[00:00:00] Speaker A: Foreign
[00:00:04] Speaker B: this is Peter Lehrman. I am your host of Masters and Small Business M and A.
I am really excited to be joined by the founding partners of Heritage holding today, Alex and Ross.
They now have 12 active investment platforms that they have completed and about 50 acquisitions.
And you might think that this is long established investment firm, but what you certainly would not realize or probably not know is that it started out not too long ago as a self funded search fund.
And so this is going to be a really interesting story, an evolutionary journey of what these two have accomplished. I'm really excited to have them on the podcast. Alex and Ross, thanks for jumping on with me, giving me your, giving me your morning.
[00:00:49] Speaker C: Thanks for having us Peter. It's great to be here.
[00:00:52] Speaker A: Thanks Peter.
[00:00:53] Speaker B: So it did start at a very certainly a well known sort of breeding ground for search and for search funds and in particular self funded search, which is hbs.
Just take us back there. I know you guys met there. Take us back there. Tell us a little bit about how you guys talk about the way that the story began.
When you're sharing the story with LPs and other folks, it's important to note
[00:01:22] Speaker C: that Ross and I were friends before we started Heritage Holding.
We were in the same section at hbs. So we took every course together the first year, got to know each other through that and then we played on the soccer team together. So we traveled around the US playing tournaments and really became friendly and started to recognize each other in our differences.
We come from very different professional backgrounds, so my background was in investment banking and sales before I went to get my mba. And Ross is a Stanford engineer and he had been a startup entrepreneur and had built his own company.
And I think we felt that between the two of us we could make a good founding team.
So we explored a few entrepreneurial ideas.
But the one that really stuck with us was the search fund model which we learned about at HBS in through Rick and Roy and Jim Sharp. And we became pretty excited about the risk reward of that model. And so a year into our first year, a year into our mba, we decided to partner up and go forward with it.
[00:02:28] Speaker A: We met at business school. I think we had entrepreneurial dreams. I think what's unique about us given where we're at today is we both didn't come from the deal world.
Alex mentioned I was doing engineering, operations, entrepreneurship type stuff. Alex was and more in the sales equity investment bank side.
And at the time, this was 2015 when we graduated, at that time it was mainly just deciding would you Go do a self funded search or a funded search and I think we were lucky enough to have enough capital saved up that we could go for a year or two without taking the salary. And I think we really select that self funded path because it gave us a lot of flexibility and autonomy of what we could go and do in small business acquisitions.
[00:03:10] Speaker B: Did you guys spend much time deliberating on the structure of the search fund or were you guys pretty committed to the self funded model? Sort of. Once you guys got together as a co founding pair?
[00:03:20] Speaker A: Yeah, I think it was pretty quick to go chase that self funded model. We probably talked to 15 or 20 HBS grads before us that have been doing search. Probably majority of those were self funded. We basically just weighed the pros and cons of what they were doing, what their advice was.
I think today there's a lot more structures that are unique and interesting. I don't know if we'd still do the self funded given the Holdco structures or long term vehicle structures that are out there today.
At the time it was really deciding between those two.
Again I think Alex and I really prioritized autonomy and flexibility. I think we heard a few of the stories of funded searches that could go wrong where you have search fund investors that are telling you what deals to go do or not do or when to sell the business or the extreme cases firing the searcher and I think that just didn't appeal to us. We wanted to build something I think we had wasn't extremely thoughtful at the time but I think we had dreams of kind of continuing to do this over a long career and I think that the self funded route really appealed to us to be able to set that up.
[00:04:23] Speaker C: Yeah, the flexibility from the self funded model was right for us. With the benefit of hindsight, that first platform that we acquired was not a textbook search front business. It had a lot of project based revenue, it had a lot of customer concentration and had a lot of key person risk.
So we benefited from being a flexible structure in order to move forward towards that deal.
[00:04:50] Speaker B: Yeah, yeah, I'd love to get into that in a second. Ross, I'm curious just to dive into your background a little bit. West coast Stanford engineer, obviously world class breeding ground for a different kind of founding venture around startups and technology.
And I also saw you spent at least a summer at Lux, which is very bleeding edge in terms of what they think about funding. What was just the intellectual kind of like conversation you had with yourself about continuing to pursue engineering oriented sort of exit from a Place like Stanford into kind of like the more sort of quote unquote, like sort of boring business sort of search fund domain. Like how much time did you machinate over those sort of that sliding door?
[00:05:40] Speaker A: Definitely a lot. You know, I worked for two or three years, the startups in Silicon Valley after Stanford, you know, doing kind of hardcore engineering type work. It was awesome, right? Like, I think being an engineer in your early 20s is so fun. Like you get a lot of responsibility early on. You're building really cool stuff.
I think I saw that path though. Like if you're not the founder of one of those startups, it can be a bit of a grind, especially in the engineering world as you grow.
So I definitely had dreams of being my own boss, of being entrepreneur. I started a business before business school, so it's probably 2010 or so and a Stanford roommate and I, we started an online hearing aid business and it was awesome. It was great to see that kind of startup journey.
We got some good traction with the business. And I think the trickiest thing on startups is it's totally different risk reward profile, right? Like there's a much higher percentage chance that you kind of go to zero. You spend a couple years of trying to get something working, it doesn't work.
Or in the search fund path, you never really saw that the likelihood that you do well, right, maybe not making a billion dollars, but you know, if you can make several million dollars and have a great exit, that that likelihood is much more, much larger in the search fund world. So I think that like that risk reward profile fit my mentality a lot more. Just I worked at Lux. I was in between the two summers.
Oh, sorry. In the summer, in between the two years at hbs.
Phenomenal place. I mean they're really impressive. They were really thoughtful on how to invest going into hbs, I thought that's what I'd want to be doing, some sort of VC investing.
It was just not the job for me. I think there's so much gut feel on backing entrepreneurs that I don't think I was that skilled at.
I think every time I have conversations with the startups that we go, you know, try to invest in, I always want to be on the other side of the table building the companies and working in them. It was a great experience. I kind of checked that box of me knowing not to, you know, VC investing wasn't for me.
