Performing Strategic Due Diligence in M&A

If you're listening to this podcast, chances are you're interested in learning, best practices and the latest trends in M and A. If you're thinking yes, I'd personally like to invite you to join me and leading M and A practitioners from companies like Polygon, Fastlap, Slalom Valuation Research Corporation, Liberty Company, Insurance Brokers, EIS holdings and more on April 10th for the M&A Science 2024 Spring Summit. In five action packed sessions, we'll dive into the latest trends, expert tips and practical takeaways that you can take back to your team to optimize your M and A process. Visit the events page@mascience.com to register. Again, that's mascience.com see you there. Foreign I'm Kisam Patel and you're listening to M and A Science where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals. Hello M and A Scientists. Welcome to the M and A Science Podcast where we learn from the best in M and A to uncover proven techniques for enterprise value creation. If you're interested in learning more about how to optimize your M and A practice, or want to get involved with our community of forward thinking M and a practitioners, visit mascience.com if you want to keep up with us on the go, head over to LinkedIn and follow M and A Science. I'm your host, Kisan Patel, CEO and Founder of M and A Science. Joining me today is Andre Galuk, Vice President, Corporate Development and Investor Relations at Dover Corporation. Dover Corporation is a diversified global manufacturer that delivers innovative equipment and components, consumable supplies, aftermarket parts, software and digital solutions and and support services traded on NYSE under dov. Today we're going to talk about performing strategic diligence in M and A. Andre, how are you doing today?

Doing very well, thank you. How are you?

We're here live at Dover Corporation. This is headquarters for Dover.

Yes, thanks for coming.

Based right outside of Chicago in Downers Grove. Yes, that's the thing I like to do. Most of you have the studio and then you got to go there. But I'll come to you and I get fun. I get to check out all these global headquarters.

Yeah, Dover was actually based in New York City till 2010, then they moved to the industrial heartland America.

Was that why just to be closer to the industrial scene?

Part of the reason, I mean it was before my time, but I think that was part of the reason. Being an industrial manufacturer headquartered in New York fell out of fashion at some point.

Can we kick things off a little bit about your background?

So first of all my accent. Everybody will notice I'm originally from Ukraine. That's where I grew up. I did a couple years of investment banking there before coming here to do my MBA in Chicago. I met my wife while at school and one thing led to another and now I'm in the suburbs of Chicago. Post MBA I've done for seven years with bcg. I was a management consultant and my specialty was corporate development. Functionally and industry wise it was industrial goods which made later Dover very natural landing spot for me when I decided to transition out of consulting to industry. I joined Dover in 2017 almost seven years ago as a head of M and A. Over time I picked up a few other roles and functions. So I oversee our strategic planning process and corporate strategy and also investor relations. We have publicly traded company now. I will caveat that I'm here in private capacity but representing Dover.

Absolutely. All the opinions are here. Just Andre is no reflection of any companies you might be associated with. 2017, seven years, long time and Dover's pretty acquisitive. How many deals have you seen in that time?

Dozens. I don't remember the exact count. In our investor materials there is always a slide. I jokingly call it my resume slide because it shows all the deals we've done cumulatively over the past five, six years. Just a little bit of history. Dover was built through M and A. So in the 50s a group of investors pulled some money. They bought several good manufacturing businesses and some of them are still in the portfolio. And then they took the company public and then they used cash that those businesses generated to buy more good businesses over time. Over this 65 year history, hundreds of acquisitions, divestitures too. So it's an active portfolio management business. It continues to be central to the strategy, to the story. It's part of the value proposition to investors. Investment company to a large extent. Interesting that you mention it. Capital allocation. It's a very important skill. CEO portfolio manager, somewhat overlooked arguably. Just to quantify it a little bit. If you think about. I'll use public company as an example. But if you look at average cash flow yield, which is just free cash flow that the company produces per year divided by market capitalization is 4 to 6%. Last I looked was S&P 500. It's changing obviously with the valuation levels. But so think you are a CEO entrusted with a business. Your tenure is, let's say 10 years. You are making decisions about reinvesting that 4 to 6% of free cash flow times 10, over half of the market capitalization of the business. Now free cash flow after capex at back Capex, you are probably somewhere 7, 8, 9, up to 10% cash yield. So in 10 years you are basically redeploying the whole value of the business in some form of fashion, either organically giving it back to shareholders or investing in M and A. So M and A is obviously one of the options you have as a capital allocator. And just I think that that magnitude just makes this capital allocation a very important skill. And that's why being strategic about it and thoughtful is so important for success.

I agree, I should teach this at high school. Start thinking about it then, because you don't otherwise it's largely in the public field that you really start thinking about capital allocation as a real discipline. What's the philosophy at Dover? Is there certain general things that you've seen in terms of the philosophy around capital allocation, of when do you approach inorganic versus focus on organic doing dividends, stock repurchases?

