The discussion outlines the process and evolution of sourcing companies for acquisition in private equity. Historically, sourcing was passive, with funds relying on inbound calls, but it has transformed into a competitive, systematic effort involving cold outreach, specialized software, and dedicated sourcing teams. A key distinction is made between bankers, who typically handle larger, more complex deals with extensive due diligence, and brokers, who often focus on smaller, niche, or regional businesses with a less structured approach.
The speakers emphasize that many acquisitions, especially in their experience, occur through direct outreach to business owners without formal representation, highlighting the value of building trust and leveraging executive networks. They describe a tiered system for managing relationships with intermediaries, prioritizing those aligned with their investment goals. For sellers, hiring a banker or broker involves trade-offs: it provides organization and market credibility but requires commitment and carries the risk of a "busted sale" if the deal fails. Ultimately, successful sourcing blends systematic outreach with relationship-building to identify and engage potential acquisition targets.
They're going to try to put you into those company traditions. So we've had one where it was ice cream Fridays. So I did our little spiel during an ice cream Friday, but which was fine. And you get some questions like, "Are ice cream Fridays going to continue?" ♪ It's not venture capital ♪ ♪ It's private equity ♪ ♪ It's the private equity fund cast ♪ ♪ For yourself a drink and have a seat ♪ Welcome back to the fund cast. We've got a good one for you today with my friend and partner, co-founder, Ryan Milligan. Many years. First time on the video. So Ryan and I met each other in 2005, and we started actively working together like five years later. So we've been actively buying companies for 15 years. Roundup. 16 years. 16 years, man, I'm getting old. And in that time, like about like 25 companies, and like maybe like 60 addons and everything. So today we're going to talk about like, how do you even buy a company? So you've started the firm, you've raised the fund, now you got to put it to work. LPs would call this deployment. So how's your deployment going? So we're going to walk through the basics of this. Many of these things we're going to talk about, probably wind up doing like individual episodes about them, which we've done on the audio pod. And we'll probably revisit a lot of stuff because the market has changed. So first step one, like a quick history of sourcing. I mean, this is like go back to the 70s, 80s, the phone would ring. There were only a couple of funds in the phone book. And it was like, hey, you want to buy a company? That was easy. Call that shooting fish in a barrel. Except you need to have the money. That is true. Yeah, once you have the money, it's like, how do you make a, how do you be a millionaire and not pay taxes? Step one. Fishing with dynamite. Someone get a million dollars. Step two, don't pay taxes. Same thing. Step one, get a fund. Step two, wait for the phone to ring. I would give my overlords and bosses in the 90s. Like a lot of crap because now is their LPs in our fund. Like, hey, I was taking so long. Like, are you kidding me? Back in the 90s, you just look under W in the phone book and you'd be like, William Blair, call them. They'll buy a company. And today it's more hand in combat. So there was that. And then like Summit and TA in the late 80s and 90s, kind of they kind of popularize the reach out. Cold call founders, develop long-term relationships. And have it be a big-- Operationalized it. Yeah, really turned it into more of a science than an art. Tracked everything. I'm sure if you saw their decks, they'd say, we knew this owner for 10 years before we bought their company. We passed their relationship on from partner to partner to partner. So that was super innovative in the 90s and maybe even into the 2000s. And then it became an absolute arms race. So now you've got banks and banks of associates and analysts, cold emailing, owners of businesses, founders, private equity firms, who they're trying to curry favor with and develop relationships with to unearth their companies. And there's whole software systems and email systems and tracking systems and reporting systems where it's like, oh, it is either a chunk of your Monday morning meeting. Where's sourcing? How are we at? Where we got? How many deals do we see? How many people have we met? How's it moving through the pipeline, all those things? Or it's its own separate meeting. And to the point where it is its own separate department in private equity. When we started in private equity, me before you, you everybody sourced, partner sourced, everybody sourced. And now it's like, you've got a sourcing department. We can talk about whether that's good or bad. In our end of the market, I think everybody should sour. Still, you should now source it to somebody else. But you have entire sourcing departments. So we're going to talk about that first because if you can't find it, you can't buy it. So let's split this in between like a banker or a broker has a deal versus like just trying to find it yourself. So I want you to do it. Let's talk a little bit about banker-led deals. Yeah, let's just talk about-- yeah, that part of the market, I would say, do you have representation? Is there an agent involved? That'll be the word that I'll probably use the most when you're looking to sell your company. So when you think about that space, there's lots of people out there looking to represent companies. And they do that just like a home agent or what it might be. They're looking to make a market, do outreach, do marketing, et cetera, and take a company. There's different sizes. I think the sophistication of the agent is directly related to probably the size and sophistication of the company. The bigger and the more sophisticated you are, the more you probably are looking at like a bold bracket bank. So if you have a $100 million business, you're probably hiring a respected, brain-name brand banker to represent you to sell your company. Yeah, because you're going to need a lot of help getting organized in the project management. And frankly, you're selling to a sector of the private equity market or a strategic that would expect a data room to be done and a lot of diligence to be done on that asset before they get after it. So-- And a bank that would take on a $100 million business might not take it on a $10 million business to represent it. Yeah, because you're not hiring Sotheby's to sell a mobile home. Yeah, and that comes down to incentives and people have their certain thresholds that they need to make a certain amount of money on each deal at the end of the day. So yeah, that's how that works. So that's a direct correlation, like the smaller, the less sophisticated you are versus larger. Unless the difference between a banker and a broker. Broker's-- there's really not. That's kind of categories that we put on them. Both have broker-dealer licenses at the end of the day. Brokers for us are people that are probably not as organized about how targeted the target list would be. Like, who are we going to go out to? A broker usually skews towards smaller companies. And they say, hey, give me your numbers. We'll put a story around it. And I'm going to go talk to as many people as as necessary to see if I can find a willing buyer. They're probably not going to be as thoughtful as a banker would be about who they go out to. They're not going to be as organized. There's also a lower cost oftentimes for that type of representation at the end of the day. So if you-- like a broker, maybe, we just do service businesses in the southeast. That would be a broker, right? We represent staffing businesses and professional services companies in the southeast. And we're three guys, and we've got a couple analysts. So we don't have all the resources to do all the stuff a William Blair or Raymond James can do. But they might have a really good niche in that space. There's a firm called Croft and Bender in Atlanta. And they're still great. But back in the '90s, they were the guys that you had a software business in Atlanta or the southeast. It was like, oh, yeah, you know it's going to be good. They have a great reputation for all that. You may have a reputation in a sector. We just do software companies. We don't do anything else. Yep. Where a big bank is going to be like, we have a software team and energy team and industrial team and consumer team. So a broker is going to skew maybe regional or maybe industry specific. Is that right? Yeah. And size and kind of approach. Like they have a CRM. They've got a bunch of emails. They're going to kind of blast it out there. See who's interested. It's kind of, it's almost like an opt-in model versus go call somebody and say, you got to look at this one. I know you like this space because-- Yeah. So how do we manage a broker or banker or a typical private equity firm? How are we managing those relationships or are they managing us? Yeah. Both, as we have a CRM, we've got six or 700, I think, names in it. And you kind of match your cadence, your outreach to those based on how many deals they show, how active they are, the probability that they're going to show a deal that you like at the end of the day. So usually, there's usually tier one, tier two, tier three. And you do an email cadence and you try to get calls on the calendar when you can or you know what cities are in and you go catch up with them in your embossed and they come catch up with you when you're here. So tier one would be like, what's a tier one? And this doesn't mean quality. This just means how we would want to interact with them or the frequency or intensity of interaction. So what's a tier one for a typical private equity firm? Yeah, typical, you'd say, willing Blair or Baird or Raymond James or-- but then I think you also throw in there's lots of smaller shops that have a couple rain makers that do three or four really good deals a year. So tier one is probably a lot of volume if you want to be in front of them a lot. And they've got a lot of industry expertise. We've got existing portfolio companies that they want to sell and they know industry is really well and they put out a lot of good research. So just kind of high value industry conversations and what's happening in certain markets. They also show up at trade shows. Like I'll be a trade show next week and every industry banker is at that show. And I'm meeting with all of them. And they often have coverage guys. And that's relatively new. Like when we both started, there weren't a lot of private equity coverage people in a tier one bank. So what does a coverage guy do? They maintain the database of us. So they're turning that same rationale on us. They kind of break it up to say, I mean, at the end of the day, they do two things. One, keep track of what companies private equity know so that they can pitch to sell them someday. So they know everything in our portfolio. That's a job. One, but two also, what most of them also do, I think, is they help make buyer lists. So they would say these hundreds-- the industry banker knows the industry would go to them and say, I've got this deal. Give me your top names. And they'll kind of tier like who are we going to reach out to? Is everybody going to see it? Or is it going to be a select group? So that's what a coverage banker does. So they like don't have an industry expertise, right? They cover.
