Paul Giannamore: Fat Pat, we're back. How were your travels? Where do you go?
Patrick Baldwin: We were at the Texas Pest Expo, but since then wife and I went down to Jamaica, following in your footsteps.
Paul Giannamore: That is true. We missed each other by a few weeks. How was it?
Patrick Baldwin: It was good. We had a good time, and hung out in the resort for the most part, just a bit of excursion. You and several others warned me not to venture off too far. I don't fit in there. If you’re some Anglo-Saxon guy off the resort, you're an easy target for whatever they want to do.
Paul Giannamore: You were in Mo-Bay?
Patrick Baldwin: No, we went to Ocho Rios. It was a two-hour drive out and 1.5 hours on the way back. The traffic is quite interesting.
Paul Giannamore: I don't know if you saw any CJs there. Crazy Jamaicans. They drive a little funny.
Patrick Baldwin: I was traveling with one, Jacob Borg. He's a CJ.
Paul Giannamore: He's a yardie.
Patrick Baldwin: I don't think he's a yardie.
Paul Giannamore: They call him a Yardi. “Are you yardie, Man?”
Patrick Baldwin: I can't understand all that.
Paul Giannamore: It was somewhat difficult to understand, particularly in certain areas of that country.
Patrick Baldwin: Should I ask you about your chicken? What do you think?
Paul Giannamore: The jerk chicken that I had was great. If you watched Fat Jakes Jamaica, Jacob Borg on Potomac TV, you get to see Jacob and I eating jerk. I was not impressed by the food, overall. Nor am I impressed by Puerto Rican food, nor Cuban food. I came back from the Dominican Republic, I had a meeting out there. I'm not into Caribbean food, which is unfortunate because I live in the Caribbean. A lot of rice and beans. It's pretty homogenous. There's not a lot of variety.
Patrick Baldwin: We found ourselves eating at different restaurants around the resort that were international. That was our thing. Fat Pat found his deserts, his sweet spot.
Paul Giannamore: Smoking ganja while you were down there?
Patrick Baldwin: I’m sure I didn't, although it was offered.
Paul Giannamore: We're going to publish an episode on Potomac TV where Jacob and I hung out with a YPO friend of mine, Alexandra Chong, who runs a company called Jacana. They grow marijuana down there. They make CBD oils and all sorts of stuff. They have branded it as the marijuana of Jamaica and they export it. Alexandra is married to Jack Brockway, who is Richard Branson's nephew. He's a photographer. He was a photographer for Obama and Branson. He adds some cool colors to the discussion as well. It was an interesting day. We stayed out at the farm, we toured it. We got to meet a lot of people.
Patrick Baldwin: Did you get to sample some?
Paul Giannamore: They gave us a ton of samples. We were there shortly after Mother's Day and they had a snafu because one of their people marketed CBD lube for Mother's Day. It went into a Mother's Day gift basket. It was a funny day after the situation. We were there the day after Mother's Day.
Patrick Baldwin: What's the snafu?
Paul Giannamore: The snafu was like, “Who wants to give their mother lube for Mother's Day?”
Patrick Baldwin: Good point. I was thinking about the wife gift. When you give the wife the Mother's Day gift, but I could see how that is quite awkward.
Paul Giannamore: It’s more complicated if you give it to your mom. Did you ever see that Saturday Night Live? It was with Justin Timberlake and Andy Samberg. The old Saturday Night Live skit, mother lover, with Justin Timberlake and Andy Samberg. It's definitely worth watching. It's hilarious. I'm glad you had a good time in Jamaica. As you know, I was in Istanbul. I've had a lot of traveling, PB.
Patrick Baldwin: The food's better in Istanbul, you're telling me?
Paul Giannamore: Turkey has got phenomenal food. I'm in Turkey 2, 3 times a year. I love Istanbul. I love the food. I highly recommend Turkish food.
Patrick Baldwin: I thought it was just a Fat Pat thing, but I'm judging a whole destination based on its food. I feel like it's not just me though.
Paul Giannamore: There’s nothing wrong with that. I do that as well.
Patrick Baldwin: Speaking of food and where I'll be. I'll be at Youth Camp coming up, out in the 100-degree weather, in the Texas sun, judging the youth camp by the cafeteria food.
Paul Giannamore: I know your level of maturity is quite low, but you do look rather old to be at a youth camp.
Patrick Baldwin: Not creepy at all. Thanks, Paul.
Paul Giannamore: Why are you going?
Patrick Baldwin: My kid’s going into ninth grade. Sponsoring a bunch of ninth grade boys, not watching.
Paul Giannamore: You’re going to camp to watch boys.
