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Peter Lehrman | M&A Matchmaking in the Lower-Middle Market
POSTED 2.16.21 M&A Masters Podcast

On this week’s episode of M&A Masters, we speak with Peter Lehrman. Peter serves lower middle market owners, acquirers, and advisors as CEO of Axial, the largest trusted online platform used for safely buying, selling, and financing private companies. Over the last 10 years, Axial has established a single well-known platform that business owners and deal professionals alike trust to discover and connect with new transaction partners.

Peter says, “The whole idea behind Axial was to develop a trusted platform on the internet where buyers and sellers of lower middle market businesses can find, connect with, and be found by one another at the right points in time, and on the right opportunities.”

We chat about the origins and philosophy of Axial as well as:

  • The big differences between the lower middle market and the venture capital community
  • The common practices of evolving out of the lower middle market
  • 10,000+ PE-backed portfolio companies looking for an add-on target
  • Navigating the overabundance of choices in the LMM
  • Trends to watch in 2021— retail 2.0 and the rise of independent sponsors and individual buyers
  • And more

Listen now…

Mentioned in this episode:

Transcript

Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here, that’s a clean exit for owners, founders and their investors. Today, I’m joined by Peter Lehrman, Founder of Axial. Axial is the largest platform on the internet for buying, selling, and financing private companies. Over the last 10 years, Axial has established a single well known platform that business owners and deal professionals alike trust to discover and connect with new transaction partners. Peter it’s a pleasure to have you. Thanks for joining me today.

Peter Lehrman: Thank you, Patrick. It’s great to be here.

Patrick: Now, Peter, before we get into Axial, let’s set the table for our audience and give a little context. Tell them tell us what brought you to this point in your career?

Peter: Sure, so you can, I’ll do the sort of medium version of the answer there in terms of length, so I, I graduated from college in 2001. And I went straight back to New York, where I was born and raised and went to go and work with my brother, who had co founded a information business focused on serving investors and public companies, not private companies, I spent the first six years of my career helping to develop that business, both in America and the business was quite successful abroad as well. Over those six years, all almost all of my time was spent developing information based services and products for investors in public companies. 

And then I went off to business school. And I was lucky enough to get a sort of year round and summer internship working for a private equity firm, investing in lower middle market businesses. And after spending the first six years of my career, focused on building information products and information tools to help investors in public companies make better decisions. I, I was just amazed by how little information there was on privately held companies. And you had all the same sort of cast of characters, highly sophisticated investors, and investment bankers and all these, you know, people, you know, investing in public companies, you had the same kinds of people largely investing in private companies, but just a radically different sort of information, infrastructure available for those transactions to be facilitated. And that did really strike me. 

And so when I, when I graduated from, from Stanford, for grad school, I, to make a somewhat long story short, I basically jumped into the deep end, and began to build what is now Axial. So, you know, six years in the public markets, appreciating how investors use information there. And then a few months in private equity, when I was back in school, made it really clear that there was an opportunity to build a much better information infrastructure for investors and private companies. And I think at the end of the day, that’s really what Axial is all about is improving the quality of the information flow between buyers and sellers.

Patrick: Yeah, I think one of the elements of the technology, evolution throughout throughout America and the world is not data storage, data collection, it’s what to do with all that data, and how to segregate is slice it up and get it out there. And so that that’s fantastic. And I think that the more data there is, the more ways it can be utilized and leveraged and so forth. So let’s get into Axial. And I always like to ask my guests this because unlike insurance firms, or law firms that name their companies after the founders’ last names and so forth. Yeah, usually a story kind of sheds a light on, on on the person at personality of that company. So why Axial? Where’d you come up with that name?

Peter: So I labored pretty hard over this name, there were a few things that I was trying to accomplish. And there’s a lot there’s a funny story that I can tell as part of this, too. So there were a couple things that I wanted to accomplish. The first was, I wanted to spend very little money on a domain name. And it’s hard to do that actually, like a lot of good domains are like already taken, and they’re really expensive, or you can’t get them. So that was one thing that I wanted to do. I wanted to not, you know, start the company and spend 10s or hundreds of 1000s of dollars just buying our domain name. So I was hunting around on GoDaddy and looking to buy a domain name for you know, 19 bucks a year that was you know, that was sort of goal number one. 

Patrick: And maybe that was common, by the way. Sorry. 

Peter: Yeah. But you know, I, you know, there’s a lot of value in a good domain name, but I just couldn’t get comfortable spending a lot of money on it. So that was one thing, the second thing that I had thought about, and then I guess I had read about, you know, in some startup article or something from grad school was, you know, sometimes these were the, you know, the name of a company can just be sort of unfairly advantage just because it comes really early in the alphabet, right. So, as I was coming up with my list of names for, you know, for the business, I did have a little bit of a predisposition to try and find something that I thought would start with an A or a B, or something like that. And it really does turn out if you look at like, you know, the way that an index or a category or a list of sponsors at ACG conference, or something like that, very often, it kind of is like alphabetized, right. 

