HoldCoConf 2022 AARON HANDLER - HOW TO SCALE A HOLDCO INTO AN INDEPENDENT SPONSOR

foreign [Music] [Applause] [Music] recordings for holdco conf 2022 are brought to you by axial axial is a lower Middle Market deal sourcing platform to learn more and to start accessing New Deal slow today head to axial.net as I mentioned in the opening remarks if John's conversation with Emily was the uh solving his personal problems and letting people leaves drop uh I think that's that's this conversation for me I've long thought about uh maybe our future for our organization looking more like an independent sponsor so I'm kind of scratching my own this year some conversations you and I have had in the past and I think it'll be applicable for folks in the audience to maybe see a potential path for how to think about structuring their future growth and I'm excited for this so maybe to kick things off uh if you could share a little bit about your background your professional experience kind of set the stage for your knowledge of the independent sponsor Market yeah sure so first of all thank you for having me excited to be here uh I think yesterday said a high bar in terms of the quality of the content so I hope we can live up to it here so um my name is Aaron Handler out of Dallas Texas um my story is pretty typical I guess I was a kid that thought he was going to go to med school worked in a hospital and realized you know a rare Moment of clarity that I didn't have what it took or it would take to be a doctor um and so went to business school instead discovered Finance became an investment banker and then we got very lucky early in my career and found my way to a lower Middle Market private Equity Group uh based out of Dallas where we did 15 transactions uh out of our committed pool of capital and we're having a great time it was sort of the uh uh you know I thought it you know really it was it was very lucky to be there um but it was very unlucky that my boss didn't want to keep doing it so um I either had to find some money or find a job and I got lucky again and a family office that was a limited partner within that fund and it's seen you know kind of where the junior guys had contributed um or was willing to essentially give us a start and that's how we got Elm Creek Partners started with the backing of a family office and we were sort of an independent sponsor before it was cool and before it was a defined category we were always raising money on a deal by deal basis and then as the market became more formalized we just sort of adopted the adopted the title so let's lean into a little bit um independent sponsor maybe the the lower case use of the word would be hey I raise money deal by idea we have people that give us money we borrow it it's equity and we do deals on a sponsored basis um independent sponsor proper could you maybe set the context for those that may not be as uh versed in kind of some of the Norms maybe your view on how that Market's developed uh put some color on like the specifics of that term proper that's a great question um so yeah I mean uh generally speaking in you know it's a nuanced term I think um yeah it is an independent sponsor on participating in the lower Middle Market so I'm targeting deals 10 to 50 million in Revenue two to eight million of ebitda so uh whether that's lower or micro we can we can debate that um the I mean the defining characteristic is that I don't have a committed pool of capital that I can you know call from um and so I am forming the capital on a deal by deal basis uh uh you know I think the the evolution of it though has been interesting it really in the wake of the great financial crisis the recession of 2008 and 2010 um you had particularly at the family office level um and increasingly I argue at the institutional level um you had uh limited partners that wanted more discretion uh over you know what deals they were being invested in um they were they were starting to resist being within uh blind pools and that really created an initial opening um for the independence sponsor model to become uh more formalized particularly as on the well I'll call on the institutional side um The People's willingness to make co-investments or directed Investments you know became more prominent you know on that side and um you know and as as a and it's and it's really been sort of an interesting I guess Evolution um you know I kind of believe that kind of whatever you see at the top of the market eventually sort of filters its way down to the lower to the lower part of the market and I think two things you know have been have been driving the independent sponsor world uh again one is that willingness or that desire I guess on the part of uh investors the limited partners to um have discretion and you first saw it with the family offices and then then came the fun to funds uh then came the svics then came what I'll call just alternative Capital providers and now even committed private Equity groups are willing to partner with independent sponsors and that's um the I think the other thing there's a couple things also driving that which is again not just the discretion but then also uh coverage we've all heard about the the private Equity overhang that's out there that's a tremendous amount of capital that needs to be deployed and independent sponsors are a way for uh all these different LP classes to gain more exposure to the market to cover the market better and to we're we're forced multipliers you know for those committed pools of capital um and uh and also and we can debate this but I think a lot of the alternative space is being divided everybody in this room might probably characterize as an investor you know we're really chasing multiples of Capital One Way or Another yeah um whereas I think a lot of the alternative space are becoming asset managers and the thing that drives them is and it affects me uh but you know it's philosophy of capital and the ability to increasingly raise more and more capital and have more and more capital or more assets under management and so independent sponsors play a role in helping them meet their goals in that regard just for the context what year was Elm Creek founded uh technically 2006. you kind of