- All right, good evening everyone.
Thank you for joining tonight's webinar
Entrepreneurship Through Acquisition 101.
I'm Joe Cortese,
co-president of the Chicago
Booth Alumni Club of Chicago,
and a Principal and Senior Consultant
with DiMeo Schneider and Associates.
I'm really excited to
host this webinar tonight
with Brian O'Connor as our guest.
Some of you may know Brian from his role
as Adjunct Associate Professor
of Entrepreneurship at Booth.
Also in addition to his
teaching responsibilities,
Brian is the Founder
and Managing Principal
of NextGen Growth Partners.
Brian founded his firm
around the concept of ETA,
so he's clearly well positioned
to enlighten all of us on the topic.
The format of this webinar
will be a fireside chat.
I have some prepared questions
for Brian to get us started.
And then we're happy to
incorporate questions
from the audience, as well.
If you would like to ask a
question during the program,
please, simply use the Q and A function
that you should see at the
bottom of the Zoom feature,
and we'll monitor questions
and bring them in, as we go.
Lastly, I'll mention quickly,
we plan to host a series
of webinars based on ETA
over the next few months.
Subsequent conversations
will dive deeper into
the concepts we'll be covering tonight,
so please be on the
lookout for information
on future events.
So with that, let's dive in.
Brian, nice to see you.
Hope all is well, and you're,
first of all, you're safe
and healthy amid the craziness here.
I really appreciate you joining tonight.
- Yeah, thank you, Joe, good to see you,
and thanks, everybody, for dialing in.
Healthy, safe, relatively sane.
Everything's about as good
as can be expected, yeah.
- Excellent, great.
You know, I'd like to start
with your background, Brian,
and your journey to founding
a firm focused on ETA.
You've lived the ETA model for the bulk
of your professional
career, so let's start
by having you tell us
kinda your background,
how you got to that point,
and kinda what has led you
to where you are today.
- Yeah, sure.
Happy to do it.
I guess we'll have
my bio as a little bit
of a backdrop there.
When I, I began I career in
corporate M and A, and principal
investing, private equity,
not dissimilar to many future
Booth students and Booth Alumni.
Really about the first decade of my career
was with the Zell organization,
so led by Sam Zell, his
series of companies,
many of them real estate.
Many of them are private
equity investing vehicles.
I really kinda cut my teeth in M and A
and private equity investing
within the Zell universe.
In 2010, after having
graduated from Booth in 2008,
I became aware of this really cool model
called a search fund.
And it might be something that
some of the folks that
are dialed in tonight
are familiar with.
We're gonna talk a little bit more about
what search funds are all about,
and what broader entrepreneurship
through acquisition
is all about.
But frankly, in 2010, I
became aware of this model,
really, just over a
conversation that I had
with a few of my friends
that had graduated from
Stanford GSB, which is really where
a lot of this investing
model kind of was born
in the mid '80s, and we
can talk a little bit about
the history of the asset class.
Frankly, we were just catching
up, a few old friends,
and the conversation
kinda came to be around
this whole notion that we were
sort of growingly frustrated
with our level of involvement that we had
with the companies, these
great small businesses
that we were investing in,
with a limited amount of a influence
and involvement that we had.
And the ultimate growth,
and sort of the plan
associated with executing
on the growth plan, and equity
value creation strategies
in these businesses post-investment.
So the conversation
quickly turned to sort of
this model called a search fund.
Which, unbeknownst to me at the
time, was a really great way
to put together a little bit of capital
with the ultimate end goal
of searching for, finding,
structuring, acquiring,
and then most importantly,
leading post-acquisition, a business.
Typically, a small or mid-size business
that you would then operate as the leader,
or the CEO that of that
business going forward.
I did just have, Joe,
in 2010 I left sort of the
comforts of private equity,
to go out and raise a
little bit of capital.
Ultimately, over a period
of nine months of searching
with my then partner, ending
up finding a great little
IT services company.
We can talk a little bit
more about that business,
and what made it attractive and appealing
to us back in 2010, 2011 timeframe.
But we ended up structuring a
really interesting acquisition
of a control position in my business.
Ultimately led that business,
I, as the co-CEO, and head
of business development
for the period of about
three and half years
over the course of
mid-2011 until early '15.
And, ultimately, took that
business through an exit process
after being approached
by two strategic buyers,
unsolicited, the business was
growing quite significantly
and caught the interest
of a few different folks,
or would-be acquirers of the business.
That got us all thinking
about a potential exit,
and we ended up engaging
an investment bank and
ultimately ending up selling to a,
not one of those two buyers
that sort of initiated
the whole process, but
to a private equity group
based out of New York.
So that was in early 2015.
And, ultimately, at
that point in my career,
Joe, I sort of said, well,
gee, here's this really
interesting model of
investing in, you know, tried,
and tried and true, and
proven in private equity.
And then there's this whole
other universe of search funds,
and entrepreneurship through acquisition
that has this really great marriage to it
that I think we're gonna get into tonight.
And when you marry the two of those,
the best pages of the
private equity playbook
and the best pages of
the search fund playbook,
really special things can happen.
And that's really the,
the basis with which I founded
NextGen Growth Partners
in mid-2016.
And we've been
buying small businesses
alongside really talented,
relatively early career
entrepreneur operators since.
- That's fantastic.
