Dave Lorenzo (00:00:02):
There we go. Okay, well, hello everyone. Today's presentation in conjunction with Cendrowski Corporate Advisors. We at Exit Success Lab are thrilled to discuss with you how to prepare a business for a sale to private equity. And the way we're going to do this is I prepared a handful of slides and I'm going to speak to the slides that are up here. And then after each slide, I'm going to pause and stop the slideshow and go to Harry Cendrowski who's the expert in this area, and get a reality check from Harry based on the concept that I'm sharing with you. Because Harry has handled more of these deals probably than just about anybody I know, and his perspective is from the dollars and cents side of things, being a CPA, being an investor himself, he understands how the sale privately held company to private equity will play out.

(00:01:02):
He's got some great stories and anecdotes, so it's my pleasure to partner with him on this presentation today. As we get going, I like to start every presentation with what's in it for you. So my goal for you today, those of you who are watching and participating, is first and foremost to demystify the concept of a sale to private equity. My hope is that after 30 minutes today, you come away with a really comfortable understanding of how the sale of a business to a private equity fund is in a lot of ways easier than the sale of a business to another business owner. Those of you who were with us last week, or those of you who are going through the certified Enterprise Value Advisor program, you may have seen or participated in the sale of a business to a strategic buyer presentation. If you are a part of the CIVA program, the certified Enterprise Value Advisor program, and you have not yet gone through that module, my wish for you is that you stop this presentation now and you go back and go through that module first because 90% of what's applicable in the sale to a strategic buyer is also applicable in the sale to private equity.

(00:02:30):
So this is building on the foundation of a sale to a strategic buyer because there is a significant amount of strategy involved in 98% of sales to private equity funds. There are some notable differences which Harry and I will highlight for you, but if you understand the concept of a sale to a strategic buyer, it will only help you if you're working with business owners or if you are a business owner and you want to sell your business to a private equity fund. So today we're going to demystify this for you. Harry, over the years has done a phenomenal job and I'm completely grateful to him for really lifting the veil of how family offices work and how private equity works. Harry and his partners have written a book on private equity. So demystifying, this is our number one goal for you today. The number two goal is to help you position your company better if you're looking to sell your company, if you're an advisor to help you position your client's company better in the process of a sale to private equity, it will allow you to provide better guidance to them.

(00:03:44):
It will help you win at the game of business. And make no mistake, if you don't view business as a game, if it's not fun for you, then you're probably not cast in the right role because this process should be a lot of fun for you in advising business owners to help them get exactly what they want out of a sale. And my experience is that if you do this right, the PE fund, the private equity fund will get exactly what they want and you as a business owner can get almost exactly what you want out of it. And then number five, of course, this will help you improve your cocktail party conversation because everybody wants to talk about private equity, but nobody knows what the hell it is. After the next 30 minutes, you will know what you're talking about and you will be able to improve your cocktail party conversation.

(00:04:38):
Let us review the exit options that we talk about in our exit success lab sessions all the time on the continuum from zero options to most options. Option number one is just to close the business, right? Throw the keys on the desk and walk away. That's divestiture. Every small law firm owner you've ever met with or solo CPA with an eye shade on, that's their plan is to just decide it's over and walk away. The second and least amount of options is to hand the keys to Fredo, the third generation of person in your family who's going to take over the business and most likely run it into the ground. That's option number two. Option number three is the business continues on without you, but you still own the business. So not necessarily a horrible option if you can't sell the business, but you've got competent people who can run it and you can check in three or four days a month.

(00:05:40):
You can be an absentee owner and get money in your mailbox every month and own the business without having to run it on a day-to-day basis. The next option after that is the sale to employees. We talk about that a lot in ESL. We can help prepare our owners for that. The next up is a management buyout. Another really good option and a great contingency plan. We talk about that a lot in Exit Success Lab. We can help our business owners prepare for that. Strategic sale is the one we covered in our most recent session. It's in the learning management system. If you haven't gone through that module yet, I encourage you to go through it. Today we're talking about a sale to private equity and then the ultimate unicorn, which is 2% or less. 2% or fewer businesses out there will ever experience an initial public offering.

(00:06:32):
We will share what that's all about in ESL so that you can speak about it intelligently, but more than likely, you probably won't have to work with a company on that. You probably won't need to prepare a company for that. If you do, there are significant resources that we can help you with, we can help you connect with so that you give them the best advice possible. Alright, so what is a private equity fund? Again, after this slide, I'm going to pause and let Harry comment on it. So a private equity fund is essentially a partnership, and then there are a private equity fund is essentially a partnership and there are general partners who tend to manage the fund and then there are limited partners who are the investors. Private equity funds attract accredited investors and institutions, and I'll explain what those are in our next slide.

(00:07:30):
And private equity funds invest in privately held companies. They don't invest in companies that are traded on any type of exchange. It is literally private money investing in private companies. So if you are talking to people about private equity, this is the very broad definition. I am going to share with you the nine different types of private equity funds two slides from now, but let me pause the screen share here so that I can have Harry comment on exactly what a private equity fund is. How did I do with that definition, Harry, and what would you like to add to it?

Harry Cendrowski (00:08:18):
Oh, you did fine. Great. So normally what happens in the private equity funds, the general partners who are really what they call the sponsors are also investing in the fund anywhere from I'd say one to 5% of the monies that they were going to raise. Obviously, the higher the percentage, the better the alignment, and they actually then control what the investments are, what the timing is and things of this nature. So the big thing here would be is if you or your clients are going to be investing in these funds, you really have to take a good look at the operating agreement. In most cases, the large family office or the institutional investors will, and this has become controversial lately, will negotiate separate deals with the private equity fund. It could be on fees, it could be we had one where a large institution didn't want them investing in any type of medical supplier because they were a medical supplier.

