Ep 557 4 Types of Buyers Circling Your Business, and the One Now Doing 28% of Deals

Speaker B And so a buyer— and we've, you know, we've done a bunch of work interviewing buyers of businesses— a buyer will put an opportunity that they're trying to get financed up on your platform, and then individual investors are able to identify deals they want to finance.

Travis Jamison So we actually work with predominantly independent sponsors, occasionally searchers, the search fund crowd.

Speaker B What's the biggest difference?

Travis Jamison They have— there's— here's the easiest way to describe it. There's probably like 4 different— I mean, so we'll say like tiers of acquisition entrepreneurs. The bottom tier will be the self-funded searchers. These are the SBA crowd. They are predominantly using an SBA loan and maybe a little bit of their own capital or a little bit of investor capital to buy a business that's probably at max of like $7 million and below. A lot of those come from the MBA crowd. They can come from all over. The next phase is kind of called traditional search funds. These almost exclusively come out of like the top MBA programs at a few universities. They raise a few hundred thousand dollars and then go spend a year or two searching, trying to find a business to buy. And then once they buy that, or once they find it, they bring it back to the investors and investors fund the rest of it. Those are a little bit bigger businesses. Then we have the tier we'll call the independent sponsors, which is where we play. And I'll actually come back to that one. And then the tier above that is just traditional private equity, right? They have a fund trying to build a portfolio of these acquisitions that they try to flip later on. So independent sponsors are very much like private equity, but instead of them raising a bunch of money, then trying to go find a bunch of deals, they do it in reverse order. They spend all their time to find one deal and only one deal that they focus on. And then once they find it, then they go get the investors to invest in that. And the, the range is fairly large. Probably the smallest independent sponsor deal is about $10 million in like enterprise value. And they go up, they go up a lot, but you usually think like $10 to $100 million. So, we say $1 to $7 million in EBITDA and then like $5 to $30 million in enterprise value is kind of like CapitalPad's sweet spot and what we invest in.

Speaker B $5 to $30 million in enterprise value. Got it. Got it. And I think a lot of our listeners would be in that zone where they've got a business that they think is worth somewhere in that $5 to $30 million space. And so, the obvious question is, what do you look for in a business assuming it meets that threshold or that criteria?

Travis Jamison Well, if you are in that threshold, you should probably go learn about the independent sponsor space, because it is, I would say, the hotness right now in the private equity world. And few people even know what that term means, legitimately. And I didn't just a few years ago, right? If you look at the statistics, we put together some, some work on this. In the lower middle market, I think now it's up to like 28% of lower middle market acquisitions come from independent sponsors. Which I think is a tad bit over actual private equity. That's a kind of a wild stat. So the space is really exploding because a lot of the typical allocators like the funds and the family offices, they like being able to pick deal by deal instead of having to just trust the manager. They can look at the deal and trust that. The economics work pretty well for independent sponsors. A lot of these private equity funds have been basically just murdered the last few years with their economics just don't work. So they know they can go out on their own and do better. So it's just a win-win for like everybody involved. So definitely learn about the independent sponsor space and kind of what they're looking for. And it will totally make your journey for selling much easier if you're in that range.

Speaker B So what does an independent sponsor look for in a business?

Travis Jamison The same thing everyone else does, pretty much. It can be simplified a little bit. So, you know, of course, everyone wants a business that has that's not cyclical, that's diversified, has no concentration issues, that's ideally not tied to, say, like one big payer, so like government or insurance or something like that. Those deals definitely still happen, but they're riskier because with all of these deals, you're adding debt. It's not like it's a $10 million business, you're just, here's $10 million. It's a $10 million business, here's $5 million of investor capital and $5 million of debt. And so when things go south, it can just wipe out investors. And so that's the reason that leverage kind of changes things. You want predictability in revenue. You want visibility. Will next year look very similar to this year? And then what are the risks all behind that? You know, what are the risks of like suppliers? I mean, you just go on and on and on, but looking at like cutting down those risks. Now, the truth is that every single deal has hair on it, right? If you find the perfect deal, well, as a seller, good for you because you're going to make a lot of money. But as a buyer, you're going to pay a ton for that. So having some problems with your company is completely normal. I've never seen one that's not. We can expand from there, though. Where do you want to go?

Speaker B Yeah, I mean, to see the range of multiples that companies would trade for, I'd be curious on the lower end where there's quite a bit of hair in the deal, so the revenue is not very predictable, there's not a good line of sight into the the future, maybe there is a bit of a dependency on a couple of customers. What's the prevailing multiple range in that company versus one that ticks all your boxes? Not cyclical, no concentration, no big payer, lots of predictability in the revenue. What are deals trading at?

