Middle Market Mergers and Acquisitions by Colonnade Advisors

In this episode, we discuss strategic steps for Equipment Leasing and Finance companies as they grow and evolve. The leadership of some of these businesses may decide to remain a certain size and complexity and be “ lifestyle businesses”, providing healthy cash flow to the owner(s) while they continue to run the business.

However, other options exist, and exiting the business for a favorable multiple to a bank or other buyer can be an excellent strategy, the dream plan for many entrepreneurs. 

In this interview, we interview Bob Rinaldi and discuss the potential to grow and leverage a business to realize a win-win exit strategy. 

This episode is a great follow-up to our previous show, Start Early & Exit Right, as we dive deep into many of the concepts of M&A rationale. What’s unique about this episode is that it is geared toward a specific target audience, our friends in the Equipment Leasing and Finance (ELF) industry.

In this episode we cover:

• How partners such as Rinaldi Advisory Services (RAS) and Colonnade work with Equipment Leasing & Finance (ELF) companies to prepare for a successful sale (1:00)
• What are the biggest challenges for the independents as they look to be “bank ready” for an acquisition? (4:00) 
• What are some of the biggest challenges for banks pursuing an acquisition of an equipment leasing company? (9:30)
• What determines the level of a premium in the sale price that an ELF company can expect? (20:00)
• What has M&A activity looked like in recent years and what are the prospects? (23:00)
• What about Private Equity buyers in this space? (26:30)

Bob: My practice has evolved around three target audiences in the equipment leasing space. About 60% of my clients are independent leasing (ELF) companies that I work with through the Confidential CEO Resource℠ model. This is multi-year exit strategy planning. Whether the company exits or not is not important. The idea is to get them from point A to point B so they’re prepared if that time comes.

The second part of my practice is working with banks, predominantly community banks who are looking to get into the ELF space.

Third, I work with a handful of service providers in the industry, as well.

Rinaldi Advisory Services (RAS) offers the Confidential CEO Resource℠ (CCR) as a robust, full-scope advisory service that provides clients with a broad base of support for long-term strategic management. RAS works with CEOs and Principals to provide meaningful analysis and actionable insights. The aim is to help ELF senior management arrive at strategic and tactical decisions geared toward managing growth as well as operational and financial efficiencies.

Colonnade has deep experience in the ELF industry. Colonnade is a leading investment banking firm that has completed over $9 billion in M&A transactions for clients in the business and financial services industries. Colonnade has advised many companies in the EFL sector on strategic transactions. Please see our Quarterly Updates on the ELF industry here.

Bob: The biggest challenge is predominantly that these founders/owners are very much entrepreneurs. They started the business. They’re very much involved in the everyday transactional nature of their business. They don’t have the time to gain the perspective to look at their company objectively and determine what needs to happen to be a better company from a non-transactional standpoint or to be a better company for the purpose of acquisition.

Jeff:  Let’s drill down a little bit on some of the biggest challenges for the independents. There’s size and scale, where are you today and where are you going? Banks are the natural resting home for specialty finance companies, and ELF companies are such a great asset class for banks in particular. Obviously, they’re a number of large independents, but from the bank’s perspective, what are the other things you see where companies need to focus? Is it finance and accounting? Is it operations? Is it servicing?

Bob: Yes. Yes. And yes. It’s really all those things. But even before you get to that, let’s look at the business and find components within the business that definitely will never, ever fit in a bank. I’m able to identify those things. You then have to decide what to do with those things. Do I jettison those things completely? Do I sell those off? Do I break it outside of the company and put it in a separate entity so that what is left is sellable and simple to understand? Compare that to a buyer looking at the company and thinking, “I like this, I like this. I hate that. Therefore, I’m not doing it [the acquisition].”

For example, say that there is a heavy services component of the (ELF) business; services component being something that has morphed, be it operational leases or servicing equipment that is leased. A bank can’t be in that business. If that is an absolute key critical component to your leasing business, then a bank buyer is probably never going to be the buyer, which is going to leave you looking at non-financial institutional-type buyers, and they’re fairly limited, so that’s a problem. That is when you look at it and go: “If that’s what we’re always going to do, then this maybe is just going to be a lifestyle business. Let’s just find ways to improve the income generation, the profitability, and keep it as a lifestyle business.”

1) The banks must use experienced advisors who understand the appropriate valuation models.

Bob: If the bank has not been in the business before and their only experience with acquisitions has predominantly been buying other smaller banks, the first challenge is the valuation models. Banks are used to paying a multiple of book value. Leasing companies are not valued that way; their valuation is based on a multiple of earnings or pretax adjusted net income. In a typical leasing company, most of the leases are on a fixed term, fully amortizing type of a structure; therefore they just generate income. But the assets don’t stay on the balance sheet that long, they continually roll-off at a rapid rate, so you’ve got to keep putting on more. It’s really not an asset play as much as it is a net income play.

Jeff: When we talk to banks as acquirers of these businesses, from either the buy-side or the sell-side, you’re absolutely right. It’s all about the income-generating opportunity. Yes, there are assets associated with it, but much more importantly, it’s “What’s the potential earning stream for this business within the bank?” (See: Discover the Rationale for a Synergistic Business Merger).

Bob: That really comes down to the financial institution’s advisor, a buy-side advisor. If they’ve not had much experience in the equipment leasing space, especially current experience like Colonnade has, they’re already at a very big disadvantage because now you’ve got two entities that are blind and stating the same thing and focused on book value, so they’re getting bad advice along with their own preconceived ideas. That’s like a double whammy right out the gate.

It’s common when you find that a bank or their board, for whatever reason, have just got very comfortable with a buy-side advisor, who has never had that much experience at it but they’ve just gotten very comfortable with them and they wouldn’t even conceive of going outside. A lot of this gets really back down to, “Is the bank nimble? Is the bank flexible? Does the bank have a CEO that has cut a bigger vision?” The same thing with the board, the death of any kind of an institution is just getting so stuck in your way that you just can’t get out of it.

2) The CEO of the bank must have a visionary leadership style that allows the acquired company to thrive.

Bob: It all still goes back to the CEO of the bank and how progressive they are, how aggressive they are. And aggressive does not mean they’re careless.

Jeff: The folks that we generally work with on the banking side have made that decision. They said, “Okay, we’re going to get into specialty finance. We want to do it in X, Y or Z asset class, and we have the headset to bid accordingly, and that these businesses are valued differently than bank deals. The multiples are different, the metrics are different. We’re committed, we’ve got board approval, we’ve got senior leadership approval and we’re going to go ahead with it.”

Bob: You and I know one of the smartest, most aggressive community bankers: Chuck Sulerzyski ​of Peoples Bank of Marietta, Ohio. Peoples Bank is located in the Southeast corner of Ohio, squarely in Appalachia country.

How does a bank that size, originally ~$1 billion in assets when he took it over and roughly $7 billion today, make such successful leasing company acquisitions? One located in Vermont and one located in Minnesota? If you take a look at the numbers, the ROA and ROE of the bank have improved dramatically. Their yields and spreads have increased dramatically. Their asset growth has increased significantly in the commercial real estate (CRE) and in the commercial and industrial (C&I) sectors. His shareholders are being rewarded handsomely and will continue to be.

Jeff: Chuck sets a great example. He has been aggressive in good ways. Peoples Bank also acquired an insurance premium finance company, and they’re diversifying. 

Chuck has the right headset in that he looks to acquire businesses to expand and diversify their geographical footprint. That’s a real success story, in my view. 

Bob: If you’re going to acquire a leasing company that’s growing, that’s used to growing assets, the last thing you want to do is turn them into a bank. That’s the whole premise for why you’re going to buy a leasing company – is to expand the scope of the bank, not to contract it. It requires an introspective look of the CEO and his team: can they make an acquisition and not micromanage it and end up turning it into a bank?

