Steering Through M&A Uncertainty with Dave Roberts from Houlihan Lokey

[00:00:00] Lloyd Metz: Get ready to peer behind the curtain of the private equity universe with each episode of Best But Never Final. Hi, I'm Lloyd Metz, joined by Doug McCormick and Sean Mooney. Together, we'll navigate the corridors of private equity, revealing the uncommon knowledge of private equity. Challenges, successes, and lessons that drive the world of private equity and business forward.

Let's go.

[00:00:37] Sean Mooney: It is great to be back with Doug and Lloyd for another awesome episode along with a special guest. So before we introduce our special guest, let's dispense with the niceties. Doug and Lloyd, how you guys doing?

[00:00:49] Lloyd Metz: Hey Sean.

[00:00:50] Doug McCormick: Good, good. Looking forward to this episode.

[00:00:52] Sean Mooney: All right. We're really pleased to have a special guest today.

We're pleased to bring into the fold Dave Roberts, Managing Director with Houlihan Loki and their sponsor, Coverage Group. Dave, thanks for joining us.

[00:01:04] Dave Roberts: Thanks for having me, guys. It's a delight to be here with all of you and my old friend, Doug McCormick. Always good to log a little quality time with him.

[00:01:11] Doug McCormick: You highlight old there and I know that Dave, but Dave, I think you are our first outside guest on the podcast so that you're either a brave soul or just poor judgment. One of the two.

[00:01:21] Dave Roberts: Well, sometimes during pitches, Doug, they will show a picture of me that's pulled from 2004 and often I'll get the comment.

Does your son work at Houlihan? So maybe these are dog years as I think Sean was saying earlier.

[00:01:37] Sean Mooney: Well, this will be good. Dave is a grand experiment. He's a brave soul. We're going to bring him into the fold. And really this came out of a conversation that Doug Lloyd and I were having about really trying to understand what's happening real time in the M& A markets.

Everyone's guessing, are they ever going to come back? And then that led us into a conversation of like, how are PE firms working with the sponsor coverage professionals now that exist in most of the big, well run, well investment banking firms in this kind of interconnection of the industry that's becoming more and more like an industry.

And so we started talking about who we should bring on just to share that wisdom. Doug and Lloyd said, you know, Dave Roberts.

[00:02:19] Doug McCormick: Hey, Sean, and as we kind of delve down this topic, the way you introduced it, it highlights to me like that one of the really interesting parts of this conversation is the difference in vantage point.

Lloyd and I, like we are so micro and If my firm does 10 deals a year, that's a pretty busy year. And Dave at Houlihan just sees so much more breadth. It's a question of depth versus breadth here. He's got a really interesting perspective on the overall market in a way that Lloyd and I could never get.

[00:02:48] Lloyd Metz: Not to mention Houlihan has some practices that also inform Dave and the rest of the investment banking colleagues about. valuations of underlying assets and the like. So Houlihan has a lot of information in the market that's pretty insightful.

[00:03:04] Sean Mooney: And I would be remiss if I didn't share that I'm a Houlihan Loki alum starting my career there in the late nineties in the wild, wild west of the Houlihan Loki financial restructuring group.

So there's a lot of kindred spiritness here. I'll save those stories for another episode.

[00:03:21] Dave Roberts: Sean, you missed a window. That restructuring guy's been pretty busy for the last year or so.

[00:03:24] Sean Mooney: Yeah, it might've been a good time to come back, but anyways, we have a great conversation here and maybe to kick things off, let's jump right into it.

One of the questions, and I think a number of us have been at a big M& A conference in Las Vegas earlier, and what everyone was asking, and everyone was asking a quarter before and a quarter before, will the M& A market come back to some semblance of what it was? Maybe not the tippy top, but will it kind of the gears become unstuck?

And with that in mind, Dave, can you give us a sense for What's the state of the market right now? Is it going to open up? What's it going to look like from the vantage that you have right now realizing, as we discussed, this market changes in dog years?

[00:04:08] Dave Roberts: Yeah, Sean. So. What is clear is that the number of deal closings over the last handful of quarters has been way off, right?

And there's several factors that we think are driving that. But as you know, pitch activity is way up. So I think the pitch activity that we're experiencing is as high as I have seen it maybe since 2011. And I think most of the banks, middle market banks for sure, are in the same boat and all of us have record backlog or near record backlog and it's growing and it's just waiting to launch.

Part of the reason That we think deal introductions and closings are slow is that there's just simply a fundamental disconnect between buyer and seller expectations. And part of that is people think that the credit markets are weak, but in truth, that's kind of a fallacy. There's plenty of credit availability.

It's just more expensive. And that increased cost of capital is being factored into return calculations. The output of that is simply the buyers can't pay as much for. These assets and get to their returns. They're looking for and this is combined with the fact that the sellers all are targeting 2021 2022 multiples in their minds.

Just kind of a disconnect. One of the other things we're seeing is due diligence is taking longer. Seems like people are grinding on issues. They used to be, they needed a 90 percent certainty. Now they need 95 percent certainty or they need more to really make an investment decision. And I'd be curious on Lloyd and Doug's view on that.

Some of the assets that banks like a lot of the middle market banks have in house, they've had some performance issues. And so lots of these funds are waiting to hit the button to go out to try and grow back into the improved performance that will get them to what they'd like to see on their target returns.

So those are some of the things that we're seeing. We're also hearing once in a while that the national election is something that people are trying to get deals out in front of. We're not really seeing that, and historically that hasn't really had an impact on M& A. Those are some of the issues that we're seeing.

[00:06:09] Lloyd Metz: I will say. We're trying to hit the window right now with a couple of our portfolio companies and selling them. Houlihan's, actually taking one of those companies out. You've had good performance with these companies over the last several years, and we think it's a good enough market to test the marketplace.

