First Conversation to LOI Session 2

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What actually happened during M and A deals.

Welcome to M and A Science where we curate knowledge from the best in M and A to continuously improve. If you're interested in keeping up the latest from M and A Science, subscribe to our free newsletter@mascience.com Every week we share highlights from interviews, invitations to events, M and A role openings and other resources as we build the greatest community of forward thinking M and A practitioners. Again, that's mascience.com I'm Keith Son Patel, CEO and founder of Mascience. Today I'm here with Ken Bon, Head of Corp Dev at Satera Financial Group. We're going to discuss how to balance speed and accuracy during the bid process. Basically from first conversation to an Loi signed the fun exciting part of doing a deal. How's it going Ken?

Fantastic. Good to see you again.

Thanks for taking the time.

Happy to talk about this stuff.

I know you've already been on here. Can you do the brief introduction of yourself?

Happy to. I'm the lifelong corporate development professional, started in 96 in corp dev mainly on the strategy side, but I came at it from one of the big consulting houses and then ultimately ended up on an in house strategy team that transformed into an M and A shop. Spent about 13 years with Aon running their corporate development team and then transitioned to Cetera about two years ago and have been there setting up their team as well. Been a lifelong Corp Dev guy, about 250 deals.

So you've been through this from first conversation to assigned?

Loi yes.

What would you say are the key steps or milestones going from start to end there?

If you want to set up an M and A shop that is pretty decent at getting deals across the line and delivering a reasonable amount of volume for the Organization. The very first step is making sure that there is very clear strategic appetite for the types of transactions that you want to go buy. Presumably what we're talking about are bolt on transactions. You're buying things that look like you, that are much smaller. You're leveraging your economies of scale and your existing infrastructure to deliver services for the businesses that you're acquiring. If you have clear strategic appetite, then the universe of potential targets becomes significantly clearer. So the very first thing that we do is make sure that we've got a view on what the universe list looks like. And you can do that through a variety of third party data sources or databases that you can acquire or build yourself with the help of some consultants. After you have that homework done, the very first step is to get your sourcing team working. We have a sourcing team and that is staffed by very senior experienced hires in the wealth management industry. These are individuals that are probably nearing retirement or are retired and are just looking for some extra things to do. And they're very good, they've got a very deep Rolodex, they know the industry very well and they've got a good feel for whether there would be a strategic fit between a target and yourself. We have a couple individuals on staff that help us with that and they do the outreach, the initial outreach to these targets. It's very important that outreach be done by somebody who is seen as credible to the targets that you're going after. Now mentioned backup. Right. Presumably we're talking about a proactive search process as opposed to reactive. Reactive being responding to processes that are being run by bankers.

Isn't that the only way to get good deals, Ken?

Yeah, absolutely right, man, absolutely. You're preaching to the choir here. Bilateral is the best way. And the evidence would back me up on that. If you look at outcomes, bilateral deals yield better outcomes than auctions.

Bilateral, what does that mean?

Just two parties? Two parties in discussions.

What would it be called if the banker was in the middle?

They may very well have a banker. Banker's acting as an agent for the seller. But yeah, you do get in trilateral deals occasionally and those are not fun. But generally that involves like a partnership or some type of other minority investment where you've got a bunch of different parties coming together. They're a nightmare. They aren't linearly more complex, they're exponentially more complex. They're very challenging to get multi party transactions done. But for bilateral deals, the issue is just first making the outreach. Now the sourcing team that we use again is experienced. What you also find though is some people hire consultants and we've done this. I've done this three times where I've helped a business unit that was engaged with a consultant trying to build their universe list. And then the consultants would flip and then do some outbound dialing and try to gauge appetite with those particular targets on whether they would be interested in having a discussion. Those have gone very poorly. I didn't have any success with those at all. And the quality of the consultants was really high. And in one instance it was using a pretty high quality banker on the buy side. We engaged on buy side engagement to help us identify targets in a specific area that would be of interest. They did a great job of building the universe list, but they were really poor at converting those targets into something that was actionable. We've had a lot more success if it's somebody who is on on staff, that is senior, has a preexisting relationship or has a name or credibility in the market that it is easy to test. And that individual do the initial outreach.

