Paul Giannamore: It's hard to look thousands of leads in the eye and push them away but that's how people don't negotiate good deals for themselves because they get caught up in that.
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Paul Giannamore: Mr. Fat Pat, it's just you and I.
Patrick Baldwin: I thought it was Mr. Fat.
Paul Giannamore: Has shortened your name. I made it easier, Mr. Fat.
Patrick Baldwin: Fat Pat is too long.
Paul Giannamore: You prefer Mr. Fat than Pat.
Patrick Baldwin: That's true. Thank you for that one. Are you the sage? Is that official now?
Paul Giannamore: You're talking about David and the paintings he sent up.
Patrick Baldwin: Got a little painting.
Paul Giannamore: David Johnson, if you're out there, and I know that you are, thank you for sending these. David Johnson sent some paintings of you and I, Patrick, in The Boardroom.
Patrick Baldwin: It wasn't just us, Paul.
Paul Giannamore: No, it was not. We had our little Mexican friend with us hanging out at the door, middle finger out, which is exactly how he is many times when we've recorded this, and telling us how much we suck at life.
Patrick Baldwin: If that on-air light is on, you know the Mexican is coming and crashes there like Kramer almost, isn't it?
Paul Giannamore: Only worse.
Patrick Baldwin: You've hung yours in the office. I don't know if I can get away with that being the middle finger in the center of the picture.
Paul Giannamore: I liked that all Mexican. It was true to life. Art reflected true life there and that's why I liked it. We may have been having a discussion when David was on The Buzz. The Mexican pops in so many times. Did he pop into his session and give him the finger?
Patrick Baldwin: It's all a big blur to me. I can only remember the time that he came in while we were talking to Cassie Krejci.
Paul Giannamore: I do remember that as well. We had to edit a lot of that out. Poor Cassie.
Patrick Baldwin: Thanks, Mex. Paul, this conversation comes from two different sides here but it all comes to me like the word perpetuity. One part, I had this thought for a couple of weeks now, I spoke with someone that listens to The Buzz, and they pay a 10% sales commission in perpetuity. I immediately thought, “That eventually could be a problem.” That business goes to sell at some point, whenever that is, 5, 10, or 20 years, I don't know, something is going to happen. They get to the closing table or they start talking about, “What's the business worth?” They say, “But we do pay this one salesperson 10% every time that job is serviced and paid.” I can see that being a problem.
Paul Giannamore: I had an hour-long chat with one of our mutual friends in the industry and he owns a quite decent-sized business.
Patrick Baldwin: His business might be eight or nine.
Paul Giannamore: A decent-sized operation and have has been extremely successful. I had a long chat with him and we were talking about some of the things we've talked about on The Buzz before. One of the points I made and I've often made here is you mentioned what's an acquirer going to think or do. What I always try to clarify is that people shouldn't be concerned so much about acquirers. What they should be concerned about is if what they're doing is making business sense and if they're doing things that are logical and reasonable. It takes care of itself.
One way people always ask is, “What does an acquirer want?” It’s because that's a shorthand bullet point way of saying, “How do I run my business appropriately?” What the heck am I talking about? With regard to the question here, paying sales commission in perpetuity is not unheard of but it's something that's extremely rare. I have had these discussions before. The first question is not so much what an acquirer would think about it but does it make business sense? I don't believe that it does.
If you and I run a pest control business and we're paying one of our sales guys a 10% commission in perpetuity and we say, “Our average customer seats around six years.” Now we're paying 10% times 6, that's 60%, and then we can use a discount rate to discount that back to the present and say maybe our effective commission rate is, let's make it up, 45%. Why on earth would we pay a 45% sales commission on pest control? We would not. We'd be far better off paying 15%, 10%, 20%, or what have you but substantially lower than 10% a year for six years. No reason to do that. It does not make business sense.
Further, humans have a high time preference. I would imagine even the sales guys might prefer 20% commission today versus 10% commission over time. Who knows? It's my assumption. The other complication you have is, now let's move into the acquisition game, if You sell that thing, no acquirer is going to honor that. First off, I'm going to discontinue that program, that's not the way I do business. That's number one.
Number two is we've got a contingent liability out there for every account that exists to pay your sales guy 10% of that. Somebody is going to pay for that and that's going to happen in one of a few different ways but most likely you're going to have to satisfy at the closing, Patrick. We sell the business and the sales folks are coming in saying, “Paul and Patrick, we had this arrangement. Is XYZ Big Co going to do this? No, they're not. How are you going to handle this?” You and I are going to end up writing the check.