private equity, they might have sectors or geography or size and they're maintaining like, oh, hey guys, this deal might come up out of their portfolio and we might want to pitch it. Let's make sure we stay in front of it. They connect us with the industry bankers. Obviously, we can go to them direct too, but they're the guys in charge of like, hey, they know everything is going on a Parker Gale. Stuff we own that we might want to sell and stuff we might want to buy. So that's the coverage guy. Brokers don't generally have coverage people, right? You're talking directly to the owner or one of the guys. Yeah, and that's part of the benefit. You get to know them over time and you build up a rapport with them and trust a relationship and then when you start bidding and when you have one you're interested in, you kind of know the main agent and the decision makers. Let's talk about tier one. Tier two is just like maybe a smaller tier one or a larger tier one or a larger tier three. So what's a tier three, like what we would call a broker? What does that look like? And what are interactions to them? And tier three doesn't kind of give them justice either. Like for us, tier threes are great because that's volume and it's just there's, you know, we'll talk about, you know, sourcing direct next, but when we look at our portfolio, I think it's 77% didn't have representation at the end of the day. So tier three, you know, it's a little bit of a needle in a haystack, but we still want to see everything and they're spending their days talking to founders, talking to small businesses, trying to find, you know, these niche opportunities. They don't have as many per year, but there's hundreds and hundreds of them. So it's our job to just make sure they understand what we're looking for, what our requirements are, what type of deal we would do because we want to see that. And then for us, like our side of that coin is, we'll be a quick no and a faster yes. Yeah. So tier three in my view is, well, here's one stat of all the 25 companies we've acquired as platforms and maybe the 60 or so add-ons we've done into those. In any deal you worked on before we met and I worked on before we started working together, we've never bought two companies from the same source. Right. There's so many sources the math would almost have to work out that way. Right. If you go high or into the multi-billion dollar fund, they're a sector fund, you know, tech sector fund, one of the big guys, they're likely buying multiple companies from the same banker, maybe in a given year. Correct. We've never bought two companies from the same source, which shows you just how many of these tier three bankers are out there. Again, tier three is an evalu judgment. It's just a, they might show us one deal every 18 months in terms of like what fits for us. I talked to a guy once at us and these people are generally like they worked at a tier two or a tier one bank. They laughed, they had some sector activities. They set up their own shop, they got the broker dear license and they just have a good reputation and they're scrappy, right. I talked to a guy once and I said, "How do you decide who to go bring a deal to?" And he said, "Devin, I don't want to scroll the spreadsheet," which is basically like, "If it doesn't fit on my laptop screen at 12 point font, I don't go to anybody more than that. Why would that be?" Because he knows he has a good asset, maybe he's a good schoozer of companies to work with. 12 people creates a good enough competition to get it done, go into 120, just makes his service level worse or doesn't make the probability it closes any better. And he needs this deal to close as much as the seller does. And at that point, that's probably a pretty mature company. They already know the asset. People have been looking to buy it for years and it's just more about brokering that process at the end of the day and doing a really good job with it. Yeah, so real quick as we wrap this up on this segment, pros and cons of sellers and buyers to have representation. Why hire a banker? Why not? Why not? There's a cost to it. What do they really do? They get you organized. They do some diligence on your. They are putting their stamp of approval to some extent, depending on the broker. There's some signals. I've seen this. I've looked at it. I've looked under the covers. I think this is investment or the ambring it to you. There's a cost to that. And there's an expectation, you don't know if it's going to trade it. It's a lot of work to put a book together. It's a lot of work to do initial diligence. It's kind of like, "Are you. I'm ready to go sell or are you trying to find the right partner and if the right opportunity came in front of me with a group I like, I would sell." How much conviction do you have that it's time to sell? You don't casually hire a banker. If you hire a banker, you are going to. Well, and I would also say if you hire a banker, you want to sell. You don't want to hire a banker and fail in a sell because then most of the markets already see your asset. They've got information on you. They're going to compare every projection you ever put out there against you three years from now when you go to sell again. You get this moniker of like, "You're a busted sale. You tried to sell and it didn't get there, whether it's your fault or not." Those are some of the downsides. I think we'll talk about it later. These bankers and brokers, to some extent, expand your list. In other extents, they might shrink your list when you talk about that later. There's definitely pros and cons. I think it comes down to level of conviction on are you ready to sell or not? Yeah, totally. Would you sell your house by yourself? Probably not. Right. But if somebody came and knocked on your door and put a number on funny and said, "I'm basically taking this off the market," then you sell. Totally. Let's talk about that. Going direct. Like you said, 77-80% of our businesses we own, there was no banker involved. It doesn't mean there was an interest in the business or competition, right? It just means they didn't hire a banker. That's probably more likely. Well, I think we're pretty good at it. We've been doing it for a long time. We've got a good reputation. But also at our end of the market, there are a lot of companies, a lot of owners, aren't maybe ready to sell. They're not fully committed to being in the market. We're just knocking on the door at the right time. Again, that's why you keep these databases. That's why you talk to everybody. This direct to owner thing. What is it? Everybody knows what it is. You can buy databases. You can get companies' names. You can get general heuristics around size. How many employees are they growing? Are they shrinking in terms of who's the owner? Do they have any funding or not? Any funding? Then you craft an email. You hit send. Now you're in the sourcing business. I think now more than ever, these owners of private businesses are just getting carpet bombed by these requests from associates and analysts and funds and even more senior people. You're trying to get in front of those people and have an impact. AI is writing a lot of these emails. It appears because we see some of them for our own companies we own. Here's what I always struggled with is why would you outsource or give the authority to the person in the organization with the least amount of authority to do the most important thing for the firm, which is reach out to the owner of a business that you want to buy. I'm old school. Maybe I think that you and I should do that. Nor he should be doing that. Certainly people on our team should be doing that, but it shouldn't be their main activity. They should be helping us figure out who to reach out to and then one of us should try and reach out to them. Another way we do this, so we do the cold calling. I'd say I'd want to call it warm calling, right? We're trying to get an executive introduction. People in the industry that they know, we want to get close to those people. Those people can get us close to the people. How do you establish credibility? What do we talk about internally? We call it how do we scale intimacy? I want the founder of a business we reach out to or get introduced to you to feel like, "Oh, I'm having a conversation with a trusted person of somebody I trust." It helps if it's a decision maker and somebody who can speak for the firm. It is not to say a junior person has no business sourcing. We tend to believe that sourcing should start at the top and not start at the bottom. Another way to do it is have really good relations with executives. Executives meaning CEOs or board members are established, successful executives in your industry that you know who trust you, who want to introduce you to their friends or the people they know in the industry when it's time to sell. We got a lot of like, "Hey, Devon, hey, Ryan, can you talk to this guy? He's not sure if he's ready to sell. He doesn't really trust lawyers or bankers. He gets a lot of emails. He just like walk him through what it might be like." We're good at that because we're not going to accidentally buy his company. He's not going to accidentally sell it to us. It's like, "Yeah, let's have a conversation and do that." That has led many times to three years later, the phone rings and say, "Hey, I enjoyed that conversation with you. My good friend introduced me so I trust you. Can we figure out if this is going to work?" I don't really want to hire a banker. If you can get to this price, probably pretty good. Obviously, there's a long path. Yeah. I think similarly, at this point, I say 80% of my time sourcing is spent with executives for two reasons. Not the owners of the businesses. No executives who know a space. Tell me more about that. Somebody who knows the space, knows the code, somebody who's run a private equity company before successfully and wants to do it again. Those are really the two major reasons. That's mostly because, well, one, they could help us do a deal if a deal comes on our radar. - So, broker calls us and says, "Hey, here's a. "
