Transcript
Speaker: Buying or selling a business might be easily repeatable for those with lots of resources and capability. But what about deals in the lower middle market? Generally companies between 10 million to 50 million in annual revenue. How do those companies need to respond?
Speaker: Welcome to the Market That Moves America, a podcast from the National Center for the Middle Market, which will educate you about the challenges facing mid -sized companies and help you take advantage of new opportunities. Welcome to the Market That Moves America podcast. I'm Doug Farin, managing director of the National Center for the Middle Market at the Ohio State University Fisher College of Business.
Speaker: We're the nation's leading research organization studying mid -sized companies, which account for a third of private sector employment in GDP and the lion's share of economic growth. It truly is the market that moves America. The National Center for the Middle Market is a partnership between Ohio State and Chubb. Today, I'm happy to welcome Elliott Holland, managing partner of Guardian Diligence. Thanks for joining me, Elliott, and welcome to the podcast.
Speaker: Thanks for having me, Doug. It's good to be here. So first, can you start by just telling us a little bit about your background and your company, Guardian? Sure, absolutely. I'm a reformed engineer who started his professional career doing strategy consulting with Accenture. I then went off to Harvard Business School, got involved with Middle Market Private Equity, worked at a couple of firms, Lynx Partners, the Watermelon Group, and then
Speaker: Spun out with a mentor of mine who became my business partner and started my own independent sponsor investment firm. Same sort of private equity thesis. We were looking at sort of deep value acquisitions, two to $8 million in EBITDA. We made acquisitions in the tow truck company into an automotive parts supplier and into a clinical trials business.
Speaker: When my partner retired, I spun out and did a similar business under the name Spartan Capital Partners. And so a lot of my background has been in private equity, particularly around independent sponsors and sort of people who put deals together based on their relationships. And about four years ago, I changed the model and moved over to the advisory side and started a firm called Guardian New Diligence.
Speaker: where we specialize in providing a full suite of buy -size solutions for acquisition entrepreneurs, independent sponsors, and sort of main street everyday business buyers who are looking for a cost -effective solution to help with due diligence, but also help through the full deal process. So there's been a lot of sort of entrepreneurial private equity finance in my background.
Speaker: And I assume then you also tend to focus on middle market companies, is that correct? Yeah, the whole time has been in the middle market. So since you've been on both sides of the table in these transactions, can you talk about some of the inefficiencies that you've noticed in the buy and sell process? I think buyers and sellers having a very different education and basis for making decisions causes inefficiency. I'm not sure how to fix it, but I know that
Speaker: A lot of us financial first business buyers think of business value as a function of cash flow and working capital pegs and caps and buckets and those kinds of things. And most entrepreneurs in the middle market think of their value as equipment, as 15 years in business, as all the employees that they've had. And so I think negotiating from those very two different points of view can be a challenge and cause so many efficiency. I think
Speaker: more and more people are coming into the middle market. That's been happening for a long time. And so oftentimes people who have been used to doing bigger deals come into the middle market and the specificity of the data, the, I'm not going to say quality, the exactness of data, the amount of
Speaker: sort of volatility that there can be in valuation, all increases in the middle market. And I think that causes some efficiency for people who may look at a monthly cash flow statement and see what they would consider huge swings if they were looking at a billion dollar business, but it's just par for the course in a hundred million dollar business. So we've done a little bit of research in prior years around M &A in the middle market.
Speaker: And I just want to throw a couple of stats out here that we found about one in five middle market companies by all or part of a company in any given year. Additionally, about 5 % sell in any given year. And these deal makers expect a little over 25 % of their growth to come from M &A. However, 70 % of the buyers and 90 % of the sellers have little to no experience.
Speaker: Is that surprising to you? Do you agree with that? Is that what you've generally see? Yeah, in practice, a lot of people don't have a great working knowledge of the process. And then they don't have a great working knowledge of each piece. You know, I do a lot of work with independent sponsors, helping them do middle market deals. And I'm surprised oftentimes by even experienced deal makers who may have done four or five acquisitions that miss the impact of human interaction
Speaker: during a buy process. And as a result, sort of caused their own inefficiencies, honestly. What are some of those common mistakes that you tend to come across either from those trying to acquire or those who are selling their business? What are some of the big issues? Sure. And just to give a sense, I work primarily on deals under $35 million in enterprise value. So I know the middle market,
Speaker: tops out probably a lot higher than that. So just to give you a sense, in the part of the market where I'm working, mistakes are made when people come in with a completely financial lens and don't have an operational lens. And how that shows up is you'll buy a company with steady cash flows. Working capital is pretty normal. In a good industry, all the cash flow stuff works. The Excel model works.
