[00:00:04] Speaker A: Hello and welcome everyone. I'm Peter Lehrman and this is Master's in Small Business M and A. This show is an ongoing exploration into the vast and undercovered world of small business M and A, where we interview both the proven and the emerging owners, operators, investors and advisors whose strategies and methods for transaction success have been put to the test. The show aims to surface the nuanced intricacies, the gift key ingredients and the important factors that can improve your decision making in your own journey in the world of small business. MA this podcast is produced by Axial, an online platform that makes it easier for business owners and their M and A advisors to find, research and privately connect with a diverse mix of professional buyers of small businesses. In addition to learning more about Axial, you can find this podcast, show notes, edited transcripts and many other related resources, all for free at Axial.
[00:01:00] Speaker B: Welcome back everybody. This is Peter Lehrman from Masters in Small Business M and A.
I am recording on Blizzard Day here in New York with a fellow New Yorker, James Bohannon. We're going to jump right into a really interesting topic, an emerging topic and category in lower middle market acquisitions and investing which has at least preliminarily been referred to as the F2E.
It's not ETA, it's not SBA, it's not independent sponsor, it's called F2E Finance to entrepreneurship and it refers to a professional who is typically mid career 10 to 20 plus years as an investment professional, investment banking professional who leaves the the comforts of a great fund or a great investment bank to go and either buy one business and then potentially serially buy others or some combination of that. But it's not a search fund and it's not an independent sponsor doing deals on a one off basis, although that's probably its most well linked first cousin to do that. I have been able to track down somebody who spent a tremendous amount of time in and around this category. I'm really lucky to have him here on the podcast today, which is James Bohannon from Bellsberg Family Office here in New York. James, thank you for putting this on my radar and then creating the opportunity for us to talk about it. I'm really excited for the chat.
[00:02:30] Speaker C: Likewise. Thank you Peter.
[00:02:32] Speaker B: Before we dive into the F2E category and what you think is potentially emerging here as a new path for investment professionals, potentially a new mini category, lower middle market private equity investing, tell us about Bellsberg and then tell us a little bit about you. And then I want to go and talk about your first exposure to this idea of F2E. So Bellsberg first and then we'll keep going.
[00:02:56] Speaker C: Awesome. Bellsberg is a family office based in New York. Started as a single family with a couple families connected through marriage and then sort of became a investment platform merchant bank basically because we built out a couple of fun businesses and added a couple more families. But we really look and feel like the family office of three connected families through marriage. I've been there, coming up on four years, have a close grade relationship with the family. It's really fun and I've really been kind of steeped in the independent sponsor lower middle market eta sort of, you name it, search world. Because I run sourcing and origination for a private markets business. So I get to talk to everybody and meet a lot of cool budding entrepreneurs. They're in this really exciting inflection point of their career that we'll sort of dig into a little more About Me I went to Trinity College in Hartford. I grew up in New York City, pretty entrepreneurial guy. Started a shoe business in high school called Del Toro.
Always had the entrepreneurial bug, but I also had a strong affinity for finance, financial services and things like that. Where the star sort of aligned for me was that there was this very entrepreneurial side of financial services. So you think of finance. I graduated 2010, so we were kind of on the later edge of that whole tiger cub, go out and start a hedge fund thing. And we were getting more from Publix into private markets and the jobs to be had then were go work at an investment bank or go work at a private equity fund. Those were sort of the two things on all of our radar in 2010. We did have that tiny little thing called a massive financial crisis around that time too. That made it super fun. So we took what we could get. But it was interesting to learn about because we saw these young guys go and start these like hedge funds. We saw 24, 26 year old guys starting hedge funds and then it took a little while for that to trickle down to the private markets. And I remember being kind of a few years out of school, I had a good friend and fraternity brother that I got to work with for a little bit who was at a big bank and he was like, there's no one putting capital in the inland marine leasing barge business down in the bayou. And. And I think if I can go out and raise some money that I could buy some of these barges and obviously they offer unbelievable yields and triple net leases and it's non cyclical and there's no capital into it. And there's all these sort of attributes, depreciation attributes and you name it. And I think I could build a business on that. And that to me was crazy. So it was like, well, you can just leave your banking job that we're all trying to get and actually just go buy kind of a business or invest in sort of niche off the run business. It just almost was a different time. Things changed so much. Even though that was 2014, 2015, he just wasn't as sort of well known. And then not to drop the name that always gets dropped in this space so much. But then you hear all these other stories of the guys that are going to buy Burger King NBAs at Harvard, they want to go buy a couple of Burger Kings. That was still this aha moment that a lot of people were having back then. It was fewer and farther in between.
But the whole idea is like, if I can find the capital, I think I could buy this business. I think I could run it maybe a little better than this person and I think that I could sell it. And that moment started this massive wave fast forwarding to kind of where we are today, where it's a very normal occurrence for people to be sitting in a large cap private equity seat, make an X, Y, Z partner track with Kerry Pool, to be like, all right, I'm out. I'm going to go buy like a random residential services roofing business and I'm moving me and my young baby to like Wichita to, to do it. That would be bananas. Even 15 years ago. And now it's like pretty normal.