We articulate our capital allocation strategy and priorities pretty clearly to our investors. The first is always organic investment. So capital expenditures, R and D, those tend to be highest confidence, highest certainty investments, you investing right back into your business. With economics, all the underlying trends pretty well. The execution risk is typically just executing that project doesn't have what M and A brings in terms of culture, the integration risks. Organic reinvestment is number one. Now the reality is that, that even though we're industrial manufacturer, it's a relatively asset light or capital light business model. It's assembly, manufacturing, it's not heavy, they call them smokestack production type. The reality is you just, you can spend only that much in logical good organic investment projects. And that's why M and A is our second priority. So after we've funded all logical good organic opportunities, there is always cash flow left be deployed. And then your choice is to either redeploy it in M and A or give it back to shareholders. You can't accumulate it indefinitely. And our second priority, M& A is a productive redeployment of capital. Now obviously we look to do it responsibly and in a disciplined way, investing in a logical way, things that fit our portfolio. And that's where strategic diligence and strategic thinking comes to play. If you couldn't spend it organically, didn't find the right M and A in a given year or period of time, then give it back to shareholders through Dividends and share repurchases with organic.

I was always curious how do you sort of balance between the two but it sounds like you generally have the surplus. Do the business leaders then present a plan and this is the capital requirements that they have and that they're looking to execute for the coming year and then you're investing into that. Then once that's all allocated, you're looking at what's left. Invest in inorganic.

It's not that sort of mechanical. But yes, every business leader has a view on what organic investments are required. There's always just maintenance capital, keep the lights on, keep the assets healthy and functioning. And then there is growth and productivity investments organically. But also every business leader is tasked with having an M and a strategy. It's an important long term driver of keeping the business competitive, having a good offering, growing over time. All the elements of long term value creation. I like to use this term like capital allocation is not a democracy. Not every business gets capital dollars just because it exists portfolio. And I think that's a pitfall that people fall into. It's we have to do deals in a given business, in a given market just because we are in that market and that's all we have. You almost need to put your shareholders lands on and think about would your shareholders, given the alternatives they have where they can play with their money, would they want to keep funding this business? One of the foundational elements of strategic diligence, this conviction in deploying capital is actually being able to articulate why a given business deserves investment. And by the way, no hard feelings, you can be a successful value creating business without M and A. You can be growing organically or improving your returns and margins over time. You will be plenty busy without layering M and A risks and effort on top of that. The concept of capital allocation not being a democracy is very important. And that in my career and even before Dover and consulting, I've seen people.

Not quite follow this is not a democracy. How would you frame it?

Meritocracy. I use this word, word deserve. It has a negative connotation that someone is undeserving.

But again, so you don't want to say arbitrary. I don't think that's like the right. It's still driven by strategy at the.

End of the day by opportunity. Deploying capital is a entrepreneurial risk taking endeavor. Fundamentally you're placing bets. Bets again has this gambling connotation. But you are never certain about the future. And yet you need to do something, make the move you want to see that opportunity and have conviction about it and do it because of that. Not because you need to signal to a given business that you're giving them capital. Or just following some math of everybody gets 2% of revenue.

All rolls back to discipline on capital allocation.

One of the key skills.

CEO, let's talk about strategic diligence. What does it mean?

There's no bright line between strategic diligence and other diligence. I divided between strategic diligence and confirmatory diligence. Okay, by confirmatory, these are the type of activities you do once you have conviction that this is the right move to make. And then I send an army of accountants, lawyers, tax experts, go check all the boxes that understand that we're not stepping into some risks, liabilities, understand exactly what we are buying, be ready for integration. But there is a layer of work and thinking that happens before you go on that final sprint that is fundamentally about articulating your thesis about that opportunity to place a bet, capital bet, and make good risk adjusted returns for whoever that capital comes from. We typically, all of us in M and A rarely invest our own money. There are entrepreneurs for sure, but if you think about private equity, family office, corporate CEO, corporate corporate development, we're all investing somebody else's money. And it's the process of building conviction about the opportunity to invest it productively and responsibly before diving into this sort of check the box type final diligence deal people, they get a tombstone, which is doing a deal, which I never celebrate a deal really. I like to wait a couple of years to see how the thesis played out. I'll get a tombstone from a bank and value creation from each deal has two components. It's making a good decision, placing a good strategic bet. And that's really what strategic diligence is about. And second is deal execution. That's doing the deal the right way. Making sure you actually know what exactly you're buying. You're not stepping into some sort of risks. I haven't seen the data what determines value creation and returns at the end of the day, I personally would speculate that probably two thirds is driven by the placing the right bets, making the right strategic decisions. And the third is that confirmatory deal execution. If you are placing the wrong bet, the terms of a purchase contract are not going to really save you. Now don't get me wrong, you can execute badly and it can sink the deal. But that execution alone won't make the deal rate. So it's more of a table stakes. You have to do it Right. There are examples where more of an execution deal structuring is a source of returns. Maybe you have a structural multiple arbitrage opportunities and that's many roll offs. Go buy smaller businesses cheaper and then trade them as a bigger enterprise for a higher multiple. That's value creation. And I would say it's more sort of execution driven. There is a good example, Warren Buffett, a lot of his greatest deals from the past where these interesting structures with preferred coupon. It's not just a straight equity investment and it's more opportunistic.