deal in the oil exploration software space. Your first thing, you're like, "Oh, what executive do I know? Look at this with me." Yep. Okay. And they know a lot of companies and they might bring you a company that they want to be a board member or advisor to, or they sometimes, oftentimes, they bring you a company, say, "I want to run this." We get the call where I've tried to buy this company a few times when I was at the other big guy in the industry. They never were going to sell to me. Now I'm on my own and my non-compete's over. I think the guy might sell it to me. Right. Right. So these executives have a ton of credibility because they know the space really well. They have relationships and people trust them, hopefully. Right? We have credibility because we have a checkbook because most executives can't write a $50 million check to buy a company. We can. So that is a great relationship. And to get walked in the front door of somebody like that of an owner with an executive like that, our view, where we play and how we conduct our business, that's absolute gold. Yep. The next one, step down, would be we just establish a good relationship with an owner of a business over time. We're doing this hundreds of times a year. We do one or two investments a year. So like you can think of the funnel and how things get triaged down to that. But if you do that every year, year and year out, eventually the phone's going to ring and somebody's saying, "Hey, can we run this by you?" Or a banker is going to call you and say, "Hey, we know you know this business. Do you want to take a look at it?" We may be like, "Ooh, it's going to be competitive. A lot of people looking at it." But at least we have a leg up because we've been talking to that owner for a while. And that's what I think the big funds do this like a lot of cold outreach and talk to businesses all the time because they say, "Oh, we've been tracking this business for a while. We could move faster." Yeah, they know what to expect. Yeah. You want to talk about the pros and cons of this approach though? Yeah, I think it's, the con is like, you kiss a lot of frogs. And I don't mean, yeah, frogs, let's just come frogs. I don't mean that in a bad way, but like there are a lot of businesses that. Well, there's some that just aren't a good fit, right? Yeah, like it's a good fit for somebody, but not for us. Yep. And you don't know that because all you've seen is their LinkedIn page, their website, and some rumors that it's a good business. And then you get talking to the founder and you're just like, "Wow, it's way too big for us." Or, "Wow, it's way too small for us." Or the metrix he's giving me sound great, but then I get a little more information and it's not kind of holding together. Yep. What we love about founders is their eternal optimists, but they're often telling you like, "Hey, we're 10 million of ARR." And then you get in there and you're like, "You're four." He's like, "But I'm going to be 10 someday." And you're like, "Well, it's a totally different conversation at four than it was at 10." So that's it. I kiss a lot of frogs. I'd say, that's the biggest thing, right? You have to be very comfortable with that. But most of your work is wasted and that it doesn't turn into a deal. I would say it's not wasted because you're making friends. And that's the pro of it is. You made a lot of really interesting people, like founders of companies are some of the most interesting people on the planet because they bet on themselves. They're super optimistic. They had a vision. They executed it. And they're at a place where a very vulnerable place. I think it's time to sell my baby. And if you treat that relationship really well, I think you get a lot of karma and a lot of, yeah, things just grow from there. The other variable that I focus on for this, positives and negatives is just time. Like, if you engage with a founder, it's probably going to take longer to get through that courting process. Yeah, yeah. Because there's no beginning, middle, and end, like with a bell. There's not a break. Well, one, they're not sure if they're ready to sell. They're not ready for diligence. They, and back to the agent point, if you're engaging directly, the market clearing price is going to be an interaction between one buyer and one seller. And they're going to see a price and they have another price in mind. And then it's this, okay, let's do some, and then it's this iterative back and forth. And it just takes time to get him comfortable. What are we going to do post-closing? You do more work and you kind of go from there. So, direct deal, the bid-ass spread could be, it could be, you could put a Walmart parking lot between the bid and ask. That's the biggest reason. Also, I think why some firms choose to set themselves up to participate in like, they call it bid-to-book, like auction processes, they're set up for that. To know what they like when they like it, put a bunch of resources against it, get it done. Yeah. If you're going to do founder-owned businesses, you're going to spend a lot of time getting people comfortable with you and who you are. You're going to be very willing to be transparent and vulnerable. You're going to be giving them lots of references. You're going to go to a lot of dinners that you may not have to do with a banked process because they won't even let you. Before you even know what the numbers of the business are, because the founder doesn't want to tell you yet. Correct. So, you may do all this great stuff to build a great relationship and then they tell, you actually see the numbers. And it's wildly different than what was represented. Correct. Usually worse, rarely better. Not a bad thing. Again, these are optimistic people who like want to show their best foot forward. And then you're in that really weird position where you've developed this great relationship where there's been trust and vulnerability and respect and all the stuff. And then you're like, there's no way I could do this investment because the numbers don't add up to where the expectations for the valuation are. And then you have to let these people down really softly. So, you don't come across as like a jerk. Oh, you've wasted all my time. You did this. You did. So, it gets really delicate. And I think we're going to get more into that when we get to winning over the seller. But before we get to that, why don't we talk about, you want to hit a thesis? Yeah, super fast. So, like, why would you you said firms that bid the book, right? Like, hey, we're not going to go chase all these companies. The market's going to clear, banks are going to call, so they're going to show us stuff. They're very high quality businesses. We want to buy high quality businesses. The reason you would you could move fast in one of those is because you had a thesis. Right? And thesis just means a research project. We really like vertical software. Okay, that's a start, maybe a little broad. We really like vertical software in the energy space, in financial services, and in aerospace and defense. Great. Okay. Those are three discrete thesis. William Blair calls to us as, hey, we've got a $50 million ARR found her own business in the aerospace and defense industry. Great. You are ready to move fast. That's one. That's one reason to do a thesis. Another reason to do a thesis, I think why you and I generally have one running at all times is it just makes you a busy, like if you know, not all the deals in the shop, we call it heating up molecules, right? Yeah, you just like there's luck and found luck and those are two very different things. Totally. If you're sitting around waiting for a banker to call you with a new deal, you're living and dying with where the market is. If you've developed a thesis or a inkling or a hunch, hopefully with an executive working alongside you would be great. But even just on your own, it gives you something to do when you come in. Instead of waiting for the phone to ring, you're like, oh, I've got these five people to talk to. I can learn about the industry. And then we heat up these molecules. When you heat up molecules, they bounce into each other faster. And when things bounce into each other faster, you're just like, oh, all of a sudden, I'm the expert on aerospace and defense vertical software companies because I've talked to all the people in the space. And I'm kind of people are now calling me and running things by me. That's like the whole point of a thesis plus to your point of like, you just want to work with executives who know companies who can introduce you to them. You just meet executives. And a lot of the good ones are talking to a lot of us all the time. And they can filter, oh, Ryan was really smart. Ryan didn't waste my time. Ryan was thoughtfully did his homework before he got me. Got to be. He gave as much as I gave, right? So I feel like I got smarter through the interaction. That's really the whole point. We've done podcasts and writing about how to do a thesis like from scratch. We'll do it again. But again, I would say that would be like an addendum to the sourcing, the sourcing machine. Yep. Right. So yeah, why don't we talk about how you win people over? You know, I think, and in general, the focus here probably be heavily weighted toward our part of the market. So not, not the playbook to win an auction, but more of the, you know, when you're getting into these interactions with, with, um, how does a private. Founders win you over, Ryan, given that most of our deals wind up another private equity firms fans like persistence. Exactly. It's like, don't waste my time. Be polite and have a sense of humor. That's a good start. So, but how do we win over the sellers? Correct. Is right. So yeah, walk us through like your play. Yeah, I think well, I just kind of set the table for this. So like what matters, you know, when you're thinking through this. So I mean, obviously at the end of the day, the elephant in the room is there's, somebody's got a price in mind and you've got a price in mind. So, you know, at the end of the day, you got to hit a price that makes sense to somebody in their willing yourself for. Yes. And that's a, that's a variator of process, in the, in the founder own company part of the market. And you can different yourself, different yourself right out of the gates with a really high price. Right. You can. Again. But yeah, we'll talk about that when we talk about L.O.I.'s and I.O.I.'s and things like that. But really, anybody can put a price on the table. The natural follow up question is how certain are you of this? How sure are you? So there's kind of this dance and this contract that's being ridden as you go is how much do they know, how much do I believe them? How consistent are they? How transparent are they? Are they actually going to be there at the end? And back to a banker led process. The banks have gotten smart over time and they've got a spreadsheet of every bid you've ever done and whether you lived up to the bid or not. Yeah, they know are you and some people build into their bids and it comes up over time, some people just try to get the meeting and it goes down over time. So reputation matters in all aspects. But yeah, you're documented in a bank process. Yeah. So the obvious ones are price terms. You give me the price. I'll give you the terms. Right. It's be I can move really fast. - Yes, I've had, yep. - We always close, we have 100% close rate or whatever, certainty.