Okay, so you gave a lot of good backdrop into the strategy appetite alignment there. That allows you to really shortlist your potential opportunities and then you're building that right into sourcing, which I think is our first step because we want to go purely from conversation to assigned loi, which is have the right person engage that initial conversation.

Absolutely correct. It's gotta be somebody who's credible. If you have your junior analyst doing the outbound dialing and all they're doing is simply dialing for dollars, it is unlikely to be successful in the context of what we've been attempting to buy. The context here is we're buying private seller owner operated businesses, meaning the individual that you're calling has probably been building this business for the past 30 years and they are also the CEO of the business and they're the largest shareholder. This will be the largest financial transaction that they ever do. They have probably hired every single person that is of any consequence in the organization and have probably spent more time with those individuals than they have their own family. So they care deeply about their employees and their clients are probably their friends, friends and family. So they care about their clients a great deal as well. So in any transaction, as you approach the mindset of the sellers for a private seller transaction is they want to get top dollar, but at the same time they care greatly about their people and their clients and they want to make sure they're not embarrassed or part of the transaction. With that backdrop, your sourcing and your initial outreach has to be aware and respectful of those priorities that the seller has. If you have somebody who believes they are simply trying to maximize purchase price and have no other concerns, you're likely to get a fairly cold reception. That being said, there are also other sellers as well, corporate sellers that do carve outs. And their priorities are very different. And how you activate those transactions is also very different. But for the most part, the larger universe is really privately owned businesses. And the approach strategy for those is, as we just discussed I wrote down.

Don'T have analysts lead the charge.

Yes, in general that's absolutely true. Although I know some industries where that actually does work to some extent. But those are very hot industries where everybody's looking to sell. If you've got an overload or a plethora of businesses that are looking for buyers, then perhaps that could actually work. But for the most part, I think most of your listeners, the answer is have a senior person do that initial outreach and see if there is appetite for a conversation. Now, that's the next thing. You're not calling to say, hi, would you like to sell your business? The initial outreach is, hi, would you like to have a conversation?

Right.

And that first conversation is let's get to know each other. I'd be very curious to understand what's your vision for how this business evolves and let them guide the conversation. And depending on where that conversation goes, there might be an appetite to explore the art of the possible between you and the target. So that's what you're attempting to get them to. Now, there will be objections to that. The primary objection to even exploring the art of the possible is that if people were to find out that you were even in discussions, that could potentially harm the business. And there is a bit of a Hippocratic oath when you go through this, which is do no harm. So you need to be credible when you have those conversations with them that you're going to keep it very tight. Any exploration between the two parties would involve a very small number of folks, a handful, a corp dev team and maybe the CEO, cfo, and that's it. So we can keep it very tight. It will not leak. We can have those conversations safely. And as a demonstration, you can typically lean on the fact that I've had 50 of those conversations already this year and you haven't heard about any of them. There's ways to give even proof points that you can do that successfully for the seller. But the goal is explore the art of the possible. That's what you want to get them to from a mindset. And if you can get them to that mindset, then you're on to the next process.

Okay, I got that. Step 2 Find the right person, explore the art of possible.

So once you get to that point, the question is, all right, how do we explore the art of the possible? Well, the very first thing you need to do is promptly put an NDA in place. Signing the NDA will almost always trigger certain things in the process. There may be steps in your corporate development process that say, ah, now people need to be certain, people need to be notified, or there's different people that engage. In our instance, our specific process, I look after the sourcing along with the other senior executive that does that for us. But once we get to a signed NDA, then members of my corporate development team, the directors, the folks that lead the deal teams, they get involved. The reason is the very first thing you need to do is you need to do some diligence so that you can start to figure out what would a transaction structure look like, what would valuation look like? And for that you're going to need a little bit of data. Not a lot of data, a little bit of data. And that's the first thing that comes across. You do not want to hit them with 100 line due diligence request. What you want to hit them with is something very limited around historical financials and enough legal information so that you can understand how to put the deal together.

