Episode #64 Chris Younger – Entrepreneur-First Investment Banking

Chris Younger co-founded Class VI in 2005 with a mission to Enable the Entrepreneurial Spirit. Prior to Class VI, Chris spent more than 20 years gaining experience in executive management, marketing, sales, law, and mergers and acquisitions. Chris was a co-founder and President of Expanets, the nation’s largest provider of converged communications solutions. During his tenure with Expanets, Chris led the acquisition and integration of 27 companies, ranging in size from $2 million to over $1 billion in annual revenues, ultimately leading to its acquisition by Avaya in late 2003. Prior to Expanets, Chris was an associate with the law firm of Wilson, Sonsini, Goodrich and Rosati, and clerked for the Honorable Jesse Eschbach of the U.S. Court of Appeals, Seventh Circuit. Chris is a graduate of Miami University and Harvard Law School and has also studied at The London School of Economics.

In this episode we talk about buying and selling entire business of several perspectives as Chris has experience in both. We explore the process of selling a business, where to find buyers, getting the timing right, and; most importantly, getting the business itself ready for sale. We talk about different mistakes entrepreneurs make, how to avoid them, and then get the best possible price for the business. We also dive into the effects of covid on the M&A market, differences between boutique investment banks vs. large Wall Street Banks, and Chris offers some career advice.  

Link

https://www.classvipartners.com

Chris Younger: chris@classvipartners.com

https://www.wsgr.com/en/

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EPISODE 64

[INTRODUCTION]

[00:00:04] ANNOUNCER: Welcome to The Wall Street Lab Podcast, where we interviewed top financial professionals and deconstruct their practices to give you an insider look into the world of finance.

[00:00:23] AVH: Hello and welcome to another episode of The Wall Street Lab Podcast. Today’s guest is Chris Younger. Chris is co-founder and managing director of Class VI Partners, a boutique investment bank based in Denver, Colorado. Before Class VI, he was the CEO and owner of Silvercloud Companies, a private equity firm based in Englewood. Before that he was the president of Expanets, a company that he co-founded and was the president of. During his time as president of the company, he led 27 acquisitions and integrations into the company, and then later sold the company to Avaya.

Chris holds a Doctor of Law degree from Harvard Law School and a bachelor from Miami University. In today’s episode, we talk about how to sell your company. If you are a founder, this is an episode that you should definitely listen to. If you’re on the investor side, then you should still listen to it, because you can see how it is to be on the acquiring side. We talked about what mistakes founders or owners of businesses make when trying to sell the companies, what Chris advises them on how to better prop up the company value, how to get in shape for an acquisition. He tells us some funny stories of his 20 years in M&A. I hope you like the episode.

Now, without further ado, my interview with Chris Younger.

[INTERVIEW]

[00:02:02] AVH: Chris, hello and welcome on the show. It’s great to have you.

[00:02:05] CY: Thanks so much, Andy. Appreciate you having me on and thanks for all that you guys do on The Wall Street Lab. I was telling my wife, I wish that we had had one of these when I was younger. I probably would have made fewer career mistakes. It’s great what you guys are doing.

[00:02:21] AVH: Thank you so much. I mean, it’s a really great way to talk to fantastic people like you, so we always say, it’s our way to cheat ourselves to some great advice. In the process, some other people get some help as well and learn something, so it’s just a win for everybody.

[00:02:38] CY: Well, I’ll try not to let you down, Andy.

[00:02:41] AVH: I’m sure you won’t, but let’s see. Who are you? Tell us a bit about yourself. I know from our previous conversation, you have a very interesting background, so fill us in.

[00:02:54] CY: Sure. I think you might describe it as career ADD, but I actually started out in law. I worked for a federal judge on the Seventh Circuit Court of Appeals here. It was in Chicago. Then spend a couple of years an attorney in a firm out in Silicon Valley called Wilson Sonsini, did that for a couple of year. Quickly learned that that probably wasn’t going to be for me long-term. Then I left to go work for an investment group in South Dakota of all places. Through that, I ended up helping start communications business that was a rollup. Rollup meaning, we went out and acquired a bunch of companies. Even at that relatively young age, they put a lot of trust in me, which I was fortunate for.

We went out and did 27 acquisitions over a couple year period, so it was really, really active. Learned quite a bit. I always joke that out of all those acquisitions, a third went kind of as we expected, a third I probably look a lot smarter than I was and another third, I probably should have been fired for. But we built that company up. We got it to over a billion dollars in revenues. Then integrated those businesses. We dealt with 9/11 and the recession and then we sold it to Avaya, which is a communications company here in the United States. Tried to retire for a couple of years. My wife decided I needed a happy to get me out of the house, so we started what has become the company I’m currently with, Class VI Partners, which is an investment bank and a financial services firm. I’ve had a great time. Our clients are mostly entrepreneurs and those are the most fun people to spend time with.

Like I said, a little bit of career ADD, but really, I’ve had a good time with it.