Right. We're going to do this. Yeah, and some of that comes down to trust. Some of it comes down to resources. Yeah. They come down to like we've looked at every business in this space. We've owned companies in this space. We know this really well. We're going to do it again. We've got an executive who we're you know working with closely. So those are like kind of the obvious things. What about squishy or like relationship and trust? Like how do you? What does that even mean when every every website and private equity says like you know we build relationships we partner with management. Yeah. We're founder friendly. We paid $25 to ache magazine to put a sonner list of founder friendly private equity firms. So like how do you win over the seller? You know bank versus unbanked maybe. Well for for banked it's kind of keeping up right like in bank you're you're on somebody else's timeline right so they have a process in mind they have a certain amount of work you're supposed to get done in what time. So like pre we'll talk a little bit about I.O.I. I.O.I. is like an early bid I.O.I. is like a like a later bid. But in a bank process they're saying you got three we here's a book you got three weeks you can ask questions you may or may not have access to management and if you're serious you should be getting as much work done as you can to firm up your bid before you know as you go now the on the private equity side you're like well I don't know the price yet so I want to manage my resources before I know what that is to see if I still want this right so the bankers going to say well we're not there yet we're going to you know get indications in a few weeks and we'll give you some feedback and again that's back to your point earlier around why do we talk to the banks in a tier one two three kind of cadence why do we talk to the coverage guys if you're the first time you've shown up in a process with a bank. Yeah they don't know you they don't know you but a bank's always going to be looking at engagement like they're in the back end they're looking at the data room they're looking at well there may not even be a data room yet but it's like have they sent a question list did they do a call are they good questions do they are the questions relevant for the industry or are they all over the place like you know if you're we own a couple businesses and with that's herbado dealerships if if the first three questions are like what's happening with auto consolidation and you know aren't the OEMs just going to take over the the auto dealer industry probably not somebody who's been looking at the space for the last five or six years right so yeah they're looking for ability to move knowledge certainty like banks at the end they want their lives to be easier because well that happens to be synonymous with like can they get this done will they get this done in a rational time frame so yeah they have money we've worked with them before they've done their homework they do what they say they're going to do and they're good owners right that would be a great way to differentiate yourself in a bank process yep right I would say you know you can work the refs whether it's direct or with a banker so working the refs would be calling the banker after the call you had with management or making sure they know hey we're really serious here we want this hey like you know we're not the highest bitters all the time but we're dead serious we're great to work with hey give us a chance tell me where I need to be at the first indication process and then we I might be on my tippy toes so they know like hey you bid but you maybe you got to confirm the bid because it was all high yep or or you just say like guys we're out right so I think I mean that's helpful with bankers how else do you differentiate yourself in a banked process I mean I think we mostly covered it is how is the work the refs how do you well yeah that there's there's kind of two purchase some people some people I think bid to get a meeting and then they figure it out other people bid to get you can try to get information back so don't bid too high like try to find you know they're saying we're bringing eight groups through all right try to be number nine see see if they try to move your bid up and how much so you know if they're guiding you to 40 million dollar purchase price bid 36 and then see if you get in or they bump you up so what happens they tell you they're only bringing eight groups through clearing prices 40 you bid 36 but you get the call you get a call from that call say hey we got eight groups but you know you guys are good fit and we know that you stand behind you know and you're not doing it just to play games you're like I want to bid something I would be excited to run as fast as I can to close yes if it's you versus a group that tends to bid a lot without conviction you get the call and they say hey you're 10% you know you're whatever you have 10% off you can bump your bid 10% we'll get you in the meeting and that's we tend to like when we are in a broker it's never eight like there's there's broker processes where there's like three and we usually put forth a bid that we say what we're there and actually if you turned it into an L.O.I. we're ready to sign that and do 40 you know 30 40 days of work and close yeah and we have conviction and they say you're low off and you say all right all right we'll go to that with that's you know we're getting closer to our tippy toes but hey let's get all the information let's see if we learn more that firms up our bid are getting makes us more convinced or more convicted at the end of the day so well our bids I think tend to go up you know when we do move through broker processes not down because if we're putting our bid down we're basically saying we're out yeah we didn't find we found something more of a binary thing then so don't even lower your bid right that would be our strategy yeah we either want it or we don't you know and that 10% isn't going to make a break it but so here's what you want on that call I think hey Devon you've done the most work management loves you you've got an executive they're excited to work with or step into run the business you're a little low could you come up a little bit you can get the meeting you know well who else is in there we'll only take in three groups one of them we don't know that well they haven't done a bunch of work on it one of them has done deals in the space before they know it really well just like you guys but management didn't like them as much and then we got one high outlier bid and it's a search fund and we're not really sure what to make of it but it's a really good number and exactly and we got to figure this out we also get the call from time to time in a banked process which is like you guys said you're on your tippy toes like the clearing bid to get a meeting is twice as high as the bid exactly you bid 40 we have 20 bids at one but in that situation I've called the banker beforehand and I said hey I'm bidding this yeah do you want me to put it on paper am I making your life easier or harder by doing that and I'm telling you I'm doing this before I do it yeah because I don't want you to be mad at me and what would the banker say why would he say yes why would he say no I mean it depends sometimes they want sometimes they want the volume and they want to show that they did their job sometimes they're like I'm always like I'm not trying to offend anybody I'm just telling you like it's about it's not even about the value of the company it's like the fit for us and how we're going to approach it yeah at the end of the day so um it kind of depends sometimes they're like yeah it's just all have to change the PowerPoint presentation and make the football chart a little wider so like just yeah no we're good um or they're saying yeah throw it in and we'll you know then they know maybe that's useful to them to say like hey some people think this like the the market is seeing it differently or or there's a tighter process with a tougher asset and the banker's like yeah I want you to give it to me the seller's probably gonna say no but at least he knows where the market is right and you're not wildly different than anybody else so I need it on paper because he needs to know it's real and uh give me a few weeks and then we might come back to you right so you kind of to smart move to call the banker rather than just throwing something over the facts machine and say here's where I tell me if I'm in or not yep so let's so so how do we differentiate when it's to work a one-on-one conversation oh man throw the kitchen sink at it everything where did they go to high school where did they go to college who were their friends where did they play golf do they play golf or they're into guns like well how do what can I find about anything about this founder how do I get close to this person you get you've heard me say this a million times in meetings and I've probably already said it three or four times on this podcast is every owner of a business we want to buy is a human being so far uh that has friends that has colleagues that has employees has ex-employees as people that used to work at the business people currently at the business do we know any of them can we get close to any of these people um again not to get information but to get social proof hey these guys are worth talking to you're gonna really like the team at Parker Gale um hey I know you know you're not ready to sell but why not have a call with somebody so we're pulling out all the stops where we can stopping it being creepy or annoying I guess creepy is and we've seen creepy where people like show up with like weird gifts or something that's like they're deep deep in this person's social media feed uh that would seem a little creepy that's happened to us with the podcast at times whereas I was like okay this person's a little don't want to research on us uh very nice uh but like that could come off the wrong way or persistent meaning like hey I haven't heard back from you from the 47 AI you know generated emails I've sent you why you call me back I have ten billion dollars under management you know I've done all these great deals like that just comes across as annoying and we've seen those emails too uh so again I just want to it's it's the six degrees of Kevin Bacon I want to be as close to this person as possible with people around them saying like really should talk to Devon about this have you talked to Nory at Parker Gail she really knows this stuff right that's kind of what we're trying to do that is the differentiator of winning over the seller to your point earlier is just like the being smart knowing what to how to ask questions we had a conversation in here earlier uh with the team around how you write the request list questions yeah take me I mean just as based like take the edge off