I don't think that's a wise way to do business. Sometimes, people look at it and say, “If I pay an ongoing commission, they're going to be more incentivized to sell recurring.” I get that but they would be equally as excited to sell recurring if you paid them all right now and didn't have that big contingent liability sitting out there.
Patrick Baldwin: First off, I don't know if you saw me looking over my shoulders, I was looking for Patrick because it's been over a year since you've called me that.
Paul Giannamore: I did not notice.
Patrick Baldwin: Second, you've said, “The closer they are effectively to the customer and the less management they are, then the more they want the hear it now.” Give them that good commission, pay them a little bit more, and incentivize. I want that next paycheck or that commission check.
Paul Giannamore: As a general rule, the closer somebody is to the customer, the more short-term in nature the incentive should be. There should be that immediate feedback. The customer is delighted and there's a reward. Whereas management would have a longer duration. The incentive structure should be more in line with ownership. We're going to make some decisions that might be painful in the short-term but we're all long-term focused.
Patrick Baldwin: I forgot what book that comes from or if that's a spark derivative there.
Paul Giannamore: Roberts talks about it in The Modern Firm to a certain degree when he talks about the economics of incentives and the principal-agent dilemma.
Patrick Baldwin: That's interesting, I was thinking about that episode while I couldn't sleep. Third, Bobby and I thought about this model, and it was more or less on a commercial basis, and having commercial relationship managers. It would almost sit up above or to the side of these commercial technicians. This is back when we were thinking about residential technicians and commercial technicians. We wanted to bring in a little bit more of a relationship manager that would help manage these higher-end accounts and be there.
I'm not saying this is right or wrong. At the end of the day, that technician needs to know that customer, that account, and that property. You're already sending them there. It didn't ever make sense for us to go down further down that road of having a relationship manager. That being said, Rob and I always viewed, at the end of the day, after the first twelve months, that becomes a house account. A technician will manage that account.
The way that we paid sales commission, we incentivized recurring business. You could see it when we switched over the way we did Sentricon and then Trelona. You could sell a termite job, let's say a liquid job, call it $1,000 dollars, and then a year later, on liquid, they're going to pay a one-year warranty. That would be a 10% sales commission. If you went and sold Sentricon or Trelona, you could do a $1,000 termite job but then incentivize that client to pay $20 or $25 a month starting at month two. Now you have a recurring job and we pay 15% recurring.
The same thing on pest control, 10% one time and 10% on any product sales like rodent baits, stations, and fly lights. Anything recurring was 15%. We did incentivize recurring and that was on the first annual value and first twelve months. If someone canceled in the first twelve months, we'd have a clawback. They only had two services, we paid you for four, and now you “owe” us. We're going to subtract that. The salesperson had the first opportunity to save that customer. After month thirteen, the technician and service manager are the ones that are working on that account to keep it.
Paul Giannamore: It's an elegant solution to a relatively simple problem. You guys did it right.
Patrick Baldwin: Thanks. Was that a compliment?
Paul Giannamore: Perhaps.
Patrick Baldwin: I'll try not to run it. Number three, does it become a problem at the time that you go make the sale or you're looking to sell? In a 10% in perpetuity model, this salesperson has built up this almost like a residual insurance business. What is the right thing to do? Maybe the right thing to do is finish this episode and change your sales plan and sales comp structure. If not, what is the right thing to do at the time of selling a business?
Paul Giannamore: What is the right thing for the owner to do if he's set up this structure? Is that what you're asking?
Patrick Baldwin: Yeah. How do you fix this?
Paul Giannamore: If I weren't an acquirer, I would look at this and say, “Patrick, you have a contingent liability.” You've got salesperson A, let's call him Jim. Jim got 300 accounts that he's getting 10% on in perpetuity. Those commissions are earned at a specific point in time when the customer exists for another year. You have this contingent liability that exists. We don't know if all 300 customers are going to stick around but if they do, here's what you owe.
What I would do as an acquirer is tell you, Patrick, “You have to calculate this. You can use historical retention rates or whatever you need to do but you need to calculate this. You need to pay off these folks in full because I'm not carrying that liability. By the way, that's not what my commission structure looks like.” I pay 15% for recurring and 10% for one-time and I do that. Let's pretend for a second I do it the exact same way 855Bugs did it.