One of the companies that is in the process, people were kind of fickle, finicky in terms of diligence, as you described, Dave, and enthusiasm is Muted for some of the bidders, we think it's a reasonable market for good assets.

[00:06:46] Doug McCormick: Yeah, Dave. I think that your assessment is generally consistent with what we're seeing as well.

I'm interested in a couple of things you said and the implications. One is record backlog to me implies that on average, businesses are actually performing really well at this point. You wouldn't be in market or getting ready to go to market unless you thought you had the financial profile that positioned you successfully for a deal.

So I guess I'm just looking for a little feedback on that topic. And then the second is diligence taking longer. I have this thesis that It's not about the recent performance that people are struggling with. It's about the choppiness of the performance over the last several years, having come through COVID.

It's like, Hey, I can validate 2023 EBITDA. What I'm struggling with is understanding is 2023 EBITDA repeatable because 21 and 22 were a mess because of COVID. So anyways, interested in your reaction to both of those questions.

[00:07:40] Dave Roberts: So on the timing question, it's fascinating and we're seeing it time and time again.

It used to be. Let's say we'd pitch a deal in December and the selling private equity firm would say, yeah, we'll, we'll probably want to take this thing out in the subsequent third quarter. And then what ends up happening is we get in there, we do our work. The third parties get in there and do their work.

A fantastic data room gets set up with a great data cube. The positioning is really good. And it used to be that the private equity firm would read that and they'd say, wow, this is a great company. We got to take it out as soon as possible. And then we would go out. It only takes us. 60 90 days to do that.

And historically, we would go out earlier than we had anticipated. And today, that is not happening. People are waiting and trying to get the results so they can look at the forward numbers and maybe get credit for the next year. So I think part of the reason these deals are taking longer is. People don't believe, they feel like they need to get later into the year to get credit for the forward numbers, and that's just a shift from where we were in 21 and 22 to where we are today.

[00:08:49] Sean Mooney: It's interesting, I was taking a peek into some of our data to see if this pitching activity is starting to turn into actual deals, and as I looked at, and this is something we've been tracking pretty closely, Over the last 30 days, we've seen a more than 100 percent increase in demand from private equity sponsors for commercial due diligence.

And so for our listeners to remind you, commercial due diligence is an essential part of any private equity firm's due diligence process where they're trying to understand the market conditions. And particularly a time right now where the market conditions are a little topsy turvy. The 100 percent increase year over year is quite striking in a level that we haven't seen in a long time.

And so it seems like they're starting to come through because this is also something that doesn't really show up in the process until people are serious about something actually potentially happening.

[00:09:40] Dave Roberts: That's definitely reflected in where we are right now. You can feel it coming. Deal introductions have started speeding up, but the pitch activity hasn't slowed down.

So both are moving right now, which puts a strain on some of the systems.

[00:09:53] Doug McCormick: Hey, Dave, so you'd say. Earlier in the year, you kind of thought it was Q2 is when it would really pick up. And now you're saying, Hey, we still believe the general call was right. There's going to be a return to something that looks normal in terms of deal activity, but the precision was probably off.

And you think you're delayed by another quarter or two?

[00:10:13] Dave Roberts: It's not just me, Doug. I participated in a survey in February, 40 bankers and 30 private equity professionals. Everyone was asked. Rank the quarters of 2024 in terms of what will be most active and what will be least active. And almost to a person, everyone said in terms of most active to least active, it was going to be Q2, Q3, Q4, Q1.

As we said today, it's May 16th. The spigot hasn't been turned on fully. So I think that that is going to push out a little bit. We think that this year still has a ton of opportunity. To restart the wheel and we heard this at the conference that Sean referenced, we heard some people looking to later in the year than we think, but my sense is, and based on what we're seeing over here, that deal flow should return, should speed up here in relatively short order, but I've been wrong for a couple of quarters.

[00:11:08] Doug McCormick: So when the seal breaks, do you think it's going to like be that flood? Like we saw, I think in 2021, or is it going to be a kind of gradual increase?

[00:11:18] Dave Roberts: I think it would be a combination of those two things in the sense that our bankers don't want to put deals on top of deals. They're aware of the broader calendar, but at the end of the day, the processes that we run on behalf of our clients, the process is their process.

We go when they tell us to go, we give our best advice, but at the end of the day, it's really up to them. But I think it'll start slowly and then build is the short answer.

[00:11:46] Doug McCormick: In the beginning of the you were talking about how basically This is an interest rate driven phenomenon. Expectations are lagging in terms of buyers feeling like their assets are worth more than the market will pay today.

I guess I'm curious, do you see a difference between the composition of the pipeline, i. e. private equity sellers versus entrepreneurs and founders today versus normal periods?

[00:12:11] Dave Roberts: That's a good question. It's funny, over the course of our firm's M& A business, it's really inverted. It used to be 70 percent founder family, 30 percent private equity, and now it's inverted.

It's probably closer to 70%, 80 percent private equity, but we're still doing a lot of founder and family deals, which makes our deal flow interesting across lots of different kinds of private equity firms. But right now I think we're seeing a healthy mix of founder owned and private equity owned businesses.

I think really it's more asset specific than seller specific.

[00:12:46] Sean Mooney: So Dave, you've got this great vantage across private equity, particularly in the perch that you sit in and the sponsor coverage world. One of the things that we certainly have heard from LPs is they're saying private equity, you got to start selling and your portfolios are getting a little older.

Why do you think that's happening from the vantage that you see? And then when do you see that changing, if at all?

[00:13:10] Dave Roberts: Yeah. So virtually everyone's familiar now with the stats on dry powder. There's 1. 4 trillion in the U S alone and it's growing. And what's interesting about that dry powder is it's relatively young dry powder.