who's sitting around like, like, wordsmithing request list questions, because you could come across as like, make the person very defensive without you asking a question or make the person feel good, feel good about themselves. We also want to be efficient. Like, to the extent available is a phrase we can use. We are not trying to buy this company in my first interaction. I am trying to be memorable. That's it. Yeah, and this is a wish list of information that allows us to be as credible as we can to give you an indication of a price or a price range. And a founder might say, "I've got a data room. I've pulled it all together. I've done this before. I'm ready to go." Like, let's talk. Rare, that could be possible. And some of them are like, "I'm not even sure if I'm going to do this. I don't have anything pulled together. And I don't want to tell anybody on my team or even having this conversation." There's two very different conversations. In the former, I'm like, "Okay, like, this is real. Like, let's go. It feels more like a banker process. Let's jump in. Let's dig into the data. Let's be efficient. Let's be transparent. Don't string them along for a month and say, like, "Mah, the market's too small. The company's too small." Get to the answer pretty quickly. Or like, "Hey, I needed more." I mean, we're in these right now. I'm in the middle of one right now. Where it's like, "Hey, still waiting on some information that probably requires a couple people on your team to know. It's totally fine. We can do a bunch of desk work." But that's kind of the gating item. And he knows it's going to take a few weeks before we get there. Or if on the ladder, like they don't want to tell anybody, and it's quite like you're, like I said, I'm just trying to be memorable. I really like that. I really like that, Devon. I'm going to keep talking to him. He cracked me up. To that point, the other one that I'd add on kind of yes and for you saying you want to get to know those founders, that's a two-way street. So how you want to make yourself as transparent as possible for them to get to know you. So how do you do that? You have a digital footprint. You've got a website. You've got the podcast as a perfect example of that. It's like they'll listen to the podcast. But I think transparency goes both ways and how you're approaching that process. There's our CEOs deal with this a lot from other private equity firms and they get on the phone and they're kind of getting information. It feels very transactional. Yes. Versus somebody saying, "This is who I am. This is why I'm talking to you." This stage one, actually, I don't know if I want to own your business yet. This is why I'm talking to you and this is how that would look. So laying out the process for them, let's understand you and your motivations and what you want to accomplish. Why are you even talking to me? Why did you take the call? Next, it's kind of like, "Okay. We do know this space or we'll figure out this space. If you want me to start to put a signal for what this might be worth, if I could get these three or four pieces of information, I can probably do that." Then you're kind of walking through the process from there. Again, this gets back to my time element. You're putting in the work. Not everybody, there's no incentive, direct incentive for us to do that other than one that's kind of the right thing to do. It's how you build a relationship with somebody. I think that's a big signal for like, "Is this firm a firm that does this a lot? Are they trying to, does it feel like they're trying to understand my ARR, my, on the first call, ARR, revenue, gross retention, net retention, cloud stats, all that?" If that's happening new, you're probably getting plugged into a CRM to see if somebody else who's a decision maker wants to talk to you. That's totally fine. That's a necessity for larger firms in our sector of the market. That's how a lot of people run the. One way to do it. How a lot of people run the play, totally understand. It's a high volume shop. They need these stats. Associate needs these stats to put in the CRM to get a sheet, to put in the Monday meeting for everybody to discuss. Not the way I would try and buy a founder-owned company outside of a process. I would try and get close to them somehow through a relationship, get a warm intro. I would say, I mean, this is like, they're not thinking of selling yet, but I've gotten introduction. I may say, "I'm going to be in Boston in a couple weeks. Let's go grab dinner." Right? That may be too much time to spend with people. We've done that. And it's like, "Oh my gosh, 10 minutes in. This is going to be a long dinner." Right. Let me just have fun and be helpful. But we waste a lot of time on that, but I think it's good karma. Or I want to be helpful. Like, "Hey, let me tell you how this probably goes. Here are some other firms we know. Let me be helpful or I can be helpful." And then also, you and I can look a founder in the eye and say, "Other than two carve-outs we've done, we've done 23 investments, so we've done 25, 23 of them were family-owned, founder-owned software companies. This is all we do." So I don't know your industry really well, but I know a lot about what you're going through and kind of what you care about and what you want this transaction to mean and look on the other side. Or I've done a lot of work in your industry and this is all we do. And you're talking to the owner of the business, my business. Yeah. You and I can think. No, I'm looking at the owner founder, you're the owner founder. Like, and again, you're just trying to build trust and that somebody says, "You know what? I want to talk to that person again, maybe in a week, maybe in a year, maybe in a decade." Yes, we're trying. The way I think about it, I don't know if you agree, is first like industry, because if you're talking to a founder, you know what their company does in what industry they're in. But then it's really situational relevance like fit for, is this the type of situation that would work for us, which is why the first call with us, we already know we like the industry, we're just figuring out if this could fit for us. And then you get in the particulars. Yeah, yeah. From there, but that's kind of the order of our population. Let's jump into some technical stuff. Yeah. What do you say? This is in the Lingo podcast. We've done it. We'll do another one. But IOI versus LOI. What do they mean and why should I care? And what does that mean to you in terms of the process? Yeah. I mean, both rely on faith a little bit, I think, right? Like the IOI versus LOI, to me is how much is an indication of interest in it? Yeah, these are just. And LOI is a letter of interest. Yeah. And they're kind of interchangeable. Basically, I think most people define an LOI from an IOI is does it have an exclusivity. Meaning are you the only one that's talking to them from that point forward? But they're really just signals of how much work have you done and how definitive is your bid. Now, neither are definitive, usually, particularly in the smaller end of the market. There's not breakup fees. There's somebody who can sign in LOI and pull out two weeks later and you wasted somebody's time and maybe a little bit of money, but nobody's, nobody's, there's no penalty for that. And a founder own situation, the early dance is kind of gaining an IOI, which can be verbal or a piece of paper, which is you're looking at a space, you're doing some information sharing, you're figuring out, does the situation fit? And it's like, I think, you know, I'd kind of be at X. So the founder at some point basically says, like, hey, we've been talking for a month. Like, I told you I wanted 50 million from my business. Like, are we close? Yeah. And that might be, you're not writing that on a piece of paper and signing it. Well, maybe you are. Maybe you're not. Probably not. But that's kind of like that stage. You've been doing something like we're kind of at four times revenue or probably at 40 to 42. So there's a gap there. Like, is that somebody want to continue to explore, you know, that type of thing? Yeah. What about in a bank process? What is it not? How's the IOI play and how much work have you done before that? Or are you? Well, there's a lot of work done for you. So you're, there's a book and there's a lot of information in that book. And there's not a lot you have to do because they've defined, you know, they've, there's, you've got their historical growth. You've got their margins. You've got their net and gross retention rates. You've got the management, your growth plan, whether you believe it or not, the bankers giving you guidance probably half the time, which means they're saying, we're kind of thinking this is going to, or we're hearing from the market. This will trade here to here. So there's just kind of a lot more information, a lot more information. Yeah. Summary financials. Maybe you have a redacted customer like top 10 customers. Yeah, but customer ABCD. But you don't know who the customers are. You don't have the customer key. You know, concentration, you know, you know, so, you have, but you're really, you're really deciding, do I want it? The bankers are using it. Are you going to get access to management, which takes like a day and a half out of their time by the time they travel somewhere, have people travel there and do a four hour meeting in a dinner? So they're trying to manage people's time based on your bit, like the middle part of the process, which is where somebody then goes gets deeper and says, like, do we think we have a shot at this or not? So they went to 100 people and they're trying to get it down to 10. Yeah, they get 20 bids and they're in 10 gets of me. Right. And that may be a whole mix like we just talked about. Right. It could be price gets you there, terms get you there, familiarity gets there, relationship with the banker gets there, you get that phone call, hey, I need you up to 10% because then you can get in and we'll bring a ninth person to the management meetings. And then yeah, it used to be, you could talk to management often before an I.O.I. And sometimes you still can. But mostly in a tier one banked process of a private equity owned asset, you know, maybe not a founder. I said, you're probably not. Right. That's the sorting hat. Step. You're either griffin door or helpful puff at that point. Right. You don't think you can do about it. And then what happens at L.O.I. Well, you've met management and you're meant to again, this it's like a, there's a scale of it. The bigger the scale, the bigger the private equity firms, the bigger the asset, kind of the easier it is to underwrite to some extent because it's got more heft. Yeah. It's easier to get lending, you know, there's, they're put, they have a legal contract that you mark up and submit with it. So really for a very large process at the L.O.I., you're mostly probably saying, I'm going to do this.
And honestly, those firms have to put their reputation on the line because of that scale. If you sign an LLI and it's pretty definitive and you don't close, like, unless there was something unknown, that's not a good look. That's pretty definitive at that point. Probably gets a little more interesting when you talk about our part of the market because there's a little more of a dance between we think we're at X and getting to an LLI. So how are you sending signals through the LLI somehow? How is this document like you read between the lines? What's it really say? Yeah, well, little phrases you should read. So if you're getting to an LLI and it's a one-on-one, you're talking directly to a founder. There's probably a request list. We're trying to get as much of that information as we can. Some of it's available, some of it's not. Like customer cube is just these, like we've done a download from Stripe and created that from scratch. We are doing one right now. Yeah, we're usually getting an Excel file that they've taken a shot at, but then contract dates and all these things don't line up. So we're doing a bunch of work on it. Reading between the lines on the LLI, little phrases like subject to the information we've seen to date or things like that. As the seller, you know what information they have, right? It gets into the lemon's prop. You know everything. They don't know everything or they know what you've given them and that's everything. So the more information you're able to get pre-LLI, the better, the firmer the bid is. That's where the question is about what diligence are you going to do, what have you done, what haven't you done is important. And we try to be as transparent as we can about that. There'll be times where it's really hard to get this Stripe download. We've got a sense for what retention is. They're saying, well, I got to ask so and so to get it. I don't want to do that. You're like, okay, that's fine. Not ideal, but we'll do it, but understand that there is more risk in this bid because I don't know what I don't know yet. So the signaling there is like, this is still a little squishy here because I don't have everything. Right. Right. And that's okay. There also be going to be signaling and we're going to do all equity in this deal. We don't have to raise debt. That obviously makes it less risky. So that would give you certainty, right? Something you want to differentiate yourself with. And another step that they don't have to take, they should be able to move faster. Because we could close in two weeks. We've seen L.O.I.'s on companies that we've owned. We can close in a week from the L.O.I. And we're like, oh my goodness. Okay. And then we've signed L.O.I.'s with family-owned software companies where we had 100 days of exclusivity. So that's really squishy. It's like, hey, based on what we have today, we could pay this price. We need 100 days to do the work to get there. Again, we're going to keep you posted along the way. But it's going to take a while. Why? Because they don't have a CFO. And they don't have a data