[00:04:46] AVH: It’s sound like a very low-key hobby, like other people, they do their garden. You just start an investment bank. I mean, I get it, right?

[00:04:57] CY: Well, I started it with my business partner, David Tolson. Seriously, we were going to do a couple deals a year and kind of enjoyed ourselves. Then we started to get busier. The way this business works is, if you do a good job, your clients will refer you. As we started to get busier, we looked at each other and said, “We better hire some folks because we’re going to run out of bandwidth here fairly shortly.” So we did and we’ve been very fortunate to build just a terrific team. We’ve got 20 people now and our theme has always been, “Take great care of clients and they’re going to take care of you” and so we’ve been really, really fortunate and it’s been a fun ride.

[00:05:39] AVH: I can’t imagine. I want to dig deeper into Class VI a bit later, but you just mentioned something that I can’t just let go. I love the book from Ray Dalio, where basically I always say the first 10 chapters of his book, Principles is just, “Look, guys. That’s all my mistakes I made in my life. It’s I’m worth $20 billion, but actually, really, I made a ton of mistake.” So tell me, what are the mistakes that you made that you should have gotten fired for?

[00:06:14] CY: Well, when you looked at the, in particular, like I said, a third of those deals, so let’s call it nine deals. Post-acquisition, they didn’t perform nearly as well as what we had expected, and some of those businesses, we had to shut down. I think that if I were to rewind and I think these are — I love Ray Dalio’s book. Those are the things that you learn the most from, right? You don’t really learned that much from things that have gone well in your life. You probably learn much more effectively when, as we say, you’ve been hit by the proverbial 2×4.

In those deals, I think what I missed was paying really clear attention to what is it that we were buying. Our business, we were a VAR, so a value-added reseller. So we resold equipment from manufacturers like Cisco, and Avaya, and NEC, and Toshiba and Siemens. And we would integrate that equipment for small to medium-size businesses. When you really boil that business down though, obviously, those vendor relationships are really important. But the critical piece are the people, right? I mean, it’s the feet on the street doing your sales, it’s the folks that are implementing the systems and it’s the management team, it’s the leader.

One of the things that I learned probably little bit too late was, if you’re doing an acquisition, your odds of success are going to be much greater if there’s a really, really strong number. That’s somebody who has been used to taking direction, is used to managing with a plan. That for us, the deals that were the phenomenal deals, those were the deals, right? They were the ones where that second-in-command was really talented because whether you believe it or not, it’s true. Once an entrepreneur sells their business, even if they’ve committed to stay on, their incentives, their motivations, the amount of time that they’re going to spend in that business is going to change.

That was probably the biggest lesson was, we failed to pay attention. We were acquiring people, right? We were buying a team. If there wasn’t a really strong management team there, those businesses tended not to do as well. There are some other mistakes. We bought a business where the owner had repurchased the business from an ESOP and so we ended up in some litigation and I’ve got a dozen of those types of stories. But those were, again, as I reflect on it, a great experience in terms of learning what makes for a good deal and a bad deal. But that depth of the management team, understanding the dynamics of the customer relationships in that kind of business was really critical.

One of my old bosses used to work at Nexttel. Nexttel was a cellular company here in the United States. I don’t know if people know that story, but they built their bandwidth, their frequency by acquiring taxi companies in United States. He used to say, when they acquired businesses, the people really weren’t relevant, right? What they were acquiring was the frequency so that they could put their traffic over those local frequencies. In that particular business, those acquisitions were much at one level much easier, because it didn’t have the people component to it.

Like I said, Andy, lots and lots of lessons. I joke that I use to be a lot taller before I went to that experience, but here I am.

[00:09:51] AVH: Well, but now you’re a lot stronger, right? It’s not about how tall you are but about how strong your roots are.

[00:09:56] CY: Right. Well, like I said, you try not to make the same mistake too many times, but I’m sure I have.

[00:10:03] AVH: After you made those mistakes with the management team, how then did you in the next transaction or I guess like couple transactions later because it’s not like, you buy the company and then instantly you see what’s going bad. But how did you try to mitigate in the next acquisition, how did you try to mitigate exactly this failure and check that you have a strong second one in command?

[00:10:26] CY: Yeah. I mean, the first one was the size of acquisitions that we did got bigger. We were looking for more mature businesses. The range and revenues, it was from at the small end, maybe a $5 million company and quite frankly, those were the riskiest because they didn’t have that depth of management team. They might have had too much of their revenues and too little, too few customers. When we acquired a division of Lucent, that was our last acquisition and that was about 800 million in revenue. What we did though, through the course of the work that we were doing is we just gradually increased the size of the acquisitions that we were doing, such that we really wouldn’t look at companies less than $20, $25, $30 million in revenues. Because at that stage of company, they typically had a fairly deep management team. They typically had somebody, not the owner who was in charge of sales. They had somebody who wasn’t the owner in charge of operations, so that those businesses would continue to execute well following the acquisition.