3) Banks must be able to create objectives around diversification of geography and asset classes. 

Bob: Equipment leasing is not a geographic-specific industry unlike, let’s call it, commercial real estate. Banks are very familiar with commercial real estate. Real estate is always local. Commercial real estate is local, you’ve got to know the geography that you’re in very well so that you understand the commercial real estate in that market.

Banks must understand what they’re trying to achieve in three to five years in terms of what percentage of their (Commercial and Insurance) C&I assets they want in various sectors.  How much do they want to get to in ELF? What do they want it to look like in three years, four years? Depending upon how big that number is, that determines the modality of the type of equipment leasing business you could get into. There are multiple facets to the equipment leasing industry: 1) small ticket, (transactions less than $250,000), middle-market/mid ticket (up to $5 million per transaction size), and large ticket (above $5 million per transaction).

Jeff. Take Wintrust. They’re not really “a bank”. More than 40% of their loan portfolio is insurance premium finance. They’ve got a big equipment finance business on top of that. There’s probably 50% to 60% of loans that are non-traditional banking assets. As a result, the ROA on that bank is considerably higher than its peers; and as a result, the stock trades higher. 

And Peoples, as we’ve discussed, has the right headset that they need to acquire or look to acquire national platforms outside of Marietta, Ohio. Obviously, they’ve done some bank acquisitions too in footprint, but expanding to get national business is part of the CEO’s strategy. 

Bob: It falls under the quality of earnings, platform, and quality of human resources.

1. Quality of earnings: I think about the repeatability of the earnings, as opposed to having a trend line of earnings that is a sawtooth (up and down, up and down). Quality of earnings should be fluid and show continued ramped-up growth over a period of time.
2. Platform: The ability to scale. What’s their technological capability? What’s the platform built off of, is it homegrown? Is it well protected? Is it SOC compliant? If you had more capital, can you scale it?
3. Quality of human resources: What does the management team look like? What’s the average age of the team? What are their qualifications? What does the core management team look like behind them?

If you cover all three of those pretty darn well, you’re going to get the higher end of the premium scale for sure.

Bob: Activity’s been strong for the past few years. Part of the activity was exacerbated when everybody thought that in 2021 there was going to be a new tax act and capital gains were going to go up.  The biggest reason over the past four to five years is because you’ve got an aging-out (in the midst of the Great Resignation) of the Principals of these companies. It’s just a normal progression, and it happens every five years or so. You get a number of individuals who have had their own leasing companies who started them 20 odd years ago. If they started 20 years ago, here we are 20 years later, they’re in their mid-60s to late 60s. If they don’t get out now, when are they going to exit? Because typically there’s going to be an earn out. If you wait till the age of 70 to get out, you may be working on an earn out between the ages of 70 and 73.

On top of that, there’s the aspect of an ELF company having a capital constraint. At some point, their capital is not going to hold them to keep borrowing on their line of credit because the debt-equity ratios will get too high and they’ll have a hard time borrowing. It’s really at about that time when they have to start thinking about what’s next. Do we bring in another equity partner? Do we bring in some sub-debt? All that does is kick the can down the road. And I always tell them at that point: “You’re already selling part of the company. Just sell the whole thing.”

Listen to this podcast episode/read through the shownotes to see the Four Reasons Company Owners Consider a Transaction (15:25)

Jeff: We regularly get calls from folks looking to find platforms to acquire and build upon. There are some opportunities there: To remain independent, nimble, and flexible outside of the bank model, and take in additional capital to grow and potentially enhance the financing capabilities through securitizations and others.

Bob: The equipment leasing industry is a fairly mature industry. It’s fairly sophisticated. For an independent leasing company to bring in private equity, I see that as only a solution if you don’t believe you’re able to sell the whole company right now. The PE firm is investing to get double-digit returns, so that means they’re going to come in and put you (as the owner/operator) on a huge ramped-up treadmill. You are going to have to keep up or they’re going to lose interest. And you’ve sold part of the company.

Now, granted, you’ve got a smaller piece but now have a bigger pie. 

Jeff: That makes sense. There are some examples of successful private-equity-backed equipment finance companies, but as we have found – the universe of financially oriented sponsors that really want to put a lot of capital into the business and are willing to wait a long time to get their return – is quite limited. Most folks attack it from the financing standpoint. It can be a good option if you have an aging founder that wants an opportunity to take some chips off the table and let the next generation continue to run it. But you’re right, it is a different exercise being put on that treadmill.

Bob: It’s a much different exercise. On the other hand, where it does work really well, is when a PE firm is backing a very experienced individual or a team who is going to start up a new entity. They could start this new entity and scale quickly with the help of private equity. They’d have a chance to really leverage that with some serious growth. Then it makes complete sense.

Before you sell your company, even the odds.

This episode features guests Mark Achler and Mert Iseri, authors of the recent book, Exit Right: How to Sell Your Startup, Maximize Your Return and Build Your Legacy.

Exit Right demystifies how to conclude the startup journey, a perfect complement to our podcast, which focuses more on the exits of larger middle-market companies. As Brad Feld states in the Foreword, “Mert and Mark set the roadmap for how entrepreneurs and business owners can proactively manage the process of getting to a successful exit along the way”.

As Jeff says at the start of the interview: Mark and Mert cover so many great informative topics in the book. There is a wealth of tips to guide business owners through what can be a tumultuous process, getting through the exit. There are also so many topics we align with: relationships matter most, planning for wealth, time kills all deals, and the importance of following a best-practice process. 

In this podcast episode, we focus on three topics with a lot of meat to each: 

1. FAIR, Mert and Mark’s framework for a successful exit, (3:00) 
2. The“Exit Talk” and how we suggest that all companies adopt this practice with their board (15:00), and
3. Who is involved in the Exit Talk and why? (28:00)

Mert: What we realized as we started to gather stories and experiences from M&A bankers, lawyers, serial entrepreneurs, etc is that the real question isn’t, “Let’s find out who’s going to pay the most.”

The real question is, “What’s the right home for this business? What’s the right home for my people? What’s the right home for the vision? Who is going to serve our customers the best?”

Our view of an exit went from being a short-term transaction to a long-term partnership. The term “exit” is a poor word choice.  You’re not really exiting anything. If anything, it’s the beginning of a brand new relationship. So when we ask ourselves, “What makes a great home for a startup?” we focus on these four elements that make exits great.

FAIR. Fit, Alignment, Integration, and Rationale. 

If you have all four of those, it just so happens that you’ve also found the person who’s willing to pay the most for your business, because they will realize the long-term value and they’ll price the deal accordingly.

Fit is the cultural fit between the two companies. Amazon and Zappos are a great fit. Time Warner and AOL, are probably not a great fit. It’s easily described. Can you sit next to this person for four hours and not want to kill them by the end of the meeting? Can you actually make decisions without written rules? Are cultural values aligned? Are the DNAs sort of similar, cousins to each other between those two companies?

Alignment is about being aligned with your co-founders, board, and shareholders in terms of the direction of where you want to go. The acquiring company also must be aligned. 

We almost always dismiss the alignment that we need from all sides of the table. This isn’t two sides looking at each other. This is two sides looking in the same direction.

Integration has to do with the plan for how these two companies will come together. We’ve seen so many examples of this plan of integration being done as an afterthought. It’s not just product and sales integration but people integration, finance integration; many, many layers. And all of these stakeholders have different agendas that need to be individually managed. 

Rationale. Can you explain to your grandmother why this acquisition makes sense? How are we going to deliver more value to our customers as a result of this partnership? How is two plus two equal to 100 in this context?

