Buying Carve-outs for Future Exits

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Role openings and other resources as we build the greatest community of forward thinking M practitioners. Again, that's Mat. I'm your host Kisan Patel, CEO and founder of M&A Science.

Joining me today is Joe Covey, a.

Serial CEO and acquirer and investor since 1992.

Also joining me today is Matthew Davidge.

Who'S the co owner of the NBC affiliate WVNC based out of Watertown, New York and several other stations around the country. Today we're going to talk about the buy side of carve outs and exit lessons. Gentlemen, how are you doing? Thank you for joining me today.

Thanks for having us. Good to be here.

We kick off with some brief intros.

I had run some venture backed businesses for about 10 or 12 years and when I met Matthew I had this idea that we could buy a business together without outside capital, run that business and eventually sell it. And we formed a partnership in 2008.

My dad always worked for himself as an entrepreneur, was always doing deals. I went in a different direction and Bruce Banner while I worked for Bain, which I did, and MTV for many years, which I did. I always wanted to burst out and be the Incredible Hulk. I was just looking for an opportunity. Joe and I knew each other and I got that chance and so I burst out of the corporate scene, shed that skin and never looked back.

Let's kind of played off of each other where Joe was like hey, I want to buy a business and then Matthew came up with an idea.

Partially what prompted it is that I had sold some businesses that were venture backed and my venture backers made significant money and I made relatively little money. Of course they deserve to be rewarded having written the checks, but I was doing a lot of work and what I thought make was making relatively little money. And so I thought, let's do it on our own and if we're successful, we're going to reap the benefits. And if we're not successful, we're going to feel it because we decided to do this with our own money without outside investors.

At the time, I was working for a number of different companies in media and Joe said to me, look, one of your clients has got a got to be interested in selling something. And I worked at MTV at the time, they had a bunch of businesses. I worked at EMI and I worked also as a consultant to Rainbow Media. I went round and said, are you selling any of these businesses? One of them said, yeah, we are actually, we're in process. And that's how Joe and I said, okay, let's go take a look.

I like it. Fundamentally very similar to a typical private equity firm in terms of buying the business, fixing the business and selling the business. But you thought, hey, why do it for the institutions where the partners reap most of the benefit? Why not do it as principals ourselves? And that's where you sought out to find a business to acquire.

That's right. But there are a lot of differences the way we do it, because when we find a deal, first of all, we have to find a deal, we have to source it, then we have to negotiate to buy the deal, then we have to run the business and then we eventually sell the business. It's not like we find a deal and we buy it and then hand it off to an integration team who hands it off to another team. We have to wear a lot of hats.

Also, I think that on day one, Joe, we didn't quite know what scale deal we were going to do. When I was at Bain, I'd worked on a couple of billion dollars deals. And so Joe and I were pretty certain we're not going to do a billion dollar deal, but we could have done a $50 million deal and we'd have had to have gone out and raised a whole bunch of investment and that would have been a crowded room. And so ultimately Joe and I decided that we would do something on our own, ourselves, with our capital, nobody else, no other decision maker, just you and me. We would own it and we'd sell that ship either to the shore or sink. And we decided in terms of scale and size to go for something in the, in the $10 million range, not something enormous.

Now, are you leveraging debt products, managing that way to do those deals or.

The best possible debt you can get is from the seller? And that's a model that we have followed. Sellers have different reasons to sell, but when they're very keen to sell and sales price maximization is not their goal, speed and certainty to close may be high on their mind. And at that point you can persuade them to lend you the money that you need to buy their business from them.

Okay. A lot of the deals are owner financed.

Yes. Yes.

As opposed to getting a third party bank finance.

Joe, you and I have done deals where it's seller finance, where the sellers are multibillion dollar company. And we've also done seller financing when the seller is just an individual person that wants to sell their business.

And in particular with a large company, a multibillion dollar company.

Yeah.

And a purchase price that is not in the hundreds of millions of dollars, Far less.

Yeah.

Doesn't make a difference. It doesn't move the needle in their world if they get paid over the next 12 months or 18 months or if they get close.

Very cool. It sounds like you guys done a couple of these carve out deals, but can we walk through maybe this first one we started talking about as an example? I often talk to the corporate side on the whole carve out divestiture process, but I don't often get the story on the buy side and would like to understand what were the steps and challenges you ran across when you were going through the process from the buy side.

One of the transactions we started by engaging an investment banker who was in between jobs. And we said, here's a list of companies, big companies in the New York area. We'd like you to reach out to their corporate development decision makers and see if they have anything that they might consider divesting. It gave us a lot of credibility that he was reaching out.

He had worked for a top tier grade A bank. Whereas if it was just Matt and Joe reaching out, they might or might not probably wouldn't have taken the call.

In that case. They were selling an asset which turned out to be what we called the Wellness Network. But they were TV channels in hospital. One is the newborn channel that almost every mom in the country has to watch. By law, they have to watch a show when they have a baby. And there are other shows about diapering and breastfeeding and things that moms have to watch. So it's a great business. But it was buried in the world of NBC in a division and they wanted to sell that business. They had a process and we were not the highest bidder in that process. Someone else bid more money. It was a private equity backed company. So we were sent away about 90 days later. Matthew, you decided to call up and see what happens.

