On this week’s episode of M&A Masters, we speak with Dan Phelps, Founder and Managing Director of Salt Creek Capital, based in Silicon Valley. Salt Creek Capital is a lower middle-market private equity firm that partners with talented executives to acquire profitable small businesses across the United States. Dan earned his MBA at the University of Chicago and spent time in both venture and smaller private equity investing experiences before founding Salt Creek Capital over 11 years ago.
“We’re identifying businesses that we believe would be quite attractive investment candidates. We look at financials and the competitive landscape while our executive partners look at operational issues and how well their background and skill set match up with that business. When those two things come together, the operator sees an opportunity to leverage or strengthen experiences and we see a great acquisition candidate,” says Dan.
We speak with Dan about giving sellers more comfort and confidence during transactions, 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 Dan Phelps, Founder and Managing Director of Salt Creek Capital based here in Silicon Valley, actually, just down the road for our offices. Salt Creek Capital is a lower middle market private equity firm that partners with talented executives to acquire profitable small businesses across the United States. And this is one of the rare times that I can actually say to a guest, howdy, neighbor. So Dan, welcome to the show.
Dan Phelps: Hi, Patrick, thanks so much for having me. It’s a pleasure to be with you.
Patrick: Now we’ve got a great story for the approach that Salt Creek Capital takes. And I think we may break a little bit of news here in this interview. So I’m looking forward to that. But before we go down that route, Dan, let’s start with you. How did you get to this point in your career?
Dan: I started in principle investing over 20 years ago, shortly after earning my MBA at the University of Chicago, and spent time in both venture as well as smaller private equity investing experiences before founding Salt Creek Capital over 11 years ago with my partners, to two of my partners who are still with me and busy working every day. And I think we we had an investment strategy on lower middle market acquisitions that really focused on two factors that evolved into our strategy first, that many lower middle market businesses, meaning those that were $5 million, and below in EBITDA, were largely underserved by the private equity community.
Most PE firms looking for businesses larger than that, well, those businesses oftentimes were too large for an individual investor to acquire. So there’s the sort of the soft spot in the market of I would say, a million and a half to about 5 million of EBITDA, and we felt like that was a good market for us to serve. And second, it’s often the case that those businesses are owner operated situations or family owned businesses. So concurrent with a sale of control in those businesses, there’s many times the need for new leadership. And so that transition of leadership, as part of the acquisition was something that we wanted to make sure that we were prepared for, and had the capabilities to work through with a seller, concurrent with the transaction.
So those two dynamics have really led to how we’ve developed our investment thesis and platform, I would say to be prepared, what we’ve done is develop a bench of executives that we work with, through what we call our executive partner program. And those folks are involved with our sourcing efforts and ultimately become CEO of a company that we acquired together. So the seller is able to see those executives and meet the CEO who would be coming in post closing giving that seller more comfort and confidence in what will happen to his business post close.
And frankly, those executives enable us to differentiate ourselves from other buyers, because, you know, they stand out with the experiences, they bring in the accomplishments they’ve had in their prior roles. And we found this to be quite attractive to a lot of executives who have maybe run larger organizations, of bigger companies, but he had more of an entrepreneurial interest in wanting to explore that be backed by a private equity firm invest personally alongside us as part of that transaction. So it does a nice job of aligning interests with the management that we bring in of that newly acquired company. And, again, differentiates us in many respects.
Patrick: I think that with, you know, this approach, which is really unique, you could probably have the executives that want to partner with you, they’re probably a little better at picking up investment opportunities, because you’ll have a lot of PEs, you know, have real talented, intelligent people that are out sourcing deals and working theories. You’ve got literally operators that know what they really want to do, and they know what works, and they know what to look for and, and are probably pretty successful in finding, you know, successful ventures.
