By Jordan Stolper
When Mo and I began talking about teaming up to buy a business, we had been friends for nearly ten years. We’d watched each other start businesses, change careers, get married, and in my case, have children. We knew our comparative strengths and weaknesses. Mo is a finance and analytics guy; my strengths are in product, sales, and marketing. We were each in our late thirties: young enough that we had the energy and drive to leap into the unknown but old enough to know that starting a new business wasn’t especially appealing. I had just spent a year and a half working for a private equity firm. Through this experience, I learned that what separated my employer from me was the willingness to go raise capital and get a deal done. Mo was winding up a role at a venture-backed company that he had joined twelve months prior. The same VCs that enticed him to join as CFO reneged on an effective promise to fund the company’s next round of growth and the business shuttered.
So there we were, walking around the lower east side of Manhattan on a Sunday afternoon, talking about career opportunities. We covered a lot of ground that day. Literally and figuratively.
On a personal level, we were done working for other people as employees. We’d each come far enough in our respective careers that we felt that we needed to own something and control our own destinies. Mo was maybe more risk-averse about this than me because of his personal responsibilities with his family. I, however, was sure I’d reached the point of unemployability given my issues with authority.
Translating this ambition into something real? Well, that was an entirely different story. Between Mo and I, we had some semblance of how to do this, but neither of us knew exactly where to start. Mo had some small investments in sponsored buyouts, but we knew it was going to be difficult. We agreed on an overall market hypothesis: let’s stick with what we know and find a software or digital media business that we would acquire. Where would we find this business? Would the valuation expectations be unrealistic? How would we get a deal financed? Would one of us move there to run it? How much of our own capital would be needed for any deal? What was our operating strategy?
There were a ton of unanswered questions. None of which could really be addressed absent a deal in hand. Which, of course, couldn’t be closed without adequate equity and debt capital. So we began a parallel process of searching for deals while at the same time searching for capital.
Our two-track process looked something like this:
On the searching front….
We stood up a simple Squarespace site and declared our intentions. There’s nothing like putting a goal down on paper (as it were) and broadcasting it to the world as a way to catalyze action. We pulled together some marketing materials to describe the profile of our target acquisition. We then proceeded to blast it out to, essentially, everyone we had ever met. We pulled down our LinkedIn contacts. Flipped through our historical contacts. And then quickly began setting up conversations with anyone who would take a call. We also identified potential target “markets.” This included VCs who hadn’t raised capital in 24+ months; startups that hadn’t raised capital in 18+ months; investment banks in the lower middle market; corporate development executives who might be considering a divestment. With all of these, we paid a low-cost data miner from UpWork to dig up email address and then sent out mass-customized email blasts introducing ourselves and asking for a conversation.
We also did a decent amount of content marketing. Mo developed a series of simple but elegant financial models that help founders calculate the exit value of their businesses. One model, which we use for all of our deals (I call it the “Mo Machine”) lets the user calculate purchase price based on target IRR. For anyone who is selling to a financial buyer, this is critical knowledge as it allows you to understand the maximum a buyer is able to pay given PE target returns. Put simply, it takes some of the subjectivity, stagecraft, and self-delusion out of the valuation process.
On the financing front….
Our first conversation was with a friend who manages a family office for a New York-based money manager. The family office does a range of direct PE and VC investments. So we thought it would be a good starting point to test our hypothesis. So we put together a deck that presented a sort of straw-man opportunity; fictitious but indicative of the profile of the type of the business we were looking to buy, the operating strategy, deal structure, and target returns. We sat down with the friend - I’ll call him Chris - for feedback. The reaction was generally positive, if skeptical. Basically, what he said is that if you can find a deal like this then we would absolutely take a look. “We do deals like this all the time” were his exact words. And while Chris was not the decision-maker he was a strong influencer. This gave us enough confidence to carry on in the search though Chris made no promises. “Go find a deal then let’s talk” was essentially the message.