Travis Jamison I would say it very much depends on the industry. Software is its own thing, which we don't invest in. We like the boring businesses a little bit more. 3 to 6 times EBITDA or earnings is probably the best way to put that. Now, we definitely see some above that 100% of the time. We see it frequently. We don't invest in that as much. More things have to go right. But the multiple is very dependent. Would you rather pay 5x EBITDA for a business, or a 5x multiple, or a 6x multiple? Well, it depends. Is the 6x multiple growing at like 25% a year? I'd probably take that. That's a much better deal. So the more levers that you can pull to juice that multiple, it'll work in your favor, right? If your business is growing really well, if it's really diversified. Also, here's a— this would probably be really useful— the levers that independent sponsors pull. So independent sponsors, there's definitely lots of different ways that they try to create value for, like, the shareholders. But the main one in the lower middle market space is they take a business that has really good bones. It's a great business all around, but it's not professionalized, right? A true private equity firm can't acquire it because it takes too much work. They do the work to professionalize that. So, they find a business that's good. They start installing management. They replace the founder because, you know, as— By the way, Jon, in our intro, you were telling me, oh yeah, I wrote this book. I don't think you know I've read this book like 10 times. I've passed out a couple dozen copies over 10 or 15 years. Your book's been out for a long time. Yeah, I'm a huge fan. But as you say in your book, like, you know, the founder can't be the business. So the independent sponsors start replacing those managers in there. They start building up other streams of revenue so it's not so concentrated. They maybe move— if there's a lot of commercial exposure, they move to more residential because the residential exposure will be more diversified, not as much concentration. They start pulling all of these different levers. They get them on one centralized software instead of a bunch of papers in the back room. All these things really actually create a lot of value because then it becomes a purchasable asset by a professional investor. So a private equity company can come in and purchase it if it's all lined up, and they pay more for that. And so there's a lot of value that can be created by these independent sponsors. Sellers can do the same thing if they just know how to do it. You just need to learn how to do it. These independent sponsors generally come from private equity, so they know the playbook. If you learn the playbook, you can probably do it yourself, at least halfway.

Speaker B Teach me the playbook.

Travis Jamison It's— so accounting is one, right? Move from cash to accrual. Big one. Definitely, let me see. The management thing is one of the bigger ones, and you want redundancies in everything. There can't be one key player that if they leave or if they get hit by a bus, whether that's a founder or a key manager, like the business doesn't work. Again, lenders don't want that, investors don't want that, and certainly the larger private equity companies just can't. They just can't do that. Are there proper systems in place and SOPs? Again, as you've talked about in your book, the diversification of the revenue is huge. You really don't want one customer being over 10% or 15% max, and, and the lower the better. What is the payer risk, right? You know, I've been in a deal where everything looks great and the insurance company redoes the rates, and like, that's a huge hit. And that's just part of certain industries, you can't really get around that. But, the more of those things that you can professionalize and remove, like, the, the better and the higher the multiple goes.

Speaker B Help me understand the difference between an independent sponsor and an ETA buyer, which oftentimes is referred to, as I understand it, as a searcher. We've interviewed lots of people in that sort of ecosystem. Will Smith from Acquiring Minds recently, as well as Rick and Royce from the Harvard program. So we've sort of done some work in that area. Our listeners will kind of recognize some of those names. But I'm a little bit fuzzy, and maybe our listeners are as well, the difference between an ETA searcher and an independent sponsor, because they sound very similar.

Travis Jamison Generally, there are 2 main differences. The biggest one that's most obvious is that searchers will generally become the CEO of the company. Yeah, almost always. They are finding the business to buy, and they're installing themselves in the driver's seat. That's the biggest one. Independent sponsors frequently don't. They more sit on like the board level. And that's what they technically say. In reality, most independent sponsors are, are very involved, but they're typically not the actual CEO. Probably like 80% of the cases, they're not the CEO. And that makes sense for the plays that they're doing. A lot of times they're, they're not going to be a professional and like how to install HVAC companies, right? But they might understand how to, you know, roll them up. They need to acquire 5, 6, 7 different HVAC companies, put them under one cohesive system. That's where their skills are, and find these other things to add on to the company. And so that's, that's the biggest one. The, the second difference is— I'm generalizing big time— independent sponsors tend to be a bit more sophisticated. They frequently come from private equity, but not always. Sometimes they're a really hot operator that's been in the space and just kind of knows things. But they tend to be a little more sophisticated. The searchers tend to be a little more green. The self-funded searchers, the smaller end, for sure. And then traditional searchers, they're coming out of, you know, they're fresh MBA. Yeah, they're fresh MBA. So they have a little bit less experience on average. And I want to say I'm speaking averages. There are some really sophisticated ones that just blow me out of the water. So those are the two differences that I would say.

Speaker B That's a really interesting distinction. I never thought of it, but the independent sponsor is not looking to become the CEO, whereas definitely the searcher, they're looking— I don't want to say they're acquiring a job, but they are doing much more than that, obviously, but they are going to install themselves as the CEO in most cases. So that's a really interesting distinction for sure.

Travis Jamison I think they are buying a job. That's a good way to think about it. Yeah. It's just hopefully it's a really well-paying job that hopefully builds a lot of wealth for them, but they have to do it.

Speaker B They have to do the work, whereas the independent sponsor, it sounds like by definition, if their playbook is, I'm going to, you know, I'm going to take out the founder, I'm going to bring in professional management, but it's not going to be me, they've got financing to finance that runway, right? That's obviously, you've got to pay searchers and you've got to pay CEOs before they sort of get their feet under them. That all takes money, and presumably they've got more of it to bring to bear. Is that fair to say?

Travis Jamison The best starting point is that the companies are large enough to support it already. And that's why you'll rarely see— like I said, like technically we'll do like a $5 million deal. That's really small for independent sponsors. There's not enough cash to really do a lot of things at that point. So really $10 million and below.

Speaker B $10 million in enterprise value?