Dan: Absolutely. You’re so right about that. It definitely helps our sourcing and the rigor of the selection process that we go through. Essentially, we’re identifying businesses that we believe would be quite attractive investment candidates and we’re looking at financials and competitive landscape, our executive partners are looking at those operational issues that you mentioned, and how well their background and skill set match up with that business.
And when those two things come together, the operator sees an opportunity to love or strength and experiences, and we see a great acquisition candidate, way we get excited, and we go after it. And we’ve completed about 35 of these transactions over the last 10 years. And in each one of those cases, that was one of our executives becoming CEO on day one. So that that’s definitely a working model. It’s it’s proven to be very effective for us.
Patrick: Well, tell me a little bit more about Salt Creek Capital, and you’ve been around 10 years. So you’re not new to this thing. And you’re committed to the lower middle market. We’ve talked about that. And we can get into that a little bit. But let’s get real basic here. Because unlike law firms or insurance firms that are completely lacking any kind of creativity, you know, we just name our companies after the founder’s name. Okay. This isn’t called Phelps Capital. How did you come up with the name Salt Creek?
Dan: Yeah, great question. I relocated from Chicago, to Northern California here. And we used to live in the western suburbs in Hinsdale and salt Creek actually runs through Oak Brook and Hinsdale and some of those communities. And, you know, many of the private businesses in those areas were Salt Creek this or Salt Creek that and I sort of liked that feel that these were, you know, family owned businesses that had been around serving the community for a long time. And so I adopted that, as we began to focus on other family owned and privately held businesses is, you know, the type that we were seeking. We actually have some pictures of the real Salt Creek here in our office.
Patrick: Well how about that. Why it’s just I mean, parallel was San Francisco’s a different districts, you’ve got the Sunset district, and the Parkside district, and, and Nob Hill, and you would have all those businesses named, you know, after the district so that it’s some continuity there. Excellent. The focus that happens with a lot of firms is they start with real small acquisitions as they’re getting started. And then over time they grow. You didn’t do that you’re not up in the, you know, 500 plus million dollar transactions, you’ve kind of kept to your knitting. Why take that rope?
Dan: Yeah, I think a couple of reasons, one of which was that approach that we took in the market that we wanted to serve again, those that were underserved by private equity firms, but too large for individual investors. And that ability to help with a change in leadership, we think really gives us a differentiating approach. And I think post acquisition, it’s also given us a playbook over time through all the various experiences we’ve had. And some of the organic improvements that we believe we can make to a business once we acquire those those companies. And initially, it’s a lot of times implementing new software and systems of family owned, a business or owner operator oftentimes may be more interested in cash flow and less interested in gap accounting, we have a different set of needs.
So we end up introducing different software’s and software and systems to help manage and focus on KPIs key performance indicators, we may end up focusing a lot more on growth than an owner who’s preparing for retirement, and less interested in taking on more risk. But instead, feeling like that business is doing a great job serving lifestyle, we may decide, hey, let’s expand our product line or let’s expand our service area. We may invest in additional capacity to to grow output.
There’s a lot of different things we do typically on an organic basis. That’s not to say we don’t do add on acquisitions, we definitely do add on acquisitions. But we do want our investment thesis to be achieved if we can get there organically. Because there’s less risk that a new add on acquisition is required for us to meet our investment objectives. There’s there’s risk that you find the right add on at the right time at the right price. So we tend to be pretty organically and operationally focused investors.
And I think that that has a nice dynamic with many of the employees of the company, because they now see more opportunity. There’s new things for them to grow into and try. Whereas maybe there wasn’t as much emphasis on growth and expansion, up until our involvement in that new leader that comes on that I’ve described and some of the skills and experiences that that executive can bring to the company and enabling growth and looking for new avenues to to build a business.
Patrick: Yeah, that’s kind of exciting because you’re finding companies are at that inflection point. And it’s at the very top, you’ve got the owner founder that they’re these ones are specifically looking for an exit, as opposed to other owners and founders are looking to partner and continue on. That’s not a fit for you. But you’re at that inflection point. And unfortunately, you have an owner that has his or her plans, but then you got everybody else that’s involved that have, you know, different time horizons timetables, and it’s at that point, you can go ahead and come in and assist an organization in a pivot, I think that’s fantastic.