got going in 2018. you've seen kind of the full cycle of the rise of this evolution in the system um if we look today at the independent sponsor Market proper could you just no two deals are alike but could you paint with broad brush Strokes um what a typical transaction could look like from a capital stack and maybe some stereotypes of what happens in the market uh yeah um so uh you know I think a typical independent sponsor deal is probably going to be roughly 50 to 60 leverage so debt um so 40 to 50 Equity those are rough percentages um you're going to find that you know of that Equity you're probably going to get a rollover uh part somewhere in the 10 to 20 percent of that is going to be you know from from your seller um you might have an earn out on top of that as well and the balance is going to come largely from you know permanent Premiere Equity Partners so I mean that's a it's a pretty there's nothing particularly original about that it's a standard sort of private Equity structure for sure and then um just touch for a moment on economics for the sponsor yeah um so if anybody's interested in economics there's uh McGuire Woods which is a law firm uh puts out a survey every year um and it's pretty it's become increasingly detailed uh around the economics of the independent sponsor world but in general there's three major components um you're gonna you're gonna try to get a closing fee a management fee and a carry and then there's terms around all that um your closing fee is probably going to run somewhere in the one to two percent range of the total Enterprise value of which your Capital Partner is going to want you to roll some or all of that you know in back into the deal and that's in addition to you writing some sort of a check into it that's meaningful to your balance sheet whatever that may be um the management fee is probably going to arrange somewhere in somewhere in the sort of five to ten percent of ebitda with hopefully a floor and probably a cap um they want you uh fed but not fat and then a carry which is likely going to have hurdles on it either some sort of tiering some sort of preference uh to your Capital Partners before you get to participate in the equity foreign operator that hears this and says this sounds like a great business model we should do this um it's a competitive market uh you and I could go look at a transaction and go to the same Capital providers and both try to get it secured um one of the things that we should be thinking about to Market ourselves to Capital providers why do sponsors deserve to get paid why wouldn't the capital provider just go direct to the market why does this business model need to exist right well some don't think you need to exist or get paid so you want to try to avoid partnering with those guys um it I've I've met some of them so um but in you know I think uh well first what we know is that um nobody can cover the entire market right so that's I mean that's number one right so even even the best private Equity groups you know if they Define their box you know here's what I want to see you know we know they're seeing less than half probably closer to maybe best in classes 20 of the market you know for whatever it is that they say they want to see um so again you know independent sponsors are you know Force multipliers to whatever their strategy is so hopefully we're able to bring you know differentiate detail flow and hopefully what we're bringing to them is by the time we have it it's uh you know either an under competed or private you know privately Source even if there's an intermediary title to it there's hundreds if not thousands of under competed deal processes out there and which we're all hunting for if not directly I'd like to find some of those yeah that sounds nice I like the phrase under competed because I think everything it's hard to find something that's entirely proprietary but um you know you're looking for something that's under competed you know in in a market where um yeah obviously multiples have been persistently Rising you know for a long period of time there's still the opportunity to find you know some sort of value Arbitrage or multiple Arbitrage so that's hopefully what you're bringing and then you know finally you you have some sort of an edge you know whether it's due to your experience the management team that you're able to bring um something that gives you an edge or um you know value-added you know some sort of value add on both on the front end and on the back end you know pre and post you know of that uh of that transaction um we did a transaction where um we did we didn't really believe we had a lot of uh sort of post-transaction value and we basically took an outsized closing fee you know for it um it was appropriate um whereas that's not my preferred model um I also like to eat so you know there's that um so we you know it just whatever the deal calls for so we've been focusing for a minute on the capital provider side of things um let's go back to the uh under competed deal flow um we write a letter of intent and um call up our seller and had great news we're making this great offer I promise we'll get the money it's fine somebody will write us a check for this talk about how you think about closing with uncommitted capital how you think about presenting yourself um Creek now has a track record maybe how did you think about it in the early days when you didn't have the tracker the record that you have today yeah well even today you know I mean like I got booted out of a process last week where I was bringing I was bringing a co-investor that could increase the business by 10 probably out of the gate an operating partner who had built two similar businesses um and could run circles around the current owner um and we still got booted out of a process for two reasons one we had an earn out um which I can solve for um but two because we were an independent sponsor and I was sort of blown away so I mean like track record it's still you know long history of closing deals uh it still happens and it's annoying do you find the the bankers and Brokers to be helpful in explaining this or is uh they're still their view still going to be cash in hand is is preferred like they're