Mark: There are profound financial implications to the FAIR framework. Let’s take Integration. Integration is the ugly stepchild. People always say, “Oh yeah, we’ll deal with integration afterward.” 

Turns out that in many transactions, it’s not always 100% cash. Sometimes there’s an earn-out for future performance. If you’re not integrated well (you don’t have the resources you need to execute your plan), there are some significant financial implications to the earn-out.

Then there are the financial implications to Rationale. Transactions are typically based on looking backward using a multiple. When you create a rationale that says one plus one equals a hundred, if it’s a strategic investment, you take your product and we plug it into the larger company’s sales force or the larger company’s customer base. What could we do inside the larger company?

What’s the impact of your product on the larger company? The way to maximize value is not looking backward as a multiple, but looking forward using the rationale. Strategically, why is the combination so valuable? If you can get everybody aligned around the rationale and the financial implications of that rationale, that’s how you’re going to drive a better price for an exit.

Mert: No one’s going to just sit down and tell you, “This is our rationale.” You uncover it. You unearth it over years. That’s why we urge entrepreneurs to put their party dresses on. Talk to many competitors. Talk to strategics. Get out the door.

You need to build this trusted relationship over time with fundamental questions.

How can I help? How can I help you push your agenda forward? How can I help my customers? This is what great partnerships really look like. We’re not saying go share your financials with your competitors or give away all your IP to a larger strategy, but you need to be that trusted partner that advances the mission on all sides and creates a situation where everybody wins.

Mark: We wrote the book about exits, but it turns out that the decisions that entrepreneurs make at the beginning of their journey have an outsized impact at the end of the journey. Even though this book is really about the exit, there is really good advice there about the beginning of the journey as well.

Jeff: That’s exactly right. This book is really about the journey.  All of the steps on the journey influence the end. There’s so much wisdom in the book and insights about all the things that you can do to proactively get to the right end. Management meetings are oftentimes the first time that business owners meet their potential acquirers, whether they’re competitors or strategics, or investors. But the longer that relationship can be developed, the more that you can uncover in terms of the shared common goal of what can we do together. And the best valuation and the best terms will just naturally evolve.

Jeff: The Exit Talk really struck a chord with me. Let’s encourage clients and future clients to have these discussions and this thought process through the FAIR framework to really think ahead.

Sometimes we as investment bankers get brought in late in the game. But most of our transactions and our best relationships really span years. We get to know the business, the goals, and importantly the people involved, the operators, the owners, the founders, and the investors. Some of these relationships for us span a decade or more. We give them advice on how to grow their companies.

This concept of an exit talk is missing from my perspective. Exit discussions are often secretive or clouded in secrecy. It is a very small universe of folks within a company that knows that a transaction is imminent. It’s rarely discussed openly among the senior leadership team until late in the game.

What you guys propose is proactive. Through your work and sharing your work with my future clients, I’d like them to embrace this philosophy.

I love this quote that you said, “Instead of fueling the awkwardness of the exit topic by staying silent, we are putting forward a new norm that we believe the entire industry should adopt, which is the Exit Talk.”

Mark: This is one of our favorite topics. But before we dive into the Exit Talk: We are such big believers in trust. Every deal has its ups and downs. It has its emotional turbulence, it’s the journey. Trust is the lubrication that gets deals done through to the conclusion. I just wanted to put a fine point on that topic of trust because it permeates everything we do.

The Exit Talk. 

It turns out that there’s a stigma to talking about exits. CEOs are afraid. They’re afraid that if they bring up the topic of an exit that their board and their investors are going to think their heart’s not in it. They’ve lost hope. They’ve lost faith.

In the Venture Capital or Private Equity world, we have a time horizon. When you take our capital, you take our agenda, and you take our time horizon. We’re looking for X return over Y timeframe. And if you’re in year one of a fund, we’ve got plenty of time.  Let’s go build and grow. If you’re in year 10 of a fund, we’ve got to start returning capital back to our LPs.

With the Exit Talk, what we’re proposing is that once a year, maybe your first board meeting of the year, you have a regularly scheduled annual talk where the CEO, without fear of being perceived as their heart’s not in it, can talk about the exit.

The reason it’s so incredibly helpful is that you have the luxury of time. If you had 18 months or two years, you have the luxury of saying, “Who’s going to be the most likely acquirer? Is it going to be a strategic acquirer? And why? Who is it and why would they want to acquire us? Or is it going to be a financial buyer and what are they looking for? Are they looking for top-line revenue?” 

If we’re going to sell to somebody who really cares about growth, we may invest a little bit more heavily in sales and marketing. If it’s somebody who is more financially oriented and really cares about EBITDA, we might tighten the ship and focus on profitability. 

It gives you the luxury of time to get your intellectual property in order, make sure that every single employee has a signed agreement, and make sure that trademarks and patents are filed appropriately. Get your data room pristine. If you have the luxury of time, you can optimize and present your business. And you could take the time to find the best bankers and attorneys who really are going to represent you well.

Mert: An outcome of this talk doesn’t necessarily have to be “we’re ready to sell, or we’re not ready to sell”. It can also be an opportunity to start prototyping some of the theories around how you add more value to your customers. This is a great centerpiece for what we believe an exit should be reasoned around. This will help our customers faster/better than what we could do on our own by just raising more money or gathering more capital or resources.

For instance, if you are going to have a strategic alignment with a larger company like Google, but you’re not ready to sell, it’s still an opportunity to start a relationship. Maybe we work on a mutual customer together. Maybe we create some content together where we tell our stories and we share our wisdom with theirs. You want to start charging up that trust battery over time. When you are ready, you are a known entity.

The reality is these M&A (Corporate Development) leaders want to buy companies from trusted entities. They don’t want an egg on their face either. They want to know the company that they’re investing in. They’re not viewing this as an acquisition, they’re really viewing it as an investment. They want to know they can trust you. They want to know that you can go the distance.

It’s a really difficult thing to do to create that kind of trust. You’re not going to rush through trust. You’re going to build it incrementally over years. Even the identification of a strategic partner when you’re not ready to sell is extremely valuable because that’s an opportunity to generate a relationship. Find out what their priorities are. See if your solution helps move those numbers forward. 

Mark: We’re big believers in empathy. We have an empathy framework. There are three rules of empathy:

1) It’s not about you. It’s always about the person sitting across the table from you.

2) Do your homework.  Deeply and truly understand what’s important. Mert just said, “Go listen to the quarterly earnings report.” They’re going to tell you what they care about.

3) Bring a gift, add value. When I say bring a gift: what can you do? If you’re an industry leader, provide some thought leadership about where the market’s heading. Share new bits of technology. Not only can you gain knowledge about their strategic direction, you can also share knowledge and be thought of as a trusted thought leader. 

If you take those empathy rules and apply them to building relationships over time, that’s how you’re going to earn trust.

Jeff: I love the idea of a trust battery and charging that up over time. You can’t do that overnight. You can’t do that in one management meeting. You can’t do that in a really compressed timeframe. You really need to start early and think about what you can bring to the table. What can you bring as a gift to add value to somebody else so that they can see the value in what you are bringing? 

That’s really the roadmap that you guys layout in your book: what steps can we take proactively to get to the best outcome.

Mark: Let’s separate out the annual exit talk from an actual transaction process. The exit talk is a board of directors-level conversation. Maybe you bring in one or two top lieutenants into that conversation, depending on the relationship between the CEO and maybe one or two C-suite members. But that’s a board-level, strategic conversation that’s not for the whole company.