I also really like the idea of serving this underserved market, the lower middle market owners and founders, especially those that are looking for an exit, they’re not used to looking at M&A, they don’t think about it very much. So they don’t know where to turn. And then they end up defaulting to big institutions, or, you know, putting a call to Goldman Sachs or something like that. But big, big, big organizations that, you know, it’s not their fault, it’s just they don’t have the bandwidth to bring resources down to that level to meet their needs.
So like you say, this group of great entrepreneurs that have added tremendous value to society, in a lot of towns where they are, they get overlooked, they get underserved. They get, you know, not very good responses from from the institutions. At the whole time they’re getting overcharged. And you know, if there is a transaction, they end up leaving money on the table, which is in nobody’s interest. And so it’s great when you got organizations like Salt Creek Capital, that you’re not a fit for everything. But for that, that one inflection point type business with the leader, I think that is ideal.
So the more people that are aware of that, I think, benefits and the great thing is, you don’t have to worry about transition, you’ve got the team ready to just step right in and carry carry forward. And that’s always I think, post post closing, introduction of new management and that kind of integration, I think it can be a real challenge that you get to bypass.
Dan: Yeah, thank you for the kind words, and we totally agree. And oftentimes, it’s not that business owner maybe hasn’t prepared or had a game plan for what to do transition wise. But that can change. You know, adult children may decide they don’t want to step into dad’s footsteps and run his business. And there’s other career paths they choose to pursue. And maybe there’s not a number to strong enough in the business to step up. At the time the owner wants to retire. There’s there’s a lot of different factors that can lead to that situation where new leadership is required.
And so finding a group like us that can assist with that leadership transition is important. I wouldn’t say there’s, as many of us that are willing to take on that that leadership transition risk, I think there’s a lot of PE firms who really look for strong management who are going to continue with the business. And I think that’s a very logical approach to take. There’s definitely risk and leadership transition. But But there is a risk there. And that risk is that you are going to see eye to eye with the CEO whose business you’re acquiring, and that you’ll line up in terms of what you’re trying to achieve growing that business and your investment thesis. Whereas we definitely take on risk that our new leader is going to learn that business.
But we have a good solid working relationship coming into that that new ownership role. Our executive partners typically work with us, you know, could be as long as a year trying to identify a good company to acquire, meaning we’ve had a lot of time in the saddle together, understand that executive strengths and where we think he or she may need some support. And likewise, that executive learns a lot about us and our expectations and what we think are good sort of risk reward value creating exercises essentially, learn a lot. They learn a lot about our playbook, even before we’re invested together in a business. So that that relationship coming in we think is valuable.
And I think is important for a seller to see that we have a cohesive group that there’s a uniform outlook as to what should be done in developing and growing that business. For many sellers, as you pointed out, they may be in a community where they’re a very large employer and they’re serving the needs of that community. Their name may be on the building out front and they have a lot of pride in that. in that business and in may have spent more time building that business than raising their kids and their families.
And so that handoff is is of critical importance, they really want to know that that person who will be sitting in their seat has a lot of great experience that the ownership group as a long term growth outlook that that makes sense to them. And I think hearing from the CEO and from Salt Creek collectively as to what our plan is for the business, you know, helps ease that that transition, if nothing else, from an emotional standpoint.
Patrick: Well, let’s also think of one other default decision, the owner founder, that’s uninformed, and just, they’re not ill educated, they’re just they’re not informed and this where you in the private equity community come in, is, if the owner founder wants an exit, their first default is possibly an institution, but that really does look for strategic. And they’ll look for one of their competitors, or, you know, a supplier or some other organization out there. And, you know, they that decision may not be always the best fit for the owner, because, you know, that industry, maybe they’re they’re, you know, hampered him.
