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Michael Kornman | Navigating M&A Deals with Founders and Family-Owned Businesses
POSTED 11.2.21 M&A Masters Podcast

On this week’s episode of M&A Masters, we speak with Michael Kornman of NCK Capital.

NCK Capital acquires controlling interests in lower-middle market companies and takes them to the next level with “right-fit” capital structures, inspiring management incentives, and nurturing support.

Michael says, “We love the lower middle market. It’s a great place to build value…” Listen as he walks us through: 

  • Why NCK Capital loves the lower-middle market, their unique perspective and target markets
  • Three rules to ensure success in lower-middle market deals
  • Their secrets for fostering organic growth, and (long term) focused wealth creation
  • And much more

MENTIONED IN THIS EPISODE:

TRANSCRIPT:

Patrick Stroth: Hello there, I’m Patrick Stroth, trusted authority in executive and transactional liability, and president of Rubicon M&A Insurance Services, now a proud member of Liberty Company Insurance Brokers, a nationwide network of specialized insurance brokerages. 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 Michael Kornman, managing partner of NCK Capital. Based in Dallas, NCK Capital acquires controlling interests and lower middle market companies and takes them to the next level, with right fit capital structures, inspiring management incentives, and nurturing support. Michael, I’m really looking forward to this conversation today. Thank you for joining me.

Michael Kornman: Thanks for having me, Patrick.

Patrick: So, Michael, before we get into NCK Capital and what you’re doing, which I think is next level, with transitions and so forth, which our audience is really going to enjoy. Let’s set the table, we’ll start with you. What brought you to this point in your career?

Michael: Yeah, so I you know, my brother and I founded in NCK Capital in 2014. And before that, we had built and run a number of lower middle market businesses, and a few different industries. And so we felt we were well positioned to, to add value to the you know, lower middle market companies. And also had a unique perspective where we, you know, walked in the shoes of a lot of founders. We’ve we’ve dealt with the same issues they they’ve dealt with and understand those on an intimate and very personal level. And so we, we thought we’d be we’d stop building companies, you know, from from a dead stop and start start investing in the lower middle market.

Patrick: And now, as we transition to NCK Capital, I always like to find out about companies, you know, how they’re named, because NCK Capital is not necessarily your initials. So give us that background, then walk in and tell us about NCK Capital.

Michael: My last name is Kornman with a K. So everybody assumes that it’s something something Kornman, but that’s not it at all. Grant and I have three daughters, Natalie, Claire, and Kate. And we were originally going to name the company, oldest to youngest. So Claire, Kate, Natalie, we got the URL, we were building out the marketing materials, and it kept looking like Chicken Capital. And so we just, we just couldn’t deal with that. So we rearranged the letters, we got the NCK. And it’s our daughter. Grant does have a son. He came after we founded the firm. He’s still he’s still, you know, a beneficiary. So it’s okay.

Patrick: Well, yeah, he will, we’ll find something separate for him down the road, that’ll be something, it’s amazing, you’re not the first guest to, you know, share with us that getting the URL had a big role in how the name ultimately came out. Si it’s just one one thing for the new age. Now you’re focusing on the lower middle market, you’ve been around for a little while. Explain why lower middle market? What is it about that, and your thought process?

Michael: Yeah, we love the lower middle market. It’s a it’s a great way, it’s a great place to build value. You know, there’s, there’s so many lower middle market companies, and there’s so much capital in the middle market, that need folks like us to grow these companies to the scale that they need so that they can invest in them. And so we’re generally the first institutional capital not always, and we have, we have two portfolio companies that we acquired from other private equity firms. 

But generally we focus on family or founder owned businesses. And we love it because it’s just, the market seems endless and, you know, our story, we’re a family. You know, Grant and I built the firm. There’s other people here now, but you know, it really resonates with sellers. And so we’ve, we’ve had, we’ve had good results.