Travis Jamison Enterprise value. Okay. Above that, things get way easier to do.

Speaker B Yeah, and walk me through in a typical independent— I know every deal is probably a bit unique, but in a typical independent sponsor deal, just walk me through the capital stack. So what's— what is the independent sponsor personally bringing in? How much are they getting from outside, you know, other equity holders? And then what's the debt ratio on a deal?

Travis Jamison Overall, the independent sponsors are putting in less of the total than a self-funded searcher would, but these are you know, these are much larger, like, size deals. There's no— as an investor, you kind of want to see something meaningful to the independent sponsor, and that's different for each person, right? We've seen independent sponsors put in $1 million on deals, and we've seen them put in $50,000. It really depends on where they're at in life, essentially, and that's fine. Obviously, the more is much better. What was your other question? Oh, there's capital stack. So probably you could say 50% is, debt on average. It does vary a little bit, compared to like the searcher deals using the SBA loans, far less leverage. Those things are really leveraged, 80%, sometimes even 90%.

Speaker B Yeah, yeah, that, that's another distinguishing characteristic between independent sponsors and searchers. Searchers with much higher debt ratios. You know, in a conversation with Will, he was saying like 80% You know, like, pretty standard. I've seen deals that go to 90% debt. But what you're saying in the independent sponsor world is it's, it's, it's much lower, 50% would be typical.

Travis Jamison The SBA deals are there, you know, the banks are lending them, but it's backed by the SBA. And so they're a little less worried, like a traditional bank would never leverage something that high. And the independent sponsor deals aren't using SBA financing, it's way above that. And so they're, they're not stupid. They're not going to leverage it up 80%. Because I mean, you know, most of the business owners who are watching this, they know how much these businesses can move. They know that's kind of scary. And so, you know, the less leverage, the more— the less certain you have to be about what the future looks like, the more time you can buy to fix things.

Speaker B Who guarantees the debt? Is it just the business that guarantees the debt in this case? Because they're larger and consistent. And it's so that the banks recourse should the deal fall apart and the, and the, and the company is unable to pay back the debt, the bank effectively takes the keys of the business over. Is that right?

Travis Jamison Exactly. Yeah, the bank covenants, they can come in, and the banks will, will try to work with, you know, the, the sponsors a good bit. But, but yeah, equity can get wiped away with that.

Speaker B Yeah, yeah, got it. So the independent sponsor, will put in some money. They will use your platform in some cases to, to get other people alongside them on the journey, so to speak. So investors to, to, to, to, to co-invest with them. And then they'll— who organizes the debt? Like, who actually goes to the bank with the proposal? Is that the independent sponsor? Yeah,

Travis Jamison Yeah. So I can walk through specifics. So the independent sponsor, you know, they get a deal under LOI, they start doing diligence. And at this stage, They've done a lot of work to get here. And this is also why I say independent sponsors tend to be a little more sophisticated. They know how the game works. Most of them know a lot of the lenders to start approaching, and they put together the packages for the lenders. So at the same time they're getting term sheets from lenders, they're also talking to the different investors, rounding those up. And the capital stack is made up of different— individuals can rarely invest in these deals. They're generally reserved for family offices and like SBIC funds. Why? They don't want to mess with a $25,000, $50,000 check.

Speaker B When you say they, the independent sponsor doesn't want to deal with it?

Travis Jamison The independent sponsor, yeah. Like, you know, they're looking for million-dollar checks, and it's, it's just not worth it. It's too difficult. And that's kind of actually— I don't want to promote CapitalPad too much, but that's the value that we add, is independent sponsors will actually talk to us because we aggregate all the investors together into one check. So we can write a $1 to $2 million check. And they don't have to worry with all the retail, quote unquote.

Speaker B You're sort of crowdsourcing investors and bringing them to the table. Interesting. Got it. So they're looking for big checks from family offices and other investors that—

Travis Jamison Family office is the predominant funding source.

Speaker B Okay, for these independent sponsors, and they're pulling— they're stitching it all together. And how do they, in addition to the independent sponsor, obviously, they're putting their own cash at risk in the deal as equity, they're also getting others to co-invest. How do they make money? Is it just on the lift of the value of the equity, or do they, the independent sponsor, take a management fee of sorts?

Travis Jamison Yeah, so they do take a little bit of fees. They don't get rich off this. They take a closing fee of probably a couple percent, and the real point of the closing fee is they've— independent sponsors probably spent a lot of money putting this deal together, you know, in the tune of like hundreds of thousands of dollars many times getting on the finish line, and they need to be reimbursed from that. And so they, they take up probably a 2% closing fee. They rarely take that out as cash. They usually roll that into the deal. So they're putting it right back into the deal.

Speaker B Basically investing that, quote, money that they've earned into additional equity in the deal.

Travis Jamison It shows alignment. And it also shows they're not just trying to, you know, get some cash out of this thing. Alignment is everything here. They also get a— go ahead.

Speaker B No, no, finish your thought.

Travis Jamison They also do get a management fee. It's probably 5% of EBITDA with a— there's usually a floor and there's a ceiling is the average. It varies from deal to deal. That management fee pays their salary, pays all the different activities that they're doing during this time. But really where they make their real money is from the increase in value. So they take a carry, essentially a profit share. So once investors get all their capital back and maybe a preferred return on top of that, they start sharing in different tiers of carry. So 20% after certain thresholds, and the more money they earn for investors, the higher their share goes up, up to probably the highest, like 35%. But, you know, 20% to 25%, maybe 30% is kind of the average based on different tiers. You know, if you, if you give investors a 2x back, they might take 20%.