But the other thing is a real risk is, you know, with private equity coming in you figure management, and most of the employees are going to be there. But if it’s a strategic acquisition, there are going to be reductions in force, there’s going to be redundancies. And there are some organizations where, you know, you’ve had your your team there for decades, as another just another thought out there to to advantage that you can bring to the table versus a strategic I imagine.
Dan: You’re absolutely right, Patrick. And I think the the range of different outcomes, and the range of different types of buyers and transaction type are endless. And you and I are involved in this everyday with our life, this is what we do. On the other hand, if you’re a business owner, and you’re manufacturing or if you’re providing industrial services, and now you’re faced with a sale of your business, this is not what you spent 10 or 20 years preparing for there’s there’s very limited guidelines, and hopefully you have a good attorney that you can work with. And your accountant is good at advising you as you prepare for a transaction.
But seeing the sort of lack of resources, one of the things we’ve done at Salt Creek is to author a book, and the book is intended, specifically to business owners. And it’s called Exit, Optimizing the Sale of Your Business to Professional Investors. And it very much is how to, to think through who are the types of buyers and some may be strategic and, and have expectations about closing down a plant and consolidating operations somewhere else and could be private equity buyers and their expectations and what they’re like to deal with.
And even within that community of private equity buyers in what what are the different transaction types, if you’re wanting to retire, and there’s there’s going to be a need for leadership transition. Or if you still have some years you want to work and you want to roll equity and have a partner for some period of time, there’s, there’s a lot of things to consider and think about, we’ve tried to cover many of those different topics in our book, and are publishing it currently will be available shortly. Both an E book and hard print versions.
But you know, we’ve we’ve just heard from so many sellers that this is a daunting and stressful process. And, you know, we’re learning in every transaction we do. But we do this, you know, 50, 60, 70 hours a week, and we’ve been doing it for decades, hard for someone who’s going to do this once in life, to get comfortable and to learn all that they need to to make sure they have a successful transaction.
Patrick: Yeah, I think is outstanding, that you’re going ahead and you’re sharing your knowledge with the market out there not only for prospective clients of yours, but for people that may want to, you know, do it themselves maybe and you know, at least it’s not, you know, exit planning for idiots. So the idiots guide to exit planning. So that’s, that gives you a little bit, you know, step up from there, but I’m sure this is something has written, you know, for the for the entrepreneur, the non M&A expert, and I’m sure you’ve got a step by step roadmap for how to stage what the process is like, because I think the biggest fearful thing is the unknown.
Dan: Yeah, you’re exactly right. And I think, you know, having a book that talks about all these different types of transactions, but also the steps along the way, what are the milestones, topics to consider related to legal and debt that a buyer may use and leveraging your business oftentimes are things that, you know, we run into business owners and they haven’t thought as much about so. So we hope that this prepares them. You know, we work with business owners who are working with an investment bank and selling their business and maybe getting good advice, we have some that, like you said, would rather try to do it on their own.
Maybe that’s because they want to talk directly to a capital provider and have more of a one on one, which I think works really well. In particular, if there’s that leadership transition dynamic, because they’re almost looking at it as much as an interview for who’s going to be sitting in their seat when they’re gone. And not necessarily willing to have the details of their business splashed about to a number of buyers. And so for that, for that owner who wants to have a more direct conversation with a PE firm interview, the person who’s going to be sitting in his seat, keep a smaller number of buyers, allow us fewer number of buyers into the details of his business. You know, we think this book will enable that type of transaction as well.
Patrick: Well, I’m looking forward to that. There’s one other element with with M&A that is discussed theoretically, and there’s quite a bit of risk that’s involved in the in these transactions, they don’t happen in a vacuum. And when owners and founders come to the realization that well is at risk to my counterparty, if things don’t go right, that comes really there to you know, front and center, because a lot of business risks can be covered, you know, with with the shield of the corporation and D&O insurance and other things like that. But when you get into a transaction, the buyer or the seller, for the first time realizes that their house could be at risk, literally when you’re talking some of these deals.