(00:09:22):
There's a whole bunch of things that come out of that. So if you are investing, I would just ask the question, do you have these side letters? Are they getting a better deal than we are? If I'm investing the same amount of money because all the institutions don't invest the same amount, it's going to be a varying amount. So if you're a decent sized family office and you're putting in a couple million dollars, you should be asking for what are the side letters and what can you negotiate too and push back a little bit on some of the provisions. That's what's really important. But the one thing here, remember when you're in a private equity investment, the normal term is 10 years and in many cases it's up to they'll ask for a two year extension so your money's in there for a very long time, even though private equity gets the reputation that they're in and out of their investments in three to five years, in many cases, that's true.

(00:10:14):
Remember, you as the investor are going to be in there for a very long time, and I think that's important for you or your clients to understand. This is not anything quick. And most cases, when you make your commitment to this, it's going to be a recourse commitment that you're going to put in the money in over time, because normally it'll be between 20 to 22% of your commitment. So if you had a $500,000 commitment, you're going to put in anywhere between a hundred to let's say $125,000 initially, and then they'll make capital calls as you're going forward. Just remember those capital calls are going to be recourse obligations to you. So if your financial situation changes, they can wind down your interest, they can go probably try to enforce it. So it's not for the faint apart as it comes to that, but it's like any other business transaction. Understand what you're getting into and what your obligations are because it's not for the ping card.

Dave Lorenzo (00:11:13):
Alright, so what type of money do PE funds take? They take money from accredited investors. So here in the US, the Securities and Exchange Commission has criteria for what an accredited investor is. The theory behind it, there's two schools of thought on the theory behind it. First, the first school of thought is the SEC wants people who can afford to lose money investing in private equity. They don't want grandma giving you the $500 she keeps under her mattress. And the second school of thought is that this is smart money. A couple of highlights from the SEC criteria on what an accredited investor is. Generally it's a net worth over $1 million excluding primary residents, which is a very low threshold if you think about it from an investment standpoint. And then the individual income must be north of 200,000 for an individual or joint income of 300,000 for two spouses for a spousal unit to be investing, or it can be investment professionals. So institutional money, and as I said, the theory is that this is smart money. So in other words, we don't want people investing that can't afford to lose it. Harry pointed out that the money, you don't plunk down your initial investment all at once. You don't give, if you're giving 'em a million bucks, probably don't give 'em the million bucks all on day one. You give it to 'em in tranches and they have to invest that money within a specific timeframe. Did I get that right, Harry? As far as accredited investors go,

Harry Cendrowski (00:13:09):
Yes. I mean the goal there is for them investing the money, it's actually in their best interest to invest the money, I would say as they call it, to invest that money quickly because it will drag on their internal rate of returns. So what a lot of private equity funds will do is they will actually close on a transaction, they will finance it and then go and ask for a capital call to be funded by the limited partners to see that kind of juices, the rates of return or there's a balance. It could be 70 30, whatever the case may be, but that would be a common practice.

Dave Lorenzo (00:13:45):
Can you explain what internal rate of return is because it's so important in private equity?

Harry Cendrowski (00:13:50):
Sure. Internal rate of return is, think about it this way, if I say I'm earning 10% of my money each and every year, I would have, that means if I reinvested that money, that's the rate of return that I would get. It's not simple interest, it's actually compounded over time, and that's what a lot of the funds are. That's how they compare what's been the rate of return. Because if I return to you, if you put in days example, if you put in a million dollars over let's say a five year time period and you get that money back, let's say in seven years after you've invested, that means more to you than waiting for 10 or 12 years. So you could get the same dollars, but because you got it back in year seven in our example, maybe it's a 10% rate of return, internal rate of return, but if you did it in the year's 10 and 12, you probably looking at a 6% internal rate of return.

(00:14:42):
So the big thing there is making sure that you're comparing apples to apples and you got to be careful on how they also present their information. And a couple of times we've caught in some of the prospectuses, they said they were in a process of selling the companies and they already baked in the internal rate of return, and we told 'em we didn't think that was appropriate because they didn't close the deals yet. So you got to be careful. It's like anything else, you got to do your due diligence. So if somebody were to do that, I would just kind of walk away because that means I could have other reporting issues down the road with them.

Dave Lorenzo (00:15:17):
So the internal rate of return factors in the timeframe that you're getting your money back and that's the reason why these guys like to use it, right?

(00:15:32):
Okay, that's an important thing to highlight. So now I'm going to share with you the nine different types of private equity funds, and I want you to keep in mind, I'm sharing these with you. These are the most broadly, these are the most broad categories of private equity funds. Keep in mind that investment professionals, if nothing else, they're really, really good at inventing new ways to take people's money. So these types of funds, all of these funds were created as a specific focus for people who have a specific desire to invest their money. If you live through 2008, 2009, 2010, we just saw the tip of the iceberg as to how creative investment professionals could be with things like credit default swaps and derivatives and those sorts of things. Well, this is kind of like the training wheels, the basics. These nine types of funds are different flavors of private equity funds that cater to different types of investors.

(00:16:41):
So the first is the one that we are all very familiar with, and that's a leveraged buyout fund, an LBO, which uses debt and strives to increase the profit of the overall fund as a whole. So it takes a business and it uses in theory, uses debt to continue to grow that business, to continue to advance that business in a way where the business with the individual owner might not be able to leverage the debt as well. So when most people talk about private equity funds, and they're talking about private equity funds that are buying companies, and we're going to get into the description of a private equity fund, buying a platform company and then adding onto that platform. Leverage buyout funds are what we're talking about, and in the purest sense, a leverage buyout fund is going to use debt to help the original company they buy grow either through acquisition or organically or both.