The other thing that we paid a lot more attention to was, we spent a lot more time pre-closing talking to the owner in the management team just about motivations, right? “Hey! Tells us what motivates you. Help us understand what gets you up, what drives you.” And we really look for people who had a really strong kind of service ethic. They were looking to serve customers. Those tend to be companies from a cultural perspective that fit really well with what we were trying to do. We didn’t always get it right, but again, if you think about the pace of deals that we were doing, like I said, we did 27 deals in 24 months. It was in hindsight probably not that responsible, but we were trying to get to critical mass very quickly and build the country’s largest bar in that space, which we were successful at.

[00:12:31] AVH: That’s more than one company a month. How do you keep track of like all the things you have to do, like how are you note completely getting confused with the deals? I mean, I tried to start a business, I tried to be an entrepreneur and run this podcast at the same time and I barely can’t keep up with all the open tabs in my head, right? How do you do this when you’re acquiring like two, three, four business at the same time?

[00:12:58] CY: When you think about the lifecycle of an acquisition, from the moment that you identify a target, to the initial conversations, “Hey! Are you interested in selling?” to then, “Hey! Let’s start talking about a deal, and doing due diligence and then putting the terms of the deal together.” Each one of those was about, call it five to six months of work. So you’re right, we were managing and by the way, it’s not as if we only look to 27 companies, right? We probably looked at 150 companies.

Yeah, it was a lot to track and a lot to manage. The nice thing was, because the businesses were all similar and the types of industries. I mean, they were all in the same industry and had the same customer dynamics, same process for the most part. From that perspective, we had a really good tight set of metrics that we looked at and we had a great team. We used an outside accounting firm to help us with financial diligence, we had an outside legal firm to help us with legal diligence. We had a couple of outside consultants who are specialists in the industry, and then we had on our end, we had a team of four or five folks managing the deals. I had a great team to support. But yeah, it was quite a bit to keep track of.

Again, not all deals are successful, so you could spend four, five months on a transaction and have it fail which is in a was always disappointing but hopefully, you were better off not doing that deals and closing that deal.

[00:14:41] AVH: Interesting. Now, let’s jump couple of years ahead. Your wife tried to get you out of the house, told you, “Okay. Sell some companies.” Why did you start again? Why are you focusing on entrepreneurs?

[00:14:56] CY: Yeah. I think for her, it probably didn’t matter what I did, as long as I was out of the house. I think this happened after I was trying to reorganize her spice drawer, I think. She decided that was the time I needed to find a hobby. One of the things that as I reflected back on this experience, doing all these acquisitions, one of the things that I learned about myself as I love working with entrepreneurs. They are some of the most interesting, talented, driven, persistent, resilient people around. I had a lot of respect for them and what they did. Particularly here in Colorado, we have a lot of midmarket businesses, so that’s really what makes the economy go around.

For me, it was more — if I had my choice, who would I like to spend time with and for me, that was an easy answer, right? I really, really love spending time with entrepreneurs. Although they have a lot of common traits, they all have their unique idiosyncrasies and they’re fun to work with. That was the primary driver and I’m happy to say, that’s proven to be true with all the work that we’ve done. We’ve probably touched over 200 entrepreneurs in our lifecycle here.

[00:16:16] AVH: How did the work that you are doing now as an investment bank differ from what you did as an attorney?

[00:16:24] CY: I think being an attorney was definitely helpful, because you understood the deal process. I think the work that I did and the consolidation was probably even more relevant, because I got deeper into the diligence process as it relates to small, medium-sized businesses. These are companies with revenues anywhere from $15 or $20 million up to $300 or $400 million. So the acquisitions that I did and all those lessons were also really helpful in understanding number one, how the process works; number two, how do you think about what makes a company valuable; and number three, how do you tell that story so that the buyer hears it.

One of the things that we’ve learned is, the language of an entrepreneur a lot of times is different from the language of an investor or a buyer. I think great investment banker is able to translate, right, the entrepreneur story into the story that the investment community is going to hear and appreciate. I think, again, being on the buy side for all those transactions helped us quite a bit.

[00:17:32] AVH: Yeah. I mean, we just started two weeks ago with an incubator for the old company I have found and they always say, “If one start to a user, one start to invest and probably a completely different.” This is what many entrepreneurs have to learn. Are the people you working with mostly sellers of the businesses or are they also coming to you to help them buy smaller businesses?

[00:17:58] CY: We do both. We do — in the vernaculars, it’s called sell-side business, right, where you’re representing a company, either to raise capital or to sell their company or recapitalize it. And then we also do buy side work, where we’ve been hired typically by a larger company. The work that we’ve done, we’ve done work for public companies, private equity firms to go and look for acquisition candidates and then help them manage those acquisitions. But most of our businesses on the sell side, probably 80% and 20% on the buy side.

[00:18:33] AVH: Can you describe how usually one of those deals would look like? Let’s focus on more involved entrepreneur looking to sell his or her business. Is it more that they come to you and say, “Hey! I want to sell my business and I don’t know who to talk to” or is it that a large company came to them, it was like, “Hey! I want to acquire” and they’re like, “I don’t really know if I should do this. I have no expertise. I’m going to talk to Chris first”? How does this usually work?