And it's great network as well. We actually hired a X Lux employee at Heritage now and stay, stay pretty close to a few guys over there as well.
[00:07:46] Speaker B: Appreciate you sharing. It's just interesting to hear a little bit about how you made that, that transition. What about you, Alex? Obviously investment banking maybe a little bit more understandable transition to, you know, to buying businesses and. But how did you get excited about this? Was it, was it catalyzed at Harvard or was it prior to Harvard where you were already starting to think about this?
[00:08:08] Speaker C: I've always had an entrepreneurial itch that I was, was trying to scratch and going to get an MBA was part of that.
I wanted to find a path towards entrepreneurship and meeting Ross was a real catalyst for that for myself in terms of my background. I did see an opportunity in the small business world where a lot of the businesses that we come into don't have much sales, many of them don't have a, are not focusing on growth necessarily. And so the ability to build and scale a sales process in these small businesses, while very different than the equity sales I would be doing at Barclays Capital, still appealed to me.
The B2B sales tactics that I had learned, some of them were pretty relevant to small business even.
And I felt that I could have an impact on growth of small businesses.
[00:09:02] Speaker A: Let's get into
[00:09:05] Speaker B: I guess kind of chapter one here with the self funded search. It sounds like you guys went, you sort of were zigging while a lot of other people were zagging in terms of just the business that you guys ultimately bought.
Customer concentration, high key man risk and a fair amount of non recurring revenue. Let's just unpack. I'd love to hear about it. It sounds really interesting, particularly since it worked out. Tell me how you guys remember finding the opportunity and ultimately how you guys got comfortable vetting a big amount of your career on it and obviously vetting the capital of others as well. Let's hear about it.
[00:09:44] Speaker A: Yeah. So 2016, we bought our first business.
We spent a year and a half in the search process before we bought that first deal. I think Alex and I expected to beat that average of buy a business within six months. I think it just takes time. I think a lot of it was we hadn't done deals before. It took us a while to learn what the pitch was, what type of business we wanted to go buy.
So it was really formative to go through that process for 18 months.
We actually did a lot of kind of thesis driven approach of reaching out to specialty medical clinics. We thought we'd do a roll up of eye care providers for the longest time, you know, that kind of fizzled out after a couple bad Deals and us realizing we just, I don't think we could be partners with some of these physicians that were running those groups. And you know, fortunately a local business broker in Boston area that we got to know over the course of our search gave us a deal on our desk of this company that did a lot of data center and telecom critical infrastructure.
So it was appealing.
It was repeat revenue I'll call it. They had customers that every year they go back into and they do maintenance and upgrades a bunch of their facilities. So there was a big customer concentration. Majority revenue was from Comcast. Comcast has a few thousand of these facilities across the US and this company would, would continually just upgrade these facilities. So this was power and cooling and generators and fire suppression systems.
They're just experts at knowing what needed to go into those facilities and how to standardize and build out those facilities as well as do the long term maintenance.
But you're right, it was very project based. You know, every year we'd have a few multimillion dollar projects go upgrade larger facilities. We'd have a bunch of six figure projects of, you know, expanding out maybe power in some of these facilities and then maybe 15, 20% of revenue was, was that recurring nature of maintaining all those products. So we love that market, we love what the company was doing. But yeah, obviously there's this big key person risk in the founder and you know, the customer concentration risk of dealing just one customer.
I think what was appealing is I think that turned off a lot of other buyers out there. You know, I think the broker struggled to find somebody, you know, an investment group that was willing to kind of take on that headline risk. Right. Like I think if you're an associate at some private equity firm and you pitch that deal to your investment committee and it doesn't go well, like it's, it's huge risk for that person. You know, meanwhile, Alex and I, it's kind of betting our own careers and, and I think we could, we could look a little bit deeper and see if that could be a good fit for us. And it did. You know, the key person risk we got comfortable with just because the founder of that business is, was just the best guy we could ever possibly partner with as our first business. Just super high integrity, really patient with Alex and ourselves. I mean we were, I was how old? 30, Alex was whatever, 26. He looked a lot younger than he looks now. And you know, to have a business owner like that, to have, to have the, you know, ability to trust his business with a couple young guys and and partner with us and train us on it takes to be the leader of a business. Like that was really, really important for us.
[00:12:53] Speaker B: Could you talk a little bit about like, do you guys feel like as, as you got to know the business that you were developing like a variant perception on the nature of this business, the headline was project based, high customer concentration and that the truth was actually something different from that or did you guys just find a way to get comfortable with that truth in a way that others didn't? Like I'm curious whether the business was misanalyzed or whether you guys just were able to get comfortable with it and you were able to put together, you know, a syndicate in addition to your own capital and your own sweat equity that was comfortable with those realities. Like which, how would you guys characterize the reality of what the business was?
[00:13:41] Speaker A: I think it's a little mix of both.
You know, we dug deeper into it with the customer concentration. It was split amongst 10 or 15 decision makers within that customer. So we got comfortable that probably wouldn't be like one stroke of the pen risk that everything would go to zero there.
So that was a big part of it.
We also loved like the repeat nature. It was project based. But, you know, we'd be doing, you know, Greater Boston Comcast work and every year they'd have a certain budget and every year we'd get a certain percentage of that budget and really felt like even though it was project based, there was good repeat nature. So I think, I think digging deeper, we saw that it was worth, you know, better than the headline risk.
And then I think the biggest thing is, you know, we, we agreed on evaluation and structure that, that really mitigated all those risks. Right. And tied the founder to make sure that he'd be alongside us for a long period of time. And it put some of the, the deal at risk for the founder based on keeping that customer concentration, you know, alive and continuing. And yeah, two of those big things that got us comfortable that it was a good investment.
[00:14:41] Speaker B: If you were to speculate on just how this owner sort of perceived you guys as buyers of the business, he obviously stayed involved. He rolled a fair amount of risk into the deal.
Why do you guys think he chose to work with you on it? And how do you think he sort of saw the two of you and sized the two of you up, particularly given that he was staying involved, which, and not just staying involved in like a, it sounds like, you know, you know, he was very involved, wasn't just kind of like closing things out over a year or so and helping you with some sales.