And so if you have a, if you have a, an A or a B, or something early in the alphabet, you kind of get a little bit of unfair visibility. So that was rattling around in my head, as I was thinking about it. Obviously, the specifics of Axial ultimately really resonated with me. So the word Axial has a couple of different meanings. There’s a medical meaning for Axial, but the one that was actually much more interesting to me, and the one that like, kind of persuaded me to try and pursue a domain name, and a company built around it is there was a, there was a philosophical and religious age called the Axial age. And that age refers to the period in, in the history of the world when some of the most profound and some of the most significant religions began to sort of take hold. 

So Confucianism, Christianity, lots of different religions, became developed during this period called the Axial age. And so the Axial age is often sort of thought about as this period when, you know, men and women and civilization began to sort of learn about right and wrong, and reason and virtue and and, you know, good and bad. And it was like this period where men sort of like, you know, came out of the caves and became, you know, sort of more enlightened right and, and filled with more information and more knowledge. And I have to say, having spent, you know, that, that summer, in that year in private equity in 2007, and 2008, I really did kind of feel like the way private equity and deals were getting done. Really, it did feel in many ways, like the Stone Age, there was no use of technology, there was really, really limited use of the internet as a means of Information Discovery, building relationships, it just sort of felt like, you know, private equity for all of its sophistication was just completely behind in terms of embracing technology, information, and, you know, just the dawn of the internet as a way to transform their work.

So it all kind of, you know, came together in my mind that, you know, there was an Axial age for private equity and for business owners, and that axial age for business owners and private equity would be an age that was based upon, you know, free or very, very affordable access to information and we could be one of the driving forces in that, you know, in that opportunity set. So I landed on it, unfortunately, axial.com was not available. So I bought axial.net for $19.99 on godaddy.com. And, and axial.com, alluded the company until actually just last year, we finally locked up the axial.com domain after a multi year negotiation. And there’s a funny story behind that, too, so.

Patrick: Well, and, you’re tackling an area when you talk about, you know, private equity, particularly in the lower middle market. When it comes to information five, six years ago, yeah, they were in the Stone Age, because it was almost as if they were an exclusive club. And if you ever wanted to identify a private equity firm, let alone team members on the on the firm or contact details, they kept that so restricted. It was as if, hey, you can’t reach us unless we know who you are, which becomes a challenge if you’re out there in the marketplace. I mean, you don’t want to be the best kept secret in the market if you want to if you want to grow. So I mean, that was pretty daunting. When you started doing that back then it would have been easier to go and look at the higher flying publicly traded or the larger area. Why? Because you have a focus with the lower middle market, both in terms of companies that are target companies looking for a buyer, as well as private equity, or financers in the lower middle market. Why that focus?

Peter: So I think that the reason that we chose the lower middle market was not in any way, accidental, I think the lower middle market has a level of dynamism to it, that makes it a market where solving the information problems that plague buyers, and sellers make it harder for buyers and sellers to find one another, to be found by one another, to assess one another as counterparties and partners, there’s a lot of problems and challenges that are, I think, much more unique to the lower middle market than to really any other sort of, you know, quote unquote, category of, of private capital markets. So, by contrast, the venture capital community still remains highly concentrated in Silicon Valley, New York, Boston, and now increasingly, you know, Austin, Texas, and maybe one or two other areas. 

You can get your hands around a great amount of that community quite quickly, it’s geographically concentrated. The super large cap private equity community, right, it’s, you know, they all have headquarters between 40th and 60th Street in Manhattan, right, and they have offices around the world. But, you know, there’s not that many multibillion dollar private equity firms out there, when you go into the lower middle market, everything changes, there are literally 10s of 1000s of, of active buyers, between the private equity community, the portfolio companies that are owned by the lower middle market, private equity community, I think, I think that there’s about 10,000 private equity backed portfolio companies in the lower middle market now. So in addition to all of the funds, then there’s then there’s a whole whole nother just huge range of acquisitive, privately held companies that are owned by those funds. And then you have, you know, folks like J2 you know, or you interviewed the folks from J2 the other week, you know, and they’re, you know, a Fortune 500, and a strategic buyer, all of that sort of fragmentation, all of the dynamism of people entering and exiting the market. That’s what makes it very, very hard, I think, for buyers to find sellers at the right points in time on the right side, on the right opportunities. 