Patrick: Yeah, I think that in addition to having the lower middle market, where it’s is a vast market out there. I think that’s where you can really make big change because so many owners and founders out there, they work hard, they’re very successful, but they can only get a company their company to grow so far. And then they get to that inflection point where they’re, you know, they’re they’re too big to be small, they’re too small to be enterprise. And they don’t know how to take that next step. 

And it gets scary because it, without organizations like NCK Capital out there, you know, they may default and either go with a very large institution or a brand or go to a strategic which may not necessarily have their best interests in mind. And so the more options that are out there and the awareness that we can we can bring to the lower middle market is our way of serving this market. Because if they don’t know about this, they’re at risk of being underserved and overcharged and we can’t do that to the owners and founders out there. 

Because they’re, they’re the back backbone out here. A big distinguishing element of NCK Capital is that you do, and you mentioned this on your site, you target family owned businesses, as opposed to a startup and so forth. Talk about that focus a little bit more. Why that’s so personal? Is it just because you guys, you and your brother are family?

Michael: Yeah, we walked in their shoes, we’ve dealt with the issues that that small business owners deal with. And these are, I mean, make no bones about these are small businesses still. I mean, we we invest in companies with two to 10 of EBITDA and our sweet spot is really like two to six. So these these companies definitely are in the early stages of their of their lifecycle. And you know, we have we’ve, we understand what it’s like to have invested personal capital over a long period of time. 

We understand what it’s like to, to build out an organization where you where you have real issues with people and challenges and you know, you’ve you’ve you fought in the trenches alongside those people for a long time. We understand what it’s like to build a culture, and develop that culture, and how important that culture is to founders. And, you know, so we’re user friendly, that’s really important to us. And I think that’s, that’s one of the reasons we’ve been successful.

Patrick: One of the things I think is really exciting, because you’re coming from an operating background, so you’re not trying to kind of financially engineer these these organizations, you know, from maybe, you know, performance to great performance, just by cutting expenses, and moving moving around numbers. I think you got an operational tilt. I’m just curious with some of the things that you’ve experienced, have you ever had an experience where you’re sitting with the the portfolio company, the management team, and they put their trust in you. And you talk about well we’re going to try doing X, Y, and Z, and you just see this epiphany, where they just look and they just like, I didn’t expect that, wow, we can do that. Did you have any kinds of things, this is kind of off script, but you know, that those things happen.

Michael: It happens, it happens regularly, and it’s really fun to see. I mean, so our focus in NCK is, is in addition to buy and build, which is obviously a common common strategy in private equity. We really focus on companies that where we can, we can get organic growth. And we think that that, you know, that’s, that’s really important. We like businesses with high cash flow conversion, that, that we can, we can grow organically. We like businesses that we can deploy, you know, whether it’s a digital marketing strategy, or, or a more sophisticated sales and marketing marketing strategy, or, you know, or, or some, you know, some of the more traditional people process and technology and operations. 

You know, we like businesses that we can grow in a way that a founder would understand. And so those conversations are do happen, and it’s, it’s fun to, to riff and collaborate with, with founders and sellers and oftentimes, you know, sellers are rolling over a substantial amount of equity. And, you know, that’s, that’s an important part of our process is educating them on kind of how how we approach the world. What we’re going to do post transaction and explain to them you know, kind of our excellent returns and, and that that helps us win deals as well.

Patrick: Well I think one of the scariest things out there for anybody, I just from personal experience, I’m getting emails constantly about marketing, lead list strategies, all these things, and I can imagine, you know, if you’re the owner, or the founder, you’re you’re operating your business, you need to get sales up, you don’t know how, and it’s such a gamble. I mean, it can be very expensive. If you don’t know what you’re doing, it’s really really scary. So I think that your experience there on helping them bridge that gap on you know, opening marketing channels, sales, bringing in people, those are all the scariest things for owners and founders, because they have so much to risk and you give them peace of mind because not only do you have the resources, you’ve got the experience and you can just walk them through that.

