Text version of interview
Isaac, can you kick off describing your market and your typical target for acquisition?
National Express is in the transportation business. We have been focused on the school bus in the US, and recently we have developed nice business in the adult transportation space as well. We are owned publicly by a company in the UK, also called the National Express Group. We were traded on the London Stock Exchange. We run about 20.000 school busses in 35 US states where districts have chosen to outsource their school bussing to a private contractor such as ourselves.
Can you tell me about your role at National Express?
We have spent the last five years doing a rollup of many smaller businesses in markets and areas that are strategic to us. I have been at National Express for 5 years, and in that time we’ve completed close to 30 deals, mostly taking out some of those smaller organizations, family-owned businesses, and providing a great vehicle for us for growth, and, on the flip side, providing a nice exit for some of these folks.
When you work with private sellers, do you prefer to work through an advisor or directly with the sellers?
It’s a bit of a double-edged sword. On one hand, when you work through a broker, you tend to find the deal process a little more organized. In many cases, especially in ones where sellers have found good representation, they’ve organized them, they’ve prepared them, they’ve gotten their books in order and given them a sense of what is coming. On the flip side, if it’s a professionalized process you may have a harder time negotiating. We have done most of our deals with the sellers that are not represented, so we have become astute in terms of understanding what we are going to face when we talk to a seller.
Interestingly, you’ve done both. I feel like if you brought in an advisor, they are going to try to drive a competitive process.
On some of those where we’ve prospected, where we’ve known the player, the business, where we understood that they are a good operator, we have just reached out and asked them would they be interested in a conversation about us buying a business. A lot of times, they’ve brought a broker to the table and in those cases, we needed to be prepared to face some of the things I have mentioned, in terms of managing the process, being able to move it forward, and go through that way.
It sounds like you’re going to have to deal with a lot more valuation expectations. If you are working with an advisor and you have stuff figured ahead of time and have a target price, whereas if they are underrepresented, then you are the one that has to help drive that.
What I tend to find in the underrepresented category, especially around value, is that their value expectations are high. These are usually family-owned and other businesses where the business was loved and cared for. The emotion and the pride that gets tied to that inflates what the business might be worth. We have been most successful if we are dealing with someone we have a prospect on our own and we like to lay the groundwork, because otherwise, they may end up overestimating the business than it is worth to us.
How early do you set that expectation?
As early as we can fit it in. When we are guiding the process on our own we reach out pretty quickly and look to have an in-person meeting as soon as possible. When we meet them, we have a cover story and are usually tagged as insurance folks. Depending on how the conversation is going, we would have a document that we would hand them and talk them through just the basics of the process, timing, what things might look like and what to expect in various phases of doing the deal. If the conversation seems to go down the right path we want to get the value range seated early on, so they don’t get surprised when we come back with a valuation.
Are you trying to get the number from them first?
Most sellers are astute enough and most will hold back, although we’ve had a few that said that if they could get an X sum of money, they would sell it. That sum is usually a pretty big number, so you usually expect that that is going to be a big number.
What’s better - not to give you a number or give you high expectations?
To us, price negotiations have been easier when we’ve been able to lay the foundation of having value expectations or a range to think about because then they can go back and talk to their accountant, look at the books and make their estimation.
Let’s walk through the process. What does the process look like when working with the private seller? Let’s break it down, step by step.
First and foremost, you have to get in touch with those folks. Every six months to a year, we pull a list of a thousand companies. We try to see who we know, who we compete against, understand who those people are, who the operators are, and we are reaching out to those folks that we think would either be viable candidates ready to sell their business or business we would like to have.
Once we have someone we are in some sort of dialogue with, we will look to have that first in-person meeting. If it seems like there’s enough interest to take a look under the hood, we’ll get an NDA in place and we will send them an initial list of 15 items that we would like to get to do a valuation. For our business, it’s financial information, we want to know some things about their properties, a bit of payroll and benefits information, and then we put a number together and do a ten-year model.
To back-up, when you make this list, you are cold calling people. How easy is it to get a hold of the owners?
Once we’ve figured out 10 or 15 players in the market, we try to find contact information, put together the form letter and mail it. A couple of people get back to us, some say “no, thanks”, and others are thrilled that you contacted them. In some instances, we send out 50 to 100 of these letters to operators in markets we want to be in and businesses that we are aware of. Once we establish that initial conversation, a lot of people come back and say they are not ready to sell, but we will keep them on the list, in case they change minds in the future.