We had this same sort of conversation with a handful of other potential lead investors. The response was generally the same. It boiled down to:
We know you guys (i.e. we trust that you are not going to screw us)
We think you’re smart (i.e. we’ve seen your careers play out and suspect that you’re odds of success are at least average, if not better than average)
We like the thesis (i.e. we aren’t seeing a ton of deals like this so the strategy is intriguing)
Items 1-3 are necessary but not sufficient. Go find a deal, package it up, and come back with something fully baked. NYC is full of clever people with good presentation skills; show us that you can actually pull this off.
Sigh...back to searching.
In 2017 we looked at approximately 130 opportunities. These ranged from businesses in our target market (software and digital media) to companies in industries we knew nothing about. Our days were spent on calls, sending out pitches, introducing ourselves, fielding occasional inbound interest, and generally, hustling for deals. There is no trick to this, and there’s certainly no glamour. It’s a matter of executing an aggressive ground game to turn up opportunities.
During our process, we had many conversations with other entrepreneurs looking to do buyouts. Some had been looking for years. They were looking for the proverbial purple dinosaur: a sizable business with strong growth prospects and a low valuation. They were concerned about the ability to raise money, the amount of work necessary, and the professional risk they are taking.
Perhaps we were more aggressive or foolish than others, but we did not want to just look. We wanted to get something done. We made offers on 10-15 businesses over the course of the year. Some of these were in the target market. Some were not.
In the latter category, we looked very closely at a manufacturing company based in Connecticut. Let’s call it Acme Inc. Acme was in the business of manufacturing the dyes necessary to make the masters used for stamping records (LPs). They were one of the few companies in the world that still made these dyes, and the company had been doing well given the resurgence of turntables. It was owned by an older gentleman who was ready to retire and move to Florida. It employed 20 or so people. Valuation expectations were more than reasonable; the business had hard assets to borrow against, and there was a foreman who could supposedly run the manufacturing shop with little to no supervision.
Was this our deal?
As an entrepreneur I’ve always believed that the businesses people start are both an outgrowth, and a reflection, of their personalities. In a weird way, it’s usually some mix of what you know and the types of risks you are comfortable with. For example, someone who knows landscape services is probably not going to start a wealth management business. There are exceptions, of course. Domain expertise cuts both ways; muscle memory can make mastering the fundamentals of the business easier, but it can also be constraining. Plenty of bright people jumped into a new business and figure it out.
And I think it can work - within reason and more importantly, with enough time.
But when it came down to it, were we - a software entrepreneur and a finance guy - going to trade our sneakers for steel-toe boots and problem solve on the factory floor? Would we know if the foreman was bullshitting us? Would we feel comfortable hiring and firing machinists? I think the answer to all of these questions could have been yes. We could have figured this all out eventually. But is this really how we wanted to spend the next phase of our careers? I very much believe that there is an element of to thine own self be true when it comes to acquiring these businesses. And after much hemming and hawing, it became clear to Mo and me that this opportunity, while compelling, was not the right one for us. Thank god we decided to pass.
By summer, 2017 we had signed ~3 LOIs. All of these deals had fallen apart for one reason or another. The most common reason was that the financials presented by the seller did not make it through early diligence. We would find discrepancies between what was presented in the CIM and what turned up in the data room. Or we would uncover some issue around customer acquisition/growth that undermined our assumptions around growth.
We were both starting to get nervous that we were not going to be able to land a deal within a reasonable period of time. We both began interviewing for jobs, and in Mo’s case, took a position for a few months while the search continued.
During this time Mo heard through the grapevine that a company by the name of Nelnet was selling off a small software company it had incubated. I chased it down, and we looked carefully at the business. We decided to pass. So I called up the CFO of Nelnet to let him know we were not going to move forward.
While on the phone, I casually asked, “Are you guys selling anything else?”
Well, it turns out that they were selling a company called Peterson’s. Were we interested?
Our search was about to end.