A lot of it has been raised fairly recently. So there's not as much pressure to put that to work. Most people in this business are aware of the massive growth in the number of portfolio companies held by private equity firms, which has been going up at a pretty meaningful clip for some time now.

There's about 11, 11 and a half thousand portfolio companies in the United States based PE firms and 26, 000 globally. And some of this can be attributed to the increase in number of funds, but I think what you're really seeing is A more rapid cycling of the better assets. And then the companies that need a little more Karen feeding are being helped by the private equity firms for a longer period of time for sort of for option value.

So that is leading to this point that you bring up, Sean, which I think is really going to ultimately drive transaction activity. And that is the increased age of these portfolios is really telling more than 30 percent of us portfolio companies have been held for five years or longer. And that number is going up.

And at Houlihan, when things are getting bumpy and tough, one of my partners is fond of saying that's when we put the managing back in managing director, it's time to come up with a strategy and lead and try and push things forward. For Lloyd and Doug. The old adage that hedge funds find value and PE funds create value with the aging of these investments.

It's time for Lloyd and Doug to start creating value for their LPs. And Sean, believe it or not, they're going to try and create a little bit of value for themselves. Actually, these two are just in it for their health and to make their LPs really wealthy. But this issue of creating value and driving value, now's when you got to roll up the sleeves and really get to work to get some stuff done.

[00:15:11] Sean Mooney: This episode is brought to you today by HCI Equity Partners, a lower middle market private equity firm focused on partnering with family and founder owned manufacturing service and distribution companies. ICV Partners, an innovative private equity firm supporting management teams of leading companies at the lower end of the middle market.

And BluWave, the business builders network connecting the most proactive business builders in the world with the best of the best service providers. for critical variable on point and on time due diligence and value creation needs. Now back to the episode. Maybe drilling down on that. Follow me on this metaphor here.

As people listen, they know I love to mix them and use bizarre metaphors all the time here. But as I think about it, I think through the lens of like Nashville. For years, they've been trying to do public transportation. Everyone knows that it's good for the whole city and that people need to take public transportation, but individually people vote with their own feet and saying, And in their own best interest roads, well, yeah, everyone else should get on a bus or train, but I'm going to drive my car because it's faster and it's cheaper.

Now the same thing if you think about in private equity, everyone's saying, yeah, the PE firm's got to sell, but individually they're saying, I get to sell this asset once and I need to make the most out of it for our investors and also all our stakeholders. It feels like we're a bit in that kind of a pinch where everyone agrees that The aging out needs to stop.

The selling should probably start occurring, but at the end of the day, people are going to make a series of individual decisions that are probably perpetuating this. Did that metaphor work?

[00:16:48] Dave Roberts: Well, an adjacency to it is this. I mean, I have a hypothesis that the smaller private equity funds are more reticent to transact.

In this market, because on a percentage basis, so much more of their compensation comes from the carry. So the larger complexes, the bigger private equity funds that are generating lots of fee income just from a U. M. They may be more apt to hit the bid while some of the smaller funds. Really need to cultivate that asset to optimize the carry.

There's people at who land who disagree with me on that. And there's lower middle market, private equity guys who I've talked to about this, who say, well, no, we've got to get these things out so we can raise more money, but that's my hypothesis. It'll be interesting to see over time who reacts first to the aging of these port codes.

Will it be the smaller guys or the bigger guys or both?

[00:17:39] Sean Mooney: Lloyd and Doug, what are your thoughts on this?

[00:17:40] Lloyd Metz: I don't know if you guys saw the Bain private equity report, but one of the things that they highlighted is that private equity as an asset class had negative cash flows. And so, in order to fund a lot of these dry powder commitments that Dave, you mentioned.

You sort of need distributions, right? To make this work. And so your cashflow negative, meaning you're putting out as an LP cash into capital calls from private equity firms, but you're not getting anything back, that's not sustainable. So I think ultimately it's going to pressure everyone from the large mega funds, all the way down to the smaller, lower middle market funds.

You have to generate distributions and get cash back to your LPs if you want to keep raising funds and keep growing. I think that's really what's driving this.

[00:18:26] Doug McCormick: I just think as you think about the choice sheet highlighted in terms of sell now or hold on and try for a better outcome later, I think that's the tension between MOIC and IRR.

And I think different investors have a different bias, but ultimately, I think, you know, When people are forced to balance those two, Mike probably matters a little bit more, at least in my mind. I think that's when I'm forced with a trade off between the two, I'm focused on driving multiple invested capital at the expense of holding longer.

If you have to.

[00:18:56] Dave Roberts: What's the old saying? You can't spend IRR.

[00:18:59] Doug McCormick: And I think it's also, this is a time and resource intensive business. And so. When you've done all the work to create the platform, you really want to have that opportunity to let it compound. And so like the front end is a lot more resource intensive.

And so if you can choose to wait a little bit and let things bake if you will, the return on effort is also really good there. One I guess environmental comment to the way you're thinking about the market. I think I generally agree with you that a lot of what we're seeing here in terms of the reduced deal volume is interest rate driven.

In my own view is. It's hard to imagine a worse time to try to transact with little visibility into the long term interest rate environment, by like, interest rates, seeing all the inflation curves and all the other stuff, like, could interest rates be in a relatively different place in 12 or 24 months? I think so.

And so I think the optionality of being able to capitalize the business in a modestly more constructive interest rate environment, that's pretty compelling.

[00:20:03] Dave Roberts: Yeah, I do think this interest rate issue is part of the stew here that's in the pot that's slowing things down. Again, I think there are other components to it, but It's fascinating to watch financial technology moves into the market to address these issues.

So we have a hundred person capital markets team and capital markets is probably the wrong name. It's really a financial solutions business, bespoke private debt and private equity placement. But part of that business. Candidly, it's been the growth engine of the organization. It was a fraction of that size, just a handful of years ago.