And for sellers to find buyers, the right points in time on the right opportunities. In addition, people tend to age out or succeed out of the lower middle market. So you know, as you get bigger and bigger as a corporate buyer, or as a private equity buyer, you kind of have to put more and more money to work. And the easiest way to do that is to do bigger deals. So even like, you know, most most operators in the private equity market in the lower middle market, if they’re really successful, they actually almost like grow out of it. And so as a result, you don’t have a lot of people who sort of stay in the lower middle market forever, there’s a natural exit and attrition out of the market. Because success means bigger font sizes, bigger font sizes mean bigger check sizes, and then all of a sudden they’ve left and they’ve gone up market, and then a new crop of people come back in right so so all of that sort of dynamism and all of that movement creates a really important information challenge for the market. 

And, and, you know, we try to solve that through the axial platform. There are other companies like pitchbook, that have built great products to try and solve, you know, aspects of those problems as well. But you just don’t have those problems if you’re a multibillion dollar firm like Goldman Sachs, Blackstone, you know, there’s just not that many buyers and not that many sellers at that part of the market. And it’s just a, it’s a different ballgame than the lower middle market entirely.

Patrick: There’s an interesting dynamic you reminded me of is as we’re doing research, and so forth, and again, five, six years ago, there are literally 1000s more private equity firms now than there were not too long ago. And a lot of them were outcrops where you had investors who really enjoyed being in that lower middle market space. And by you know, the very nature they just grew bigger and bigger and the deals got bigger and bigger and they lost touch it was almost like my daughter’s where they would start crying when they as they started growing. They outgrew their favorite shoes, and they still try to cram their feet in and they just couldn’t and you know, it’s just a natural law of evolution for them. 

There are others though with with private equity. You love that small lower middle market. You just build that portfolio. You, sell it to there. There’s always a bigger buyer out there and they’re actually more bigger buyers out there now than before. But you know, as I see it not only in the private equity side, but just for owner, owner and founder businesses out there that a lot of them are aging out, or they’re finding some way to take that next step, if there’s not enough resources out there information wise for those owner founder individuals out there, they’re gonna default to large institutions, because they just they’re familiar with the name, they’re not familiar with being out there, who are these other buyers and sellers, they don’t even know about family offices, this is another class of buyer out there. And so if they default to brand names or institutions, they run the risk of trying to transition their business with an organization that for no fault of their own, you know, these institutions overlook them, they’re not as responsive, they won’t value them as much. 

But they will overcharge that. And, you know, there are resources that can be brought to bear that are, you know, fit to that lower middle market. And it’s a vast, vast market. That’s one thing that’s very nice for, you know, supply siders like me, I want to be in markets that are growing, not markets that are very limited, they may grow a bit. But you know, there are a lot of these out there that all need help. And so the more that we can bring information to bear on that, on that group, that is a part. That’s why I have a passion for the lower middle market. 

Peter: Yeah, I mean, you know, I hear all the time and about, you know, all the lower middle market, you know, it’s so underserved. And, you know, and that’s like, you know, to me, that’s kind of old news, and sort of a cliched theme, there are a lot of outstanding investment professionals, investment bankers, lawyers, CPAs, providers of financial products, insurance products, like what Rubicon is doing in the lower middle market, I don’t actually think that the lower middle market is underserved. In the way that I hear people always talking about well, you know, buying businesses in the lower middle market, because it’s really underserved. I think the real issue in the lower middle market, at least now, is not that it’s underserved. It’s that there’s a huge, you know, diversity and array of different providers and partners that you can, you know, theoretically choose from, right, you can sell your business to a private equity firm, you can sell it to a permanent capital organization like J2, you can sell it to a strategic buyer. 

There are family offices in the market, there are lots of different intermediaries. Some of them are two, three person, four person organizations that do high quality work, others that do low quality work. Others that are 100 person organizations. Yeah, so I think I don’t think it’s underserved. I think it’s, I think it’s well served, I just think it’s very, very hard to, as a business owner, to know, to know, all of these people to know how to sort of assess all of these potential partners to work with. And so I think that’s actually the bigger challenge, right? It’s not whether it’s not that there’s not enough people serving the lower middle market, it’s helping the owners and entrepreneurs navigate those, that huge list of choices, right, there’s 100, private equity firms, I mean, what am I going to do, like, you know, go to every single one of their websites, they all sound the same and say the same thing, right? So how am I really going to figure this out? 

