Struggling to Maximize Exit Value? Master Buy-Side M&A Strategy for Higher Valuations

Bruce EckfeldtWelcome, everyone. This is From Angel to Exit. I'm Bruce Eckfeldt, I'm your host. Our guest today is Clay Risher. He is managing director at TrueNorth Capital Partners. We're going to talk to him about his experience working with many businesses. He's had a lot of personal background in the business space, and obviously now in the M&A space, working with several companies, with a lot of insight into different markets and different industries. We'll really talk to him about what that whole process is like.

One thing I always tell founders is that this may be your only deal as a founder when you exit. For the other side of the table, oftentimes it's a Tuesday, and they're going to be running many, many processes, many, many transactions. It's a very asymmetric process at times. I'm really hoping Clay can give us some insights on what the other side is like, what you need to anticipate, and some learnings from someone who's been through the process more than once. So with all that, Clay, welcome to the program.

Clay RisherBruce, thanks a lot. It's a pleasure to be here. I've always enjoyed having conversations with you, so thank you for having me on. I appreciate it.

Bruce EckfeldtIt's great to have you. Before we dive into the world of M&A and exits and all the learnings there, I would love to get a little personal background. Give us your personal story, your professional story. What got you into business? What was the background there?

Clay RisherI'll try to make it brief, because at my age I have to talk in sound bites. Basically, I was born a Texan, in Austin, and grew up with very upwardly mobile parents. My dad was a pretty ambitious guy. He went and got his MBA at the University of Texas at Austin when most people didn't know what that was. He matriculated through his career, through IBM and some other large corporations, before he finally took over as CEO of a company called Exide Electronics in Raleigh. So I always had this business mind from my dad. It was like having a professional football coach as a dad.

But I always had a creative side, and I think that came from my mom. She's a writer. She's a Wellesley College grad. They're two of the smartest people I've ever met. We all have caveats as family members, but both were really good at knowing what they wanted to do with their lives and how they wanted to go about it. I think it shaped me to utilize both sides of my brain, whereas a lot of folks I meet in business today are one side of the brain or the other.

So, long story short, I got into corporate sales and then got into investment banking, which is where I'm at today. It was kind of a long way around. I worked in corporate America, branched off, started my own businesses, exited one, and got back into corporate. It's a long story, I think because my wife and I don't have any children, so we've had some flexibility that most people don't. We were bummed about that, but we have a bunch of nieces and nephews, and it's kind of nice that they all have a return policy on them too. So we don't get stuck.

Bruce EckfeldtExactly. The best of both worlds.

Clay RisherWe just spoil them and then give them back. But it's allowed me to take chances in my career and do different things. I took time out to write a novel. I had a New York City literary agent. I was favorably reviewed by Kirkus. So, for good or for bad, I've been able to take those swings. That's my background. If you were to label it one thing, it'd be a lifelong learner and a lifelong curious person. Every day is a new opportunity to learn something new or meet somebody new who could really have an impact.

Bruce EckfeldtI'm curious, seeing your father in the executive role and being in business, what were your takeaways? Was it, "This is absolutely what I want to do"? Or, "There are some learnings here, and maybe I want to do something differently"? Were there things that were not appealing, given that exposure when you were younger?

Clay RisherMy dad lived for business, and I think he lived for business because his mother was an entrepreneur in the fifties, when women just weren't entrepreneurs. She and my grandfather owned three furniture stores in the Dallas area for years. It's funny, because my dad excelled at sports. He had 200 athletic scholarship offers to play football, from Alabama to Penn State. I think he was so good at business and athletics because the alternative, for my grandmother, who was Finnish and very, very strict, was: you either really excel as a student athlete, or you come work at the furniture store. So he was like, "Okay, I'll get straight A's and I'll get all these scholarships, because I'm never going back to that thing."

Bruce EckfeldtHighly motivated.

Clay RisherHe worked in the store, and that impacted him. I think he was a guy who was driven to lead, and a guy who was driven to constantly perform better the next day than he did the day before. I got a letter the other day from an employee of his company, which I worked at 20 years ago. This guy said, "I just want to take some time to tell you how much your dad meant to me." I still get that a lot. He passed in 2019, and it's hard, because he had a tremendous influence on me.

