What to Expect When Selling Your Business to an Independent Sponsor

We can be a lot more opportunistic. We can go after good investment opportunities that may not be right down the middle of what a fund would be required to do. We have no pressure to deploy capital, so we don't have a fund sitting there that we have to deploy 500 million or 750 million or a certain amount of money over a certain period of time. We can be very patient, I personally invest in every company that we buy, my partners invest in every company and we buy, so we only have to buy something if we feel like it's a great investment for ourselves personally. Because then we know our investments are going to do well. I mean, at the end of the day we are responsible to get the best return on our investment and that's our focus. Welcome to M&A Todd, the number one podcast and all things related to mergers and acquisitions brought to you by Morgan and Westfield, a nationwide leader in mergers and acquisitions for small to mid market companies. We bring you exclusive interviews with industry experts in business sales, valuation, private equity, investment banking and more. It's our mission to provide you with insight and guidance on how to build your company's bottom line and maximize value for eventual sale. Here's your host, Jacob. This is Jacob Oros, your host and president of Morgan and Westfield, AboTeak, M&A firm, specializing in the sale of small to mid-sized companies. And if you're considering selling your company and if you'd like to schedule a free consultation with me, you can schedule that at [email protected] and I'll have that link in the show notes. Or if you'd like us to perform a valuation and assessment of your company, before you go to market work, you're just planning the sale a couple years in advance. We can also do that. It's a very nominal fee. I'll have that link in the show notes as well. There's no contract required. It's a one-time fee and it takes us two weeks to put that together. So I'll have that link in the show notes. If you own a company and if you'd like me to mail you out a copy of one of my recent books, my two recent books, The Art of the Exit, or Acquired, I will have our email address in these show notes and you can send us an email. And we'll gladly send you out a copy of one of those. And now onto today's show. We're going to talk with Sequoia Borgman, he's the CEO and founder of Borgman Capital. He is an independent sponsor. And if you own a small to mid-sized company with, I'd say, a million to 15 million EBITDA, an independent sponsor is a likely potential buyer of your company. And if you don't know how they operate, then this show is for you. And Sequoia, welcome to the show. Yeah, thanks for having me on. So let's dive right in. If you own a middle-market company or lower-middle-market company, you may encounter what's called an independent sponsor as a potential buyer, very similar to private equity firm. You are an independent sponsor. Let's dive right in here. What is an independent sponsor? Yeah, I can tell you a little bit about the differences with independent sponsors. Traditionally, they were called fundless sponsors. Really anybody that's sponsoring the acquisition of a business that's not doing it through what kind of committed fund structure, traditional funds or a 10-year structure, you buy three to 10 businesses over that period. And then you have to exit and return the money to your LPs. In an independent sponsor model, it's more you raise the money for each acquisition. So if you're buying a business, you raise the money. And it's similar to a fund, but you raise the money just for that one deal. And there is no life on that investment. So it could be three years. It could be 20 years when you go in and buy a business. It's a lot more flexible. It's a lot more popular structure these days. Really over the last decade, I'd say, an independent sponsor model's really grown. There's a lot of independent sponsors out there these days. How is it different than a private equity firm just to really clarify this for the listeners? The more established independent sponsors like ourselves, I mean, we've bought 20 companies. We've been around almost a decade. We've got 13 people on the team, three offices around the country. There's really no difference between us and a committed lower mill market fund. We have the same fund administration all out same back office all the same processes that value creation plans really are very similar. The only difference is we have the flexibility of not having one fund mandate. Our hold periods can be longer, which does a lot of business owners don't want to sell to somebody that's going to flip their business in two or three years and be that disruptive on their people. Like I said, we can hold for 10 or 20 years. We really, it's similar to a family office type investment model, kind of a longer horizon. A lot of the wealth built in investing in lower mill market businesses is usually over decades or generations. We're two or three years and a longer hold really does resonate with a lot of sellers. How many investors are usually bringing in an each deal with the typical range? It really depends on the size. I mean, we're kind of a retail investor shop. Most are LPs or family offices or high net worth individuals. We'll have maybe an 80 to 100 investors in a larger deal less than a smaller deal. We've got about 500 LPs have invested with us over the life of our firm. So on a typical deal, what do you do? You send that out to all 500 investors and you say, here's the deal we got who wants to invest or what does that process look like? Yeah, once we get something under L.O.I. and we've done the initial diligence around the numbers, the quality earnings report, we've got some good term sheets from banks. We'll send it out to our investor group and we'll do one-on-one