So that’s what I think is actually the bigger challenge. It’s not that they’re underserved. It’s that it’s that there’s too much choice, and, and they need help slicing through those choices by getting their hands on, you know, good information, and, and good resources. So that’s a little bit of my sort of, like devil’s advocate argument to what you know, is sort of the cliched chatter on how the lower middle market is underserved. I think it’s really well served. I just think it’s a lot a lot of different operators down here. I mean, one of the things I was going to say just prior to your prior question. In the lower middle market, it’s the only part of the sort of private equity sort of quote unquote market where you truly have these, like individual business buyers who are buying, owning and operating businesses for their own account. We on the Axial platform serve a set of clients who are buying businesses, they’re not raising outside capital. They are not a family office, they are a person, they are an entrepreneur. And they own and operate a small portfolio of SMBs small and medium sized businesses, they buy their own capital they buy it with a combination of bank financing and their own capital. No such creature exists up market right yeah, there’s no there’s nobody who’s you know, buying businesses for their own account in the multi 100 million dollar category except t for Jeff Bezos, right, you know, who’s behind the Washington Post or whatever. But there is none of that. 

And so I think that’s one of the really interesting things in the lower middle market is you can, you don’t have to sell your business to a private equity firm, you don’t have to sell it to a strategic buyer. There are actual entrepreneurs in the lower middle market who have made a career buying businesses for their own account. They’re not a fund, they’re not anything, they’re there, they’re a person just like you are. And that kind of buyer just doesn’t exist in any other sort of part of the the private market. So lower middle market is just so unique, because it’s just got all of this sort of dynamism and diversity and different ways to skin the cat.

Patrick: Well I didn’t, I didn’t realize because I’ve been chanting that same thing underserved market and so forth. I think it’s almost like they’re getting an overabundance of choice. And, and they’re, they’re almost just blip stuck, and with with too many choices, and it can feed into, okay, well, where do we go, you know, information overload and choice overload, and so forth. But yeah, you’ve got a, you’ve got an Axial brings a solution to that. So let’s talk about this a great segue into because Axial isn’t just Axial, there’s the Axial, that’s the online platform, but then you’ve also got the Axial network. 

Peter: Sure. Yeah. So I mean, you know, the whole idea behind Axial was, can you develop a trusted platform on the internet, where buyers and sellers of lower middle market businesses can find and connect and be found by one another, at the right points in time and on the right opportunities. And that’s a straightforward concept, right? It’s like, you know, we’ve been written up in various publications, as you know, the match.com for m&a or the, you know, the Tinder for m&a is the way Bloomberg wrote the story on us. So it’s just it’s a straightforward concept. It’s obviously a hard problem to actually solve perfectly. 

And we definitely have a long long road to go that we’re excited to go down to make it better and better. But the core functionality of the Axial platform allows for a owner of a business who’s looking to raise capital or sell to either on his or her own behalf, or through a trusted intermediary, who they have hired on their behalf to go on to the Axial platform to confidentially upload a bunch of information on the business and the transaction that they’re looking to execute. And to do that, in total secrecy, as if you’re sort of like you have like a one way mirror on the market of buyers, as you upload the data onto the platform, Axial returns back to you a set of recommended potential buyers or lenders based upon the data that you’ve uploaded. 

So if you’re looking to raise $30 million of debt, we’re not going to recommend growth, equity investors, if you’re looking to sell your business, and you operate a manufacturing company, we’re not going to be recommending buyers of software businesses. So the more data you add into the sort of fields that we’ve built, the richer a set of recommended buyers we can provide to you, or lenders or equity investors in the business. And it’s at that point that the business owner who is deciding, okay, who do I want to engage as part of this process gets to sort of have that one way mirror, it’s kind of like, you know, the, you know, the, the lineups when you’re in prison where like the person goes and looks and you know, sort of points, you know, but you don’t get to see who they are, they’re behind a one way mirror, that’s basically, that’s basically the tool set that we give to, to the investment banker and to his or her client. 

So they get to confidentially upload the data on the business and the deal they’re looking to execute, they get to see all the potential buyers on the axial platform that might be a fit. And those buyers have all essentially articulated their investment criteria, their transaction histories, the reasons for their interest in particular types of businesses. And then the seller gets to decide who they want to invite into a private dialogue to begin discussing the transaction. So that’s basically what you know what the business. That’s what the business does, again, and again, and again and again, for different sellers and for different buyers is enable those kinds of introductions and those kinds of customized conversations to happen at a scale that we think didn’t happen and couldn’t happen before. 

Something like Axial. We automate in addition to that, we automate you know, the execution of NDA s and the distribution of CIMs the confidential information memorandum. So we we’ve used software to automate I think a lot of the more busy drudgery oriented admin work of an analyst or associate investment banker, and let the the bankers and the deal team sort of focus on more valuable sort of more value added interactions and and more interesting work. From the buyers perspective, that obviously, you know, creates a a, I mean, ideally, we’re augmenting your your pre existing deal flow, right. So you know, every buyer buying businesses have some of their own deal flow, it’s a function of their first party sourcing networks and their personal networks, we don’t aim to replace that, we just aim to augment that and sit on top of that, and grow the reach and distribution that you have on the buy side. 