(For an actual transaction process), there are lots of different ways of handling it. My own personal opinion is that there is a dance that takes place starting as an aperture that broadens over time. One of the challenges with telling any employee about a transaction is human nature. “What’s that mean to me? Am I going to have a job? Am I going to get fired? Am I going to become rich? What are my stock options worth?”

One of the challenges is that not all deals happen; deals fall apart all the time. So the team has to have their eye on the ball. For the CEO, when they’re going through a transaction, it can be all-consuming.  We’ve seen instances where companies started slowing down, missing their numbers because the CEO was distracted and not focused on running their business. 

The way I think about it is starting with the CEO and the board, keeping a really tight circle of information. And then as the conversations start to broaden and deepen in a transaction, then people are going to start the due diligence process. 

Make sure your C-suite is involved and your executive team is involved. The people who are going to be part of the due diligence process, obviously you’re going to have to inform them. I don’t think it’s a great thing to just wake up one morning and say to your entire employee base, “Hey, guess what? We just got sold.” There’s a middle ground someplace in that continuum. Try to keep it confidential through most of the process. As you start to get to certainty you need to start opening it up so it’s not a surprise to everybody.

Mert: There’s one major stakeholder that hasn’t been discussed and I just want to bring that up, and that’s your family. Most founders overlook that and think of this transaction as a business event. This is a life event.

Your family is a humongous stakeholder. We want to highlight that this is a critical component of whether an exit happens or not. What’s happening with your family is just as important as what is happening with your board and other stakeholders.

Mark: I couldn’t agree with you more. It’s not just us, it’s our families and our loved ones too that have a stake in this.

Jeff: It goes for all key constituents, starting with the family and then moving down to the board members and the C-suite and figuring out what’s the right communication style and method and frequency. These things are really critical decisions that most folks don’t really spend the time thinking about.

Mark: One of the questions we ask CEOs is: when you’re done with the transaction, will your employees come back to work for you in the next company you start? Will your investors want to invest in you in the next company you start? Will the biz dev lead of the large company who goes on to the next company, are they going to want to buy your next company?

I think what many entrepreneurs fail to understand is that the relationships you build and your legacy live on way past the deal and the transaction. 

We’re big believers in servant leadership and that the best CEOs don’t view life as a zero-sum game. They make sure that they take care of their customers, their employees, and their investors. They try to find the balance of supporting all relationships over time.

ABOUT OUR GUESTS

While a successful entrepreneur may exit a handful of companies in their lifetime, large buyers close deals all the time. Without decades of experience in mergers and acquisitions, founders don’t have the tools they need to get the best results for themselves, their teams, or the new parent company.

Through dozens of interviews with M&A leaders at the biggest Silicon Valley acquirers—as well as attorneys, bankers, and founders who have been through the trenches—Exit Right delivers the hard-earned lessons that lead to successful exits. From negotiation to valuation to breaking down a term sheet, managing legal costs, and handling emotional turbulence—this unparalleled guide covers every critical aspect of a technology startup sale.

Learn where deals get into trouble, how to create alignment between negotiating parties, and what terms you should care about most. Above all, learn how to win in both the short and the long term, maximizing your price while positioning your company for a legacy you can be proud of.

Author Biographies

An early employee of Apple and Head of Innovation at Redbox, Mark Achler has been creating and investing in tech startups since 1986. Today, he is a founding partner of MATH Venture Partners, a technology venture capital fund, and an adjunct professor at the Northwestern Kellogg School of Management.

Mert Iseri co-founded SwipeSense, a healthcare technology company acquired by SC Johnson in 2020. Prior to that, he co-founded Design for America, a national network of students using design thinking to create social impact, now part of the IBM Watson Foundation. He is currently an Entrepreneur in Residence at MATH Venture Partners.

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Gina Cocking serves as the Chief Executive Officer of Colonnade Advisors. Gina began her career in investment banking at Kidder Peabody, was an analyst at Madison Dearborn Partners and an associate at J.P. Morgan & Co. She was the Chief Financial Officer of Cobalt Finance, a specialty finance company. She went on to become the Chief Financial Officer of Healthcare Laundry Systems, a private equity-backed company for which she oversaw the successful sale to a strategic acquirer. Gina served as the Line of Business CFO – Consumer Banking and Lending at Discover Financial Services. Gina serves on the Board of Directors of CIB Marine Bancshares, Inc. Gina received her BA in Economics and an MBA from the University of Chicago.

Jeff Guylay is a Managing Director of Colonnade Advisors. Prior to joining Colonnade in 2000, Jeff was an investment banker at J.P. Morgan in the firm’s Mergers & Acquisitions and Fixed Income Capital Markets groups in New York. He also spent several years in J.P. Morgan’s Chicago office. Jeff has over 20 years of M&A and investment banking experience and has served as lead execution partner on over 25 M&A and financing transactions at Colonnade. Jeff received an MBA from Northwestern University’s Kellogg Graduate School of Management and a Master of Engineering Management from the University’s McCormick School of Engineering. Jeff received a BA from Dartmouth College and a BE from Dartmouth’s Thayer School of Engineering.

Get the insiders’ take on mergers and acquisitions. M&A investment bankers Gina Cocking and Jeff Guylay of Colonnade Advisors discuss the technical aspects of and tactics used in middle market deals. This podcast offers actionable advice and strategies for selling your company and is aimed at owners of middle market companies in the financial services and business services sectors. Middle market companies are generally valued between $20 million and $500 million.

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Colonnade has studied the F&I Agencies and Payment Plan Provider markets for the last 20+ years. We have worked on nearly 30 M&A transactions on the buy-side and the sell-side. We have gotten to know the industry players and the buyers. We’ve identified some high-opportunity M&A plays that could help to drive even more value, scale, and customer satisfaction in the industry.

In this first part of our episode, we answer the following questions:

• Where do F&I agencies sit in the F&I ecosystem? (1:00)
• What does a typical F&I agency look like? (7:00)
• What is going on in terms of M&A and what are the value drivers in the industry? (9:00)
• What is driving M&A transactions right now and what are some potential M&A plays? (12:00)

Gina: Between the F&I administrators and the F&I office and the dealership, there are F&I agencies. They are independent agencies with independent agents. They are like insurance agents. They bring together the product administrators and the dealers. 

Gina:  The agents have deep knowledge about the products they represent. They can train the F&I office on those products and how to sell the products. They also act as the middle man or the interface with the administrator. They are one distribution arm for the administrators, which makes them critical in the ecosystem. They are a valuable component of the overall F&I ecosystem.

Jeff: The F&I agency is a particular point in the value chain. It’s a differentiator. Some administrators sell to dealers through a direct sales force, others use F&I agents. 

Gina: There are administrators who go direct to dealers, but most administrators also use independent agents. They may have a direct sales force, but they have independent agents also. The only sector where that seems to not always be the case is selling into independent dealerships. You tend to see more direct agents that are employed by the administrators selling into the independent dealerships.

Gina: An important component of what the agents do is help the dealership with reinsurance. Reinsurance is an important component of a dealership owner’s profits. For every contract, every F&I product that is sold, there is a reserve set aside for future claims. F&I agents are usually very fluid and educated in talking about reinsurance and making sure that the dealership has the right reinsurance programs. So they deal with reinsurance, they do training on products, they do training on how to sell products. They sometimes help with staffing in the F&I office, and they’ll help with some of the technology that is between the F&I office and the administrator.

Gina: F&I represents a third of a dealership’s profits. Everybody within the organization and affiliated with the organization is going to make sure that F&I runs smoothly.

Gina: There are well over 100 independent agencies, and approximately 75%-80% of F&I agencies are less than 10 employees. There are very few large agencies. There are a few that are scaling, but there really aren’t many. There is only one national agency that comes to mind and that’s Vanguard (owned by Spectrum Automotive). Vanguard has been very acquisitive in building out its agent network.