We have our first question
from the audience from Drew.
He asks about, you know,
in today's climate,
do you see companies being
acquired at lower multiples?
Drew, we're gonna get
to that in a little bit.
So let's hold that one for
a couple minutes, and then,
we'll speak to, you know, sort of
the dynamics of the
market that we're seeing.
Very interesting, Brian, and thank you,
for going through our background there.
When you started down this
path, were you aware of,
you know, the tremendous opportunity set,
or i.e. the right sort of
picking grounds that are out there with
the types of companies
that we're talking about,
and that could potentially be targets
of an entrepreneurship through acquisition
business model?
And so, I wanted to ask you that.
And then, if you could kind of go through
what you're seeing in the marketplace,
and how these dynamics
are playing out today,
I think it'd be helpful
to set the stage there.
- Yeah, yeah, so you
know, the short answer
to your question, Joe, is no.
You know, I wasn't really aware of the
enormity of this market, of
smaller firms that generate,
you know, you'll see on this slide,
$5 to $50 million in annual revenue.
Or you know, we often think
about it in terms of EBITDA.
You know, $1 to $5 or $1 to $6
or $7 million in annual EBITDA,
which is usually a pretty
good proxy for free cash flow
in these types of businesses
that are usually in favor
in the ETA community.
The short answer is, back in 2010, Joe,
this data that you see here
is part of some research
that we put together at Booth.
Really, it wasn't available.
I just knew that I wanted
to roll up my sleeves
and operate a small business. (laughs)
This model, whereby I could
take some of the skillsets
and lessons learned through
my career in private equity
was a really interesting,
and available one
to me at that point.
And so, this notion that there are greater
than 200000 businesses in the US
that generate between $5
and $50 million dollars
in annual revenue, which made
for really interesting targets
in the entrepreneurship
through acquisition world.
And then, approximately half of the owners
of those businesses are
approaching retirement age,
creating a really
interesting need for economic
and operational succession.
That was all sort of (chuckles)
after the fact validation
of my pursuit of this model.
And, frankly, it makes
a very compelling case
for those people
that might be inclined
to pursue this path,
given the imbalance, frankly,
that is very different than what you find
in mid-market private equity.
Whereby there's limit to amount of capital
chasing a finite universe
of capital targets.
Really, quite the opposite is true
in this part of the market,
where you have very little
organized and sophisticated
capital chasing an enormous
what we like to think about as,
in a lot of their industry
pieces that we do at our firm,
a TAM, or Total Adjustable Market.
I mean, the TAM there is enormous,
relative to the amount of
sophisticated buyers and organized capital
that is chasing after these opportunities.
- That's fantastic, yeah, well, you know.
My firm, you know, we're
investment consultants
and we often talk about how, you know,
there's 6000 publicly traded
companies in the US today.
Which obviously, is a very
small number compared to,
you know, the 112000
companies you have listed
on this slide in the private
universe that's out there.
Clearly, garnering more and more interest
from investors and business owners alike.
Obviously, that's a huge
factor in all of this.
- Well, I'm told we have
about 200 people on the call.
But, if all 200 of us
could just kinda keep
this a little bit quiet,
that'll be better for all of us.
Let's enjoy the imbalance that exists,
and the opportunity that exists
in this part of the market,
but Joe, don't tell of all of
your institutional friends about this.
- Your secret is safe with us, Brian.
(laughing)
Fantastic, well, let's continue on here.
I wanted to take a look at
some of the historical data
surrounding the ETA business model.
You know, what are some the key factors
that have made this a
successful strategy in the past?
How can we sort of, you
know, look at that data
and sort of extrapolate it out?
What are we looking for
in terms of multiples
and those sorts of things?
- Yeah so,
unlike, you know, data
that's very available in
public equity markets,
and even in, you know,
mid-market private equity,
the data, (chuckles) there's
not a robust set of data.
What we're gonna do here on
this slide, is take a look
at this research that
Stanford regularly puts out
on this search fund model.
Which, again, we'll get into the nuances
of what that actually means,
what a search fund means.
But let's, for a moment, take that data
as a proxy for
the broader themes and trends
that exist in this universe
of entrepreneurship through acquisition.
Whereby a really talented
Booth alum would go out
and raise capital,
whether it's through a search
fund, or an affiliation
with a private equity fund,
like the one I manage, or
for their own savings,
and their own personal
and professional network.
And let's take this data for a moment
as a proxy for those different paths
that we'll talk a little bit more about.
I mean, as you can see,
according the research,
you know, the asset class has generated
some very interesting returns
since the mid '80s, when this
business model was founded
in Palo Alto,
in collaboration with
a gentleman by the name
of Irv Grousbeck.
That might be a name that
people are familiar with.
But, in collaboration
with one of his students.
Again, in the mid '80s they decided
to put a little capital together,
go out and buy a business
where that student would ultimately go
and take the leadership position
immediately post
acquisition, and drive growth
and value creation within that business.
Very interesting asset class returns.
Even when you exclude a
handful of outlier outcomes,
you know, you really still arrive
at close to a 30% internal rate of return.
One of those three outcomes
might be a household name
for many people on this call.
You know, the company Asurion
was a business that was
originally a different named business,
and the model has evolved over time into
the largest provider of cell phone
and mobile device insurance.