Speaker: And you'll forget 50 % of the sales were done by the owner who you're kicking out six months after close. And those steady revenues that you bought are a function of that person who's not sticking around in the company. So you kind of miss the forest for the trees. I think the other mistake people make is in my mind, communication. So I think a lot of people are good at talking and emailing and they're really good at their own preferred
Speaker: means of communication, but I think a lot of people make mistakes when they're sort of mid -career deal makers dealing with later career entrepreneurs and the mid -career people prefer emails, even text messages and don't realize that for the other generation, phone calls and visits are the way to manage difficult things. And so I think those mistakes cause issues
Speaker: getting negotiations done and building trust. So we did some follow -up research actually on business transitions and we found that business leaders were seeing challenges really around getting the strategy right first. Second would be finding the right buyer or seller. And the third would be integration. What are your thoughts on those three? Yeah, I think integration is tough because again,
Speaker: A lot of the buyers are financial first and integration is operational tasks. And so what you end up doing is putting things in the spreadsheet that you think could happen reasonably without consulting an expert who has done the work before and not having a great sort of basis around what is possible, what constraints are there with change management, what constraints are there with
Speaker: capacity of the people who are need to execute the project. So I think integration can cause issues in that way. And I'm sorry, Doug, the first and second, I was having a hard time. Can you repeat those? Specifically thinking about finding the right buyer or seller. Say I'm a company and I'm
Speaker: thinking about acquiring a new business or maybe I'm a second, third generation owner and the family doesn't want to continue on. I'm looking to exit. How do I go about finding a buyer, even a seller, those targets? What are the questions that owners can do to accelerate? So buyers have a hard time finding deals.
Speaker: because I think that's the hardest part of the business. And I've come back to this theme several times Doug, so forgive me, but I do think that communication and business development becomes so much more important in the middle market and the large market. When deals transact for any portion of things that are not cash related, in my mind that comes down to interpersonal finesse and sometimes
Speaker: Financial first folks don't have it as well as some others. And so looking for deals is almost like a sales process. And so for people who have not done sales, it can be problematic to try to fill your funnel with stuff. The other thing is that when you start off or when you're rolling out of some of the bigger firms to start your own independent sponsor thing that may focus on the middle market, some of the relationships just don't carry over. You also might not be able to compete head to head with
Speaker: a middle market private equity fund. And so therefore, searching for deals can be tough because you may see some things that you can't really win an auction on. And then I'll touch on the buyers, sorry, on the sellers for a minute as well. Oftentimes what I see is the owners wait until six months before they want to sell to sort of raise their hand and say they want to sell. And I give
Speaker: sellers and buyers the same advice. If you come to me and say, hey, I want to close in six months, you're too late. As a seller, you need to put your business in a package that's going to sort of create maximum value. Some of that is truly operational, right? Some of that is packaging, and those things take time. Evening out customer concentration, bringing in a management team that can stick around with the company,
Speaker: shoring up some technology issues, all those things take time and can increase the value 30, 40%. And then the other piece is that you can't just get your business together, put together a good confidential information memorandum and then expect in two weeks somebody's gonna write you an LOI for the price that you want to sell your business for. So that sales process takes a while and I think because
Speaker: Again, it's not like a house, you know, it's not a four week to 10 week process. People wait far too long to get started. In that business transition study that I mentioned, we found that the average prep time for a deal was about 14 to 15 months. Does that sound about right? Absolutely accurate. And I'll tell you what,
Speaker: Sometimes like you're surprised that more sellers don't engage almost by side counsel for sell side purpose earlier. Now that might be an investment bank. So I know I probably have investment bankers that are listening to me. But I think even if it's not a full on investment bank process, you'd want to talk to your friends or find someone that buys companies to give them to allow them to
Speaker: counsel you on what the process is to go from two years before you want to sell to how to land the plane on a closed deal. Because that 13 to 14 months you mentioned, Doug, is real. And then, oh, by the way, if you want the changes you're going to make to show up in a full calendar year of financials, it's longer than that. And so that house example that you used earlier, it's like hiring a realtor to come in and maybe
Speaker: tell you what things you need to upgrade, change, you know, staging so that you show your house most effectively. Is that the type of advice that a consultant or advisor can provide to a business as well? I watched a television show the other day and you know how sometimes you watch stuff that's totally off that helps you about your core business. It was a show about a guy who went in and helped people who had properties for sale that just were kind of crummy.