(00:17:45):
That's the theory behind it. It gets abused a bit and if you're familiar with what happened with Toys R us being purchased and being loaded up with debt and other companies being loaded up with debt, that's kind of the stepchild black sheep version of it. But for the most part, a leveraged buyout fund is what most of us are talking about when we're talking about private equity buying companies. The second type of fund, and again, this is one that you've all heard of, is a venture capital fund. So this is when a business is kind of brand new or they've used up their own personal money from the founders and they want to raise funds to take the business to the next level. That would be a venture capital fund. So when you're watching movies, based movies about, say Facebook like the movie, the Social Network, they're raising money from venture capital funds because they tend to be startups or early stage companies.

(00:18:50):
The third type of fund is a growth equity fund. So this might be a mature company that has the opportunity to really gain market share quickly. They're profitable and they just want to go out and solicit additional investments. In my mind, my own opinion, this is kind of almost like the IPO replacement. They don't want to go public. They don't want to have the burden of going public, but they want to take on additional money. Maybe they only want to take on additional money from a handful of folks, a handful of institutions, growth equity is the third type of fund, the fourth type of fund, if you were with us when Glenn Wasserman from Driftwood Capital presented, these are his funds. Those are real estate funds. So they buy real estate, they buy tangible assets, they buy real property and they develop it or they manage it, they operate it.

(00:19:42):
That's the fourth type of fund is a real estate focused fund. I would also put REITs into this category as well. And then the fifth type of fund is an infrastructure fund. Infrastructure funds primarily invest in utilities and services, so they differ from real estate in that they're investing specifically in utilities and services. Number six is the fund of funds. You may hear about this more and more. These are funds that actually invest in other funds, so they will buy into a dozen or a half dozen or two or three other funds. The seventh is mezzanine capital. These are typically transactional in nature. So maybe a fund is converting from debt to equity or they're raising money to finish a specific acquisition, raising money to finish a specific project. Generally, mezzanine capital funds are funds that are into and out of an investment. I mean, I hesitate to generalize, but they're into and out of an investment at a quicker pace than your leverage buyout fund would be into and out of an investment.

(00:21:08):
The eighth type is a distressed asset fund, otherwise known as a vulture capital fund. They tend to buy failed ventures, buy failed businesses, or buy businesses that are on the verge of failing. They will buy them and break them up. They will divest and sell off the parts or they will buy them, keep the good part and build upon that. They tend to be able to find deals that failed for one specific reason or for a handful of reasons that they have the cure to. So distressed asset funds can be particularly interesting if you have a deep amount of knowledge in an industry niche or an industry sector. And then the final one is secondary funds. So they buy investments in other funds. So let's say you're an investor and you want to get out of a fund before the time horizon is up. You want to get out of a fund before the typical period when you're able to get out, you would be able to sell your interest in that fund to a secondary investor. They will take over your investment in that fund for a fee, and that's what secondary funds are about. So those are the nine most common. I'm going to stop here and go to Harry now. Go

Harry Cendrowski (00:22:28):
Ahead. Yeah, on the secondary funds, you got to make sure that your partnership allows you to do that, so some of 'em don't, but it's actually kind of interesting. Over time, that market really got started because of individual investors wanting liquidity, and now with the last couple of years with some of the endowments in pension funds rebalancing their portfolios, they've actually gone to that secondary market to sell very large positions. So it's kind of institutionalized even that level. So that's picked up quite a bit of activity in the last couple of years where they're pretty efficient markets where before the markets weren't that efficient and the fund of funds, the only thing I would say to you is if you or your clients are getting into those, make sure you understand the fee structure because you're going to have fees on top of fees, on top of fees. So the question then would be is what type of investment do you really have there and what needs to be earned by the operating companies coming up for you to even see your rate of return on the investment? Those are good for people maybe wanting to have a lower capital commitment, but you are going to pay, it's what I call, it's retail. Retail,

(00:23:44):
A lot of fees to have the privilege of investing.

Dave Lorenzo (00:23:47):
Harry, let's take a second now and you're the perfect person to explain this. Explain the general, the two and 20 model, how most funds get paid.

Harry Cendrowski (00:23:57):
So sure. So what normally happens is the 2% is a management fee that is paid to the general partner in their management company. And that's usually the idea originally was to pay for them to get set up. It helps them pay their salaries and things of this nature. If you look at that 2% though, and let's assume they have three or four funds in place, it's a very, very lucrative aspect of managing those funds. That's why they want to have more funds. The 20% is, let's assume that the limited partnership says if you're entitled to an 8% return on your money, once there's enough profits in order to pay for that 8%, then any profits above that, the fund is actually going to get 20% of the profits along with the limited partners, which is huge. And usually what happens is once that kicks in, it kicks in for each transaction afterward.

(00:25:05):
The problem with that is if one or two companies they sell for at the end, in many cases, if it was at a loss and not a gain, they could still collect money, but you are actually losing money in those couple. It's not like a clawback provision that once they get paid, they get paid. But that's why that term has come up. There are many times where your larger investors negotiate those fees where it could be one and a half percent and 15% depending on how big the checks are. And that had became a big subject matter over the last couple of years as these funds have grown because just to think about it, if they have a billion dollar fund, which is not unheard of anymore, 2% is an awfully big number, and then on top of that, we throw the 20% on it. It's making a lot of people rich out there. So it's really up to the endowments and the pension funds to negotiate that because it's only at their level they're going to have any leverage, but it's very, very lucrative for these people. That's why you have people in their thirties and forties or worth 40, $50 million out of a shoot because of the private equity aspects.

Dave Lorenzo (00:26:13):
So Harry, explain as well the fees that are layered on top of this, right? Because there's the two and 20, but then there's also, you just alluded to it when you were talking about the fund of funds, they layer on other fees associated,

Harry Cendrowski (00:26:31):
Well, they're going to charge you two and 22, so you're going to be paying it twice.