So, many of you have insurance
on your mobile devices.
It's very likely provided by Asurion,
which is a massive company now.
A few things
that they cited and we
also would reiterate here.
And we'll use the analogy
of sort of like a horse,
a jockey, and a trainer.
The horse and, you know,
we're typically talking about
small, recurring revenue businesses
with relatively simple operations.
But these businesses do
have enough cash flow
at time of acquisition, and enough health,
and profitability, and growth
to sustain temporary headwinds,
and a very relevant sort
of point here, (laughs)
given all that's going on around us.
But, so you'll find that the median EBITDA
of these businesses at time of acquisition
is right around $2 million.
Different models will have
different EBITDA entry points,
so typically, you know, self-funded.
Again, this model we'll
talk a little bit about,
you might find slightly smaller
acquisitions, maybe $1
million in annual EBITDA.
And then, you know, search
funds tend to hover around,
you know, $1.5, $2, $2.5,
$3 million in annual EBITDA
at time of acquisition.
And then you can get into
some larger acquisitions.
Typically, that will
happen if you're, again,
affiliated with a family office,
or a funded private equity group
like NGP, the firm I'm in.
You know, again, these
are typically businesses
with existing profitability and growth,
you know, healthy EBITDA
margins at time of acquisition,
and a, you know, a pretty
attractive incoming growth rate
of right around median
12% at time of purchase.
So these are not languishing businesses,
in tired and deteriorating industries.
These are very much
good, fundamentally sound businesses
in healthy, growing
industries and end markets.
They just happen to be undersized
relative to their mid-market counterparts
that have become the darlings,
and very competitive assets
of mid-market and upper
middle market private equity.
Typically, low entry multiples.
You know, I was actually a
little bit shocked by this data.
They report a 6.3 times trailing
12 months EBITDA multiple
at time of acquisition.
You know, I often see pricing
pretty significantly below that.
You know, it's not uncommon
to find good businesses
in this universe that can trade
in environments even prior to
the COVID pandemic that
we're living in right now,
trading at four, or four and a half,
five times trailing 12 months EBITDA.
All of us are Booth folks on this call,
so you can understand
and appreciate that even
if you weren't to use leverage
in the capital structure,
and you take EBITDA as a
proxy for free cash flow,
you know, buying at five times represents
an unlevered 20% free
cash flow yield, which is
pretty darn interesting.
Even if you just take the acquisition
at sort of face value without any
assumed growth going forward.
You know, strategic,
prudent use of leverage,
so, you know, it's very
likely that sub three times
of those trailing 12 months,
of that 6.3 times
trailing 12 months EBITDA,
you know, sub two and
a half, or three times
is usually from third-party debt.
The rest coming from a
seller equity rollover,
a seller financing,
and the equity from you and your ultimate
investment sponsor group.
But the jockey, worth spending
a minute on the jockey,
because that's what all of us
are really in this analogy.
Typically the folks that are
pursuing these acquisitions,
with the intention of leading them
on a full-time basis post-acquisition,
are relatively early career,
coachable, business athletes,
usually post-MBA, and
usually post-top tier MBA,
which is good news for
everyone on the call.
And, you know, again, I think
that business athlete piece
is important when you think
about these businesses
that are recurring revenue
with simple operation.
Typically, you're not going to see
a relatively early career business athlete
buying a business that's overly technical,
or maybe plays in life sciences,
or a business that requires
a PhD level understanding
of the subject matter to be
effective in the CEO seat.
Usually, these are fairly
simple, straightforward, B2B,
mission critical, asset light,
recurring revenue models.
And there's a lot of reasons why that is,
we can kind of get into it later.
Those are the situations that, typically,
these early career business
athletes find the most success
in driving growth in these
businesses post-acquisition.
And then finally, the trainer.
You know, these are your investors.
These are your mentors,
these are your advisors
with relevant operating
and industry expertise
that are gonna help you out.
None of us have all the answers
in every business situation,
and in every industry.
Especially one that may
be relatively new to you,
if you've made an acquisition
in an industry that,
say, you don't have a ton
of operating experience in.
So you're really gonna want to,
and, again, in this analogy,
you're gonna want to
surround the horse and jockey
with those trainers that
are gonna be able to
help them win the race at the end of day.
- That's great, super helpful.
We're getting a few questions here,
so why don't we take a moment,
go through some of these questions.
Jose asks, how big a
factor is timing of entry?
Interesting question.
Is it a good time to
muster investor support
in the back of the current crisis?
What do you think about
timing, and clearly,
in the environment that we're
in, do you think this is a,
a good environment for
these types of investments
on a go-forward basis?
- Yeah.
I mean, it's a great question.
We often, at least at my firm,
we don't talk about timing
the market, necessarily.
We talk about
trying to find good
businesses at good values.
And when you have an event
like we're living through right now,
I think what happens in the immediate term
is buyers and sellers go into a little bit
of a freak out mode. (chuckles)
And that tends to
widen, not contract bid asset spreads
between buyers and sellers.
That and banks that lend to
these type of acquisitions.
You know, many of them are still lending.
But it's a different environment,
and people are being cautious and patient.
So I think that what we'll
end up seeing, you know,
through the second and third quarter,
or perhaps into the fourth,
is there will be decreased
transaction volume.
Now, things will still get done.