That makes sense in terms of placing the right bet. You want to buy the right company. And I think I'm getting a sense of the strategic diligence part, like the prelim, but really associating with doing diligence against the strategy to make sure you're buying the right company going to align with the goals for the company. The execution part I'm curious about the integration because this is a big thing that always comes up is how well you execute the integration. When you think of the other component placing the right bet, then there's obviously executing the close. But then how about the part about executing actual integration to see that two years out what their final results are.

That's a good point. I should probably caveat if you go back to my of two legged stool of strategic diligence and deal execution that it should be a third leg of integration and executing on your thesis. I have to go back and revise my weighting. So I said it was 2/3 and a third. It's probably half and then a quarter and a quarter.

So half by the right company quarter. Nailed it. Confirmatory diligence. Make sure you identify those risks and so forth. And then the other quarter is your ability to maximize value and integrate it capture on the investment thesis.

Now reasonable people may disagree with that and I know you read literature and articles. A lot of people talk about integration as being that holy grail of value creation. And yes, it's a must again. You can have a great thesis and do a deal and then if you don't execute rigorously on that thesis, what good is that thesis? So it's another sort of table stakes. But in my mind it all rests on that bad rock of making the sound decision in the first place that even positions you to execute against something.

I agree. The other variable comes in is how much are you integrating? What actually goes into that. Because you could have a huge variable of doing something very transformative to. We're just going to wrap some Back end things together and let the business operate autonomously. Okay, so when we focus on that, the practical how to's of doing strategic diligence. Walk me through somebody. Let's say I'm doing my first deal and you want to teach me your thinking so I can not screw it up.

So let's talk about the five W's of strategic diligence. What it is, why you do it, who does it, when and how. You sort of alluded to the when component of this, but let's start with what what it is and articulating your thesis. How it links to your strategy, what are you betting on and why your business deserves that investment. Going back to our meritocracy and not a democracy, that all starts there. This is why I want to invest in a given space and I think it will be productive value creating reasonably safe investment for the owners of the capital that I'm investing. Then identifying that thesis again, going back to the concept of this is a risk taking entrepreneurial endeavor. Future is uncertain. There will always be uncertainties in your thesis. There will be many of them. Identifying the ones that are least certain and most impactful and really pressure testing them. Well, that's in a nutshell what diligence is about. A lot of it is what people would call market diligence or commercial diligence or combination thereof. But it's not just that. So second w why you do it, that's a foundation of making the right good business decision. But second it allows you as a corporate development and M and A professional to look good. As an M and a professional, you will probably find yourself pitching that acquisition investment committee to your executive team, board of directors, whatever is the decision making process you are facing. So, so having a crisp articulated, supported strategic thesis why it's a good investment will make you look good in addition to making sure you actually recommending good decisions. Okay, so who does strategic diligence? I would say the key participants would be the business and the business. At least in the corporate context. Typically you are adding to an existing business. Sometimes you are buying a new platform or a private equity context. Okay, so there wouldn't be necessarily a business leader pitching the acquisition, but someone on the investment team will need to wear that hat. It will not be necessarily like a deal hat, but more of a formulating thesis. Whether we are doing a roll up in a given market or we see an opportunity for adoption of technology. Okay, so there is someone wearing that business hat. Then corporate development M and A professionals supporting them. And then lastly you Would often involve some external resources or other functional resources as needed. Okay, when you do, it starts way before the deal. If you're starting to do strategic diligence when a specific sim pops up in your inbox, possible to still do it, but it's probably too late. It's all grounded in your portfolio strategy and the business strategy. And that's why the engagement with the business. If you're in a corporate role and you are adding to existing businesses, you would want to engage with them pretty closely to understand what they're building. What is the game in their marketplace, what is the competitive landscape, where it's moving, what are the investable opportunities and changes happening in the world? I view that having corporate development and M and A professionals also involved in corporate and business strategy is very synergistic. Makes you a more astute and insightful and M and A professional. If you understand that underlying business strategy, then also way before the deal. I would argue the best practice is what I call this ponds and fish approach about thinking about investment opportunities. And we can elaborate in a moment about what that is. And once you identify good ponds to invest in good markets, good businesses, then you validate the specific target that either you cultivated or just keep came onto your radar from the external world. So we talked about what, why, who and when. I think the last one would be how to perform strategic diligence. Well, first of all, it's a multidisciplinary, multifunctional endeavor. And I can't stress this enough, M and A is one of the most fun and sought after roles, at least in the corporate world, because you need to be dangerous enough in so many areas of the business. Obviously, tax, accounting, some basic legal concepts are table stakes in M and A. You just need to understand that language. But if you are also credible and dangerous enough in operations, be able to talk to operations leaders and validate some of the elements of your thesis. If you understand how the commercial side of the business works, the go to market, organization, different models, you can validate that side of your strategic thesis well too. So the talent you involve in strategic diligence has to have that ability to operate horizontally. Another animalistic analogy. You want to operate as a hawk. And what I mean by that is you want to be able to soar 30,000ft. I don't think hawks flies that high, but basically zoom out, understand the landscape in the market, what are the opportunities, what is the grand thesis you're investing behind? But you can't just be there. You can be at a high Level and be credible and rigorous and insightful. You have to be then able to just pivot down to the level of detail. Remember I talked about identifying those important and uncertain elements of your thesis. Being able to really zero in on those and be rigorous about that can give you a couple examples. Someone tells you about customer stickiness, oh, it's a business with customer stickiness. Just trust us. But do you truly understand why the customer, why those customer relationships or your products are so sticky? The switching cost that just it's very expensive for your customers. But do you truly understand where is the threshold that I mean at some point customers will switch. Do you understand how far you can push it? Often it's not switching costs, it's some career risk. Nobody wants something to fail. Do you understand how your product, who buys it? How does your product fit into their view of what else they do in their organization? How are you helping them be successful? There's a lot of detail and you just need to go and talk to those people and with the expert networks and some of the tools we have, you can and should be doing that being rigorous. There will be a consulting report. It's just that the market is growing 5% and it has grown 5% and will be growing 5%. Do you truly understand why and some reports would be more insightful than others. But do you truly understand what is the change happening in the world that this product is needed? So service at the rate above the rate, at the growth rate above the general economy and gdp. Who is adopting this technology? What is changing and why? What is the total available opportunity to you? Market. There are these flow and stock concept in accounting especially market is a flow. It's just amount of goods that trades every year. Do you understand the stock? How many of these products or potential customers are out there and can you articulate that?