There were several people in the process. We bid what we thought was a fair but lower price and they rightfully pursued it with somebody else. We kept checking the trades to see the announcement didn't come on the 90th day. I said, joe, we still haven't seen the announcement yet. Let's send them a letter and tell them a little bit tongue in cheek, let's tell them that we're self financed, we'll close in a week. And we did send that letter and they did call us back the next day and they said, we're not sure we can really talk to you because we're trying to close the transaction with somebody else. So I don't, we don't really think we can talk to you. But of course, because they were talking to us, we knew that they would do something. And so we said, we'll close in, in a week, we'll close it in a week. You got to let us in. And so what they did is they didn't say yes. They went back to the other buyer and they said, look, you're taking too long and if you're going to keep doing this and procrastinating, we're going to go with this other company. So they basically called their bluff and the other buyers said, sure, go off and do it then. And we did make the offer. They did engage with us and we did close. And they were like, what? And we did buy the business.

Wow, I love that story. There's a good theme here, even from originating. This is the same deal where you asked around and basically found the opportunity.

Yeah.

So there's just reaching out and being proactive that led you to identify the opportunity. And then even though you didn't pass it, you didn't give up on it. You had this level of persistence where he followed up, got a little window back in and then ended up winning the deal.

Of course, after we did that transaction, we then became a part of the Patient Ed business, which we were in for five years. We were a big player in that business. Very quickly we came to meet and work with the party that we beat it Was bound to happen. And very quickly we ended up meeting that guy Joe, you remember the story.

We laughed about it over a drink and said they were a competitor of ours and a private equity backed company. He said we were going a little too deep on the due diligence and NBC was frustrated and so good for you guys for making it happen.

So what was the advantage we had? The advantage was speed because they certainly, we don't know what they bid Joe, but they certainly outbid us. But this company just, NBC just wanted to get rid of this division. Time was of the essence. You got quarterlies. The deal team needs to move on to something five times bigger. It's like we can't be spending another four months doing this. And so speed and flexibility was what got us that deal.

What's the key in your approach to doing diligence that allows you to do it? I feel like you probably less bodies digging in looking at things.

Two bodies, Joe and me.

Yeah.

So is it more of a, hey, we got a slim down process. We're going to put the hours, we're going to touch base about our findings and make a decision. Were you acting on speed? Is just having a slimmed down diligence process or just less people accountable for doing diligence?

Partially it was a slimmed down diligence process and partially when you're buying a business from an NBC or a big company, they're very buttoned up. They have a lot of lawyers, they have a lot of accountants. It's highly unlikely there's some surprise buried in there that would be problematic. And Matthew and I do have a little bit more of a team than the two of us. We have a lawyer that we've worked with on all our transactions for the past 15 years. We have an accountant and we have various consultants we can bring in. One for hr, another for other kind of financial due diligence. So we have our little mini team and we are scrappy and resourceful and we do dig deep, but we probably don't dig as deep as.

But again, two people running the deal have one conversation. Three people running the deal have three conversations. Four people running the deal have 10 conversations, bilateral conversations. So Joe and I, we're on the same page every day. We're looking at the same documents. We make a quick call, our experts advise us and we just keep moving, tearing forward at a terrifying speed, frankly.

So for the corporation, the whole process of unbinding a company is pretty complex. And on your side, how did that work in terms of really getting Assurance that you know what you're actually buying. And these all these little TSA things that people complain about how that unfold.

Well, we've had transition services agreements where they continue to run the business for some period of time where we can make sure that we smooth out any kind of HR issues or business issues that take time, but we can close quickly and still have the momentum, but make sure we don't have any bad bumps along the way.

Fantastic, though, when the seller is going to give you finance to buy the company and enter into a TSA to run the company for you while they're lending you the money to buy it, it means that you don't have to create the organization to receive it in advance. And we're just, we're laser focused on the most important terms of the overall deal is when you're getting down to the reps, warranties and indemnifications. The end of the day, you can dig and dig, you can dig forever. And at some point you just have to say, there is risk there. We'll take the risk. I'll give you an example, a specific example of that deal. This was a business that had recurring annual contracts, millions of dollars. And so you're going to inherit millions of dollars of deferred revenue, a deferred revenue obligation, the obligation to provide services in the future without the cash to recognize the revenue. But you're not going to get cash. Is that schedule right? Is there really that much deferred revenue or not? We gave it our best shot to try and validate. It was correct. It wasn't correct, but again, the deal was still a good one anyway. So was the difference material? Ultimately, no. But if you're in a corporation where you can get fired for making a mistake, you're going to due diligence. That deferred revenue schedule with hundreds and hundreds of lines, you're going to diligence that to death. And we have to eyeball it, do a bit of math and take the risk.

It's interesting how you do that because it can sound so easy, lucrative, I should say, to be able to carve a business out of a large corporation. You think of those dollar acquisitions. If you can figure out those terms in between, you can get a lot of value generated. Why is it not as easy said than done?

It's very hard to find the deal, very hard to identify those little unloved divisions that are swept in the corner somewhere in the basement of these big companies.

Let's talk about that. Let's talk about Sourcing those opportunities. You've obviously figured out a few times what's the approach to do that?