Lenders in this lower middle
market will still lend
to good credits.
And many of these businesses
are very good credits
at time of acquisition.
But I think you will see
a little bit of a slowdown
in just transaction volume over
the next couple of quarters.
Now, that said, I think that as we merge
from what's going on right
now, you may find that
the business owner that owned
a very healthy, profitable
B2B, recurring revenue
business that generated
$3, $4, $5 million of annual EBITDA,
you know, that was maybe holding out
for a premium valuation that
they understood was commonplace
in the mid-market.
You know, you often talked
about double-digit multiples,
you know, or a business
owner may have a conversation
with a friend that has a bigger business,
or just a different profile of business,
and they sold their business for 12 times.
And in a market like we
were living in in 2019,
you know, that might have been a,
a flag that was planted
in the ground for them.
What I think will happen,
and what tends to happen
when you've got a recessionary
periods, a la 2008, 2009,
is that there is a little
bit of a recalibration
of valuation expectations
on the seller side.
Whereby really good assets
that can weather a storm
like we're living in right
now, may become within reach.
Those business owners may sort
of dread the idea (laughs)
of living through another
crisis like we're in right now.
Therefore accelerating
their succession planning,
or their desire to enter
into their next phase of retirement,
or whatever that looks like.
Typically, these situations are
founder, owner, or
operator led businesses,
and the plan is to transition
those to the buyer.
And when you come with both an economic
and operational succession
plan, that becomes attractive.
I'll try to kind of veer
back to the question.
I realize I'm on a little
bit of tangent right now.
I think it's all sort of related.
But I do think, in the
medium to long-term,
coming out of a situation like this,
there will be very interesting
buying opportunities
for those businesses that,
you know, were on the
edging toward $5 million in EBITDA,
and starting to believe
that they should command
some of that frocky pricing that we saw
in mid-market private equity.
- I think that makes great sense.
I agree with that.
A couple questions about
like specific sectors,
or specific areas where you see the,
are there are particular sectors,
or particular areas within
the market where you see
a majority of these
transactions taking place?
Or do you sort of, is your
firm sort of industry agnostic?
A couple people mention
retail, consumer, tech.
How do you kinda think about sectors,
and do you see more--
- Yeah.
Yeah, well, I'll speak
for myself and my firm.
Retail, no, consumer,
no, tech, yeah probably.
And I'll tell you why (laughs)
I give that cavalier reaction.
What we found has worked
best in ETA broadly,
and also specifically at my firm,
is that when you can buy an
asset-like recurring revenue
B2B service model
that generates recurring
and highly predictable streams of revenue
from their client base
with low levels of churn,
that's a very attractive model
to step into in any event,
but especially when you're
partnering with people
that are extremely
motivated, highly talented,
but might be not the seasoned operator
that has been around the track
a few times as an operator
in that particular industry.
Those make for really,
really good business models.
And that's what we look for as a firm.
So we try to stay away from anything
that's too asset or capital intensive.
That capital then tends to be
an inhibitor to scalability.
We tend to look for spaces that are,
have some tailwinds behind
them instead of headwinds.
So you know, when people
start to talk about retail
I get a little bit concerned
about some of the trends there.
I get concerned around cyclical trends,
I get concerned around trends that exist
around purchasing behaviors
and things of that nature
in B2C environments
that don't exist as much
in B2B environments.
And you can tend to have business
models that generate more
in the way of recurring,
or at least repeat and highly
predictable revenue streams
from a base of highly loyal and extremely,
again, predictable and reliable customers
year in and year out.
- Got it, great.
Let's move forward.
You've mentioned this a couple times,
the different models that
you've identified here.
So why don't we go ahead and define those
and talk about each of these a little?
- Yeah, this slide is like,
embarrassingly simplistic.
(laughs) In the way that
it tries to distill down
the universe of ETA
into these three different
categories or buckets.
But let's see how this goes.
Let's hit on 'em real quick.
So you know, on the far left
you've got a self-funded approach.
And what this means is you have someone
that's dialed into this call
that is compelled to go
out and buy a business
that they intend to
operate post-acquisition.
They decided for whatever reason,
they maybe have some budget flexibility,
they've built up a nest egg
they've got an ability to maybe
take no or a reduced income
for a period of time while
they go about this endeavor.
Which is a full-time endeavor
of really trying to chase
talent, opportunities,
usually directly with business owners.
Usually you're developing
an industry thesis,
and that's where this all starts.
And then you're building
a pipeline of deal flow
and conversations directly
with business owners.
If you have good reason to believe,
have attractive businesses
that may generate
$5 to $50 million in annual revenue,
just to use that same range.
And you're developing relationships
and communication with them directly
as opposed to going and pursuing
things that are brought to
you by an investment bank
or a business broker.
Those opportunities tend
to be more competitive.
Good investment bankers often
I've found earn their fee.
That's why it's always
a good idea (laughs)
to hire one on the exit of your business.
But as a buyer, that gets tricky.
Because often you'll have to
find yourself into a position
where you're gonna be the
highest bidder for an asset
in a very well-run sale auction process.
And we all know about the
concept of winner's curse, right?
So again, here I am on a tangent.
But self-funded, you're doing
this out of your own pocket.
So you've built up a
little bit of savings,
perhaps you have some family
capital or a wealthy uncle.
I never had one of those unfortunately.