[00:06:43] Speaker B: Why is it happening now? Do you have a sense for what's changed? I agree with you. It's definitely happening now. That's a fact. You can see it happening, you can hear it happening. There are more and more examples of it. But any sense as to why this is happening now and why these opportunities are becoming interesting to that kind of professional?
[00:07:03] Speaker C: I think you can almost attribute it to a bunch of different factors. If you look at our parents generation, it was go get a job and go get a steady job and get a paycheck. Maybe you get carried interest or you get partnership or you get equity and maybe you sort of be the CEO. And our generation obviously is way more entrepreneurial. We saw the whole go start a business in college, go get venture funding, go build Facebook. All that became much more normal.
But then I think the natural evolution of that was I'm not a tech entrepreneur. I don't have some new great idea. I want to apply my skills of investing and analyzing businesses and building businesses. But I still want ownership. And I think it's a generational thing that we understood that you need to own in this world. You can't be an employee because then you're just renting time. And then the more you study, like the actual great investors, I mean, Munger and Warren Buffett and all these people, all these life lessons, you actually have to own something to have control. You need equity. If you just have a job in today's world, you're waiting for someone else to give you a discretionary bonus. You can get fired, you can get displaced, you can get moved, you can get laid off. Like something can happen and you're not in control of your own destiny. So I think our generation wants to own. When it came out that, wait a minute, all I have to do is raise some money to go buy a business and then I'm in charge and I control my own destiny. And I can hire and I can make a positive aspect in a business that's insanely desirable. And that's not going away. Now. We introduced the whole technological revolution where we can all get a website going and AI and all these things and everyone's going to be able to build their own businesses. The desire to own your own stuff, and that's from Munger all the way to like Naval Ravikant. You must own. I don't think that desire is going away.
I agree.
[00:08:56] Speaker B: There's no question. It feels like that's a reasonable explanation for the acceleration and the expansion of eta. Self funded search acquisitions, Big expansion in funded search as a category coming out of business schools and elsewhere.
[00:09:14] Speaker C: Are there just less jobs that paid the huge amounts that they used to? It felt like there were so many seats and now it's just so much more competitive, maybe in the banks or private equity or something like that. It's like now to really make a mark and do something fulfilling and swing for the fences. There's a huge desire now to own versus just climb a corporate ladder.
[00:09:37] Speaker B: What feels more new to me is not eta, not independent sponsors in general as a category.
But what feels interesting is this class of people who have a super high opportunity cost on their next best alternative, like you said, their partner track at a great firm or great investment fund that are increasingly leaving those paths to do something like that. That's the category that I wanted to dive in on and discuss today with you. I think there's a huge number of podcasts and a large amount of literature that already exists. On ETA and self funded search and funded search and there's a reasonable amount of literature and a meaningful amount of momentum generally speaking around independent sponsors. But there's this Persona, there's this archetype that is coming out of a mid career path with a lot of pedigree at a public investment firm or a major investment bank or a really significant private equity firm that are leaving to go and buy lower middle market businesses.
This category which I mentioned as being f2e, which I'll let you explain the reference to f2e in the normal course of the conversation.
Do you view this as an archetype that sits inside the overall independent sponsor category or do you view this as something different from that?
[00:11:04] Speaker C: I do view it as a certain type of independent sponsor and it's on the farther end of the spectrum of search ETA type MBA person. This is now more of experience. This is a mid career professional. So it's in my mind a higher caliber, different risk spectrum, more experienced version of an independent sponsor.
[00:11:28] Speaker B: What is the other category of independent sponsor that this is distinct from? Who else fits in the independent sponsor bucket that doesn't fit into this bucket?
[00:11:38] Speaker C: There's a handful. So if I think of just financial professionals, there's going to be people that maybe are four to six years of experience, maybe they weren't part of an MBA program, maybe they did a couple years of banking, but very early on in their career they're like, I want to go buy a business and be either a searcher or an independent sponsor and get out there. Then there are those who are like, okay, I actually have spent 6, 7, 10, 12 years at multiple different firms. I've sat on boards, I've invested, I've sat in ICs, I've been at a banker, They've kind of been around the block four or five times. That type of person is a different animal. And they're just less green, they've got more mileage, they've gotten beaten up a little bit more by life. They're probably like still scrappy and hungry and they're still like searching for something. Like maybe they're 37, 38 years old and they're like, all right, what do I really have? Maybe I've made some money, maybe I have some carry over here. I haven't really like gotten to put my stamp on something. I've been fired, you know, over here. I've had partner fights here. I've had some success here. I had a couple exits here, but they've yet to kind of fully prove themselves and take that shot. And that part of their career is crucial because it's usually people are like, maybe they're married, they've made some money, some. They have some money to invest. They, you know, many cases will have a child. It's a good time. Like, if you have a child, you got more to lose. As an investor, you like investing with someone like that. They have 15 years of their career equity that they are putting on the line. They're putting $700,000 of their savings, or a million and a half or 3 million, whatever it is that means something to them. They're putting that on the line and they're saying, this first business has to work out because I have all that to lose. If you're 22 years old, you start a startup and you invest $10,000, you have nothing to lose. That blows up. Doesn't matter if you're 37 and you take all your career contacts to invest in this new company you're going to buy and you screw that up, there's risk there. That's skin in the game, and that's probably a good place to invest. And that person, that operator, is going to have a lot more chops. That's a pretty attractive partner to invest with.