So that’s the, you know, that’s the core nuts and bolts of Axial without creating too much of an advertisement for it. I mean, well, but we just, you know, found is that, you know, as a result of building this network of buyers and sellers on the platform, there was an opportunity for us to build real community around that and not just have it be this sort of cold machine like software organization. And so we began to hold events for our members that use our software platform. And for the last six or seven years, those events have all been in person, we started holding digital events in March of 2020. Coincidental with the arrival of COVID. 

But what we’ve really found is that by creating an environment where both digital and in person events can happen among and between our members, it’s just kind of like the Yin and Yang, for the business, the software platform enables a lot of scale, a lot of productivity, a lot of automation solves a lot of problems for you know, for the members on the buy side and the sell side. But the events, enrich the network, enrich the platform, create the opportunity for more meaningful relationships to be formed. And while that’s not important at the beginning of a deal that is critical at the end of the deal, so you just can’t very few deals get done. And go all the way, you know, go the whole distance, when there isn’t a pretty strong sense of trust and chemistry between the buyer and the seller. 

And so anything that we can be doing to improve the quality of the relationships and strengthen the trust within the community of members that use Axial, that’s good for us, because it makes it easier for them to find and be comfortable doing deals with one another. So that’s kind of how we thought about the network that sits on top of Axial as opposed to just sort of raw lines of code that you know, that power of the application itself.

Patrick: Now well, I think that you know, my belief about M&A is this is a people business, this is not a Company A buying Company B, it is a group of people choosing to partner with another group of people. So ideally, one plus one equals six and and that’s the objective get out there. And you cannot get the human element out as much as there’s a lot more efficiencies with technology and the gathering of information, that you’re still the person to person network, it is essential, I think that you’ve honed down the membership, because it is the lower middle market area. And these are the deal players that are there. 

And these are long term players, they’ve been around for a while, and you’ve built up the network over 10 years. So this is a fairly well established credible venable group group of participants in there that, you know, they don’t do it once I mean that, particularly the buyers, they they, you know, we’ll be doing this again and again, and some some sellers may want to go out and adventure down down the road as well. That’s the big element out there that you just referenced was, you know, with business development, in M&A, a lot of it because it was all in person was fragmented. And then when you could collect people together would be at an ACG conference and other industry conference. 

And that’s where, you know, for me, it was a real challenge, just trying to track down private equity, managing directors that are either at conferences or at shows or out on the road, and so forth. COVID comes in, boom, all that stops. And, you know, the whole traditional model for business development now has changed. Actually one of the members put out a real thought provoking article, I interviewed him not too long ago, Mark Gartner, where he talked, business development has changed forever. And there are organizations like yours that at least, you know, you may not close something from beginning to end virtually. But you’re getting, you know, around second base by using the Axial network that does that. Why don’t we talk about you know, how COVID has changed Axial and M&A in your realm?

Peter: Yeah, for sure. I mean, I think, you know, I do think that COVID has definitely had a permanent and material impact on on on, on financial transactions deal making in private markets. I mean, the public markets were already so automated, you know, the exchanges and trading and all of that. So I think they were really far less impacted by COVID than the private markets. And, and so, here, I guess a couple of thoughts that I have with respect to to COVID, and business development, and just generally private markets, I think the first thing is now that everybody can meet face to face, without meeting face to face. 

That is going to redefine the, the value of the need for and the appropriateness for an actual physical in person meeting, right. So, fast forward two years, vaccinations are done, you know, COVID is effectively gone. Everybody can now meet with one another very cost effectively without leaving, you know, their their basement. Right. So what does that mean, for the in person meeting, I think the in person meeting is not going away, I think in a world where everybody can easily meet on zoom, and there’s essentially no marginal cost to meet, you know, over zoom. The people who make the effort to continue to meet with people in person to continue to have that be part of their business development mix, whether it’s in private equity, or whether it’s in any other sort of high touch, you know, sort of big stakes transactional category are going to, I think they’re gonna have like an advantage if they use those types of meetings, right? It’s like, if you think about what happened to the written letter, once email arrived, yeah, right. 

So, you know, if someone sends me a bottle of champagne at Christmas, or whatever, and I send them an email, like, Hey, thank you so much for the champagne. You know, from their perspective, that’s nice that I sent, you know, sent them a thank you note, right. But there’s something totally different when I take out a fountain pen and a nice piece of stationery, and I write them a note and put it in the mail and put a stamp on it and go out of my way to do those things. And, you know, and and they get a nice piece of, of, you know, handwritten mail in, in the mailbox a couple days later, I think there’s the same, I think the same kind of shift can can can now translate to this kind of Zoom in person meeting, it’s going to be a way more efficient space because of Zoom and the speed with which you can meet in person, you know, or not in person, but you know, meet face to face over the internet. 