room. And it just takes time. And the guy who owned it, you know, who isn't running the business day to day as son is or somebody an employee is, is just like, show me the money. I don't believe it unless it's written down. Okay. I guess we're writing in L.O.I. Let's keep it pretty squishy. Right. We're in a very competitive process. The L.O.I. is basically all about certainty and speed. Yep. Like, we will pay this price on these terms. We don't need anybody's approval. We're not using debt. We'll close it on our line and we will close it a week. That's a move. Yeah. And it's a very powerful move. More typically for us though, I'd say the I.O.I. kind of evolves to the L.O.I. Meaning there's kind of that initial conversation about price. And there is a gap. Yes. And they say, well, I think I'm worth X and you say I think you're worth Y. It's like, okay, well, let's just go do some more work. Yeah. Okay. So then the request list gets a little thicker. It's like, all right, let's see this, this and this and that will help us sharpen our pencil. Yeah. I've had the time from submitting the first L.O.I. So signing an L.O.I. Be 75 days. Yeah. Yeah. There's a level of patience. It's just, but that's not, that's not like, that wasn't contentious. It's just like, well, all right, let's do some more work and then let's see where we get. Yeah. We're working throughout that time period. But we asked for information like, oh, I can get that. And it actually took a couple of weeks to get it. So then we look at it and we get it. And it just becomes a set of a process where we get smarter. Our bid moves up. They're starting to understand why our bid is the way it, where it is. There's comes down. And I always joke like the point where the buyer is a little uncomfortable where they're at and the seller is a little uncomfortable where they're at, that, that, you just created the bank process because you iterated through it. You created the market clearing price just through time and work and understanding, et cetera. So, but back to the like, not everybody's built to work this part of the market. Like a big firm doesn't have the patience for that. It's just not their game, right? They, it's like, so that's why I think time and those type of elements are, are a big part of this part of the market. Given where we live in the market, the very, you know, the low end of the, you know, institutional market, we have a very high bar to get to L.O.I. for a growing business. Correct. Well, yeah, I mean, we just ran these stats because it's kind of that time of year, but in the last three years, where we feel like we've been very consistent in how we've, how we're doing this. I think we've submitted six L.O.I.s. We own five. Yeah. Five out of six, like, we're picking our spots and we know what we want. And yeah, if we're engaged on something like that, we have an angle. We probably have an executive. We know we've got a good relationship with the founder and we're going to submit and we're going to win for the most part. We've submitted that bid knowing this is going to get done. Yeah, we've already pre-cut, like we said, was we spent months, maybe years talking to that owner before we've submitted it. And I don't tend to put a piece of paper in front of somebody and have it surprise them. I've probably had a conversation about it's going to be more like this and this is why versus like somebody waiting, you know, hitting refresh on their email inbox and then, oh, there's a PDF and then they open it up and it's like, surprise. Yeah. Like, not really our game. And we're giving it to the founder owner because they now actually have to share something with a lawyer. So that's why we're writing. It makes it real. That's what we're writing. I mean, that's an emotional moment. Like the founder mentally is selling their business when they sign the L.I. In our market because they're like, I trust this person, they're going to get this done. They've told me it's going to be painful. It's going to be more painful than you thought to get from here to closed. But like the emotional moment for them, like, okay, we're going to try to do this is that moment. Signing the L.I. Yeah. 100% agree. All right. So how much modeling are we doing before that? Like, there are some shops that model every deal that comes in. I feel bad for associates who have that work at firms like this where every deal that comes in full deck gets put together full IC memo, full, full model. My age, my model is going to get smaller and smaller and smaller. And I'm really looking for like the what matters here. I don't need 50 assumptions on a page and then tweak them to kind of get to my, you know, the return I need. Really like is this about do I have to grow accelerate growth here? Do I need to improve margins here? Do I need to reduce costs here? Like what am I trying to do here? And what's the lever that moves things the most? That's kind of the get to that conversation with the founder and really, you don't really need to do models for that kind of stuff. But when you're modeling it, it's like, I'm just trying to get rough and tough here. You're at 50. My math is like, I'm at 40. Let's do some work to try and close the gap. Yep. And then by L.O.I. you've done, we've done full-blown modeling with all the different scenarios upside-down, side case. What do we have to believe? All that stuff. But at that time for us, maybe different than other firms, our operating team has also been inside this business for weeks and weeks. And they're putting their post ownership plan together and kind of underwriting our team's post ownership plan rather than the founder's projections. Is that fair? Yeah. I think we're pretty straightforward. There's an existing inertia to the business. That's your starting point. There's a growth rate that you've figured out for the industry. You're either gaining share or losing share based on your relation to that. That's kind of the top line. For the existing, we have an operating plan. We're going to make some investments that, if it's in sales and marketing, that probably changes the trajectory of the top line. We've got some investments in the rest of the business. How does that affect margins and how does that affect top line going forward? We definitely know and overthink it. There's definitely a false precision at a certain point. If you unleashed an analyst on a model and you gave him 50 variables, the compounding effect, none of those decisions they make on a model makes a huge difference. That's also dangerous because an associate might be really excited to do this deal. They could just put one pinky on the scale in little increments for 50 assumptions and make that model look better or worse at the end of the day. It's got to pass the straight face test at the end of the day. We want to be sophisticated enough where a lender or we just understand what resources are being put against it at the end of the day and how adults structurally works. We're definitely not overmodelers by any. Given where we live and what we do and the things we like are operating capabilities, definitely in that margin of safety. Obviously.
we're going to have a highly precise model for ourselves, for the lenders, for others. But we're also going to laugh at it in a year about how wrong we were. A big piece of it for us too is how much investment do I need to put into this business to change the trajectory of it somehow? The business may not be able to just handle that level of investment. We really like this business, but we're going to take it way down in EBITDA or take it negative for a while to get there. We just maybe like that's too much. Let's quick talk about lenders. Not all of our deals have lenders when we start because some lenders are like, "Let's see, you're changing the trajectory of the business. I need to see some proof first." It's a little too small. Let's get up a little more. Let's get past 10 million of ARR and make it easy. In the, maybe it's like a half and a half. A little more than half of our deals had no debt. We'll be closing. But the other 45% did. When are we starting to talk to lenders, to get them ready? What do we need to provide those lenders? How are we picking a lender? Take those. Yeah. I think if we're making that, so we'll just talk for us. There's the bigger the firm, lending is a huge part of it. It's also bigger assets and it's much easier. You have a whole capital markets team. Yeah, exactly. We're ignoring that part of the market. But for us, it's a binary decision, are we using debt or not? You pretty much know that upfront. Yeah, we do. This deal could probably handle some leverage and we should probably use it because it'll help you turn. This deal couldn't handle leverage because it's too small. It's too funky. We need to some time before we go bring an lender. Early on, if you're saying, "Let's just assume you say that." Are you calling a lender like, "I had a great meeting with management." Hey, Maranon or Eldridge, do you want to talk about this? How soon are you getting them involved? I think in general, if you're kind of like, "We're going to spend some time on this." You're not going to ask them to do work, but you're going to send an email to 3, 4, 5 and say, "We're looking at a company in this space at this size." Or the general metrics. Yeah. But lenders like certain spaces and don't like others too. We've done a state and local government deal, which was fine. But the second you say government, they're like, "Is it federal?" Just like examples like that. There's certain things they're on and off on exposure to cyclicality and things like that. So you just want to check yourself. Is this a lendable space even at the end of the day? So you can get some feedback. We were in a deal like that. It worked out great. Or get some hand razors. We don't do anything that's got federal exposure. We wouldn't do something with that kind of retention profile. It needs to be a little bigger for us. You're like, "Okay. Let's not waste my time on these guys who are putting their hand down. Let me spend some time." You're kind of marching to put a price in front of a founder. If that price relies on leverage, then you want to have some idea. Can I get leverage? But then you're kind of like, "All right, sit Pat, tell them what you're probably telling them like we're good until we sign an L.O.I. and then we'll catch you up with us at the end of the day. Maybe you have a model that you kind of run past them and things like that." But they really draft on our office. We do a lot of work. We do it ourselves. There's not a existing book in our part of the market. So in our space, they're probably going to draft off our work. Our work probably isn't prepared enough for them until we've started some confirmatory work. They really don't start work until the accounting report's done. Which means you're not showing up with an L.O.I. in our part of the market with a lender ready to go. No, you're. Now. For us, we want to. For us, we've got a sense of what we know and don't know in the risks to that. So we're kind of vouching for our own ability to get leverage in place, just based on what we've seen in the relationships. And you definitely don't want to get over your skis there when we don't. But yeah, that's. And in a good process done well, management doesn't spend a lot of time with the lender. We're not over-levering things anyway. We're not trying to get that last 10%, you know, 10%. So try to keep it in a comfortable place where we can get it. It's going to be some work. All the ongoing shareholders will benefit from that leverage because it's a cheaper cost capital. Right. And we have access to hopefully some liquidity, some cash so we can invest. But what do you care about most with a lender? Yeah, price is a number one. It's really more flexibility and. It's kind of flexibility and trust. Like, okay, we've got leverage. Is it a reasonable enough price? Okay. What are the covenants? Does this give us enough wiggle room to hire that person we didn't think we know what need but now we need? Or could we. There's. Or we. It takes a little longer to go to market, motion going, etc. So for us, and if something doesn't go perfect, do we have a relationship with this lender where we've worked it out? You know? So we're generally seeing a revenue covenant, like an ARR covenant and a liquidity covenant. Yep. You can't go below this. Maybe an EBITDAB like floor. Yeah. You know, that