They probably placed 14, 15 billion in capital last year. They did a hundred transactions. They worked with 70 plus discrete sponsors. But one of the product areas that they have really started to emphasize are these fund level financing tools, including continuation vehicles, NAV financings, and those used to sort of be the province of certainly the NAV financing of sort of the broken toy fact pattern.

And today, it's quite the opposite. Because of this lack of liquidity, we're seeing a lot of inbound interest, and we've got a great team that does this. For example, these really successful funds are trying to raise their next fund, but maybe some of the junior partners don't have the liquidity necessary to make the kind of commitment to the general partnership that they'd like to make.

And so these groups are using these tools, the really successful, great funds are using these tools to sort of maybe create a little more glue, if you will, for their junior partners to be more invested in the organization. So, When there's a vacuum like this and you've got these long dated assets. The technology changes, right?

People come up with interesting solutions, whether it be continuation vehicles or fund level financing of different types and guys like us hire really good athletes who understand that work to go in and help our clients solve those problems.

[00:22:00] Doug McCormick: Yeah, Dave, I, first of all, I got to give you a hard time. I love the way you describe that as technology.

It sounds way sexier, and I'm sure it garners a much better fee when you talk about it that way. But actually, I totally agree with you. And I think one thing that most people would acknowledge is I think the private equity community is really good at innovating. And I think there's actually an argument you could say, you know, there's these chapters of innovation, When the first buyouts were started, it was all financial engineering.

Then we migrated to techniques around consolidation plays and this value creation in terms of business building. And I think like the next frontier is. The way people are thinking about financing fund level, the way private equity ownership is transferred into different forms and formats. And so I do think that's a rapidly changing part of the market, both because I think the industry's maturing and then all the things you've just discussed in terms of like why whole periods are elongating and what that's doing to stress the system, if you will.

[00:22:55] Sean Mooney: I do appreciate Dave's comment as well, because if it can be a technology business. Then I think what you can do is you can get a fee that's equal to a multiple of the capital raised versus a percentage, right?

[00:23:08] Dave Roberts: Exactly. Sean, it's actually a SaaS. It's actually a SaaS multiple.

[00:23:13] Sean Mooney: I like that. It's as a service.

[00:23:14] Dave Roberts: Exactly. Fund level financing as a service. Go long on it, guys. Go long on it.

[00:23:19] Sean Mooney: You wonder, like, to what extent is the fact that these continuation vehicles are enabling private equity firms to have the optionality, which I think is a really good thing for both the LPs and the GPs, because then they can in some ways segment the return potential.

If you need the cash now, you can take cash out through the continuation vehicle, or you can continue to play versus you only get to sell at one time. And so I am curious, and I don't know if you have a perspective on this, Dave, to what degree, maybe there's less. traditional M& A because more and more assets are being put into these continuation vehicles that in prior cycles, you wouldn't be able to kick the can down the field a little bit, but now you can because you can use these kinds of interesting vehicles.

[00:24:00] Dave Roberts: For sure, there's a lot more activity in and around those processes, but at the end of the day, it's still small relative to the total amount of M& A. I mean, it's still, the total addressable market is a fraction of what the M& A market is. And what's interesting is the M& A market, the TAM of that is a fraction of the financing market.

So it depends on where you categorize it. If you bucket it with the broader financing world, it's part of a bigger pie, but just those kinds of transactions relative to total M& A are small.

[00:24:29] Sean Mooney: Okay. Maybe to wrap this part of the conversation up, it's going to be very interesting to monitor this kind of aging out of the portfolios across the PE industry. In part because I think not necessarily even an issue related to PE. If you think what's going on in PE, it's optimization and timing. They're waiting until the environment's just a little bit better because you only get to sell an asset once from their perspective. But if you look at the broader portfolios of the allocators, It becomes more of an issue of quality of kind of asset.

So outside of PE, which by and large is print forming, as they typically have done through cycles, you also look at other large parts of the limited partner asset allocator portfolio, which includes a lot of real estate, particularly commercial real estate and venture capital, which by and large have not been marked down yet.

And so it's not only about just the timing of cash in total across a broad portfolio, but it's going to be certain portfolios when they get accurately marked, probably just not going to deliver what they're on the books for. So that pressure is going to build when you're the one kind of ship that's still floating and sailing.

Everyone's going to be swimming towards it a little bit.

[00:25:36] Dave Roberts: There's always been a flight to quality in this business. When you look at the. Longitudinal returns in the space. The big complexes have done really, really well as a group, but an interesting overlap to what you just asked and this new technology, which I'm calling technology, Doug.

Is the fact that people are using these fund level tools for DPI, for distribution to paid in capital. So in some instances, they're using these fund level techniques to scratch the itch that their LPs have, which is to get dollars returned to them.

[00:26:10] Sean Mooney: So they can almost do like an advance or the private equity equivalent of the payday loan.

We'll give it to you now, but we'll get it later because the rest of the portfolio is strong and weak. That's interesting.

[00:26:20] Dave Roberts: Advance rates low, but yes, that is correct.

[00:26:22] Sean Mooney: This is I think a really helpful. Lens into what's happening in the broader M& A markets and maybe with the foundation set here. Let's kind of take it back to the fundamentals and the foundations of this conversation and Dave, one of the things that as I started in the late 90s, in investment banking there really wasn't a sponsor coverage model that was established at that point. The whole private equity market was smaller, and there were fewer private equity firms, there were fewer private equity buyers, it wasn't nearly as complex, and now this industry has turned into an industry, and one of the most critical roles that's come out of that is the role of a private equity sponsor coverage investment banker that serves as that kind of glue in between the two ecosystems.