they're their job their fiduciary duties to their client that's me and you know they want to they want to maximize value with the highest and balancing is the highest probability of close and so there is no doubt that I mean look there's a risk factor um you know with within with an independent sponsor but I would argue but my argument would be the the Gap is more narrow than than perceived um at least for somebody who's done it a long time we solve for it by bringing uh Capital support letters at the appropriate time um and we've had a long history and success of being able to do that um the um and and we really view our Capital sources as as an investment committee you know quite frankly they they make us better we use them to you know really improve those early conversations from really smart investor sets who are seeing swaths of the market that we don't see because we're often heads down you know looking for our thing they ask awesome questions and uh and we've walked away from deals because of conversations that we've had with capital sources um and because they see the deal differently they see something about it differently and um and and and we've just you know we we take that advice uh seriously so so we really view them as an asset we view our Capital sources as an asset and try to project that to to the sellers you know this is how they make us better um sometimes it works sometimes sometimes it doesn't the value prop for um a sponsor to go to a seller and say hey it's it's an outsourced investment committee instead of me having committed fund I just you know it's outsourced makes a lot of sense um let's talk for a minute about [Music] um strategy when it comes to having multiple assets and we have multiple um sources of capital backing those assets how do you think about things like shared services synergies maybe even conflicts of interest when a sponsor has multiple business activities going on across maybe a microcosm of the world where they specialize and have deep expertise how should they think about shared services and things of that nature uh so I think you know I think in that regard we're we're pretty typical you know compared to say a traditional committed private Equity Group um you know um we thought that we don't look for synergies or ways for for Investments to partner but each investment tends to be its own um Silo um that said you raise a good point though is you know how do you how do you scale private equities notoriously hard to scale and I think the uh the answer to it's really easy so that's under management you deploy it the fees come in it's great I wish um in the answer is systems you know and uh we we are constantly looking for assistance I was just just having this debate with one of my partners on a deal that we closed a month ago um where you know just things like I I'm advocating for implementing a um a system like Carta um where you use you can use your corporate governance and capture level tracking which today is you know simple and my Capital partners are kind of looking at me like why would we want to do this it seems like Overkill it's like until you're five years out and things change and things happen and people change and things shift so we think a lot about no different than the template discussion I think that was happening on this couch yesterday and we think a lot about systems early implementing things earlier than than they need to be done you know so that you know so that we can you know manage more you know over time and do it effectively and not run into conflicts um because we do wind up having even though we talk to a relatively limited set of capital sources it's never exactly the same and we have to and we have we have to do Sherry duties to each of them you know that are very similar and we have to make sure we can find a way to maintain and honor those those commitments you mentioned a minute ago um commitment letters for capital or um that sounds like a great asset to bring to a transaction how do you think or how would you advise somebody uh that sees this model wants to pursue it with the Chicken and the Egg problem I need to get started I'm not Aaron yet so I can't yet get a letter from a capital provider I can go talk to them but I don't have a deal I can go talk to deals but I don't have uh Capital yet I feel like there's a compounding through time where you frankly have a competitive advantage that you've been in the market how would somebody entering the market think about that Chicken and the Egg problem yeah I mean Capital formation probably is my competitive my biggest competitive Advantage is just a function of time and having had success doing it um my my recommendation is it's all about the wraps right so I mean one of the things that I think folks in this room do better than than I do is probably directly Source deals um you can take that deal flow and you can and that is the best opener for a conversation with a capital partner and you know and you take that deal flow uh judiciously you know and you start having conversations with them and it's a learning process you get to know them you get to know how they think you understand kind of what their parameters are um and like any other Capital Partner um and you know and you use that as an iterative process you know and over time you will find and you'll build you'll have confidence and when the right one then comes along is you're having a much different conversation you know with with that with those Capital partners you mentioned earlier I think we'd all relate to this the notion of private Equity moving down Market uh and you've seen the evolution of the sponsor model where do you think we're headed what are the risks and opportunities what if you had a crystal ball what happens five to ten years out with the capital provider the independent sponsor Market what do you what do you see I don't know and and but I'm I'm infinitely curious right what it looks like 10 years from now um again kind of continuing with that idea that anything that's kind of going up at the tippy top of the market eventually presses its way down um that's it some somehow there's there's going to become there will be more efficiency pushed into the into the