Speaker B Are there independent sponsors who just do the whole deal themselves?

Travis Jamison I haven't seen those. Well, of course I wouldn't see those. Right. Yeah, they wouldn't come to us. But yeah.

Speaker B Yeah. Yeah. So most of them are looking for other people to co-invest with them. You know, one of the things that I think is a real challenge for our listeners is, is trying to decipher who is on the other end of the email. I got two of them yesterday. They're like, "Hey John, we place equity with software companies. Are you interested in selling Value Builder?" That'll be the email, and it'll be like some you know some email address, and and they're they're often disguising their you know their their their title in the email, so they kind of maybe sound more senior than they are. And then you kind of get underneath them. You look up on LinkedIn, and they're like twenty-two years old, and they just graduated last year, and they're they're. just, just chasing deals. And so that's probably a private equity group, but I don't actually know. Other times, you know, our listeners are getting calls from or emails from searchers who sound really important, but, you know, when you kind of pick away a little bit at their LinkedIn profile, they don't have a lot of experience. How does, how does a How would you advise a business owner who is being approached to try to understand, is this an independent sponsor that is approaching me, or is this an ETA buyer? Is this a private equity group? Like, what signals would they look for to determine who's calling them?

Travis Jamison The first thing is quite a lot of these will actually be from Oh, not recruiting firms. What's the term I'm looking for? Basically, they're trying to find deal flow for private equity firms, or sponsors, or searchers. There's a huge industry of this, and they're quite thorough and elaborate, and they're hitting up— I mean, if you've owned an HVAC company, for example, you probably get 30 things a day. Hey, you want to sell? So huge industry of this, and the reason is They get rewarded very handsomely if they find a deal that a private equity company will purchase.

Speaker B So, the private equity company, if I'm understanding what you're saying, Travis, is that they will hire one of these third-party companies that specialize in getting them proprietary deal flow, like getting them business owners who want to sell. Like, there's actually companies out there that do nothing more than dial for dollars. Is that right?

Travis Jamison Ton of them.

Speaker B Really? I didn't even know that. That's crazy.

Travis Jamison Hit us up at CapitalPad every day. Hey, we can help you get proprietary deal flow. Hey, we can— like, the same thing business owners are getting, we're getting from them. Yeah.

Speaker B These are sleazy organizations, aren't they? Like, if all you're doing is like, that's a pretty sleazy play. No.

Travis Jamison There are definitely sleazy people in that. And there's some like very legitimate. Like, we've worked with SourceCo, and what a great organization of how they're doing this, right? And they actually care. They're helping the business owners. They're helping the private equity funds themselves. They're just really like matchmaking. If you think about it from the private equity firm's point of view, they are really good, in theory, hopefully, at doing deals and increasing value, right? Creating value for shareholders. maybe hitting up 100,000 different business owners is not in their main skill set. And so they'll just outsource that to someone else to do that, and they'll pay them for that. Like, that's probably the best way to do it.

Speaker B Got it. Some of the bigger private equity groups will have teams of analysts that do it, but I'm assuming some of the more boutique-y, you know, or ones that just say that's not our expertise, we'll hire these third-party firms to go kick up deals.

Travis Jamison Yeah, yeah. And it's different for like the larger private equity firms, you know, they're universe of companies to buy is much smaller. For these, like, lower middle market, there's millions, right? So it's a lot of touchpoints.

Speaker B Okay, you brought HVAC up a couple of times in this conversation. So let's, let's assume I, you know, I've got a $10 million HVAC company as an example. I, I'm getting people calling me, you said 30 times a day or whatever, 30 emails, whatever. These are maybe these kind of professional I'd love to know the name of the category, but they're basically outsourced deal flow people that get paid to originate a deal for a private equity company. Are there one or two major names that they should watch out for? Not individual names, but companies. Okay. So then, so they might be getting that correspondence from someone like that. Then they also might hear from, it sounds like, an independent sponsor. How would they distinguish between an independent sponsor contacting them and a sourcer for a private equity group contacting them? Would there be any way they could decipher the two?

Travis Jamison Honestly, I don't know that much because I'm not on the receiving end of that as much. I mean, some of my businesses get those, but I don't know. I think a lot of it, the sniff test can be passed pretty quickly. It also depends on the independent sponsor's thesis. So frequently, like say searchers, they're just like, I want to find a business in this rough criteria, $750,000 to $1.5 million EBITDA, whatever. Independent sponsors tend to build a thesis about this industry, maybe this area, and then they start strategically hitting those up. And so maybe they'll hire a firm to do that as well, but it could be more likely that they're reaching out more personalized. They have Do they have a link to their LinkedIn? Stuff like that.

Speaker B But they don't— but the independent sponsor is such a funny— it's such a goofy label. Independent sponsor is such a terrible label. Like what? It sounds just— yeah, yeah. I don't even know what it sounds like.

Travis Jamison It used to be called a fundless sponsor. And then that kind of turned slightly derogatory. And so like, no, independent. So whatever.