What do you think his experience of you guys was? Why do you think he ultimately got excited to work with you? Yeah, I'm curious, like, if you put your. Put yourself in his shoes, like, how do you think he reflects on getting to know you guys and ultimately choosing you guys to work with?
[00:15:37] Speaker C: I think Paul had built an increasingly very large business that was running on some systems that might have been set up for much smaller business.
And he was pretty tapped out in terms of his time. He was on the road constantly dealing with operational fires, replacing people that were leaving.
I think that he wanted. He wanted some support was the first piece of it. And I think that he saw in Ross and myself some potential support on the growth and operational side. He saw two young guys willing to work hard and willing to take some stuff off his plate and the opportunity to take some risk off the table. He was very aware of that customer concentration risk. And while the Comcast budgets were good and strong and there was a lot of spending going into data centers and network facilities, he was cognizant of the fact that that might not last forever.
And so he saw it as an opportunity to take some chips off the table and to work with Ross and I to add some support.
That was the partnership we had with Emil. The terms and conditions of our marriage, if you want to call it that, was that we would take stuff out fist plate that he didn't like doing and allow him to focus on the intellectually stimulating things that he liked doing, which relied around the project engineering and the scoping of work. And for these critical facilities, Ross and I took on the hiring, the back office, the financial function, as well as sales for new customers. And that worked very well.
And that actually was the initial playbook that we're now still using today. We've refined it over time. But that partnership with sellers, where we're taking stuff off their plate that might not be the best value for their time, best return on their time and that they don't like doing has been a good way for us to have strong, lasting partnership with business owners.
[00:17:34] Speaker A: Yeah,
[00:17:37] Speaker B: any color on just leverage levels in light of the way that the business ran and how you guys arrived at how did you guys lever the business or not? And any thoughts on that?
[00:17:49] Speaker A: Given the business's characteristics, we did put some leverage on. We kept the modest reason there. There was some risk in the business. It was about a turn and a half of lever.
So one and a half times EBITDA that we had the hindsight, that's probably a lot. We'd probably do less now because, you know, we have better access to capital. But frankly, you know, at the time it was our first deal and took us a while to even raise the equity that we had to go raise, you know, back in 2016. So yeah, we definitely try to keep leverage as low as possible, including today. Like we, we don't think, you know, leverage is great for, for great returns. But I think we always want to make sure we're in control of these businesses and never dictated by lenders and, and leverage to how to operate the business.
[00:18:30] Speaker B: It's really interesting. You know, most self funded searchers are obviously using a ton of leverage. They're usually involving the sba.
So yeah, there's a lot of things that you guys did differently. Despite starting out as a self funded searcher, you also chose a business that most people would have run the other way on. I think it's super illustrative on what can happen when you don't do what everybody else is doing. Obviously there's, I'm sure a bunch of failed stories where people bought businesses with a lot of customer concentration and a lot of key man risk and, and had to go in, in, in a different direction. But I just, I do think it's interesting how many decisions you guys did differently relative to like the, the template of self funded search.
[00:19:11] Speaker A: In hindsight, you know, it all worked out and it was a great investment. We did great. But I, you know, don't get us wrong, we, we were definitely very stressed for the first couple years. Like running a business with customer concentration is, is, is not that fun, you know.
You know, we were comfortable that there were 10 or 15 decision makers. But sure enough, within six months I think we got a corporate notice from Comcast that instead of paying all of our receivables in 30 days as we had been, and they were changing every to 60 days and then the company, you know, we're doing 50 million in revenue and majority of that was Comcast. You know, all of a sudden we're seeing increases, you know, five, six million dollars in working capital that we didn't have. Right. We had to figure out how we were going to get through a cash crunch like that. And stuff like that always happened. You know, we get calls from Paul of issues that were happening on these jobs and you know, we couldn't gauge whether this was like, you know, the end of the business or just a fine blip in the relationship with Comcast and you know, causes a Lot of stress and unknowns.
So it was definitely a hard business.
[00:20:09] Speaker C: Our heart sank every time the phone rang from Paul. Okay, this is the bad news we've been expecting. You know, like Comcast is centralizing everything under one decision maker. Like we're done, you know, a crane fell on the project site. That's it, we're out of business. You know, so it was, it was definitely a stressful time, as Ross said.
[00:20:27] Speaker B: Did you guys get the phone call from Paul on people related issues or was it mostly sort of customer and project related issues like who got the first call on tough people issues, resignations, HR considerations? Was that going straight to you or was Paul sort of in the line of fire there as well?
[00:20:43] Speaker A: It's the three of us would, would get onto everything, you know, all the big issues that popped up. We'd, we'd talk through it. I think Paul handle a lot of the day to day kind of operational issues of, you know, how to build out these, these different projects and what's needed on, on the field.
I was doing a lot more of the operational side on, you know, how to all the project management software back office. A lot of the kind of strategic side on that. And then Alex was driving a lot of the growth. So M and A and new business development, but also like building out a sales team and you know, how to continue to grow the business.
And honestly it was great like that. That trio relationship I think can sometimes fail when there's too many cooks in the and big egos. But I think the three of us really understood what we should be doing.
He's still there. He's still there. We bought his company. He was doing 50 million in revenue. When we sold it, it was over 100 million.
And today I think it's grown another 150, $200 million range. I'd guess somewhere in the range. And he's still running it. He really enjoys the business, really committed to keep on growing it and I think, I think he's really enjoyed the growth that we've helped put into the business to get to where it's at today.
[00:21:54] Speaker B: Yeah, well, part of the story for today's podcast is about you guys traversing from self funded search land into being an independent private equity sponsor and then developing and raising a committed pool of capital.
So I guess we'll keep on going through the chronology.
Is it fair to say that you guys kind of accidentally stumbled into being an independent sponsor by virtue of this deal that you sourced while, while you were mostly full time running this business with Paul, is that the right way to sort of introduce the, the accidental transition to being an independent sponsor?
[00:22:29] Speaker C: With the benefit of hindsight, it's very easy to, to look at a trajectory and say it was all planned. The reality is that we, we were just very opportunistic. You know that that second platform, as you mentioned, came through our sourcing effort for add ons for, for micom, the first platform.