Well, we're going to go through the W's and the how the what is basically where you really articulate your investment thesis. And this is where you want to pressure test some of the areas that you want to make sure is valid. And that's first place thing you want to start with. The why is building that narrative. This is where you're going to present this to the executive team, the board and make sure you got that story that helps everybody really understand the who who's really driving this. The business Corp Dev strategy team. And then when this is really interesting because this starts a lot earlier than when you even find this opportunity that you really understand this market. Even probably building the relationships with People early on and starting to shape what this opportunities are going to look like. And then the how definitely multifunctional by nature because you're working with all the different functions in the company. But then you talk through this ability to really zoom in, zoom out, looking at the whole picture, being able to click into these specific details that could be critical in the business success.

Yeah, exactly.

I want to talk more about the pond and fish. I like that analogy. It's a good one.

Not my term by the way I heard it at BCG they use this concept of pond and fish. The basic premise here is it's more important to pick the right pond to fish in first. And by pond, that's an analogy to the market for the type of business translated to business in M and a context. Before you start throwing the line. If you pick a wrong pond and the wrong pond could be too little fish in it, the wrong fish, not the taste your family likes and you can be the best fisherman with the best equipment. Think of diligence and execution. Your family will still be hungry. That's why it's so important to pick the right pond first. And this may sound trivial, but you would be surprised how often I've seen in my career, not at all, but even before people having a bit of a tunnel vision and I referenced it before but well, we will invest in this market because we are already in this market. Not a good argument. Okay. Everybody will want to fish in good ponds and generally people will agree on what good ponds are. Everybody wants to be in software business, great business objectively. So there is some art and skill and luck in identifying these good ponds either earlier than others or having a unique view on a why what something makes good bond good for you. That's really the strategic fit. So how to go about mapping, finding these ponds or markets or businesses to invest in? First you need to map out the universe of markets and determine how far you are willing to go. And that's applicable both in a corporate context and private equity or portfolio investment context. Some may have a strategy. I'm absolutely omnivorous. Any good business can be in my portfolio. And some would be much more comfortable investing closer to their set of competencies, their core businesses. And there is a separate sort of discussion than work that needs to happen around that and that will by the way be driven by what's the impetus for you to invest outside? Is it just because you have some free cash flow and instead of just giving back to capital owners, you would rather try to invest it productively or Are you in a business that's maybe dying and you know it and you need to reposition it and you have a sense of urgency. So there is a lot that would go into that thinking about what universe would you look at? Okay. And then you evaluate these markets, these ponds, through a lens of strategic attractiveness and fit and attractiveness people would generally agree on. It's growing markets with incredible and understood growth drivers, stable with good margins, good returns, good market structure, behaved competition. Nobody is too powerful in that market. Okay. The fit element is a little trickier. It's very straightforward if you invest close to your core. If you go buy competitors, you understand why it fits. That's a business I'm in. I just, I will buy them and take out some cost. And that's a synergy and I know exactly what business this is. Now, the further out you step out in adjacencies in that universe of bonds, you will need to start thinking more creatively but still have conviction about the fit. Here you will often need to start thinking about the business model. What is the type of business my team is good at running or investing in? Is it making something small or big? Is it project driven or am I selling nuts and bolts? Am I going direct to customers or through distributors? Or is it online? Is it heavy manufacturing or light assembly? Is it serving a single market or customer segment or is it global? I'll sell my product to 15 different end markets. You can be successful stepping out pretty far from your core business and find good investment opportunities if you can think rigorously about why is it a good fit. Why do I have the right fish in that pond? Going through the ponds is understanding the universe. I'm comfortable even evaluating and going after and then systematically evaluating with the attractiveness and fit. And best in class companies would have actually very precise, almost quantitative way of going about that. It's not just intuitive feeling all of these elements of attractiveness, obviously growth returns, all of those things are quantified. But things like balance of power in the market and elements of fit. Each portfolio, each company needs to articulate for themselves what fits you and that may differentiate you in that hunt for good bonds. Again, everybody will recognize attractive bonds, but not all of them will fit.