Speaker B But it's— trust the finance people to come up with their own lingo that makes no sense to anybody. But anyways, so you've got these Independent sponsors, and so what what I hear you saying is they might be more like hey we're we're buying plumbing companies in the Southeast with at least two million dollars of EBITDA, and so that would sound more credible than we're looking for businesses in your industry. Like when you can hear and see the thesis that they have, I'm assuming also that there would their title like with the title of the person reaching out, it's not going to say independent sponsor. Like what what What would the title be?

Travis Jamison Managing director, something like that. There's— the problem is there's just no one way to describe it. It depends how broad their process is, how broad their search is. If they're having to hit up, say, 20,000 different companies, then delivery rates of emails really matter. It's not personalized. And with delivery rates matter, you can't put in links. Like, you put a link to your LinkedIn, you put a link to this, it lowers the delivery rate from cold email. And so they have to do all these things that kind of— it's kind of a— it's a game, essentially. But the more personalized and like, you know, the more narrow their search is, the more personalized it could be, the more you can like see who they are.

Speaker B Yeah, it's a game. And I don't think our listeners want to be a pawn in the game. Like they don't want to be sort of the meat, the fresh meat for all these These searchers, some very legitimate and others less so, right?

Travis Jamison It's crazy. Some are incredibly legitimate and then some are just yahoos that don't know any better. Probably one of the bigger risks from the seller's point of view is not, from my opinion, not necessarily wasting your time responding to them and it's kind of like not being useful. And some of the proprietary search deal firms, they can still be very useful. They want you to sell your company because that's how they get paid. But the bigger deal with like searchers and even independent sponsors somewhat is they can't close the deal, right? They don't have the funding to start with, so they have to get the funding afterwards. And that's, that's the big difference. We have seen deals happen where, you know, the deal's under LOI, everyone's agreed, and they just can't find the investors. And the deal goes away.

Speaker B I'm glad you brought that up because it's, it's one of the things that I think this whole world, if we, if we think of it as sort of searchers and buyers in general, the process for my listeners' edification is usually they'll, they'll, they'll have you sign a letter of intent, which includes a no-shop clause. So you kind of lose negotiating leverage. And then with that LOI in hand, they go try to shop the deal and get financing for it, both debt and equity investors. And during that time, you're kind of— you're not in limbo, but your negotiating leverage has sort of been lost because you've signed this no-shop clause. So that's a very dangerous position for our organization.

Travis Jamison So on the flip side, it's good to see what the independent sponsors are seeing. They're about to spend a lot of money diliging this deal. Quality of earnings, legal. They're going to spend 6 figures for sure. on this. And so the LOI and the no-shop clause is in place to protect them. They don't want to spend all this money and then you just turn around and do something else.

Speaker B Oh, for sure. Yeah, I would, you know, if I was buying a business, I'd want it for sure. I, you know, our focus is on sellers. And so they, you know, they— The reason that a buyer is asking for that is legitimate for sure, as Travis points out. But at the same time, Just know that you do lose some negotiating leverage when you sign that. And it doesn't necessarily mean that the independent sponsor can close. It just means that they're trying to close.

Travis Jamison Yeah. And if you're a seller, and you have some connection to someone in the space, it's worth talking to. Because so many of the independent sponsors, you know, if they've spent a decade in private equity, they've got a ton of great relationships. They've been doing this for a while, maybe they even closed deals before, you know, they can probably get the funding. You know, they know the family offices, they know the lenders, they just got to run the process of talking to them. Newer ones will have more difficulty with that. Doesn't mean they can't do it. We see new ones succeed all the time. But they will have more difficulty with it. So it's kind of what to watch out for.

Speaker B Got it. Okay, I want to switch gears a little bit and talk about the CEOs and that they bring in. So the independent sponsors, they don't want to become the CEO in general, they want to bring in a CEO. And obviously, that means that the founder is, is going to be going away. Do you— does an independent sponsor ever try to keep the founder? Is that a play they do?

Travis Jamison Okay, more than you would think, actually. So it kind of depends. Maybe if a business isn't as established, or maybe the founder seems a little more dependent, they might keep them on for like a couple years. That's one play. Another play with a lot of these independent sponsor deals is they're doing buy and builds, roll-ups. They know if they can buy a lot of companies that are doing, say, $1 million, $1.5 million EBITDA, stack them together— I'm simplifying here— but pull them all together into one cohesive company and get it to $5, $6, $7, $8, $10 million EBITDA, its valuation is far higher, right? And a founder might want to be part of that because they stand to make a— get a second bite of the apple. that can be far larger than their original one, right? If you're selling at a 3 to 4x multiple but this platform sells at a 10x multiple and you've kept 30%, like, that's a lot of money. So—

Speaker B That sounds like a private equity group though, Travis. Isn't that like when you— that sounds like a private equity playbook. How is that different than an independent sponsor doing the same thing?

Travis Jamison It's, it's the same thing except it's smaller, right? Private equity firms in general If you've got a $500 million fund, you're not going to go buy $1 million EBITDA companies and add on.

Speaker B Okay. So it's the same playbook, just at a different level, a lower level.

Travis Jamison Yes. I think it's a little bit more of a clear playbook, in my opinion. For private equity doing the bigger deals, they have to get a lot more things right. At the lower end, there's a lot more low-hanging fruit. I would say.