meetings or webcast going through the investment thesis and we'll see what the interest levels are. We also have a proprietary retail investor platform similar to the real estate platforms out there or the angel or venture platforms where investors don't want access to these types of deals can sign up and then they can get on the list for that is called passahat.com. So really for anyone that you have to be an accredited investor in the US, but if you want access to traditional, low-mil market established, leveraged by outs, we have that platform for that. What size deals are you doing? There are between probably 20 and 50 million dollars is a typical deal size enterprise value. Yeah, so maybe 10 to 30 million of equity and the rest some type of mezz or subordinate debt and then traditional bank financing and then seller notes and earnouts are a lot more popular these days just with the current deal environment. So maybe 3 to 7 million in EBITDA? I'd say 3 to 15 million are about the size we work on under 20 million typically. And what's the capital structure again? You mentioned that, but let's talk about that some are. Yeah, we're pretty conservative investors and we're investing in traditional more industrial and food type businesses businesses have been around a long time. They're not technology or high growth businesses like newer industries. So we're paying lower multiples and we're putting less debt on those businesses. I'd say traditionally maybe 2 to 4 times leverage on those and the rest will be some type of some equity structure. So a $50 million deal what might that look like for you? How much equity? How much debt? Sell or note and so forth? I mean it really depends on the multiple we're paying but a $50 million deal when maybe 20 million of equity including deal transaction costs and then 30 million dollars of some type of senior note with a bank probably maybe 20 million there and then 10 million of some type of seller note or mezzanine financing. I just had a curiosity how do you structure it with investors from a legal standpoint? Do they all join together into when and to tear what does that look like? Yeah, it's like investing a fund. We set up a separate investment vehicle. It's just for that and to write the filing is registered and we'll say we have 100 investors that fund they'll invest in the fund in that LP level. But that is only for that particular investment. It's not for future investments. There are no future commitments. And then that LP will invest into the offering business or the holding business that we're buying. How do you handle if you're buying a platform if you have an answer tuck ins or so forth? Yeah, traditionally we don't get commitments for those up front because those are hard and we've done plenty of roll up type opportunities. It's hard to time those. They could come you could have three opportunities in one year or you could have none for three years. Is that the same fund or would that be a new set of investors normally with sending out to the same investors and give them an opportunity to avoid any type of delusion they can reinvest in the next round. But if it's a larger and on say we need some outside investors we would open it up to outside investors but the current investors would have the first look at it. Do the investors have any say on the deal? How the deal structure diligence anything like that. Do investors do they get involved? Are they going to interface at all like your lead investor? They can interface at all get involved in the deal or is that all behind the scenes. We traditionally have an anchor investor that'll do full diligence and get into digging the data room and interact go to management meetings. Yeah, they'll do full diligence. Maybe they might have a board seat as well. What are some other differences between you and an independent sponsor or private equity firm? I really think that the value of the independent sponsors we have no pressure to deploy capital. So we don't have a fund sitting there that we have to deploy 500 million or 750 million or a certain amount of money over a certain period of time. very patient, I personally invest in every company that we buy, my partners invest in every company and we buy. So we only have to buy something. We feel like it's a great investment for ourselves personally. So there's a little pressure to deploy capital. That's one big difference for independent sponsors. I mean, we've been pretty active, but that is because we've come across good opportunities in the space and companies that. Another thing, independent sponsors that we tend to focus more on proprietary deals, like off-market deals where we're negotiating directly with the seller. We spend a little bit less time in auction processes than I'd say a fund would. Again, we have to resale these investments to our investors. It's not like we, I mean, we have investment committee, of course, that we meet with every Monday, but part of the consideration is once we're convinced that it's a great investment, then we have to go and convince our investors there's a great investment to where if you're a committed fund, if you're investment committee, thinks it's a great investment, that's the end of that decision process right there. So we have to think about how would our investors look at this opportunity and if it's a blind kind of auction process, there's a lot buyers out there for those types of businesses. So more competitive. Yeah, it's more competitive. And I'm not saying we're paying a less than we would in an auction process. It just tends to be where we focus our time. As you know, every transaction and management meeting and L-O-I-I-I process that you participate in, and you've got travel costs and diligence costs and everything. And if you don't have a high likelihood of winning that process, I mean, the costs add up. So you really want