A lot of people will share this. This is not like a new idea that I have or you have, but I think the articulation of financier to entrepreneur, and I must credit Andy Freeman of Bricket Point, beautifully articulated that acronym. There it is. That's exactly what it is. Because I'd always been dealing with these guys. But you're really aligning yourself someone in this crucial point of their career, and it's almost akin to someone's first album. They've been writing music for 10 years of their childhood, and they're going to put out their first album. It's their best work. It's got to be like the best. And you got someone like this cool inflection point of their career where they're willing to put it all on the line and invest their own personal money. They've got the kid and the apartment, and they've been comfortable. That's where you want to be as the investor.
[00:14:40] Speaker B: Why are so many of the professionals who kind of fit into this box, why are they buying one business as opposed to raising a small fund?
[00:14:51] Speaker C: That is just, I think, a evolution slightly of where we are in the capital formation cycle. And I think the desire of the capital bases just to get away from blind pool funds and to be more a Part of the sausage making process, that is the underwriting process.
Family offices would rather see a deal. Take this F2E version that we just talked about. Who's mid career has got the three year old and the lab and the mortgage and they're putting in $700,000. I want to look at the business. I don't want to hear, oh, I'm going to invest in the lower middle market and I've got a good network. It's like, no, let's actually look at something together. Give me bird in hand, give me something tangible. What are we actually talking about? That's why everyone loves to look at a deal with an independent sponsor, not just a fund for funds. For me, the story has to be so good. This guy was running strategic partners at Blackstone and he was managing $6 billion and he's spinning out and he's getting 2 billion from this pension fund. Then it makes sense. When it's just so high profile or like on the venture you see that, or Bobby James spins out a Citadel or Millennium or whatever, then it sort of makes sense. But I say to a lot of people, don't start the fund unless it's makes total sense. Some assets you need the fund, or if it's just such a natural evolution of doing deals that okay, these investors are all coming with you anyway, you may as well start the fund. I think appetites have changed.
[00:16:18] Speaker B: Let's talk a little bit about the structure of what you're seeing in this category, this F2E category.
It sounds like potentially one of the places where it might be different from independent sponsors is or a different approach to capital formation than independent sponsors is.
While it is one deal, it seems like at least some of these professionals that sort of fit into this archetype are raising a small slug of capital prior to even finding the deal itself. They don't always have a deal under loi, whereas I think a lot of independent sponsors, they're out of the market, then maybe they've bought a couple of businesses already, they're out of the market again, they find a new business, they go under LOI and they reach out to a set of preexisting as well as potentially new capital partners. Seems like the F2E category has professionals who say, I'm going to go buy one business, that's how I'm going to start building my holding company or how I'm going to start this entrepreneurial chapter after finance, but I'm going to raise 15 million or 20 or 30 million dollars to go and do that.
Am I just on the receiving end of one or two of those pitches or does that tend to be more the way that these guys are looking to operate?
[00:17:33] Speaker C: I would probably say that is the minority of scenarios. I definitely see some cases where people are like, look, I want to build a real business.
I'm going to do this for the next 30 years.
I want to invest a little bit upfront in the management company. So I do want to hire a little bit. I do want some cash for the say, sourcing mechanisms and maybe an office and all that. And if that's someone that's 15, 20 years in, they might have the quality of relationship so they can go to people and do some sort of like management company level deal or GP stake deal just to get some working capital in the business. And that also gets like the credibility of whatever family is sort of backing it. So like I do see that. But at the end of the day it really just comes down to the first deal. What are we actually talking about here so you can get those deals. It's less interesting unless you really as the investor, if you've been tracking someone's whole career, they're friends, you know them like you've done deals together, all that, and you see them spin out and you really want to be part of the journey. Even pre deal one, that is a good way to like get that involved. So it all kind of depends on what the sponsor wants.
[00:18:43] Speaker B: How are they navigating the off ramp from their current career to then tracking down the first deal that they sit down and talk to with someone like you at Bellsberg, do they quit and then leave? You see so much of this. What are they doing?
[00:18:59] Speaker C: It's so funny. I had two young guys reach out to me from their work email last week, send me a presentation, come into the office and they're like, yeah, we're going to leave as soon as we get our bonuses. I was like, it's like almost like so out in the open, so flu flagrant, so blatant. I sort of loved sort of depends. There's sometimes a burn the boat mentality. Some people are like, look, I need to just quit now. And once I quit, I know there's no going back. And I'm gonna focus 100% on getting a deal. I don't have a paycheck so I gotta like get into it and just get after it. Other people are like, I'm gonna start planting the seeds for two years while I leave, do stuff on the side and send emails out of my personal. It kind of depends on personal circumstances. But you see all the above. You see people sending side text messages saying, meet me in this corner of a Starbucks way downtown. And I'm terrified to see anyone wearing the mustache and the hat and the secret thing. That's always kind of fun. It's a little cloak and dagger on the other side. I see super high profile people leaving Blackstone and then it's like, you know, you can't say anything and heaven forbid, because all of Wall street is going to ripple with excitement when they find out this person's leaving. Some people are more transparent with their existing employers and they're like, I know little Bobby's going to leave. He's wanted to go buy a business for ages. We're super supportive of it. He can use the conference room in the meantime. We see all the above, but earlier is better. It is fun to see earlier. Just like it's easier to find a job when you have a job, it's almost probably easier to like get people excited about what you're doing right before you've left. So it's probably not a terrible idea to like plant a couple of seeds and some conversations, especially if you have a mentorship network. And then it's probably good to find that fine line of like, all right, now I'm going to actually quit. Go full time, fully commit to this. Do everything on the up and up with your previous employer. That's key because they're getting a phone call, they're going to want to know how you were towards the end. And if you handle yourself well, you're upfront, realize you're getting paid, there's a little search going on at the same time. Usually no one's faulted too much for that. But you know, there's a fine line of how you handle things, but it's delicate to your point, It's a good question.