But he and I are just different people, you know what I mean? He was balls to the wall, all out. He always used to say, "You've got to play hurt. You've got to play hurt in this league." His body was beat up at the end of it. He gave everything and left it on the field. I'm a little more conservative, and a little more bookish at the end of the day. I'm a little less gregarious. So I figured I'd take the best of what he did and try to meld it into my approach, and the things I probably wouldn't excel in, or didn't really have an interest in excelling at, I left by the wayside. But he was a tremendous influence and a tremendous man. They just don't make them like that anymore.

Bruce EckfeldtIt's just a different generation in many respects. When did you first get into the M&A process, or go through an actual transaction, either directly or indirectly? I'm curious when that first came up.

Clay RisherIt's funny, because it happened really early in my career. I was the guy who tested at a 12th grade reading level when I was in seventh grade, and in remedial math. So I was always told, "You're not going to be good at banking. You're not going to be good at Wall Street. Go figure something else out."

I first got exposure to it when we took my dad's company public in '98, on Nasdaq. He'd come back from the road shows, and I'd be out selling our boxes, and I'm like, "God, that seems a shit load more interesting than me going out and selling stuff." So I got exposure to it, but I was always like, "Well, I'm not going to be good at that, so I'll just stay away from it." So I went and started a few companies, but I always had the itch. I tried to get into Wachovia's investment banking program way back when I was much younger, but I think my dad was on the board, and they had an anti-nepotism clause, so I was out.

So I started a marketing firm and turned that around. We built it up to a couple million bucks, and I sold it back to my partners, and I figured, what's next? Then I got into consulting, and I was with RSM, which is under the big four consulting and accounting firms. It's number five, or that's how they bill themselves. If I were marketing them, I wouldn't have billed it like that. But my clients at that point in time were hedge funds, investment banks, and private equity, and I started to say, "Number one, this seems interesting. Number two, these people all put their pants on one leg at a time. I get it."

So I started gravitating towards that. I figured, whether you're a PE firm or an investment bank or whatever, you need somebody with some sales acumen, and I brought a lifetime of sales to the investment banking firm I'm at. I actually went to them because they were a client. I said, "I'm about to launch a search, and I'd really like to become a business developer at a private equity firm or an investment bank or something." This was some years ago. And Fred Rossetti, who's one of the founding partners at TrueNorth Capital Partners, which is the investment bank I'm at today, said, "Well, we're looking." And I said, "Okay, cool. Then I won't have to look far."

So I got into TrueNorth about six years ago, got my licenses, my 79 and my 63, and I've been working in international M&A, lower middle market M&A, with TrueNorth for the last six years.

Bruce EckfeldtJust for the audience, because I sometimes assume everyone knows everything and they often don't, define investment banking for me. When we talk about what an investment banker does, I always joke that it has very little to do with investments or banking, but we call it investment banking. From your point of view, what is your role, and what is your day-to-day activity around it?

Clay RisherThe other bankers in my firm don't want to hear me say this, so I'll give you two versions of what it is. You're a trusted advisor to CEOs and founders, helping manage every aspect of a sale or a buy-side mandate. You have to know valuations. You have to know different vertical markets. You have to be a really quick study.

But you're right. I don't know how many times I get approached with, "Can we sell something to your portfolio companies?" And I'm like, "We're just a glorified real estate office." We have a product, which is our client's business, and we know the investors we can take that business to, pretty much. It's a lot of frog kissing.

I probably get a kid a week coming into their senior year of school saying, "All I want to do is investment banking. Tell me how to get in here. Can you sponsor me?" And I say, "What do you think investment banking is?" Because it's a lot of kissing frogs. It's a lot of sitting in a blind for hours on end and not seeing any 20 point buck anytime soon. It's a lot of highs and a lot of lows. But it's exciting, and every day is different. So I guess to define it, it's an interesting spot to work.

Bruce EckfeldtYou mentioned lower middle market, and you mentioned industries. Do you have a particular area of focus? What types of situations, what types of companies are you primarily focused on?

Clay RisherGreat question. We're generalists as a firm, but for whatever set of reasons, I've gotten pretty good at consumer products. With the exception of one other banker at the firm, I'm probably the resident TMT banker, because a lot of our guys work on smokestack value businesses. I don't know how to put that eloquently. It's just not what they've been doing for the last 20 years: AI, SaaS, all that stuff.