And we were able to find a much smaller deal at a great purchase price that unlike our first platform, checked a lot of the boxes that a private equity investor would be excited about. High recurring revenue, 40% plus margin, steady growth.
And we were buying it at a very fair purchase price. So we felt that we should dig in. And it was a big internal debate between Ross and I on whether to move forward with that second platform. Um, we, we moved forward under the condition that we could find a manager to run it.
And that's when we brought on Adam Parker, who, who was in our section made at HBS as well, who had a lot more data center and server design experience than, than we, than we did. And, and so he, he, he jumped into that business and grew it Eightfold and in three and a half years. So he did an amazing job and still works with us today. Adam, he's been a great partner to us.
So yes, it was somewhat accidental. It was not an obvious decision given that most of our net worth and upside was tied into this much microme that was 10 times larger than Quoinix, which was our second platform.
But we decided to move forward because we felt that we should try it out with Adam at the helm.
[00:23:59] Speaker B: What were the dialogues with the original investor base that had capitalized the original business alongside you?
[00:24:06] Speaker C: We were lucky enough that most of the investors in our first deal were excited and decided to follow us into the second platform, which created some great alignment. In fact, that same investor base followed us across our seven independent sponsor platforms pretty much, which has been a great aligner of incentives. If a business was not performing as well as another, some of their advice was, hey, focus on the ones that are going great. Don't necessarily focus on the ones that are underperforming because there was that sort of shared cap tables over time from the same investors.
[00:24:41] Speaker B: And did they have a debate with you guys the way that you guys had your own internal debate in terms of just being distracted by this kind of independent sponsor second platform?
Or were they just like, guys, go for it.
You've got a great president running the first one. This is the right way for you guys to be opportunistically spending your time. What was the dialogue there?
Sounds like they were supported.
[00:25:04] Speaker A: Maybe a couple were questioned it. Right. Just wanted to make sure that we knew how to allocate our time properly between the two and wanted to know what was going to go on. But I think we were fortunate that a lot of the investors were kind of just backing Alex and Ross and like, trusting that we would do the right thing in certain situations and allocate our time properly and. And, you know, be able to do. Do both investments. And, you know, we really appreciated that support early on.
[00:25:29] Speaker B: So at this point, how much had you. Roughly how much equity had you guys raised across the two transactions? The first business where you were getting out of the gates with it, and
[00:25:38] Speaker A: then the second one, that's probably less than 10. Yeah, 5 to 10 million.
[00:25:44] Speaker C: Yeah, closer to 5. Ross. I think, yeah, it was small dollars in the large scheme of things, but meaningful for us in terms of getting those deals done.
[00:25:54] Speaker A: Maybe.
[00:25:56] Speaker B: Like, it might be interesting to talk a little bit about sourcing because you guys have.
You sourced a lot of transactions in a relatively short period of time and with a limited amount of, you know, it's not like you guys had substantial private equity track records yourselves.
And I'd be interested just to hear about, like, the sourcing side of the journey for you. One of the things we thought we might talk about is just the way you've thought about developing relationships with the brokerage and advisory community, how you've gone about doing that. But maybe before we get into some of the specifics there, what. How do you guys think that your sort of sourcing efforts have developed and changed over time? How do you think about it? How much time are you guys thinking about? I know it's a bunch of questions there, but I'd love to hear just how that topic has evolved for. For you guys as the founding partners and what's changed and what's kind of always stayed the same since the early days.
[00:26:55] Speaker C: Sourcing is a super important part of our process. I would argue that it's one of our key core competencies is our ability to get in touch with business owners and the industries that we're targeting and to be able to convey our message and what Heritage stands for.
Our sourcing process has evolved a lot over time. When we started 11 years ago, we were sending mail merge emails, and that was novel at the time. We were getting fairly high response rates, 10% plus. And we were able to get the eyeballs of business owners that we're reaching out to.
That's changed a lot in the last 11 years. Our email response rates are now 2% or less. Everyone's using that channel. So we've had to keep on thinking of different ways to get in touch with business owners.
So we've actually moved a lot more back to the analog channel now. And we call on business owners a lot. We're very present at local conferences.
Think trade associations for certain industries, think leadership organizations, but YPO equivalents, but at a much more local level.
We try and build those in person relationships a lot different than we did a few years ago.
The key for us for evolution of our sourcing has been just tracking, diligently tracking what's working and what's not and then doubling down the channels that are working right now, knowing that what works today might be very different than what works in a couple of years.
We consider sourcing to be really an arms race. And in order to stay ahead of that arms race, we have to keep trying out new tools, investing in new outreach methods and technologies to make sure that, you know, we're able to leverage the next new thing that we can use to source a few years from now.
On the broker side, I will say that business brokers have been a very important part of their heritage story.
Ross mentioned the local business broker that we met when we acquired our first platform, Micom. That broker was actually based in Worcester. It's a company called George Co. And, and Ron, who was our counterpart there, did a very good job in terms of matchmaking for this asset. I think he really understood that this wasn't a cookie cutter private equity investment because of the headline risk and the hair with the customer concentration. And so he spent a lot of time getting to know us and understanding whether we would be a good fit to be a partner to Paul.
And those types of relationships are the ones we gravitate towards. Those lessons structured broker processes where we tend to build relationships with the brokers that got to know us, know that they can credibly introduce us to their clients because we will do right by them and because they think we might be a great fit to be the legacy for the businesses that those founders they represent have built.
So I think that's our broker channel is very focused on those types of brokers and they've been a. They've been a great source of partnership for Heritage holding as we've grown a
[00:30:06] Speaker B: lot of different brokers out there running different kinds of processes.
You guys mentioned the other day that maybe there's a A dozen or so that you've decided to spend a fair amount of time with on a more maybe involved basis and you've just sort of gotten to know them over time. Maybe that dozen is rotating or it's changing over time. But I guess I would be curious and maybe you just sort of already shared this just now. But like, what is the wish list from Alex and you know, and Ross in terms of like the best, the, the best set of practices and methods for a broker from your perspective and, and obviously factoring in the fact that you know, they need to be doing right by, you know, by the client who they serve. So like this is one of the interesting questions I always have is just sort of like what is zero sum about you know, versus positive sum about the relations?