So we had the third step, basically NDA come to terms and how we're going to agree to exchange and respect the do's and don'ts. Then you bring in the troops.

The troops, just a small number of folks. So in this instance I would bring in a director and probably his analyst that's helping him on the transaction, introduce them to the team, provide an initial data request and make sure that the seller understands that we want canned information. It should be historical financials for three to five years. Depends on your industry as well as simple basic legal structure. You want to understand what the perimeter of the transaction would be so that you can understand what the financial statements represent. There's probably one call with the bookkeeper to walk through their financials to make sure you understand what's in and what's out. And then you can probably build or populate your valuation. With the valuation template comes a value. Presumably there are assumptions around synergies, both revenue and expense, that you need to make in order to get to that value. Now here's where I think A lot of firms have challenges. There's risk in delivering a letter of intent and many people want to make sure they get a number as accurate as possible. I think that is often at the expense of speed and often requires significantly more diligence than is needed. The way you should approach it is the amount of diligence you want to do. Tree LOI needs to reflect cost of your full blown due diligence effort. After you sign the loi, to the extent you're going to spend a lot of money on external advisors, say half million dollars or a million dollars on advisors in your diligence effort to get to definitive docs, why then you probably ought to make sure that your LOI is pretty close to being in the ballpark. If it's a smaller transaction where the diligence costs are significantly lower, then you can take a little bit more risk. An experienced corp dev team generally has got enough thumb rules around where the synergies are going to be and how to estimate the rough size and magnitude of each of those sources and the viability of achieving them that they can get in the ballpark. Pretty decent. They come up with a pretty decent estimation. If you document in the loi, then your assumptions as well as your structure and your value, then as the assumptions change during your diligence process, you've got a basis for adjusting value. The key is you don't want to seem random or capricious. You certainly don't want to be viewed as retrading value. So if you've documented your assumptions in your letter of intent and those assumptions turn out to be false during your diligence effort, it's a difficult conversation. But you've got a basis of going back to the seller and adjusting value that's fact based and honest. You're not looking like you're retraining.

Well. Let's break that apart a little bit because I feel like that's my golden nugget of the day is that when I do have an alloy put together, I'm putting in outlining the assumptions that I have, the big drivers of the value I came up with and putting that front and center. I'm curious, how do you even word.

That it's easier than you expect. In some instances the sellers are indicating here's my revenue and here's my ebitda. Here are the number of assets. Here's a key metric. It doesn't necessarily need to be only financial metrics. It can be non financial metrics as well. For example, in your loi, you're going to have a section on structure, you're going to have a section on value, you're going to have a section on contingent consideration or earnouts. And we'll get to that in a moment. And then the fourth or fifth paragraph is probably assumptions. And then you'll get into employees and legal structure and integration and operations, a whole bunch of other things. But in, in the assumptions, you can indicate that this letter of intent is predicated upon following assumptions which have yet to be diligence, financial. And you can list off revenue and ebitda. You can also list off if number of widgets being sold per year is an important metric, then you put the number of widgets in there that you believe have been sold or were represented, that have been sold, even if it's not provided to you. But it's a critical metric and that's how you're basing your value. And you can even write that down. It needs to be the key metrics. You wouldn't go in and say, I'm assuming amortization and depreciation is X per year. You don't want to go to that level of granularity, but you do want to have the top line numbers that really drive the valuation.

Or if it's more something around the people. Can you put stuff around there?

Oh, absolutely. The assumption is the management team will come over as part of the transaction and be retained through close. Okay. And it doesn't necessarily need to be there. You probably got a paragraph on employees as well that you're where you're indicating that you have appetite or desire or require that the management team will transition through close. That certain members will have agreed to employment contracts and the retention plan will be put in place to ensure that the management team is retained post close.

Go back. So we had step four. You're bringing in retail. We didn't use the word troops. What would be like the Navy equivalency.