I like that view because it doesn't get talked about much is these deals get harder to do the further you go away from your core. But you have this view of really understanding your strengths that you're going to be able to leverage. Despite going further away from your core. What is that you're going to be able to have that advantage around recognizing.

That you'll be taking more risk. Go read some of these studies by consultants and they will always say that obviously probably the bigger deals and further out from the core, more risk.

Agree. And then how do you counter that with your strength? Do you have examples of what would be specific strengths that you could leverage even despite going further away from your core? Cause I'm imagining customers could be different. Maybe it's business models fundamentally similar and that could be a strength. I don't know if you had other examples of what would be strengths, you'd latch onto strength.

You can describe them either if I'm a business, things that have assets that I can leverage better by adding M and A to it, or things I'm good at, I can do well. They are slightly different assets versus capabilities.

So I feel like incredibly good at marketing that even though we're going further away from our core, we may still look at it and saying, hey, this is a strength we can still leverage. We can bring our marketing competency to this company.

I'll give you an example. I think it's well known in the business world and relatively dated, but I don't remember the name of the brand. But this arm and hammer consumer goods. The company at some point realized they had a much, much narrower portfolio of products. And now you'll find a ton of consumer products. And the asset, the thing they had was we have this channel, big retailers and shelf space and some brand recognition. How can we add to it? Like once I'm sending a truck to Walmart, what else can I put on it? Okay, you can productively exploit that through M and A. That's an asset. I have something. What can I add to it? That wouldn't necessarily be obvious if you didn't think about it that way.

Toothpaste.

Right. You can keep building it out. That's leveraging your assets. What I have capabilities. It's more what I talked about. What am I good at? And that's where you can invest behind businesses. It looks similar. It's not the same customers. I can't leverage my distribution channel. I can't make it in my plant. My salespeople can't sell it. So it's completely unrelated. I can't leverage any of my assets, but I know how to run that type of business. If the product is something that, let's say, sells for thousand dollars a unit and it's a little widget and it goes through distribution and it's light electronic assembly. Okay. And I'm good at running that type of business, doing the sales and operational planning, optimizing the supply chain for it, that assembly, optimizing distributor management, doing some of the R and D in that space. Okay, I can go and invest behind businesses that look like that, that have nothing in common in terms of, you know, customer segments, specific customers, specific channels.

Can we make up an example to go through the strategic diligence exercise? I can pick one for mine. I don't want to get you in trouble. Okay, we have our deal room products, our main business which is like M and A lifecycle management. But we have the spinoff data room product called Firm Room. I have a hypothesis that is a pond which is pretty fragmented and pretty ripe for consolidation. And our product, because it's spinoff operates at a really high margin. We can essentially acquire something in that pond that's like a pretty straightforward. And I'm just using this a general example. We'll expand from here. One, how do you look at this pond? And right away there's sort of a good sense because I'm doing the one we're playing away and then we can make up one away from the core. When I started thinking about the size of this overall pond because we say this is about data room markets, about billion and a half market cap. When you start looking at it in the fragmentation, I know there's three companies that have maybe about 70%, 75% market share and then the rest is like fragmented with a bunch of little companies. When you start looking at that, does that give you any indicators or do you start putting consideration around that in terms of how diversified how many fish are in there and how big they are?