[00:19:05] CY: I would say, it kind of breaks into thirds. One third is the situation that you just described, Andy, which is, somebody’s been approached by a buyer. Since they’ve never been through this process before, they want to talk to somebody who has that can help shepherd them through that process. Because it is, I always explain to entrepreneurs, selling a company is like any business process, right? If you have a really disciplined, proven process and it’s executed by people who have done it a bunch of times, you’re likely going to get predictable results. If you do it ad hoc without a process or try to — we call self-medicating, it’s probably not going to end well. That’s maybe a third of the people, right? That, “Hey, they’ve been approached and they show up.”

There’s another third that they’ve concluded, “Hey! This is the right time for me to sell my company,” whether that’s for them personally or maybe there’s a certain cycle in their business that they feel this is the right time to sell the company. Those clients want to run the process, they want to put the book together, get the financials, prepare all the diligence materials, and then go to market and go talk to a bunch of different potential bidders so that they can solicit bids and run really an auction process for their business.

Then there a third group that I would put in the category of lifelong learners or planners and they come to us. One segment of our businesses is exit planning. That’s really working with business owners, two, three, four years ahead of when they intend to take their business to market to go sell it. As you might expect, right, the deals in that first third, they can be fine deals, but the deals in that last third, right, where an owner has been intentional, and put a plan together, and dealt with any diligence issues in their business and really refine their story. Those deals tend to go a lot more smoothly and they ended up getting more money. It’s kind of those three buckets.

[00:21:13] AVH: Do the prices vary a lot that you can achieve? I imagine because if the company already wants your business and you didn’t even think about it might have to offer more than if you were the one coming to plea and wanting to sell. Do you think that affects the price or is it just how you end up doing the process?

[00:21:35] CY: That’s a great question, Andy. Because if you think about it, think about that first scenario. Somebody’s approached you to buy your business. So if you walk through how that conversation occurs. “Andy, this is Chris. I’ve done some research and I really think your business is one that we would like to acquire or invest in.” If it’s interesting to you, if I’m credible and this for whatever reason the timing makes sense to you, you might engage in the conversation and you’re likely going to tell me a story about your business that reflects its best attributes, right? You’re going to paint the story of your business probably in really good light, which makes sense. Because at one level, you’re selling, right? You want to maximize the price that you get for your business.

“Andy, you’ve told me about your business, it sounds really interesting. I’ve asked for some information, you’ve sent it to me, I’ve digested it.” And I come back to you and say, “Andy, based on what you’ve told me, here’s the value for your business, it’s $25 million.” And you’re excited about that, so you like me, you like the offer that’s come across and so you decide, “You know what, I think this makes sense. Let’s go down the path with Chris and see if we can get a deal done here.”

Now, mind you, ahead of this, you’ve never done any preparation for a sale process, you’ve never done any diligence on your business, you haven’t scrubbed your financials to make sure you don’t have any issues. And look, we know from working with hundreds of companies, every company has issues. I will tell you. Every owner tells us at the beginning of the process, “Hey, my financials are really clean, you’ll never going to find any cleaner.” I can tell you, in every one of those, we find issues, right? There are challenges.

The buyer, they’re doing their diligence on — I’m doing my diligence on your business now. Based on the information in this deep dive that I’m doing because I’m asking for every contract you have, I’m looking at every line item on every month of your financials, your income statement. your balance sheet and I’m going to find things. Now, all of a sudden, the picture that I have in my mind of your business is different, right? Andy told me this story, what I’m really learning is, “Hey! It may not be quite as good as Andy told me. What do you expect happens next? That’s when I come back to you and say, “Hey, Andy. We priced this deal at $25 million based on what you told me, but it turns out that what you told me is, it was mostly true but we found some exceptions. I really think your business is worth $20 million.”

I’ve now, as the buyer, I’ve concluded, “Hey! Maybe Andy hasn’t been perfectly straight with me.” You as the seller are concluding, “Hey! This is what I heard about those private equity firms, right? They’re just trying to tie me up and steal my business, and renegotiate the price and try to get a lower price of my business.” When you have that trust breakdown between buyer and seller, it becomes really, really hard to close a successful deal. That’s why 80% of that category of deals that’s in that first bucket fail if you haven’t really been prepared.

Yeah, there’s a big difference in price that we see for deals in that first third versus deals you know in the second and third thirds, right? Whether you’re running a process to make it competitive. When I talked to entrepreneurs to explain this to them, I’ll say, “If you’re bidding on a project and you know you’re the only bidder, my guess is, your price that you’re offering to the customer might be a little bit higher than if you knew you were competing with 10 other bidders, right?” That’s true in the deal world as well.