But there’s going to be something very significant about the person who makes the effort and the investment, to get on an airplane to get in their car to get in a train, and come in and see a business owner face to face. Right. And so I don’t think that that advantage is going to go away. One of the things that I think so that that’s one big change, I think another really interesting changes. You as a buyer of businesses, or as an investment banker, courting business owners to to earn their business and be their advisor of choice, if you have been developing the relationships in advance of any transaction, and part of the development of that relationship has been in person and part of it has been over Zoom. I think that subsequent transaction can occur extremely quickly now, right? 

So if you if I’m buying businesses, and I’ve already met an entrepreneur, and I’ve been following his business for two or three years, and he picks up the phone, and he calls me, and we have a Zoom call, and he says, Hey, I’m ready to go, Well, I’ve already met him in person, I know who he is, I’ve been following his business, I can basically do the rest of that deal over Zoom. Right. So I think that like the back half of a lot of transactions can happen way more quickly, in a post COVID world, provided that the relationships between the buyer and the seller have already been sort of created, you know, up the funnel. So I think that’s, you know, that’s really interesting. I also would say that private equity is probably a few years away from actually moving to a fully virtual diligence process, the venture capital community has already gotten there. And they tend to move more quickly for a number of good reasons than private equity, largely because they’re not really ever doing controlled transactions.

But it is totally common now in the venture capital world, to meet an entrepreneur over Zoom, and, you know, right them a $10 million Series A or Series B check, you know, six weeks later or two, three months later, without having ever met them in person that’s happening all the time now, in the venture capital category. I know that private equity still feels like they more or less can’t quite fully do all of the m&a due diligence that they need to that way. But again, I would take the devil’s advocate point of view here and say, the efficiency of of being able to do things like this, the quality of bandwidth, the quality of the technology, all this stuff. Just think that within five years people are going to be capable of and comfortable doing full control buyouts with very, very limited in person contact. I just, you know, you heard it here first. 

Patrick: And you’re gonna just see competitive pressures forced that, where

Peter: I think that’s right. You know, as soon as one private equity firm says, hey, we’re willing to do it all virtual? Well, I mean, you know, it’s just a prisoner’s dilemma at that point, right, then everybody else has to sort of try and figure out how to do it too, right. So it only takes a few brave souls in private equity to say, hey, let’s try and figure out how to really do basically all of this virtually. And in the course of figuring out how to do that, they have created a really interesting competitive advantage that allows them to move faster and close deals with shorter closing windows. And that’s really compelling to bankers and to, you know, to business owners, and then the whole rest of the market has to follow suit. So I really do think it will happen, I don’t think it’ll happen in 2021. But I do think it will happen before 2025, for sure.

Patrick: Well, there’s a perfect segue when you talk about diligence, and you know, dealing with risk, and so forth, I mean, you have to get over the first hurdle of just making sure that you know, by yourself that there’s a fit there, and then and then you move forward, then you go through the whole diligence process. And, you know, there’s risk with a lot of stuff. And you know, both parties want to go ahead, and if they can’t, if they can’t mitigate or limit the risk they want to transfer now. And so that brings me right over to probably one of the other big developments in M&A. 

And that’s insuring deals through a product called rep and warranty insurance where the seller reps, rather than being the personal liability of the sellers, to the buyers financially for any breach of the seller reps. Well, now we can just transfer that risk over to a third party insurance company with deeper pockets in both parties in most cases, and all of a sudden, seller gets clean exit, they don’t have to worry buyer if something does blow up, their their risk is hedged. And it is something that’s beneficial. They’ve gotten cheaper, because the claims they’re there, but they’re not huge monster monster claims that are driving up rates as in other things. 

And so it’s become just a real, efficient, elegant tool. I’m curious, because this product wasn’t really available for the lower middle market until about 18-24 months ago, it was reserved for the 100 million dollar plus deals. Right? Tell me with, you know, whether ever experience that you’ve seen, and you’ve drawn from your members, what have you heard about rep and warranty?

Peter: Well, so, you know, I have never been an M&A buyer of businesses in the lower middle market in the way that our clients are, but I have raised outside capital for Axial. And, you know, I remember very well, the, you know, the, the endless back and forth over reps and warranties, as part of, you know, raising rounds of financing for Axial. So it’s a huge deal. There’s lots of deal breaking moments that can emerge in the reps and warranties part of the negotiation. And yeah, from, from my perspective, for that piece of risk in a transaction, to become the focus of professional underwriters with very, very deep pockets, to transfer that risk away from the seller, that I mean, you know, I’m sure the buyer still have to get comfortable with just the inherent risks of buying the business. 