independent sponsor Market um in terms of the way the capital formation process happens which is not efficient right now just make a bunch of phone calls so somebody says yes yeah I mean and and look one of the reasons that we sit where we do in terms of size is because we've migrated towards wanting to have most of our conversations be with institutional folks who are in the market all day every day and their parameters are relatively stable um whereas when we were when we started we were operating uh and targeting smaller businesses um and uh in our in the capital set there was um more variable um in terms of are they in the market are they not what are they looking for you know and so it's pushed us up Market into a more stable Market but it has changed what we had to look for and and how we operate a little bit but but even with that which has made us more efficient um and uh and we have better I don't want to say better we've had we have deeper relationships I think today um uh it's still a relatively inefficient process so somehow the efficiency of both I think in the capital formation process as well as posts uh post investment and you see the the rise of the secondary Market within within private Equity um you know LP interests getting traded somehow this all filters its way down uh to the to the independent sponsor market and it does kind of call into question then is like well if it becomes more efficient and more systematized does the need for the independent sponsor start to start to decrease and I don't know the answer to that question I still think like we're all in a people business right is it businesses are collections of people and people are investing um and uh and we all we all need leadership and guidance at every level and peer sets and all that kind of stuff so I don't think the independent sponsor gets eliminated but I do think it changes over the next five to ten years I have one more thing here that I will open it for for Q a but again it's kind of scratching my own edge with thoughts on my mind about division that maybe we had done this path one day uh and there's probably others in the room that are thinking the same thing I have a portfolio I have a bunch of businesses I own we have some SBA debt or we have existing investors we have some machine that exists that is today and that machine is now bringing me deal flood that maybe I have a competitive Advantage maybe a differentiation in and I don't need to change business models I need to go from a true small business up to this Middle Market and I can find a larger transaction how should I or somebody in my position that's listening to this think about balancing a current organization in communicating with Kappa providers about this new business model or new organization Pros cons conflicts of interest just any thoughts on I have a business today and now we have a new model going forward yeah I've I've I knew you're gonna ask that and uh I've been thinking about it and I've had some conversations here over you know kind of trying to quietly survey the room you know to try to gain more insight into into the whole Co framework and mentality and there's so many ways to answer that I guess um you know I think I mean the first this issue that comes up as sort of the The Hive the how why and what of what of why you've gone down this path of of holdco because I think when switching to the independent sponsor mindset which is you know basically just a riff on committed private Equity you know it's it's different and um and to the extent that I'm correct that you know alternative asset managers are asset managers and velocity of capital and deployment in NASA that's under management are are key in delivering that premium to whatever the next best alternative is that requires exits I mean and you're incentivized to exit so if if uh someone listened to this has had a mindset of long-term hold I want to be Warren Buffett when I grow up and we switch to deal by deal raising Capital it may mean that the assets we buy into that model are not forever hold assets they are much more private Equity three to five year mindset to underwrite too yeah yes because your your Capital sources with some unless unless you're able to attract I mean never say never you know I mean but the majority of the capital sources that I speak to if you're if you're talking to fund of funds sbic's alternative Capital providers they they have incentives to create exits as well it that pressure pushes its way down it's not good it's not bad it just is um and and uh and so yes so it's either these are not forever whole assets I I tend I've always thought of it as I invest in a chapter of the life you know of an organization sometimes I have to invest in two chapters because we messed up the first one um but uh nobody else here has done that it's fine golly but you know it's a chapter in The Life and and I take great pride in what we what we've built and created and then it's time to hand it on to the next one and you know and oftentimes the team that we build and what we did you know we assembled the right team and and we met the market and did it and the the group that should take it to that next to that next place is a different group so you know I think there's an appropriate Evolution there you know the life of in the life of a company um but it and and again when you consider the the incentive structure closing fee management fee carry well the carry only gets realized if you exit right not only but largely only gets realized if you exit so um I'm sorry I lost the thread a little bit but in terms of like this room considering the independent sponsor model I think one of the biggest challenges you have is what commitments did you make to the to the investors you have today and to the extent that you're sourcing deal flow because of your hold cow are you are you and I'm not a lawyer but I mean just what is your commitment to to they made an investment in your hold code with some some sense of you know that's the asset of the whole cow how about that um and are you able to take it and push it over here and do do a different deal so I think that's a challenge that any most people in this room are going to face that said I think