We also see Brown & Brown, which is a P&C insurance brokerage. They’ve been acquiring F&I agencies over the last few years. I don’t know if they have a national footprint yet, but they’re probably getting pretty close. And then you have acquired a lot of small agencies.

​​Jeff: The Brown & Brown example is an interesting one that we’ve watched over the last five to six years as they’ve entered the industry. We’ve always thought their participation in the F&I agency world makes a lot of sense, given the parallels to the P&C distribution market.

Gina: We think that the M&A market for F&I agencies will continue to be hot in 2022. (See Gina’s cover article in Agent Entrepreneur, 2022 M&A Predictions for F&I Agents)

Agent value is driven by a couple of different factors. One is diversification. One of the challenges for these small agencies, just like any small company, is having all of their eggs in one basket. An F&I agency may have one dealership group that represents 40% of sales. That is a gating factor to trading and getting the highest possible value. Agencies that have significant concentration, which I call greater than 15%, trade at a lower multiple than agencies that have little concentration.

Another value driver is size. We look at the number of W-2 employees (as well as financials).

Jeff:  Important when you go to sell these companies: Who owns the dealer relationships? And what’s the risk of attrition in a transaction?

Gina: A lot of diligence needs to be done in these transactions to really understand the nitty-gritty of who, not just on paper but in practice, owns the relationships.

Jeff: It sounds like an industry that could be rolled up further. Following the playbook of the P&C insurance distribution market, you got a lot of mom and pops out there and a few large players. 

Gina: Both Brown & Brown and Vanguard Dealer Services (Spectrum Automotive) are rolling up agencies. The rest of M&A activity we see is not a roll up, but administrators buying agencies. National Autocare and Portfolio Group have been very inquisitive. There are many other administrators who bought one, two, three agencies, as they attempt to lock in their distribution channels. 

Gina:  There should be another roll up of F&I agencies. There should be a private equity firm that’s coming in here saying, “I’m going to put a hundred, $150 million to work and we’re going to leverage it. And we’re going to buy up 20 F&I agencies. We’re going to make a super-agency with national coverage.” That could be uber-successful for everybody involved. It just hasn’t happened yet.

Jeff: The folks that are acquiring are paying pretty high multiples, and that’s a challenge. Any new entrant would have to go in and go big pretty quickly. They’d have to find a platform that they can scale and put a lot of capital to work while holding their nose as they pay big prices upfront.

Gina: A lot of the M&A activity we have seen is with an older generation that is retiring. There’s also some leakage happening where the younger, talented, hungrier F&I agents are like, “I get it, I can do this.” They leave and go start their own agency. I think we’ll see that next-generation starting to trade in about a year or two.

Gina: I have one last point I want to cover about F&I agency M&A: what’s driving the activity.

First of all, there’s a lot of money looking for deals. There are private equity firms backing administrators that need to grow inorganically. But we also see a lot of M&A activity at the dealership level. They’re getting bigger. Big dealership groups are buying up other dealers, independent shops, and dealership groups.  Every time one of those transactions happens, the agent that represents the target dealership is at risk of losing that client. Dealership M&A is driving F&I agency M&A.

I think that this is the question that keeps a lot of agents up at night: Are they one or several M&A transactions away from losing a significant portion of their relationships and their livelihood?

In this second part of our episode, we answer the following questions:

• How do payment plan providers add value to the auto F&I sector? (18:00)
• How big is the industry and who are the biggest players? (23:00)
• Why are payment plan providers a favorite industry of Colonnade? (25:00)
• What is going on in terms of M&A and what are the value drivers in the industry? (29:00)

Jeff: Payment plan companies came out of the ground around 20 years ago. They started as an offshoot of the insurance premium finance market, which we’ve talked about in a previous podcast.

Fundamentally, this market is designed to help consumers purchase F&I products cost-effectively.

Whether you’re in a dealership (point of sale) and the F&I person says, “This VSC is going to cost you $3,000” or whether you get a piece of mail about an extended auto warranty (aftermarket), once you get sold on buying the coverage, the questions is always: Do you want to write a check for three grand or do you want to finance it over two or three years? 

In most cases, the VSC/extended auto warranty gets financed. That’s where these payment plan companies come in.

Jeff: At the dealership (point of sale), the payment for an F&I product typically gets rolled into the auto loan. It’s just one of the line items in the auto loan, and you (as the consumer) pay it off as you go. There are some payment plan providers that focus on point of sale at the dealership, allowing a consumer to finance the product outside the auto loan.

In the aftermarket, which is really where we see these payment plans flourish, it’s a different dynamic. If you’re on the phone with a direct marketer and you agree to buy the coverage, you can put 10% down and pay over 18 or 36 months, depending on the payment plan. Interestingly, they’re interest-free and cancelable at any time.

And as you continue to drive your car and assess the usefulness of the product, you can cancel it at any time. If you cancel it, all you do is call up the seller or the administrator and say, “I want to cancel my payment plan.” 

In that case, you get a portion of your money back (the unearned premium). It works in a similar way to the insurance premium finance market. The contract is earned over the life of the product. If it’s a five-year product and you’re one year into it, you might get 80% of the money back. The payment plan company is indifferent because it will just get their pro rata share back from the administrator and seller.

The seller will sell the product to the consumer, and if they attach financing to it, the seller will collect the 10 or 15% down payment. The payment plan company will insert themselves and front the rest of the money to the administrator and to the seller.

The administrator has to front some money to the CLIP (1) provider, but the revenue to the seller and the admin fee gets fronted by the payment plan company.

Jeff: Our Industry Report on this sector goes into much more detail about the industry.

Jeff: We estimate this is about a $5 billion a year originations market. There’s not good data. We’ve done a number of studies over the years and think that’s the size of the market. It grows with auto sales and the adoption of products. It’s grown considerably over the last several years.

There are probably 10 independent players in the market. There are just a small handful of large players.

The biggest players are PayLink, which is owned by Fortress and Milestone. Walco is the next biggest, and they’re growing nicely. This is the Walder team that previously ran Mepco and Omnisure, and they’ve started up a new finance company that’s growing quite rapidly. Mepco is a large player, they’re top three, that’s owned by Seabury.

There are other smaller players like Budco, Line 5. Service Payment Plan is a big company in the dealer space, again different dynamics but similar product offering.

PayLink, Omnisure, and Mepco really dominate the aftermarket space. Folks like Service Payment Plan dominate the dealer (point of sale) channel.

Gina: I love the payment plan business because it is so low-risk. What the payment plan companies do is hold a cash reserve on each funding in case the underlying consumer cancels. And that happens. There are a lot of cancellations in the direct consumer marketing of vehicle service contracts. As we’ve discussed before, it’s not because the contracts are bad contracts, but it’s because consumers actually have transparency. In the case of vehicle service contracts rolled into an auto loan, consumers don’t get a breakout every month of the components of their auto loan that they’re paying. They don’t see that 80% of your auto loan payment is for the car, 10% is for the vehicle service contract, et cetera, cetera. But when a consumer is financing or using a payment plan for a vehicle service contract in the aftermarket, they have complete transparency as to what that cost is for.

And if they decide as a household, they no longer need that product (they need to redeploy that payment to something else like their mortgage), they can cancel. The payment plan businesses have a cash reserve for this. So it is a very low risk business and has great returns.

Jeff: Some of these companies have several hundred million dollars of portfolio and each contract starts out at $3,000 and burns down. These are very granular portfolios. You’re not going to take a big loss on any particular contract. Unlike the insurance premium finance industry, the incidence or likelihood of fraud is negligible, and the risk here is quite low given the granularity.