We've tried a few different ways, tried networking with people we know and we've tried hiring, in that case, an out of work investment banker. Another time we hired a corporate development executive who was in between jobs. He also found us a deal. We've tried using databases. It's challenging though, and it can take a long time and it's very unpredictable. It could take you a month to find a business, it could take you two years to find a business.

I think once you get down to subscale opportunities, is that it's very uncorporate. Whereas the corporate acquisition or divestiture screen has parameters. Officers, executives, admins, they all run it, they all march as an army. And we're on track. We're on track. Whereas we have to be very entrepreneurial, go off the beaten path, look under some strange stones, be prepared to adjust our approach at a moment's notice. And so when you look at the deals, we've done a couple from searches we did one out of a database. One was a men, was somebody you were mentoring at the time who sold their business to us. So you have to be flexible in everything, not just how you do the deal, what the structure of the deal is, is it an SBA is an apa, but also how you finance the deal, how you find the deal. You've got to be comfortable ad living it. If you're in our space, if you're up with an extra couple of zeros, there probably isn't a lot of ad libbing going on.

So no secret formula. It's just a lot of different things that you do.

Be brave. That's the secret formula.

Is there a certain title of person that you'd want to talk to in a larger company? We have a lot of conversations with the corporate development people, but does it make sense to get into the C suite or talk to one of the.

Board members in the first few that we did because we did two from very large media organizations. At NBC, which was at the time a multibillion dollar business, you just aren't going even six rungs down. You're not even at that level. You are talking to biz dev people who've been tasked with the disposal of an asset. They are the right people to talk to. Try going over your head won't do you any good. Will create bad blood. Hey, I know the CEO. Yeah, that's not going to help here. It's not going to Help. But at other times in smaller organizations, actually. Sorry, let me take that back. On reflection, the way in which the business tells you they want to sell the asset is the way in which you should address them.

Tell me more.

What I'm saying is that. Don't sneak around is that we go in there and we say, you see that Rolls Royce? I know you think it's worth $100,000, but it's old and it's tired. And we'll give you 15,000 cash, and we'll give it to you today. And we approach the buyer directly. We're straightforward. We will close. We have a track record of bidding and closing. And we're very direct and we don't take any tangential approach. There's no asterisk in the contract. Whatever we say we're going to do. And some of the times the person says, not on your I'm going to sell you my Rolls Royce $15,000. Are you mad? But occasionally somebody does. You own a rolls Royce for $15,000.

Are you finding it where they're explicit that this is something we're going to sell prior to that, or are you sending in some nonsense, elicited interest on a. You got this asset? We're interested in buying it.

Oh, we've knocked on a lot of doors of people that aren't selling.

We have. And we make them aware of us. And so when they do decide they have a division or a small business unit that they want to divest, they think of us.

Is that inquiry on a specific asset? Hey, I saw you got this asset. I want to talk to you about it. Or is it. I want to introduce myself and let you know about who we are. Because we like to buy things that in your space.

We've tried to reach out to companies and say, this is who we are. We bought some businesses. If you have something, please consider us. But more likely it's through a relationship. It's through someone who knows someone. Could be the business development person at the large company. It could be an operating executive who knows that a division is going to be sold.

My experience may be a little different. I would say that in today's noisy business environment, if you hit the right person at the right time, they will call you back immediately if it's relevant. If you hit the right person at the wrong time or the wrong person at the right time, they will never call you back and they will never remember you. So the strategy must be to be reaching out at all times to all people about everything and looking for who responds, don't go planting seeds and then go take a break and wait for one of the people to call you. Will never happen. You just got to pound it and keep calling these people and eventually you'll find somebody who says, you know what, I think we are selling that thing. Talk to that person over there.

Now I see how you guys compliment each other. Matthew's the thoroughbred hunter, while Joe wants to be more strategic and figure the right introduction avenue to go.

I run up a lot of blind alleys. Yeah, Joe, not so much.

I mean, together we bought six businesses and we've sold five of them. They were not all corporate carve outs, but we have complimentary skills and eventually we've come to an agreement on each of these deals.

Are there other points to really negotiate or really key things when doing a carve out, like clarifying the people that are going with the business or how do you. What are the key things to make sure I don't screw up carve out deal I try to do in the future?

Well, interestingly, with one of our deals, one of the most important factors was that the people were taken care of. The people who worked at NBC were to be taken care of in our smaller company, our new entity that was going to hire them. And we knew that these people were important and were key people. And one of the things NBC wanted was to make sure that these people had similar compensation and similar benefits to what they had in the world of NBC. Of course, our small company, we didn't have the ability to give them all benefits that a big company like NBC had, but we had to make sure that we at least compensated them in a way that they could have those benefits. So there are factors like that that are not necessarily about purchase price but are important to the seller. And we abided by them just talking.

About that specific deal without breaching any confidentiality. So they had these key executives, they'd already slimmed the team down a great deal, but they had a number of people they thought were important to them, key resources. They were selling a Skinny Dan team. We negotiate the transaction, we come to a price and then somebody pipes up and says, yeah, we just want to make sure that you have similar pension agreements in place and 401k in place for the executives. And we're like, no, there's nothing, there's nothing, I'm sorry, there's nothing at all. And they're like, oh. And so what we did is that we did a quick one day analysis of what the dollar value of those benefits would be. And we asked them to discount the price that we would financially compensate the executives for the loss of benefits. And NBC agreed.