(00:26:34):
You pay two 20 at one level, maybe two 20 at another level might be slightly different. But you have to then sit down and think, man, if I'm paying in effect 4% because of the layering and everything else in 20 and 20, I mean, I don't know how you really make that good of money over time. So you got to be very careful. Now, some of the funds have fine tuned some of those numbers, but it's a very, very expensive process. And remember these funds, if there's due diligence fees, lawyer fees, accounting fees, all these acquisitions, they pay nothing of that. That's the cost of running the fund. So their 2% is kind of like money that goes to the bottom line to pay their personnel. And the same thing with the 20%. That's all after all those other fees. So it's really the investors incurring those costs and not the general partner.

Dave Lorenzo (00:27:22):
Okay, let's take a look now at the funds that we're looking at that invest in mid-market companies. So for our purposes, we're generally talking about a leverage buyout fund, and they typically have, again, this is a big rule of thumb, but they typically have a 10 to 12 year investment horizon. So the first five years is when the money's coming into the fund and they're investing the money into companies that they're buying. Then there's the harvest period, which is years five through, tends to be years five through the end of the fund lifecycle, and then depends on the charter of the fund, they can apply for an extension up to about year 12. So there's pressure for them to raise money in the beginning and then invest that money for the money to grow for them to multiply that money and then for them to give the money back.

(00:28:23):
Hopefully the investors roll the money into the next fund and then the fund closes to investors after the first five years they harvest the money and then they give you the money back. There are redemptions after whatever time period they decide up until the end of the fund. They can extend the life of the fund for a couple of years after that, and then they hope that you invest in their next fund, that you take a portion of your profits roll it over into the next one. That's the average, that's the typical life cycle of one of these funds that's investing in businesses. Harry, your thoughts?

Harry Cendrowski (00:29:00):
No, I think that's a pretty accurate description. The extension, the first two year extension is normally written the documents that could be at the option of the journal partner, not the limited partners. Anything beyond that would be you need a limited partner's approval. But if they're going out that long, that kind of means then that you're probably not going to be investing necessarily near other funds because it's a very long time period and you're vetting on the jockey. And if it's taking 'em that long to get rid of the companies, then there's something fundamental fundamentally may be wrong unless there was a big recession like we've had before. But the big thing here to remember is the longer that money tied up, the longer you can't invest the proceeds in other investments. And that's where a lot of people got caught in between 2008 and 2010. They were getting their capital calls, the money wasn't being distributed. And so a lot of people had severe liquidity issues including family offices because they used to try to time all that and then the music stopped when the reception hit. So you've got to be really, really careful about what your long-term commitments are. But you can have, I know of one right now, they're out on their 14th year. They still can't get rid of their last two companies

(00:30:21):
And they have two other funds since then. And I think it's really hurting on their reputation because their internal rate of return on that one's going to be in the single digits, which is obviously not very, very good.

Dave Lorenzo (00:30:36):
So here's why time horizon matters, and when you're looking at these funds from the fund perspective, time horizon matters because of the pressure. The early years, there's pressure for them to invest in companies because they take the money from the investors to invest in companies. They can't have the money just sitting on the sidelines. The money has to go to work immediately. So the early years, there's pressure to invest in the harvest years, there's pressure to maximize the return pressure to get rid of those companies at the maximum value that they can. And then the extension years, Harry just illustrated it for you in the extension years, if it's taken them that long to get rid of these companies, they got some dogs with fleas because they can't get rid and they just absolutely cannot get rid of them. So when you're talking to your clients or when your company is looking at selling to private equity, there is pressure on the PE fund and you can't lose sight of that.

(00:31:35):
You need to know if you're advising your clients or you need to know if you're selling your company yourself, where that fund is in its life cycle. Are they at the end of their investment period? If they are, they want to get you on board because they feel like they can get a great return on their investment. Are they early in their investment period? There's less incentive for them to pay you a premium because they can take their time and look at other comparable businesses to yours. So understanding where they are in that life cycle when they're looking to invest in you is really, really important. Now, if I hear, and I was talking to Eddie Perez is with us today. I was just having this conversation with him a couple of weeks ago or maybe a week and a half ago. If I hear the term dry powder one more time, you know what dry powder is? Dry powder is these people with that money and they got to put it somewhere. That's what dry powder is. They can't find a place to put their damn money. That's why they need your companies. And I guarantee you, Harry's going to you that there was a lot of dry powder walking around at that deal maker conference last week. Harry, your thoughts?

Harry Cendrowski (00:32:45):
Oh no, there is, and everyone's the private equity and venture capital firms. That's why they're there because they're looking for companies to invest in and that's the whole purpose there. But there is a lot of money on the sidelines. They don't make money, real money until they invest and obviously disclose to the companies. But to Dave's point about where they are in the life cycle of the fund, one of the things too, some of the funds have provisions that they cannot set up a new fund until they're fully vested in the current fund. Not all of 'em have that, but a lot of 'em do. But they spot on with respect to that because you might be able to get a better deal with respect to that. The other side of that too though is if that's the last deal they're doing, they're probably going to flip your company out maybe a little bit earlier on in waiting five or seven years.

(00:33:36):
So depending on what you want to do and where that becomes important is what we have seen in the last two years, and everyone was talking about this in Chicago at the DEALMAKERS conference, is we've seen it used to be, would you like to roll over part of your equity? Yes or no? Then it went to, okay, we'd like you to roll over something. And now what we're seeing is almost that every single deal is mandatory. That part of your, you have a rollover part of your company. It could be anywhere from 15% to 45%, but that's what we're seeing more and more of. They're requiring that to do the deal. And that's not always bad because if you think they're going to grow the companies we have seen in certain cases where the money's received on the rollover amount exceed what they would've received upfront because it's a multiplying effect and they're getting a better multiple than they're paying you.