[00:21:13] Speaker B: They're typically not actually that far along on a specific deal at this point. It's really just preliminary conversations with capital sources like you and others that they're sort of talking to, but they're not actively working for Blackstone and sourcing some, like lower middle market deal because that's a lot of plates to spin all at the same time.
[00:21:36] Speaker C: Some of the bigger firms like a Blackstone tell me there's crazy non competes and garden leaves and all that. But just take those aside, take your standard job. I think it's very common for people to be searching on the side.
Get an loi, get the pen out Ready, Tell their employers on the loi and then out their bag is packed and like secretly like redbushcapital.com has been registered. They've got their thing, very common.
[00:22:03] Speaker B: That's good color. I would be curious to talk a little bit maybe about if you were to just again, stay focused on this archetype of really, really promising professionals with a lot of upside. If they just continue on the partner track where they are. They're not someone who got started in their mid-20s. They're someone who's taking this leap, maybe between 35 and 55. Do you source these professionals actively? Do they come to you?
Do you have an outbound motion to try and persuade people that are in this chapter of their life to think about this opportunity? I'm curious how the conversations occur.
Who tends to approach who and then I want to get into who are going to be great capital partners to this type of professional. What do they need from their capital partners? So maybe two part question. But yeah, I'm curious how sourcing works for this part of the market. You mentioned Andy Freeman at Bricket Point. He obviously is investing in this category. Obviously not asking you to speak for him, but how do you and him and other guys like that, how do you guys think about trying to go hunt down these high potential people and think about being their first phone calls?
[00:23:12] Speaker C: I think you've got to just meet a ton of people and be, be encouraging and be a sounding board and be supportive of what they're trying to do. I mean, for me, I'm very pro, Go for it and I'm very pro. You can do it and chase your dreams and all that stuff. I'm not the voice of conservative dad, like, stay with your job, like you'll never succeed type of thing. So I'm always telling people, yeah, look, this guy did it and this buddy of mine did it. And I have just so many friends that are my age, younger or older, that have success stories in the space of doing it on various levels. Just buying a small business and doing well over here, building an empire over here so it's totally possible. And I'm always trying to meet and talk to more and more of my friends. Anyone that knows me will be like, yeah, like, I don't shut up about this stuff. I get excited about this. And the more I get people talking and whenever I'm talking to someone that works at a fund, I'm like, so do you love this place? Do you want to run this place? Like, I can't help myself. Do you want to be the CEO. And they're like, nah, not really. I'm like, what do you want to do? And they're like, well, honestly, what I want to do, like, yes. Like, that's where I get engaged. They're like, I want to dance. And I'm like, good. I'm always needling people for that personally. And then on top of that, it's a lot of like power networking and it's going to the conferences and the coolest thing you can do, and I'm lucky in my seat.
If you just go to 30 different other family office investors and you say, who do you like the most? Who are your three? You then have a 90 person curated CRM of highly talented people. And that's a great way to do it. And whenever I'm talking to other families, I'm saying, look, what independent sponsors do you like? And who's been a great partner to you? It's being vocal, it's being supportive, it's actively looking for people that are on this hero's journey. It's being enthusiastic and getting out there and doing stuff like this. And my whole career I've been excited about entrepreneurship. I've been lucky enough to get people that come to me and I get to help them, maybe they help me, all that. So I've seen a lot of people build their businesses. The funny thing about where we are in the cycle of when all these businesses started is I think there's this thing in private equity. A lot of these firms are started in like the 60s and 70s and 80s, and those people are now like 70. And the next gen is in there like late 50s and 60s. And my gen is in their mid-30s and into their 40s. A lot of times that middle group hasn't left yet, so they're holding on to Carrie and they've got like another 15 years in them. So if you're like 36, you're like, my 56 year old boss is not leaving for 15 years, what do I do? And then like there's four versions of that. Dude, what am I doing here? I'm doing all the work. This guy is sitting down in Palm Beach. I'm the one like on these boards. If I just knew a bunch of family offices, I could do this myself. The only reason I'm here is because they have the capital in house. And as capital went less captive to funds and it became more of a direct market, there's just more and more appetite for those people to go direct and build their relationships with family. Offices and take a swing.
[00:26:17] Speaker B: You were saying, he's down in Palm beach and I'm doing all the work.
Is there a little more to it than that? Do you feel like that's true a lot of the time? Are they really doing all the work?