to focus where you have the biggest odds of actually winning. How do you pay your expenses if there's no fund to generate a 2% management fee? Yeah, my wife's asked me that all the time. It comes out of our pockets. But again, if the transactions successful, we go over to closing line, we do charge it, closing fee for that. And that covers a lot of our diligence costs and overhead and insurance and staff and all that kind of stuff. So that's where most of those fees come from. How often do you find a deal and just no investors see you can't get the equity? How common is that? Fortunately, not going to we've never had that process. I mean, a decade ago when we were launching the first deal was harder to raise the money. But then since then, every deal has been over subscribed. So, fortunately, like I said, me personally, my partners are some of the largest investors in the deals now that we've had liquidity. A lot of the money that we received back, which is roll into future deals. I know, last year we did three acquisitions. I was the largest investor in one of them and the second largest in another one. So, I mean, we have large commitments in these and our investors, like I said, we have over 500 or nearly 500 investors at this point. So people want access to these nice lower-mill market direct investments. How involved do you get in the operations? Went you? Acquire a company. We're very involved. Sometimes more than I would like. I mean, lower-mill market companies. All our companies are under 200 million in sales. They don't have a lot of resources. They don't have big departments to handle every little thing. We help them as much as we can. I mean, we're not micromanaging the management team. I mean, we hire good leaders and expect them to do what's best for the business. But we're very involved in helping with strategy and bringing in the outside resources. And we try and share best practices across all of the portfolio companies. We get to all the presidents and management teams together every month or two and share what's going on. I mean, tariffs have, of course, been a big topic here recently. But I mean, if you're a hundred million dollar business or a fifty million dollar business, you don't usually have those types of resources to call on. And that's what we're there for. How many companies do you have in your portfolio now? We have eight platforms right now. And we've bought 20 companies since we launched. We've exceeded three platforms today. What's your number one piece of advice to sellers when it comes to preparing their company for sale? Number one, I mean, yeah, there's a lot of advice. I mean, you're probably better at the advice for sellers. We look at so many businesses. Really, the ones that we like the most are business owners that really care about their businesses, care about their employees, care about their legacy, and really want that company to continue to thrive and be successful. Because then we know our investments going to do well. I mean, at the end of the day, we are responsible to get the best return on our investment. And that's our focus. But when you find a seller that's aligned and has that same incentive, those are the best opportunities. So I'd say find a buyer that you're really aligned with. I mean, it is a partnership. Even if you're selling 100% of the equity, you're still going to be involved to some aspect. Maybe there's a seller note or a earn out or you do care about the employees. You don't want somebody that's going to come in and replace your whole team or change a bunch of stuff that you've taken decades to build. So make sure you're aligned and you're not just focused on the structure of the value, which of course, this are not to be to take the largest check. I'm not saying don't do that, but really make sure you vet who the buyers are before you enter into any type of even at the IY or LY stage. Make sure you're both comfortable that is right for both parties. Well, solid advice. Let's take a quick break and we'll be right back. This is your host, Jacob. And thank you for listening to the show. If you're interested in selling your business and you'd like to work directly with me, you can go to MorganandWestfield.com and you can schedule a free consultation. And like I mentioned, you'll work directly with me throughout the process. And now back to today's show. Welcome back to the M&A talk with Sequoia Borgman. Sequoia, to what extent do you require the seller or the owner to stay involved in the business? Unlike some firms, we don't require them to be involved or roll over a percentage equity. It does align interests. I'd say 80% of the time the seller does roll over maybe 20% of the equity maybe a little bit more, maybe a little bit less. And the usual transition period is, I'd say six to 24 months. Most of the sellers that we're buying from our family, businesses or entrepreneur led businesses that do not have a successor. So that's kind of known up, Ron, is we'll work with them to find some way that is a cultural fit for that business and can step in and lead that business in a certain period of time. I do find that there's the longer overlaps traditionally don't work very well. When you have to type A leaders trying to run a company, they tend to butt heads. So I like the shorter transition period to maybe a three or six month overlap, just depending on that situation. What's your strategy for finding a new CEO? I was just talking to somebody that does that for us and they said that success rates around 50% and I'd say we've probably had similar success. I mean, you've had a lot of candidates, you interview them, you have the boards interview them, you do all the perfect finale profiles and you never really know if they're going to be a fit for that particular business until after they start. So I mean, we do have the previous owner and founder, air, we