Dave Lorenzo (00:34:32):
One of the reasons why we as professionals in Exit Success Lab are a huge advantage for the businesses that work with us is that we think about this stuff. I'm going to give you an example of something that this happened to Nicola and I on Friday. On Friday at breakfast. And whenever you're watching this, just imagine it was last Friday. At Friday at breakfast, Nico and I do a presentation and an advisor runs up to us after the breakfast and says, I'm working with a technology company right now. The technology company had a PE fund come to them and offer them $3 million, and it's what I would call an exploding offer. It's a take it or leave it, and you have a very short time period or the offer explodes, the offer goes away. And I said to this advisor, that's somebody who's desperate, that's somebody who wants to make a deal quickly.

(00:35:34):
I said, I guarantee you, if they're offering million, we can do better. And here's what we would do. We will investigate funds that invest in this sector. We will put as much lipstick on the pig as we have to make the business look the best it possibly can look, and we will find 5, 6, 7, maybe even 10 funds that invest in this sector and will hold an auction. And we can even do it because the market is so tough. We can even do it blind. And Nicola and I would do this through Sunbelt. We partner with Sunbelt Business Brokers. We could run this auction. They have a broker dealer division. They also operate in just about every state in the United States. So we can put this out there, and if you give us 60 days, we can get a better offer than 3 million. If it's an exploding offer, I guarantee you they're offering a take it or leave it now because they want to get this business on board.

(00:36:30):
Either they need it as an add-on for a specific reason or they want to use it as a platform for a specific reason. We can hold an auction, we can make the business look better and we can get them a better deal. And the advisor went back to the business owner, and the business owner was just so flattered and overwhelmed by the offer, they're going to take the $3 million. I can almost guarantee you that they're leaving money on the table because anybody who's going out there and is being that aggressive is doing it because they see value and maybe they can take that business and flip it in a year or a year and a half by adding it to another business for six, seven, $10 million. So the advantage that you have when you work with ESL, if you don't want to sell this business tomorrow, you can give us 18 months or two years, we'll put you in a position to dictate what number you want to get because we'll have built the business for the funds that will invest in this business.

(00:37:29):
If that's what you want to do even better, we will build the business so that you can acquire other businesses and multiply the value of your business. But to me, that's the predatory nature of funds working to acquire businesses. When the business owner doesn't have the ability to do the research, the business owner doesn't know the rules of the game. I'm just halfway through these slides. Harry and I are halfway through this presentation, and you'll already know more than 98% of business owners who are being offered money from private equity to sell their businesses right now. And these private equity folks are taking advantage. They're predatorily coming after business owners saying, 3 million bucks. Nobody's ever going to offer you this. Take it or leave it. You have a week to decide and you go to your CPA and your CPA is not like Roski. Your CPA has never done an acquisition before, and your CPA goes, well, $3 million, that's 1.5 million more than you need to retire. You should take this deal when the business is probably worth seven to 10 or seven to 50. You don't know what you don't know can absolutely result in you leaving a, it's a scientific term shit ton of money on the table, okay? That's the value in working with us. That's the value in working with somebody like Harry. How many times have you seen this, Harry?

Harry Cendrowski (00:38:58):
We see it all the time. They're trying to make you rush a decision that you shouldn't be rushing. First of all, also what it tells if the owner's not prepared. I already agree with you, Dave. We've seen cases where that 3 million should have been seven or 8 million based on what's going on in the marketplace. So don't even give you time to take a look at it or get it structured properly. And they're taking advantage of putting that cash in front of the person, which I don't like ethically, but that's a whole different issue. But it gets to surrounding yourself with good people. And Dave, I mean, the advice you gave them was spot on, and that's what people should be doing is going out to the market to see what's out there. So all we can do is try to educate our clients on it and be forceful about it, but I think we have an obligation to do that.

Dave Lorenzo (00:39:54):
The reason that, so Nicola and I started ESL and about six months in, I said to Nicola, we need to have the capability to take these businesses and make offer and go out and solicit offers on their behalf because the business owners just, they don't know what they don't know. And the more we educate them, the more they feel like they're empowered to make better decisions. Our entire mission at Exit Success Lab is to increase your enterprise value so you have more options when you're ready to exit. If you have a good business and you don't want to work on any of the 10 drivers, just let us take you to market with an auction and you're going to make more money than if you just succumb to the only offer that's out there. No matter how attractive, let us test the market to make sure that we're doing everything we can to get the best value for you.

(00:40:52):
Alright, so here's the real insight. Here's the secret that these masters of the universe at the private equity funds don't want you to know. Okay? Sale to a private equity fund is a marketing exercise. That's my point. We can make the business, you and I together professionals, you and us, we can make the business look so much better so that the funds want them. So you got to figure out what funds are investing in your industry sector. What funds have a platform company and they need a presence in your geographic area? What part of the fund life cycle are they in? Can we take advantage of where they are in the fund life cycle? And do they have a platform in your industry? If they don't have a platform company in your industry, we can make you the platform. We can get you ready to be the platform, and you may not be a platform for fund A, but you may be a platform for a fund B or a fund C, so you'll be more valuable to fund B or fund C. And if you're a platform for fund B and C, depending on what stage in the fund life cycle they are, you may be more valuable to one or the other. Harry, do me a favor and give the explanation of platform versus add-on and how it plays into private equity.

Harry Cendrowski (00:42:19):
So the platform is somebody who wants to get into an industry and they're looking for the first acquisition in the order to allow them to do that. That could be in pest control, it could be in whatever the case may be. They need that first company in order to start building out, and then you do the add-ons from after acquiring that company. Now, if you are a platform company for someone, that's the case where you really do want to do a rollover of a lot of your equity because then you're going to be adding on all these other companies down the road and you want to share in that success with respect to that particular fund. So usually add-on companies, you have a lot less leverage. Usually if it's a platform because they really need you, you're going to have a little more leverage in negotiating.