Is there a follow-up after sending out letters and emails in case you don’t get a response?
In some cases, yes, but generally no. If there was a business that was on our list that we felt strongly about making a connection with we may follow up with something like “hey, we sent you something, don’t know if you got it”. If we have a phone number, one of us may pick up a phone and see if we can make contact that way.
Then, you get to the meeting. Can you walk me through some of the key points that you would frame in the introduction?
For us, part of it is selling ourselves. We want them to understand who we are, what we have working behind us, and how we approach deals. A lot of businesses will buy someone else and rebrand it, but we typically leave names and visual identity intact and that brand will continue to live in the community, so we would outline that.
We would ask them about their level of interest in staying around if a deal were to happen, talk about what we look for and we would assure them about their employees because they usually care about what happens to their people. We will talk about the process if we were to proceed and let them know what they can expect, sign NDA, do a valuation, and give them a step by step process as to what to expect there.
In terms of what you are looking to learn, you mentioned having certain people stay around post-close. Are there other things that you are looking for at that point?
They’ll take us on a tour around the facility so we can visually observe some things and gather the information.
- How organized are they?
- Do they follow safety protocols?
- Are there red flags?
- What are our risk factors?
- If we were to complete a deal, what would be the things we would need to pay attention to as we think about integrating the business and mitigating risks?
We would look for a few of those things early on. We can start to get a sense of how concentrated is the revenue and how secure are the customer relationships. This way we will start to get a sense of what we are dealing with and validate if this is a business that we still like.
Would you share your initial diligence requests when prospecting? Do you start putting together the NDA and the initial diligence list at the same time?
It depends. In many cases, we’ll send the NDA, go back to legal rounds and we’ll get it signed. We have our form and we prefer to use it as there are a few things in there that we want to have in the NDA. As soon as we get it back signed we send our list of 15 things that we are looking for in terms of evaluation, they get back with us, and we’ll start putting the model together as soon as we start getting information.
What are those 15 things?
We ask for tax returns, last three years financial statements that are ideally produced in Excel, audited financials if they have them, and a fleet list. We will ask for an employee roster, their benefits package, property details, details on their insurance, do they own the building or pay rent, and if there are expenses that run through the business that wouldn’t be considered ordinary, such as boats or cars. There are a couple of others, but those are the big ones.
When you do that, you put things in your hands and start doing the valuation model?
That’s right. We put together a 10-year model we project on the business. If they have a long-range plan or a long-term budget we would ask for that just to get their understanding of what they think things are worth. We ask for customer contracts because that will help us build our revenue. We put that model together and we calculate our internal return metrics, we do a DCF and come up with what we think business is worth based on the things that we are seeing. If we come up with a number that we find is well-justified, then we go ahead and figure out the best way to deliver an offer.
My friend Jeff Desroches asks: Do you tend to do asset or share deals in your market?
You can do an asset deal, but then you have to go through and get all customer contracts assigned to yourselves as the purchaser, which is, in most cases, a showstopper. Plus, maybe there is a clause that could be taken to the RFP, which then degrades the value of the business.
Another reason is employees. As a larger business, where you have around 500 bus drivers on a school bus, there is a big effort needed between signing and closing to go ahead and hire all those drivers and go through open enrollment, so it’s much easier for us to take the stock and bring the employees over. On the flip-side, we are being very careful about the liabilities that we are taking and there is a lot of diligence that we need to do. Stock deals are logistically a better option for us.
Another question Jeff had was do you employ earn-outs?
We’ve used earnouts, we dislike them, but in some cases, that’s one lever we’ve pulled to close a value gap. Invariably, our earnouts, as well as we constructed them and as much though as we put into them haven’t always ended in litigation, almost always end up in some sort of dispute with bad feelings involved at the end.
So, you go through the valuation, come up with a number and you put together a letter of intent?
Yes. We would schedule face-to-face and put in front of them a simplified term sheet that states what is the EBITDA we have arrived at, our 10-year outlook on the business, the number that we’ve arrived at, and the math that gets them to that number. We will tell them what that EBITDA multiple looks like based upon what we are seeing, we’ll talk about key terms and conditions around that. If the dialogue goes well, we will send them and their attorneys the formalized LOI that has all the points in it, including the exclusivity period and legal terms.