Patrick Baldwin: I’ll keep my distance. Thanks, Paul. It'll be awesome, 1,200 people. It’s a big camp. It's been going on for almost 40 years. Before I head off to youth camp, we'll have a serious conversation because I haven't asked you in a hot minute what the markets been like. I know the stock market's been doing something sideways that I wasn't expecting. A little equity run out caught me with my shorts down.
Paul Giannamore: You had your shorts on PB, not watching this. The old pest control M&A market has continued to change. We've had three new private equity firms enter the pest control industry. These private equity firms like to make the investment and then just sit on this, and then go out and make a few add on acquisitions before they announce it.
We've added three new participants. One firm might be the second largest, it could be the largest in terms of assets under management, that has entered the pest control industry. It's a massive private equity fund, they made a majority investment in a platform.
We got that deal done, prior that, on my way out to Turkey, I stopped through and we got another one done. Immediately, prior to that, another private equity firm has now entered the pest control industry. We've got three new platforms that are private equity owned that are hush hush and won't be announcing those until Fall 2023.
We're seeing the private equity guys. If you look around town, you've seen Anticimex. They have been extremely aggressive with their email outreaches and the social media stuff that Anticimex is trying to do to drum up proprietary deals, because the auction deals, the adviser led deals like the ones we do are particularly expensive.
They've tried to do everything they can to go out and find sellers who are unsophisticated, who will deal only with them, which is exactly what you should do if you're a buyer. If you're a buyer, you should not call Potomac because everything we do is going to be far too expensive. You need to cultivate those relationships on your own and try to get an un-shopped deal.
You see these strategics really trying to push to this because there is a massive disparity between the shopped deals and the un-shopped deal deals and sometimes in the order of 50% to 75% in terms of purchase price. The strategics are relatively slow. Rollins, Rentokil, Terminix and Anticimex are still doing deals, but it's really just the private equity firms that have been extremely active.
Patrick Baldwin: In your modified auction process, you have a sequence of events, right? The LOI is due this week, and then you're going to go through and get their next offer, next offer. Do you find where these strategics are not even making it to the second step?
Paul Giannamore: Yes. Most of the time now, in this market, the strategics don't even make it to round two in the bidding process, if they even make it into round one. The smart ones, sometimes, say, “We’ll never be able to compete.” If a private equity firm is going to pay $100 million for something, they might say, “We're not going to get north of 60 for it, so why compete?” Some of these private equity deals, on the high end for the quality firms, we're seeing it in the low 20s in terms of EBITDA multiples and 2 to 3 deals got done north of five times revenue, one of them was at north of four times revenue.
Patrick Baldwin: That's stuff that you saw back in 2021. We're still there. What about on the lower end?
Paul Giannamore: One thing that's published is the Fox deal. That's about half of that. That would be on the low end, between 2- and 3-times revenue. I would say for the most part, even on some of the door-to-door ones, we're pushing five times.
Patrick Baldwin: Private equity wasn't interested, at least this might be a timing component, but even revenue side $3.75 million, top line, private equity wouldn't have touched that knowing that they're looking for so much, minimum of EBITDA. What are you finding on these $1 million to $5 million gross revenue deals? Is the valuation still there?
Paul Giannamore: When I talk about these private equity firms, to be a platform, you want to have somewhere $2 million in EBITDA or greater. $5 million in EBITDA puts you in a nice position, but you need to be at $2 million bottom line. If you guys weren't doing $2 million in EBITDA, you wouldn't have been an interesting platform for private equity, but you certainly would have been an interesting add-on.
As more private equity firms get into this space, they need to blend down their multiples. They need to do deals. There'll be pockets around the country that are particularly active. It'll continue to change the contours of the playing field because the national players are national. They'll buy something in Kansas, something in New Jersey, something in Texas. Whereas, private equity firms that are based in the South, the Northeast, or the West Coast are going to focus on their territory. There will be pockets in the country where acquisitions remain highly competitive. There'll then be certain areas where it's going to be rather lethargic and more difficult to get a deal done.
How long the private equity game last, though, will continue to be interesting because when you're buying a small platform, $2 million to $5 million in EBITDA, you don't have to go out and do a lot of financing. You start buying $10 million in EBITDA and these bigger deals with financing costs continuing to go up, it’s extremely likely the Feds is going to hike again here at the next FOMC meeting based on recent data.
Financial conditions have loosened up, you talked about the equity markets have loosened up quite a bit over the last couple of months. We've had the AI narrative, and there's been some speculative frenzy. Of course, the US financial conditions tightened up here in the next couple of months. We haven't seen the economic impacts of tighter monetary policy. That's a long lag on that. We've got industries like commercial real estate that are going to be difficult in the coming months.
For now, we continue to focus on financial sponsors. I've mentioned in The Buzz before, an average pest control transaction, we're going out to 50 to 65 participants in the process, which is just mind blowing. In an industry like Pest Control, you've got one seller, and you take it out to 60 different potential buyers, and you run a process from there. It is very difficult when I think about these last three private equity deals that we did, it would have been a 3% chance of determining who the buyer would be at the start of the process.