We like the short duration of these assets. We like the low loss rates. Generally, these transactions are priced at a 15% to 20% unlevered return. They’re very high-yield. There’s no credit risk. We’re not doing anything with consumer credit risk.  We really don’t care. We’re just managing relationships with sellers and administrators.

All those dynamics are favorable to this lending universe. I love this business. It’s a niche industry, $5 billion is not the $50 billion commercial P&C market, but it’s meaningful and growing.

Jeff: There really hasn’t been much activity as there’s a limited universe of players. Some of the administrators are vertically integrating and getting into the payment plan industry.

We worked on the initial sale of Mepco to Independent Bank almost 20 years ago.

We sold PayLink (which used to be called Warranty Finance Company) to Oxford Financial. It’s now owned by Milestone and Fortress.

Omnisure: Ed and Paul Walder started up that business from scratch and grew it to a couple hundred million dollars of receivables. We advised on the sale to Fortress. 

PayLink and Omnisure merged in 2017 and put together two leading players in the industry.

The other important transaction to mention is Seabury’s acquisition of Mepco out of Independent Bank in 2017. 

Most recently Walco has come out of the ground. Walco was started in early 2020 by Ed and Paul Walder again, starting up another competitor in the sector. They’ve grown considerably in recent years and are doing a great job building out that business.

We don’t see a ton of M&A activity per se, but it’s a really interesting market. Part of the challenge from an M&A perspective is that there has not traditionally been a deep bank buyer universe of this product and that confounds me a bit. For all the reasons we mentioned, this is a really interesting, dynamic asset class. It’s very similar to insurance premium finance, which has a number of large banks in the sector and a number that want to get into it.  The collateral structure looks very similar, except that payment plan providers have higher yields, higher return on assets, and even lower losses. And there’s no fraud.

I think there’s a real opportunity for forward-thinking banks to embrace this asset class and do quite well with very little risk.

(1) A CLIP is a commercial liability insurance product that covers the contractual obligations of the insured. A full reimbursement CLIP would indemnify the insured commercial entity for all monies it expends to fulfill a contractual commitment.

Gina Cocking serves as the Chief Executive Officer of Colonnade Advisors. Gina began her career in investment banking at Kidder Peabody, was an analyst at Madison Dearborn Partners and an associate at J.P. Morgan & Co. She was the Chief Financial Officer of Cobalt Finance, a specialty finance company. She went on to become the Chief Financial Officer of Healthcare Laundry Systems, a private equity-backed company for which she oversaw the successful sale to a strategic acquirer. Gina served as the Line of Business CFO – Consumer Banking and Lending at Discover Financial Services. Gina serves on the Board of Directors of CIB Marine Bancshares, Inc. Gina received her BA in Economics and an MBA from the University of Chicago.

Jeff Guylay is a Managing Director of Colonnade Advisors. Prior to joining Colonnade in 2000, Jeff was an investment banker at J.P. Morgan in the firm’s Mergers & Acquisitions and Fixed Income Capital Markets groups in New York. He also spent several years in J.P. Morgan’s Chicago office. Jeff has over 20 years of M&A and investment banking experience and has served as lead execution partner on over 25 M&A and financing transactions at Colonnade. Jeff received an MBA from Northwestern University’s Kellogg Graduate School of Management and a Master of Engineering Management from the University’s McCormick School of Engineering. Jeff received a BA from Dartmouth College and a BE from Dartmouth’s Thayer School of Engineering.

This episode is a great add-on to the previously released four-episode series exploring the due diligence process:

EP003: Business aspects of due diligence

EP004: Legal aspects of due diligence 

EP005: Accounting aspects of due diligence 

EP006: Technology aspects of due diligence 

As we explore the organizational aspects of a due diligence data room, you’ll hear the reminiscing of both Gina and Jeff as they remember their days on Wall Street physically managing the data rooms of decades past when there were literally rooms full of documents that buyers would make appointments to review while the analysts on the deal watched.  

You’ll hear how much data rooms have transformed in recent years with the birth of the electronic data room.

Get ready for a call-to-action, which Gina describes as a “resolution” that you can make any time, to get your company’s documents located, organized, and filed in a neat system to be ready for a transaction.   

Thus our title for the episode: Get your Ducks in a Row.

We answer the following questions in this podcast episode:

What are data rooms, and why are they so important in the due diligence process? (2:00)

What were data rooms like in decades past? (2:30)

What are data rooms like today? (4:30)

What is contained in an electronic data room? (6:20)

Are data rooms static or do they change over time? (10:00)

How is confidentiality protected in a data room?  (16:00)

What can a company do to prepare for a transaction? (20:00)

What do you suggest companies do immediately after listening to this episode in regards to data rooms? (27:00)

Jeff: Big picture, data rooms are the electronic location of all the materials that we help our clients collect and collate during our process of selling the company.

They contain all the information that buyers and investors will need to complete a transaction. So it’s everything from articles of incorporations, to financial models, to contracts, etc.

Gina: The data room is critical in any buyside or sellside process. The data room is where all the documents are kept that the buyers have access to when reviewing the business. We also give access to the buyers’ accountants, attorneys, HR consultants, marketing consultants, etc.

Datarooms are all electronic (online) nowadays, but it has not always been that way.

Jeff: As an analyst in investment banking in the ’90s, I would sit in a physical data room on Wall Street. We would have buyers come through, and they would have to sign into the data room and show ID.

It was a room full of documents where buyers could spend several days going through documents. They were not able to take any documents out of the data room. They could ask to selectively photocopy certain documents, and we analysts would photocopy them.

The business folks, the attorneys, the accountants would come in in-person and spend days digging through the documents. 

Gina: I remember being stuck in Bethlehem, Pennsylvania in a basement of a chemicals manufacturing facility for about two weeks.

One of the challenges in a physical data room is you couldn’t have multiple buyers come in at the same time. 

You also had to double-check all the files when everyone left to make sure nobody took a document. 

Jeff: The efficiency with electronic data rooms has been a game-changer.  You can have 30 professionals across various functions looking at documents at the same time and really increase the cycle time of the transaction.

Everybody has a unique password, they sign in (online). We can see what documents they’ve downloaded, which ones they’ve reviewed, and which ones they haven’t looked at.

You can see who is really being active. It’s a great tool for us as advisors to see who is most interested in a transaction.

Gina: In the data room, you will have various workstreams based on who will be asking for documents. You’ll have workstreams for business, accounting, tax, legal, technology consultants, marketing, HR, and insurance professionals.

From a business perspective, it will include all monthly reporting packages, KPIs (Key Performance Indicators), MD&As (Management Discussion and Analysis of the financial results); whatever a business is using to manage the business on a day-to-day basis.

Business information will also include company presentations made to outside shareholders and banks, internal presentations, presentations made to clients, information on past employees, current employees, payroll data, insurance information, claims history, insurance applications. 

Jeff: The data room acts as a central repository of all the information that describes the company, its operations, history, and future. 

We start building this data room on day one of our engagement. Colonnade is always thinking ahead about ways that we can help our clients manage the process as efficiently and effectively as possible.

Download Colonnade’s sample due diligence list here.

Jeff: Our data rooms are living data rooms. Documents continue to be populated throughout the process.

On day one, we start asking for documents. These documents include items that we need to produce the financial model and create the Confidential Information Memorandum.

Later, we assess what information we need for second-round bids and ultimately confirmatory diligence. 

Gina: Everything that we ask for is to help us to understand our client’s story and to position us to be able to answer questions as if we were a company insider.  I would say our typical list is 250 to 300 documents that we’re requesting.

Gina: All of our clients worry about what goes into the data room, who’s going to see it, and how we protect the secret sauce of the business.