Patrick Baldwin: What would you look at? If instead of six years, they're halfway through three years’ time, would you sit there and do the math? $500 x 3 years x 10% and pay out a lump sum to the salesperson?
Paul Giannamore: I certainly hope that I am never faced with this issue my entire life but if I were, it would be something like that. It would be, “Our average annual retention rate is 85%. Let's run a quick model and see what this looks like over time.”
Patrick Baldwin: It's best just to do it now. It's going to get harder and harder to unwind the bigger nut to pay at the end.
Paul Giannamore: I know some reader does this, I don't know who this is, but I know that you've raised this for a legitimate reason. I don't see a lot of benefits for anyone doing it this way, I would kill it. You never have to face that discussion with an acquirer because that's most definitely what would happen. No one is going to want to get stuck with that.
Patrick Baldwin: Great advice. Paul, I had a conversation when Seth invaded The Boardroom, took your place, and took advantage of you being out of town.
Paul Giannamore: What he might be doing again here soon because I'm getting on the plane.
Patrick Baldwin: I hope that plane doesn’t fall.
Paul Giannamore: Yes, I remember you and Seth jumped in.
Patrick Baldwin: There's a home inspection business that does 4,500 or 5,000 home inspections a year, converts into a pest control company, gives them these termite leads, and then eventually there's an opportunity for these pest control leads. The scenario is the home inspection business wants equity and the pest control business is not ready to get equity yet. He listens to The Boardroom Buzz and we're like, “Equity is the most expensive form of capital per Uncle Paul.” I told him, “Delay the equity conversation.” This home inspection business is more or less a marketing funnel. All these leads are coming to the pest control business.
An idea came up similar to what we discussed in the sales commission. What about a 10% perpetuity? It's almost a joint venture. Is this a whole nother level of complication different than sales commission in which you have another entity and you are working alongside each other, providing service for the other, and where they want some kind of equity play? It's almost a hybrid model. You can give 10% in perpetuity for these clients that stay on the books but I thought, “Is this going to run into the same issue in the long run?” Is there a point of exit? We haven't agreed upon those customers came from you and we can pay out a certain thing there.
Paul Giannamore: This is a far more common discussion point than sales guys getting paid 10% in perpetuity. Around the world, there are a lot of channel partner agreements or venture agreements. There's a variety of different ways to do this. My first foray into home inspection was with the Lunsfords. Semi-odd years ago, when they built Inspect-All Services, they had the inspection business feeding the pest control.
I don't even remember what episode this was but it was relatively early on in The Buzz and they grew the heck outta their pest control business and it was primarily from leads from home inspection. Subsequent to that, there were 6 or 7 home inspection guys that are in a peer group of some sort. They randomly came down to Puerto Rico, looked me up, and said, “We're down here. Do you want to get together with us for dinner? We want to talk a little pest control,” which I happily did.
The Mexican and his twin brother came by, it was like a roving traveling comic act. They dazzled the mind and offended the ears. It was a good time with those guys and I learned a lot about home inspection. I'm extremely bullish on guys doing this stuff. These home inspection businesses can kick off depending on the area of the country. In the termite belt, it's extremely lucrative because termites are prolific and you can tell Sentricon and all sorts of jazz.
In cooler states, it's less exciting than Georgia or the Carolinas, for example, if you start thinking about Minnesota and Michigan. At the end of the day, a channeled partner situation with a home inspection business or any other lead source is a great idea. A lot of times, pest control owners get an opportunity to do something like that, and they like the idea of getting a thousand leads today. That sounds great. They don't think a lot about what the ramifications of things could be a year, 2, or 5 years down the line.
From what I've heard, there are a lot of home inspection companies that say, “I've got a home inspection business. I do $5 million a year in revenue. I'm kicking off thousands of leads.” You, Patrick, or a pest control guy, you come in, and we'll do a JV company. I own half, you own half, or you own 60 or whatever. I'll feed you leads and you'll do it. My opinion on that was always equity. For you, Patrick, the best control guy is extremely expensive. You might be better off paying for the leads.
I always say don't bring somebody on as a partner if you can go out into the market and buy that same resource on the open market. It's the same way if you can figure out a way to buy the leads. I tend to focus on shorter-term incentives for the home inspection business. Sometimes you're better off paying them a slightly higher rate today but that's it. You give me a thousand leads, it turns into 800 actual customers, I'm going to give you X percent, and here's your check. I'll do it quarterly, I'll do it bi-annually, or I'll do it once a year.