Patrick Baldwin: How much does it complicate the process? Or does it?
Paul Giannamore: It slows it down a little bit, there's a lot more work involved because you're communicating with dozens and dozens of buyers. These private equity firms tend to obviously not have nearly as much pest control experience so they've got a lot more questions that for you and I and everyone else reading this would be like, “Why do you even ask that? It's a silly question.” From a time perspective, there are certain constraints there.
Patrick Baldwin: You're talking about strategics might not even get an offer because they know we're not going to compete, but if you have 60 private equities that are newer to pest control, are you seeing 60 LOIs coming in, and then you're having to sift through them and try to compare as best as possible apples to apples.
Paul Giannamore: No, when we run a process, even before we even start talking about LOIs. We start with an IOIs, Indication of Interest. It's a 1- or 2-page document that basically says, “What are you willing to pay for the business?” Whether either an absolute number or a range, “We're willing to pay between $10 million and $30 million for this business.” “Okay, that's a broad range.” What financing contingencies are there? What's their statement of intent? What they intend to do with a business as their equity roll opportunity? Is it required? Is it optional?
There's a variety of things that go into an IOI, but before we even start a process, we typically start with an IOI, or Indication of Interest phase. If you send out materials to 60 private equity firms, you might end up with 25 IOIs. Fifteen of those might be garbage in general, but the IOI stage is the first glimpse into price discovery in the market.
It's an extremely important stage that allows us to come out of the gate in round one of bidding in a strong position. Once we do the IOIs, depending upon how we're going to run the process, we might go into an LOI stage, and then a management meeting, or we might go right to management meetings after we've asked them to revise IOIs. It depends on the process, but that's how it looks.
Patrick Baldwin: I don't remember. Did we have an IOI stage? Smaller business in Central Texas definitely didn't have the same kind of bidders.
Paul Giannamore: Usually, if I'm not bringing financial sponsors into the process, I'm going to skip the IOI stage. The IOI stage is one way for me to limit the playing field. Let's say we start with 60. We get 25 IOIs, we're not doing 25 management meetings, it doesn't make any sense. We need to immediately begin to whittle down the playing field and that's what happens. In a sell side competitive process. Each stage allows the sell side to remove participants that they A) don't like, B) are not as competitive from a price perspective, or C) any other reason.
Patrick Baldwin: Going back to what you said. There are so many more variables now, geography, size, and all this stuff. I'm picturing a scatterplot with a lot more dots around it. These people that aren't in the know, want to say how much pest control businesses are going for? It's all over the place, isn’t it?
Paul Giannamore: If you look back when we did bubble trouble, there was a market median. We plotted that out. That was an era in 2020, 2021, where everything was being purchased. It didn't matter in terms of quality or geographical location, those sorts of things. As the market deteriorates, you see some bifurcation, particularly with assets of scale, where certain businesses will continue to garner those. For example, the S&P 500 Index or the NASDAQ, you might have Nvidia, Google, and a small handful of companies that are trading at extremely high multiples. You then might have 70% of the index trading at a depressed multiple, but the index hasn't moved a whole lot.
We're seeing a dispersion in the market, whereby businesses of scale that are quality, that are in interesting locations for financial sponsors are continuing to trade at extremely high multiples. Other companies are trading for lower multiples but still way above historical mean. It doesn't change the aggregate index much, but it definitely changes what components of that index are ultimately trading for. That's what we are seeing in the market. That's what we're going to continue to see here in the near term.
Patrick Baldwin: Are you still bearish long term? Is there a recession still coming in?
Paul Giannamore: It's baked in the cake at this point, yes, my opinion. I can't comprehend how a global economy that needed real negative interest rates to grow can continue to grow in an era of positive interest rates with this much leverage. There will be a reckoning.
Patrick Baldwin: I appreciate the update, but I do have a couple of listener questions if you can humor me here. First question from Joe. “Random thought, forgive me if I'm weird for asking this, but have you ever seen a buyer take advantage of a seller that backs out and then markets to their client list?” Paul, I don't know how far in process a potential buyer sees the client list but I don't know what kind of protections there are besides ethics. Can they even have the capability to pull it off?
Paul Giannamore: That's a great question. It's one that I think about often and I deal with because sellers are concerned about their customer list. If you think about your business down there in Texas, you're getting ready to sell, the last thing you want is they acquire and get all your customer names and run off with it. In a normal process, or at least a process that I run, an acquirer is not going to see any of that specific customer data until very late in the due diligence process. They’re not going to see that upfront.