Outside of price, are there any specific negotiables that are important to sellers?
It comes down to price. A couple of sellers have brought up employees’ matters. If there are key employees we will talk about employment agreements for the people that we want to keep.
You go through this process, you agree on LOI, and then from there, you are moving into confirmatory diligence?
Yes, and hopefully, if they are not represented or underrepresented, we’ve done a good job of preparing them for what that looks like. Our due diligence list has about 150 items on it, so once we’ve agreed to an LOI I send that to whoever they’ve designated to manage the document and the followup flow. We’ll set up a data room and we’ll get started in getting those things populated.
Is this where you see deal fatigue and burnout set in?
Yes, absolutely. Even the most prepared, most organized sellers who had done a great job on responding to those 150 items, where fatigue starts to set in is once our experts have looked at that and start to ask questions and then we go back and forth between us asking and them answering.
You went from 15 diligence items to 150 and then on top of it, you have all of this corresponding back and forth. What advice do you have for either side?
A professional contractor from a chosen firm can really make the process more comfortable. The worst thing you can do is not follow through on timing commitments and be mindful of how you are approaching sellers, respect their time, and the fact that they are running their business day to day and also accommodating all of the things that we are looking for.
Have you ever used a tool like DealRoom to help you manage the deal process?
Yes, and those tools can be very helpful. You can find a way to manage documents, but if you can manage a back and forth in terms of follow-ups and questions, that is really helpful and can really cut down on the frustration and the deal fatigue that starts to creep in.
What is the best humanistic approach to working with a private seller? What’s the mental and emotional prep?
In our case, we have mostly dealt with family-owned businesses, so they are interwoven into their daily life in every way possible. It comes down to reps and warranties, deal points, valuation, and integration time. Mitigating risk is critical, but we have felt like we are the most successful long-term in terms of creating value from a deal when we’ve respected the fact that this is someone's baby and when during and after the process we treat it as such. People care about their legacy, and talking through some of those emotional pieces can help you with value-creation, especially if you are looking to keep a seller on board post-close.
Let’s talk about empathy. What are your thoughts on that in terms of mindset or just being able to practice it as opposed to just using it as a word?
I think empathy can be trained, but I think people are inherently nice people or not. If you could at least continue to remind yourself that this is an emotional process as much as anything else for the seller would help the process go smoother and will give you a better chance of having a more positive value creation outcome.
Going through all this post-close activity, what’s the degree of integration you guys typically do?
We don’t necessarily always integrate the brand, but we do bring them on our safety platform. We let people know upfront about what things are going to change. In almost all cases, there are going to be safety practices and safety technology that we are going to bring in as part of our process. If they are not up to snuff on regulatory compliance items, whether that be labor or fleet management, we will certainly be bringing them into compliance. We do integrate the back office to a certain extent, we bring them on to our benefits platform. In most cases, this platform is going to create value for the employees, so there is usually little resistance to that. We have also learned a lot from sellers.
What usually happens with the leadership with the private seller?
Retiring sellers may stay around 6 months and help with the change management, transferring customer relationships to our management and they will also help do a lot of the talking to the employees. For some sellers who are in the younger category, coming into our organization and has been a great opportunity to advance in career. If it’s not going to be the seller who continues on running that operation in the local market, we also need them to at least help us identify someone who is already inside of the organization that can then become a general manager that will lead local day-to-day operations.
How can the seller help themselves?
Having a good M&A attorney representing yourself if you are a seller is key. In most cases that’s not the family attorney, as they are probably not going to be familiar with looking at the SBA or understanding how reps and warranties work. Think through about finding someone who can not only prepare you for valuation but who can also be someone you can trust and talk about your concerns about selling your business, who can prepare you for diligence.
What’s the craziest thing you’ve seen in M&A?
The other side had an advisor who was a very tough negotiator and had literal shouting matches with us, our representatives and our attorneys, telling us how horrible of people we were in terms of what we were requiring. We just weren't willing to hold onto certain positions, and he didn’t like it. It was a good deal for us and got us into the market we wanted to be in, but the actual doing of the deal was one of the most painful processes we went through.
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