That's pretty cool.

That deal. They were very ethical. They cared about their employees. They wanted them to be treated right. So much so that they would take a small reduction in the purchase price in order that their employees would be adequately and equally compensated post close. And that's how we got to an agreement there. That was a very large organization that showed remarkable flexibility and moral fiber, I thought.

Yeah, because it's of their interest. And they took it upon themselves to take accountability with it instead of just forcing it on you, as some people do on these deal points and on.

The HR point, I'll add that often we find that people coming out of a large company are not as comfortable in a scrappy little entrepreneurial company like ours. But there were some real entrepreneurial people there that were successful in the world of NBC and were successful in the small world of Joe and Matthew.

Also on that deal as well is that you remember we brought in an external HR consultant who had been very senior in a media organization. Very senior. We didn't walk in arm in arm and say, welcome to the toy shop. We brought somebody with us who was one of them. Basically. They knew who she was. They knew where she worked. And so we brought this person in as our HR transition expert that would transition all of these employees and settle them. And that also helped.

You had some alignment there with the management team pretty early, it sounds like, for close.

Yes, this was unusual. Some sellers will let you interact with. With the employees, their employees, before you close. Some sellers do not want you to interact with the employees before you close. In this case, we were encouraged to visit the employees in their places of work, not just New York. And we did do that, Joe. Right?

We did. We got to know the employees somewhat well before we closed that transaction.

I'm trying to boil this down, though, into lessons that are applicable beyond the specific instance we're talking about. And I think it again comes back to energy, earnestness, flexibility, all of the things that a lot of corporations don't have too much of. You're playing the violin and they say, play the cello. And you got to take the violin and put it on the floor and play the violin like the cello, immediately.

Have you ever walked away from a deal just because you didn't think the people were cut out for what you wanted to work with?

We've walked away from deals. I'm not sure it was about the people. There was one in the sports category, Matthew, you probably remember that we walked away from. But there are a few things wrong with that deal. But one of the positives of these deals that we haven't addressed is that when you pull a little business out of a large company, you remove these corporate allocations so you no longer have to pay for the CEO's private jet or the fancy offices in midtown Manhattan. And when you run the business as we do out of a, in our case a tiny little office on 57th street with a window facing a brick wall and much more modest rent expense, it becomes even more profitable. Those corporate allocations coming off the P and L immediately make the business profitable. Not to mention things that we do.

A business that looks unprofitable within the corporation can in fact be profitable on day one outside the corporation.

Is that a lot of your consideration around how you model that out? I'm curious too, in addition, like how accurate did you end up with this sort of carve out based pro forma versus what your actual numbers ended up?

We go to great lengths put together a pro forma before we buy the business and make sure that in a worst case scenario is still going to be something that we can live with and that we're somewhat happy with, but there's still risk, there's still uncertainty, and you never know until you're in it. So there is a moment, Matthew and I talk about this moment when you're about to close and you're about to wire a large amount of money, millions of dollars of money. You have to be just a little bit crazy or a real believer that you are going to be successful.

Joe, don't you remember walking across the street? Because our bank was across the street on 57th Street. We're like, okay, let's go down and wire the money. So Joe and I go down there, we show up at the bank, literally at the time was a retail bank. We're like, hi, we're here to wire a few million dollars to somebody. And they're like, what? Oh, come over here, sit down. So we sit down, we do this like how many numbers are on this wire? And so we do the wire and Joe is looking at me and he's like, are you sure you want to do this? This isn't just vacation money, this is, this is real money. And ultimately we're like, we've done the numbers and this is going to be okay.

Of course we have to come home and in my case tell my wife and watch the blood drain from her face and she Realizes that. Here we go again. Thus far it's worked out okay.

Was there a big difference between what you model out in your best case scenario to what your actuals were?

I would say that in all of the deals we've done, the modeling we did prove to be very accurate for the first year or two. So there was never a misrepresentation of what the business was. And most of what we modeled would have been very minimal revenue enhancement in the first year, but some realistic cost reduction. And all of those things proved to be true. In one of our deals, we had some representations from the selling entity, Joe, that revenue per contract, per binding contract would rise. We looked at those contracts, looked like it was going to be true, bought the company and proved to be true. For people doing our size deals, you have to stop at 10 contracts. We had one company that we bought that had 2,400 contracts. You could go on forever. You could go on down that list forever. But once you looked at the top 25 and they're all solid, the other 2,175 are going to be fine. But you got to be a little bit brave to say I've looked at the 25 biggest, it looks good.

That's what counts on the carve out. Are there any other challenges or big things to look out when working on the buy side of carve out?

I would. So let me ask first. As we did more, we paid more attention to cash flow and working capital and true ups. Because when somebody says to you this is going to be an $11.5 million transaction, you have to think through all of the networking capital and changes in networking capital because that can, depending on the business, vary radically from quarter to quarter. And we've gotten better at thinking of the number above the headline price, which is term 1.1 in the contract. When you run down through it, there's a lot of other numbers that you have to think through to do with working capital, balance sheet and adjustments.

Get into those details, make sure you know what you're ultimately committing to in regards to those adjustments.

Or the headline price is one is the most important aspect financial aspect of the deal. But there are many other financial aspects of the deal, including net working capital, true ups, balance sheet items, financing and so on. It's not just the headline purchase price.