There are a million different ways you can do it but do it monthly. That is the best way to do it. There are revenue share-type agreements out there though and I don't think that's nearly as complicated. If you decided, which I'm not suggesting that you do, but if somebody says, “I'm going to give a home inspection business 10% of revenue generated from customers referred by the home inspection business. I'm going to do that 10% in perpetuity.” If we got 10,000 clients, they're getting 10% of that in perpetuity, that doesn't exist in perpetuity.
If that pest control business ultimately sells, of course, an acquirer is certainly not going to do that. The question becomes, does the home inspection business want some sort of a buyout or are they comfortable knowing that when it gets sold, it gets sold and that ends? It's complicated when you have those long-duration incentives. If I'm the inspection guy, I might want this gravy train to run twenty years and you're building something up and you've gotten all these leads from me and you're like, “It would've taken me ten years before. With all the leads from Paul, it can take me five years.”
The more leads I send to you, the greater the likelihood of you selling it and turning off my gravy train. There were not 100% aligned there. In those particular cases, if you're an inspection business, you might have some sort of a buyout clause. There might be some predetermined value for it. I can't even count how many conversations I've had between pest control guys and home inspection guys.
We've gotten requests for valuations and joint ventures. Paul, “Can Potomac value this joint venture company?” A myriad of different things. I'm not against you, Fat Pat and Tom. The inspection guy is saying, “Let's set up a company together and let's share equity.” I'm not saying that that's not the right thing to do. I'm saying that there are a lot of other options that should be vetted and explored prior to doing the equity share.
Patrick Baldwin: You mentioned setting up a standalone JV entity. Effectively, when that pest control business sells, that JV business goes away also. It's more or less just a holding company to move money back and forth.
Paul Giannamore: The JV business is ultimately monetized. What I was thinking about is you own Fat Pat’s in Waco and then I'm the inspection guy in Dallas. I'm like, “Patrick, you know pest control. I don't think anything about it but I'm throwing all these leads in the trash. Let's set up a Fat Pat’ss 2.0 in Dallas Metro. I'll channel in the leads and you'll bring your pest control capabilities and together we'll make money and then we'll have something to monetize.” not throwing leads in the trash and you're getting a lot of traction by not having to do a whole lot. That's what I'm talking about with a JV company. This is where I would advise strong caution. Taking Fat Pat's pest control and Waco and all of a sudden bringing on a home inspector as a partner, you're far better paying for leads.
Patrick Baldwin: Especially, equity convolutes things if I'm like, “Fat Pat’s wants to go to Austin but Uncle Paul's home inspection is only in Dallas.” If we've tied in equity together, now we're not aligned in Austin.
Paul Giannamore: You and I would be partners in Dallas if you wanted to go and do this with another home inspector in Austin. If I'm not in Austin, what am I going to do about it? Let's say that Fat Pat’s, the amalgamated business, is sold five years from now and it includes Austin, Waco, and Dallas. Me, the home inspector, I'm only going to have equity in a portion of the business that's in Dallas. Proceeds, of course, would be bifurcated. I don't have any claim on Waco or Austin.
Patrick Baldwin: Let's say that you and I don't have a business relationship set up other than rev share. To give you some incentive, if Fat Pat’s does sell in Dallas and you've been providing me leads and I've been paying you for those leads over time, at the point that I sell Fat Pat’s in Dallas, is there a, “Thanks, Paul. I'm going to peg you this much of the business that's still on the books at that point.” Is there an exit kicker to Paul?
Paul Giannamore: You should never hesitate to pay me.
Patrick Baldwin: Of course, that's your role of life.
Paul Giannamore: I've gotten into a lot of discussions with pest control guys over the years who view home inspection as a great lead source, which it is. Inevitably, the conversation always starts with, “I can get 4,000 leads a year and I know I can convert 75% of those.” I got 3,000 new customers with zero effort. That's great. You should do it. Here's the problem. I was talking to the home inspector guy. I've got my business and then he wants to set up a separate business where we each own half of it.
I would imagine that makes sense why the home inspection business would do it. My initial response is always like, “Why muddy the waters? Why don't you just own 100% of it and you pay the home inspection business per lead or per converted lead?” The home inspection business knows the value in pest control and he's not doing that. He's going to ultimately want to cash in when we turn around and sell it. If I don't do that, he'll go with somebody else.
Patrick Baldwin: Or stand up his own pest control business.