And then by virtue of working with Japan's largest trading firms as our clients, I've been exposed to industries I didn't even know existed before I got pulled into the mandate. Cementitious materials: I didn't realize that the asphalt on the highways is made out of fly ash coming out of steel mills. There's all sorts of stuff you learn. I've gotten pretty well versed in the building products industry. I won't bore you, but all sorts of different stuff.

Bruce EckfeldtOne of the things I personally love about what I do, working with all these founders, is that you learn about these industries and these markets, and it's like, well, someone's got to make that thing. You realize it's a $50 million business, and it's fascinating to see what really drives our economy. It's made up of thousands and thousands of these mid-market and lower mid-market businesses. That's really the huge part of the market.

Clay RisherIt is amazing. You really get a micro and macroeconomic view of things, and a global view. It's wild. You'll never learn enough, you know what I mean?

Bruce EckfeldtYou were mentioning buy-side and sell-side mandates. Give me a sense of how those are different from an M&A advisor or investment banker point of view, and where your focus has been and why.

Clay RisherI've shaken out as more of a buy-side banker. For the crowd's information, buy side is when we get hired by a large corporation or a private equity firm to go out and do a search for a company. They either want to create a platform investment, which is the first investment in an industry, and/or go find add-ons for that. So you're representing the buyer on the buy side. Conversely, on the sell side, you're representing the seller of the business. That's a whole different methodology of doing road shows, for lack of a better term, and doing all the analysis to come up with a valuation. I hope I explained that eloquently and coherently.

Bruce EckfeldtI think it's interesting, because a lot of founders are talking to the sell-side M&A folks, the investment bankers. I've got a business, I want to sell it. I find a banker who's going to make a market for it. We're going to find potential buyers. They're going to help navigate that process. But the flip side is true as well. It's, "I have equity capital that I want to deploy, and rather than trying to scale my business internally, I think we want to do an acquisition." I'm curious, on the buy side, what generally are the motivating factors that make companies want to go out and do acquisitions? How do you assess the driving forces for the buyer?

Clay RisherWell, it's different if you're talking about a strategic acquirer, like a large corporation that's vertically integrated. Say some of our Japanese firms: $100 billion, 150-year-old firms. Warren Buffett's Berkshire Hathaway owns 10% of one of our biggest Japanese clients. They're into everything. And unlike a private equity investor, or what we call a financial sponsor, strategics really want to focus on finding good businesses and making them better. Financial sponsors and private equity are generally looking for distressed companies, or situations where it's a good company but they can improve it.

So they're looking for a bargain. They're looking to get something at a discount. And conversely, very few private equity or strategic buyers want to pay much of a premium. I'll give you an example. Data centers are so hot right now, along with the digitization of the legacy grid in the world: hydro and all the things that drive electricity. Specifically data center MROs, which are maintenance repair organizations. They're third-party organizations that come in and clean out whatever needs to be cleaned out, maintained, upgraded. The big data center companies don't want to deal with that. It's just a service they outsource. So these guys are trading at 20 times, 25 times EBITDA, which is outrageous.

Usually, and I don't want to minimize it, pretty much any business we look at is generally trading between six and nine x EBITDA. It is what it is. So those kinds of things drive buy sides: basically wanting to add on, build, maintain, and grow an existing platform to make it larger. In the context of strategic buyers, they generally buy and hold forever. Whereas private equity will buy, fix, and/or hold, and then sell within a five to seven year timeframe.

Bruce EckfeldtMy general experience and impression is that private equity, the financial side, is more of a game of math. They're looking at the financials and saying, "How capital efficient is this? If I put more money in it, or we figure out how to rightsize some of these things or develop a better strategy, we could scale it, and that scaling can produce additional net margin contribution." There's a financial rationale to scaling the company that's going to generate cash or generate value they can realize on a second exit or second transaction.

Whereas with the strategics, I find it tends to be more one plus one equals three thinking. "We've got these products and services, you've got these customers. Maybe we could figure out a way to leverage that." Or there's a geography, or there's an asset, or there's IP. It tends to be a little more nuanced. I'm always curious, particularly with buy-side advisors, how you figure out what those drivers are. "This company is looking for this type of asset or this kind of situation, because it's going to plug into their bigger strategy." And then how you evaluate deals. It feels much more like wizardry. How do I see where the opportunity is, rather than just, "Send me your financials, I'll run some numbers and decide whether we're going to buy you or not"?