And in some cases even closing transactional costs can be significant. We're very careful and we have help to make sure that we can do it carefully but inexpensively. But we've seen others do M and A activity where Those transactional costs can be very high.

I feel like if this is your first deal, you just don't know better and you're going to get taken for a ride. If you're a first time acquirer, how do you prevent yourself from running into those problems?

You have to surround yourself with people who have done it before and can help you avoid some mistakes.

We chose not to hire a big law firm even on our first transaction, because I knew that I would start yelling at them very quickly because I'd get frustrated because they'd say, on the matter of patents, we'll bring the patent team in and they'll talk to the IP team, which will talk to the labor team. And this would drive me crazy. So we happened to find an attorney who had been in a very large, prestigious firm who was just like us. He set out with his own stall to help people like us buy assets from big companies. And doing these, he was like a guerrilla attorney. He would run in there amongst the opposite team and they'd all fall over dead without even realizing he'd work them over. He was fantastic because he was one of them, but they didn't realize he was one of them. But he was on our side of the table. So you got to have a good lawyer and you got to have a busy lawyer. A lawyer that doesn't need your hours to make his number. He's already busy. Doesn't matter whether he's billing you or he's billing clients six or seven. You don't want a guy who's like, I got a few more hours for you. And he's just filling his hours full of the nonsense he could think up to do for you.

I like that tip a lot. I got to take that in my book here.

Look on the other side, we've. For the companies that we've bought, the seller has always had outside counsel, never inside counsel. It's always outside counsel. They're all the obvious people, the most famous law firms, and there's squads of them. They come in, they're like mushrooms. You deal with five of them, there's five more of them. They're just, there's hundreds of thousands of dollars. They're just running the clock. We don't have anything to do with that. So on a transaction cost, our cost might be $75,000. Their cost might be $675,000. Because you see it all in the 8594. At the end of the day, you see your deal, transaction costs, they see yours, you see theirs, you're like, holy mackerel, you spent that sending the business crazy.

Great tips on managing a carve out in terms of the business that you acquired and your approach in creating value. I'm sure so much of this is around your leadership style, your operating model that you bring to these businesses to create value. How has that evolved over company to company in terms of what drives success for you?

One of the things that we do is we put a lot of thought and effort and time and money into growing sales. In a big company, sometimes a small division will just, as I said earlier, get swept in the corner and doesn't necessarily get the sales and marketing support it needs. And so when you focus on that and you reinvest in the sales process, you can get good results simultaneously. As you gather from our conversation, we're very sensitive to costs and making sure that wherever costs can be trimmed or things can be done in a more efficient way, we do it. Almost everything we'll do will have to do with raising revenue and cutting costs.

I don't want to scare your listeners, but do you remember, Joe, we had the. I mean, I will scare the listeners, but do you remember Joe, we used to have these policies where it was like 2.5 star hotels, right? Or is it 3 star hotels? I would fly and I would stay in a Motel 6 just to make the point. Just to make the point to the other staff that Joe's typically the CEO, I'm typically the president, just to make the point that when I travel I stay in a Motel 6. So don't come to us and ask to stay in an Intercontinental because I'm staying in a Motel 6. So we're very frugal and we have to eat our own dog food. Do you remember the hotel we stayed at in New Orleans where there's basically there was been a murder. It was one of those motels with the pool and there was a murder like three doors down. It was taped up with police tape. There were roaches in the hotel. You don't have to go that far.

I will say that as I've gotten older, the hotels have maybe crept up a little bit.

I don't sell motels.

The point you're making is valid that we are very sensitive to cost, travel costs, cost of operating the business, and we live it. It's not like we're traveling business class and everyone else is traveling coach. No, we are careful in how we run our businesses and I think it's paid off.

It's a discipline. And I like how you said it from the beginning. I think it makes it well earned for the long run in terms of as you grow and people respect you.

If you're prepared to stay in that Motel 6 and you bring donuts to the introductory staff meeting, you're setting the expectation that I'm not Nero fiddling around while you employees work. I'm in there with you. We're going to make this work together. We're facilitators, financiers, planners. It's not them and us. We're there with you. We're traveling the same way you are now.

In the world after Covid, people are remote, and people don't need to have an office for the same reasons they used to. But when we have bought our businesses, we've always had a very modest office because we didn't really have clients coming to that office anyway. As long as it was clean and it was safe, didn't matter if we had a view of a brick wall or others might want a view of Central park here in New York City. But it didn't seem like a good use of our money.

So I had color to that. So our first office, we had a music executive to record labels. He had all of his colleagues walk out, and so he had three offices to rent. And he was in the back corner. We moved in, so there was a music executive in the back corner. And you remember the carpet was so bad, Joe. So bad that when we left that office and upgraded, we cut a piece out, we had it mounted in a frame, and we put that on our wall. And when people would come in, we would say, there's the carpet from our first acquisition. Look how disgusting it is. Because we prefer to put money into the business and spend it on the carpet.

I like it.

The best thing was when people asked, is that some new avant garde artwork? When they came to our office. And we say, no, that is carpet.

That's a piece of the carpet from the first office.

Yeah, I would have went with artwork. No, these are great examples in terms of your operating approach, the focus on revenues.