Paul Giannamore: Correct. The one main problem with that is when you're entering into that negotiation, you haven't expanded your options, and you're looking at things as binary. It's either this or that. Rarely is it ever just this or that. There are oftentimes shades to this. The first line of defense for a pest control operator is paying a healthy commission structure. You and I do a JV company. You're a pest control guy and I'm a home inspector guy, there are going to be capital calls. We got to buy equipment, we gotta hire people and stuff. The devil gets into the details.
When you start talking to these guys, The home inspection guy wants 50% of the business but he doesn't want to put any money. There's no drain on his resources, meaning he's sending leads. Me, I'm the home inspector, I'm sending you leads, you've got got to go out hire people, train people, and you've got a business to run. There's a lot more work. Attempt at all costs to have an equity partnership, could you do a revenue share in perpetuity? Sure, you could. That'll come to an end.
It's always my recommendation. Price, what is this worth to you? What is your customer acquisition cost? What is it worth to you to get a ton of leads from a home inspection business? Try to negotiate something that's as favorable to you as possible and that makes economic sense. If it doesn't, sometimes you're better off forgoing an opportunity than getting into a partnership that ultimately will put more of a drain on your resources and provide somebody else a far better economic opportunity that you'll ultimately end up presenting. It's hard to look thousands of leads in the eye and push them away but that's how people don't negotiate good deals for themselves because they get caught up in that.
Patrick Baldwin: I see why David Johnson calls you the Sage.
Paul Giannamore: It's not that I'm the sage, it's just that I find myself constantly in these discussions. I will tell you from direct experience when you turn around and you sell a business to a strategic acquirer that has home inspection as a lead source. I’ve been involved in this. Fat Pat, you’re running Fat Pat’s Pest Control. You are paying a commission rate to me, the home inspector, for sending you leads. I can think of 5 or 6 different occasions this has happened over the last twenty years.
Inevitably, the acquirer wants to be able to step into your shoes and continue to pay that commission. I, the home inspector, might look at this as an opportunity to say, “I'm not willing to take 10% anymore, Patrick. You're selling the big bag company. I want 25%.” This isn't just pest controlling, this works in lawn care, and this works in a variety of different industries.
I've always talked about on The Buzz that channel partners are a great way to rapidly grow your business but it behooves you to sit back and say, “If I can pay commission, how do I do a long-term supply agreement whereby it's assignable to a successor and Paul has to honor this price agreement?” Maybe there's a rider in there where there's maybe an increase over time based on volume, this, that, or the other, but it's certainly not a deal killer. Clearly, you can tell the acquirer, “This guy doesn't want to do it.”
Why this can be complicated? If you do get into these relationships, you have to realize that, and I'm throwing out random numbers, you might be organically drumming up 1,000 new accounts per year through your sales and marketing routines. You might be getting an additional 3,000 accounts per year from the home inspection business. When I'm buying a company, I'm buying the future, not the past. I'm looking at both your growth rates and revenue as well as your growth rate and cashflow. If there's something on the horizon that can significantly impact or impair that growth rate in cashflow, that's a valuation issue for me.
It would behoove you, Patrick, to have a supply agreement or a service agreement or some sort of agreement where, I, Paul, the home inspector, will honor this and continue, and we'll have this exclusive relationship with you. It’s not easy to get. In life, there's always quid pro quo but it's something to think about if you start going down these paths. I'm glad we're having this discussion because I get so many calls about these sorts of channel partnerships, which I'm not an expert on, I've just seen it a lot. I'm glad we're having this discussion because I don't think we've done this before and maybe this will answer a lot of the same questions I get over and over.
Patrick Baldwin: How do they value that top-line growth? Surprisingly, I wasn't expecting that. You're saying the acquires would like to keep that relationship. I was thinking maybe it doesn't fit the Rollins or the Rentokil-Terminix.
Paul Giannamore: I don't know. It fits every one of them. If they can turn around and pay for a successful closed lead at a reasonable market rate, why would they not do that? They'll do that. They all want it. I've heard one of them say, “It's mandatory that this continues at this valuation.” Everyone is programmed in the industry, especially lawn and pest because, for so long, relatively low multiples were paid for these businesses, and the acquirers were the exact opposite of sophisticated. It was always like, “What's your book of business? What assets do you have plus your accounts receivable, this, that, or the other?” It's not the way you value a business but that's the way it had been done for so long.