To the troops is fantastic. Right. It just means there's a lot of people in reality getting to an loi. The probability of a successful outcome when you're courting targets in this stage is still low. It's always low because it's not diligence yet. The burden you want to put on the organization needs to be commensurate with the probability of a successful outcome. So because you're just doing Lois and you're churning through Lois, I don't want to be grinding 50 people in the organization to help me come up with what is going to look like a round One bid. Now if it's a billion dollar acquisition, that's a different topic. But still round one bid for something like that, the number of people involved is going to look very different than a round two offering. When you're doing a full blown diligence effort for small deals, say anywhere from 20 to 100, $150 million, you want to keep in the corp dev team if you can, leveraging kind of preexisting or historical precedent or some of the other transactions that you've got done so that you can try to build those models without really burdening the rest of the organization on helping you construct a financial model.

So who's involved?

Who's involved? Right. At that point, it's my deal team that's a director, probably an analyst myself. So you've always got two sets of eyes on a model and our legal attorney. And you're probably not even using outside counsel yet.

So in that case, nobody else, HR or anybody, I don't need them at this stage.

Not for a smaller loi, not at all. You've got pattern recognition on how certain deals are going to get structured and what the likely outcome is of synergies, cost synergies or specific revenue synergies. You're ballparking it at this stage. So you just, it's good enough to get the LOI out the door. You're not going to be that far off if this is your very first LOI that you've ever issued. Yeah, you want to involve the functional leaders. But in a round one for your initial oi, you're going to keep it pretty small.

And if you supersize this deal and it was something much bigger, 500 million plus, then who would you have involved then?

I'm going to want to review my assumptions with the key functional leaders just to make sure we're in the right ballpark. But it's really more of a review. Right. You're doing a 30 minute or an hour meeting with them to walk them through the model and then you're done.

Okay. Bringing the people you need. You're putting the data request together for the target company. When you get that data request, you're developing your model, which is step five. I don't know. I had a note about advisors.

Advisors in the pre LOI stage. Yeah, you don't want to do that. The likelihood is it's going to fail. They cost money. And until you got a deal, I wouldn't want to do that.

Okay, Financial model. This is what gets us to putting an LOI together?

Yes, sir.

And we talked about outlining those assumptions. What are some approaches on the loi?

Yeah, you're going to negotiate the loi. There's going to be back and forth and there may be likely the area of you're going to be trading risk for value. This is almost true in every negotiation. They're going to push risk to you and they're going to want value in exchange. So you're trying to find if there's middle ground that allows both parties to be equally happy or unhappy. In professional services organizations frequently, since the people are the important, the most important asset of the firm, oftentimes the way to bridge those valuation gaps is with using contingent consideration or earnouts. Where you are basically saying I hear that you want a multiple of X, I'm only willing to pay Y. For me to believe the business is worth the multiple of X, it would need to grow at a specific rate. I will pay a portion of the value at close and the rest of it I'm going to put in an earn out and contingent upon your ability to demonstrate that the business actually is capable of growing at the levels that you indicated can. If you achieve those growth rates, why then I will pay you some additional consideration in years 1, 2, 3, 4, however long you want to put it out there. That's an easy way to bridge valuation gaps between buyer and seller. That comes with a bit of a warning that earnouts can go bad quickly if they're not properly documented, structured and thought through. You need counsel to help you if you haven't done them before. Counsel is critical or good counsel is critical that understands how to structure earn outs and how not to structure them and that they can have unintended consequences on integrated entities as well as, for example, if you're integrating a new team into an existing team and if they've got both got sales functions, you could cause some disharmony between the two organizations. If part of the organization is subject to an earnout and part of it isn't, there's lots of different considerations that need to be thought through when you're doing those types of structures. Even what are the trigger events that cause the earn out to be paid? Whether it's a financial metric like a revenue growth rate or an operational metric like number of clients or number of widgets sold, there's lots of different ways to approach them.

Are you pro, negative or necessary evil on earnouts?