[00:25:27] AVH: Okay. That’s really interesting. What about the ones in the second bucket? The ones that they want to sell a business, maybe not like three, four, or five years ahead. I’m like, “Yeah. I’m getting older, I want to sell the business at one point. But it’s like, you know what, I just found an amazing house in the Maldives. It’s just like, spend own vacation, I really want to go there now.” Where do you usually find the buyers? Do you have a database? Do you have connections in the industry? You’re like, “Okay. I have done hundred deals with hundred buyers or hundred sellers.” I know this guy is in the health tech industry and now I know ten pharma companies. I just reached out to them or how was the process of finding a buyer if somebody comes to you and wants to sell?

[00:26:16] CY: Another great question. Usually, we like to think of buyers, right, for a business. There’s a set of usual suspects, right? For any business and any industry, there are typically active buyers in that market. In industries where the market is particularly active, where you have a lot of buyers. Those buyers are very easy to identify. What we do in our processes and we think it works pretty well is, we absolutely, you want to include the usual suspects in your process. But we also want to look outside that, and the reason being, if you have a very active market and you have buyers that have done repeat deals in a particular industry, it makes sense of those valuation ranges will start to compress, right? Everybody starts to figure out where the other deals have been done at, and they’re going to tighten their valuation. So the valuation range for those usual suspects are usually in a pretty tight band.

But if you find somebody who is interested in that particular business for a unique reason, right? They want entry into that space, they want to expand their geographies, they want to expand the products that they want to offer, that they can offer. Those deals tend to be at a premium. So typically, our recommendation to clients is yeah, you do want to run a fairly broad process, you want to look at companies that might not be obvious picks. We always tell clients, “Look, 90% of those companies probably are not going to be interested.” But if you find that 10% that are, those valuations are likely to be the outliers. That means, you’ll trade higher than the standard range that the usual suspects would pay.

Our experience has been 50% of the deals that we do are bought by companies or firms that were not in that bucket of usual suspects and those deals tend to be really, really good deals. You do want to be fairly thorough in your search.

[00:28:22] AVH: Would those be usually trade sale deals or strategic acquirers or selling to private equity companies? What kind of deals are those outliers?

[00:28:31] CY: It can be both. We did a deal, a consumer product’s deal a few years back that there were, again, a handful of private equity firms in particular that had done a lot of acquisitions in the space. We clearly talked to all of those firms. But there were a couple of other private equity firms who had basically been left at the altar on a number of those other deals, so they had not yet gotten a foothold in this particular consumer products segment. Because they had lost two or three bids in a row and as you can expect, that’s expensive for them to do the diligence and lose that bid. They ended up bidding even higher on the process that we were running and they ended up winning that. That was a private equity firm. You can see it both for strategic buyers as well as private equity or financial sponsors, where again, they can have — we try not to make any assumptions around the buyer’s motivations. But sometimes, their motivations can drive the price that they’re willing to pay a lot higher.

[00:29:35] AVH: How do you find those outlier buyers? Do you just try to “propagate” in a network or are there any industry events? The thing is, as you said, they are not obvious buyers, right? How do you find somebody that is not obvious?

[00:29:57] CY: Yeah, it’s a lot of elbow grease, right? You certainly participate in the industry events. We have a lot of conversations in the industry itself, so we’re talking to lots and lots of different players in a particular industry and getting a better sense for what that ecosystem looks like. We’re looking up and down the value chain of our client’s business. “Hey! Who are the suppliers to this business? Who are the customers to this business?” Is there anybody in that value chain that could be of interest? Are there people in adjacent markets that could be of interest? We’ve got a fairly disciplined process for how we understand the market and how we understand the players in the market. Then after that, it’s a lot of elbow grease and a lot of conversations talking to folks in getting a sense for, “Hey!” Without being very specific, because you don’t want to disclose the identity of your client, but you want to explain, “Hey! Here’s the type of business. Would you be interested? If you’re not interested, do you know other companies that have expressed interest in this space?” Again, its, I wish I could tell you that, “Hey! In a week you can figure all that out,” but it does take a little bit of time to find those outliers.

[00:31:09] AVH: That’s actually a good segue or a good queue. How long does one of those processes take? Just average. I know everything is different, but how long would it take from a client of yours approach you, “I want to sell” to actually deal being done?

[00:31:27] CY: Yeah. On average, if it’s a client that we’re just meeting, we’ll tell clients, probably 6 to 12 months to get to the wire, to closing. Now, that can vary quite a bit, depending on how well prepared the company is, how well put together their financials and books are. We’ve also had clients where we may have run a process with them that didn’t work for whatever reason. Maybe our client had some issues in their business that made the business less appealing or maybe they decided to pull back in. The next time you take them out, it can be very fast. We just closed a deal recently, where it was a client that we had worked with and they wanted to go back out. We got a deal done in three months, which is, that’s very, very quick.

[00:32:11] AVH: You said you worked with the client before, but if you’re mostly focusing on setting businesses, how did you work with the company before?