A lot of folks in the industry are already programmed to this. Anyone that had ever historically done a deal with Terminix always thinks about, “This is exactly the way it's done,” but that's not the way it's done. You always have to think about, “I’m selling the future. What does cashflow look a month out from now, six months out from now, a year out from now? What arrangements do I have in place that may potentially impact that?” You can't have your cake and eat it too.
Patrick Baldwin: You can't.
Paul Giannamore: You cannot from what I understand.
Patrick Baldwin: I'm Fat Pat. I have my ways. It was way back in episode eight, what do acquirers want? Speaking of that and this perpetuity, it made me think that, oftentimes, I'm talking to listeners and they say, “I want to stay on after selling. The acquirer want to keep me around for a few years. I work themselves back into a job,” or, “I want to do this private equity exit, take some chips off the table, and stick around for a while.”
This conversation even came up. Private equities approached a listener and said, “I'd like to have a conversation.” I'm thinking, “This owner has built the business from scratch, a little bit younger than us, and not a pressing need for cash. His business is profitable. He’s pretty thrifty, I would say.” I'm like, “Why?” It's a big shift going from owner to employee. I'm thinking of private equities coming in, they're setting the rules, and you're a glorified employee at that point. I don't mean to ruin any part of the M&A business here but doesn't it make sense for someone that's selling the business not to stick around too long?
Paul Giannamore: I would always draw the distinction between ownership as well as employment with a business. Those are two different things. I can own a business and not work in it at all, I could work in a business and not own it at all, or I could do both. We've got two private equity transactions closing and they're with brand-new sponsors in this space. There'll be two new private equity firms now in the pest control world.
One transaction is probably with the largest. In North American Pest Control, this company ultimately will be owned now by the largest private equity firm in pest control from an assets under management perspective. We're still seeing that. I spent three days with Jacob Borg down in Jamaica. Did you see Jacob Borg’s Jamaica Potomac TV? It was a phenomenal three days with him and we've got another episode coming out here that's going to be completely outta left field. It's something different that we did down in Jamaica and Jacob is in it a little bit. I had a long chat with him about now that the dust has settled, that deal closed earlier in the year. He is a partner at PestCo now.
A lot of guys are enticed by private equity in general, especially the guys who are younger. A 75-year-old or 80-year-old, maybe not so much. If you're 40, 35, or 45, private equity can be an extremely enticing opportunity because these firms are paying extremely high multiples for businesses right off the bat and then you're rolling equity, meaning you might sell 80% of the business and now you're at 20%. Now you've ruled 20% of the value of your business into either a current platform, you become a platform.
There is a myriad of instances whereby somebody sells a $100 million business, takes $80 million off the table, reinvests that $20 million, and that $20 million becomes $200 million. That 20% that was left in the business becomes substantially higher. You're partnering with sophisticated players, guys that have access to capital that you don't have access to, that have access to resources that you don't have access to, and then ultimately, every single time they sell their business, they do it right. They go out and they hire the absolute best advisors to run the most competitive processes.
You can rest assured that you're partnering typically with somebody who's at least as sophisticated to you, if not more. That's not always the right answer for folks. There'll be tons of opportunities where that $20 million that you roll does not turn into $200 million. If we have approached an end of a particular era, the returns might be dramatically lower. Working for a private equity firm, if you're an employee and an owner, at some point, one of those hats has to take the lead.
You might say, “I want to continue to be involved in the business but I also want to take some cash and put it in my pocket and go out and buy some toys. I want to have some upside for the future.” If that's the case, It's a good opportunity. Not all private equity firms want owners to stick around. I'm doing a deal right now that's quite large and the owners will depart and the next generation there, not family generation, these are non-family members, but the management bench will ultimately run it for the private equity firm. There's a myriad of different ways that this could take shape.
Patrick Baldwin: Does it matter between strategics and private equity what that looks like after an exit?
Paul Giannamore: Let's say that you run Fat Pat’s and it's a $25 million revenue business, you're in your 40s, you look around and say, “I've got this business that's worth a lot but I'm relatively cash poor because I've been investing all this money back in my business.” If you take a step back and say, “I would like to buy a house here, buy a boat, and buy all these sorts of things, and I don't want to take on a lot of leverage. Now might be a good opportunity for me to do a recapitalization of the business with a financial sponsor and a private equity firm.”