just have their input. I mean, they know what the culture is of that business better than we will on day one. So again, they tend to be more supportive of somebody they help pick versus you trying to jam somebody down their throat, which that just doesn't work very well. But yeah, I'd be the first to admit we've had to replace some presidents more than I would like to do. What's the typical compensation package look like for company in the lower metal market? I'd say our typical package is maybe a little bit a lower base than they would the president would get running a division of a bigger company or public company, but a higher incentive comp, most are in some cops are not capped. So if they grow the air price value on annual basis, their incentive cop can be multiple of their base. And then we set aside usually about 10% of the equity for the management team to earn if they hit kind of enterprise value growth targets on an annual basis. So a big chunk of the equity set aside for the management team. And that can be significant on these side deals. That's really why we're looking for somebody that's an entrepreneurial willing to take a risk on themselves and they're really in it for the accident at some point. That really aligns their interests, our interests and our LPs interests. How would you differentiate yourself from a family office? I would say the resources. We do have a lot more resources and the most difficult family offices family offices tend to do a lot more passive investments as well. We've been control investors on every deal we've ever done. So we're not minority investors are more passive. I mean, we're responsible for a lot of people's hard earned money and so we need some type of control to be in the GP position. So that's one difference. Like we have lots of family offices to invest with us. And they're welcome to sell the board and help out with that investment. The more help the better for my standpoint, but I'd say the difference is although some of the bigger family offices are now building out the whole PE teams and doing all the diligence and value creation and kind of offering partners out of the business as well. So but I'd say the smaller, more passive family offices, that's really the big difference. And what about search funds? Of course, search funds typically are doing a little bit smaller deals, but what's the difference there for listeners? I love search funds. I wish I knew about that when I was in college just a long time ago, but really wasn't a thing. I mean, those search funds usually newly minted MBAs are got year or two to find a business so they're very aggressive. They're talking to a ton of business owners and they stumble across great opportunities. I mean, if there's opportunities, they're too big for them to pull off with their backing. I'd love to partner with them on those types of opportunities. What is your deal process look like? At what stage do you involve the investors? Sounds like you do the QIV before the investors. What else do you do before you introduce these investors? We just want to be very confident that the cap stack is really laid out. Like I said, the term sheets from the banks, the QIV initial diligence, if there's any risk areas on that business, we want to make sure we've done that diligence. I mean, of course, a lot of legal and diligence will be done later in the process. But you prioritize it based on the risks? Yeah, exactly. Usually you know what the risks are in that industry. Maybe it's some environmental. We have bought some chemical distribution businesses. Environmental tends to drag out the deal timeline. Those types of deals, we just don't want to take something to our investors, get commitments and then have to go back and change. And then we never call any funds until we're confident that we're going to close under those terms. We won't want to have to return the money to our investors. What's your typical timeframe? It's longer these days than it was a couple of years ago. A couple of years ago, deals were getting closed in 60 or 90 days. And we were closing deals in that period. I mean, we did several in 60 days. But now in the current deal environment, it's a lot slower. I'd say the typical timeline is by more $90 or 20 days. What has contributed to that? What slowed it down? It's just there's not the deal for a frenzy that we had several years ago. There's a lot less buyers out there. There's a lot less sellers in the market. People are very not saying anybody cut corners around diligence, but people are much more strict around the diligence process. And like I said, the multiples are down slightly, but it's really the banks are driving that. I mean, they're putting less leverage on businesses. So there's a lot more earnouts or seller notes. So it takes more time to negotiate those parts of the transactions. And you get the term sheets from the bank before you take this out to the investors, right? Yeah, we've usually picked a bank by the time we go out to our investors or have a really good idea of what the terms are. At what stage do you get a commitment letter from the lenders, from the debt providers? Usually about a month in the process. I'd say 30, 30 days. We go out really in the first week or so as soon as we can put together a bank package, we'll send that out to the lenders. And then we'll be talking to the meds providers in the same timeline. And then I'd say 30 days in, we'll get a commitment. We'll make a decision on who we're going to go forward with. And then they have about 60 days to do their site visits and do all their diligence. And they'll bring in some outside diligence, sometimes paying on the size of the institution. What is mezzanine capital for those that don't know? It's subordinate debt. It sits above the equity, but below the senior lender, the traditional commercial bank and its higher rates. Of