What do people who leave and head in this direction?
What do they not appreciate about how hard it is? Or what do they forget to appreciate before they go out on their own? Are they truly already doing all aspects of the job? Or is there something that they need to appreciate before they collect their bonus? Turn in their letter of resignation, go sign up a business under LOI and call James.
[00:26:54] Speaker C: Part of the investigative process that we have as an investor is we want to look at someone's track record and say, how much is that person's attribution versus the firm? If you're like, I was at Apollo for all these years. Look at all these exits we did, it's like, all right, well, was that you? Was that the unbelievable franchise that is Apollo? And trying to sort of figure that out. We'll just stick with the big cat PE example for now.
And then that person leaves Apollo and they're like, all right, wait a minute. It's just me now. I don't have the fancy business card. People aren't picking up the phone. I'm just a dude in the garage that doesn't know anybody that now has to dial for dollars. Cause that's kind of what you're doing in the beginning. And there is a huge learning curve there, I think. And I think people don't quite understand.
You're in the business of investing. You're building a business from scratch.
Sales is a huge part of that capital formation, I. E. Fundraising. No one wants to say it. You're a fundraiser. You are a fundraiser who needs to tell a great story. And you need to buy a business and operate that's your product. A lot of times people will come out and just don't realize how difficult it is once they're out of that big ecosystem, to just drum up 50, 75, $150 million. The people that don't have an interesting strong thesis, and they're like, oh, we want to do a fund one. It's $175 million. We both came from these okay firms. There's like a harsh reality there that's actually very hard. When people sort of make that switch, they don't fully appreciate what it's going to be like.
[00:28:25] Speaker B: Maybe just to get a little more specific on the lower middle market, because that's where I certainly spend all of my time and that's all that I think about for the most part. Same for you. What's your view on someone leaving Apollo, Blackstone, kkr, Carlyle and then going into the lower middle market versus someone who leaves Shore Group, Alpine, one of these very, very well run lower middle market private equity funds. Is there a difference in how you evaluate those people? Obviously one came from Apollo. Apollo's the best in the world at what Apollo does. Incredibly high bar for talent, but they've probably been buying businesses from Morgan Stanley and Goldman Sachs. They've never spoken to a business broker before in their life.
All of the information on the businesses was really, really well compiled and well organized by a banker and a sell side process.
[00:29:23] Speaker C: So just nice and neat, tied up in a bow for them.
[00:29:26] Speaker B: I'm not saying it's easy to be an investment professional at Apollo. I'm sure there's a lot of things to do really, really well. There's. But what is your view when you're evaluating someone as an investment partner, as an LP to them and they're coming from a place like that versus someone who's been at a maybe less pedigreed or less well known firm, but that has more lower middle market chops and experience? Do you think about that a lot? Does that matter to you?
[00:29:52] Speaker C: Big time. There's pros and cons. The man or woman that's coming out of a nice lower middle market scrappy firm where all the partners are doing everything and they're very operationally intensive and they are on the ground floor and they got the dirt in their fingernails and they are really involved in the business. You need that. That's very important and very crucial. Maybe that Apollo partner has been so far removed from that. When they're doing the deal, you want to make sure they have a good management team and there's a really good operator involved. Maybe you're less worried about that if it's a real buy and build lower middle market person that's been on the ground. So there's pros and cons. That said, let's say that Apollo person is very polished. They have, like you said, huge bar for talent. They've been trained really well. Their institutional quality. They really know what they're doing. They can grind very hard. They tell an amazing story like they're going to build a big business and you're like, all right, this person's no joke. Like I can trust that the franchise is going to be done well, but I want to make sure they have an operator that's really on the ground. Maybe that really operational, intense, scrappy car wash dude that's building the business over here. He's great. I wish he was a little more polished. Maybe he should partner with the Apollo guy and they're going to build a great business. That more I think is probably relevant if you're talking about them raising a fund because you have more risk of if they don't raise money on this deal, then things are going to fall apart. If you're just looking at a standalone business, you care less about the.
You do care maybe about. All right, this is a high integrity person that's behaved well in a large institution and all that.
[00:31:35] Speaker B: How would you characterize what they're looking for in the capital partners that they talk to? What are they looking for from someone like you? What are they looking for from other family offices?
Are they looking for one big check writer that speaks to 75, 80% of the capital that they need? Is it more like a search fund where they're going to sell units and maybe it's going to be more broadly distributed. Cap table of LPs what are you seeing there in terms of what they're looking for from the core LPs that are going to capitalize the first deal?
[00:32:10] Speaker C: I think they ideally want five big partners. Just like customer concentration or supplier concentration. You don't want someone that's more than 20 to 25%.
But right off the bat you do want someone that's 20 to 25% because you want an anchor, someone that's going to vouch for you just like you're coming into a new group or like I'm the king or you. Someone's gonna be like, I vouch for this person. Especially if it's a well known family office that has a really good program that's done a lot of deals in this space. And if you get XYZ name and we know these, we'll just say Pritzker. That's a really famous. The Pritzker family is backing you. That's going to give you a lot of credibility in the Chicago family office world. And that's going to probably lead to a lot of other families like, oh well, Pritzker's doing it like they best go to them. It's the same phenomenon. And obviously venture and Sequoia, A16Z, et cetera.