We work carefully with our clients from the start to determine what documents they are comfortable sharing at which stages of the process.

Jeff: If we contact 50 buyers, and 20 folks are interested enough to take a book (Confidential Information Memorandum), we might have an initial data room that would be a prelude to initial Indications of Interest.

(See our podcast episode, Narrowing the Field – Indications of Interest and Letters of Intent).

Moving to the next phase you might have six interested buyers, and you can phase in the documents that folks are able to see. We control access electronically. 

Gina: I am a big proponent of putting a lot of information in the data room before LOIs are due because then you get better LOIs. They are more well thought out, a lot of the diligence has been done, and when they say, “We are going to pay X,” there’s really not much else that they are going to discover at that point that can change that price. 

We do a lot of redacting. Instead of putting a customer’s name in, it’s company one, company two, company three. We take out employee names. We black out contract terms. We black out the name of vendors. We can do that also in the financial information. 

Jeff:  We as advisors do a lot of the heavy lifting to first identify the sensitive topics and then manage methods of disclosure. Sometimes we have multiple versions of the data room. We might have a strategic (competitor) data room that is different from the financial sponsor data room.

Gina: First and foremost, digitize everything. We’re in 2022. There should be nothing that is still on paper. You should have a central repository, a server, Dropbox – some solution for all of your documents in one place.

Create a document tracker. It can be an Excel list of key documents in your organization including business licenses, lawsuits, complaints, vendor contracts, client contracts, etc.

The list should have the title, the date, the expiration date, key contract terms, etc. Do it now. Pay a temp $20 an hour to get that all into a diligence tracker for you. This will avoid paying lawyers $300 to $500 an hour later. 

Jeff: Being organized upfront is exactly the right strategy. The more that you can front-load, the smoother the process will go, and your legal costs will ultimately be lower if you’re more organized.

Gina (23:41): Data hygiene is critical to any process, and the time to start is now.

Jeff:  Doing this heavy lifting upfront in the process is really key to driving efficiency. Speed is key in any transaction and making sure that we can streamline the process from the day that we pick up the phone and start talking to folks through the closing date is really key. The data room is the place where it happens.

Gina: A great resolution for a company is to get your documents organized. It is easier to stay on top of your contracts and your licenses if you’re organized. If you have a tracker, you know where everything is. You won’t wake up in the middle of the night wondering where things are. 

You will also realize what you don’t have, what is not documented, what has expired. Keeping everything in one place instead of in the control of various employees of the business will put you in a position to run your business better and go through a sale process better. 

From 10:45 (earlier in the podcast). 

Gina: The other thing to remember is that speed is key to any process. Once you get into that exclusivity phase, we want to get through that to signing and funding as quickly as possible. 

Jeff: Getting these documents in advance is key. It takes time to find, organize, and scrub all the documents for confidentiality. It’s critical to moving the process along because time kills all deals.

Colonnade works with our clients to:

• Get them ready for a sale – including some of the tips we talked about today
• Prepare a thorough, company-specific due diligence list, with an eye towards what buyers and investors will expect in both preliminary and confirmatory due diligence
• Manage the assembly and dissemination of information throughout the process, being mindful of confidential information and when and to whom we present that sensitive data
• Manage buyers and investors throughout the diligence phase on our clients’ behalf so they can stay focused on running their businesses

When a company is considering an M&A transaction, there’s a range of alternatives. On one side of the spectrum, there’s selling 100% of the company and exiting. On the other side of the spectrum is no transaction at all (“stay the course”). 

In the middle are the options to sell various amounts of a company’s equity.

When considering raising capital, more often, we see our clients sell a majority stake, in which an investor buys more than 50% of the equity in the company. In some cases, we see a minority stake investment, which is less than 50% of the economics.

Today’s episode dives in deep on minority investments, and Colonnade Advisor’s Managing Directors Gina Cocking and Jeff Guylay explore:

• Reasons companies take on minority investments
• Different types of minority investors and what they are seeking 
• How minority investments are valued
• What rights come with minority investments 
• The biggest challenges associated with a minority stakes investment 
• Advice for companies exploring minority stake investments 

Gina: The most common reason we see is to buy out a minority partner. Another reason is to increase the equity capital in the business so it can raise debt and finance growth. Often, there’s a thin layer of equity in founder-owned companies because they’ve been distributing their own capital. They now want to make an acquisition, for instance. To make that acquisition, they will need more capital in the business. They need equity to then raise debt.

We hear business owners say, “I want to diversify my investments. Or, I would like to fund my kids’ education, weddings, etc.” Minority investments can be raised to give owners of businesses some liquidity.

Jeff: In our last podcast (E023), we talked about the value that financial sponsors bring to a founder-owned or an entrepreneurial-run company in terms of strategic benefits to the growth of the business. Sometimes we hear our clients say: “I don’t need a lot of growth capital” or “I don’t need a lot of liquidity” or “I don’t need to buy anybody out. But this might be the right time, given what’s going on in my industry, at this particular point in time, to bring on somebody who can help me out. I might need help in the capital markets. I might need help with a growth plan. I might need help with acquisitions.”

These strategic issues are important and sometimes supersede the economics of the transaction.

Gina: I tend to put the investors into three buckets: venture capital firms, strategic investors, and private equity firms and family offices. 

Venture capital funds frequently make minority investments in companies. VCs are more focused on companies that are pre-profit and in the early stages with a lot of growth ahead. When you take an investment from a venture capital firm, you’re not getting liquidity. Dollars are not going into your pocket. 

Jeff: Venture capitalists are focused on putting capital into the business to help you grow. 

A strategic investor is interested in investing in a company to lock in a long-term relationship. If one of your vendors has an investment in you, you’re probably not going to move away from that vendor. So that’s where you can get strategic money. Strategic investors will also invest in companies to watch new technologies as they grow. They are then at the forefront and in a position to make an acquisition later of that company.

Jeff: Strategic partners bring not just capital but relationships. They’re investing in you because there’s a good business case, and they’re going to help you grow. 

Gina: The third bucket is private equity firms and family offices. Some PE firms will make minority investments. We often see private equity firms making minority investments because they really like the company and they want to get their foot in the door. The company’s not ready to sell yet, and the investor wants to be the first capital there. They partner with the company, sit at the board level, and help with strategic decisions. When the company’s ready to sell, they’re a trusted partner and the first one in line.

Gina: There is typically a minority discount. A minority position is less liquid. A minority shareholder will have different rights than a majority shareholder. We see valuations of minority investments typically at a 10% to 15% discount to a complete sale.

For example: A $100 million company, no debt, so $100 million equity value. If a minority investor wants to come in and buy 40% of the company, they may do so for $30 million. So they’re buying at a discount.

Jeff: Conversely, when an investor or buyer is looking to buy a significant majority stake, or 100% of the company, they’re going to pay a premium to the valuation. They’re going to pay a 10%, 20%, or 30% premium for control of the business. 

Gina: When we work with private companies, they often assume a minority investor invests in common stock. When we talk to the investors, it’s more often as preferred stock or even debt with warrants. If the capital stack can accommodate the debt, they’ll do debt with warrants. That way, they’re de-risking their investment, because they’re higher in the liquidity preference. Debt will be paid back before equity if a company goes into bankruptcy.

We sometimes see it as a bait and switch. We’ll see companies that are talking to minority investors. They think they’re talking about common stock. And then, all of a sudden, they get a term sheet that is debt with warrants. 

The term that we use in finance is pari passu (equal footing). Are the securities that the investors are coming in with pari passu with the owner’s securities? Are they the same security? When raising capital, the ideal situation for taking on a minority investment is that the equity coming in is pari passu with what the founder/owners of the business have.