You know, if they give you an early look, is that an advantage for you and is that a disadvantage for the owner? So I'm just curious how you guys think about like the role of the broker, what you hope to get in terms of behavior out of them and how you see them doing right by you but, but you know, making sure that they're, they're also doing right by the owner.
[00:31:24] Speaker C: The number one thing for me is, is brokers that allow us to build a relationship with the founders and the sellers of those businesses.
That relationship with business owners that we partner with is so critical to our success and to go forward dynamic in the business after we acquire it that we need to be able to spend a lot of time getting to know each other, building trust with the business owners we partner with. The brokers or the investment banks that tend to run very efficient processes, make that relationship building harder because the process feels more transactional.
You have three hours for management meeting and you have two hours for dinner and then that's kind of it. And then you can maybe do some on site visits, et cetera. But the business brokers and advisors we like to work with allow access to the founder in a deep way and gives us a lot of time to do mutual diligence, right for the founders to get to know us and heritage and for us to get to know them well and to make sure that we can establish a great working dynamic post close.
[00:32:31] Speaker B: What is the length of time over which that when you're in a situation like that where you have that kind of access to the owner and the owner has that, that kind of access to you, what is the time period over which that relationship is getting developed and is that part of the active sort of diligence process or I'M just curious sort of over what time frame that's happening and how much else is going on in the background. Is the founder of the business meeting with a bunch of other firms at the same time? Yeah, just kind of curious to understand how that time gets made available and over what time period and where are you in the process and is that always before the LOI or is a lot of that after an loi?
[00:33:10] Speaker A: Usually there's like a month period during, during the process kind of pre loi where you know, hopefully we have a lot of conversations and in person meetings with that founder.
You know, we find that just to be really useful for us to get, you know, better understanding what the business is like what the partnership will be like post closing.
And yeah, like Alex said, I think the brokers who encourage that and offer that up to, to us and other other potential buyers, it's just usually leaves like a much better transaction post closing. Right. It's much less transactional of hey, just take the best price and structure and be done with it. It's much more about getting the fit right.
And yeah, small business acquisitions like this, like that's just so critical, right? Like the bigger acquisitions, it can be very transactional. It's probably less critical to get that fit perfectly right.
[00:33:56] Speaker B: Why do you think it's, it's different when they're bigger?
[00:33:59] Speaker A: I think there's just so much more people driven at this size range. Right. There's so much more about how we're going to work alongside that founder, work alongside the key people at that business. I think the larger firms out there, when there's 500 people in the companies and a full management team and probably less involvement between the investment firm, we'll call it, and the operating company, usually that involvement's probably quarterly, monthly, and it's much more, I'd say, numbers driven than kind of people driven.
These small businesses, like we're talking to the founders daily, weekly, we're solving problems alongside them.
It really matters kind of how we interact and how we trust each other and how we get along and run the business together. And that's really important to us. And I think the brokers that understand that well and want to make sure that they're solving not just for the business owners, you know, valuation at the end of the day, but also like, you know, their happiness over the next couple years if they're staying in the ball in the business. A lot of these business owners will have, you know, sons and daughters within the business or friends and relationships or you know, Just love their customers, whatever it is like that, that goes a long way to make sure that they're picking the right partner for the business. And, and the more that we can have those interactions, the better. So that timeline, yeah, there's usually a month like that. Usually at that point we're, we're having some conversations about valuation and making sure that there's, there's good valuation expectations on both sides that we can match up and meet.
And then hopefully it's signing an LOI and going through the diligence process. And two to three months later, after all the diligence and QVs and legal docs are done, the deal's closed and we're working alongside together.
[00:35:38] Speaker B: When you meet with an opportunity where the process and the access to the owner is not as you've just laid it out, but you're excited about the
[00:35:47] Speaker A: business,
[00:35:49] Speaker B: how do you guys triage those kinds of opportunities? Do you leave open the opportunity to potentially pursue a more structured process, or do you just say, great business, seems like a great owner, but we just aren't going to get the time with this guy.
Let's withdraw.
What's the calculus on those?
[00:36:10] Speaker A: We're still very opportunistic. Yeah, we'll definitely try. We'll definitely participate. I think it's just harder to get conviction to pay a high price or conviction that we'll go chase it and spend a lot of time on it.
[00:36:20] Speaker B: Why do you think they run the process that way? I mean, I could see how a lot of other investors would feel the same way as you. Why do you think they ultimately conclude that that is the right way to run the process? Are they just time constrained? Do you think it's preferences of the founder? Like what, what drives that more structured form of process? If it's ultimately a tougher way for investors to get comfortable paying the number that is sort of in the zone of value that makes everybody, makes the whole deal work.
[00:36:50] Speaker A: Some of just brokers making sure that they're, they're using the founder's time wisely, I think they're, they're resistant to have them have a bunch of these management meetings for several hours and, you know, just have valuation be way under their expectations and waste that time.
So I think a lot of people want to get kind of valuation expectations on the table before spending time with the founder, which again's fine. You know, we'll participate in that and we'll go forward with that. But I do think the more time we can spend with the founder and the team just A lot easier it is to make an offer that's credible and good and as strong as we can possibly give.
[00:37:23] Speaker C: And I think it does self select a little bit.
Those most structured, efficient processes that are led by larger investment banks might be assets that are better held by a typical private equity buyer, I'll call them, that will get integrated into an existing platform and, and where the sellers would be less important within the go forward plan than a lot of the companies we look at.
So for that private equity world, I understand the need to be very efficient with time and to maybe not focus as much on the relationship building that we care a lot about.
So I think there's somewhat of a self selection exercise here as well. The other thing, Peter, which I think is, is important in the context of our relationships with business brokers.
Some really value speed to get answers when we get a memo from a business broker and advisor and we like what we see, the next step for us is get on the plane and meet that business owner wherever they are in the United States. And I think that reactivity and responsiveness is valued by a number of business brokers.