Dave Lorenzo (00:43:17):
I actually have a slide on that. So the platform is the foundation, right? The platform is the first company in and then add-on companies increase the capability of the portfolio or they increase the footprint. That's the secret to being an add-on, right? If you have to be an add-on, then you want to make the case that my company is going to increase your capability. I'm providing something that you don't currently have with your platform, or I'm extending the capabilities that you currently have with your platform, or I'm increasing your footprint. Your platform only operates east of the Mississippi, and I'm the dominant player west of the Mississippi, so I'm increasing your footprint. So if we're not selling a platform, if we're selling an add-on and all the funds in the industry already have a platform, then we have to make the case from a marketing perspective that we're increasing capability or increasing footprint, generally speaking.

(00:44:18):
Again, this is big broad rule of thumb. Generally speaking, eliminating redundancy unlocks the value. So if you're doing roll-ups, let's say of pest control companies, and you're buying all pest control companies in Toledo, right? You're basically just buying customer lists because you don't need, you got seven trucks, you maybe need one more truck, but if there's three companies that all have seven trucks in Toledo, you only need seven trucks to cover all of Toledo. Maybe you'll buy two or three other, you keep two or three other trucks, but you're essentially buying the customer lists and you're eliminating the redundancy. So you're taking two companies that each had 20%, 20% profits, you're combining them, and now you have one company that, and it unlocks maybe 35% profit because you've eliminated the redundancy. So if you can't be the platform, you want to try to be the platform, and there's so many different private equity funds out there now, there's a pretty good chance you can be a platform for somebody.

(00:45:24):
If you can't be the platform, then you want to be the add-on that increases capability, increases footprint, and they're going to look to you as a way to unlock the total value by eliminating their redundancy. I want to highlight one of Harry's points, and I have this neat slide that does this, and this is the real value for the owner. So benefit for the CEO or an owner in selling to private equity. So people will come to me and they'll say, listen, Dave, you seem to favor strategic sales. You seem to favor that option. There's one thing that private equity gives you. I mean, I'm going to list all the benefits out, but there's one thing that private equity gives you that a strategic sale generally will not give you, and that's the benefit of the secondary transactions. So here are all the benefits of selling to private equity, but there's really one that makes private equity a lot more attractive if you have a long enough time horizon, and that's your ability to roll over a portion of your equity into a secondary transaction that may be worth as much if not more than your initial transaction.

(00:46:42):
So before I have Harry speak to that, you get strategic guidance from the masters of the universe of private equity, you'll be exposed to new opportunities. You'll have access to scale your original business won't have had access to. You'll have more resources because there's more money involved in private equity. It will foster an environment of continuous personal improvement for you as a CEO. And there are psychological and emotional rewards, right? Selling your company for $300 million, psychological, emotional, financial reward. But in that 300 million, you may take a hundred million out and then roll 200 million into the fund, and then your business is sold again, and the multiple that business is sold for makes that 200 million worth 600 million, and you make more. You can pull out a third of that, you make more on that secondary transaction than you made on the initial transaction. So for my money, for my mind, this is the real benefit in private equity. Harry, your thoughts?

Harry Cendrowski (00:47:48):
Yeah, no, I agree with you, Dave. I mean, if you look at your industry, I mean, for example, it's not unusual to have the multiple range from let's say six to 13 in the same industry based on size. It's based on strategy. So even if you sold in let's say the six to eight range initially, if they're able to grow that and you're able to then flip that at a 12 or 13 multiplier, I don't need a calculator to tell. I'm going to do is ally well. So as you build that up, you're getting the benefit of that higher multiplier. The other thing too is I would got to be careful too about your own industry. One thing that's happening right now in the HVAC industry, which has been really big with the private equity and the roll-ups, that's kind of has settled down where we know of a couple funds now that overpaid for the companies and they just overpaid and now they're kind of sucking wind. So you also have to be careful about too what's going on in the industry about how much hype there is and things of this nature to make sure that you're actually going to be able to get that second turn.

Dave Lorenzo (00:48:59):
Here's the buyer's perspective, right? And I gave this to you when we did the strategic sales session previously. From the buyer's perspective, the platform is everything Harry just highlighted. If your platform is bad, you're going to have to bolster it. You're going to spend that dry powder is going to have to be invested in making the platform better. So what does a good platform look like? Well, in addition to probably being number one or number two in the industry sector, the platform also has a great leadership team. The platform has a good CEO that's willing to go through another round of transactions with you. If you invest in a platform with a good CEO, with a good leadership team, your job as a fund manager, then you don't have to worry about the operating company. You're going to meetings with the operating company where the CEO O is essentially leading the meeting.

(00:49:54):
If you as a fund manager are leading the meeting with the operating company, you're dictating what the operating company should be doing. You are not out there looking for add-ons that can add value. So your platform investment in private equity as a private equity fund manager is critical. It's essential. And Harry used the phrase, you're betting on the jockey, you're betting on that CEO. You're betting on that management team that they can run a company that's 3, 4, 5, 10 times the size because that's what you're going to do. You're going to layer in as a fund manager, other add-ons to make that business 3, 4, 5, 10 times the size. So the platform investment is critical, and the platform investment from a talent perspective is critical. Your add-ons then add exponential value. So your add-ons are complimentary, they're extensions of what the platform company is doing. They're adding capability, they're adding geographic footprint, they're adding market segmentation that could not have been done organically or would've taken decades to do organically.

(00:50:57):
You're shortening that time horizon as a fund manager. After the platform, you want to pay as little as possible for the add-ons. You want to acquire as much footprint for as little as possible, acquire as much capability for as little as possible because the rest of it's falling right to the bottom line. You're looking to find damage that can be fixed with the transaction. So if the add-on company is defective in a way that suppresses its value in a strategic sale, but it will increase in value when it's combined with another company that fixes its weakness, that's a great find for you as a fund manager. So let's go back to our example with pest control companies. In Toledo, there's three pest control companies in Toledo, one has 60%, 70% market share. You scoop that up, you make it the platform. And then the 30% market share is dominated by one company that has 20% of the market share, but its equipment is incredibly old and it's bleeding market share.