Speaker: And his eye for design, he was sort of pull all the furniture out of somebody's house. He changed all the decoration. He rearranged furniture. He rent top -notch furniture to put into the place. And the house, which was the foundation for what was there, everything else was very small value and building a comparison. But that simple change would get not only, you know, five to 10X the people coming to look, but, you know, 50 % higher purchase prices. And I'm not so sure.
Speaker: generally those things aren't the same for businesses. How has these last 10 or 11 months of the COVID pandemic impacted the marketplace? Are there temporary adjustments that you see kind of returning to normal or do you think there are more permanent changes in the marketplace? So a couple of things. I think the first four to six months
Speaker: after COVID hit the states, which I will call it March 1. Some will call it March 14. But those next four to six months, deal activity just slowed to a halt in a lot of places. People were looking to figure out what was going on. Nobody knew the impact it would have on business. Then around, in my mind, July, August, September, everybody just said, hey, we got to get deals done no matter what the environment is. But a couple of changes that I think will stay
Speaker: Doug, some folks got really good at doing deal transactions and meetings over Zoom. Some people never would have done that before. Some people didn't want to do it when they did it, but they did it. I mean, I was helping one independent sponsor group out of Chicago that was buying a company in Canada and couldn't get into Canada. So they closed that deal without seeing the company for several months before it closed. I think they had seen it.
Speaker: before the pandemic hit, but I think that's a change that will be around for a while. I also think a lot of industries that had pretty steady trajectories are going to fundamentally change. I don't think we fully know how the impact of COVID and office space will impact commercial real estate and therefore all kinds of businesses that service commercial real estate and even the restaurants and hospitality I think will be different going forward.
Speaker: And so I think a lot of groups that focus on those kinds of deals are sort of re -working and revamping their valuation models and sort of paths to market. And so as a follow -up, do you think this is an opportune time for someone to buy or sell a business or do you think they should kind of step back and maybe buy their time a little bit and wait to see while some of the uncertainty might clear up depending on industry?
Speaker: As an entrepreneur, when things get messy, I make money. And so in that vein, and knowing the lens that I'm seeing things from, I think if you're a seller, you have to recognize that if there was, for good companies, if there were 10 people looking for good companies before, because so much of the market took a major hit,
Speaker: there's probably gonna be 50 % more people looking at your business now if it didn't have a bad COVID environment. So if I was a business in a good industry, I would absolutely be looking to sell. If I was a buyer, I would almost take the opposite tact and say, hey, there are some industries that I wanted for years, but the multiple was too high, I wasn't comfortable paying them. Now that there's some impact of COVID,
Speaker: the multiple and then for the purchase price may be muted to a certain extent. Now's the time to buy if I have a long -term sort of bullish opinion about the business.
Speaker: And my last question for you, Elliot, what advice would you give to middle market business owners out there right now? Maybe either those that are doing extremely well, because we've certainly seen that across some industries, or you might have companies that are struggling to recover lost revenue that they incurred in 2020, thinking about ways to kind of get back to normal operating efficiency and profitability.
Speaker: Yeah, absolutely. So I was fortunate when the pandemic started. I was actually coming off of a sabbatical and so I had very little pipeline and almost no customers. And so when things hit, it was tough. And I think the tack that I took was just to try to get on the phone with as many other industry participants as I could to really get a sense of what the new market was for me.
Speaker: And I think going through that process helped me both build relationships, but be recognized I wasn't alone and that there were other people dealing and still kind of smiling and functioning and pushing on. If I was a business owner right now that had a pretty significant impact on their business, I would try to get on the horn with similar business owners or even service providers that all probably had a similarly difficult time. You know, not to sit around and have a cry party,
Speaker: But I think when you sort of recognize that a lot of smart people took a hit and how they're dealing with it, I think getting some thoughts from other people who have a similar challenge is a good way to kind of get out of your own way. Well, this has been a great discussion, Ellie. I really thank you for your time and, and, uh, for joining me on our podcast today. For more about Elliott, you can check out the guardian due diligence website at www .guardian due diligence .com.
Speaker: where you can find his profile and more about their business. I'd also like to thank you for listening to the Market That Moves America. Never miss an episode. Subscribe to the podcast on iTunes, Stitcher, Google Play, or wherever podcasts can be found. Or you can subscribe and learn more about us at our website, middlemarketcenter .org. Thank you.