You might say, “I'm certainly not going to lay out on the beach. I'm too young to retire. I would get bored outta my mind. Plus, it's not a great financial decision for me to retire.” I can't sell a Rollins or Anticimex because, sure, they'll let me have a job but then I'm going to make $150,000 a year and I'm making a lot more money running my $25 million pest control business. What should I do? The age-old conundrum was always you had to make a choice because financial sponsors weren't willing to pay as much as strategics.
Back in 2017, ‘18, and ’19, in the year of pre-Covid, everyone was always like, “If I want the most amount of money, I have to sell to a strategic, but then I've got some stupid lame job. I'm not making a lot of money and then I got to figure out what I'm going to do.” Anticimex, which is owned by EQT, comes to town and says, “There's an opportunity for you to roll equity in EQT.” That's different than rolling equity right now with what we're seeing in the market. I can explain a little bit about that.
AX came to town and for platform businesses like the Killingsworth, the McHals, and all these larger platform businesses that would remain said, “You could sell 80% and retain 10% or what have you.” You said earlier that you can't have your cake and eat it too. In this particular case, they were able to do that. They can take some money off the table, roll some money, have some upside, and it worked out for a lot of these sellers.
A lot of these sellers, depending upon when they got on an AX and exited, some of these guys were making 5, 6, or 7 times a roll. You invest $10 million, which turns into $50 million, $60 million, or $70 million and you've already taken chips off the table. That was that era. This era though is if you own this $25 million business and you come to me and you say, “Paul, You are XYZ capital. You have billions. I want to grow the living heck out of this business. I want to take some chips off the table. I want to buy my boat. I want to do all these sorts of things. I don't want to have as much stress but I'm super excited to grow this. I want to partner with you.”
That makes me, the private equity firm, excited because now I can say, “Fat Pat’s got a great business. The only thing I need to bring to the table realistically is capital and maybe some corporate governance stuff.” I can invest in acquisitions. Fat Pat's never done a deal. I know everything about deals. I'm going to start doing M&A. We're going to grow the heck out of this. It's going to be great. I can get excited and I can pay you a lot of money.
If you come to me and I'm a private equity firm and you say, “Paul, I got my $25 million business and I want to sell it. I'm not interested in partnering with you. I'll stick around and work for a bit but not full-time. Should we do something?” I'm going to be much less excited about partnering. That's not an investment opportunity I want to take. If I had a platform and I could add Fat Pat’s on to it, I might give strong consideration to booting you out on the street and saying, “I'm taking your business and your bench.”
Every situation is unique. I would urge everyone involved in this discussion right now to say that every private equity firm, for the most part, is different. There are little nuances. They have different risk appetites. They have different requirements from non-competes to roles and so on and so forth. We can tend to get ourselves into a box and negotiate a bad deal if we generalized. The most recent private equity transaction here in the market that was signed went out to 63 financial sponsors.
Patrick Baldwin: Because you didn't like the Mexican and wanted him to do some work.
Paul Giannamore: Unfortunately, the work gets pushed down on my other valuable team members whom I care deeply for as opposed to the Mexican. It's going broad and understanding all the various nuances. It's one of those things where it's very easy to own a business and talk to one private equity firm and be like, “I like these guys. They got a lot of money. They seem cool to work with. I'm going to structure a deal.”
It's hard to understand what it is that you are potentially giving up or not even understanding what you can get unless you're across the board looking at dozens and dozens of different opportunities. That's why it's one of the many reasons outside of competitive pressure to do it that way. There are a lot of these guys looking at this right now. It's different, Patrick.
Patrick Baldwin: To answer my question, it depends.
Paul Giannamore: I don't even know what your question was.
Patrick Baldwin: I don't even know what my question was but I think it had to do with sticking around after selling what the expectation is. It depends.
Paul Giannamore: I can give specific reference points. Romney sold the private equity down in Texas. He'll phase out. Jacob is still working but his brother, Jared, is largely not doing much for the PestCo platform anymore. A lot of it depends upon at Fat Pat’s. What sort of a bench do you have? Are you an active CEO who's extremely active in the day-to-day management of the business? Are you more strategic, stand back, more being an owner, and less being an operator and you have a president there and you've got a great bench?
In that particular case, if you're excited about partnering with me, the private equity firm, I might say, “Fat Pat, I'd like to partner with founders, and you're the founder of Fat Pat’s. I want you to be on board here.” I want you to be on the board. I want to partner with you. I want you to have skin in the game here but I also appreciate the fact that you've toiled in the pest control vineyards for decades. You should be able to go to Europe for three months in the summer and you've got a strong bench. You've positioned yourself so that you don't have to worry about things that others might.