Think of it as an entrepreneur. Like, you've done it. You bought this business. You're the boss. You're the boss. You give orders, people take those orders. It's incredible. Let's go out and buy myself a beautiful recliner and sit. Enormous desk. It's like, no, no, no, no, no, no, no. Go buy a plastic table from Staples. Sit down and get to work. Don't do any of that nonsense.

Yeah, no, I agree. I think it's a Good discipline to have in the beginning because then you'll inherit a lot more value in the long run. And like you mentioned, you can ease up over time, get upgraded and a little bit when you see the returns coming back. What about the time to exit? How do you determine the right time to exit?

The best time to exit is when someone comes and approaches you and says, we want to buy your business. However, I have an internal time clock. Matthew will tell you about it.

Basically, when we buy the business from the day we close, Joe puts the date five years into the future and it's like we will have sold by this day, the fifth anniversary, we go in there and from day two and day three, can we sell the business? Can we sell the business? We're not really going to sell the business, but Joe is always interested in selling and I'm never interested in selling. And so we fight it out. We do always know that the five year clock is coming and we need to exit on or by the fifth year because by that time as entrepreneurs you've done whatever you can do again is that you can grow a business from two to $10 million and maybe you can convince yourself you're the right team to go from 10 to 20. But there's probably a better team who can take it to the next level. If you haven't done it in five years, let's reset and do what we do again for another five years in a different organization.

But it's important that when the time comes to sell, the business is healthy, that it's growing, that it's profitable and the kind of machine is well oiled.

Yeah.

You mentioned earlier, Joe, that when somebody approaches you, can you contrast that between working with an investment bank? Have you looked at creating that competitive process?

We have hired investment bankers to do it, run a process and been effective and well run. In a perfect world, someone comes and approaches you. But more likely and more often for us, we have engaged the banker, we made a list of the potential acquirers, we put together a SIM and prepare the management team and it's, as you know, a disciplined process that works.

Why is one better than the other to have a buyer approach you and have more of a proprietary process as opposed to running a competitive process through an investment bank?

Hiring a competent outside bank will guarantee that you expose the opportunity to all relevant, appropriate buyers. You may not like what you get, you may not like the response you get, but you will have covered the market. If you choose to do something in a private way, somebody approaches you, you never quite know how the market would speak. Whereas if you go out wide using a bank that has contacts in the particular sector sector prices the deal for you.

So you prefer the bank process. It sounds like Matthew.

I prefer the bank process as a seller, yes. Unless I'm very sure that the list of the buyers is very small and I know them all.

Joe, on the other hand, prefers the source by the buyer process.

Well, yeah.

I mean when a buyer comes and approaches you and you know by comparison by looking at comps and other deals that have happened that you're being offered very healthy price can be quick and simple because the process with an investment banker has not been quick for us. When we hire a banker it sometimes can be a prolonged process.

Never goes as quickly as you think. Never.

Yeah, you have this marketing phase and prep before the marketing phase and it could, I could see it overall being a lengthier process. Do you feel it's easier on a proprietary deal or the buyer source? That it's just easier? We can mutually agree on our timelines and be more amicable in how we work together versus the bank process or there are other things that are different.

It's hard to say which is easier, which is quicker. I already spoke about, but which is easier. I think it varies.

I hate bank run processes. I really do because they're going to start talking about PowerPoints and as soon as somebody mentions the word PowerPoint I get hives all over my skin. I gave up PowerPoints in the 1980s. I'm not doing any PowerPoint slide, but they do this deck and it's got a hundred slides and it drives me crazy. Ideally you would sell to a knowledgeable, informed person that's already in your business because they could quickly deliver you the value because they're knowledgeable. But some businesses, the pool of potential buyers is extremely wide. Strategic buyers, investment buyers, left of center buyers. And you do have to engage a bank. But I'm allergic to large companies so I do get the highs very easily.

But luckily Joe, I don't mind a slide deck. I agree if it's 100 slides it's painful and who pays attention? But if it's 10 slides, I can get through 10 slides and there's real value there.

Yeah. Again, if anybody ever says the word merry mako to me, you probably have to put me in a straightjacket and haul me off to the asylum because I did so much of that stuff in my 20s when we were doing strategic stuff for Bain or Growth Share Matrix. I'm going to. I'm probably going to have some kind of fit.

Overall, it sounds like you're open to the direct inquiries, but as timelines get near, you're more likely to engage with an investment bank to sell a business.

That's well said.

Can we talk through lessons learned during the exits you've gone through or the key lessons?

Well, one of the biggest lessons is don't miss your numbers. When you go through that exercise with an investment bank and you put together your sim and you put together your projections, you better make sure that those projections are realistic and that you're going to hit them.

Yeah, absolutely.

If you miss those numbers, there's a direct impact to the purchase price.

Isn't that what the bankers do? Pull out lipstick on the pig? Isn't that.

Yeah. They want you to show the hockey stick.

Yeah.

And it's going to be a quick sale. So the broken hockey stick, that's somebody else's problem. But we know that the sale process can take a year. And so whatever you forecast for next year, you're going to live it and you're going to have to justify it. We tend to resist hockey stick Itis right, Joe.

Realistic. We want a realistic set of numbers that we can hit.