Clay RisherIt really goes upstream. Once we've identified a target industry we want to go after, these large strategics I work with have vast corporate finance departments with people munging on numbers all day long, or munging on lists and databases and all the rest of it. Then our analysts will also go to town, working in cahoots with our partners, to come up with a master list between the corporate finance group of our clients and our analysts and partners, putting together what we think are good targets. We base that on a lot of criteria that nowadays you just check off within the data in CapIQ or whatever you're looking through. It'll give you a reasonable facsimile of some companies that might be a fit.

The bigger thing, and it's not really a problem, it's just a known, is that when you're dealing with private companies, which predominantly we are, CapIQ will say they're a $100 million company. You'll make a phone call in there and they'll be like, "Oh yeah, we just did $5 million last year." So these are the things.

Then what I do is take the finalized list, and I just start smiling and dialing, building relationships and talking to founders, owners, and operators about what their appetite is for wanting to sell. Is it more of a recap? Keep a few people in, send a few people to retirement? What are the long-term goals? I don't love the cold calling aspect of it, but we're kind of warm calling. And I do like the psychological connection you make with founders, because I've been one. I get it. It's kind of lonely.

When somebody comes around and says, "I've walked in your shoes and I understand it," that's not easy. People say, "You're really good at your job," and it's almost like they're implying that it's simple. But it's the sum total of however many years of getting my ass kicked and learning life's lessons to be able to talk to a 40, 50, 60-year-old founder who may have never even considered selling their company until we start talking. You know what I mean?

Bruce EckfeldtI'm curious what those initial conversations are like. You've identified something on paper that looks interesting, you've got the contact, you make a call or you connect with the founder. What are you actually looking for in those early conversations?

Clay RisherThat's a great question. I think just synergy. You know your clients, and you know the kinds of personalities that are probably going to gel if there is an acquisition. I can go through a morning full of hang-ups, and this kills me, because I think people are so ill-informed. I'm like Willy Wonka calling in with a golden ticket, and people are so harried, or they don't get it. I'm talking about multibillion-dollar companies that are going to be cash buyers, or cash and equity, and then you get another bite of the apple. Why would you hang up on that opportunity? That's a once-in-a-lifetime deal.

But anyway, most of the time people will call me back, and it just starts with a simple conversation. I just try to listen and add value where I can. It's so far from being a manipulator. It's cliché, but I go to each conversation to meet that person where they are. I've done my research. I've looked them up on LinkedIn. I've seen if we have people in common. I spend a lot of time on their sites trying to understand their business before I even pick up the phone. So the conversation is like a first date, and then you hope it goes forward from there. But pretty much, the data we get on these private companies is far from reality.

Bruce EckfeldtYou need to get real information. So assuming a founder is interested in talking, like, "I'm curious to learn more," walk me through the phases you go through in terms of evaluating. "We have to answer these things, and if that looks good, then we go to this step." Walk me through a little of your process.

Clay RisherYou want to weave a little science and a little art into every conversation. You want to get to know the person a little better first. Then you're going to ask some key metrics, and they may not be willing to divulge them unless we're under NDA. That's fine. You just say it as innocuously as possible: "If you don't want to go down this route right now, that's fine." Those first phone calls are generally, "I've given you a lot to think about."

I usually have a thought process of how best and most efficiently to describe my client. In the instance of my one client, it's very easy to get people interested once you say Warren Buffett and Berkshire Hathaway own 10% of the company. Because then they're like, "Whoa, wait a minute. Who?"

Bruce EckfeldtThat's serious.

Clay RisherBut you just have to find those kinds of hooks, and then you can have those secondary conversations: how many employees do you have? How was last year? A couple of years back, it was a big question about how COVID was. Did you take PPP?

Bruce EckfeldtExactly. SBA loan, or whatever.

Clay RisherEIDL, yeah. All that stuff. And you know what your client's looking for, because you've already discussed it. They're looking to buy a $50 to $250 million enterprise value deal. They're looking in a geography that's very relevant. They're looking for a nice customer spread, no customer concentration. And what does the executive management team look like? It's not rocket science, but I think it's all in the delivery.