type of thing or sometimes there's cash for lending and it's more of an EBITDA covenant and liquidity covenant. So for plus four or so for plus five, that's not going to kill the deal for us. No. Yeah. Just because we're not pricing it to perfection, we're not levering it to perfection. And we need some wiggle room because we're bringing in new management teams. We're going to find something six months into the deal. We didn't find indiligence that's going to maybe got to hire somebody else, something cost, a customer churned out of the blue. You can't have a deal that's in the penalty box right now. Yeah. And oftentimes we're going to get leveraged later. You know, when we do consolidations, we're doing a consolidation now. We've got our second business under L.O.I. We might use a little bit of debt, but that third deal we're going to use debt. A lot of debt. Or, you know, that type of thing. So. It all depends. All right. And then diligence. This is not real quick through diligence because we'll do. Yeah. You sign in L.O.I. This confirmatory diligence. Yeah. What's on that list? Yeah. So I.O.I. Maybe we've spent a little money, right? But not a ton. L.O.I. Yeah. Depending on, again, most of our processes, it's one or two people. If it's banked, if it's an L.O.I. With a founder, obviously we have full exclusivity with the only person working with them. So tech diligence. We're hiring code and co or one of the guys we've worked with to come in and like look at everything under the covers are again, it are firm. There's an operator running alongside them and driving that. Including their value creation plan together while they're doing the diligence. You and I aren't doing the tech diligence with a vendor and then sending it over, you know, closing the deal and say, "Hey Jim, here's the report. Good luck, right?" Commercial diligence, meaning like how big is the opportunity, who are the customers, who are the competitors, market share, go to market. How does the engine run, right? It's tax, big issue, oftentimes. Are the numbers the numbers, right? Does the math math? Are they things in EBITDA that need to come out and need to go in? They probably had some addbacks or some one-time things or those actually legitimate. Legal, all the things you would expect. Maybe some things you wouldn't expect. We want to understand are the people, good people, do they, you know, we want to do background checks. We want to look into their business practices. We want to know that they have all the contracts and the contracts. We bought a company and we were like, "Oh, we don't have contracts with our customers. We just send them an invoice." We were just like, "Okay. How do we underwrite that?" Speeds up the sales cycle. It does when you don't have to get somebody to leave a little look at the contract. Turned out to be part of their secret sauce. We wound up owning that company, but that was a thing. We don't actually have contracts. It was like, "You could have told us that a few weeks ago before we signed the L.O.I." And then talent, that would be like assessments, background checks, all those kinds of things. We have found some very interesting things when you do talent diligence early. And then it's all like, "What's Red Yellow Green?" And a lot of our stuff is kind of like amber one way or the other. When we start, and again, we'll do individual episodes on each one of these things, probably with a lot of the vendors we use to go through it. But let's finish up with just like war stories from, you know, from the, from diligence. Like, you know, things only a seller could know that we found out later. Yeah, just to categorize them. Yeah, there's back to the, we only know what we know. Like, we only know what you've told us, what a seller has told us in the day. So then you do go into the confirmatory stage and there can be some times, there's things in there that they know and sometimes there's things in there that they don't know or just we're naive to. So we will say most founders just didn't remember that thing. Right. Or maybe they were holding it back. So yeah, we've seen some pretty gnarly tax things, I would say, in software, often comes up sales and new stacks because I'm just selling, I'm a company in Illinois. I sell software everywhere. I don't even employees anywhere else other than Illinois. Why do I need to sell, pay taxes to the state of Texas or California? It's like because they told you you have to. And it's, it's a judgment call and there's a materiality threshold and things like that. So yeah, usually people are selling their software in like 40 states and a lot of times there's some states have a million or two million of revenue running through them and then there's some smaller ones and then there's kind of a long tail that has between 75,000 and 200,000 of revenue running through it. So that's just always a dance with a buyer that says like which one, you know, you make a list of which, which ones you should be filing in. There's a materiality threshold. Become to an agreement on how it's going to get cleaned up and you kind of go from there. But it's just common. Even in our deals, like there's still judgment calls as we've grown, you know, and that's a good thing. And we know how to do this. Most sellers don't know how to do it. Right. They don't have the advisors and the helpers. So for us, they're systems, there's that maybe part of the gang's, it's 40, you're at 50, right. Well, really, you're at 48 because you have $2 million clean up to do. We'll do it for you. But like you got to pay for it. Stuff like that. Open source software. A lot of people, I just use open source.
You have to have different licensing rules and things like that. So we wouldn't know that until we do a code scan and just know everything that's in there. Yeah, and what about like risk tolerance of the founders or the management team we're trying to back? A lot of that can come out of, well, that can be references or that could come out of different tax returns and things like that. So we've had founders that you, you know, you're buying a business for a certain price and then you get their tax returns and it or a background check and there's they have quite a bit of debt, which again, that happens. This is America. There's plenty of debt to go around in America, but that can be an indicator of like how much risk do they take? If you knew it was willing against the the owner of the business personally, I would do a lot more financial diligence and legal diligence. Yeah, and this is just gets into what are your motivations? What are your goals? How do you, you know, how do you, how do you run your personal life? How do you run your business? Etc. Etc. And then like security cyber other things like you get in there like, oh, there's credit card numbers and flat files and the application, right? A vertical software business with built-in payments. Oh my goodness, they're storing the credit card files in the application. That would be risky. It needs to be remediated. Again, we can put dollar amounts on it or risk stuff. These are things you don't know until you're in the guts of it. Yeah, and then and then other things can just be cleaned up. Like there's there's certain training, you know, most industries, there's just a lot of like awareness and policies and training that employees need to go through. Those are things that sometimes it's remediated, preclosing sometimes as you just put a plan in place to do that going forward. Totally. And then we can do a whole episode with our insurance friends about rep and warranty insurance. Right. Would you like, forget all about all that, you don't need to worry about that. Exactly. We'll take the risk on that. Working capital, funds flow real quick. Like these are the technical things that like a first time, you know, maybe it's a fun-less sponsor, maybe it's a first time fund. They were never in the lead doing these things and you get to like the end and you're like, oh goodness, okay, working capital and funds flow. I think smart people say let's talk about working capital real early. Maybe that's even part of the problem. Yeah, I did a whole piece on this on our website now and just on working capital. My advice is just write the methodology at the L-O-I. At the L-O-I. Yeah, at the L-O-I. There's no reason not to write the, so not just like, we expect you have a reasonable amount of working capital in the business to close. We're paying 50 million. That's not good enough. Yeah, you should say, let's do a 12 month peg based on the numbers that come out of the L-O-I. And et cetera. There's a method that is pretty straightforward that we do every time that we can easily call out at the beginning. Now, we'll fill in the numbers later and this becomes, if you don't do that, this becomes the contentious, like founders are all like all their friends tell them like, because they've been sometime, you can play, you can really gain it. I mean, if you can use working capital negotiation as a price cut or they can use it as price. You can come up with 15 different, you can come up with a definition of what AR, like if you wait, you can say this type of AR is kicked out. This type of accrual is this. We're going to hit you with tax on deferred revenue because we have to deliver the service. There's all kinds of things you can do later. I'd say, get, pull it up front, define it at the L-O-I. Then you do your conformatory diligence and you fill all the numbers. So Q-A-V comes back. Everybody agrees. These are the numbers. We all look at it. They can tell us, no, we disagree with this, we do sure that we agree. These are the numbers and they just run it through the formula. You already established the L-O-I. And I like that. Otherwise, if you don't do that, the founders stress out about the win and win and win and win and you get to work capital win and win and you get to work it. It becomes the thing. Versus, we did this at the L-O-I. The numbers are going to be what they're going to be. I have a whole spreadsheet where I can walk people through where there is no winning and losing. It's all on the net basis. You either get the cash or you get the, you know, it's just, so that's a whole thing we can do a whole nother podcast on. But do it up front. And your lawyers and accountants looked at this at the L-O-I and we all agree. This is the right formula. We're just pumping in the numbers. That we all agree are the right numbers. That's a good smart thing. I say post pre-closing prep for like owning it. Again, a value creation plan. Hate the term. Understand that everybody uses it. The VCP. We'll get into this later. This is just like the what is the funds plan and management plan to do with the business after we own it before we own it. Just basically like, you know, the pre-mortem. Yep. What are we going to do with this thing? And that often drives a lot of the, all the decisions that get made certainly early until you find out actually what you own. But we reference that throughout the entire investment period. And then here's my pet peeve and why it's on this list. The will again do another whole episode about it is employment docs and like onboarding management teams. Like do not wait till after you close the deal to like show your management team their employment docs, their employment agreements, their equity agreements, how it's structured, how they make money, how they get fired, what happens in the case of, you know, of cause, not cause, all that kind of stuff. You and I get called all the time by current private equity executives for other funds asking about how to negotiate their employment stuff. That's one of the top ways we've been meeting new executives. It literally is one of the greatest sourcing machines ever, which is send me your document. Yeah. First of all, it gives me great. With lots of caveats that I'm not a lawyer and accountant 100% but I'm pretty good. But I find out new ways to screw over management every time I see one of these. It's fantastic. So I can add to my list of tricks. But but often it comes like I mean, I literally had a call with somebody other day. If I don't sign this now, we can't close the deal. Right. And it's got such a nasty non-compete in it that I can't sign it. It's probably not even enforceable in the state of, you know, wherever, Illinois. And I have it and I have it 48 hours before closed. I've been told I have to sign this employment agreement or we can't close. You