Our ability to then follow on with quick decisions, quick yeses, quick no's, quick comments on a counteroffer or on a structural change is valued. We don't have a very formal multi layered IC process.
Most of our teams sits in the same room or always on calls on a weekly basis, on a daily basis, which allows us to just, just move quickly and get on the same page fast.
[00:39:08] Speaker B: Well, maybe we should keep on going and get into the independent sponsor chapter.
And obviously you guys raised about $220 million at the end of that and decided to go into a more committed sort of capital.
That's kind of like the committed capital era of heritage, which I think started maybe about two years ago.
[00:39:31] Speaker A: Right?
[00:39:33] Speaker C: You announced that August of 24. Exactly.
[00:39:36] Speaker B: Yeah. So the interim period, it wasn't just one or two transactions that you did and investments that you made as an independent sponsor. It was more than a handful.
Let's hear a little bit about like how you ultimately decided that you wanted to raise a committed pool of capital and you know, some of the big takeaways and learnings from the independent sponsor chapter.
[00:39:59] Speaker C: I think the two big reasons from my perspective for raising the fund, number one, we have always been targeting fragmented industries in which there's plenty of opportunity to do add on acquisitions.
As independent sponsors, we had averaged three to four deals per platform and we're very much raising the capital for each deal or every year. To add bandwidth to our add on acquisition capital.
The ability to have committed fund allows us to move much faster. That was the hypothesis when we raised the fund, was that hey, we should really be doing 10 plus deals per platform in these fragmented industries. Because once we're in, we understand what to look for. We start to generate a higher velocity of deal flow. We want to be able to go faster, which I think is proving out now that we're two years in our average kind of run rate.
We closed 15 deals last year, 14 year to date. So I think that velocity is showing. So that's been nice to see. The other big reason is for our team, by 2023, we had built a strong team of seven to eight individuals who we had worked with very well, were great cultural fits, were very attuned to what we were building in Heritage Holding. And having a fund is a much clearer goalpost for career progression.
And we felt that in order to continue to incentivize and retain our team, having a fund made a lot of sense.
[00:41:31] Speaker B: Does it make sense from just an economics and compensation perspective or is there something.
It sounds like you might be signaling that there's something else about having a fund which in and of itself is helpful to great talent.
[00:41:42] Speaker C: The fact that Ross and Alex are independent sponsors and could own five platforms one day and then that goes down to two platforms the next year, which is what happened between 2122 does create a level of uncertainty about the future and how many platforms we'll be going back into.
There's also a much more dependable revenue stream to build a business off of with a fund. Right. We're able to now hire ahead of the need. We're able to think long term and prioritize strategic hires even though they might not be urgent.
So it's been very helpful in terms of strengthening the team, building the firm to be able to know that we could depend on certain revenue base for the next few years.
[00:42:28] Speaker B: Do you feel like the 220 million, how did you arrive at that number and did that feel like a big step up in terms of transaction sizes that you want to do, or does that feel like a number that lets you stay more or less consistent with the independent sponsor led transactions that you'd executed prior?
[00:42:50] Speaker A: Transaction size has been the same even since day one of Heritage Holding. Like we really focus on this lower middle market.
You know, the average deal that we do is about 2 million in EBITDA, but it could be a range of half a million up to, you know, 5, 6, 7, 7 million EBITDA that we're doing. We're really adamant about that size range. I think that's like what we've built out at Heritage is, you know, a talent pool and group that can handle operations of that size of company and sourcing of that size of company. So we really, really don't want to move on that size range. So in order to scale for Heritage, it's doing more deals. And so our focus now, and it really has been for the last eight years or so, is finding industries that we really like, you know, just have great tailwinds, have great fragmentation. It really makes sense to build through acquisition and then doing 10 plus acquisitions in that industry and then integrating the companies really well into a solid platform that just inherently will be less risky and usually higher growth and the core management team that can run a larger group there. And at that point, if there's a lot of value that we create in that, we can sell it off to another investment firm that's at a larger scale. We can hold onto it for a while and keep on benefiting from the cash flow of the business.
But that's been our focus for the last eight years.
And I will say you can kind of define like the self funded search period, the independent sponsor period, now like this committed capital investment firm period. It's the day job of what we've been doing hasn't really changed that much. Like we're still doing the same types of deals, we're still dealing with the same founders that are looking to transition. Same size of business, same basic issues. I think only difference maybe now is we built out our team to be able to handle more of these acquisitions at a given time and scale up the number of companies that we're doing. And I think we just get better at it. We have some pattern recognition now of what types of companies we want to partner with, what types of founders are great fits for what we're doing at Heritage and how to get these deals done efficiently and smoothly and keep founders really happy going forward in the businesses.
[00:44:53] Speaker B: Alex, you mentioned the engineering services business when we were just doing a little bit of prep yesterday.
And maybe that's also just a great way to like spend some of the last few minutes that we have here.
Why don't you just tell us a little bit about that business and how it sort of maps really nicely to what you're trying to achieve, you know, within the Fund 1 framework and velocity and scaling through add ons.
Let's hear about that business, how you guys found it and how you guys are organizing around it.
[00:45:22] Speaker C: Now, engineering is a, is, is a, a very big industry.
It fits with the way we do industry selection. We look at highly fragmented industries and we look at that fragmentation in the context of how many consolidators exist.
We think there's over 25,000 engineering firms in the U.S.
we think that most of these businesses perform fairly well in a recessionary environment as long as a lot of their revenue is tied to the end markets we're going after which, which tend to be more institutional, more municipality based revenue.
We have found that, that those businesses have a real, real captive revenue base. Because when you're the engineer on record for a public structure, storm, stormwater treatment plant, wastewater treatment plant, you know, stormwater drainage system, a bridge or tunnel, when that structure needs to be redesigned or retrofitted or augmented, you're more likely than not to get the work just because you've got all that institutional knowledge, having worked on that structure for years or decades.
And so we have found that to be a very dependable source of repeat revenue in our businesses that we're acquiring.
We have also found that this industry in the US the average business owner is in their 60s. We have found that there are a number of business owners in the engineering world that are looking for the next path in their career, whether that's going into retirement soon or taking their foot off the pedal in terms of working long days and long weeks.