I'm a pro. I like using earnouts. I think they motivate the right behavior. We've got Enough scars. I think we know what mistakes not to repeat and we've got enough experience with them to use them safely. But they can lead to some true horror stories. And I think every conference we go to, we hear somebody who's structured about earn out and he's sharing, or he or she is sharing, sharing the story on how it blew up in their face. So absolutely there's risk there for sure. So ensuring that you get good, competent counsel to help you structure them appropriately is critical.

How does, like economic crisis, such as our global pandemic impact those kind of things? That's what I've been curious about.

It's a market variable like any other market variable. Depending on how you've agreed to share risk with a seller, you've either agreed to bear that, share it or push it all to them. That's one of the many risk factors that will have to be taken into consideration. People risks, client risk, market risk, Covid. All of that kind of boils down into the framework that you've adopted in the transaction.

Hopefully that was part of it. It was spelled out pretty clear with those kind of circumstances, it's in there.

One way or the other. Whether you intend to negotiate it that way or not. There is a framework in there on what you're absorbing in the transaction.

Okay. The earnouts are part of it. I want to know, how do you deliver this loi? Do you know what I'm talking about? Are you emailing it with a note? Are you calling it, talking through it? What's your delivery approach?

Making them look formal is important. In general, it just has good optic value. Right. It looks official. It'll be given better consideration than if you slap it together. I think there's a lot of it that can be reused. Right. There's always, almost always a lead in section on the background of who you, you are and why you're a wonderful firm and a good acquirer. Even if they're somebody who's friendly and known you for 30 years, it's still important to reiterate that and make sure that you're delivering your best show once it's executed. And delivery, we've actually already had a conversation, a verbal conversation with the seller around value. So we step them through a couple different conversations before the LOI actually gets delivered to them. The first conversation is after we get the, after we get the number, the financial metrics, the numbers, and we build the pnl. We then walk through that PNL that's been reshaped or recategorized into the Way we view Piano, both what was reported and any pro forma adjustments that we may be making, just that we can get agreement with the seller around. What are the numbers that we're bidding off of and getting them to just put a stake in the ground that says, yes, my EBITDA is $1,000,000. That's very valuable because then the next conversation with them after you lock that down is, all right, then you go away for a couple of days, and then you come back to them with a conversation that says, okay, here's our view now on value. We value the firm at eight times EBITDA. So $8 million is what we're looking at, the value of the business. And here's the transaction structure, here's how that consideration would be delivered, and here's what it would mean for you. We need you to stick around for the earnout period. You convert as an employee X, Y, and Z. You're having that verbal discussion with them through that and delivery. Potentially you're talking through an email that you sent just prior to that conversation, or you're walking through a document that you are sharing in a zoom call. After that, you're gauging their response. If they've thrown up all over that, then no need for the loi. If they react neutral to positive, why, then you actually send the loi.

Okay, I got two things. One is it sounds like you put a good amount of presentation around your actual LOI language when you talk about the firm. And some of those things, I don't really do that. I just put, here's a letter. I want to learn this. What are those key things? Because now I'm starting to think of things that we do for our pitch deck, where you tell a little bit of that story and things like that. What exactly do you put in that resonation part?

It's the same content. It's a pitch deck.

How big is it? Are you doing five slides? 10?

No. For a letter of intent, it's probably anywhere from five to eight pages. For big transactions, really big transactions, maybe 15 pages long.

And so it's in there, it's written out, is all text. Then basically, hey, here's.

It's all text. You're going through the different pieces now a couple pages of the short form. If it's a simple transaction, the first couple pages that lead in are background of the firm and who we are, history, relevant history that they're going to care about. The intent there is. We want them to understand the key elements of your value prop your Walk away. If it's a we're a mature acquirer, you want them to walk away with after reading that going, hey, these guys have bought a bunch of stuff, they've successfully integrated it and they've delivered value to sellers. Great, okay. And then let's step now into the proposal, the non binding proposal and how it'll be structured. Here's how we value your firm. Here's what shareholder proceeds would look like based on the balance sheet that we got. Here's what the assumptions were that went into our evaluation. Here's what we're going to do with the employees. Here's how we integrate the firm. Here's what operations would look like post close. And then in the end you get into the non binding nature, the confidentiality paragraph. And then finally an exclusivity paragraph. You almost always want that. So you know it adds up. You get the five pages or eight pages pretty quickly.