But I, that is an incredibly good development, in my opinion for the lower middle market and for capital markets for private companies. Because it is, it’s hard to believe that that doesn’t increase the velocity with which capital can form around small and medium sized businesses, if you can take a piece of risk. And, you know, and transfer it both away from the seller, and also have the buyer have peace of mind, you’ve just taken a huge a huge aspect of deal making that makes the deal longer, makes it slower increases breakage risk, and you’ve taken all of that and you know, you haven’t, like farmed it out in some careless way. 

But you now just have a place where you can you know, where you can lay off that risk, and that allows the deals to proceed probably more quickly. I don’t know how the insurance underwriters of reps and warranties go about their work. Are they doing that work fairly expeditiously? Like how fast can they diligence, the reps and warranties that they’re preparing to underwrite?

Patrick: Yeah, the misconception out there is that underwriters will perform a whole set of their own diligence when they’re looking at a transaction. In reality, what they do is they’re relying exclusively almost exclusively on the buyers diligence. They Want to see what the buyer looked at? They look at the reps than they just are going to be pulling the buyer and say, show us your legal report, show us your HR report, show us financial reports. And if they’re not audited now they flex they’re flexible will show us a quality of earnings report, show us that you went check the boxes as much as possible. And if we felt that you you’ve done a thorough enough job, then we’re gonna we’ll backstop you. It’s completed in a matter of days. So the only thing that’s been constraining on the insurance industry is more deals are getting quoted. And so more diligence reports have to be analyzed. And, you know, five years ago, there were only three rep and warranty insurance companies. Now there’s over twenty.

Peter: I mean, I think that’s an incredible development for the lower middle market, I think for for underwriting to happen in a handful of days in, you know, in many cases, that takes the reps and warranties risk takes the tension that that creates between the seller and the buyer and creates a third party, I think, the way we tend to look at the you know, for us at Axial, we’re always trying to sort of figure out where’s the friction in deal making in the lower middle market, right, what is the source of friction, because, you know, that’s what’s slowing down the pace and the velocity of transaction execution, that’s what increases the likelihood of deals falling apart. 

So whenever an innovation arrives in the lower middle market, that’s decreasing the speed with you know, improving the speed with which deals can get done, figuring out ways to take risk, and move it off the table or distribute it more efficiently. Those from our perspective, usually, those are almost always very good things for the lower middle market, they’re good for entrepreneurs, they’re good for business owners, they’re good for the economy. So it’s great to hear that the reps and warranties market is growing in the lower middle market and not just, you know, sort of for the big dogs north of $100 million. I mean, that’s, that’s really exciting.

Patrick: Well why don’t we because everybody’s all had their appetites whetted for Axial. Give us the profile of an Axial member.

Peter: So, you know, I guess, it’s been so great to just serve the diversity of member types that we’ve served, you know, you know, the, you know, sort of at the top of the food chain, so to speak, I mean, they’re, you know, the portfolio companies at a place like, you know, KKR that are looking to acquire small, lower middle market businesses, those are customers of Axial, right, we have a, you know, corporate corporation that’s buying home health businesses and behavioral health businesses, it’s owned by KKR. And, you know, their clients of Axial and they’re out looking to buy small, you know, just small, you know, single location, retail, behavioral health clinics, and they use Axial as a channel to source deals for that, right. 

So that’s like some, you know, big name and KKR. And then, you know, just, you know, just a month and a half ago, a ex investment banker, professionally trained, I think at B of A for many years spent, you know, did his tour of duty in New York City, he went back to move back down south, and he’s, he’s one of these guys who buys and owns businesses for his own account. He doesn’t have outside capital. And he bought a wholesale distributor of dairy products and dairy supplies business, and he bought the business, he sourced it through axial, bought the business for about 5 million bucks. And, you know, so what we’re really trying to do on Axial is not create a platform where only the really well heeled and really well capitalized sort of institutional and corporate buyers can, can succeed, we’re trying to create a platform and a business model and an offering where all different kinds of buyers from all different sort of walks of life, can pursue acquisition opportunities through, you know, through the platform. 

So that’s a little bit about like, sort of, you know, the spectrum of buyers on Axial, I mean, you know, the, the, you know, the bullseye target, are, you know, lower middle market, buyers of businesses focused on companies that have typically somewhere between a half a million and 10 million of EBITDA. So that’s really like, that’s the sort of core sweet spot for Axial is sort of half a million, maybe 1 million of EBITDA up to about 10 million. There’s transaction activity that occurs above that range. But the overwhelming sweet spot is sort of within those two goalposts on the sell side. Again, you know, some of the more well known names on the sell side in the investment banking world using Axial, there’s firms like Stephens, which is a pretty well known investment bank based out of Little Rock, Arkansas. 