Okay, so maybe there needs to be a third element of a pond assessment. Strategic attractiveness, fit and can I do something with it? Sometimes you will see pond. Yeah, it's a great business. It's a duopoly and none of those are available. It's not investable because it's not actionable. Finding out the number of fish in the pond and the actionability, what is the reason to believe I can actually go and buy some of them should be that third element. One deal is not a strategy. Just saying like oh, that's the market and I can go buy this target to enter that market. Okay, that's very binary. Like it will happen or not. It's not a strategy. If you are convinced I want to invest in a given market, you better make sure there are like three, four, five, six targets and hopefully you get one or two. Now there are 15. Yeah, your thesis can be. I'll go and roll up seven of them.

It had to be in that direction. You would have to look and say, okay, there's probably 100 different companies out there. Three of them control 70% of the market. Could we string together 10 of them and start getting towards 15% market share then that's more of a role at play. We're trying to arbitrage a multiplier.

If there is already like three market leaders and you are rolling up some sort of long tail, is the thesis that you are creating a scale competitor that will will be able to take some market share from the leaders or not?

This isn't that sexy. Let's find a different one. Let's go out of our core, Obviously we got AIs hot. I see a bunch of data companies popping up. I'm sure you're getting a lot of calls from folks that want to sell you data to go find targets. There's integration software, but that gets a little murky. But maybe if we went for our services that's further away from the core. If we got into BCG type business M and A consulting.

So if you think about the core is just data room as a segment, there is other M and A related software. There is deal pipeline management. That's not data room. There are other tools, but they're still within M and A. So like you would be leveraging your channel, hey, I know corporate development professionals. I can sell them. Can I add more things in my.

Okay, so we're not going to get too far from the core. Stay in the software domain.

But even before going to software, okay, there is M and A software and there is other business software. Maybe a vector could be. Okay, so I have data room and I can expand in other M and A software or I can leap and say, hey, I'm good at selling professional workflow automation software to highly professional users in corporate America. Okay, that's a capability. There's other software that's not M and A related that fits that. Then maybe you can find now many of those markets mature, but maybe you find a niche that's more emerging. It's AI powered. And I would argue after that you would leap into more of a service. And you can also think about I can provide more services around M and A than just deal room. I can advise on M and A.

I like where you're going with this. Yeah, let's pick one. I, I want to get to the other steps of we build our hypothesis and we want to Create our investment thesis. If we did aerospace, defense, government, that's like its own sector. And if they look at project management type of tools, those are like super outdated and pretty enterprise y. That's definitely an area we want to get into because you pretty much need to get Fedramp certified to really play in that space. And that's a big blocker for us. We don't have that capability, but we do have a lot of that workflow examples and stuff like that. So we start mapping that out and this looks like a nice, you know, away from the core. But we see some of these strengths that we have that we can bring some of the modern. Now we're building AI and bring it to this old pretty slow moving industry here. So if we start building that next thing is just pressure test, like what are those things? How would that actually fit in? Is there any like thinking that you would start with in terms of pressure testing that investment thesis?

So you found a good pond and then I think the question should be, do you, is it possible to pursue it organically or is inorganic as a way to enter? Because when you say licensing and all these barriers to entry, okay, go buy someone and that gives you a foothold and you can build from there, what you're saying is that's probably hard to enter it organically, but that's why inorganic may be the answer. Now on the organic front, depending on what capital you're willing to put at play to pursue a market, some of these high barriers to entry markets at the end of the day can still be entered if you are persistent and you are willing again to place that bet with enough capital. There are examples in aerospace and defense. A company you may have heard, Enduril, I think it was founded by a person who sold Oculus virtual reality to Facebook to Meta. And I think he went on and founded this basically defense contractor, which was considered a very small club industry. Lockheed and some of these primes with enough insight in what's needed capital to put at work, persistence and enthusiasm. I think they're making big strides.

Be open minded that there may be a way or in this example, like partnering with a reseller could be an avenue to get into the industry. But we found something, we found the pond and maybe we are getting. So you're right, those are good areas to pressure test. And then if we get past that saying, hey, this seems like the opportunities are valued pretty reasonable, especially if we find a business that's pretty stagnant with the growth that we could acquire them and expedite getting into this industry then am I ready to build my pitch?

I think we talked more about ponds that is evaluating the fish. That's where the deals start hitting your inbox.

So now my investment thesis got to target a specific fish.

So ideally now you have a good thesis, you know where to fish. But ideally you would have multiple ponds. Again depending on maybe you are a little funded, just rolling up. I don't dental clinics like that's your pond. And then your pond could be different regions of the U.S. now if you're in some bigger portfolio, you'd be hopefully worth multiple ponds. And then fish will start hitting your radar and you will need to be evaluating. And again there is a strategic element to evaluation of targets before the confirmatory diligence. Things like market share, the competitiveness of the products. Why do truly customers buy that product over the other product. Analyzing wins and losses. Why do they win and why do they lose? Do you truly understand that going back to some of this it has to be rigorous. You have to be able to pivot and not just sort of accept oh they're gaining market share. It's growing this hand wavy.