Is there a way I can get some examples somehow? Be nice, you can link them to this podcast.

I don't know, I think you could probably get some samples pretty easily for sure.

Not online. You get the garbage online. I want to make M and A Science stands for excellence. I want to try to get some quality ones.

I'll see what I can do for you.

A public company deal, they wouldn't have that really published, would they?

Oh, no. Public company deals happen very differently than what we're talking about here. You'd argue that there's three different processes. There's the bilateral where we're talking with other private companies about potentially acquiring them. That's the process we've been talking about here. The other would be a corporate carve out. That'll be a slightly different process than what we're talking, talking about mainly on the sourcing side. Those get sourced very differently. The other major way you're going to get deal volume is with bankers on inbound where you're going through an auction process. That process will be much more scripted. Right. They're going to give you a process letter. The process letter will spell, spell out what they want to see in your bid letter. And it will cover down to the number of paragraphs. Right. It'll indicate exactly what it wants to see in your bid, what the bankers would like to see in your bid letter. So it behooves you to deliver a compliant, a compliant bid response. So you want to make sure you're delivered, touching on each and every item that they're, that they've questioned about on.

The carve outsourcing what makes that different? Are you rubbing elbows with other corporate leaders to find Those opportunities or CEOs?

Absolutely, you are. You source them just like you source the other ones. In this case though, your sourcing leader is probably leaning on you, trying to set up conversations with you and other corp dev leaders within those organizations to ask them if they've gone through a strategic review, if there's appetite to even look at what the art of the possible might be with division that their competitors has recently sold. What you may be seeing is that certain segments or certain business unit within an industry is frequently, frequently being sold at the moment. That many, many industry participants feel that continued ownership of a segment, a specific segment, is no longer attractive and it's more valuable in the hands of somebody else. And they're going through a lot of disposals. Now, not everybody in the industry may have come upon that revelation or believe that is the correct outcome. We're going to call those folks and make sure that they're seeing the same rationale that other folks have seen and the way to approach them more often than is acknowledge that they are probably going through a strategic review process, either expressly or implicitly through the budgeting process every year, and that it would be certainly helpful and best if they had real numbers when they're making decisions about whether they should be retaining a business unit or exploring strategic options, not that they would sell it to you. And that's the trick. You're not engaging with them at that time to actually have them come to a realization that I want to sell the business to you. What you're engaging with them on is you need to make a decision about value. How about if we give you a real view on value that you can then use in yourself or hold decision making as opposed to hypothetical numbers. And if you like that, then you can either engage bankers to run a process or you can call us back. You're trying to get in early so that you can try to influence that outcome. In some instances, albeit rarely, a corporate entity, and by corporate I mean a publicly traded entity, may decide to sell that division to you without going through an auction. That's rare. They almost always have a fiduciary duty that they need to get a fair value and that almost always requires them to go through some type of auction process.

I wrote a note here. I'll reach out to some of the corp dev folks in our industry. I was thinking of Charles at data site and just sent him a note. Got anything for sale? Question mark?

I get that all the time.

Should I be that forward and direct about it or is it better to be informal?

I would just say, hey, you got time for a cup of coffee? I would get them on the phone rather than send them a note like that. It's easier to get them on the phone to just have a conversation, then to be responsive to any question that comes at them. Yeah, you can send them a note, it can be that.

Then I can just add, you got anything for sale?

I literally get comments every week from private equity sponsors. With being that blunt, I we do a lot of corporate buyout, corporate carve outs. Got anything for sale at the moment?

What are other things that get negotiated on loi make sure I negotiate a good deal. Even putting the price. Do I put in like padding for 5% of the purchase price to know where my room is or but you.

