August 3, 2015
Interviewed by: David Snow
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Sourcing and Vetting Add-on Acquisitions

How do private equity firms source add-on acquisitions and perform due diligence to evaluate whether or not they will successfully integrate with a platform company? Three veterans of the buy-and-build strategy compare notes.

How do private equity firms source add-on acquisitions and perform due diligence to evaluate whether or not they will successfully integrate with a platform company? Three veterans of the buy-and-build strategy compare notes.

Sourcing and Vetting Add-on Acquisitions
Inside the Buy-and-Build Strategy

David Snow, Privcap: Today, we’re joined by Jay Jester of Audax Private Equity; Dennis Cail of RSM; and Greg Belinfanti of One Equity Partners. Gentlemen, welcome to Privcap. Thanks for being here.

Unison: Thank you.

Snow: We’re talking about an important strategy in private equity: buy-and-build. All of you are involved in this private equity strategy of creating value, so I’m fascinated to hear your varying approaches to it. Let’s talk about an important part of the process, which is actually going out and looking for the add-on acquisitions to plug into the platform company, performing due diligence on them, and vetting them to make sure they are going to be a good fit. Starting with a question for Greg: I take it you probably map out what you think is going to be a successful strategy in a buy-and-build format. But then, you actually have to go find these companies to combine. How does that process work?

Greg Belinfanti, One Equity Partners: For us, we basically start with an industry and a thesis. Once we have that thesis, it’s our job [to call people]—honestly, we just start calling people—but always calling them with an idea. We’ll typically start with a company that we think is of the size we want to invest in—a $30, $40 or $50million company. Typically, we’ll call that person and say, “I’m Greg Belinfanti from One Equity, and I’d like to talk to you about an idea….We think your company should merge with Company X.” If you call that guy and say, “I want to buy your company.” He says, “Take a number. There’s 100 guys out there who want to buy my company.”

Snow: Will you actually specify the other company?

Belinfanti: Yeah. We’ll just map out…what our idea is for them. If we have a relationship, it’s obviously better. But what we’re trying to do is…to sell that we’re thinking strategically and long-term about where your business should go and what the direction of your business should be. So, once we’ve got a thesis, our job is to go out in the industry and basically meet as many managers and as many companies as possible. [We] always call them with the notion that we think [their] company should merge with this company.

Over time, once you’ve done that three or four times, what happens is people start introducing you. You start meeting the bankers who are knowledgeable in that industry and, before you know it, you’ve met with 15 or 20 companies in the industry and you’re putting together a thesis of who should merge with whom and trying to allocate capital in that manner.

Snow: I have some follow-up questions for you, but maybe first we can move to Jay from Audax. How does it work at your firm when you’re actually having to go out and identify add-ons?

Jay Jester, Audax Private Equity: I think it’s one of the particular challenges of the size market where we’ve chosen to spend our time. You think about that lower mid-market is just enormous. Hundreds of thousands of companies—in some cases, millions of companies—in the U.S. are out there at the lower end of the spectrum. It’s interesting. We went and looked at—as you start thinking about deals with maybe $30 million of EBITA and up, an awful lot of those deals are handled by the New York boltandbracket firms. And if you’re going to have that strategy of focusing on larger deals for the platforms, it’s 22 firms, two zip codes, that you really care about.

When I…think about enterprise value—$5 to $100 million—it’s all over the country. We think there are 3,500 different firms out there in the business of M&A in terms of transacting. And they are literally spread across every small town across the U.S. Coming up with a comprehensive way to target those firms and to see that deal flow is a huge part of what we do. I’d say it’s also one of the most challenging parts of our strategy at Audax.

Snow: Dennis, given that you advise a number of GP groups on buy-and-build strategies, can you talk about the range of sourcing techniques and sourcing platforms you’ve seen among these groups?

Dennis Cail, RSM:

Most of our PE firms focus on acquisitions between $50 and $500 million. What we’re seeing now is they’re actually starting to create their own in-house business development teams, if you will, that are going out and evangelizing the firm, the investment thesis and why you should partner with OEP versus Audax or another firm.

A lot of these operator-owners (and I’ve been one myself, so I’ve been on both sides of the table where I’ve bought and sold companies) don’t necessarily have a good impression of PE firms. The same thing goes for consulting firms. I mean, they basically have a hard time finding the value. What you’re selling is the value of the deal and you have to deliver on the value of the deal. It takes time to nurture that relationship and, quite frankly, to change that perception.

I will say, on the flip side of that coin, GPs have a challenge because they’re also lobbying for the same dollars as all the other PE firms when they’re going out and raising money. One of the big things these LPs want to know is how do you source your deals? What’s your strategy? What makes you unique versus the other firms that have come in and asked us for these same asset dollars?

Jester: I think you hit a really interesting point and, as I hear Greg talk about your strategy, at your size of the market, you guys are hunters. You’re figuring out, you’re looking out and saying, “There’s six or seven companies in this area. We think these are one, two and three, and we’re going to go on a very targeted basis and see if we can pull two of three of those companies together.” At our end of the market, we’re farmers. We are planting thousands and thousands of seeds across an enormous field and they don’t always grow up in the same year.