(00:51:57):
Every year you can scoop that 20% up and you just get rid of the equipment, put it in a scrap yard, sell it for scrap. You don't need the equipment anymore because you've got the dominant player that's damage that's fixed by the transaction, and you're stealing that 20% market share just by buying the customer list from that company that would've had to pay hundreds of millions of dollars to replace the infrastructure that's aged out. Number five, from the buyer's perspective is eliminating redundancy leads to maximum profit. You got two operations managers, you only need one. That's the salary that you can save. You can do that all the way down the line. Talent versatility is critical. It's not unusual in the PE universe to have a great operator in the HVAC industry say then when they divest themselves of their HVAC companies, have that same operator move into pest control or route management person for a distributor, move from route management into HVAC or pest control because there's such a route management aspect of that.

(00:53:04):
So having diverse talent in your portfolio is critical because good CEOs have the potential to move from sector to sector in related businesses. And then finally, getting talent to commit through the second transaction. It's almost like Harry, read my mind. Getting talent to commit through that second round of transactions is critical. More and more funds are demanding this because that CEO talent is so valuable that the fund managers don't want to spend their time operating the companies. They want to spend their time finding other companies to add to the portfolio. So having that talent commit through second and even third round transactions and paying them handsomely to do so is essential. Harry, your thoughts?

Harry Cendrowski (00:53:54):
No, I agree with you. I mean, the crossing over in industries, if you have a well experienced executive actually can bring a lot of great ideas to the table. The other thing too, what that does is with that experience that if you do experience a downturn, they're going to know when to cut early and to cut out the expenses. So it's really a defensive move. But there are a lot of executives now that they're just continuing to work with one or two funds over time. They've actually made a career out of it because they did such a great job. So some funds actually have people on the bench, they have CFOs, CEOs, and a lot of other people. So it's just kind of interesting. But the redundancy you talked about too also comes in how do you recruit people today? Because a lot of your recruiting is done via Zoom or teams. So there are so many different ways you can cut out redundancy. It's almost limitless. So I think everything you said there, Dave was right. And the interesting for everyone here, I never saw this presentation before. Dave was pulling us up, so we didn't even go over this beforehand.

Dave Lorenzo (00:55:03):
No, but you've taught me over the years to listen to what the market says. Harry, I'm just repeating back what you have told me to do. Listen to what the market wants.

(00:55:15):
So

(00:55:16):
Here's our approach, okay? So the ESL approach is we never want our clients to immediately accept an unsolicited offer. And I'm going to go out on a limb and say this, and Cola's going to give me pow, pow. That's what dumb money does. Dumb money accepts an unsolicited offer. So the best thing that you can do is even if you're not ready to sell your business today, call Harry and have Harry get John and their team to do a valuation of your business. And for our purposes, I would love for them to do a quality of earnings so that we know exactly what they know. These are the two things that a private equity firm is going to use as a club to beat your client over the head. They're going to use a third party valuation, and then they're going to look at the quality of earnings.

(00:56:02):
By the way, you're going to get charged back a shit ton, excuse my language for quality of earnings. So have Harry's guys do a valuation and quality of earnings first so that you know everything there is to know in politics. This would be doing internal opposition research on yourself, do a valuation, do a quality of earnings, and then when we go to market, we know what the value of that business is and let's go to market for an auction. So our playbook is to do that market assessment on the way in identify target funds that would be a good fit for the business that we want to put on the market list all the businesses, list the business with all the funds, and then field, we list all businesses and then field offers. If there's an offer, if you don't get an offer you like, you pull the business back, there's no requirement to sell, nobody's got a gun to your head.

(00:56:57):
We want to identify hidden value as if we were going to invest in your business and then use that as a marketing tool. And we make the buy and buy or hold decision based on what the market currently has to offer and whether we can improve the value. And that becomes your exit strategy. So all these folks out there who are, and I love you, financial advisors, you're our best friends, we want to work with you forever. But if you're a financial advisor and you've got an exit planning certification, you cannot do what I just outlined. Okay? You're a financial advisor. Your role is to take the money that comes from the sale of the business and make sure you don't blow it. Make sure there's enough so that that person passes away with at least a dollar left in their bank account. That's your job as a financial advisor to protect the money for future generations, if that's what your mission is.

(00:57:52):
Our goal in helping these businesses is to do this, okay? This is what we do. We maximize the value of the business. We give you the most options so that when you're ready to exit, you can make good choices. If someone out there is advising you to do anything but maximize your options when you exit, they're not an exit advisor. They're not performing exit strategy work for you. This is the right way to do exit strategy, whether it's a strategic sale or whether it's the sale of a business to private equity. That's how we do it. So we play the long game.

Harry Cendrowski (00:58:32):
So Dave, just on that point at the DEALMAKERS conference, again, I mentioned one of our panelists was Sharon G. Really bright Indian businessman. What he said was, he doesn't believe you can get a business ready for sale in less than two years and do it the right way. And he's been involved in IPOs, serial entrepreneur, our other panelists, basically said the same thing. So that's what you really need to drive home. It takes time to do this. And then once you start looking at your company this way, you're going to find waste to increase the value yourself. Based on competition and things of this nature. So everything you had up there was spot on.

Dave Lorenzo (00:59:12):
I think that you would do this if you were selling a car, right? If you want to sell a car, you're going to get it. You're going to have the outside spotless before somebody comes to look at it, and you're going to take multiple offers. You're not going to take the only offer you get. So you would do this if you're selling home, selling your car. Why wouldn't you do this when you're going to sell your business? So our advantage from an ESL standpoint is that we're in this, just like Harry said, to play the long game. We know both sides of the table. Nicola and I are spending as much time talking to buyers, talking to fund managers as we are talking to business owners now, and that's to the advantage of all the businesses that we sign up in the future. It's to the advantage of you as professionals who are working with businesses because we know what's going on out there.