Know you're going to move, so you're certainly not opening with your final value number. So you always got to leave yourself some level of wheel rooms that you can negotiate. But what you don't want to be is overly conservative in your initial offer, thinking that I don't want to have to be in a position where I have to pull my offer back. If you're overly conservative, you can easily either turn off the bidder and they won't even engage with you, especially if they feel like they've been offended by your valuation. Or if it's a competitive auction, you might not even make it into round two. You need to be careful on the sandbagging for sure so that you're delivering a good value but still got enough room to maneuver any other term that's really material, like is it an asset deal, Is it an equity deal? Am I taking the people? Are there any unusual deal structures that you want to negotiate? Is there a key employee that you need or is there a key management team that you need? Anything that is front and center and critical is a deal that would torpedo the deal in your eyes. You probably ought to put it in there.

I was trained to never put the price first. This is my number one rule in negotiations. You may come across an unsophisticated seller, maybe the better way to say it. If there is an opportunity to really get a good deal, how do you get that little bit of intel to know you can do that?

You're going to figure that out in your discussions with them about what's motivating the transaction. Why are they having the discussion with you? Let's have that talk first. And if there almost always are priorities outside of just transaction value. Rarely are they going to simply say I want to maximize purchase price. And even if they say that there are other things as well. Do you want to continue to engage in the business? Do you want to retire? Are you looking to spend more time with your grandchildren? Are you looking to go start a different business or enter into a different chapter of your life? Are you going to open a coffee shop and that's what you want to go do for the rest of your life or go back to school whatever it might be, or sit on a boat? All of that matters and influences kind of the terms that that you can offer and to the extent you can be highly responsive to those other needs, then yeah, that's complementary to your purchase price. You don't necessarily have to be the person with the highest purchase price to win the deal. Especially if you can fully address the other considerations that are highly important to the seller.

I like that. Is really digging into the why.

Yeah.

That allows you to put the pieces together so that you know where you should really bid without risking pissing them off and having them not talk to you.

Absolutely. And that's why we step through that initial conversation and we step through. Let's talk about your financials first. Let's all come to agreement around what is truly your EBITDA of your business. Because almost always there's a number in there that or perform adjustments that you've missed or some one time expenses in there that probably ought to come out. Especially if they're owner operator businesses that are frequently there's personal expenses that are flowing through their P and L that wouldn't continue post close. So you want to make sure you're getting the right perform adjustments in there for that. And then once you have agreement around the numbers then it's kind of hard to argue that you're going to be offensive. The risk that your deal is offensive goes down dramatically because market multiples are what market multiples are. We can argue am I a turn off here or there. But it's not like I'm three turns off. What market is.

I like that how you build the confidence with some real evidence around your value. That's a good way to do business. I wanted to ask you about speed and accuracy and this one gets me Ken, because we put this purchase price on the front end. I feel like the whole effort of diligence uncovers so much. But then we look at what we do to get to that loi purchase price and we got two big elements right. Synergy and your capital expenditures. How do you get these assumptions really dialed in in a way that you're getting a bit on the table quickly but accurate without missing some big capital expenditure or synergy, the synergies.

So what I would argue is you've got some historical financials, you're making assumptions around what CapEx is going forward. You're making assumptions around what their balance sheet looks like and what their revenue and EBITDA effectively is. And from that you then build your P and L by stating those assumptions to the extent confirmatory diligence reveals undisclosed liabilities that weren't reflected on their balance sheet, that reveals inaccuracies or perform adjustments that need to be made one time expenses or reveals potentially that alleged one time expenses aren't one time and they're in fact recurring, then you've got a basis to go back and adjust value. Coming out with a bid that is quick is important. You can get a lot of the accuracy needed at that point. That's sufficient. The goal isn't getting absolutely the right number. The goal is providing a number that has a solid basis from which you can make adjustments so that you not look like you're retrading. Because if it takes you forever to do pre confirmatory diligence to get to an loi, you're sending a signal to the seller that you are difficult to negotiate with, that it's going to take forever to get contract, that you're going to take forever for confirmatory diligence. If this took three months to negotiate an loi, good God, how long before I get to definitive docs and what is that going to look like? You're going to nitpick everything on me. So I think it's helpful that you get the at bats. You get as many at bats as possible and you get it quick. And the faster you are, generally the less internal resources you're consuming to get there so that you can do more. Lois, with the same amount of resources and it costs the organization less.