Let's pretend for a second though, I've often argued that customer lists for pest control companies are not particularly valuable whatsoever. Because even if you've got your crosstown rivals customer list, and you've got Aunt Susie out in the suburbs, and she pays $105 a quarter, how valuable is that? Are you going to go out there into Susie and say, “Susie, pay me $90 a quarter instead of paying Fat Pat $105, and I'll do your pest control.” She's probably got a relationship with your firm, and quite frankly, undercutting from a pricing perspective is not a great way to compete.
Even on the commercial side, people worry about customer lists. First off, buyers are super lazy. If you think about what a lot of these big companies do and don't do, you see who your competition is. Sometimes, I'm surprised when these guys can get out of bed in the morning, let alone get a hold of your customer list and be able to do something with it.
Certainly, we do everything that we possibly can to protect the confidential nature of all company materials for our clients, but almost every single deal I feel like I'm having the same discussion with sellers and basically saying, “You could pretty much publish that list online. I guarantee you, nothing's going to happen if you think about it.” I'm not out there in the pest control vineyards. What do you think?
Patrick Baldwin: I can see you getting asked this a lot. I don't know. Because eventually the buyers do get the list.
Paul Giannamore: Yeah, of course. That's what they're buying.
Patrick Baldwin: Even before they close. Do they end up with a customer list or they end up with access to the CRM?
Paul Giannamore: How it should normally work is you're providing an acquired summary of data. There are 1,000 customers with a mean and median pricing of X and Y, and here's the tenure reach customer, and here's how all this works. At some point, they're going to need to know, client A is Fat Pat in Waco, Texas, and he's on a quarterly program and we got to continue to service that. They're likely going to service that with the same technician that you, the seller, are using, and so on and so forth. When they're “buying” the customer list, they're buying a lot of intangible relationships with that customer, they're not, in fact, just buying that customer’s name, and the fact that they pay that company. They’re buying the cash that's generated by those relationships.
I had a conversation with somebody yesterday who called me and said, “Paul, I want to sell this thing. We've made an error. All of our residential customers don't have written contracts.” I'm like, “That's so 9099.” I'm not saying don't do that, but as we talked about the recurring revenue discussion that we had, recurring revenue is the expectation between the parties. It's the expectation of the customer to continue to pay for ongoing services at regularly scheduled frequencies. It's the expectation of the service provider, you, the pest control operator, to continue to provide those services for that specific price. You don't need to have a contract, it just happens.
You can be with a woman for 40 years, you don't need to have a marriage contract. If you want a domicile with her and raise kids with her and split the budget or however you do it, a lot of people would say you actually need to have a marriage contract. Even from a biblical perspective, were there marriage contracts under Hebrew law? Patrick.
Patrick Baldwin: I don't know that there were. I don't know if it was an oral tradition.
Paul Giannamore: There was a written decree of divorce, this is way far beyond the discourse of the Boardroom Buzz, but I'm just saying there's indicia of an agreement, it doesn't have to be written. At the end of the day, the customer list in and of itself, has a tremendous amount of value due to the cashflow that that customer list generates. The means by which it generates cashflow is the relationships and the act of service by the pest control provider, the list, in a vacuum, is probably not worth a whole lot.
Patrick Baldwin: In 20 years you've done this, you've never seen someone take the data list and do anything with it?
Paul Giannamore: Not once have I seen a deal fall apart and a buyer makes off with a list and market to that customer.
Patrick Baldwin: I could see legal ramifications. The strategics have to keep their name out there. They can’t have the reputation of doing the wrong thing and taking customer lists.
Paul Giannamore: I know what you're going to say, the financial sponsor is not known in the industry, they can do whatever they want, leave. Here's the deal. If you've done this right, you've executed a nondisclosure agreement that has a variety of different provisions, one of which is the non-solicitation of employees. A buyer can't go out and solicit your employees for a number of years. You can't look at a pest control company and say, “This company got four people, I want them to go out and try to snag them.” No. They've signed an agreement, there are damages there. They're liable.
The same thing with customers. There is a long duration on a non-solicitation in an NDA whereby, if somehow, you walk down the path of a deal, it falls apart, and then a buyer takes the customer list and begins to market to those customers, there are damages. You can go after and there's legal recourse for that. Number one, you've set it up from a legal recourse perspective, but in all practical purposes, my opinion on all of this is if that NDA did not exist, which it should, but if you didn't enter an NDA, and a buyer gets your customer list, it is difficult to go after those customers.
With the customer lists, sure, you can pinpoint them now that you know their names and their contact information but it's not easy to get customers to switch. Customers oftentimes won't switch even if they're dissatisfied with a service, let alone if you're doing a good job and your customers actually like you and your technicians have built a relationship. It's difficult. If I'm a customer, I'd want to know, “Fat Pat, how do you know I'm paying Paul's pest control $105 a quarter?”