Speaker B And they're buying at lower multiples. So there's a little bit more room to—

Travis Jamison Yeah. So here's an actual deal we've closed. So we can talk about it. Yeah. It's a man, I hate to use HVAC again. We don't do that much HVAC. It just happens to come up.

Speaker B They're the belle of the ball right now. Everybody uses HVAC.

Travis Jamison So yeah, we did an HVAC deal recently. We had to go to Canada to do it. So we do the US and Canada. Because the US company is just too overvalued. But we paid 6x for what we call like the platform company. It's a good business. It's been around for a long time, you know, great reviews, good management in place. The, he's not the founder, he's the CEO. He is staying in place. And then they're going to buy— so paid 6x for that. But then there's a lot of smaller subscale HVAC companies that you can buy for like 3x, 4x, right? And they're going to start adding those on, building a bigger platform. And so as they do that, your blended multiple of what you paid— you paid 6x for the first one and all the others are smaller— your blended multiple goes down, but the total size of the company goes up. And so, speaking generalities, the value of it will go up, right? And so that's the play. And the CEO who's in place, he stands to make a lot of money. Obviously, the investor is an independent sponsor, stands to do that. It's also not as simple as just buying other companies and, hey, the EBIT is bigger. Like, you have to actually integrate them, make sure they're like one thing. It's simplifying, but that's kind of the playbook that's going on with those roll-ups. And it works with the larger private equity firms as well as the lower end. Just the lower end, it's more work that the private equity firms themselves just cannot do. It's just too in the weeds.

Speaker B You mentioned the word subscale, and I just want to understand. So the HVAC company you bought for 6 times EBITDA, just ballpark with revenue, like how big is it?

Travis Jamison I want to say it was $3 million EBITDA. So, okay, I don't remember the exact revenue, but yeah.

Speaker B Okay, so $3 million EBITDA. The subscale businesses that you're gonna tuck in underneath that, like, what would they be in terms of EBITDA?

Travis Jamison Anywhere from $400,000 to $1 million, probably.

Speaker B And what would those businesses generally trade for? Like, you mentioned Sixt, the platform I'm assuming on the lower end of the—

Travis Jamison There's a lot more variation here because the quality of the business varies a lot, but, you know, anywhere from 2x to 4 or 5, depending on like the quality of it.

Speaker B Got it. Got it. So your blended multiple on the high end is the 6 for the platform, but then you're buying stuff from between 2 and 4. So you're probably netting at 4.5, 5, something like that. And the play is that if you can make that $3 million EBITDA business, turn it into a $10 million EBITDA business, By stitching all these businesses together, maybe the collection trades at 8, 9, 10 times EBITDA.

Travis Jamison That's exactly the thesis. And it's repeatable. You see it time and time again.

Speaker B When does it break?

Travis Jamison Wow. Plenty of things can make it break. One, it's really hard to do this. Imagine blending— like, I mean, just having one company, like, I know, you know, is hard enough. Blending a bunch of companies and cultures together is very difficult. Also, there's going to be a lack of focus on any one business. I think, like the holdco model, for example, individual companies tend to suffer a little bit from that, because there's no focus on one thing. There's that. The thesis can be wrong. The multiples can be wrong. There's a million ways it can go, but it's just really hard. It's really hard to do that.

Speaker B Yeah.

Travis Jamison So they get rewarded for a reason.

Speaker B So in some cases, to go back to my original question, the founder is encouraged to stay. In others, the founder either wants to or is probably best to leave. In the latter cases, how are the independent sponsor locking in the founder so they don't leave on day one? Is it an earnout or an equity role? Or like, how do they keep the founder around for that institutional knowledge?

Travis Jamison They generally want a seller note. They like for the founders to roll equity 100% of the time. Those are the, the most common levers. Also, with these deals with independent sponsor, they don't want a business where the founder makes up too much of the business itself, where they're too important. A searcher is a little more willing to do that because they're installing themselves in the CEO spot. They're the operator. The independent sponsors, they want something, so they have to have at least some sort of management layer that can suffice, or they've been working with someone already. Like, the independent sponsor's been working— like, they're doing the transaction, they have a, a person who's an expert in this industry that's just looking for the right thing, and so they'll install them on day 1. There's different ways to do it.

Speaker B Got it. So I just want to— so get underneath— you said they try to lock in the founder, the seller, using 2 instruments. One, a seller note. And the other is getting them to roll a little bit of equity. In layman's terms, can you define both of those?

Travis Jamison Rolling equity just means you're taking part of the proceeds of the deal and you're just putting it into this new deal. Technically, it's a new company, so you're just investing that. You don't actually get the cash, you don't actually invest it, it just counts as the same thing. And the seller note is just debt, essentially. So say you're selling it for $10 million, maybe you have a $500,000 or a million-dollar seller note. It's like just debt owed to you from that, and you want to receive that, right? And there's different ways of— some of the seller notes are, you know, cancelable. If certain criteria is not met, the seller note disappears. Mm-hmm. So say you're like, oh, it's $4 million EBITDA, it's really solid. They're like, all right, well, if it stays there, then I'll give you this much. But if it falls below, well, the price isn't— and isn't going to be the same. And they're never going to ask for cash back. They're not going to like pay you money and ask for it back. So they just put that in a seller note. That you earn if it works out like you said it did. And if it doesn't, then it goes away.