Michael: I mean, some of these founders want to stay on and continue to run the business but want to take a substantial amount of money off the table. And you know, their analysis up to this point is hey, I can grow this business but I’m gonna it’s gonna reduce my distributions. And you know, I’m gonna have to go it alone, where, you know, we come in and we’re, you know, we, we’re a team. So it’s a lot of fun to collaborate with these, with these folks. And the the leverage you get is, is huge.

Patrick: Now I’m gonna go back to something we talked about, at the very beginning about, there are a couple of elements that distinguish what NCK Capital does, again, as a Californian, it’s like the software approach with business. But you are doing a couple of things here. If you could just give us a sentence or two, just how you mean it. And we’ll start with right size capital structures.

Michael: Yeah, I mean, that’s a really great, great question. In the lower middle market, these small in the, in the lower end of the lower middle market, when you start to start to grow these businesses, there’s definitely a J curve. There’s definitely a dip in EBITDA. And so you just have to make sure that, that you’re, you’re planning for that. Because if you if you in generally it’s through over equitizing the business, but if you use that, or the wrong kind of debt, or or too much debt, rather, we all use debt. But it can be it can really be painful and disruptive in the in the early part of the investment period. 

So we just like to make sure that that you know, we’re set up for success and you know, there may be a, you know, period where things things are a little less smooth than you’d like. I mean, generally, the inflection point in our experience is two years. The first few years you’re investing, you’re growing and you know, it really takes about 18 months to two years for the EBITDA to really really be able to grow to materialize.

Patrick: That’s a term that a lot of people tie in with family offices, they call that patient capital. But you know, if you know that out front that you’ve got this time window, don’t panic let’s just go through it and I mean at our age now 18 months goes by really quick. You’re gonna get to the other side. So you bring that on, and I think that’s very helpful because it also brings the temperature down. Especially following you know, the closing, I’m sure management is they roll over they want to hit the ground running and they’re they’re very stressed. They want to make a good impression. Relax, you know, you want that so that that’s a great way to ensure success. The other thing you mentioned is not just management incentives but inspiring management incentives. So talk about that a little bit.

Michael: Yeah, so a lot of times we’re we’re recruiting managers from outside the business and and that’s where you experience a lot of a lot of growth just hiring fantastic people that you know, some of these businesses just haven’t had exposure to people of this quality and sophistication before. And so, you know, our focus is we really we really view those management teams as partners and a lot of people say that. You know, we’re really focused on wealth creation for them, and that is we want to make sure that they’re they’re focused on the long run, they’re focused on you know, ultimately the exit and you know we we get really excited when when when our our management team partners build considerable amounts of wealth in these in these deals.

Patrick: Kinda fun, kinda fun when you watch that. The, it ensures just everybody everybody’s interests are aligned and what why wouldn’t that be. Because I’m personally have an abundance mindset. So if that’s being passed out that just only inures to the benefit of all which is which is fantastic. And it also speaks to a track record for future investments down the road. I think I think that is just credibility, that can’t be questioned. 

The final thing you talk about again, as as Californians, we look at this, we’ve talked about nurturing, and culture and things, which I there are a lot of people that look at that sideways, maybe 5, 10 years ago. But then the book, Infinite Game came out with Simon Sinek. And you’re seeing a change in mindset with management, looking at things like culture, where they’re, they’re, like, grading it, they are measuring it, and so forth. Let’s talk about what you do when you’re talking about nurturing.

Michael: Yeah, well the first thing we do when we talk about culture, well, we provide a lot of support to our management companies. I’ve never walked in I’m sorry, to our management teams. I’ve never walked in to a company where people were sitting idle, and they were they had a lot of extra capacity. But we you know, they’re they’re dealing with, you know, day to day issues running a business. And we all agree as a as a, as a team, there are certain initiatives that can can add a lot of value that that may or may require outside resources. It may be us at NCK Capital. 