[00:32:20] CY: When you take a business to market, as we said, it’s a 6 to 12-month process. There are absolutely situations in which we start that process, and maybe we get into the process and we uncover something in the business which might make the business a lot less valuable than it could be. We’ll have that conversation with the owner and say, “Hey! If we were in your shoes, we might wait. Let’s wait a little bit and let’s take it back out.” You also have deals where you take them out to market and the offers that you get don’t meet the owner’s expectations. Our advice to the client is always in those situations, “No problem. You’ve got a great company, let’s just pull back. We’ll focus on the things that were issues for buyers. We’ll focus on those things that might have heard valuation, and let’s go back out in a year or two years and will reapproach the market.”

I happens maybe in 20% of the deals that we work on, and I will tell you that in 8 out of 10 of those deals, the deal that they ultimately close is usually much, much higher than the deal that they saw when they went out the first time. That’s because they had that feedback from the market and they were able to address things that might have been an issue for the initial set of buyers.

[00:33:41] AVH: What are those issues typically? If you were to name three common issues that where buyers said, “Okay. Look, I don’t feel well doing this.”? Then maybe afterwards, what are three things where buyers, when they see this, they’re like, “This is amazing”? I don’t know if it’s kind of ratio, free cash flow or dept or like any of those ratios. What are the three top to dos and the three worst to dos for a company?

[00:34:09] CY: This will be different sides of the same coin for each one of these, I think. The first one, when you think about why a buyer is buying a company and this applies to most deals, there are distressed buyers out there who acquire companies that are in distress but the deals that we work on are generally these are healthy companies that you have good prospects. If the buyer senses that financial performance is deteriorating or that growth is going to be much more limited than it has been in the past, there’s nothing that will kill a deal faster than not meeting the expectations of the buyer during the due diligence period. If financial performance suffers during diligence, that’s a big, big problem and that will cause buyers to step back and pause, if not back away from the table completely. And likewise, if your business is growing, and it’s growing profitably and is accelerating in its growth, that’s very, very attractive to buyers, because that maximizes their chances of getting a great return on their investment.

The second piece that we see, I mean, financial performance is probably the biggest one. Then there are a whole host of things that can cause buyers to get concerned. One of the more common ones in smaller business is, you’ve got too much of your revenues tied up with a single customer or a small group of customers. It’s called customer concentration. Particularly in project business where, 50% of your revenue came from one customer. In order for us to get comfortable know, that’s just too much revenue tied up in one relationship. Customer concentration is a big one. Businesses where the depth of management team isn’t what it needs to be, so these are — as we talked about before, right? A business that is too dependent on the owner, whether it’s for sales, or marketing, or product development, or operations. That can tend to make buyers nervous.

Then there are factors like, maybe you have an environmental issue that hasn’t been remediated. Well, here in the US, that’s pretty much unlimited liability or maybe you’ve got a significant labor issue. There are all kinds of diligence factors that go into it. On the flipside, what do buyers like. Some of the highest valuations that we see our SaaS businesses here in the United States. These are software as a service, right, they’re subscription models. In particular, those businesses where the renewal rate is very high, the turn rate, customer loses are very low, where the margins that they get on every incremental sale are very high over 90%. Those are extremely attractive businesses and sell for some crazy, crazy multiples. Those are some of the factors.

As a business owner, you definitely want to understand, what are the factors in my own business that could degrade value. We use a tool and I think I mentioned to you, we’re happy to make it available, called CoPilot, which is an assessment that we use to try to get a better sense quickly what are the issues in this business that if an owner had a chance and they fixed them could really increase value.

[00:37:35] AVH: What are the crazy valuations for SaaS businesses? Asking for a friend, it’s not because I want to find a subscription business but it’s for a friend.

[00:37:46] CY: Yeah. I mean, if you’ve got a SaaS business that’s growing rapidly, where it starts to get interesting to most institutional investors, which of the folks that we talk to is, you probably need to be kind of more than $10 million in revenues. But if you’re at that level, or higher and you’re growing really fast, and those incremental margins are high and you’ve got very low churn, those can be 15, 20 times earnings if they’ve got earning or four, five, six, seven times revenues. Again, if you think about it, what do investors want? They want predictable, profitable growth and those businesses provide that and it makes those deals very, very valuable.

[00:38:29] AVH: How did COVID and the whole situation affects the market? Is it that you see an uptake in people trying to sell the business, people that want to get out? Is it that multiples decrease because people are careful? What’s your take of last year?

[00:38:47] CY: Great question, Andy. I would say, it’s almost a tale of two markets, right? For businesses that were relatively unaffected by COVID or benefited from COVID, we’ve had a couple of businesses, one in home fitness, the other one in online training and learning. Both of which did exceedingly well during COVID and those businesses are — the multiples for those businesses went up versus pre-COVID.

It’s almost, if you think back to the recession, right, the great recession, 2008, 2009, 2010. The deals that we’re getting on ’11, ’12, ’13 and ’14, if your business did well during the financial crisis and was what we call recession proof, you traded at a premium. Because that pain for investors of having watched some of their portfolio go through significant downturns, that created an attraction to businesses that were in a much more recession resistant. I think similarly and hopefully we never have another pandemic. But I’m guessing, it’s open people’s eyes to some of these fat tail risks that can happen. Businesses that performed really well during the pandemic, I think will get a premium at least for some period of time, maybe not forever.

