In this episode, Mark Miller and I discuss the process of executing deals without overburdening the management team. Mark is currently the Vice-President of Huron Capital, a private equity firm that invests in lower middle-market companies.
He is familiar with the private equity process from start to finish, deal sourcing, execution, and portfolio company management. Mark discusses the role of management, choosing an advisor, and customizable exit plans.
Here's more from Mark.
I'm a Vice-President at Huron capital. I've been with the firm for the last three years, and I am responsible for our transaction teams for all aspects of deal sourcing, execution, and portfolio company management.
On the execution front, I'm involved in everything from managing the due diligence process to negotiating legal documentation, to setting the ultimate capital structure for the investments that we make, lining up all the financing documentation, and everything that goes along with that.
After graduation from college, I spent six years in the world of finance, two years with JP Morgan, and four years with Glencoe Capital, so I've been in the world of finance, private equity, and banking.
It sounds like you've seen the sale process from multiple angles.
It's been a fantastic learning experience for me, seeing the private equity process, from start to finish, executing deals on the buy side, being heavily involved in strategic initiatives that our portfolio companies focused on growing those businesses all the way through, and ultimately selling those companies.
So Mark, from your experience and just looking at the sale process, what's the worst thing that can happen when selling a company?
I think that the worst thing that can happen is you create an environment where the management team of the portfolio company can easily lose focus on the business itself because the sale process or the transaction process can be so time-consuming. That can lead to bumps in the road in terms of operational and financial performance.
When there is performance throughout the sale process, that does not meet the expectations of the advisers or buyers who are participating in that process, that creates wrinkles. This can be quite challenging to work through at the end of the day.
So how do you keep that from happening?
It starts with working with an advisor that you truly trust, that has deep experience in managing transaction processes over a long period, and has deep experience in the specific industry in which the portfolio company resides. As an investment team, we want to be working closely with that advisor to take as much as we can off of the management team's plate during the transaction process.
This is why an effective advisor and an effective deal team from the private equity firm’s perspective can play an active role to prevent overload. This way, the management team isn't spending too much of its time on those transaction activities and can do what's important for creating value and making sure that the operations of the business and the underlying financial performance continues to be strong.
Can you take me back to when you first start planning for an exit and the steps involved?
We take the approach of planning for an exit on day one. We take a very long-term and a very patient approach to investing. That typically means that we'll hold our investments in the portfolio for 5+ years.
That’s not to say that we're taking a shorter-term view on the investment and looking to make a quick exit. But it is important to start thinking about how you can enter into a strategic planning process shortly after an investment closes that involves strategic initiatives that are part of a long-range five-year plan.
Each of those initiatives needs to be geared toward focusing the leadership team of the portfolio company, which includes the management and the board of directors, on initiatives that are ultimately going to maximize the value of the portfolio companies in which we invest.
It starts on day one because you need to execute on those strategic initiatives and action items throughout a several-year period.
So early on, you're developing this strategy for the exit. How does that evolve as you get closer to executing the exit?
It's a strategic plan. We are not planning the nuts and bolts of what that exit process is going to look like, but planning the nuts and bolts of what those strategic initiatives are going to take us to an exit event that we can successfully run and one that we think can maximize the value of the company.
It needs to be a plan that we as investors, board members, and management teams can constantly look at and refine over time, depending on how dynamics in an industry might change, how dynamics within the company's leadership team might change, etc. You need to be able to adjust.
As you get closer to the exit process you need to be able to tell the marketplace why the underlying business that you’ve been invested in and been working so hard on is positioned to continue to grow its revenue and cash flows? You need to have a story and a positioning in place.
If we've been successful in executing our strategic plan, by the time we exit an investment, we still have several growth opportunities.
What happens next?
I should say at that point, when you feel pretty good about the elements of the strategic plan, that the team has executed over the life of our investment, that's when you can begin the process of engaging with advisors who can market the business and ultimately run a sale process.
Tell me a little bit about the type of advisors that you use.
We use a variety of advisors. The common thread among the advisors and investment banks that we work with is that they have core expertise in the middle-market and lower middle-market mergers and acquisitions. So we tend not to work with the larger, old bracket, investment banking firms of the world, just because those banks naturally due to their size, tend to focus on deals and companies that are much larger.
Other than size, what factors do you evaluate when selecting an advisor?
An excellent reputation in the middle market is the number one factor. Next, you want to be engaging with the deal team that understands the industry in which the underlying portfolio company resides. The deal team of the investment bank that you'd be working with would be able to be in a position to have a deep understanding of the portfolio company’s business model.
We want the investment banking advisor to be coming to us with similar experiences with companies that have similar business models and they have a deep understanding of how to position those businesses in the marketplace, given the business dynamics and given the business files. As the final point, we want to know that our deal is high on that advisor's priority list and that he will be focused on it and passionate about working with us.
Do you have a firm you go to right away?