course, sometimes they'll have some equity or some warrants in the transaction. So primarily debt with an equity kicker. Yeah, yeah, sometimes. I mean, it's all types of different mezzanine structures. Sometimes we'll do our own mezz, our investors want a slice of current paying mezz. We'll do that on some of the smaller deals. Larger deals will bring in kind of larger mezz funds or unitracht type investors. What's the difference there on the senior debt in mezzanine terms of the cost on your side? Yeah, usually the mezz rates are 6, 7 percent higher than the traditional senior lender rates. And then there's an equity kicker on top of that? Not always, but sometimes there is some type of warrant or they'll invest traditional equity alongside our LPs. Who are the mezzanine providers? They're funds. The SBIC funds, they get some of their backing from government financing. So those traditionally have pretty good rates on mezzanine financing. There's a lot of retail funds out there as well that do financing a lot of them. One due unitracht, which unitracht is both the senior and the mezz kind of combined. Lended into one. One blended rate. Yeah. And instead of having to go with a commercial bank and a mezz fund, you can go with one provider. What's unique about your deal structure versus AP firms or family offices or strategics? I'm not sure that our deal structures unique. The terms are pretty standard across the industry. I'd say we're a little bit more conservative. So we may put a little bit more equity into a deal over-equitize it or close a transaction with a little bit of cash on the balance sheet. That's sometimes other lenders or a lot more or other investors or a lot more aggressive. I'd say they push the envelope on the leverage sign because that does help with your returns. We're probably less so. What's most important to you in terms of criteria? The terms acquisition criteria? Just buying from a seller that I really trust and that we're aligned. I think that's the number one thing. At the end of the day, you're investing in people. I mean, technically we're buying businesses, but all these businesses are just a collection of people that have been built over a long period of time and you want to invest in businesses with people that are aligned with you and that you trust that want what's best for the business. What's your growth strategy? What's your toolkit that you pull from? Fortunately, in private equity, there's a lot of toolkits. They call it financial engineering, but a lot of your turn comes from the leverage. There's that and then not all businesses have to have a real aggressive growth strategy. Some of them, if you buy right, LOR multiple and you pay down that debt, you can double your money. Others, you really have to grow those businesses. If you're paying up for a business that those tend to be a growing business is already. If they have a large year-to-year kegur, you want to maintain that or increase that and that's a different strategy. Then there's the roll-up strategies where you're buying companies for lower multiples than what your platform is and that adds some accretion to your investment. Although the multiple accretion is, I'd say less so these days, multiples aren't increasing like they were for the last decade. They're really flat to down. What's the biggest mistake that you see sellers make? The biggest mistake is probably not taking the time to get your business ready for sale. I mean, it takes years, sometimes two years, three years, five years. A lot of sellers think about selling for a decade or so. So they have the time, but other people just get to a point in their life for their rate of sell and they pull the trigger higher investment banker and sell in six or nine months. That's probably the biggest mistake. Take the time, get your business ready. It's not different than like, stay in a house before you sell it. You're going to get a lot more buyers. You're going to get a lot more interest. You're going to get a higher price if you get that business ready. Also, I mean, just focus on the balance sheet. This is the one stuff we do. Working capital down as much as possible. All that cash goes in your pocket when you sell. Don't be sitting on the excess inventory. That's a big one, but millions of dollars in your pocket if you lean that down. I'll have an article on a networking capital for those that don't know. But how much do you think an owner of a company can save if they lean that down? They can save a lot. I mean, just depends on the size of the business. But I mean, that's just very straightforward low hanging fruit right there. Most transactions are a working capital peg. This probably at 12 month average. There's a lot of different ways to go about that. But if you're just working it down for one year, you're not going to get a lot of benefit. Where if you work that down over a two year period or longer period, all that again, all that cash is sitting in your pocket. Same with cat bags and any other expenses that you really don't have to incur prior to the transaction. How do you factor cat bags into the valuation? It impacts the valuation. You're going to pay a lower multiple for a company that has high cat bags. I mean, really, we're buying a string of cash flow. And if that business requires a lot of maintenance or a lot of cat bags each year, that stream of cat flow is less. And that's why this business is straight burdened a lower multiple. As we wrap up the show here, Sequoia, what do you think the most important takeaways for listeners? Just considering the pen sponsors when you're thinking of selling. And yeah, I think that's the big one. There we go. Simple enough that Sequoia Borgman founder and CEO of Borgman Capital will have his contact information in the show notes. And Sequoia, thanks again for joining us in the show. Thanks for having me. Thanks again.