Be real on the numbers.

What else be realistic about your expectations is that when you start a process, by the time you sign with a bank, you should be done 365 days later. Nobody will give you that number. They will all talk about four to six months, but you may well still be working on that project 365 days later. Can't get ahead of yourself, get frustrated or annoyed. The process does take time. Sometimes you get lucky.

Anything around timing. I always curious about it. I've heard from a family member, if you get a good offer, you should put a consideration on it. That might have been your cue to sell. Actually had an uncle that had that lucrative strategic offer didn't do it. Raised, raised, raised. Ended up selling a number of years later, less than what the original preemptive offer he had from a strategic.

I think there's a famous quote along those lines from Jimmy Goldsmith, who is a very successful UK based business person who said someone asked him, how did you get so rich? And he said, I always sold too soon. And so if you sell too late, it can be very problematic.

Joe will always sell, always. And I will always want to hold. And so it's only a matter of time before Joe overwhelms me and we sell.

And one of the craziest things that we saw in our experience together is an asset, a small asset that at one time had an offer north of $20 million.

I think we saw the LOI. Yep, 20 million bucks.

And then the world changed. And we ended up buying that for $10,000. Yeah.

Wow.

If you don't sell when you can.

At the right price, close that deal, when that money's on the table and the world changes, the tide goes out. You're left naked. Wow, that was a little bit extreme. That was real and it was true. But that is a crazy example.

Anything around communications, when exiting part of this lends to how do you choose? Because a lot of times if you run a competitive process between the different buyers. But any specifics around the approach to communications and even getting into how that can lend to knowing which buyer you should work with, or is it just about the numbers?

Well, it's about confidence that you will.

Close as the buyer. We always give exceptional confidence that we will do what we say. We may not offer the price they want, but if you want to sell and you want to be certain of closure, we will close.

And you look for the same thing when you exit 100%.

No point in somebody dangling something in front of our eyes with an extra zero on it. If they don't have the financing. Many people don't. If they're not actually going to close, many people aren't. If they're shopping many other deals at the same time, they'll pick another one. Confidence to close is really important.

What are your clues to identify that?

I think that's a radiation, that's a sense, a trust, a business sense about somebody. Also their track record. We got to a point where we bought five, where people like, how can I trust you? Is there's announcement five, four, three, two and one over the last eight years. You'll be number six. It's all very straightforward. There's also personal judgment. When you look somebody in the eye and you assess whether you can trust.

Them or not, how much of it goes to alignment on how the business is going to be operated after close. And really, I guess aligning on the strategy or vision of the deal, you get into versus do you hold that close and just try to negotiate terms to get the deal done?

Well, we did buy one business for a founder, an elderly person who didn't have anyone who wanted to take over the business and his family. And he said that he had a higher offer from someone else, but he sold to us because he thought that we were going to do right by his business and he knew what we intended to do. And he thought that was more important than taking more money from someone else. Which I thought was interesting and kind of nice, reassuring.

Is that part of the approach? He build that in this narrative of being good operators and doing what's best for the company and the people? Is that a big part of it?

I think so. We have a track record of doing right by our employees and making sure that they have some ownership and that they are treated well and find working with us rewarding many people when they sell a business, that's the top priority. How they feel about the team.

Also when you come out of a deal, everybody's got to feel good about the deal because we're not going to do one deal. So if you do one deal or you only do one deal in your life, you can create a lot of destruction and bad will from amongst people. But we do many deals so we always need everybody. The buyer, the seller, the buying bank, the selling bank. Everybody needs to talk well of us and everybody needs to speak well of us because there'll always be some connection from the next entity somehow to the old entity. So you can't have a reputation that follows you that you're a poor person. Morally. People know that we're straight and they know that we are value buyers. We do close quickly. That serves us well. We sleep better at night and we get more deals.

That's an important part. Reputation matters. Earlier he gave me advice first time carving out a company as a first time founder exiting. What's your best advice? To make sure I don't screw up some things that lose a lot of.

Value for me as a first time founder exiting.

Yep.

What are these key things? I really want to negotiate and it seems like some of it might be relevant from the buy side. When you talked about these adjustments to make a closing and paying attention to those.

Joe I think that sometimes we underestimate the importance of our attorney as the third person around the deal team. He's not with us as we run the business, but the same guy that buys the business with us is there at the end and selling the business and that person can save you from disaster. When you're buying and selling a deal and you have to listen carefully to what they say because unfortunately they don't always agree with you. But as a first time buyer and a first time seller, ignoring your attorney's best advice is not a wise thing to do if you've got the right attorney.

So we go back to the same theme of lawing up. Make sure you got a really Good lawyer you're working with gotta have a fantastic lawyer.

You've got to interview a bunch of lawyers and you've got to find somebody that sees the world your way and not somebody who's 70% booked and wants to use you to get towards being 100% occupied. You want to find a lawyer who's already 100% working flat out because that's a guy who's got a lot of clients that want to buy a lot of his hours. You want to steal some hours from that guy, not fill in an attorney's schedule who hasn't got enough clients. And again, when you negotiate, a lot of the terms are principle to principle. I'm going to buy this for $10 million. No, you're going to buy it for $11 million. Your attorney doesn't negotiate that. You negotiate that, but then you leave the room and then they get into all of the holdbacks and demnifications, the escrow amounts. That attorney is going to run point on several of those deals. And so he has to be completely aligned with you and you need to pick that person very carefully. Joe and I will do all principal terms, a lot of other terms that get put into that 40 page APA.