Speaker B Isn't that interesting? I didn't— I mean, I've heard of earnouts, obviously, but I had never heard that a seller note could be canceled, based on the performance of the business post-transaction. That's really interesting and something to be aware of in the T&Cs of the, you know, the share purchase agreement that obviously would, would be in the, in the details of the deal.

Travis Jamison Definitely get an M&A attorney for sure. Don't get your local tax advisor or your local divorce attorney. No.

Speaker B Yeah, yeah, that's one we've seen again and again. The— there are lawyers who probably incorporated your business, did your like employee, you know, agreement, and M&A lawyers is a different species altogether. Maybe in the same firm, but oftentimes not.

Travis Jamison I've had pretty good I've had good experiences with M&A lawyers for the most part. I think the thing to watch out for most with them is to make sure that they don't try and over-lawyer things and kill deals. Like, they're there to protect you, and they're gonna do everything they can. But sometimes I've had to say, like, look, we really want to do this transaction. Don't over-lawyer this thing. Like, okay. Lawyers kill deals more than a lot of people think.

Speaker B Particularly ones that don't do a lot of M&A. Because from my experience, M&A lawyers, They'll know kind of what's quote market, and they'll say, yeah, that's a, that's a market term. That's pretty normal. Like, I wouldn't argue over that because that's in every deal I see versus like a new M&A lawyer or one that does 90% of the work in family law, as an example. They're not going to know what's market. And as a result, they kind of argue on every point because they're trying to protect the client, but not a great situation for sure.

Travis Jamison Yeah, there's so many variations of them. There's the big institutional players and they have to act a certain way. There's, there's the hybrids. Like, I personally use Revision Legal a lot, and I think they're great because they are top-tier attorneys, but they're also just like real guys and just like, you know, under— understand what the real world is like and will talk to you like normal people and not push things too far. So, all kinds of different realms of them.

Speaker B You've done a great job of articulating what makes a business attractive to an independent sponsor. We've talked about it recurring revenue and, you know, not an overly reliant business on the owner and so forth. Having said that, in your experience, why did deals die during diligence? In particular, independent sponsor-led deals? Like, what is it that causes them to die after the LOI has been signed?

Travis Jamison Uncovering skeletons, things that maybe the owner didn't realize when covering. I would say concentration issues they didn't realize. The thing is, it's hard to really generalize because every deal is different. I don't know if I have a great answer for you here. Every deal we see die dies for different reasons.

Speaker B Can you share a story? I mean, obviously anonymized, so we're not talking about a specific— Yeah,

Travis Jamison Well, here's, here's the reason that you see frequently that people wouldn't think. The owner changed their mind, right? They, they've been making good money for a long time. It's time to sell the business. They're getting older. And last minute, the daughter comes in like, you know, Dad, I actually would like to run this. Toast. Yeah, the independent sponsor spent like $300,000 on that too, and just like gone. We see somewhere the deeper you go into it, there's insurance company risk that didn't appear like that at first.

Speaker B Sorry, insurance company risk? I don't know what that is.

Travis Jamison Insurance are payers for health-related businesses, and one rerating can really hurt that. We had a portfolio company that they had 3 You know, they were diversified between insurance companies, and they all re-rated at the same time. And that was a hit. And the company's alive, but like that hurt, right?

Speaker B So sorry, this is like a medical business that that the the person who pays their bills are the insurance companies.

Travis Jamison Yeah, yeah, yeah.

Speaker B Got it, got it.

Travis Jamison Oh yes, I wasn't clear about that. Yeah, it was in my head. It made sense. So we've seen we've seen issues where one of their major clients was like. a family member they hadn't disclosed. They're like, I mean, can't trust that relationship to stay. There's just, there's all kinds of stuff. Some of them are sketchy, plenty of them are innocent. Everything's different.

Speaker B Interesting. And, and the founder deciding not to sell had, you know, and you raised the, the idea of like, like a daughter walks into the, you know, mom or dad's office and says, look, I want to buy the business, and the deal's off, obviously. Have you seen any other trends among founders who get cold feet?

Travis Jamison Yeah. So the people from my end doing these deals, this is what they do all the time. The people selling the businesses, they maybe sell one in their lifetime, maybe up to 5 in their lifetime. So they don't have as many reps, and so sometimes they just don't understand what everything really is until the very end. Like, oh, that's not what I thought it was.

Speaker B Like what?

Travis Jamison Even just like the taxes they would have to pay, stuff like that. All these things, we've seen that actually kill a deal. We've seen— what else have we seen? We've seen situations where they, in the the seller's head, they were just like done and they could walk away. And then they kind of like start realizing, no, I'm actually going to still have a job for a while. I mean, and you see this probably even more with private equity itself, traditional private equity. They kind of have you for a while with most deals. And I think working for some private equity firms would not be very fun. And I think once they start looking at employment agreements, stuff like that, like, oh, this actually kind of sucks, I don't want to do this. Especially if you've been a founder, an owner for a while, you've had a lot of freedom, especially the business has been doing well. Why trade that? Yeah. And I've had that with some, you know, I still own several different companies myself and, you know, we get offers sometimes like, nah, like it's good. And I think probably one of the bigger ones, oh, this one's huge, people's identity. Yeah. people's identities attached to this, and that they start getting scared the closer it gets to selling. They're like, well, who am I going to be after this? What am I going to do with my time? What's going to represent me now? So all kinds of different reasons.