can close without signing the employment agreement. Yeah. So oftentimes we believe in management where partners with the management trust management own. We're going to stuff the management team right before close because yeah, yeah, we'll get to it. Yeah, yeah, we'll get to it. My view is like at least lay out the a term sheet of what the employment agreement is going to look like you may not have it signed at close. I would say you probably should, but maybe you don't need to. You should have the terms outlined again. So you don't look back and management doesn't feel like you pull the fast one on them. You're rug pulled them just like I'm working. Yeah, and it's not always done deliberate. Like it founders do this kind of by accident too because they're, you know, they're worried about getting people to excited about the deal closing and things like that. So the negotiation, the discussion we're often planning with founders is we care about the senior team. We're trying to back them going forward. Like can we get to the sooner? They're always a little hesitant to do it because they don't want to put the can't put it back in the bag, you know, and they start working for you and things like that. But I air on the side of like transparency and treating people like adults and like let's just get this to them sooner because you know, listen, we know a lot and we're going to close this. So like, let's just start doing this in orderly fashion. So sometimes it kind of happens by accident, but I would encourage people to do it sooner. You want to freak out a management team? Say we'll get to that after closing. Yeah, exactly. Right. Don't do it. All right. So two things. The closing call, the most anticlimactic thing in the world. Back in the day, in the 90s, you would walk over to Kirkland and Alice. It would be a big, long table of documents. You would walk down there. You'd sign them. Sometimes you have to sit there and read every single one and you'd sign, sign, sign, sign, sign, sign, go around the table and everybody would go do that. It was kind of fun. Because you got to do one when we did that and then the side doors open and there was a stake dent. There was a stake lunch for real. Yeah. That was amazing. I've never had a strategic deal. There's a fee. We were at the strategic deal. I won't name it, but we were at their headquarters. That's a nice company because the family really was really wanted it. Yeah, that's awesome. So, yeah. Welcome to the new world, man. It's done over as soon as it's done over as soon. It's like congratulations, everybody. You're a multi-millionaire. Yeah. And then it's like, okay, thanks, everybody. No, and I've never sold my business. I always worn the founders. I'm like, that's going to happen. And then you're going to hang up and you're going to be a little lonely. It's a little lonely. You're like, that was it. But so you get to that later and you can sell it later. At least when it's in that moment, and then you have to wait three hours for the money to clear. At least when it's in person, then you have to stake lunch. Right. If it takes 15 or 20 minutes or a couple hours delay, like now it's just like they keep moving the zoom meeting. Right. An extra 10 or 15 minutes. And you're just like, this is driving in your watching your legal bill just go. Yeah, exactly. And the founders sitting there like, why I thought we were closing at eight o'clock this morning. Why is it now? It's usually what? Why is it nine forty five? It's exactly. So that's just for us, right? But then then you have the closing party often or closing dinner where you get together. So like, let's just, we've got so many funny stories. No, that's coming. Like just give me a few of those. So we own the business. It's a week or two later. We've, maybe it's the day we close, whatever, depending on what the owner of the business wants to do. And we fly down there and I'll just give it my favorite is, I step into the company. This was a founder who did not want anybody in the company to know. It's only like the CFO, the CTO and the owner of the business knew that he was even for sale. Family owned business passed down a couple generations. I get introduced by the CEO and she said, and she's standing up in front of the entire company at a podium in like the lunch room. And she start bawling, absolutely bawling. It was a very emotional process. I totally understand that. And then says, I've sold the company. Definity want to come up and say, I was like, oh my god, that is literally the worst introduction I could ever get. Now you know, it's like to appear to be tears of joy. Well, you know what it's like. You're up and coming comic and you're working the seller in New York and you're about to go on and David Tell comes up and says, here, I'm going to go first. Oh, rough crap. It kills the room. And then you're like, all right, all right, good luck. Yeah, total cooler, man. Yeah. It just like cooled the room. So I'm standing up there like, oh my gosh. And I'm looking at the CEO. We're backing because she was retiring and be like, what do I do with this? So that was one. And then we went outside and sabered
champagne bottles. It was like a tradition in the family that when something great happened, grand child was born a wedding. They would like saber a champagne bottle. Like I grew up with pacifist parents. I didn't even have like toy guns let alone a saber in the house. So I'm holding a wet bottle of champagne, trying to like, chop, like do this saber thing. So I just decided to just chop the top of it off. And then the whole thing was to drink that champagne. Oh, it just did. It's integrated in my hands. Right. And then we had a pizza party. And then on the way out, the owner handed, they just made tens of millions of dollars. She handed me the receipt for the pizza party. Amazing. All right, give me yours. Now, I don't have any like that quite, but I think in general, you just, you realize very quickly there are company traditions. You know, they're gonna try to put you into those company traditions. So we've had one where it was at ice cream Fridays. So I did our little spiel during an ice cream Friday, but which was fine and you get some questions like, "Are ice cream Friday is gonna continue?" But you do realize like these feet, you know, it's-- You don't get questions of like, as my salary going up, have my benefits change and so-- No, they might get a few of those. Are we still doing ice cream Friday? Yeah, exactly. But yeah, in seriousness though, like you do realize, you know, so you're giving them, you're telling the truth, like for us, it's like, we're gonna tell you how it's gonna be, we're trying to be transparent. This is how it's gonna go. This is what we know is what we don't know, looking forward to get to know you. There are a few people that will ask questions like that and the ice cream Fridays. And then everybody else is like, "Uh-huh, okay." And they're kind of right and mental notes and they're like, "All right, we're gonna watch you for the next six months and figure out if we trust you or not." So like what you say in that meeting, you're, they're gonna hold you accountable to hold that up. So we do try to be thoughtful about that, but yeah, plenty of interesting company traditions that come at you and you learn ways to gather people that you might not have thought of. I would say for anybody listening or watching, do it in person because when you're doing it on Zoom and half the company doesn't have their camera on, it's just so demoralizing. It's at least in person they could stare at you blank. - And you can try and get in person. - And you can just know back and forth. - Yeah, the whole doing these over Zoom's is such a, I mean, talk about all that down. I mean, it's hard to inspire anybody over Zoom these days. - So, all right. So this is the crazy world of how to buy a company once you have a fund, especially in the lower market, but I think a lower end of the middle market. So, but I think these apply to a lot of people and we'd love to hear other people's stories about this. The next in the episode is like, what do you do with a company now that you own it? So Jim and Paul are gonna walk through the VCP and kind of how they stage the stuff they need to go do after we buy it. - Can't wait to hear it. ♪ From the heart of Chicago ♪ ♪ To all over the globe ♪ ♪ Couple private equity geniuses ♪ ♪ They share what they know ♪ ♪ They love to mess with technology ♪ ♪ Where the future is single-swim ♪ ♪ It's the private equity fund cast ♪ ♪ Where Devon and Jim ♪ ♪ Technology issues ♪ ♪ The middle market PE back companies ♪ ♪ They pick up with each other ♪ ♪ And they don't take themselves too seriously ♪ ♪ It's not venture capital ♪ ♪ It's private equity ♪ ♪ It's the private equity fund cast ♪ ♪ For yourself a drink and have a seat ♪ ♪ It's private equity fund cast ♪ ♪ That equity is private ♪ ♪ If PE excites you ♪ ♪ Let us show and do not hide it ♪ ♪ Now the private equity fund cast ♪ ♪ Is about to begin ♪ ♪ So give it up for your host ♪ ♪ Devon and Jim ♪
Podcast Summary
Key Points:
The evolution of company sourcing in private equity from passive phone inquiries in the 1970s-80s to modern, systematic outreach and dedicated sourcing departments.
Distinction between bankers (typically for larger, sophisticated deals) and brokers (often for smaller, niche, or regional businesses) in representing companies for sale.
Importance of direct outreach to business owners, with many acquisitions occurring without formal representation, relying on relationships and trust.
Tiered approach to managing broker/banker relationships based on deal frequency, specialization, and alignment with investment criteria.
Considerations for sellers when hiring representation, including costs, market exposure, and the commitment required for a successful sale.
Summary:
The discussion outlines the process and evolution of sourcing companies for acquisition in private equity. Historically, sourcing was passive, with funds relying on inbound calls, but it has transformed into a competitive, systematic effort involving cold outreach, specialized software, and dedicated sourcing teams. A key distinction is made between bankers, who typically handle larger, more complex deals with extensive due diligence, and brokers, who often focus on smaller, niche, or regional businesses with a less structured approach.
The speakers emphasize that many acquisitions, especially in their experience, occur through direct outreach to business owners without formal representation, highlighting the value of building trust and leveraging executive networks. They describe a tiered system for managing relationships with intermediaries, prioritizing those aligned with their investment goals. For sellers, hiring a banker or broker involves trade-offs: it provides organization and market credibility but requires commitment and carries the risk of a "busted sale" if the deal fails. Ultimately, successful sourcing blends systematic outreach with relationship-building to identify and engage potential acquisition targets.
FAQs
A banker typically represents larger, more sophisticated companies with organized processes and targeted outreach, while a broker often handles smaller companies with a broader, less structured approach, focusing on niche markets or regions.
Hiring a banker provides organization, due diligence support, and credibility, helping to manage the sale process and attract serious buyers. However, it involves costs and signals a strong commitment to selling.
If a sale fails after hiring a banker, the company may be labeled a 'busted sale,' with market participants having seen its data, which can complicate future sale attempts and affect perceptions.
Firms use a tiered system (e.g., tier one, two, three) based on deal volume, expertise, and interaction frequency, managing these relationships through CRM systems, email cadences, and regular meetings to prioritize opportunities.
A coverage banker maintains relationships with private equity firms, tracks their portfolios for potential sales, and helps create buyer lists for deals, acting as a liaison between industry bankers and investors.
Firms use databases, cold or warm outreach, and executive introductions to contact business owners directly, emphasizing credibility and trust-building, often involving senior team members to scale intimacy and avoid junior-led spam.
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