Patrick Baldwin: Definitely starting off on the wrong foot. I was even thinking about what if they don't come through the process, but it's two guys in the same market, smaller businesses, maybe a $3 million guy buying out a $200,000 guy. He eventually gets the client list. There's no NDA, it's not structured. They go, “Let me see your client list?” Is there really a risk there? What I'm hearing you say is these customers are a lot stickier across the board.
Paul Giannamore: That actually dramatically decreases the risk. If I run a $2 million business and I'm going to buy a $200,000 business, those customers have relationships with the owner, the guy who's selling that. That relationship tends to be an order of magnitude greater than the relationship that those customers otherwise would have had with some random technician. Those are the real difficult ones.
I've been using Rodney for 26 years, they love Rodney. Rodney knows their kids pops by on holidays. They're not leaving. Of course, the Rodneys of the world that own the small businesses are the ones who are worried the most. I always say to these guys, “I would relax about that.” You should put some value in the fact you've built great relationships. It's not a customer list anymore. It's your black book of relationships.
Patrick Baldwin: That leads me to the next question. Eric writes, “From listening to The Buzz, it sounds like the majority of the time, sellers don't stick around long. I think, I could be mistaken, that you're accounting for sellers’ salary and perks when selling. What or whose story are you telling? The sellers or the remaining staff?”
Paul Giannamore: From a narrative perspective, when you're selling a business, here's what you're attempting to do. Let's use Fat Pats Pest Control as an example, you and I, Patrick, are partners, and we run Fat Pats Pest Control, we each take a salary of $500,000 a year. We probably shouldn't do that. We should probably take a salary of $125,000 and distribute the rest. Let's just say we're doing what a lot of people do, we take $500,000 a year salaries, it's $1 million in cost.
Patrick Baldwin: It's really Fat Pat. It's good business.
Paul Giannamore: What we would do if we were selling it is we would normalize our compensation for the economic value that we're actually providing the business. What would be the replacement cost for what we are actually doing in the business. That varies. It's unique. It's a case-by-case analysis because I might make $500,000, I'm in Puerto Rico, I'm not doing nearly as much as you are, and you're out on the scene, and you're dealing with customer issues, and so on and so forth, you're local.
The adjustment, I might just be completely wiped out. Paul's worthless, he doesn't do anything for the business. He's gone. $500,000 gets added back. For you, we would have to determine what we are going to do to replace what you do for the business based on economic value. If done correctly, you should end up with a financial model that's normalized under market. Basically, everyone's getting paid market rates. Whether you stay or go, you might end up being a redundancy or an add-back. We can't know that because we don't know who's ultimately buying the business, specifically when we live in a world where there are financial sponsors that might need somebody like you to stick around for an indefinite period.
Our job on the sell side, and your job as a seller out there is to say, “If this were a business that we're running, and I made decisions based on market dynamics. What would the cost structure look like?” Instead of making decisions based on the fact that it's my prerogative as the owner, I can pay myself what I want. I've seen bookkeepers at businesses getting paid $700,000 a year because they're the daughter of the owner.
Once you do this analysis, you'll ultimately normalize the financial statements to what it would look like if it weren't run under your regime. An acquirer will ultimately make its own decisions as to what to do with you and those particular people. When you're running a process, what's important is to make sure that when you normalize things, you provide extensive and detailed backup to all acquires as to the decisions and the rationale by which you made certain adjustments so that going into this everyone's clear.
It doesn't matter what the actual numbers are, it matters that no one is materially misstating fact. You're not adding back people who are required and necessary in order to operate that business. Because if you do that in an acquire basis offer on those particular numbers and then in diligence realize, “These guys went crazy with the add-backs. Now, we're going to re-trade.” In the era of private equity, those guys show no mercy. They will re-trade, and quite frankly, they deserve to be able to re-trade if you're not stating things correctly.
Patrick Baldwin: After you're in exclusivity?
Paul Giannamore: You're in exclusivity and they change the purchase price. It's almost like back when you were in school, the teacher would say in a math class, “Explain your answer, and write it out in long form.” It's not so much what the answer is. It's the methodology by which the answer was derived. Let's make sure that we're using the same methodology so that we, as buyers, can make our own decision, but at least we're on the same page as to what that is.
Patrick Baldwin: Financials aside, this is what the business could or should look like once you acquire it. It depends on what you want to do with Fat Pat, keep them around or not. Aren't you providing context to the rest of the team? How long they've been around? What their specialties are? What their competencies are? Can they manage a P&L? What licenses do they have? Do you put a lot of work? Are the buyers putting a lot of effort and understanding what is there that they're getting outside of the financials?