Bruce EckfeldtI do a lot of advising with founders on the sell side, and one of the things we say is that we've got to get ready to go to market. Don't take an unsolicited offer. Let's figure out how we create some competitive sense here. We want to get a couple of people interested so we can understand where the numbers really should be and play things off each other to some extent. How do you navigate this, or advise potential buyers, when a seller is like, "I'm interested," but there isn't any other competitive bid? Are you looking to make these quick deals before sellers really go to market and create a competitive landscape? How do you navigate that?

Clay RisherIt's deal by deal, and it's a great question, because ideally what we want are unsponsored, founder-led businesses that haven't gone to market yet. Some of our largest buy-side clients just say, "Look, don't even get me involved in a PE-owned company," even though it may be time for them to exit. So you're really looking for that diamond in the rough. Competition's ubiquitous.

Some owners, like a guy I talked to with a general electrical contracting company for Mid-Atlantic data centers, are like, "I started building this business QoE ready since week one." So he runs his books like a private equity firm runs their books. He knows exactly what his free cash flows are at the end of the month, what his customer concentration is, what's forecasted. And then you've got the owner where maybe it's a lifestyle business, or it's a couple of generations down and they're not as focused as grandpa was, and the Aspen ski vacations end up on the list of add-backs and all the rest of it. So it just depends. Ideally, you want to get them unsponsored and not in the middle of a process.

Bruce EckfeldtTell me more about the things that either make a deal go well or make the deal complicated, or potentially even sabotage it. You mentioned having the books in good order. You also mentioned having a whole bunch of expenses that are really personal expenses going through the company. What are the deal accelerators and deal detractors you've seen in the work you've done?

Clay RisherI'll give you an example. A small manufacturing company in the Southeast, I'll put it that way because it's a live deal. There are some state and local tax issues. I believe it was an act of omission, not commission, to not file tax forms in certain states where their products are sold. But that kind of stuff just sets off red flags. You may not want to have outside accounting, but unless you're a CPA also running your business, I would highly recommend giving that part of your business over to the experts, so they're building your business with you foundationally.

So it's stuff like that. And are the executive leaders using this as a piggy bank? Is it a lifestyle piggy bank for them, or is it a going concern that's profitable? You always want to be looking at your EBITDA margins. I think anything from 15 to 25% and beyond are always good numbers for acquirers. They like that. Customer concentration: you cannot come to a buyer and say, "I've got a $100 million business, and $99 million of it comes from Exxon."

Bruce EckfeldtDoes this vary a little by industry or situation? Because on the advisory side, it's tough. We certainly run into this a lot under $50 million. They've got big clients, and sometimes it's 10, 20, 30% of the revenue. I'm not going to tell somebody, "Stop doing business with them and reduce your revenues by $10 million." We can try to figure out how to diversify, but there's always a little bit of: it's easy to grow existing accounts. Where do you see the trade-off between scaling the business and adding more revenue versus that concentration of revenue? Where do you see the break points, where it really becomes an issue?

Clay RisherAs a percentage, do you mean, Bruce? As a percentage of customers?

Bruce EckfeldtYeah. When does the flag really go up when you see client concentration? Maybe it's by industry or type of business.

Clay RisherI think when you're in that 30 to 50% range, you're probably starting to get the little buzzers going off, like in a submarine. It's not quite red, but you've got to go wake up your salespeople. I'm a former salesperson, so I can say that. Go wake up your sales and marketing people and get them working on new client acquisition, basically.

Bruce EckfeldtI'm always curious whether you look at industry concentration versus customer concentration. I've run into a couple of cases where no customer is more than 10%, but 80% of the revenue is all in a really specific, highly related industry or situation. So there's no individual client concentration issue, but 80% of the revenue comes from this area, and if there's an economic downturn or interest rates change or something like that, it's going to affect everyone. How do you look at industry concentration?

Clay RisherIt's a great question. I think it just depends. Some businesses are just built to support one or two industries. But I think that's why you want to perhaps position yourself for sale as a tine in the fork of a larger organization that doesn't capture that vertical. It's a little more research, a little more understanding. But if there's no way to diversify, I think you have to look at that kind of exit. You're doing the one thing this one big company isn't doing. Does that make sense?