It may be it may be the right consultants, but we like it could be something like, sourcing the right vendor for additional marketing initiative. It could be selecting a new site for you know a new location, geographic expansion. It could be really, really anything that an executive team member would do, that they may not have, have capacity to do. So we will parachute in, we’ll help will work alongside of the management teams. And, and, and get those high value initiatives completed. But we also back to the culture discussion, we we really believe it’s important to understand the culture of the business and understand the people and no matter how much diligence you do, it’s really hard to, to understand that completely pre acquisition. 

So when it comes to culture, which we think is an incredible accelerant for, for value creation and growth, we take a I wouldn’t say a passive approach, but a more patient approach in stepping back and observing and learning. And that’s, that’s just, you know, I think there’s a lot of everybody’s pressured to move fast in this business. I think that’s one place where you just can’t move move that quickly.

Patrick: Yeah, I think that’s everybody mistaked culture for well, we’ve got a very formal dress code, you know, attitude versus, you know, relaxed dress code. No it’s how you do things. There are some some organizations that are comfortable, just do putting as much, throwing as much on the wall as possible, see what sticks. Then others don’t want to go step by step on a process, and you’ve got to get that kind of synched up. And and and you do this. And I’m remiss, are there particular industries that you target?

Michael: Yeah, so we really like services, businesses. And that could be any service that provides an essential service to another, any business that provides an essential service to another business. Could be tech enabled service, it could be environmental service company, it could be a we have a building services company in our portfolio. Really, we like healthcare services of certain types.

 We really like all all all sorts of service businesses. We also kind of what, it’s a little bit different and not in everybody’s investment criteria is we really like for-profit education. We have two, well, we just exited one, we have two vocational schools in our portfolio. And, and really, really like education, businesses of all types. Not just schools. Specialty distribution businesses, we’re working on one now. And then niche manufacturing, where we, those are our four buckets.

Patrick: Okay, fantastic. When we talk about mergers and acquisitions, in the lower middle market, we’re dealing with, you know, two parties. We got a one party that that’s experienced, that’s almost always the buyer. And then the less experienced is the seller where they don’t sell their business every day, this is usually their one time. And when you have situations where you have a deficit of experience, fear and distrust can come in, where you know, once I say we’re going to do X, Y, and Z, and this is market, this is how it works. And then the unfamiliar side is just like, wait a minute. 

I didn’t see this coming. And so there’s always the real danger for these deals happening. And they look good on paper, but when you’re dealing with people, okay, we’ve got those elements of fear and greed out there and you can’t get around that. And so as you go through the myriad of the process with due diligence, and everything else, and all these things can side track a deal and sometimes it comes down to the people. What we’re very proud about in the insurance industry is we found ways because with fear, it’s fear of risk and fear of loss of money, and so forth. 

And what’s been nice is the insurance industry has come in with an insurance product called reps and warranties insurance. The buyer suffers a financial loss as a result of a breach of the seller reps. Now the seller is looking, saying wait, I’ve disclosed everything to you. You’ve done diligence. If I didn’t know it, I didn’t know it. And the buyer says I’m sorry this is market we have to do this. We have to you know put this little backstop on, it’s what everybody does, and we just have to do this to go forward. 

And so there’s an element of distrust. Well, if you’ve got a rep and warranty policy, all of a sudden an insurance policy takes the place of the seller’s indemnity obligation. Seller gets a clean exit. If the buyer suffers a loss, buyer’s made whole. And so it’s just been a real revolutionary product that’s accelerated deals getting closed successfully. It’s lower the temperature, it’s done a lot of wonderful things. But you know, don’t take my word for it. You know, Michael, good, bad or indifferent, what experience have you had with rep and warranty insurance?

Michael: I mean, it’s the greatest thing since sliced bread, right? I mean, we we we just exited one of our portfolio companies. So reps and warranties, warranties policy there. You know, of course, reduce the escrow, maximize proceeds to the seller. It made negotiation of of the purchase agreement considerably easier. And you know, we’re excited being in the lower middle market that that’s now available. It obviously started in the middle market. And is is, you know, a tool that is available to us in the lower middle market. And I just, we use it everywhere we can.