[00:33:04] Speaker B: Do you think it's the same? And there are these firms that, whether they're family offices or otherwise, really do tend to see the very best FTEs when they're making their leap.
[00:33:17] Speaker C: When you're early days and you haven't proven yourself as an F2E, having the brand name of a family that every other investor knows is going to add a huge amount of credibility and it's just going to make people comfortable. The same thing with institutions. If Texas Teachers is investing in this startup fund, I just feel a little more comfortable about it than like my neighbor Bob, whose nephew is doing this. And it's some dripped out thing, right? I'm like, all right, this has been vetted. In the family world, there's 10, 20 of these names that just have really, well, highly regarded programs.
[00:33:52] Speaker B: Do you feel like those programs are highly regarded for the right reasons? Have they distinguished themselves as being exceptional at sourcing and selecting great emerging managers? F2ES emerging managers, or are they just billionaires with significant family names?
[00:34:10] Speaker C: The verdict is out. The data is not yet in. I think a lot of it is. They're just famous names. But when you really get in the weeds, you could say, all right, Walton or whatever. That sounds great. Sure, the Walton family backed me. But then when you really learn about the program and you're like, well, they don't pick managers that well. They don't. I'm not saying them, but I'm saying a group. Maybe they don't pick managers that well. Maybe they don't treat their sponsors that well, their FJs that well. People don't ask them to re up something like that. In those cases for sure. Within the community, people know who have really good and thoughtful programs. And I think that the sponsors, like if they're successful, they're going to be singing these people's praises. Cause they were good partners all along. Like everyone knows who backed Garnett station on day one. Everyone knows who backed Preg in the early days. Like everyone knows who backed Kleiner and kkr. These early families have built reputations. And what's cool is it's all kind of under the radar. There's not public information, but people know it. In the ecosystem, if people are treated well and they're supportive and they're there when you need them, and they're good communicators, sort of both ways in the partner relationship. Cause it's limited partner and its general partner. So if the marriage goes well, that reputation is crucial. I think people want really good partners who are going to be along with them the whole ride. And if they do well and you deliver someone a 5X, you kind of want them there for the next Deal to re up on the next deal. And then eventually when you do launch a fund, ideally they're there with you too. And I think a good independent sponsor or fund program wants to go the whole journey too, because I think you want someone that's like, look, I'm not just going to do this fund, I'm going to do it, or this deal. Like, I'm going to go with you the whole way.
And a lot of times you can't. A lot of times the capital is constrained or things change. And in an ideal scenario, you've got two people that are going to be doing business for 30 years together across deals, across funds, and just creating a nice diaspora of trusted relationships.
[00:36:10] Speaker B: Yeah, I just wonder how repeatable the outperformance is in these scenarios where there's a great first outcome.
If you look at the great investment firms in the venture business, they keep their returns quite secret. But I don't think it's any secret that Sequoia and Benchmark's returns are really, really, really good. So there's something at those firms that at least for a little while now, they have been able to create real repeatability around outperformance, real predictable, repeatable outperformance in the form of investment returns, which has led to huge demand to invest behind those names.
And there's something about those partnerships that seems to successfully attract the very best technical entrepreneurs who want to start huge businesses in America. Huge technical businesses in America. And I'm just curious whether that is where we will find ourselves in this category.
But the capital bases will be as opposed to being for profit institutions.
It seems like this category is going to get capitalized more by families as opposed to by anything else. But I'm just curious how repeatable some of these families will be at continuing to back one great F2E after the next.
[00:37:35] Speaker C: It's a really interesting question and thought experiment. The reason that those are such good brands and venture is because they're intentionally trying to build great brands because that they know that sourcing is their edge and they know the best founder is going to want to go to A16Z and they're a business. A16Z is a business that's raising money from investors. What's different is family offices aren't really businesses. And a lot of times, like the owner of the capital is just not trying to build a brand. I think a lot of times the employees are because you're like, we want to have a really good program. So we get this whole flywheel coming. That's on top of the sports team they own and the hedge fund program. And innately it's not a for profit entity, but it could be back to Pritzker. I think that's one of the reasons they're like, all right, we need to take Pritzker and call it Pritzker Private Capital. And that's an actual brand that is a for profit entity. And I think you see this dynamic now where family offices are, are taking their brand name and they're creating commercial enterprises from it. And you've seen Declaration Capital doing that with David Rubenstein. You've seen obviously Pritzker doing it.
Rubenstein says this, this is where the whole industry is at it. Sam Zell's firm has done it. They're going from family offices into commercial enterprises and they're just turning into private equity firms. Embedded in that slightly is the nuance that you're describing. Is it like you want to build brand and awareness? Because it's all about sourcing.
[00:39:07] Speaker B: In the last 10 to 15 years, there have been a series of GPs that have raised LP capital to raise a fund in order to invest in search funds. So it's a fund of search fund. I think some of them are doing reasonably well today. The independent sponsor category, the F2E category, seems like they really are just being capitalized in one way or another by family offices. And as you said, it's like a family office. And he wants a 3-5x and there's the sports team and the hedge fund program and the long only program. But do you think that you could see a series of funds emerge that are just organized around backing F2ES?