But then you have other businesses, right? We don’t do a lot in restaurants or retail, but a lot of those are, they’re just done. So it’s been really sad, because lot of these were really well-run companies, but for them, there’s not going to be any deals other than maybe bankruptcy buyouts or really distressed deals. But it’s interesting, the M&A market kind of shut down in March, when the lockdown occurred. I think there was this perception that, “Hey! We just got to get through the lockdown and everything will come back to normal.” We didn’t really have a frame of reference for how this was going to play out. Then June happened, the lockdown ended and we figured out pretty quickly life is not normal and it’s not to going to go back to what we viewed as normal for quite some time.

I think that took a couple months to process for everybody and then what we saw was August, September, activity pick up dramatically. I think we signed seven deals in that September, October time frame to try to close by year-end. Some of that was driven by the election and concerned about increase in capital gains tax after the election. But we’re still seeing really, really strong activity. Now, the processes are different. In a typical process, you might have six or seven meetings between buyer and seller. The deals that we’ve worked on recently are, you might have one in-person meeting and a lot of Zoom meetings. The market has adapted, which has been fun to watch.

[00:41:49] AVH: Yeah, I also feel, at least in Germany this year, the beginning of 2021. It’s only February and we had so many really big fundings, especially for FinTech companies. This is like something that we felt really scalable as you said, software as a service, subscription-based models. They got on funding this year. Do you see that the money available is increasing because we had other guest talking how more and more money is flowing into VC private equity funds? Because the interest rates are so low, they don’t know where else to put their money, so they’re putting it into alternative investments. Do you see the number of deals going up or the deal sizes or both probably the last couple of years?

[00:42:42] CY: Both. I think there’s really — there are two impacts to the low interest rate environment. As you said with lower returns in the public markets, lower returns certainly from bond investing and in equity, public equity investing coming down. There’s a lot of capital that is looking at alternatives, right? Whether that’s a real estate fund, or private equity fund, or venture capital fund or even these debt funds that provide alternative financing to banks for financing deals, that has pushed capital into the private markets. But the other driver is for most private equity deals, the deals that when we sell a company to a private equity firm, all if those deals are using debt. So the availability of debt and the cost of debt, when the cost goes down and the availability goes up and it’s more competitive, that makes deals for private equity even more attractive, because they get cheap leverage to do their acquisitions with. That bumps up their equity returns. You kind of have a double whammy with this low interest rate environment, and I think it’s been a boom in a lot of private capital providers.

[00:44:03] AVH: We looked a bit into the last couple of years right now. If you worked with so many deals, so many banks, I bet you have some really good stories. The last guest I interviewed had fantastic stories that he also referred to in his book. I’m curious to ask if you have any stories over your experience that really stand out.

[00:44:25] CY: With banks?

[00:44:25] AVH: With banks, with entrepreneurs, with deals that you made?

[00:44:30] CY: Yeah, there are lots of great stories. Some that we put in the bucket of stories we wished he hadn’t seen and stories that I would put in the bucket of that give you hope. I’ll use the latter in the sense of — one of the deals that we’ve — it’s a company we’ve actually sold twice. It was a company called Outward Hound, so they do pet products. We originally sold that business back in, geez, I want to say it was 2013 or ’14. As I mentioned, businesses that did well during the recession got a premium and Kyle Hansen was the name of the CEO. Remember we talked about the thirds. The third of the folks that kind of wait for the offer to come in, the third that decide to go to market.

Kyle was in that last third, where he was a planner, lifelong learner, wanted to prepare his business, so we actually started working with Kyle in 2010. Kyle like a lot of entrepreneurs, just very focused on execution. He built his team, diversified his revenue base, grew his business really well and then did that first sale and got more than he had planned. Then he stayed, he’s one of the very few entrepreneurs that I’ve seen be successful. He grew the business, sold it, then he managed the business again with the private equity firm, a group out of Cleveland called Riverside. Then he sold it again to a group out of Boston and stayed on as the CEO again. He’s one of the few people that I’ve met that can do a startup, migrate, manage for private equity and then manage a much, much bigger business. I think when we started with Kyle, maybe their revenues were $3 or $4 million, they’re probably over hundred million now.

When we were on the dark days of COVID, those are the stories we pulled up and told to our team to pitch that. It’s one of the reasons why we love working with entrepreneurs. They’re resilient, they figure stuff out in and we knew that the entrepreneurs would figure things out. And I think they have by and large.

[00:46:41] AVH: Yeah. I think it’s a great accomplishment if you manage to like grow something from like really small to really big. I mean, how many founders that went out — but on the other side, there’s like also really, really knowledgeable companies, like the companies that had a lot of people know. There are also many of those stores, Twitter, Apple where the founder stayed on for like ages.

[00:47:04] CY: Yeah.