Bruce EckfeldtYou can complete the puzzle. You're the missing corner piece they haven't been able to find. And while you may be specific, in the context of the buyer, it may actually be diversification.

Clay RisherI'll give you an example, going back to grid maintenance. Our client has a very large subsidiary in the northwest United States. They do the data center MRO, they do solar maintenance and repair, they install the big substation stuff. But we bumped into a small company they had a very expressed interest in. It was maybe $10 million in revenue, and it was a relatively new business, but they had a LiDAR application that they used with actual helicopters. It'll probably evolve to drones. They can go down the line. Think about how long some of these lines are, especially in mid-America, the flyover states. They just go on forever. And this can quickly fly over and say, "There's a power glitch here. There's a need for maintenance here."

So our client's eyes were this big, going, "Oh my God, this is something we don't do. It's really cool, it's necessary, and it saves a lot of time." So I think maybe you just have to use that first mover advantage when you're in a business like that, one that's very industry and/or customer centric.

Bruce EckfeldtI do find that on the sell side, a lot of it is understanding why buyers are buying. If you can figure out what they're really trying to achieve. Is it just financial? Are they trying to round out a portfolio? Are they trying to get access to a certain customer, or do they want geographic presence or something like that? That is where you can really juice deals and get deals done, if you can really understand the buyer's motivation.

Clay RisherA hundred percent.

Bruce EckfeldtLet's talk a little about valuation and what factors go into the valuation process. My general thinking is that there's always a valuation range, and the question is, based on the nature of your business, how well run you are, and some of these factors we've been talking about, are you going to skew to the higher side of that range, or are you going to get pushed down to the lower side? When you're advising buyers and looking at companies, how are you setting valuation ranges and expectations? How do you create that spread, and how do you evaluate where companies might fall on it?

Clay RisherIt's funny, and this is no surprise to you, I know, but every investment banker thinks they have the secret sauce. The secret sauce consists of three components that everybody has: trades, comps, and discounted cash flows will give you the valuation. And I think people in our industry don't see that it's a dinosaur. Not necessarily the way things are valued, but the way things get to a valuation, the man hours that go into it. I guarantee you somebody's already got an AI program that'll do a DCF in a nanosecond.

So I think it's a great question. It's always a bit of a discussion with sellers. I haven't met a seller yet who doesn't think their business is worth more than the valuation.

Bruce EckfeldtSomething's wrong if that's not the case.

Clay RisherBless them. I've been in that position. "You're telling me it's worth four, and I think it's worth 12." So there's a lot of that stuff. But generally, most of the businesses we end up filtering through are pretty well run.

Bruce EckfeldtClay, this has been a pleasure. We're going to hit time here. Any other piece of advice or suggestions you'd give founders as they're thinking about exits or preparing for exits? One or two things you think they really should do to get themselves prepared for this kind of transaction?

Clay RisherI think begin with the end in mind. Every entrepreneur has to have that balance. You've got to believe you're going to succeed. And I think you need to start from day one thinking there's going to be at least a two or three year look-back on all your books. Keep the personal expenses personal and the business expenses business. File your taxes. Do whatever you can to be, as this owner said to me, QoE ready.

For those who don't know what QoE is, it means quality of earnings, which is one of the diligence processes that goes on when a company is going to be acquired. It's a verification, or rubber stamp, by CPAs that says the earnings they're reporting as a private company are true and verified to the best of their knowledge. So just understand that, specifically if you're going to sell to a financial sponsor, private equity, those guys live in the financials. So run it with as much best practice as you can, I guess. Have fun, and be glad you're not working for somebody else. That would be the other advice.

Bruce EckfeldtExactly. Clay, it has been a pleasure. If people want to find out more about you and the work you're doing, what's the best way to get that information?

Clay RisherSure. My email address is crisher@truenorthcp.com.

Bruce EckfeldtThanks, Clay. This has been a pleasure, with some great takeaways. It's always fun to talk about the M&A side and the buy side and get the insights. Like I said in the beginning, this is the first time founders are doing it, and the other side is often doing this multiple times a week. So these are really helpful insights. I really appreciate your time.

Clay RisherI really enjoyed it, and I always like talking to you, Bruce. So anytime you get bored, give me a call. All right, see you, Bruce.