If you don't have that, I might be a little bit more leery about letting you go or letting you wind down. Patrick, if we're going to do this, I need a commitment from you that you're in this hardcore. We can talk in the future about replacing you and I can help you do that as a financial sponsor but I need you to stick around.
There are no hard and fast rules. There are no clear-cut templates for how this works. Everything is based on a unique fact pattern about the particular target business as well as the actual private equity firm that's investing. On the strategic side, for the most part, it's rare that I do a deal where an owner comes to me and says, “Paul, I'll do three months but then I want to be out,” and us not being able to accomplish that if it's going to an Orkin or it's going to a Rentokil or something like that.
I will say though, there are times that you won't be able to get a deal done unless you're willing to participate with a strategic. What I mean by that is let's say that you've got a big business. Let's make up something totally ridiculous. You're in Billings, Montana, and you do $10 million in revenue. I don't even know if that's possible. I've never been to Billings but it's just an isolated city and a rural state. You're running a $10 million business in Billings, Montana and you don't have a strong bench.
Orkin, Rentokill, and all these guys come to town and they want to buy this business. They're like, “We'll own Montana.” You start saying, “I'm going to go buy a mountain bike and do fly fishing.” If I'm one of those acquirers, I might say, “That's all well and good but I don't have anyone to run this business. I don't even operate in the state of Montana. Fat Pat, I can't buy this business and let you walk out the door.”
In that particular case, there has to be a legitimate bonafide transition plan whereby you're like, “I'm going to do this for a year or two years or so on and so forth.” The alternative then is a deal doesn't get done. It's either you do the deal and you stick around or you don't. That's not the norm but that does and can happen and I thought I would mention that so somebody doesn't come back to me and say, “You said they could always leave.”
Patrick Baldwin: Paul, that is helpful, especially with the change in what you've seen with financial sponsors. In the past, I was thinking from the acquirer standpoint, sticking around it. I've not seen it a lot. I’m thinking about the different guests and the people I've spoken with usually have not stuck around Bbt it looks like that climate has changed.
Paul Giannamore: It certainly has.
Patrick Baldwin: Speaking of, I'm going to Cafe Homestead.
Paul Giannamore: I thought that burnt down.
Patrick Baldwin: It did. It opened up. I don't mess around.
Paul Giannamore: It's a weird place, Patrick.
Patrick Baldwin: Perfect for me. I'll fit right in.
Paul Giannamore: I feel like all the waitresses there are captives like they've been abducted off the street and forced to work there.
Patrick Baldwin: It is more peculiar because it is on the side of town that your buddy used to live on.
Paul Giannamore: It's almost like when I ate there with you, I wanted to write a note on the napkin to the waitress saying, “Are you okay? Do you need help?” Slide that over to her.
Patrick Baldwin: Our buddy, Kyle Waltz, is coming to town. We’ll chat a little wildlife and a little fraction, we'll see. You might be traveling.
Paul Giannamore: That's true, Patrick. I might be overseas depending on how things line up. Maybe Seth will have to step back into The Boardroom.
Patrick Baldwin: We'll do that. I can't say, “Let's do this,” but we'll do that.
Paul Giannamore: Sounds good.
Patrick Baldwin: See you, Paul.
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Dylan Seals: Thank you so much as always for supporting us at The Boardroom Buzz. We know your time is valuable and the fact that you spend 45 minutes or an hour with us means the world. All the media that we put out from Potomac is meant to honor and celebrate you, the service industry owner. As Paul would say, “Yee who toil in the pest control vineyards.”
As part of giving back, we have this podcast, but more than that, Paul and I have been working our tails off over at POTOMAC TV. We've spent a tremendous amount of time, energy, and resources to build out that platform to bring you market updates, to bring you visual breakdowns of the merger acquisition process, and to tell stories and present information in ways that, frankly, it's not possible for us to do on The Boardroom Buzz.
Adding the visual element takes it to the next level. I want to invite you to go to YouTube and find us, it's POTOMAC TV. Potomac.tv will get you there. Go there and subscribe. Check out some videos and leave some comments. Let us know what you like and let us know what you don't like. Let us know what you want to see more of and we'll see you over there.
The Modern Firm
Episode 8
Jacob Borg’s Jamaica Potomac TV
Potomac.tv