Speaker B You know, the one that really Triggered for me is the employment agreement, because as a founder, you, you never have an employment agreement. I remember when I sold my last company, I got like a you know, like the damn lawyer, okay, we got to do your employment agreement. I'm like, oh, right. I'm going to be an employee. And, you know, like, you know, this is my boss and these are my stock units and all that BS that you go into. Like when you go work for a big company, I'm like, oh God, I'm not sure I'm up for this. And that was the trigger when I saw the employment agreement that was like, gave me a little cold feet. You know, I ended up signing it, but, but I, I know exactly what you're talking about when you think about. Like, to me, those silly little things that are just like, of course, there's like 19, like there's a checklist of 19 things we got to get negotiated. And one of them is like, yeah, the employment agreement. But to your point, it's one of those for a founder who's never had one is like one of those come-to-Jesus moments to where they're like, oh, wow, this is actually changing my life materially.

Travis Jamison Now, I will say on the flip side, that can be a good thing too. So I had a friend, he recently had a a nice large exit, probably mid-8 figures. And the people that bought him or bought his company, they're a much larger organization with like different portfolios there. And he, he got to go work for them for a while. Not that he had to, he did have to, but it's great. Like, he has a really cushy job now, right? They're, they're not expecting him to, to be there till 9 PM at night like a lot of the other people. He's more an advisor at this point, but he gets to see how these— this bigger organization works that, you know, like, I've never seen inside of that. I don't know what that is. It's a ton of fun. Does he want to do it for the next 10 years? No. But can he put a year or two into that? Yes. And he's going to come out with way more knowledge. He's learned a ton. He's had fun. He made a lot more money from it. So it can really work. And as from the founder seat, there's— I think we all know everything comes back to you. Like, maybe you've got a team running it, but stuff goes wrong, right? You're the person up till midnight trying to fix stuff, stressing, all this stuff. In, in hit, you know, situation where you're just an employee, like, nah, not my problem. You, when 5 PM hits, or in his case 3 PM, like, you go home and you enjoy yourself, and that's great. So it's a flip side to it.

Speaker B It works both ways for sure, and I grant you that. Yeah, yeah, no, for sure. You've been generous with your time. I've got a couple quick questions left. One is around breakup fees. So, you mentioned the example of the founder gets all the way through the process, daughter walks in, says, I want to, you know, want to run the business, and the deal's off. I know breakup fees are very common or somewhat common in very large deals, like massive Fortune 500 Company A wants to buy B, and there's a breakup fee, and that, that there's some problem. Have you ever seen breakup fees in independent sponsor-led deals?

Travis Jamison No. I'm sure they exist somewhere, but no. I think the bigger thing in independent sponsor deals are when deals fall through, does the sponsor cover it all themselves, which is frequently the case, or are there other investors already involved who will cover that as well? At CapitalPad, we don't, but a couple of the family offices probably working closely with certain sponsors might do. that. I don't think we've ever seen it between sellers and buyers.

Speaker B Wow. There you go. Well, listen, I could talk to you forever on this whole independent sponsor thing. For me, it's just a real curiosity because I don't— as we started this conversation, I don't actually know the difference. And so now I feel like having spent an hour with you, I'm now much, much more knowledgeable about independent sponsors, how they're different than private equity, and—

Travis Jamison Deal-by-deal private equity. That's all it is. Deal-by-deal private equity. And so instead of trying to build a portfolio of all this, you just find the one thing, right? Think of like Buffett's punch card theory. If you only had 20 punches and those are the only investments you can make in your entire life, you'd probably end up better. And pin sponsors, the same thing. They spend all their time finding that one perfect deal instead of trying to build a portfolio of them.

Speaker B And they're helped through your platform. So tell folks where they can find CapitalPad and what, what, what they can do to get in touch with you if they're interested.

Travis Jamison Yeah, capitalpad.com. So if you're an accredited investor, you can apply to sign up. And if you're approved, then you can co-invest in these deals, right? $25,000 minimum per deal. And inside, you know, we are— we're not just connecting the sponsors and investors, we're like underwriting these. And we look at dozens and dozens before everyone that we say yes to. And once we do, we send it out to our users like, hey, this is the deal, here's the overview, you can sign an NDA to get the full deal memo and tax returns and statements and all that. We've got interviews with the sponsors, and then you just request an allocation right there. And then we put everybody into an SPV, which is just like a little fund for each deal. And then we invest it together. And from the independent sponsor point of view, it's the opposite. You know, they, they bring their deals to us post-LOI. Here's the full deal memo, we evaluate it and see if it's a good fit for the audience.

Speaker B Such a cool platform, capitalpad.com. And if folks wanted to reach out to you personally, Travis, are you— are you— do you accept LinkedIn connections or Instagram?

Travis Jamison I'm on, I'm on Twitter. I'm not on those too much. But yeah, hit me up. I'll definitely respond.

Speaker B Okay, well, we'll put Travis's coordinates on LinkedIn along with CapitalPad's URL in the show notes at builttosell.com. Travis Jamison, thank you very much for educating us on the unique world of independent sponsors.

Travis Jamison It's been a real pleasure. And yeah, again, thanks for writing that book. It's helped me and so many of my friends legitimately.

Speaker B Really generous of you to say. Cheers.