But you've basically
gotten into a position
where you said, okay listen,
for the next X amount of months
or the next two years,
which I often advise people
is a good runway to think
about fully developing
a series of theses and chasing
down proprietary deal flow,
you are funding all of your
salary and your pursuit costs
out of your own pocket.
Now on the flip side, you've
got full autonomy and control
of your own destiny.
Once you get into the search fund column
or a sponsored search column,
you have investors that
now have an opinion
about how their capital is used
and how their capital is deployed
and how you're doing that on their behalf.
Those models also on this
third bullet in self-funded,
the other two models, search
fund and sponsored search
tend to have a pretty formulaic approach
toward the deal economics
associated with your acquisition.
And I'll get into that in one second
when I describe the search fund.
So, actually before I ask you
to keep me honest on this column
I will add one last thing.
Self-funded, in this column here
does not necessarily mean
that the ultimate acquisition
is fully self-funded.
It may mean that.
It may mean that the equity requirement
associated with that acquisition
is sufficiently small
such that, Joe, are you with me?
- [Tim] It appears that
Joe's internet connection
may have frozen.
- Okay, but Tim, can you hear me?
- [Tim] Yes, I can hear you just fine.
- Okay, (laughs) well all right.
Why don't we, what do you advise Tim?
Should we carry on
and hope that Joe should get back?
- [Tim] Joe is logging back in.
Hang on just a sec.
All right.
Joe, I think you're back?
- I'm back, can you hear me?
- Yes, we can hear you.
Terrific.
- Of course, right in
the middle of a webinar,
Zoom decides to freak out on me.
Apology, I apologize for that.
Brian, you were talking about,
you were gonna get to the
sponsored search column,
you were still on the search fund column.
Apologies for that.
- Yeah, no worries Joe.
Do you wanna tap back
over to the presentation
or should we keep it like this for now?
- Lemme go back over.
I apologize, lemme share that here.
- That's okay.
- Thanks everyone, for bearing with us.
I think we're back up and running here.
- I think we're all adjusting
to our unfortunate normal
for the time being.
I do wish we could all be in person.
But I was just making one
final point on the self-funded.
To be clear about this,
this means that you're
self-funding the search component
of trying to find a business.
You may find a very attractive business
in the pursuit, doing this self-funded,
a business that generates
$7 million in annual EBITDA
and you structure
a very attractive
acquisition for that business
at five times trailing 12-month EBITDA.
And you may have to raise
some equity financing
to ultimately get that deal done.
And you see self-funded searchers
doing that all the time.
The notion of self-funded
just means that you're
coming out of pocket
for your own pursuit and
advancing intelligence cost
on would-be companies that
you'd like to acquire.
Okay, let's transition
real quick to search fund,
'cause this one has a little bit of nuance
in corporate planning to
those folks on the call
that might not be as familiar.
So in a search fund model,
and this is the path
that Stanford reports the most data on.
This is the path that
they've been collecting data
for decades on, and share their findings.
And if anybody is inclined, they put out,
every other year they
put out their findings
in a report that you can find
on their entrepreneurship website.
So here, during your search period
you have a captive audience
of investors and advisors.
Because those folks have actually
taken out their checkbooks
and wrote you a check to
go pursue an acquisition
that you will go lead on their behalf.
And just to put it into perspective,
typically, I'm gonna
use very round numbers
and broad-brush strokes
because we don't have all
night to talk about this stuff.
I wish we did.
But typically, you would,
let's call it, raise
half a million dollars.
And that might be from
10 different investors.
So each of them are writing
you a $50000 check and saying,
Joe, you seem like a
very talented young man
that's extremely capable of going out
and finding a great acquisition target
at a really good value and structure.
And then my biggest bet,
and I'll make that bet in a minute here,
is then you're ultimately
then gonna be able
to roll up your sleeves
and lead the people, make the changes,
really drive growth and
profitability in that business
over the next five, seven, 10 years.
That's the second bet that they're making.
We're gonna talk about that in a second.
So exchange for that $50000 investment
that they've just made in Joe,
they get the right but not the obligation
to participate in their pro rata share
of the equity required
at time of acquisition.
So let's just say Joe finds
a $2 million EBITDA business,
and it's a really attractive
B2B recurring revenue service business
in a growing end market,
and all the investors love it
and they wanna participate.
What happens then is that
$2 million EBITDA business,
bought it five times, so $10
million in enterprise value.
Chances are you're gonna
maybe lever that up
50% of the capital structure.
So let's just say at that point in time,
Joe needs to go back to investors
with the notion of them funding
a $5 million equity component
associated with his acquisition.
Those folks are gonna have the
right but not the obligation
to participate in their ratable share
of that equity component.
Which for each of them, simple math,
would represent $500000 opportunity
to back Joe in his effort
of acquiring this business
and leading it through
its next phase of growth.
They can pass, and if they should so pass
or if they don't pass,
there's a risk premium
that's applied to the initial investment
that they've made in Joe
for making a bet on him and his effort
of ultimately finding
and acquiring a business.
There's some nuance to that
that you can read all about
in some of the Stanford research.
I won't bore you with that tonight.
But there's a predetermined
economic structure
associated with that.
Typically that $5 million in
equity that goes into the deal
would be treated
as a participating
preferred equity security
that would earn some sort
of PIK, payment in kind,
interest rate on it
that would accumulate over the
holding period of the asset.