And so that brings just a higher level of concern of stress. And and you know, dealing with the unknown, what’s been great in the insurance industry is there’s a product called rep and warranty insurance that heretofore was available only to deals north of $100 million in transaction value, it has now come down both in price and eligibility criteria to be able to provide insurance for deals as low as between 10 and 15 million in transaction value. It’s it’s it’s become very accommodating.
And the purpose of it is to take that indemnity obligation that the seller owes to the buyer and remove it from the seller and put it with the insurance company so that if there is a post closing breach of the seller reps to the buyer, buyer doesn’t pursue the seller, buyer goes right to an insurance company collects the check. Seller gets a clean exit, they’re not going to be fearful of a clawback. And in a lot of cases, the insurance policy replaces any monies held in escrow or withheld. It is a nice nice thing that goes out there is not a fit for every deal. But I’m just curious than, you know, good, bad or indifferent. Tell us of any experience you’ve had with rep and warranty insurance.
Dan: Yeah, we had a great experience with rep and warranty insurance on a sale not too long ago. And this was a business that we’d owned for three and a half years and had an opportunity to combine with a strategic and a new platform essentially. And by acquiring the rep and warranty insurance, we were able to distribute cash out to investors more quickly, it helped our IRR because we weren’t waiting for an escrow. Whereas larger than escrow to break, somewhere down the line, the buyer felt good about the fact that there was a backstop for any breaches of reps and warranties.
So it was a more efficient use of capital than tying up the purchase proceeds in a larger amount for a longer period of time than we would have otherwise. So I think we’re going to increasingly look to rep and warranty insurance, especially on the exit. On the buy, depending on the size of the transaction and how much complexity that may introduce into the transaction, we’ll have to make a decision. Like you said, every transaction is unique, but I think it’s worked very well for us on the exit. And we’ll continue to to look for those types of products to help us.
Patrick: You mentioned that the ideal profile of a prospective investment for you is going to be an organization where management and owner founders looking to transition out. Could you fill out that profile a little bit more. I mean, what’s what’s your ideal target look like?
Dan: Yeah, that’s a great question. And there’s really sort of two general profiles. One is the executive who’s later in life you may be late 60s, early 70s. And the purpose of the transition really is to achieve liquidity for retirement and so on. They are not as excited about rolling equity or having ongoing involvement with the company, it’s really more of a clean break type of situation. And so this, this transaction allows them to achieve liquidity many, many times, most of their net worth is tied up in that business. And this enables retirement.
The other type of transaction, and we’ve done several of these is someone who’s younger, and maybe still has some energy and enthusiasm and excitement to be involved with the business. But they have other professional interests. So they want to spend time pursuing other things in life. We bought a business, for example, from someone who started the business in college. And so by the time he was in his late 30s, early 40s, and feeling like, gosh, is this the only job I’m ever gonna have? And good for him, he was an excellent entrepreneur for starting a business in college.
But he got involved in investing in real estate and doing some other things outside of the area that he lived in, and needed a partner, essentially, to provide the day to day operation. And the focus required to grow that business and take it to the next level. And he chose to roll some equity with us, he chose to remain on the board. He had a wealth of knowledge on the industry and was and continues to be a great partner to us. But we were able to free him up and provide him liquidity to go do other real estate investing and professional things that you now has the time to do.
So those are sort of the two main in profiles, it’s either that sort of last transaction before retirement or it’s the transit transition to another part of a professional career, and providing liquidity and some chips off the table to go do those other things that you may have an interest in doing. Another aspect of the executives that we work with it’s important is many of them are recent empty nesters. Last child just went off to college or maybe just graduated college, they’ve got one or two more stops in their career before retirement. And they’ve done well, from a W2 standpoint, but they want to have a wealth creating event that will really help them enjoy their retirement that much more, they have some more flexibility.
