoided. And here’s how it goes. And I would say on this on the on the buyer side, my goodness, the in a lot of cases, particularly where the buyer has leverage reps and warranties at no cost because 99 out of 100 sellers will pay the entire cost just to get the benefit of the of the indemnity indemnity transfer. They really really do appreciate it. Scott, now tell me because I had referenced this slightly, but we are talking about industrials, because you’re in Houston. So you’ve got the energy sector over there.
Patrick: Give me give me a profile of your ideal client. What is Sterling Group looking for now?
Scott: And be very clear. We don’t we don’t touch anything in energy. So it’s odd to be done here in Houston, and be one of the few private equity firms that that doesn’t touch the energy space, we touch the downstream a little bit but midstream, upstream, different types of investing different firms. It’s just, you know, Houston’s where the firm started. And we’ve stayed here, but the vast majority of our companies are outside of Houston, and certainly you know, most outside the state of Texas. But an ideal partner for us and ideal company, that would be a target is a good business. In a consistent industry. Typically, like I said earlier, usually not a sexy industry, usually an industry that folks don’t typically think about, that has a management team, whether it’s a founder or a family of corporate carve out management team that wants a partner that can help make a step change in their business and work with them to make that step change.
Or that has a you know, an industry that they know well that wants to partner with someone and go out. And can you continue to acquire competitors continue to grow through acquisition, we do many buy and builds. And oftentimes we’ll bump into founders in industries that think that they’ve created the best mousetrap. And oftentimes they have, and that allows them to go out there and swallow up competitors, or get the competitors to join the team. And then continue to grow and get the benefits of scale. And we’d like that playbook just as well. And we’ve partnered with with many folks in doing that.
Patrick: So they the partners, you’re looking for our management teams where they’re looking to, you know, they’ve reached perhaps an inflection point. And they want to stay on and see this through or do you have other situations where owner, founder, they just want out?
Scott: Yeah, we have we see both, probably equally as much. There are certain situations where you have bounders that have run the business for forever, and we’re looking for retirement. And and that’s fine. And oftentimes we’ll have those individuals sit on a board of directors and continue to help and advise and find a CEO that we all trust can run and grow business. But equally as much we see folks out there management teams that have gotten their business and grown it to a point where they know that that next level is a complexity that they’re uncomfortable with, and they want some help navigating that and growing the business. Or that next level requires capital that they may not have access to. Like I gave the example of out there doing a buy and build in an industry and that’s something that we can help them with and put in place a program that helps them do those add on acquisitions in an efficient manner. You know we’ll have portfolio companies that have made 12 13 14 acquisitions in their lifecycle with us.
Patrick: It’s just I can imagine the inflection point for them is they’re they’re too big to be small but they’re too small to be enterprise.
Scott: That’s a good way to put it. Agreed. Agreed. In looking at enterprise it can be daunting sometimes.
Patrick: And that’s the resource the private equity provides on that so that that’s fantastic not to mention the second bite of the apple for owners and founders. So there’s a real great value proposition which is why you’ve got the big growth in these PE firms by numbers so forth. Scott we’re well into 2021 right now we can see only the beginning of the end of the pandemic. Give me your thoughts or what trends do you see for manufacturers or for the industrials for Sterling Group as we go through into the next year or two. What do you see down the road?
Scott: Yeah, no it’s a good question. Yeah we’ll see I can make some predictions who knows if we’ll be right. I would say in the deal making environment first, I think we see a return to in person meetings. You know we have been doing deals throughout the pandemic, closed a couple last year, we’ve closed a couple of the beginning of this year. And started off a lot of Zoom meetings and folks but it’s really hard to get to know management team over zoom and it’s there’s not a replacement for an in person meeting when you’re getting to know a management team and getting to know a partner that’s going to be a significant partner for the next 5, 6, 7 years of your company’s of your company’s life.
So I see us returning back to these in person management meetings and we’ll see how that goes. I think there are other folks who disagree, but we’ll see. And I think the pace of deals right now it’s already back to I think pre pandemic levels. The number of deals out in the market right now it’s been surprising. From a more macro perspective um I can tell you what I’d really like to see. I really like to see us get an infrastructure bill done investment in infrastructure would be very beneficial to some our companies that we own in the space and I think much needed for us. So we’ll see how that turns out but it would be a nice tailwind to the the current environment we’re seeing with our businesses.
Patrick: For any of you out there that are in the industrial sector and you’re looking for some way to partner up and get past that inflection point really should look at The Sterling Group. Scott MacLaren how can our audience members reach you? How can they find you?
Scott: Yeah so our web pages www.sterling-group.com and I’m on there. My email’s on there. Feel free to reach out. Happy to talk to anybody and certainly always happy to talk to any potential companies out there thinking of partnership.
Patrick: Yeah let me highlight that also with the website because there’s more than one Sterling out there in the financial sector so it is sterling-group.com. And Scott absolute pleasure meeting you. Great to hear about the story. Again thanks for your service, and we wish you all the best going forward okay. Thank you.
Scott: Thank you. You, too, Patrick. Take care.