They do really big deals, they’ve got a really respected presence, you know, up here in New York City. But, you know, we were working with, you know, Business Brokers that operate a single shingle, you know, and, you know, they have their own LLC, they sell one or two businesses a year. That’s how they pay for, you know, their mortgage, and put their kids through college. And they’re able to use Axial, the same as, you know, a fancy investment bank, with a lot of, you know, a lot of pedigree. So we really are trying to basically, what we care about is whether or not you are a good faith, high quality participant in the lower middle market, right. And we don’t care. 

You know, if you’re at a fancy brand name, whether you’re at a big organization or a small organization, what we care about is whether or not you’re genuinely focused on doing high quality deal making, and transacting in lower middle market businesses, as an owner and operator, an advisor or a capital partner. And if you can clear that criteria, then we really feel like we have built something that could be you know, could be helpful for you. So that’s the spectrum of profiles. There’s very little business owner activity on Axial directly. So most of the business owners hire an intermediary and the intermediary is using axial on their behalf. I’d say 15% of all activity on Axial is from a business owner directly. And the remaining 85% is intermediaries who use Axial’s tools on behalf of their their sell side clients.

Patrick: What trends do you see this coming year 2021 for either Axial in particular or M&A in general?

Peter: Well, I think what’s going to be really interesting is to is to watch how dealmaking occurs in the world, in and around sort of retail 2.0, right. So, you know, when COVID hit, like, retail 1.0 just got destroyed, right? I mean, unless you were a grocery store, or you had the scale of Walmart or Target. You know, I mean, it just was it’s very, very brutal out there. But I think now, there’s been almost a year of time. And so I think, retail businesses of all different kinds are have have had eight or nine months to try and survive, and to try and sort of reinvent their business models, right. And so I think there’s going to be some really interesting, innovative models that take advantage of local retail distribution and storefront capabilities. 

And I think while the big mega wave trend is obviously ecommerce, and that’s only accelerated because of COVID, I think there’s going to be this sort of resurgence of a new model and a new form of retail. And I think there’s going to be some really interesting growth capital and maybe interesting m&a transactions that sort of occur on the, you know, on the upswing of retail, which right now is so massively distressed. So I think that’s like an interesting area to watch for some interesting green shoots, as new business models get get created there. I think on axial in particular. Look, I think, you know, one of the interesting trends, and it’s not a new trend, but I just think that there’s more and more. There’s more and more entrepreneurship through acquisition happening in, in the lower middle market. So there’s a lot of people who are leaving Apollo or leaving KKR, and saying, you know, what, I’m just, I know how to do deals. 

Now, I’ve been really well trained, I’m a professional principal investor, I can go out and using a platform like axial or even not using a platform like this using my own relationships, I can go out and find deals, you know, for my own account, I really think that that form of entrepreneurship, where people can go and buy small and mid sized businesses either for their own account, or the little bit of backing from family offices, not just the independent private equity sponsor model, I think there could be like a really huge wave of growth in that category. In 2021, and and beyond. 

And I think that that that’s another interesting, interesting one to watch where, you know, people say, I’m not going to make the climb to managing director over the next 10 years, I’ve decided, I’m just going to go out on my own, I’m going to set up my own little principal investing vehicle, and I’m going to go buy five to $10 million businesses. And so I think that that’s going to change the face of private equity in the lower middle market pretty significantly. I think the trends already underway, but I think if you like by 2025, I think it’s going to have like, been quite transformational to the complexion and the demographic realities of lower middle market buyers.

Patrick: Peter Lehrman, thank you so much. This has just been very entertaining. Very informative.

Peter: Well good. It’s been great to be on the show. Thank you very much.

Patrick: This is great. How can our audience members find you?

Peter: Well, I’m available to anybody anytime via my email address, Peter@axial.net. The website is www.axial.net and it’s also now axial.com which is great. So either one of those will take you to our website. And it’s free to get started on Axial. So we have subscription based offerings, but we also have offerings that are free to get started. So anybody can get underway for free on Axial on the buy side or the sell side. And there’s lots of resources there as well to just sort of learn about what we do and how we’ve been helping people. So feel free to reach out to me or feel free to head to the website.

Patrick: I agree. I will say that I have stolen from you and Axial content wise, just ideas because you guys have some great content out there. Great cutting edge trend things and because you’re in, of and for the lower middle market, who better is a resource to rely on for cutting edge insights.

Peter: Appreciate the thumbs up there.

Patrick: Very good. Thank you.

Peter: All right, Patrick. Thank you.