Because when we buy a business, it’s not necessarily going to be where that executive happens to live. So that often results in that executive relocating to where the business is. and investing alongside of us and having ideally a very nice seven digit or more outcome after five years when we go to sell that business. And so it’s a program that fits very nicely for those empty nesters who want to really take a try something new for that last experience or two before retirement.
Patrick: And Dan you mentioned earlier 35 transactions in the last 10 years.
Dan: That’s right.
Patrick: Okay. Yeah, you’re not new to this. So I think you’ve completed that learning curve. Let me ask you just we’re just in the new year, I think everybody’s glad that 2020 is in rearview mirror. But, you know, share with me your thoughts on just what trends you see for 2021 into 2022, either macro or specific to Salt Creek capital.
Dan: Yeah, I would say one of the big trends that we’ve been tracking for years, and we see, fortunately, over the coming decade, is the large number of baby boomers that are going to be retiring over the next 10 to 15 years, it was a very entrepreneurial generation. Many businesses are owned by someone in their 60s or 70s. And we’ll need to transition so that that that first character is characteristic of a seller of someone looking for liquidity for retirement, we think will be a nice, a nice wave over the coming years for us to participate in somewhere around 200,000 businesses of the size and type in the us that we would be interested in based on our research.
And we’re doing a lot of work to actually build a database of all of those businesses. And we’re doing outreach to those business owners as part of our sourcing efforts. So we hope to find a lot of those businesses of retiring owners or those that are baby boomer, but we’d also be delighted to find those that are still early in their career and wanting a partner and wanting some liquidity and a PE firm to partner with and help drive that business to the next stage of growth. So either either of those two characteristics of a seller or business owner are exciting to us, but we’re, we’re feeling like we’re going to be in business for a while. And hopefully this, this is my last job. And it takes me another 20 years until I’m retiring.
Patrick: That’s great to hear. I have two observations from from those which are absolutely profound as I was speaking with another fellow, Brett Hickey from Star Mountain Capital. And he had mentioned one thing where people are aware of things like COVID, or they’re aware of taxes or whatever, and they’re distracted. But one thing that just keeps marching on while you’re worried about all these temporary temporary issues, is time doesn’t stop. And so that was the thing is we’ve got that aging population that continues to age. So I think that’s very, very relevant.
The other issue is that I think the younger folks coming in to take over businesses very talented, and they are more focused and highly valued that live work balance. And so I think you’re going to have a lot of owners, but new owners or younger owners that are going to be looking to partner with somebody because they don’t have to do it all because they want to do the other things and have the diversity in their life’s lifestyle. So I think I think that Yeah, your market is not shrinking by any way, shape, or form. So I think that’s fantastic. Dan, in addition to this great book Exit, which please look for, and we’ll have a link on their show notes for so you can go ahead and grab it. How else can our audience find you?
Dan: Probably the easiest way is our website. And that’s out there at saltcreekcap.com. We’ve got all of our team members and representative portfolio companies there. And I would say we’d love to hear from business owners that want to have a conversation with us, investment banks and and brokers that are working with business owners. But also importantly, executives who are interested in pursuing an entrepreneurial track and wanting to consider our Executive Partnership Program is a way to get there. And Carol Onderka is the person on our team who leads all of our executive recruiting efforts. And she’s also on our website and can be reached that way.
Patrick: Well, Dan Phelps, Salt Creek Capital, thanks very much I would say to everybody, if you go to their website is a very user friendly website, unlike the private equity sites of 5-10 years ago, where you had to have some kind of password just to get into get get access to them. All the information is there. So it is very user friendly. Thank you again for joining us and best of luck for 2021.
Dan: Thank you, Patrick. It was a pleasure talking to you today and I really enjoyed the time together.