(01:00:01):
Harry's always a source of information for us, and where Harry's information comes from, he's talking to the people who are buying the businesses. So we have options and we don't need the one buyer that's willing to make an offer today because we offer options to our owners, to our business owners that aren't available to them on their own. The experience that we have, we're out there. I mean, the Dealmakers conference that Harry was at last week is a great example. He's swimming with the sharks so he knows what they're looking for. We're out there. We understand what people are looking for in these businesses. And just like we told you with strategic sales, we're going to red team it. We're going to do a red team to understand where the holes are in our presentation, where the holes are in the market value of the business that we're offering, and we'll know our vulnerabilities better than the fund managers that are going to make the bids for the company.

(01:01:04):
So how can you start this conversation as an advisor, right? So you want to help business owners improve the value of their business. All of you in your area, you all work in the 10 drivers of enterprise value. How can you improve the value of the business? Well, the first thing you can do is you can ask them how this business ends for them. Mr. CEO, Mr. Business owner, how does this business end for you? They're never going to have an answer or the answer they have is, I'm going to give the keys to Fredo and you're going to remind them that Fredo is weak and stupid. He's going to run the business into the ground. Is that what you want for your legacy? No. So let us offer you more options. You're also going to want to find out what makes them better than their competitors and whatever their competitive advantages, we can accentuate it.

(01:01:50):
We can lead with that. You're going to ask them if anyone's offered to buy their business, and you're going to ask them why that person wanted or that company wanted to buy their business. And then we're going to ask them if they would want to remain involved after the sale. And here's the real difference, and this is the close of the presentation, and we'll get Harry's final thoughts on this. If the business owner wants to remain involved or is willing to remain involved after the sale, let's say they got another five years or they got another 10 years before they want to retire and they're open to selling their business, but they want to be involved, private equity can be incredibly lucrative. You've all heard me tell the story of the medical billing firm that I worked with and the medical billing firm. The gentleman got $300 million for his company.

(01:02:39):
He was only able to take a hundred million in cash out only. He took a third and he rolled the other two thirds into the fund and he ended up taking his company and all the other add-ons and running that company. He only had to run the company for another five years. That company where he got the a hundred million, but he rolled 200 million in equity into it, that company ended up being sold for like $780 million. So he was able to make more on the second go around. Then he made on the first, he took a third of his portion out. That second time rolled two thirds back in and they're getting ready to sell the firm again. They're getting ready to sell the business a third time. So in a 13 year period, this guy has sold the same business twice for incrementally more on the second and third sale.

(01:03:41):
So if you're a business owner and you just want to get out and go fishing, maybe a strategic sale is the way for you to go. But if you're a business owner and you got five years, or you got 10 years, or you're willing to put in another 15 years and play with house money, the wealth you can accumulate from rolling over your interest in your company is staggering, absolutely staggering. So that's how to prepare for a sale to private equity. Harry, any final thoughts before we open the floor? We'll stop the recording after your final thoughts and then we'll open the floor to questions.

Harry Cendrowski (01:04:18):
Yeah, I'd like to, just to expand on what you were saying about selling the company, what actually, what happens in those scenarios is remember early on you had venture capital, you had private equity, then you had LVO.

(01:04:29):
What's really happening there is the venture capital company that you probably sold your business when you're willing to stick around, they're now going to sell to a bigger venture capital or a private equity firm. They might sell 20 or 30% and then again down the road to five years down the road, what you're talking about. And that's going to get a substantially increased value, probably all your multiple and then the LVO or that the other one's going to come in. So that's what Dave was really talking about. You're not selling a hundred percent of the company three times, but you're really getting the upswing of all those increase in values and you're a bigger, bigger player out there. So there's actually a lot of businesses out there. One of the funds that we work with in the venture capital fund, they consider themselves now to be the minor leads for the next level. So they're already setting up the companies to be sold to these people, and then they're doing their own rollovers. So they no longer will sell a hundred percent of their portfolio company. They keep 20% and roll it up. They know what's going to happen. So it's not only for the business owners, it's also the funds are doing the same.

Dave Lorenzo (01:05:36):
There's one question that I want to make sure we capture before we end our time together. So Sheldon asked in the chat that I commented that it's advantageous to go to auction. What, if any, are situations where it's not necessarily recommended to go to auction? I mean, my opinion is if you as the owner have some urgency, right? So you've got a short time horizon. God forbid you've got a disease and you want to sell because you need to get out because you have to get treatment. Or a member of your family has a disease and you got to get out in the short term and you don't have the time to field multiple offers. Or if there's somebody, and I call this the shark tank effect, right? There's somebody specific you want to work with. I see this all the time, it drives me nuts. People who are on Shark Tank want to work with one specific person. So you've always dreamed of selling to BlackRock, or there's one specific reason for you to sell to that one specific fund. The 800 pound gorilla, they made the offer and you're in love with them. In my opinion, that would be the reason not to go to auction. So you have urgency or you want to work with somebody specifically, Harry, what other times would you say it's not advantageous to go to auction?

Harry Cendrowski (01:07:02):
I'd say if you don't have a strong management team and then they could splinter up. If they're not going to do that, I mean, time will kill all deals. It could also kill your company. So I think you got to be careful on both ends.

Dave Lorenzo (01:07:16):
Okay. Alright, so we'll take other questions. Thank you for joining us for today's session on how to sell to private equity. We will be back with another session. Just look wherever you found this video for the other sessions and information. If you're a certified enterprise value advisor candidate, there will be a thought provoking exam that follows this. Be sure and answer all the questions so that you can get your certification credits.