[00:39:49] Speaker C: Oh yeah, because we already are. There's a handful out there. And if you go down to McGuire woods, you'll see a bunch of institutional name tags. And they're creating either co invest funds or slush bucket funds that are doing one off deals. And maybe they'll do a primary with some co invest or you'll just have straight, we only do independent sponsored deals with 5-7F 2Es or sponsors or whatever, sometimes funded sponsors as well. But there's more and more of that happening and it's kind of funny because the independent sponsor of the FTE is going direct. So they've unbuttoned, bundled the deal from the fund structure. And then someone comes along and says, well wait a minute, I could just rebundle that over here into another fund. So we will constantly be rebundling and repackaging businesses into funds. And that's all of finance. How can I slap these together and then I'm going to find them better and sell it over here? And then the independent sponsor is like, wait a minute, I purposely broke open the model because it's better like this.
[00:40:50] Speaker B: What are the returns considerations or the fees considerations for those funds? If you're an independent sponsor and you want your economics and part of the reason you became an independent sponsor and left Apollo is for ownership, for autonomy, but also a certain amount of significant economic control and ownership.
And then you have a institutional fund of funds that backslidge independent sponsors like you. And then there's an LP on the back end of that.
Are you familiar with those economics or are they all over the place?
[00:41:25] Speaker C: They're going to be all over the place. In some cases they'll just take a rev share on top. In some cases they'll throw a 1 in 10 on top of a 1 in 10. And investors paying 2 and 20. It's all slice and dice a thousand different ways. And I think that the fund of search funds or the fund of independent sponsor deals, they'll have their own way of describing where their blended returns are actually better. And there is something to be said if someone just has $200 million and is not really dedicated to this space and they're like, I'm just going to go start doing independent sponsor deals, there is something to be said like, all right, this is a dedicated independent sponsor program. They're going to every single conference, they're tracking every one of these upcoming F2Es, they've got notes and CRMs, and they're in the data room and they're doing an unbelievable job in that space.
Who's going to do better? Net net. Is it worth paying that relatively non onerous fee layer to a fund of independent sponsored funds? Probably, especially in the early days, if you're trying to build a program. The sourcing part is interesting because there's a little bit of an averse selection thing. I think a GP that comes out in the early days is glad to have one of these funds come in for multiple reasons. They will sometimes help with fundraising, they'll sometimes make introductions.
They've seen everything. So you sort of have this institutional partner that can be helpful across the board and sounding board and you have this advisory board. You're kind of in this system, in this network, but I think as you graduate out of that, you don't really want that. You just want a straight family office. There's kind of like an adverse selection thing.
[00:43:05] Speaker B: What about you, James? In Light of all this knowledge that you have, all these different flavors of the rainbow that are out there in terms of ways to put capital to work in this part of the market. Where do you like to put capital to work? What are you excited about doing? What are some of the deals that you've become really excited about? With all of this different activity funds and family offices, Pritzker going institutional, what have you decided to do as a result of all this?
[00:43:33] Speaker C: I think a big part of my process is trying to learn where the puck is going and trying to be a part of this ecosystem as much as I can and trying to be as helpful as I can to a lot of these up and coming sponsors. Our program, to be honest, is not the most sophisticated. We're not putting out huge dollars and we're not doing a ton of deals. Given that, how can I distinguish myself?
[00:43:58] Speaker B: We do about one a quarter, right?
[00:44:00] Speaker C: Yeah, we do about one a quarter. So because we don't have a big fancy name and we're not writing massive checks, how can I, James, differentiate myself? It's like, well, I can be super helpful. I can really show up and I can be thoughtful and I can make introductions over here. I can always be a phone call away and a shoulder to cry on and a concert going, buddy, not to get too corny or whatever. I can try like really hard to get out there and then I can also meet everyone in the space. If I like you, the world's gonna know I'm shouting from the rooftop. There's no other side of that. If I really don't like you, maybe. No, I'm kidding. Talking like Michael Ovitz style. No, I'm very discreet. I am a champion for these people that come in because I love it. It's totally sincere. Like, I'm super excited for them. In the great scenarios, I'm the one that's helping them push them out the door, their firm and getting to be there on day one. And a lot of times we don't even get to invest in the deal, but just getting to be along for the journey. That's super exciting. And we are so heavily relationship based at our farm. So we want to know every deal that someone has done, every investor that was in the deal, what their last jobs were like. We view it as sort of a marriage and a partnership. So you get very close with these sponsors and I think finding the combination of the right horse at the right time with the right industry and the right structure. There's these sort of four things in what Order you look at them. Yes, we have our general areas where we will invest and where we won't invest. We're not going to invest in things we don't understand.
Things with heavy sort of payer, reinsurance, risk, all that stuff. Heavy regulated businesses, a lot of deep tech stuff we're not doing. Obviously we're investing in like simple, easy to understand, cash flowing businesses in durable markets. That's where we invest. Beyond that, it's much more about the individual and where they are in their career. You're investing with this highly talented alpha person at the most crucial part of their career who's putting their children's house on the line.
One could say you don't even have to look at the deal if you feel that good about that.
[00:46:07] Speaker B: How much time are you guys spending on the deal or the industry?