Yes. So it goes back to on the why part. It's answering the why this pun, why this fish and then you're basically doing like a swat on both of those. And then who or little company, 50 people. I'd pull a few other leaders in place, probably our COO and a few other leads identifying who's involved in the team. The when is an interesting one that ties back to doing this research and really spending the time to know this market so that we are identifying the right company and making sure stars are aligned to go execute at the right time.

Maybe you were in a sleepy company that was in a given business, didn't really think about deploying capital productively or didn't have capital to deploy. Okay. And then maybe the company woke up, realized we need to do something right, be great. And you go through an exercise and you find ponds and you want to be more aggressive. That's more of a one off exercise. But then you do need to maintain and constantly update your views. It's a dynamic world and it's changing faster than ever. One thing, one market is hot, red hot one year and the next year it's not need to stay up to date on all the ponds both that you've chosen to keep validating the thesis. Yes, it's still investable, but also maybe some of the ones you written off deprioritized, maybe they are Becoming more investable over time. So it's an ongoing, iterative activity.

One of the things that we didn't talk about is in terms of sourcing these opportunities. Do you proactively source these opportunities with building your own pipeline and finding what's available in the market, or do you network with the bankers and get on their radar for them and bring you deals?

Let's both. At the end of the day, I don't think you can rely just on one approach. If you follow the process I laid out, identifying the ponds, validating that there is fish there, you would know what that fish is. Constantly having a long list or short list, both ponds and fishes, targets in that pond and trying to cultivate it. Yeah, that would be the best practice. And that's a way to cultivate what people call proprietary opportunities before they become auctions and highly competitive. But you do need that network. You do need a flow, especially if you hunt in this middle market, lower middle market, and that's where most of the deals we do here, middle market. You will probably not know 100% of the targets that are available there. And sometimes you will see a target that's in a pond you just didn't think about. And then once you see it and you go through your sort of thought process, is it attractive? Does it fit? And you realize, yeah. Why? Because that process of laying out what ponds I should be looking at, it's creative. You can say the whole economy, the whole universe, I can go invest. But people usually don't do that. They draw a line somewhere reasonably, not too far from the business they are in. And you can miss interesting markets and ponds and it's okay. Again, it's an iterative process. And then you learn about that pond. But sometimes just through getting an inbound target.

I agree. That's a really good way to learn an industry is to see what's being marketed and study it.

And then you can be more proactive. You can learn about an industry reacting to it, but then you can get more proactive.

Yeah. With that knowledge. Absolutely. When does culture come into the picture? Comes up a lot when I do these interviews. But as I'm going through this exercise of strategic diligence, Culture anywhere there, or does this stuff happen after we sign?

I would say it's an element of fit. Probably not so much about the pond, the market, as it is about a specific target. It's something like to be doing business in a given industry. Some industries have reputation, and you can think about, is that the culture I want to be okay. And by the way, that could be like ethical risk and some industries are just more prone to it.

Fair enough. When we look at building this investment thesis for the specific fish, does that culture come up to the story and presenting to the board of why they think they're such a good culture fit for us, or is that.

I would argue it should be. If you identify yourself as a, let's say engineering driven, R and D driven technological company, you want to see that similar culture in the target you acquire. Yes. So for sure. And by the way, in diligence and negotiations, it certainly should be an element of evaluating that culture. When you interact with the leadership, the management of the company, can you pick up the signals, the data points about what culture they adhere to, how they negotiate with you? There is a signal of culture, especially if you plan to retain the sellers as management for your business. How they behave in negotiations, how they treat, how they approach it is very much signal of culture in the business.

You ever had that where they're such a pain in the ass just negotiating the NDA? You just said forget about this.

Yes, there are more painful processes.

So you get early signs just from that.

I've had once I saw a seller of a smaller business and you see a lot of sort of quirky things when buying businesses from private sellers and entrepreneurs. And I have immense respect for all of them. These are people who built businesses. Sometimes they acquired them, sometimes they inherited them, but they made them generally stronger or maintained them. M and A is not what they do. And so they would have some interesting ideas about how to do M and A. Once I remember was a seller was thinking about selling a company. I was selling a house and wanted an earnest money like a deposit that we are serious and have some sort of like standard pre negotiated contract before allowing even the diligence.

Oh wow. Yeah.

So yeah, people get pretty creative.

Yeah, that's fair point. I get a sense of culture from how we're going to do the deal. The integration part, how do you start thinking through integration?

It varies obviously by organization.

I almost probably should have framed it more as when do you start thinking about integration?

Early on, by the way, I would say you go back all the way to does the business deserve investment. An element of that is can they integrate and execute whoever they are, the team you will be entrusting.