And then and only then,
once Joe and his board of
directors and his investors
are ready to exit that business
and they satisfy all
third-party debt obligations
and all of the equity capital
plus its accrued
participating rate of return
is returned back to those investors
does Joe then begin to earn
into the common equity value
that's then been created in that business
above the participating preferred.
I realize that some of
this is pretty nuanced
and pretty technical.
We're covering it at a very high level,
and there's plenty of research out there
that you can follow up and dig more into.
But Joe, again, in exchange for
sourcing, structuring, acquiring,
and busting his tail over
the course of several years
and growing this business,
would then have a really exciting
opportunity ahead of him.
He would have the opportunity
to lead that business as CEO,
earn a salary and bonus and
cash compensation package
that would be commensurate for the CEO
of a similarly-sized business
in that particular industry,
which would be a fairly
attractive compensation package.
But then, really the
true economic opportunity
comes on the exit,
where Joe, in the search fund model,
has a fairly pre-prescribed
economic package
whereby he has the chance to earn into 25%
of the common equity value
that's created at that business.
And that would vest in
three different ways.
1/3 of that 25% would vest
at time of acquisition,
immediately when you get the deal done.
The second 1/3 would vest over
a four-year operating period
if Joe is in the CEO seat
doing what he said he was going to do
and executing on the plan.
And then the final 1/3
would be performance-based.
And typically there's a formula
whereby there's a sliding scale
of internal rates of return
back to the investors.
And if you hit sort of the highest tranche
or the highest hurdle
within that IRR scale,
Joe then earns into his final tranche
of his 25% of the common equity value.
I'll talk about sponsored
search in a much quicker way.
Sponsored search is really a way,
again, like I talked about
where you merge some of the best pages
out of a private equity fund playbook,
tools, systems, resources,
infrastructure, committed capital
that is available and ready
to use at time of acquisition,
support and involvement
from investment
professionals and advisors.
Sort of all that great infrastructure
that private equity funds enjoy,
plus you as an entrepreneur
will affiliate with that group,
earn a salary and
diligence and pursuit costs
all along the way as you
search for a business.
And ultimately earn into a
similar economic structure
as you would if you had decided
to pursue the search fund route.
So that feels high-level enough
but enough to give people
information to be dangerous
(laughs) in these three different kinds.
- I feel like I'm ready
to go out and do it,
that's for sure. (laughs)
A couple more questions
here that have come in
that I think are interesting.
Mark asked the question,
I think one of these,
he has a couple questions
but I think part of one,
we haven't covered yet but
I think is interesting.
So should the seller leave?
What is the role of the
seller in these businesses
in the acquisition?
- Yeah, that's such a good question.
And the answer is, it depends.
I mentioned earlier, often
this is a great retirement plan
for these business owners,
that maybe founded the
business 30 years ago,
he or she has been pouring
their heart and soul
into this business for the last 30 years,
they've grown it to a point
where they've just sorta said like,
this is great, it's a good business,
it's generating a lot of free
cash flow, that's been nice,
and it's supported my lifestyle.
But listen, I need
to canonically and
operationally take a step back.
And that's fine, and that
happens all the time.
You find situations, and we
make investments at our firm
that fit that category.
And then the category of, you know,
someone realizes at an
earlier point in their career
that they need some outside involvement.
They need Joe, who
graduated from Booth in 2010
to come along and lead the team
and fill the sales and
business development function
and implement new systems
and software and technology.
Bring this business into
current-day operating standards.
Which many of the folks on this call
are very familiar with
in their various careers
and what they're doing.
It needs to be Boothed
a little bit. (laughs)
In those situations you find
that maybe that
owner-operator, current CEO,
is interested in taking a
role that looks more like
head of product.
You have people that are really
product or service oriented.
They've built a business
around being creative
about product or the delivery of service,
or the founder or operator that's like,
really passionate about
their relationships
that they have with their customers
and so they wanna focus their efforts
on client satisfaction
and business development.
Kinda find a really cool
role for them there.
But you can have
situations where there are
sort of a new entrant, a la a Booth alum,
they can add their own unique
and really special skills
and leverage those skills and
abilities and expertise
that is inherent in that
owner-operator-founder.
You can really, there are
numerous ways to skin a cat.
- Got it.
Another interesting question,
how are skills gaps effectively addressed?
I.e. someone that obviously
has the skill in a certain area
but needs other skills to
be able to run the business
and be the jockey in your analogy?
- Yeah, this one hits home for me
because I have so many skill deficiencies
it's hard to count them.
I mean, listen.
I hired for them.
I surrounded myself with
investors, mentors, advisors,
a really well-appointed board of directors
that frankly had no business
being the board of directors
for a small, lower middle market company.
It was really an outsized board
which served me extremely well.
And these are the things
that we're doing at our firm
with our entrepreneurs in
residence that we partner with
to go out and lead these businesses
after we have acquired them.
You know, we're surrounding them
with hiring at the number
two and number three levels
within the organization,
whether that's the Chief
Technology Officer,
Chief Operating Officer, Chief of Staff,
maybe the head of ED or head
of corporate development,
maybe a head of M and A if
rollup is part of this strategy.