We have been able to source quite a few deals in the industry and we've closed four companies so far within that sector.
The goal Is to do 20 deals over the next five years.
[00:47:11] Speaker B: And is that within one platform, Alex?
[00:47:14] Speaker C: Within one platform. And we're looking to build a diversified engineering firm, so multidisciplinary one that includes today civil engineering, structural engineering and MEP engineering. And we'll be looking to add a couple of more divisions over time, preserving the integrity of the end markets that we'd like to serve, which are more focused on the institutional government. Hospital types versus versus new construction is important to note, but it's been a really interesting one to be a part of so far. We've been able to build a strong team from the heritage team that's leading the platform.
And we've got six signed LOIs, that we're hoping to close over the next few months. So the pace will hopefully accelerate soon. Yeah, that's exciting.
[00:48:06] Speaker B: You do mention on your website, right on the homepage there's a. You guys have chosen the word scaling quickly.
You don't necessarily see quickly on the homepage of a lot of investment firms. I'm sure it was chosen
[00:48:25] Speaker A: deliberately.
[00:48:27] Speaker B: Am I right about that?
[00:48:28] Speaker C: Yeah, I think so.
We do want to move fast sometimes. It's never as fast as we'd like, actually, but we'd like to move fast. But I think the focus is on building great companies. I think to Ross's earlier point around, our job has not really changed over time. It's kind of evolved a little bit, but we're still highly focused on building great companies that are going to last way past us, way past our holding period.
And I think our fund is a very helpful tool for us to build these great companies and to go quickly, to go faster.
[00:49:02] Speaker A: Yeah, it's definitely culturally something we're trying to drive at Heritage. I think a lot of the small businesses that we're partnering with, they inherently just move really quickly. There's not like layers of management. It's usually a founder just deciding, with a ton of experience, you know, quickly how to. How to make a decision. And that's what we try to inspire in our team. Right. We don't want to overburden, you know, all the different layers and make these too corporate or anything like that. We really try to move quickly, respond quickly, and that's. That's how Alex and I are driven, and we try to really espouse that in our team as well.
[00:49:35] Speaker B: I think it's important. I think it's. That's why I wanted to, like, just
[00:49:38] Speaker A: spend a minute on it.
[00:49:39] Speaker B: Are there places where you deliberately go slowly?
[00:49:42] Speaker A: I'd say the diligence process and that partnership process is relatively slowly for us. We try to do it as quickly as possible, but it does take several months to go through all the diligence and spend time with the owners and get the deals done. We really want to make sure it's a really strong mutual fit.
We're really making sure that the partnership's going to work out, that we're going to be able to work well together and that we trust and respect and we'll be good partners for that business
[00:50:08] Speaker C: owner as well in the transition period, too.
[00:50:10] Speaker A: Yeah, that's true.
[00:50:11] Speaker C: We think that business owners that we partner with do a lot more than just typically be CEO of their businesses. They've got a lot of institutional knowledge about the companies that they've built. And so we like to transition things slowly.
We want to spend a few months understanding their business before making any big changes. Right. We understand that things are set up a certain way for a reason most of the time. And So I think we are slow on the trigger when it comes to making big changes, big structural changes within the organizations that we buy as well as in the transition for business owners. We're not pushing business owners out. In fact, we would prefer to work with them for a longer period of time. So I think we're more, we're slower when it comes to transitions in the first few months of owning the business.
[00:51:02] Speaker A: Yeah.
[00:51:03] Speaker B: Do any of the owners that you guys have partnered with have a history of doing acquisitions prior to you being part of the organization?
[00:51:09] Speaker A: Yeah, there's definitely been a few. I'd say probably, you know, out of the 60 acquisitions we've done, I think three or four probably have done acquisitions before us. Usually they're relatively small. Like, you know, one of our commercial mechanical companies that we bought, they bought a plumbing business, you know, not a large one, but it offered them some licenses and, you know, exposure into that service area.
We bought an IT services business. We have a platform right now.
We've I think done about 12 acquisitions of IT services business and the first one had done two acquisitions prior to partnering with it. It's definitely a great thing. Like they had the culture and the understanding of how to integrate companies and the whole M and A playbook.
So we'd love if that's the case. It's. This just doesn't happen that much for a founder led business out there.
[00:51:55] Speaker B: What do you think will stay the same over the next few years for Heritage Holding? And you've changed things along the way in terms of structure One business, the two of you working on it with the original founder, then with Paul. Exactly. And then independent sponsor chapter, while still continuing to be a key partner to Paul in that business.
Then you've raised a committed pool of capital. It seemed very dedicated to the sub $10 million EBITDA market. What, what do you think needs to change next? How do you guys think about that? Or are you just pausing on that question for the time being and have your hands full with six Lois at the time anyway.
[00:52:38] Speaker C: That's six Lois just in engineering, by the way. We've got a lot more.
[00:52:41] Speaker B: Exactly.
[00:52:42] Speaker C: Across the board of Heritage.
[00:52:43] Speaker B: It's incredible. Yeah, it's incredible capacity.
[00:52:46] Speaker C: Part of Ross is a nice nature to keep challenging ourselves. I think we're both highly ambitious and want to build something great and that will inherently create the need for change over time within our organization.
The changes I foresee are continuing to grow our team to be able to do more add on acquisitions within our existing platforms to continue to build out our sourcing capabilities to make sure we stay cutting edge in terms of the ways we get in touch with business owners to continue to partner with the best operators out there.
We're very big on our VP of operations role within Heritage Holding. That is a key role that is the bridge between Heritage and the platform.
That person is responsible for M and a integration seller, relationship management, making sure that we deliver on the promises that we've made to business owners during the sale process. And so our ability to grow is driven by our ability to to bring on talented folks for that position. So we'll continue to bring on more people there and then within the separate functions that we're building out Heritage holding like talent acquisitions, go to market. We will also be continuing to hire dedicated in house resources to support our companies.
[00:54:07] Speaker A: I think my main goal is not change that much.
I love what we're doing. I love kind of partnering with small businesses out there.