No, we do evaluate multiple options. What we tried to do, sometimes very early in our investment period, is meeting with a variety of advisors who have experience in the industries, in which our portfolio companies are in. We'll be speaking to them early. And then when you get down to selecting an advisor for a specific sale process, we would focus on four to five banks on the high end and then ultimately make a selection from that process.
What really impresses you when you see presentations from bankers?
It's going to be a deep list of relevant transaction experience in the particular industry that we're looking to engage with.
If, for example, they have 20 successful lemonade transactions in this space we are looking at, that is quite impressive because at that point they can bring to bear in our process all of the nuances that they went through and in each of those individual transactions to really be sure that we're optimizing value, making the right decisions and speaking to the right people in our transaction process.
The second thing would be seeing that they've done their homework, they understand the industry dynamics and they come to the table with a very thoughtful approach for how they would market a capital portfolio company in the marketplace.
When you're getting these different pitches from bankers, a lot of times they may project a value that they can fetch from the market. Do you sense that this person's on point or this guy just blowing it out just to get the business?
You have to think about whether the outlier on the high side is realistic, or if the outlier on the low side is overly pessimistic, or is that a signal that they're not confident that they can get the deal done.
You have to pair the communication on what the value expectations are with that advisor's experience in the specific industry that we are talking about and with transactions in that industry that have similar dynamics to the transaction that we at the table are discussing.
If they can support their valuation range with some sound facts from what's going on in the broader industry, the story has to all hold together for it to be believable and considered.
Would you ever pull your comps through different data sources?
For sure. If we're going to be successful as investors, we have to know what's going on in the industry and pay very close attention to M&A transactions that are impacting the industries in which we're invested.
What multiples are those M&A transactions? What valuation multiples are being ascribed to the targets in those M&A transactions? We keep close track of that constantly. We'll always test it ourselves, but the support from the bankers makes us feel all the better if the support that they have is sound and aligns with our view as well.
When you signed this engagement with the banker, what are your expectations from your advisor from that point on?
There are three points. First, we expect that the deal that we're talking about will be a priority for all members of the advisors deal team, especially the managing director or the senior team member, who's leading the engagement.
We also expect that the deep transaction experience that the advisor has will allow them to customize the exit process for our specific deal. They need to be able to run a smart process that takes advantage of what they see as the unique opportunities to create value in the process. And we expect that thoughtful customization to come to us.
The third expectation would be rapid thoughtful responses to questions and requests that we, as the private equity firm and the deal team have for our advisors, as we're preparing to launch the exit process and then ultimately, and the management team. We expect that same sort of rapid and thoughtful responsiveness and decision-making when buyers who are ultimately involved in the process make requests for information.
Have you ever retained a banker that was just bad to work with?
Yes. They need to be reaching out to the right buyers and the right constituents at the right time, so it can be disappointing if an advisor selects a strategy or takes an approach that doesn't work out as expected. Responsiveness to questions and calls that come from either us, the private equity firm, or the buyers is also crucial, so how rapid and thoughtful their responses are can be a big differentiation factor.
As they start presenting buyers to you, what are some of the factors that you look at to narrow it down? How do you deal with situations where it's difficult to pick between buyers?
Valuation becomes your screening tool and that becomes a very cut and dry way to separate buyers. The next component that is critically important is a certainty to close. Oftentimes, in the sell-side processes, a buyer can be in the mix and doesn't have the highest valuation, but for a variety of reasons might have the highest certainty of closing.
The weight of the certainty of closing in terms of importance is huge. If you have a low valuation, but you have a high level of activity in all those areas, and you come to the table with a very smart approach and a thoughtfulness to your evaluation that can still be a very, very compelling offer. The highest offer might be from a buyer that doesn't necessarily have strong support for the valuation.
We want to know which buyers, based on the level of activity, is our advisor most confident about and believes that they can get to closing at the valuation and proposals that they've put forth.
Here is a question from a technology perspective. Aside from file activity, and looking at the diligence activity, is there consideration in terms of what type of diligence requests are you getting from potential buyers?
Data rooms are repeatedly updated throughout the transaction process, and you do want to see that when new files are uploaded, the buyers are downloading the latest version of the data room so that they're aware of what has been posted there. This way you can monitor activity to a certain extent using technology.
If there is an engagement with the materials, if there are questions to advise the management team, and an intent to develop a relationship with the management team, you feel pretty good about their level of engagement with the materials, and you don't need to rely on a technical analysis of the activity to get a clear picture how engaged they are.
What happens post-transaction, once you get the deal closed? What needs to be done from your side? How about the advisor?
There are contractual obligations per the purchase agreement. There are various financial and tax items that the buyer needs to deliver to the seller, such as the working capital amount in the purchase agreement.