[00:47:04] AVH: Or like came back. Now, before we close up. I mean, you know that our listeners are starting out and always looking for insights into the industry. I was wondering too, as the last section of the interview. Can you describe a bit what’s the difference between a small or like a boutique investment bank like yours versus one of the big Wall Street banks? Why would it might be interesting for young people starting out in the industry to choose a smaller one versus the bigger one?

[00:47:36] CY: That’s a great question, Andy. I mean, the core difference right between a big Wall Street bank and a boutique or a regional bank like Class VI Partners is really the size of deals that they’re working on. Our average deal is $50 or $60 million. Their average deal might be a billion or $2 billion or more. That directly impacts the type of experience that a young analyst or associate is going to have in either bank, right? The experience that an associate or an analyst might have at a big bank is likely to be much more limited, in the sense of, you’re going to be very focused on doing modeling, maybe working on pitch books for new opportunities. It’s probably rare that you’re going to meet, let alone develop a relationship with one of those clients.

Whereas, in our bank or any regional bank, we’re working on smaller deals. So in our personal philosophy and this came to my experience at Wilson Sonsini, we want our analysts and associates to get to meet clients and work with them just as soon as we possibly can. Because we know if they develop a relationship with that client. Number one, they’re going to find respect for that person because again, it’s back to that notion of entrepreneurs. They’re going to find respect for that person and they’re likely going to work much harder for that person than they ever would for me or somebody in our business, right? The other thing, probably the other big difference is that the variety of experience that somebody will get at a smaller bank is going to be much broader.

Our associates absolutely do the modeling, right? They’ve got to be proficient in Excel. They absolutely will help us with pitches. We don’t do a ton of pitches, but they will help with pitches. But they’re also helping tell the client story. They’re getting to understand that client’s business in depth, they’re getting to know the client in depth. They’re going to be participating in the management meetings. They’re going to be participating in the full range of the diligence process. As a result, I mean, it’s interesting because we get calls from folks, kids coming out of college. My basic advice is, I think a lot of it has to do with what are you’re looking to learn and what you’re looking to accomplish with this step of your career.

I think the big banks do a great job of feeding into the big private equity firms. My guess is that, the analysts and associates at a small bank like ours are going to get to learn a lot more about smaller businesses and they’re going to get to know a lot more about business models, and strategy, and positioning and what makes those companies valuable. A lot of it just depends on what you want to do with your career and what types of businesses would you like to work with. I think there’s sometimes a lot of romance about working with large companies at least in my personal experience. I would 10 times out of 10 rather work with an entrepreneur than a corporate board or a business development guy at a big corporation. Most of that is because the quality of the relationship you get with that entrepreneur is just different.

[00:50:51] AVH: Yeah. I mean, I can see that happening. I’ve worked at startups and corporations and I like the intimacy. Now, before I let you go, you mentioned something about free stuff. And as a German when I hear free stuff for my listeners, I’m paying attention. Can you tell us about the software that you and what you — if you would be willing to have listeners that want to start a business or already have a business to check it out.

[00:51:18] CY: Yeah, no problem. This is really probably more relevant for business owners. But certainly, if you had a student or somebody that was just starting out and wanted to learn a little bit more about a how do you assess risk in a business and what impact does that have on valuation. Again, we developed this tool, it’s called CoPilot. If you go to our website, it’s classvipartners.com, you’ll see a link there to take our CoPilot assessment. Certainly, we’ll make it available to any of the listeners that are interested in taking it and also happy especially for your young listeners, if they ever wanted to have a conversation about it, we’re happy to jump on a quick call and chat with them. Like you guys, we take our responsibility to that next generation of folks working in the industry pretty seriously and want to do what we can to help.

[00:52:09] AVH: How could people get in touch with you if they want to know more, interest in you and your firm?

[00:52:14] CY: Sure. You can certainly email me, chris@classvipartners.com or our website. It’s actually a really good source of information. We write quite a bit in our blog section, which hopefully is helpful both to business owners and I think your listeners as well. But again, that’s www.classvipartners.com. Again, I appreciate Andy being on with you and again, thank you guys for what you’re doing. I think The Wall Street lab, like I said, I wish it were around when I was younger. I could have been much more successful, Andy.

[00:52:47] AVH: I’m blushing. Thank you so much for the compliments and thank you for coming on. For me, you definitely didn’t disappoint me and it was super exciting to talk to you. Maybe in a couple of years, we will see each other again and then sitting on the same side of a company.

[00:53:04] CY: We would love to work with you. You definitely fit our profile, so fun people to work with.

[00:53:08] AVH: Awesome. Thank you so much, Chris.

[00:53:11] CY: You bet.

[END OF INTERVIEW]

[00:53:14] AVH: Hey, again. This is Andy, I hope you enjoy the episode. If you did, please leave us five-star review on Apple Podcasts or wherever you get your podcast from or share the episode with your friends, with your colleagues and everybody that is interested. If you want to reach out, feel free to drop us an email or message on social media and I look forward to hearing your thoughts, your comments, your feedback and thanks again for listening. Have a great day.

[OUTRO]

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