This is before conversations with the team or early conversation, your business team.

So if you are in the corporate context, that's a little different. In let's say private equity context, if you are in a Corporate environment and you are adding business to your existing business. Thinking about the team I have, can they integrate, can they execute?

Who would you rely on for that insight? Whether it's the business unit leader or is it. Here's a designated integration function.

Assuming you have, I mean generally, let's say it's a role of senior management.

Okay.

CEO level, segment or even corporate management. Yeah, it's.

And you'd want to get their pulse of, hey, we're looking at bringing fish in to our company here. With that we have the capability or capacity to do it very much. Yeah, you get some validation like yes, go ahead. But then there's not like too much clicking in and trying to build like a real detailed plan. More of going back to the assessment if there's a real strong strategic fit. Building out this investment thesis.

Well, ideally you would have a blueprint very early on, even before you start this final confirmatory, expensive diligence phase. While you're still formulating your thesis in a strategic diligence phase, you do need to have a blueprint of how I'm going to run this, how I'm going to integrate it and some of the main opportunities, risks and decisions involved in that. And then obviously you flesh it out as you go through in more and.

More detail a blueprint before loi. Hey, this is a rough idea of how we're going to integrate.

Look, and by, by blueprint, I mean it can be in somebody's head. Whoever will be responsible for delivering needs to be able to convincingly say okay, and I have general idea how, how we can run it and how it fits into our existing organization.

I feel like this thinking gets along the lines of the big red flag items that you would start looking for early in the deal. Obviously a big integration risk would be one of them. What are other big red flag items that you're looking for in this strategic diligence phase?

Big hockey stick projections.

That's every bank deal.

Yes, there's still a spectrum there and how it's articulated. There's also a spectrum from complete hand waving, just trust us to at least some attempt to have a driver tree. The 7%, 10%, 20% growth rate will be driven by this and this. So there's a spectrum there from business evaluating the business standpoint, like big wins and losses, customer wins and losses, understanding why they're happening. If it's wins, we'll help you understand why they're strong, why they're winning. If they lost customers, you really need to make sure it's not Some sort of obsolete technology or there is an emerging competitor coming up. Really need to think about that market share gain projections. You would often see sims just that's a market growth rate and then a couple percentage points for market share gain. And you really need to pressure test why and especially if it's happening over the long term. It's a finite strategy to gain share. You need to be thinking about what will competitive response be your continued attempts to gain share from them.

So all of those are market strategy, customer base, what about the people? How do you know these people are going to be good long term investments versus you're going to have to invest.

In changing some things that's highly situation dependent. Sometimes you are more reliant on people that you are sort of bringing over versus less. Sometimes again closer to core you invest, the more comfortable you are that figure out how to run this business. Now you do need to understand especially maybe in less sophisticated, smaller, less mature businesses there could be key man risks, some repository of knowledge that's not documented, codified, that is very important and identifying those people in diligence and thinking about the retention obviously as a big element of any good M and A process.

I don't know if anybody listening to this is getting convinced M and A is really easy to do. There's so many variables here to unpack. What's your best advice for people approaching strategic diligence?

I like to tell people on my team you have to have a almost quantum mindset. You have to be both the biggest proponent of the deal and the biggest skeptic of the deal at the same time and not have cognitive dissonance because of that. And that will change depending on the audience. Working with diligence teams, driving diligence, strategic and confirmatory. You kind of want to be skeptic. You don't want to take things for granted or just trust. You want to pressure test, validate again, be thoughtful about things that matter now. But at the same time as a person who helps decision makers deploy capital, build better businesses, get the deal through approval processes, whatever they are, investment committee, executive boards, you want to be the proponent. You want to use the learnings and being a skeptic to steel, man your thesis and be a good proponent of the deal. And that's not trivial. People like the deal or not, they may just default into one or the other mode. And I think there is some art in trying to keep both.

They're really good because one, you'll it's not a good opportunity, you eliminate it quicker and 2. It's very defensible when you're presenting this opportunity to leadership. Andre, thank you so much for the time today. I enjoyed this conversation. You helped me become a better M and A scientist.

All right, sounds good. I enjoyed it too. Thanks for coming.

Those of you still with us, thank you for sticking through. Till next time. Here's to the deal.

Foreign.

Thank you for taking the time to explore the world of M and A with our podcast. We love hearing feedback. Tag us on a LinkedIn post, add a review on Apple Podcasts. We'd love to hear from you. If you need help standing up an M and A function or optimizing one that you already have, we're here to help. And if we can't help you, we probably know someone that can. You can reach out to me by email Kison K I S o n a science.com or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter. Again, that's mascience.com here's to the deal. Foreign Views and opinions expressed on M and A Science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual. This podcast is purely educational and is not intended to serve as a basis for any investment or financial decisions.