Or is it really just a set of things that you won't do? And then as long as it's outside of one of those categories, it's not in deep tech or it's not in whatever. The horse versus the jockey question.
The other question is if you guys are doing about a deal a quarter, what's the lead time typically on a deal that you're executing? If you guys do a deal here in the first quarter, is that a deal that you've been working on for a year, three months, one month, three years? I'm sure it varies. What typically is the lead time that you're finding when you guys actually close a transaction? Given the diligence you're doing on the gp?
[00:46:52] Speaker C: Two months is probably the shortest. And that's if we already know the gp. Actually if I'm saying like two months before we meet someone and get the deal done, like that's very short. And then I would say like a year. And it really depends how in the sausage we are. Some cases we're helping them design the thesis a little bit, right. And be supportive of it. Watch them percolate and chew on something and we're giving them feedback on maybe how sellable it is. Maybe she'd go talk to this family over here because they might have some ideas, maybe will be really helpful. Those are really deep active partnerships that we have with repeat people that we've followed along. David Leed Aaronova is an example of that. And I think we're going three year relationship with him, et cetera. In other cases we'll meet someone and it's a very good deal. And if we're able to reference them extremely well. And if six people that we Trust very well that we've done deals with know them and they check out like we can move maybe in three months. About that time. So that's the second part of your question. It's a long process. You're getting married for 10 years and there's going to be ups and downs. You want to like take the time to get to know somebody. So I do think a deal is a great way to get to know people. But it's also nice just to have a conversation.
[00:48:08] Speaker B: Do you think it ends up being 10 years? These aren't funds. Do you think it ends up being about 10 years before an independent sponsor is seeking liquidity or do you think that there's just more duration to these deals?
[00:48:20] Speaker C: I think it can be up to 10 years. That's going to be outer limit. Who knows where anyone is in 10 years. But I think you got to be prepared for that type of timeline. Look, it could be three years. If it's three years, that probably means it's a pretty good outcome and it probably means you're doing the next deals. It's only a three year relationship if you had a bad experience because if it was a good experience, you're probably doing another deal again.
And if not, there's always the question mark, why not? I think we are very heavily focused on underwriting the jockey, the individual, because it's all about that individual. And then in doing that we're learning about the business and we're doing it with and along them and then we're doing a huge amount of referencing outside of that sponsor. Speaking of the market, bankers, other sponsors in the market, the largest players, whatever paid sort of diligence or consulting studies you need to do. Speaking to other families about their thoughts.
One thing that you get to do as an allocator is you get to just call the competitors, get to call the other funds that are investing in the space. So you guys are investing in this. What do you think? And everyone will talk to you because if you're an investor, it's equally important to be comfortable around the structure, the industry, the company and the sponsor. Those are like the four big things. I always go back to the alignment and the incentive of the individual that you're investing behind. It's just like if you're investing in a startup, like what's the most important thing the actual individual feels like we
[00:49:48] Speaker B: would continue to have a more and more interesting and more and more colorful lower middle market if we could foment an F2E movement in the next five to 10 years.
That is even half the magnitude of the ETA and search fund movement of the last 10 or 15 years. I've only seen a few of these F2Es, particularly of the ones that are coming out of just super high powered brands. But hopefully over the next few years we can see more and more of that talent getting absorbed in the lower middle market and stepping out of the sort of more mega cap, large cap financial services category. That would be my hope.
[00:50:23] Speaker C: I think we will. People are maybe less afraid than they are. If you're mid career, you're 15 years in, you're just in a different place of life way back when. Oh my goodness. I'm 37 and I'm going to retire when I'm 50. I'm halfway through my career. I think people are kind of like, I'm 45 and I'm young. I'm just getting going. So it's not as daunting as it once was. But there's still people that are conservative and don't want to take the shot. It's hard. It's a hero's journey. Like there's no way. The first five years are not incredibly painful and difficult. I've done it and other stuff. I've been sort of financial service business but had entrepreneurial ventures. It is crazy hard. You will cry yourself to sleep at some point. And that's why when you're looking for like partners, when you're crying yourself to sleep, is this person going to be supportive and with you and along the ride and like they're. Or are they going to be a huge pain in the ass?
[00:51:22] Speaker B: I've learned a ton talking to you about this. Hopefully everybody who's thinking about the F2E chapter turns off this podcast before your comment about how they're going to cry themselves to sleep.
[00:51:35] Speaker C: So I leave it at the very, very end. Don't do it. Stay. Stay where you are. No, I'm kidding.
[00:51:41] Speaker B: James, it's great to talk to you about this. It's been a lot of fun.
I'm really enthusiastic for this category within the independent sponsor category to grow and to emerge. I know what you're talking about. You kind of know it when you see these guys. I hope to see many more of them with capital partners like you out in the ecosystem. There's certainly something for them to look forward to in terms of great new partners for them to talk to. So I wish you all the best of luck with your work in this category and maybe we can check in on this topic from time to time feels like it might be interesting to cover every so often. So thank you. This has been great.
[00:52:15] Speaker C: Thank you Peter. Anytime. Had a blast and thanks for having me.
[00:52:19] Speaker A: 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 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
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[00:53:07] Speaker D: 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.