So you're hiring for it,
you're solving for it
by the model that you should so choose,
whether it's a self-funded,
search fund, or sponsored.
Remember back to our analogy,
the trainers are very important in this,
where you get your capital from
and who you surround yourself with.
Those are, and you do see
people occasionally follow
mainly the search fund path
potentially with a partnership.
If there's a partnership
that really makes sense
and one plus one equals more than two,
one of the folks is really
business development-inclined
and the other one is
really kinda back of house,
finance, accounting, ops,
human resource focus,
that can be a really nice one-two punch.
You can solve for it in a
number of different ways.
- That's great, very helpful.
Good segue as well.
Let's take a look and talk
about your firm specifically,
NextGen Growth Partners.
Describe NGP's approach to ETA.
Highlight some of the investments
your team has made thus far.
Give us a little background on what you do
day-in, day-out with the firm.
- For sure.
So this is a nice little, I
guess a snapshot of fund one,
existing portfolio companies in fund one.
Finding the right business
means different things
for everyone, right?
I latch onto, when I have
conversations like this,
again, I sound like a broken record
but this notion of like,
unbreakable, mission-critical,
in this market of essential
services type businesses
that are recurring revenue in nature
and asset light, very scalable,
and represent a critical
service for their clients
that they serve to be in existence.
So like, and I would go
a step further and say,
and don't represent an
enormous share of wallet.
So when they look at their
PnL during times like this
and they say, boy, we
need to defer payments
to our landlord
or we need to furlough employees.
Unfortunately that's a reality
that we're living in right now.
Or we need to look at
expense line item X Y or Z.
You know, you don't often
look to these businesses,
and I'll explain a little bit
why, to kinda tighten the belt
when they represent a mission-critical
but very appropriately
outsourced component
to a client delivering
their good or service.
MHW, I'll use this as an example.
We don't have to get into each of these.
I wanna be mindful of time here.
MHW is a really great example.
So what this business
does is, at a high level
they do beverage alcohol compliance.
So they're the mission-critical
service provider
to both domestic and global
producers of beverage alcohol.
Any product that has
beverage alcohol in it,
as we all know, is highly
regulated and is subject
to the three-tiered alcohol
distribution system.
It's highly bureaucratic,
highly complex, highly regulated
here in the US.
Just imagine how complex that is
for a Mexican mezcal producer
or a Japanese sake producer
or a French Bordeaux producer.
Those folks need a partner
that is boots on the ground
and has a system with which
they help their clients
on a contractual, recurring basis
navigate the complexities associated
with getting their products into the US
and through the highly complex
three-tiered alcohol distribution system,
through their importation compliance
and regulatory functions that they do
on behalf of their clients,
that don't make sense
to have that function
as something that they in-house.
Once a producer gets to a certain size,
you know, I'll use an example
of Jose Cuervo tequila,
staying on the tequila topic,
they may make the decision
that that's a function
that should be insourced
within their organization.
But the vast majority of producers
and many of the household
names that we know,
it does make more operational
and economic sense
for them to have an
outsourced solution for this.
So again, we don't need to go through
all of the logos here Joe,
but suffice to say we
make a habit at our firm
of partnering with
entrepreneurs and residents
that represent these business athletes
who wanna go roll up their
sleeves and operate companies.
We developed a thesis in
beverage alcohol compliance.
We developed a thesis
in freight post audit.
We called on anyone and everyone
that would take our calls in that industry
to try to develop
relationships and conversations
directly with business owners
that we stood to believe generated
between $2 and $7
million in annual EBITDA.
That's typically the
zone that we look for.
And we tried to find a needle
in a haystack, frankly.
And these are some of
the logos where we did.
RecordConnect, very relevant
in today's environment.
They provide the
mission-critical HIPAA-compliant
patient record management
retrieval and dissemination
and release of information
in hospitals and large
healthcare networks.
Again, a very mission-critical component
of hospital and healthcare
organization operations,
but it doesn't make sense for the hospital
to have that as an in-house function
when they're more focused on patient care
and delivery of service and all the things
that are core to operating
a world-class hospital.
- A question along these lines,
and maybe you could speak
to how your firm does this.
What are some of the best resources
to find businesses to acquire?
How do you develop this target list?
- Yeah.
I mean, (laughs)
there's some online databases.
There are some
technologies that you can use.
And then there's like,
stuff that's as scrappy as
getting the trade show list
and calling in through all the exhibitors,
figuring out which of
those 1000 exhibitors
that are at the annual Release
of Information conference
and try to call on them
and take meetings with them
and attending the trade show
and trying to get their
business card, following up.
And so there's a lot of different ways.
You gotta get really scrappy
and really resourceful.
And listen, I don't wanna
dismiss entirely the notion
that you can establish
lines of communication and relationships
with business brokers that may specialize
in a certain space.
I just caution people
against combing through
every business brokerage or
investment banking publication
that comes out,
'cause that stuff tends
to be pretty picked over.
The best banks and brokers
will run very competitive processes.
And you know, in the
market we're living in
leading up to this COVID pandemic,
that was a pretty well-traveled path.
Even though this is part of the market
where there's not a ton
of organized and sophisticated capital,
there still are people chasing
down those opportunities.
Sometimes it's a larger strategic buyer,
it's a company that has
an inquisitive mandate
to buy up smaller competitors
on a creative basis.