So maybe for those of our listeners that aren't as familiar with the inside baseball, can you share a little bit about what role private equity sponsor coverage investment bankers serve?

[00:27:22] Dave Roberts: Sure. Like it or not, the investment banking business, all of our businesses, in fact, whether it's PE or services around the ecosystem, they're really out of sight, out of mind businesses.

We view the coverage role At Houlihan is sort of the connective tissue, both internally within our own firm and externally between our firm and the investment community. And so what does that mean internally? My team knows all, and even with all of our group knows almost all of the senior product and industry experts throughout the organization were able to connect the dots internally, disseminate important information, timely information, best practices.

We have a longitudinal view that we share internally on counterparties, on how various private equity firms will be as prospective partners. We have a view on our competitive dynamic and our competitive situation. And then from the PE perspective, from an external perspective, we like to think of ourselves as internal advocates for the firms we work with.

We get them on buyers lists, we show them deals. We get them access to our product and industry experts. We bring them ideas, we push for them in a process. And because we've known the senior leadership of these private equity funds for many years, decades, in some cases, we can tell our stakeholder clients that this is a good group to partner with in good times.

And when things get bumpy, we can talk about culture. We can talk about what's important to them. But we're also, in some senses, the institutional memory when a group has mistreated either us or our clients. There's no percentage in staying mad in the private equity business for very long. But at the same time, past can be prelude.

There are groups that we just continue to try and work with over time, and we just, Don't make any progress with them.

[00:29:17] Sean Mooney: Dave, one of the things that I think is really interesting, you brought up this kind of data construct, and one of it is, I imagine you're quite involved in selecting, or at least bringing into the conversation, which groups should be able to see an opportunity that is being brought to market.

Cause there's a lot of private equity firms and you can't do a 500 person auction, but there's value to precision in that. And then when they're navigating through the process, being able to give someone some sort Is this worth your time? Because time is scarce. So can you peel back the onion a little bit in terms of how you all are using data to understand buyer behaviors, who to include in a process, how to think about how potential buyers will behave during the process, et cetera.

[00:30:01] Dave Roberts: Yeah. We keep a very detailed records. There's lots of data internally on how particular counterparties behave in a traditional two step auction with a check in bid. And we use that information to help our clients. Optimize their time. We all know that in a transaction, fantastic execution by the management team is the best way to drive value in a transaction.

So we don't want them to fall asleep in the wheel meeting with a bunch of folks who are just simply going to be tire kickers. So we use that data and we use the experience of my team and their relationships with these organizations. To really determine how serious a buyer is. And we really try to make sure that our clients are not wasting time with guys who are unlikely to transact.

We sell more companies than any other firm in the world. And we have sold more in the U S for the last several years. And we use that data to our client's advantage. It's set up in such a way that there's a constant feedback loop about whether or not any given organization should proceed in a process.

And my team is part of that analysis.

[00:31:06] Lloyd Metz: Dave, can you give some examples of what you guys are tracking or keeping records of?

[00:31:12] Dave Roberts: Bid behavior for sure. Bid behavior is the easiest one. Uh, what they do with respect to terms in a purchase agreement. One of the key metrics that we check, Lloyd, is. How many IOIs does a group have in on our deals at any given time?

So let's say you've got in a hot market. You've got five, six, seven IOIs in on our deals at any given time, which means you've probably got meaningfully more across all the middle market banks. Do these organizations have the resources to focus or are they really just testing the market to see if a management meetings in the offing, those are the kinds of things that we're paying real attention to.

But I'll tell you, part of the value of sponsors coverage, whether it's Houlihan or any bank, is really the ability to understand the things that aren't on the website. Anybody can look at your website, Lloyd, and see what companies you've done and what companies you're in today. But what they can't tell is where have you made money in the past?

Where have you lost money? Because a lot of times you don't find that on the website. The other thing we can tell you, which deal professional inside of an organization hasn't done a deal in two years. I can assure you back when I was running deals, I liked it. If somebody hadn't done a deal in a long time, sometimes they were willing to do unnatural things in the event to get a deal done.

And I can remember a deal vividly where that was exactly the fact pattern. It really allowed us to push the envelope in the transaction. When it came to the short strokes, some of that softer, and that's just simply having hung around the rim for as long as a lot of us have. But part of it is really just the hard data that our organization and many organizations keep.

[00:32:57] Doug McCormick: I'm struck as you articulated your role in the coverage group's role. Obviously you're bringing good value to your clients, but it's actually one of those scenarios where like, there's really good value to both parties here. So I'll speak for our strategy in particular, but we're, we're generalist, lower middle market, more agnostic to end market and focused on business models and consolidation.

And so for me, I'm less likely to have a deep relationship with the end market banker, the distribution banker, the healthcare banker, or what have you. And I'm trying to leverage the entire resources of the whole hand firm and having one person that can help me navigate that is valuable. And also I think you can speak for the recurring nature of the relationship.

So if you need to plug me into a part of the group that I'm unknown to, because of a longstanding relationship, that's been mutually beneficial, you can exercise the organization in a way that I probably can't just given the lack of continuity or history. The value proposition is unique in the coverage role for financial sponsors.

Given the nature of the repeat business, if you're an entrepreneur, you probably have one or two transactions in a lifetime, whereas a sponsor could be doing. Several or several dozen a year. And I think the value is really enhanced. Just given that dynamic.

[00:34:19] Sean Mooney: Lloyd, how about you? How do you interact with sponsor coverage professionals?

[00:34:23] Lloyd Metz: So we tend to work with our sponsor coverage bankers to give us Intel on the marketplace. What are they seeing in terms of deal flow in terms of sale assignments? What kind of behavior are they seeing with prospective buyers? Because we're generally prepping our portfolio companies for sale. 18 to 24 months in advance.