Paul Giannamore: Absolutely. We put a ton of effort into it and so do the buyers, every single employee. If a company has 250 employees, we're literally going down the list looking at tenure, what does this particular employee do? How many people are in the office? What does each individual person in the office do? How long they've been around? What is their pay versus what is the economic benefit they provide the company? We think about all these things, because years ago, when something would sell at five times EBITDA is a very different situation than when something sells at 20 times EBITDA so every single dollar that comes to the bottom line is worth 20 instead of five. It really moves the needle.
Patrick Baldwin: As a seller with the end in mind, what could I be doing for Fat Pat? Documenting these things? Reviews? I can't remember all 250 employees. What things can I be doing or certifications can I take them through to make that more valuable in the end?
Paul Giannamore: I don't know if the juice is worth the squeeze on that. I think you just run your business the way that you're supposed to run your business. There are certain things that you can plan in advance, entity structures, tax planning, trusts, organizational design, incentives. There are a lot of things that you can do years in advance. There are certain things that are dynamic, they change from month to month, week to week. You'll figure that out when you get to that point. That's one of those things that you should be comfortable waiting.
Patrick Baldwin: Have you had a seller that documented employee by employee, “Here's their quarterly review. Here's everyone in their own little folder?”
Paul Giannamore: Absolutely.
Patrick Baldwin: You've then seen the opposite. You've seen where there's nothing. Have you seen a vast difference in the end result when they sell it?
Paul Giannamore: No. It's the same thing when you are doing your taxes. If you're super organized, have all your receipts put together, and you've got everything documented, when you do your taxes, it is easy. If you haven't been doing any bookkeeping, then it's a cluster and you hate your life. We've all been in both of those positions. The more organized you are and have those personnel files and have reviews and understand all that sort of stuff, it'll be easy for you when it comes time, but I wouldn't get caught up on that aspect of it too far in advance.
Patrick Baldwin: Paul, we've talked about private equity earlier. I'm going back here. I came to thought of how when we went through a process, Orkin tells their story, and Rentokil was telling their story. Terminix was telling her story and so on. With private equity, they don't even have names or faces with a few exceptions. What does that look like? How are they differentiating themselves or are they as they're giving their IOI and LOI, in telling what their narrative is to the potential seller?
Paul Giannamore: The difference is amongst the financial sponsors are very nuanced. It's easy for Rollins, Rentokil, and Terminix to distinguish themselves, particularly in certain markets. They do that by bringing local management and talking about performance in the market. It's difficult for a financial sponsor, a private equity firm, which is like a group of dudes in blue button-down shirts and khakis sitting in an office 3,000 miles away from you. They always like to talk about how, “We're different. We're long-term investors. Our capital is patient,” and so on and so forth. At the end of the day, they all end up saying the same thing.
When you live in a market, where it's very difficult to differentiate your product from that of your competition, it becomes a commodity. It becomes price based. When people can't tell the difference between grades of oil, you get the point. It is very difficult. There are things to think about like when you're partnering with a financial sponsor, you're typically required to roll equity and partner with them in the future. You're going to be actual business partners with them. They're going to buy a portion of your business.
If you're a sophisticated seller, you start to say, “What sort of resources and capabilities does this private equity firm bring to the table? What's their portfolio look like? What companies have they invested in? What have they done with the other companies in their portfolio since they've made those investments? Are they experts in digital marketing? Salesforce automation? What are the capabilities that they have or that they've exercised that we don't have?”
One way to figure that out is talk to people that are in your position with the portfolio. I run Paul's pest control. I'm talking to a private equity firm, they tell me about all these grand slams they've had over the years and all these great things that they've done. I say, “I'm looking at your portfolio here. I see XYZ company and ABC company, I want to talk to the Paul of these businesses.” You then have those discussions. What was it like under that regime? What are board meetings like? What are reporting requirements? What does corporate governance look like? How did they negotiate your transaction? Were they true to their word that they try to re-trade? How was financing? What sort of capabilities do they bring? Do they come in and bring anything to the table that really helped you accelerate growth or was it a lot of puffery?
With private equity firms, you, as the seller, have to do a lot of homework. Every time we run through a process, you're not going to call portfolio companies of 63 private equity firms and talk to hundreds of different people, it's a total waste of everyone's time, especially your own. What you do is you whittle down the playing field, and now you might have 5 or 3 participants, or sometimes even 2 or 1 that you're interested in. At that point in time, you would interview those that have gone before you.
I've been in situations where we've actually talked to LPs or Limited Partners or investors in the fund, why have you partnered with his GP, general partner, the private equity firm to deploy your capital? There are a lot of things that you can do. You will be a co-investor with them so the money that you effectively roll into that new investment will become important to you once you sell.
It's very difficult for private equity firms to differentiate themselves in the eyes of sellers. You can't sit back and wait for the private equity firm to differentiate themselves. They try, but you've got to take a very active role. You got to look at it like, I'm not just selling here. I'm selling, putting my people with these people, but I'm also co-investing with them.