It's a my favorite part of the job. I'd probably guess it's Alex's as well, is sitting down with a small business owner for the first time, just hearing their story, understanding what makes their business special. And I think there's nothing more amazing than the US small business owner come from very different angles of how to run a business. Their philosophies on what works, all the deals that we're buying are profitable and growing and great.
It's amazing. There's so many different ways to make a business so successful and it's so fascinating to sit down with them, understand this. Business owners that are leadership driven and just hire them, train the right people. There's business owners that are, you know, operationally driven. They're just so regimented about the process. They're ones that are really sales and marketing driven and, and it's fascinating to kind of see what works, learn, you know, what makes them special as a business and then, you know, try to understand that and build it into our platform. Right. Kind of get best practices across the different businesses that we're partnering with so we can leverage some of these people that do fat, you know, fantastic work at the smaller businesses into a much larger base of revenue and and also partner with these business owners and really achieve their goals in the business. A lot of them love doing a component of what they're doing at the business, but maybe not the whole thing. And it's just great to learn what they're doing, what we can help offer them, what we can take off their plate and how we can enable these businesses to keep that Same culture and what they're doing, but allow them to scale and grow. And we'd love to keep on doing that. I think we're really focused on hiring our team that also loves that nature of small business.
I think a cool fact about the heritage team is more than half the people here grew up in small business. So their parents were small business owners and founders and a lot of them had early teens jobs of working stocking shelves at their parents gas stations.
[00:55:59] Speaker B: That sounds like that's part of the job spec for the heritage holding opportunity.
[00:56:06] Speaker A: It's definitely a big plus.
[00:56:08] Speaker C: It is the best job in the world.
We get to spend our time meeting business owners and learning their secret sauce from them directly because we're learning something new every day, something that's been vetted and refined over decades of experience. And so it's a huge privilege that we're able to do that.
[00:56:25] Speaker B: It's a great place to stop for now. I hope we get a chance to do this again in the future. Maybe one last thing though.
Have you guys gone back to HBS or anywhere else or.
And what are the questions that you get and what are the answers that you tend to give when you're talking to the next generation of people that are thinking about starting on a journey similar to the one that you guys started on about 10 years ago?
[00:56:50] Speaker A: Yeah, we definitely do. And we're fortunate to have a case about heritage holding and that 10 year history.
Just like the trajectory from self funded search to independent sponsor to fund.
So we've got to go back, gone back, last four or five years, go back and teach the case where we go with the case with the Rick and Royce class, which we're really lucky to have. We also love all the conferences and supporting everyone else. I think a big part of it is a lot of the alumni helped us when we were starting out and we really want to give it back to the community. I think it's a fascinating world. I mean, we try to encourage as many people as we can to get into ETA pursuits. I think it keeps on getting more and more sophisticated. I think more money's coming into it, more different types of structures are coming out of it. I'd say my general advice is early on trying to figure out what, you know, what type of search you want to be doing, what, like what day job you want to be having. Is it, you know, deep in the operations of business, is it trying to do a roll up? Is it more like committed capital vehicle where you're hiring people maybe to operate? I Think just really understanding, you know, who you are and what your skill sets are.
I think search is so fascinating because you can come at it from the sourcing investor angle. You can come as like the CEO operating angle. And I think you have to be just very clear with yourself of what you want to be doing and what you think you're good at, maybe lacking. I think a big, big question too is the partnership side of it. I'm super lucky and fortunate to have met Alex. I think we're very complimentary in their skill sets and backgrounds, and he does a lot of the stuff that I don't want to be doing and vice versa. And I think that's a big question to answer early on in the search. We're big proponents. We try to convince as many people as we can to go into this path. I think it's just a great way to spend your life running small businesses, partnering with small businesses.
Probably the biggest question is, I think a lot of people want to get to the stage we're at managing lots of different platforms and maybe de risking from just the one single concentration.
I think our answer is, unfortunately, I think you have to do one company and do it well. Yeah, totally get the process of what it's like to run a business before you step into more deals.
[00:58:48] Speaker C: The advice that we often give is start with one business, run it well, grow it well, and then everything else will fall into place if your ambition is to own multiple platforms over time. But I think that initial small business acquisitions is super important to focus on. And understanding business operations is very different at a small business than it is within most businesses that most HBs MBAs come from. And so really getting under the hood and learning small business operations is a core priority that I like to advocate for for MBAs who want to get into the space.
[00:59:28] Speaker B: Guys, I've learned a ton and this has been great.
I'm happy that we got an episode published here so that your story lives on beyond just the HBS case archive.
And congratulations on everything you've done and it's been a pleasure to get to know you guys a little bit. So thanks for the time this morning and look forward to following following the Heritage Holding.
One last question. Are you guys ever going to change from holding to Holdings?
[00:59:59] Speaker C: Jim Sharp, who's our key mentor and advisor.
When we were starting our initial search, we had come up with Heritage holdings and his take was, guys, what are you doing? You're looking to buy one business? Buy and operate one business. That's the name of the game, you can't have holdings you got to be holding. And now I think we're stuck that name so we'll keep it forever.
[01:00:22] Speaker B: Good answer. Let's leave it there. Thanks. Thanks again to you both. Really appreciate the time.
[01:00:27] Speaker C: Thanks for having us Peter. And thanks. Thank you as well for the impact you're having on the small business community part of it and look forward to keep working together.
[01:00:36] Speaker B: Sounds great.
If you enjoyed this episode, check out axial.com there you'll find every episode of this podcast, as well as our recorded Axial member roundtables, some downloadable tools for dealmakers, Axial's quarterly league table, rankings of top small business acquirers and investment banks, and lots of other useful content that we've created over the course of time. If you're interested in joining Axial as either an acquirer, an owner considering an exit, or as a sell side M and a advisor, you can get started for
[email protected] as well last year. Lastly, if you have ideas for podcast show guests, feel free to reach out to me
[email protected] I promise I will respond. Thanks for listening.
[01:01:28] Speaker A: Peter Lerman is the CEO of Axial. All opinions expressed by Peter and podcast guests do not reflect the views or opinions of Axial. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Podcast guests may have ongoing client relationships with Axial.