So we start trying to gather Intel on market conditions and behaviors well in advance. We also, and again, Dave may not like to hear this, but we use our coverage banker partners as intelligence gatherers for us, as we were thinking about new industry spaces to go explore. You may have at HulaHand sold A set of companies in a particular market space that we think is interesting.

So we'll ask our coverage banker, can you go find out information for us? How big was this company? How fast was it growing ballpark? What kind of multiple did it sell for? Just to help us get smarter on an area that we may want to start investing time, get a marker on the board and a new investment, use them as thought partners, as much as we possibly can.

[00:35:33] Dave Roberts: And to the extent we're able to do that within the bounds of confidentiality and otherwise, we're delighted to do it. Exactly. Gentlemen, and by the way, as difficult as it is for me to do, I'm going to give Doug a compliment. He and his guys do a great job of interfacing with my team and the folks that are relevant to him at Houlihan.

And Lloyd, your reputation is the same, that you guys really do a nice job. of making sure folks are in the loop and you're very good at collaborating. But gentlemen, you got to keep in mind that in the relationship between middle market investment banks and private equity funds, the opposite of love is not hate.

The opposite of love is ambivalence. There are firms out there where we have a cordial relationship, but we don't view it as commercial. And that puts a PE fund in a place where they definitely do not want to be. And that's on a list of a hundred other PE funds that look just like them. Are you guys familiar with the term jamboff?

People don't use it really anymore, but it means just another middle market buyout fund. You really don't want to be on the jamb off list. At a place like Houlihan and our peers, the integrity of the process and driving great outcomes for our clients is paramount. I mean, full stop. That's what we're due.

That's why we're in business. And that's why we've grown the way we've grown. But after that, we're going to do what's right for our organization and right for our shareholders. So firms that are unresponsive, difficult to work with, burn a lot of our resources. Outside of a deal context, they begin to fall into this cordial, but not commercial category.

And there's lots of funds that are really big and think they're important. And therefore they think you need to pay attention to them. It's really not how the business works anymore. The firms that we work with more closely, we get to know better. They become clients and that ones that really work at developing the personal relationship, they simply get more attention in a process.

At the end of the day, ours is a people business. The bankers want to work with. Others who they know, who they like, who they believe value them as advisors, as an industry or product expert and candidly value them as people at the end of the day, guys, this is a people business.

[00:37:40] Sean Mooney: I really appreciate that perspective.

And certainly one of the things I've found most liberating since I'm now directly out of the direct investment machine of private equity is I get to ask all these questions I wished I could have asked before. And sometimes that gets me in trouble in the show. So, but that's okay. Cause I'm now I'm out of the recourse is less and less.

Now I'm, I'm feeling empowered.

[00:38:03] Lloyd Metz: This is my favorite part of every,

[00:38:07] Sean Mooney: I'm empowered and no one can get me now. Well, you go where I live. But anyways, one of the things I always love to ask people like you, Dave is the question I was always afraid to ask when I was in the engine, uh, the machine of private equity was How exactly should I be using you to get the most out of you that would make my firm as successful as possible?

And it seems like an easy question that I should have asked, but I was always afraid to ask people that when I was in it, because particularly as a PE investor, I always felt like I was supposed to know everything and Usually I knew about an inch of what I should have known.

[00:38:39] Dave Roberts: Let me answer that in what not to do.

I said earlier, there's no percentage in being angry in this business for very long, but patterns develop in terms of a relationship between an investment bank and a private equity firm, and it gets to the point at some times where it's just a, a Sisyphean task. I grew up in Indiana. The analog to the Sisyphean task in Indiana is called a goat rope.

And what that means is, you've got a post, and then you've got a rope, and you've got a goat tied to it. And that goat circles the post, and it winds the rope around the post, and eventually the goat hits his head on the post. And then he turns around, and he starts walking the other way, and the rope loosens.

And over time it then tightens up again and he keeps walking and ultimately he hits his head on the post again If you're a private equity firm that continues to do that to a bank or to a coverage officer to further torture the metaphor Lucy can only move the football so many times before we decide that maybe we shouldn't be playing football with Lucy anymore, right?

Again, we're always open to talking about a commercial relationship. We're always open to it. But if you continue to waste our time, if you continue to mistreat our clients and our professionals, it's going to have an impact over the course of a relationship. That's what not to do. What do you do? Over communicate, keep your coverage people involved and keep them up to date on all the back and forth between your organization, because we can use that as leverage internally to.

Help further your cause, help further the broader relationship. One thing that some private equity firms do really well is they use their portfolio to enhance relationships with a bank. So they bring them in to have a debrief after they've done the deal. They would talk about how they want to grow it through acquisition.

They introduce you to the management team over time. You just use the portfolio to deepen the relationship. And every time in one of those conversations, something else comes out of it. Our bankers are in it for the long haul. They recognize that the sales cycle in this business can be years and years, and it generally is.

And I think this is true also for companies that you might acquire for. Work companies that you're looking at and analyzing our guys are happy to chat with you about them and get involved if appropriate. This is the way you deepen that relationship. And candidly, you create sort of political capital internally at a place like Houlihan.

These PE funds have to remember that if you don't have a portfolio company that a specific banker or a banking team is tracking. There's likely one person in that investment bank that's thinking about you on a regular basis and that's your coverage officer. Our bankers, our product guys and our industry guys, they're just too busy executing and pitching to be worried about what's going on at specific fund XYZ if they don't have an asset in there.

That's what our group is set up to do. A firm like Houlihan spent a lot of time, energy and resources to create that continuity relationship and it's not a recurring revenue business. It's a reoccurring episodic relationship that we're trying to cultivate in a two way fashion. One other thing, Sean, that I think really is important is when private equity guys are trying to get smart on a space, actually be smart.