There are companies we have had conversations with for 5, 10 or 15 years before they’ve finally come around and become that platform company. And…you talked about the importance of having the dedicated sourcing team that has not only that visibility across all those different plantings, if you will, but the visibility across years and across different cycles and industry groups.

Snow: Follow-up question for Greg: do you ever get into Mexican standoff-type situations where one CEO says, “Yeah, sure, it would make sense to merge with the other guy”? Is he even interested? And, if he says yes, I’ll do it.

Belinfanti: Yeah. The governance of putting two companies together where a guy’s run his business for 40 years and another guy’s run his business for 40 years. That can be delicate. But we tend to try to focus on the industrial logic of it, just the logic of bringing these two businesses together. We’re happy to say one guy can be the executive chairman and the other person can be a CEO. The managerial aspect of it can be challenging, but we have not found that that has been a restriction on our ability to get deals done. Where the deals makes sense, we’ve found that, by and large, the managers have found ways to work with each other.

Jester: We’ve actually seen the opposite of that in some cases, where Company A and Company B are fierce competitors over decades. And each one at their high point has gone and talked to the other about buying the other company. It’s like, “I’ll sell to anybody, but I’m never selling to those guys.” And following that deal, Company B says he’s not looking at it as, “I’m selling to Company A.” [He’s looking at is as], “I’m selling to the same guy that bought Company A, but he didn’t beat me.”

Belinfanti: We call that being “the Irish cop on the corner.” We want to be the guy who’s just on the corner. He’s got a gang over here. He’s got a gang over here. You take your 30%. You take your 30%. I’ll own 30% and we’ll be the Irish cop on the corner, just making sure everything is peaceful.

Snow: I would imagine that, especially for the smaller companies, your firm might have been the first to offer to acquire them, right?

Jester: I would like to think that, 10 years ago, I might be the first guy calling in. Not in this market.

When the deal’s done and a CEO will take me over—and it’s always the bottom left-hand corner of his desk—one of the last things we do and having come together on a deal he goes, “Look.” And he pulls out the drawer and he shows me a file this thick and says, “These are all the guys who’ve been beating on my door for years. And I’m picking you.”

Snow: I’d like to move to the very important topic of due diligence. Greg, can I throw the first question to you? What are some of the most important tire-kicking exercises you engage in once you’ve identified an add-on to make sure it is going to be as you hope once the two companies are combined?

Belinfanti: For us, obviously, everything starts with the financial due diligence….A lot of times, when you’re buying a business where it’s been either a family-owned business or a closely-held business, the financials may not always be what they’ve been represented to you at first.

The second thing is the operational due diligence around IT. I mean, IT is incredibly important. It’s unbelievable how many times putting in an ERP system, which seems to be something so simple, can completely turn your business upsidedown.

Jester: Really digging deep and testing—I don’t want to say testing a thesis, but testing your management partner’s buy-in to the thesis—from a lot of different angles. There are dozens and dozens of wonderful investment banks out there that’ll run a lot of these processes, especially for larger companies, and they are very good at coaching management teams as to what buyers want to hear.

They are often coached to talk about, “Yeah, we can do add-on. We’ve never done them before, but we know how to do add-on acquisitions.” To go and figure out if that really is the case and then if they do have the capability to do add-on acquisitions, does it make sense to them? Is this their idea or is this the investment bank’s idea?

Cail: What we do is come in and look at everything purely from an operations standpoint and all the systems that are required to support that, especially around ERP. As Greg mentioned, these are very complex systems to stand up and if you do them the right way, it works great. If you do them the wrong way, you’re basically living with a dysfunctional system and companies. Then, it’s really hard to manage because you need…to be able to measure the performance of any company that’s in your portfolio.

Snow: Let’s say you have an assumption about the customer base of one company being receptive to the product offering of another company and that turns out not to be the case. How do you make sure the fit strategically is going to be what you hoped?

Belinfanti: We think part of our job is to go speak to all of the customers and/or competitors in the industry.

If I’m buying a company that sells to hospitals and he’s got a large percentage of his revenue going into HCA, I want to talk to the purchasing manager at HCA in order to verify what’s happening.

Jester: Having focused on the lower middle-market for 15 years, we have a senior partner group that has on average—I believe—12 or 13 years of experience together. I think we’ve built some very nice depth in a lot of different industries. And [with] that depth of seeing thousands of companies over 15 years in different industries and spoken with literally thousands of different management teams as we’ve looked at those platforms and those add-ons, you begin to get your own very strong opinions about what will work and what won’t.

How does your firm help private equity firms succeed in combining and integrating portfolio companies?

Cail: We start by setting up the integration management office. Then, we want to create a very detailed integration plan to make that happen. Then, we focus on identifying all the key business processes from end to end, which includes coming up with the functional and technical specifications.

We have a proven framework and methodology that’s been tweaked and tested time and time again.

Beyond integration management, how else does RSM work with PE firms?

Cail: We actually offer a range of services. In fact, RSM is the only firm within this space that offers financial advisory services and risk advisory services, as well as technology and management consulting. All these things are important, because that means we can be involved—and we are involved—throughout the lifecycle of that fund and making sure the companies within their portfolio are successful.

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