In terms of a buyer interacting with the seller, post-closing, all of those post-closing items are legal. From our perspective, outside of the legal documentation and the legal follow-up items that are required once a deal closes, there's not much more to do. There's not much that needs to be done with the advisor once the deal closes either.
Going through that whole process, what would you say are your biggest challenges?
It is an incredibly time-consuming process for everyone and requires the sophisticated management team to figure out how to prioritize and juggle and appropriately delegate during that process. The biggest challenge is managing the transaction activity and the sell-side process with the all-important elements of operating a business, ensuring continuity in operations, excellent customer service, and maintenance of strong relationships with suppliers.
The fundamentals of the business need to stay in place to continue to grow and maintain cash flows and profitability and revenue. The challenge lies in balancing those two and the business continuing to perform strongly in a way that keeps buyers eager and excited to own the company.
It sounds like your biggest priority is to minimize the distraction for the management team throughout the transaction.
I wouldn't say it's a priority to minimize the distraction just because you can't avoid the distraction. But if we, as investors, are being an effective partner to our management teams, we are selecting very strong advisors and we're also playing an active role in the sale process itself.
Our goal is to be actively involved so that the management team is not shouldering the entire burden, so they can feel like we're a value-added resource as they are responding to all the myriad requests that come in during a transaction process, which are time-consuming.
That's interesting. So you actually take a pass at a lot of these diligence requests before it goes to the management team.
They'll go simultaneously to the management team and us, and we'll often need to work with the management team to develop responses. However, we will get involved with crafting those responses in partnership with the management team and take on all responsibilities that we can to help them.
It seems like that might be an area that could possibly get improved in terms of streamlining the process, to be able to deal with a lot of those inbound requests.
That’s a challenge, but if you have a good team built between the advisor, the deal team at the private equity firm deal team at Huron, and the management team at the portfolio company, you are going to have a smoother process and hopefully a better outcome.
What would you say are some of the most important lessons that you've learned from your experience?
One lesson, when selecting a sell-side advisor is to be wary that if the valuation range does not have strong or has only flimsy support, you'd have to discredit it. Another lesson is if a lower valuation range has really strong support from an advisor that can get the deal done, and it's based on a great track record of experience, selecting that advisor doesn’t mean that that's going to result in a lower valuation.
Ironically, it can be the opposite. The weight that is put on the importance of having a buyer that has a strong certainty to closing when choosing the adviser is essential, so when focusing on which buyer to select, you have to balance certainty to close with valuation.
Can you share a bit of experience in terms of deals where you realize you didn't pick the right buyer? I'm curious to know, what are some things that came up that made you decide to abandon ship?
One thing that can blow up the deal is if they start doing their work, start digging in, and they're discovering issues that in fact should have been discovered or vetted earlier in the process and that ultimately, these new issues change their view on valuation. That leaves a bad taste in everybody's mouth because you have already signed the LOI, people have invested time and money.
We've seen parties come to the table that hasn’t developed strong relationships with the management team, and then they start doing their due diligence and that chemistry isn't there between the CEO, CFO, and the new buyer or investor group. That can also sour the deal.
So here is a scenario. Diligence is done, and there happen to be some things you can’t resolve and you decide you can’t move forward with the buyer. What happens then?
You got to make a decision and you gotta make a decision quickly. The decision that needs to be made whether we move forward with this buyer and continue under a less than ideal set of circumstances. It's a risk to move a transaction forward under those circumstances, because you're on a path where you have to have an inflection point to improve, or else things can continue to get worse and you end up being forced into a decision.
If we decide to move in another direction, then in that situation, we're heavily engaged in a decision with our advisor. They'll be with us every step of the way in recommending what direction we move as well and we lean on their expertise to make that ultimate decision.
When we do make a decision, then you're back to the table in terms of who is the next party we are going to reach out to. Was it the second place person or are we going to go out to a broader group and remarket the business to see what type of outcome we can generate?
There are several different paths. Sell-side advisors earn their fees in those types of situations, where they have to adjust, change the course, and are successful in finding the right path forward.
Would you ever take a consideration that maybe you need to just pull this off for 6 or 12 months and then re-introduce it when the timing is better?
If you are not satisfied with how the transaction process is unfolding and there are still significant opportunities to grow the business and create value with the management team, you absolutely have to consider all options.
This is a sell versus hold scenario, and if you have a path to creating value in that whole scenario, that needs to be considered very middle-market use the smartest decision might not be tabling a process for six months.
If you have a couple of different initiatives that can be pursued right now and your leadership team is confident in their ability to execute on them, we might delay this for 12, 18, or 24 months.
Looking into the future, what things might you guys be considering to improve your process?
One of the things that we do is be sure that when we're selecting an advisor or a buyer that we are really getting the opinions and recommendations from each member of the board of directors and the key members of the management team.
You want all key constituents at that point to be on the same page and the same team with regards to the decisions that are made. The collective team needs to be comfortable and confident in the decision and how the process is going to be run.
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