And by that, I mean, If you've got one of my industry bankers on the phone in a conversation that I've set up and I've asked him or her to do that, do your homework before the meeting. Don't ask one on one questions that you can easily get the answers to with a little desktop research when you're on that call with my guys.

I watch it all the time where folks are asking one on one questions when you really need to be at a graduate level at that point in a transaction cycle to benefit from a conversation with one of our guys. I think the next thing I would say, Sean, is be honest. If one of our bankers wants to get involved with one of your companies and they have no shot at it, tell us that.

We're still going to be helpful to you, but we're not going to dedicate the resources to it that we would otherwise do. I can't, there are a number of pitches I've been in where I've walked out and I said, we didn't have a shot at that walking in. In that lack of transparency and honesty, it's reflected in sort of how the organization looks at any given private equity firm.

[00:42:48] Sean Mooney: And certainly the VP, the associate, and the analyst whose weekend you ruined will remember.

[00:42:55] Dave Roberts: They love that. And look, the sponsors guys at our firm are here to help you get to know the right folks on our organization and understand our capabilities. As I said earlier, it's a people business. Be thoughtful, kind, be considered and be smart and be fun.

At the end of the day, this is a people business, whether, like I said earlier, whether we like it or not, all of our businesses, private equity. And the service is provided there too, or they're people business.

[00:43:23] Doug McCormick: Yeah, Dave, a couple of things you said there really resonate with me. I think the one would be this whole concept of, we may have the relationship from sponsor to Houlihan and your coverage group, but the real value can be derived by making the direct linkages between the industry coverage banker and the portfolio company, because there's value outside of the transaction.

Right? Like I think our portfolio companies are better served for having interacted. With those teams, because they're challenged, they're understanding the market and it positions you guys well to be successful, to give good advice and get hired, and I think this whole concept of let's just acknowledge.

That we're going to do a lot of business outside of Houlihan and Houlihan is going to do a lot of business that doesn't make sense for us. And we only have to make that Venn diagram overlap a little bit to still have a really powerful relationship. And so, it's like baseball, if you get on base three times out of ten, you're a hero.

And then the last thing is, I'm curious in your reaction to this, there's this balance between not exercising versus not surprising. Candidly, one of my learning moments, Dave and I have known each other for two decades plus. And he gave me a hard time one time, not because he didn't get the mandate, because he didn't know about the mandate.

And I said, but Dave, you guys didn't have a chance. And he said, yeah, but I wanted to know I didn't have a chance because that would have allowed me to manage my constituents better. And so I think it gets back to this over communicating and just helping both sides efficiently allocate resources. And that goes both ways.

I know. There are a number of times I've been in a deal where Dave will say you got no chance, don't waste your time, and that's valuable to me, and at the same time if he says hey it's worth your time, I'm willing to invest resources to get to an answer to deliver a certain proposal to his client, which can benefit the client.

It's that open, transparent, help each side make good decisions with resources in a world of scarce resources.

[00:45:19] Dave Roberts: That's well said.

[00:45:21] Sean Mooney: A couple kind of final questions I have here for you, Dave, that I've kind of itching to ask that, like I said, I wish I could ask. So in prior life, we were a business model focused PE firm.

We knew the industry bankers, but not intimately. We have an asset that's ready to sell. And the one thing we know is any investment banker within an industry group that we bring it to suddenly that's their deal, no matter what, right. It's just the way the world works, but we were never sure if that was exactly the person we should have brought it to because you're always hiring and bringing in new people and the world's changing and people are taking different roles, but no matter what that person was, they would say that's, oh, I'm the best person for it.

And so. What role can your sponsor coverage banker play kind of going to them first saying, who should I bring this to within your organization?

[00:46:04] Dave Roberts: Absolutely. We can help navigate that and we do it all day, every day. Right. I totally feel your point in terms of just like there's no upward referrals and investment banking, no investment bank thinks that deal is too big for them.

Many bankers believe they can do just about any transaction. It doesn't really matter what it is, but over the last decade or more, Deep, deep industry expertise has been the hallmark of organizations like Houlihan. We're just getting deeper and deeper as we grow. We've got 10 broad industry groups and inside that we have subsections and those numbers are in the mid low hundreds today.

Over time, it's going to go into the several hundred in terms of subgroup expertise. So your sponsors guys can help you navigate that. But what's really powerful is when it touches two sub verticals, right? Or three, our system is set up to use the sponsor guy to get the right team on the field, the team tackle and win.

And there are other organizations where if it touches healthcare, but really is a business services company. Whoever gets it first goes with it. Our system is designed to make sure all the relevant industry sub vertical experts are involved because, candidly, It helps you win the work. We're pretty good at, once we've won it, sorting out credit over time.

We want the right guys in front of you, and we want to define the right roles in a pitch, ideally well before the pitch, ideally years before the pitch, so that your management team has seen these guys, and they've talked to them over time, and as Doug was saying, that conversation leads to other benefits.

Maybe a deal's in market that we're not banking, and they should know about it. Or maybe there's a small tuck in. That would be too small for us to bank that we might be able to refer into him. So there's a lot of ancillary benefits to using the sponsors guys to absolutely make sure you're talking to each of the right touch points, not just the right touch point.

[00:47:59] Sean Mooney: Dave, the last question I have that I'm curious about really kind of was inspired by another one of these liberating conversations PE to do BluWave. And I was talking with a friend of mine who's a banker and I was asking him, We were having a beer after probably some conference or something like that, and he was saying, the one thing I was really surprised that you all never did was follow up to me after you bought one of our assets to just kind of see, like, what are you seeing?

What are the things that we should be thinking of after the sum total of this process here? Because we see a lot of things, not only in this process, but everywhere, and you would never come to us and ask us, like, what are the lessons we can learn? And if I were candid about myself, it's probably because of I got to act like I know everything and everyone who knows me knows that's far from the truth.