Another piece of advice for someone, if they're entrepreneurs who want to do what we do and find these businesses and acquire them, is start small because the first one invariably will have some surprises and it may not go as you hoped and you want to make sure that you don't bet the farm on the very first deal, get wiped out.

These are good examples. Are there any things that you would consider negotiating around to preventing a buyer from screwing up the business? One element I think of is retention packages or some of the key people and maybe working with them and helping them identify and negotiate those things. Is that something that's really relevant in terms of trying to preserve the business or hand it off in a good way that doesn't get screwed up by the buyer? Or do you just not put as much consideration on that and that's solely the buyer's responsibility.

It's very difficult to have control over the situation once you've sold the business. If you have strong team and they take on your team, you can be a little bit more confident. But still there's often us versus them when a M and a transaction occurs and some things happen that are not the way you would do them or want them to unfold. So it's difficult. And I do keep tabs on the businesses we've sold and some of the people. And sometimes it went great, sometimes it didn't go quite as well. Even though I find that a little frustrating personally when it doesn't go well. It was sold, so it was out of our control.

You are walking on very thin ice. If you are trying to tell a buyer what to do in any way once you have closed that door and sold, it's like trying to put your hand through the hinge. You know, good luck. They want to be able to call on you for advice, but they don't want to be attached to you or forced to do anything at all. And even though you might want to lean forward and protect a key resource, the way you do that is that you make sure before you close that there's some agreement that gives them protection after close. But you're effectively we're going to have nothing to do after close and we're going to always. We're going to reduce significantly the amount of money we're going to have to pay after close. That is in any way contingent or either as a buyer or a seller, you want to reduce the amount of contingency. You just don't want the arguments after close, we sell, we move on. It's great to work with you. You're great. We move on then.

Just what you're obligated to for any transition period, if you have those in the terms.

Sometimes there's a three month TSA or something like that. We also don't want to if you've got things like earnouts, unless it's a very simple earn out a percentage of revenue, for example. But that might work. But if you're looking at any percentage of net profits two years down the road, get it. It's never going to work. This is going to be fuzzy math. They're not going to spend money marketing your business. They're going to merge streams of revenue together. You got to try and keep it simple.

It's really good points, Joe. Matthew, what's the craziest thing you've seen in M and A?

I think that transaction that I mentioned earlier where a business could have sold for 20 million and ended up going for 10,000, that was you actually acquired crazy as I've seen.

Yeah, it really was instructive in many ways because we got to know the sellers and to be honest, we felt sorry for them. You remember the analysis they gave about the Rolls Royce, we'll give you a hundred bucks for the Rolls Royce because the wheels have fallen off. And they took it because at the time I think we Got a call saying we have to take an offer. So give us an offer. That was a very sobering moment because there, but for the grace of God go we is that we buy these things. The tide can go out on us too. It was crazy to think of the difference in valuation between three years prior and when we acquired that asset. There is a humanity to this, especially when you're buying from people, not a corporation. The end of the day, when you're buying from a multibillion dollar corporation, if your deal closes or it doesn't close, none of the deal team care, don't care about you. All they care about is executing the transaction and getting their next bonus. A big corporation. But these were entrepreneurs and didn't work out. And we looked at each other and if we're going to be in that situation on a deal, we're going to be in a deal where we lose money. It's a sobering thought. We've been up to bat, what, six times together, Joe, and we've lost money on a deal. You can't get annoyed. You can't punch a hole in the wall. You've just got to think, what's my RBI? Is that nobody has an RBI of 0.9. Doesn't exist. You just gotta go again. You gotta go out and swing again.

Yeah. Keep the batting average up. Best you can.

Best you can.

Any other crazy stories? Did you have one to top that, Matthew?

I do not. That was. That was pretty crazy. Along the way, Joe, we've met some very crazy people.

Yes.

You'll recall that we almost bought a radio station.

Yes. We've met people who are unethical and.

We couldn't close because they're in jail.

Right.

By the time we. Yes. And then. Yes, actually we've met a couple of people. A couple of people selling businesses that, that actually went to jail a couple of months or years later. You have to kiss a lot of frogs to find a prince. We spent our time together talking about deals that we did. My goodness me. There were lots and lots and lots of deals. We didn't do all kinds of odd things. I think that we let the fish get away, that we should have let swim away.

You look at those as wins or just part of the process?

Not buying those two businesses. The owners did end up serving in federal penitentiary. Those were good decisions, not like Winds of Their Own.

I don't think we have any regrets about deals that we didn't do that we should have done, and particularly not those when the people were unethical. Or of that caliber.

Well, but he's not asking us to tell a story, a really crazy story. Those guys, those different businesses we got back on the train that day, you were like, I don't know about this, feels really weird. And yeah, it was weird.

Also, you have all your gut.

It was great.

Great. Joe Matthew I enjoy the conversation. I really appreciate taking time helping me become a better M and a scientist.

Thank you for having us.

We've enjoyed rustling through our memories together very much.

Those of you still tuned in, thank you. Till next time. Here's to the deal.

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