Patrick Baldwin: A little more work, it sounds like but you're not taking all your chips off the table, or whatever.
Paul Giannamore: You're not. In theory, you're having your cake and you eat it too because you're selling a business for a valuation that's much higher than you would get in the industry from the strategic acquirers, and then the opportunity to co-invest. If you take somebody like Jacob Borg, he wanted to take chips off the table, go off, and do other things, but he didn't actually want to sell his business.
For him, being able to partner with a private equity firm and be on the board, stay a part of his business in perpetuity until they ultimately exit it, but also take cash off the table now, and be able to be an owner and watch some of that cash continue to grow was very enticing to him. For some people, that doesn't make sense. Sometimes, for the old-timers, this is when it really gets difficult, you're 75 years old or older, and you don't have a child in the business that'll be rolling equity. In some of these deals we've done, we've seen a father who's in his 70s gift stock to his son. His son is running the business, perhaps.
His son actually has some equity that he can roll into New Co, so now the son is a partner with a private equity firm, and the father's not. He's taken the cash out. There are certain instances where a father will roll equity as well, but there are a million different ways to skin that cat. At its core, if you're going to do a financial sponsor-led deal, meaning if you're going to partner with private equity, you're in the best position to get a phenomenal deal.
You've got a great scarce resource, you've got a business of decent scale, and you're looking for additional resources and capabilities, both financial resources. I want some investment from a private equity firm. And I want somebody to help me with A, B, C, and D. Whenever we get into a process, whereas before when it was just strategics, we didn't have to do nearly as much homework. Now, when we get into a process, we're really doing a lot of gap analysis as to what sort of capabilities the firm might need to grow.
Where are we weak? When we're selling a strategic, we focus on where are we strong, because we know that they can fill in the gaps somehow. Whereas a private equity firm, at least here on the sell side, we're focusing on understanding where those gaps are, and what is the best firm out there to be able to plug those gaps in order to help us grow.
Patrick Baldwin: That's very interesting. Judging my business that I'm selling, where am I weak and then looking at which private equity has that strength to fill that. That's new.
Paul Giannamore: If you weren't co-investing, you wouldn't really care. “That's not my problem anymore. I took the money and I'm out.” If you really value the equity that you're leaving in the business, which I have no reason to believe that no one would not value that, then you would want to take the time to do the homework to figure out who is best going to help you scale that business.
Patrick Baldwin: They've narrowed it down. They have a field of, let's say, 2, 3, or 5 private equity players, and you're not in an exclusivity yet. They're making those calls. I'm curious what kind of feedback you've heard from sellers making these calls?
Paul Giannamore: It runs the gamut. Some of these calls are phenomenally great. This private equity firm contacted me, I didn't realize there were 10,000 of them out there, I wish I would have done my homework. I wish I would have talked to other private equity firms and really understood what options are out there. Because I have friends who sold or partnered with private equity firm ABC, and I'm with XYZ and his situation is way better. We do hear that.
Patrick Baldwin: Are those firms that are not going through Potomac that kind of did their own deal?
Paul Giannamore: What ends up happening is you get an email, and you respond to it. “We're a financial sponsor, private equity firm, or investment firm, we're interested in pest.” We're impressed by XYZ, they do a little research and put together a nice email. You talk to them and you make the assumption like most people make is, that price is objective. There's an objective price for their business, there's almost a price tag, which there's not, it's subjective. In order to maximize that is run through a process.
It's akin to just whatever girl smiled and was nice to you at the dance, all the sudden, a couple of weeks later you get married. That's not necessarily the best way to find the spouse. Sometimes people are lazy and that's what they do. I don't recommend it. You should not do a private equity deal without some sort of an advisor. You can do it, I guarantee, you're going to learn some very hard and expensive lessons if you do that.
At the end of the day, even if you don't use an advisor, in this market, you need to sit down with at least fifteen private equity firms because private equity firms have a hard time differentiating themselves, because they're a bunch of dudes sit in an office thousands of miles away. You tend to quickly think these guys are all the same. They are not. They're going to pay different prices. They're going to be very different stewards of your hard-earned capital. They're going to have different sorts of working relationships with their portfolios.
You have to ask yourself, “Do I want a financial sponsor that's extremely active in the management of the business or do I not? Do I just want to be able to come on a quarterly basis, show report and say, ‘This is what we're doing.’” Get an attaboy, slap on the back, and you're out the door. Some people want that. Some people don't even know what they want because I've never dealt with that before. It’s important to try to understand what that actually means.
Will that additional corporate government structure and those processes and rhythms and routines within your organization help you grow that more or will that be a hindrance? These are things that you have to think through. You have to talk to people who've done it. You have to talk to a lot of private equity firms. Of course, the big question is the money. Show me the money. The money's got to be there. You got to run that competitive process.