And you can run into competition there.
So I guess I'd just go back to like,
you gotta be resourceful
and you gotta be scrappy sometimes.
You gotta look under a lot of rocks
and find some resources that have lists,
or you can become part
of trade organizations,
et cetera, et cetera.
And knocking on a lot of doors.
- I guess if they were easier to find,
the returns wouldn't be
so attractive, right?
- Yeah, yeah, I think that's
part of (laughs) the dynamic.
Yeah.
- Speaking of that, let's take a look
at some potential outcomes
for, as you call them,
the entrepreneurs in residence.
What could this potential
path mean for somebody
that's interested in this
and that actually keeps
on this type of model?
- Wow, I don't know if
I've seen this slide.
Our team has the ability
to make that much money?
That's great for them.
So here's the scoop on the EIR deal.
And it's effectively the
same as the search fund deal.
So let's take a look at
these assumptions here.
So you assume a $4 million EBITDA entry
at time of acquisition,
which just so happens to be,
across all of the investments we've made,
our average entry point.
4.5 times purchase multiple,
which is pretty much in line.
50% of capital structure in debt,
which again, is about right.
You paid out some debt along the way.
So yeah, here's what happens.
The business, again, at
that purchase multiple,
generates a really nice
free cash flow yield.
But then once you start growing it,
some pretty interesting things happen.
So assuming a 5% EBITDA CAGR
I think is likely the assumption there.
The entrepreneur in residence
at time of exit, assuming a five year hold
stands to earn $3 million
in addition to the compensation
they've earned along the way
as CEO of that business.
You grow it at 10% under
these same assumptions
and it's $6.5 million
at time of acquisition.
15%, it starts getting more
interesting at $12 million.
Sort of their take of the sale proceeds.
And at 20% CAGR,
close to $18 million.
And if you get one that
really runs on you,
then numbers can get pretty big.
And this is a customary look
at how this EIR path with
our firm specifically,
but more broadly the economic,
the available economic outcome, I guess,
in the ETA space probably.
- Great.
Speaking of that, let's take a look at
some of the folks that
you're working with thus far.
And we've got about five minutes here,
just so folks get a sense
of who these folks are
that you've worked with thus far.
Again, if any last minute
questions are out there,
go ahead and enter them into
the question and answer box,
we'll take those as well--
- Let's keep this quick.
This actually, this
slide is just the folks
that are currently searching today,
that are looking for businesses to acquire
in partnership with our firm.
Not pictured here are any of
the entrepreneurs in residence
that have become CEOs of
our portfolio companies.
So these are folks that
are currently partnered,
so Jake, Nick, Kyle, and Dan.
Two Booth alums, a Kelley School
of Business out of IU alum,
a Kellogg alum, don't hold it against him.
But you know, these, again, are folks
that are partnered with our
firm, they're fully funded,
they're out pounding the pavement
trying to find really great businesses,
again, that generate $2
to $7 million in EBITDA
at time of acquisition.
And they've got varied work experience.
Some of them come from more,
I guess what I would call
traditional MBA paths
like banking, private equity,
or consulting background.
Some of them are entrepreneurs,
some of them are operators.
You'll find all sorts
of different profiles
and different backgrounds
deciding to pursue this path.
I think there was a common thread, though,
in these are really, really talented
and motivated and driven folks.
I call 'em the 4H club.
It's a little bit cheesy,
but the four H's are for
heart, hunger, hustle, and humility.
And frankly, if you've got those
coupled with a Booth MBA,
you're in pretty good shape.
You can pretty much
figure a lot of stuff out
in this part of the market
as a small business operator.
Again, if you do all the right things
and you organize the right
infrastructure around you
and the right advisors and the
right mentors and the right,
again, you need to land the,
to get back to the analogy,
you need to make sure you're
riding the right horse.
You are the jockey in this analogy
and you need to absolutely
surround yourself
with the right trainers.
But if you get that right,
there's big opportunity.
- Are you specifically
looking for every candidate
to have a postgraduate degree, an MBA?
- Yeah, at our firm we do favor
post-MBA and specifically
post-MBA from a top tier program.
So we spend a lot of time
getting to know Booth alum,
Kellogg, Stanford, Harvard, Wharton,
spend some time at Kelley School and Ross,
they're right in our backyard.
But yeah, we do tend to
favor folks with an MBA.
- Got it, great.
Well we've got just a couple minutes here.
I really wanna take a
moment, Brian, to thank you
for your time.
I know we've got some
information from your firm here
on the last slide.
Thank you so much for joining.
This has been a really
enjoyable meeting to host.
I'm looking forward to doing
a few more of these with you
over the coming months
as we can dive deeper into
some of the concepts here.
I'd encourage anyone that
was joining us tonight
to reach out if you have questions.
Certainly happy to follow
up as we go from there.
But again, Brian, I wanna
thank you for your time.
I also wanna thank everyone
that joined the meeting tonight.
Really appreciate
everyone's participation.
Wanted to say, again, in light
of everything that's going on
I hope everyone is safe,
hope everyone is healthy,
and look forward to more
of these in the future.
Thanks so much Brian,
have a wonderful evening.
- Yeah, thank you Joe.
I really enjoyed it.
We'd love to hear from
anyone who's interested
in what we're up to, yeah.
- Excellent.
Take care everyone.