What's your thoughts on that kind of opportunity that may or may not be missed after a process?

[00:48:51] Dave Roberts: Yeah. Spearheaded by our business services, the former head of our business services group and now one of the heads of corporate finance. We use a roadmap approach to identifying an asset, tracking it over time, working with the CEO, working with, being involved in our conferences.

And then ultimately getting to a point where it might be a pitch and then a transaction. One of those steps is the post transaction follow up with the buyer. And again, I said earlier, within the bounds of the integrity of the process, we don't reveal anything that would be confidential information, but we do sit down with the buyer and really walk them through some of the salient points of a transaction, including what items did others due diligence In a way that you didn't.

And why this post transaction meeting typically includes a list of potential add on targets that we're aware of that they should be thinking about. We really get in there and help them think about not only how they maybe didn't think of something the way others did, but we also really help them think about how the broader market thought about issues and really it helps them frame their strategy going forward because ultimately they're going to build the asset.

Into one that they want to optimize for sale. We spend half a day in most instances and candidly, and just about any instance that we can. With the buying shareholder and really talk through what were those issues again, not tied to a specific alternative buyer, nothing that would compromise the process in terms of the integrity of the process, but really what they can use concrete things that they can use as they think about their tactical plan and their and their overall strategic plan to really build that business into what should be hopefully a great exit that hopefully we're banking.

That's part of the idea.

[00:50:42] Doug McCormick: Yeah. Dave, that is so intriguing. You get back to. One of our first comments, I said, we have this difference of the micro view versus the macro view. And as a firm that's trying to invest in capabilities to really build businesses, like we have a view of what a good business looks like, but that market check is the ultimate arbiter, right?

Like forget about what I think in theory, it's how the buyer community is going to look at it. And so like that gut check early on as you're developing your strategic roadmap is super helpful and interesting.

[00:51:13] Dave Roberts: Remember our industry guys are. living in these sub verticals all day, every day. Yes, there are private equity professionals that do that too.

But many have a slightly more generalist approach or maybe have a couple of industries that they're tracking. And our guys are happy to come in and really help you benchmark relative to other deals that they have seen or worked on, give you strategies that other people are thinking about how to grow your business in such a way that you can optimize multiple over time, find a great acquisition strategy.

The other thing that we do a ton of is help our clients. Think about personnel. We know lots of guys in these sub verticals and in these broader verticals, and if you're looking for a board member, if you're looking for an executive, we're always happy to make those connections because it's all part of a virtuous circle that hopefully ends with a better relationship over time and potentially a client engagement, but that's something we do all the time.

It's table stakes. We think we're pretty good at it and we're always delighted to do it for our friends.

[00:52:17] Sean Mooney: That's a really great point. If you think about the name of this podcast, it's Best But Never Final, right? Everyone's constantly trying to get better and better and better, and I think that's probably something all of us on this episode share.

And as I look back and reflect on things I wish I knew or did before, and there's many of them, that's one that strikes me right out of the gate, like, why didn't I do that? How do you work more strategically with your strategic partners? Towards a more beneficial outcome that ultimately is going to help this whole kind of karma wheel of business improve for everyone.

Does that kind of resonate? With you guys.

[00:52:53] Lloyd Metz: Absolutely. That's a great suggestion, Dave. I'm taking notes right now. Make sure we start doing that.

[00:52:58] Dave Roberts: Nah, we're, and our guys are delighted to do it again. They know the sales cycle in this business is forever. They understand that, again, the private equity community, there's going to be relationship and revenue opportunity over time.

And we're prepared to make that investment. And we're delighted, we're delighted to do it.

[00:53:17] Sean Mooney: So Dave, this has been really, really generous of your time, incredibly informative. I've learned all sorts of things, at least personally, I'll say, that I wish I knew before. For our listeners who would like to get in touch with you or Houlihan Loki, what's the best way to reach out and get in touch?

[00:53:33] Dave Roberts: You can just go to our website. I'm on there. And just send me an email. I'm happy to chat. And, uh, yeah. Again, we'll find whatever your question is, if we can answer it, we'll direct it to the right folks internally.

[00:53:45] Sean Mooney: Great. Well, we really appreciate you joining us. This is a fun conversation. Thanks, Dave.

[00:53:49] Dave Roberts: I'm delighted to be here.

Thank you guys. It's an esteemed group. You've put together Sean. So thanks for letting me be part of it today.

[00:53:55] Lloyd Metz: Thanks a lot, Dave.

[00:53:55] Doug McCormick: Thanks Dave.

A special thanks to HCI equity partners, a lower middle market private equity firm focused on driving transformational growth through consolidation strategies by partnering with family and founder owned manufacturing.

services and distribution companies. Learn more at hciequity. com. ICV Partners, an innovative lower middle market private equity firm supporting management teams of leading companies at the lower end of the middle market. Learn more about ICV at icvpartners. com. And finally, BluWave, the business builders network connecting the most proactive business builders in the world.

With the best of the best service providers for critical, variable, on point, and on time due diligence and value creation needs, learn more about BluWave at BluWave. net. For further information on HCI, ICV, and BluWave, and relevant topics discussed here in the episode, please see the episode notes for links.

[00:54:58] Sean Mooney: The views and opinions expressed in this program are those of the individuals presenting, and do not necessarily reflect the views or positions of any other persons or entities Including those referenced herein.

Join Doug McCormick from Oridian Capital Partners, Lloyd Metz from ICV Partners, and Sean Mooney from BluWave as they explore timely private equity topics and offer their seasoned perspectives on crucial areas of focus within the industry. Gain valuable insights from these industry experts in this engaging podcast tailored for PE professionals.