Patrick Baldwin: You've worked for yourself, nothing like private equities. You run your pest control business that you started from the ground up. Now, all of a sudden, you're in New York is when I think of private equity, guys in suits and their corporate offices, like you're saying, thousands of miles away. I don't even know where to start.
Paul Giannamore: You'd be surprised. Over the years, I hear all of these stories from financial sponsors in the pest control industry, as well as other residential commercial services spaces. There are a lot of failed deals that litter this industry that you don't know about, that no one knows about, that I don't know about. There are a lot of situations whereby you might be relaxed in your office right now and see the sign for one of your competitors down the street. It's a $10 million business. They may have spent the last eighteen months in some sort of hardcore diligence process with a private equity firm, and that thing has completely blown up. Now, there's no process going on.
There's a variety of reasons for that. One of the main reasons is the inability of the private equity firm to actually appropriately communicate with a seller of a pest control business. When you've got all these Wharton and Harvard MBAs there that have actually never worked a real day in their life, dealing with somebody who's actually managing 200 employees out there and trying to satisfy customers.
There's a big gap in their ability to communicate and understand each other. That's the biggest reason why these deals fall apart is because sellers have an emotional attachment to their business and they get frustrated when up private equity firm takes a very cold and detached approach to things. The private equity firms, unfortunately, sometimes don't have enough emotional intelligence to be able to appropriately communicate.
I can think of probably two dozen deals out there over the years that private equity firms have emailed and called and tried and put an offer on the table. Everyone puts offers on the table, it's easy to throw around an IOI, but no, I've actually signed some sort of a term sheet and begun due diligence and it just has fallen apart.
I always say, if you're going to do a deal, you should be opportunistic. You should hear what folks have to say, you should be willing to talk to different people and understand things and talk to private equity firms. I think you should avoid search funds. When you get emails and calls, you really have to understand, are you dealing with an actual financial sponsor that has hundreds of millions or billions of dollars in capital? Are you dealing with somebody who's out trying to buy a business and going to raise money, and that's a whole other ball of wax. That's a total waste of your time in most cases.
Exploring these things is important. It's part of the educational process for all of us. My main point on all of this is that if you're actually going to do something, though, it is a process that you as the seller need to own. If you wait into this haphazardly, and say, “I'll see if the offer’s right. Everything's for sale, let me see.” That's not a good position to be in.
The position that you want to be in is, “I've got a fungible asset here that I'm going to sell. Multiples are still at screeching levels. If I do this, I'm going to own this. I'm talking to 65 different financial sponsors, and you guys are going to bid for this. It'd be very, very painful but I'm not going to sit back, answer a million questions, send a bunch of data over, wait around for some sort of an IOI or an LOI, and let the private equity firm come out whine me. That's not how I'm going to roll. I'm going to own this process. I am the process setter. I am the seller. You compete by my rules. I guarantee you, if you do that, you will see a far better outcome for yourself, your family, as well as for employees.”
Patrick Baldwin: Paul, not to promote you and Potomac, but you killed the first Potomac. I'll even give credit to the Mexican this one time. I think back on what the process and the deal looked like over the years, as we began having these conversations, even Bobby and I had a meeting with Massey when they came to Waco years and years ago, and I think about Arrow, and they've got a great M&A department, Kevin Burns, Ryan, great people with Tim and Emily at the top.
You've got Anticimex in the mix. I think about Terminix, now, Rentokil-Terminix. Rollins and Orkin. If I know these six players, and I know them well, it's less complicated than what I'm hearing now. You have 60-ish private equity, financial sponsors with no name, no face, no brand, that I'm aware of. I don't know them. All of a sudden, I'm supposed to figure out how to differentiate themselves. To me, it even stresses the further necessity to get someone on my side to represent me.
Paul Giannamore: If your point is this is more of a financial sponsor game than yes, it is more important now more than ever to have an advisor. I will promote myself. We absolutely kill it for our clients. We've done more private equity deals than anyone else in the industry combined. We've done them globally. We've been doing it for decades. I come from the private equity space. We absolutely destroy it for our clients. I can say unequivocally, the deals that we put together for our clients are the absolute best. It's not bragging if it's true, Patrick.
Patrick Baldwin: Paul, take a look at this unburnt top of my head. When I come back from youth camp, they might look a little browner, a little redder.
Paul Giannamore: Put some sunscreen on, Patrick, it's my only recommendation to you. Have a great time at camp.
Patrick Baldwin: What wisdom did you give me go into youth camp? Don't watch ninth grade boys?
Paul Giannamore: Yeah, don't watch ninth grade boys. Put your sunscreen on you. Have a good time and until next week, PB. Travel safe.
Patrick Baldwin: Thanks, Paul.
Pest Expo
Jacana