That's some pretty damn sound advice right there, my friend.

I don't know about that.

Yeah, take it to heart. I think that's absolutely right. That's really the right way to get that bid there. That's going to be demonstrating of how it is to work with you because you, you're right, you can't be a pain in the ass from that beginning or make it too cumbersome. I would assume there's some good learnings over time that you know how to make those calls a lot better and.

We'Ve had multiple discussions with sellers. That said, ultimately when we got into final diligence, listen, it looks like probably the most, most frequent example is you're in confirmatory diligence. You based your bid on say Q1 earnings and now you're past Q1 because by definition if they deliver Q1 numbers to you, you're deep into Q2 probably or at least the second month into Q2 and maybe now in confirmatory diligence. Q2 has been posted and now you're actually in Q3 and Q2 results were different than expected. Okay, guess what? You may adjust your purchase price and you probably should adjust your purchase price if the numbers have come down and you've got a solid basis for doing that because EBITDA has moved. I already have a valuation multiple. I've already established that you perform your ebitda came down 10%. Our purchase prices coming down 10%. Those are easier discussions to have than hey, I forgot about this. Well, I already told you that. The fact that now you fully assess what I've told you and it's going to impact value like you said. Well, actually we missed our synergy. We thought we could get X out of it. Looks like we can't and now we need to lower value. I mean you can do that, but that's going to come across very poorly to a seller.

Very good point. And what's the craziest thing you've seen in M and A?

Oh, I've seen a lot of silly things to be honest. At the LOI stage, the craziest thing that we saw was actually fraud being advertised in a sim. The way the business was operating was actually fraudulent. And once we looked at it, it was actually disclosed in the SIM on how they were operating. So it was a little weird. Once you read that you're like, wait a minute, they can't actually be putting that in their marketing documents. And then you go talk to the attorneys and yep, that is actually not legal. They can't do what they're doing. They start to backtrack. That was pretty surprising. But we've seen a lot of assets when you do with private sellers, you've seen everything, everything's on the balance sheet. Cars to art to homes. I've seen entire families being employed that have never set foot in the business. I've seen locations that are either owned by a family member and they're paying no rent or they're paying five times market rent. You see all types of crazy perform adjustments when you get into smaller mid market companies that are family owned.

Wow, that's funny. You ever see anything interesting on a larger, not private company?

Listen, that's the nice thing about corporate sellers is general. They're really paranoid and the businesses are fairly well buttoned up in terms of how they operate. So there's generally knock on wood here, generally a bunch of tail liability that you're stepping into when you do those transactions.

That's what I was looking for. I thought if you uncover something there you come with something big. You're like, hey, here's a big embezzlement scheme here.

Fraud is probably the biggest thing that comes back to bite you in the backside for transactions. You can't really diligence fraud. It happens. And the structure of the transaction is not. Doesn't contemplate that one party's been fraudulent. So when it does happen, it's got a massive impact.

What would be the typical fraud?

Faking the data that's in the data.

Room, all the numbers and everything.

Yeah, that's gonna happen. Absolutely can happen. And not frequent, mind you. Thank God it's only happened a handful of times in a whole bunch of transactions. But when it does happen, it's. It's pretty shocking and has a massive impact.

That's interesting. We'll save those for our series, the M and A Fraud series.

There you go.

Ken, thanks so much for the time. I enjoyed this conversation. I always learned a lot from you. You're helping me become a better M and A scientist.

Fantastic. I'm glad you enjoyed the conversation. I did as well. I love the dialogue, I love the topic and happy to be helpful on any other topics as well.

Those of you still with us, amazing. I'm proud of you. Until next time, here's to the deal.

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