Patrick: But I’m very pleased because you know, especially for the lower middle market, there’s been a little bit of a threshold. Because while rep and warranty does come down to smaller deals, there’s there’s a point at which the cost for due diligence to be eligible becomes a barrier to entry. And this is largely on deals where the transaction value starts falling below 20 million. A lot of buyers do not want to incur the expense to do all the diligence to get there. And at this time in 2021, the insurance industry is so full with the larger deals, there’s absolutely no bandwidth to even entertain small deals. 

What I’m very excited about is that there is a new facility out there. Provides a sell side policy. But it’s one where it’s designed exclusively for micro market deals where the transaction value goes from under a million to 10 million. Where the policy we can ensure that deal all the way up to full transaction value up to 10 million. There is no underwriting fee, there is no diligence process required. It’s just an application. And it’s designed to address that area. And you know, we’re using this as a platform to get the word out because even though a lot of lower middle market deals are involving companies larger than 10 million, you always have add ons. 

And it’s really nice if you can backstop you know, a sub $10 million add on where the seller has a policy at the seller’s expense so the buyer has some protection. And so it’s called TLPE. So I want to make sure that we just make a mention of that. Because for NCK Capital forward as they go on, this could be a fit on some areas where the traditional rep a warranty policy just just doesn’t work.

Michael: Sounds like a fantastic tool to have in the toolbox, especially for add ons. So that can make, make that, make those a lot easier.

Patrick: Thanks a lot. Thanks a lot for your comments on this. I’m glad that you know you got you got that one deal done. It’s interesting. We’re we’re kind of curious with private equity, the view of private equity is they are very reluctant to incur insurance premium expenses. If they can transfer risk, however, they can limit their expenditures, they won’t hesitate. Rep and warranty is the one exception where they they gladly go. And I’m very proud, because it’s been the good performance by the insurance companies. 

They’ve kept their word. They’ve delivered on claims. And so we’re very, very happy. But as we get back into, you know, NCK Capital, Michael, where I mean, I blanked, and we’re already planning for 2022. You know, could you tell share with us, what trends do you see as we go end of 2021 into 2022? Either macro or NCK Capital in particular? 

Michael: You know, sentiment is mixed. Some people think that, you know, there’s going to be reduced deal volume in 2022. And everything and some of the proposed tax changes were driving the, or anticipated tax changes, were driving 2021. Deal volumes, obviously 2021 was incredibly busy for everyone. You know, I’m a little more optimistic. I think there’s I think there’s a lot of businesses that are waited to come to market due to you know, they wanted to get some, some some time away from the pandemic. 

And I think there’s going to be an enormous number of great businesses in the marketplace. One of the things that I think that we’ve, we’ve seen just from a deal structure standpoint is it’s been more structure in deals this year, then then, I mean, earnouts were dead pre pandemic. I mean, they’re just, they just weren’t, weren’t very commonly used. And you’re starting to see those more and more. And I think that’s really interesting. So I think that’s going to be I think that trend may continue on into 2022 as well.

Patrick: Right. I agree. I see no end in sight with M&A. I think that we’re just going to get a lot more creative as we go forward. And I think that tax issues, taxes are gonna go where taxes are going to go, that should never be your primary motivator for doing things. I also agree there have been a lot of sellers that have been on the sidelines because they’re kind of refilling their balance sheets, and just upping their value as they go along. Well, Michael Kornman with NCK Capital, how can our audience members find you?

Michael: Yeah, I thank you for asking. Our website is NCKcapital.com You can find both Grant and I there. And, you know, really a pleasure to chat with you today, Patrick. It’s a great podcast. I listened to it regularly and I I was honored that you invited me on so. So thank you very much.

Patrick: Thank you so much. And I will just as a shameless plug for NCK Capital, I would say too and we’ve got quite a few audience members out there that are family owned businesses that are owners and founders out there. Give NCK Capital a quick look, especially because I think they’ve got a soft spot for you. And that always works to everybody’s benefit. So Michael, thank you again.

Michael: Thank you so much.