there are a lot of companies being built here which would be great independent sponsor platforms and you you could partner with a guy like me you could probably do it on your own you know um you guys are all master Capital formation people um we're all sales people um so you know but it but it will require a shift in mindset and over and it'll require a shift in your in who you're who your Capital partners are Let's uh open it up for questions yeah I mean our ability to I hate to use the word source and operating partner but to to find operating Partners people with deep industry expertise is key to our being able to bring the whole thing together um and you know over time we've gravitated towards Industries and niches and themes where we know we have relationships that we can bring to the table it's part of part of what we do on a regular basis um it's not a hundred percent but it's it's it certainly makes the deals better when we can when we can do that and the ones we frankly would get most excited about are ones where we have those relationships that we can call on you know to uh to bring to understand Nuance to do all the things that you hope to get out of an operating partner sometimes they serve as board members sometimes they become they become the CEO um it takes on all different shapes and shapes and sizes you know when we do a deal I don't know what the right metaphor is but you've gone from chicken and egg to now you have like a third variable in that equation to have the talent to operate that ass side yeah I mean it's as important as the deal itself yeah we Outsource all of that there are people who are going to do that better better than me I want a heart I want to hire a guardian you know I want to uh you know I use we use a variety of you know law firms you know who bring different perspectives uh to video and have different styles that we try to match to the to the deal process um you know with if it's a health care deal we might use one firm versus you know a manufacturer so you know we really value our our our orbit of of service providers they bring a lot to us and we don't need them all day every day right so better to Outsource that what what is the structures today at Elm Creek you you have a partner there's an office walk us through that real quick I'm running the I'm ruling the world from my laundry room right now so um we're a small team we're a two-person team we've been bigger um you know as much as many as six people um but right now we're a two-person team uh and uh you know it's a straighter partnership between the two of us when you were larger what were those other roles that you had yeah again pretty classic we had you know a couple Associates and an analysts you know at the time um we had a larger portfolio we've largely just evolution of Elm Creek we're kind of on Elm Creek 2.0 and my current partner is not the one I started with I was very lucky to have a great partner for a decade um he moved on to it to something new and uh very lucky to find a new a new partner uh and uh we've done three Deals together now so um that's gosh you can if you can find a good partner that's that's gold I can relate we got time for uh for one more yeah I mean as a small team right you know you get distracted you know depending on what's going on uh in the either in the portfolio or in the deal process my sort of rule of thumb is it's the max per senior partner um is somewhere around three Deals um it's probably more like two and a half um so in the minute and if because the minute two of them go off the rails um you know everything else stops right so um it's it's somewhere in that two to three range per person that that you can oversee and that and that assumes that you have you know really well developed teams you know at the companies themselves you know one of the reasons we focus on the size that we do is that our ability to recruit talent to those to those platforms is better than when we were operating at a smaller level um it's a competitive market out there people want resources um and so we can we can recruit better management teams to larger platforms which allows us then to do more there I'll wrap up with uh one last question on my own so it's kind of double clicking on that you have two or three that you're focused on your partner is two or three what's a day in the life are you playing board member are you parachuting and fixing problems are you getting the phone calls late at night what what is your relationship Ben and I'm sure it Ebbs and flows through time but give us like a snapshot yeah um yeah it might my day in the life is a mixture of deal sourcing uh interacting with our Senior Management teams you know in terms of just sort of our weekly Cadence in terms of what's going on and special projects um and usually hopefully those special projects are positive projects um occasionally they are not they are not um like today you know I'll be on board I'll be on a you know ad hoc report call later this afternoon solving a negative issue hopefully um and uh and you know in reaching out to our Network to help bring resources to to Bear you know on the issue um you know yesterday it was uh you know the afternoon was filled with you know positive you know you know uh positive momentum opportunities on another on a different portfolio company so um so it's a mixture of deal flow um problem solving uh and then uh you know and there's admin work right somebody could solve admin work for me I'd really appreciate it um yeah if I never follow another franchise tax report again I'd be really happy but um you know that's that's the general unless something goes terribly wrong and we have at times had to drop in and and be the management team and we'll do that that's that's and that's part of our we feel that's part of our um not so much our value add but Our obligation really to our Capital Partners it kind of gets back to the um reason why the independent sponsor model exists if you are a capital Source Capital allocator they truly don't want to parachute in and operate as a sponsor you truly can when you need to we in in the when it worked correctly we're the first call and we're the last man standing okay Aaron thank you so much [Applause]