Jeff: Pari passu is an important concept. We always try to get our clients to have new money come in pari passu with the existing shareholder’s ownership and investment. With a majority sale or majority investment, that’s more common. With a minority investment, the investor is looking to get additional rights, controls, and protections in any way they can.

Gina:  What’s key in minority investing is not just the money. 

What’s key is all the other terms. What do the minority shareholders want for the money that they’re investing? They want to vote. They’re going to want a board seat. Minority shareholders always get the right to inspect company records. The company will need to prepare financial statements and present them to minority shareholders. Along those lines, minority shareholders may sometimes require that audits be done.

Jeff: Minority investors will also want anti-dilution protection. The valuations of earlier stage companies are less concrete. As investors look to the next round of financing, an important question they ask is, “What’s going to happen to me as the investor when the next round of money comes in?” 

Another area that we will see in minority term sheets is in regard to dividends. The minority shareholders will expect to have pro-rata dividends. Everybody who owns a security gets a dividend when dividends are paid. 

What is sometimes unexpected are dividends that are basically tax distributions. The business might be making $10 million a year pre-tax. All of the members of that LLC or an S Corp. have to pay taxes on those earnings. If those earnings are not distributed to the individuals, or the equity holders, it’s called phantom income. For tax purposes, they’ve received income, but they actually never received the cash. Oftentimes, term sheets will have specific criteria around tax distributions.

Gina: Term sheets may also give minority investors approval rights, a supermajority approval right. We see term sheets where the minority investor must approve any merger, acquisition, consolidation, or reorganization of the company.

The investor could also have approval rights in order for the business owner to get a new line of credit or make any material changes in management. For a business owner, that can be pretty difficult to swallow.

Jeff: These potential controls can affect profit sharing plans and equity incentive grants. 

Gina: Entering into new lines of business can be restricted for the business owners. The company cannot make a capital expenditure over a certain amount without approval.

The company has to prepare a year-end budget. The budget gets approved by the minority investor and then continually measured. 

Jeff: Controlling the exit is the most important element that a financial sponsor seeks. They want to know when the company’s going to be sold, who it’s going to be sold to, what the valuation is, and what the terms will look like.

For an entrepreneur who has been running this business successfully for years, having somebody have a hammer over them, with respect to the exit, can be a real problem. 

Jeff: The biggest challenge that we see in minority investments is this balance of ownership versus control. 

A minority investor comes in, puts some money in the company, perhaps puts some money in the existing investors’ pockets, and ends up owning less than 50% of the company. The challenge for this minority institutional investor is they’ve got limited partners that they report to. They need to be very comfortable that they have sufficient control elements in the deal structurally. They want to have significant influence on all these topics we talked about, particularly the exit. 

Voting, dividends, changes of the business line, etc; these are all important to the minority investor.  They want to make sure that they’re in the driver’s seat, even though they have a minority position. 

Gina: From the business owner’s perspective, the question is: how much is the capital really worth to you? Is it worth it to give up control of your company, knowing that that investor can force a sale within five years for say, 20% of the economics? Whether or not it’s really in your best interest, they could force a sale. They could prohibit you from doing acquisitions. They could prohibit you from selling the company. Is it worth it for that minority investment?

Partner with a financial advisor who is experienced with these types of transactions and can best protect your interests. Colonnade has developed deep relationships with private equity firms and family offices that make minority investments and can help guide you.

Gina: When it comes to working with investors that are founder friendly when doing a minority investment, three firms that come to mind: McCarthy Capital, Copley Equity, and New Heritage Capital. 

All three of these firms respect the rights of the business owner. They’re making the investment not to disguise a majority acquisition, but to do a true minority investment and putting in place structures that work well for the business owner to continue to grow and get the company to the next level.

Jeff: The advice we would give is to focus on those investors that have a successful track record of being good minority partners and work diligently in striking a fair deal. The fairness here is really the balance between economic and voting control.

This episode continues our series of "industry spotlights," in which we focus on specific trends and opportunities in middle market M&A transactions.

This episode continues our series of "industry spotlights," in which we focus on specific trends and opportunities in middle market M&A transactions.

This episode focuses on the automotive reconditioning industry, a $5.4 billion industry that is highly fragmented and ripe for consolidation.

Colonnade has extensive transaction experience in the automotive services industry and has been the sell side or buy side M&A advisor on many of the automotive services industry transactions that have taken place over the last decade. Colonnade has insider-level mastery of the drivers of valuation, competitive positioning, business trends, relevant metrics, and the right buyer universe, enabling us to provide superior deal execution to our clients.

Colonnade recently published a white paper on the automotive reconditioning industry. The white paper is available here.

In this episode, we answer the following questions:

• What is automotive reconditioning?
• Why do automotive dealerships outsource reconditioning?
• What is the industry size, and who are the largest participants in the industry?
• What are the value drivers for automotive reconditioning companies?
• What are the M&A trends in the automotive reconditioning industry?

What is automotive reconditioning? (02:10)

Gina: Automotive reconditioning is the process of making a newly acquired vehicle retail-ready. Dealerships get cars in a couple of ways. On the new side, they get it directly from the OEMs, and on the used side, they may be buying it from auctions or taking vehicles as a trade-in. Used vehicles need to be reconditioned to be car lot ready.

Do dealerships have an in-house reconditioning department? (04:17)

Gina: The majority of dealerships outsource reconditioning.

What is the size of the automotive reconditioning industry, and who are the industry participants? (05:01)

Gina: We estimate that the automotive reconditioning industry is a $5.4 billion market. It is comprised of mainly single technician entrepreneurs, a technician who is skilled in a specific trade. When a dealership outsources reconditioning, they are probably outsourcing it to three to five reconditioning technicians that are independent contractors.

What types of dealerships typically outsource automotive reconditioning versus having it in-house? (06:25)

Gina: The largest dealerships are the most likely to outsource because they realize how inefficient it is to have highly paid employees reconditioning cars.  They could use that time doing much more valuable service lane work. Independent dealerships and smaller dealerships tend to have automotive reconditioning done in-house.

How many companies are in the automotive reconditioning industry? (07:50)

Gina:  We don't really see many companies of scale. Based on the number of dealerships out there, we estimated as many as 40,000 independent technicians nationwide doing this type of work.

Why do dealerships outsource automotive reconditioning? (09:57)

Gina: Skilled technicians are expensive and in high demand at dealerships. Outsourcing automotive reconditioning helps to keep up the profitability of the dealership.

Why do dealerships need to make vehicles retail ready as quickly as possible? (10:30)

Gina: New and used vehicle supplies are low, and demand is high. Low supply and high demand are driving prices of cars to an all-time high, so dealerships need to get vehicles retail ready as quickly as possible.

How do dealerships manage relationships with multiple outsourced automotive reconditioning vendors? (13:02)

Gina: It is a lot of process management, and there is some software to manage the process, but still, managing five different vendors is inefficient, especially if the dealers do not control their daily activity because they are independent.

Who are the largest participants in the automotive reconditioning industry? (14:05)

Gina: The largest in the industry is Dent Wizard. Some companies, such as Streamline Recon, are located in large metropolitan markets, and they may have some scale. But, aside from these companies, there are not many companies of scale. This industry is very fragmented.

What systems or processes do automotive reconditioning companies need to scale up? (16:16)

Gina: There are a couple of reconditioning workflow management software available, which seem to be critical to any dealership technician relationships that they want to run efficiently. There is room for the adoption of robust workflow management software in the reconditioning process.

Does automotive reconditioning include fixing a vehicle's mechanical issues? (18:00)

Gina: The mechanical part, making sure the car runs without banging noises and that it starts and stops, is all done before it gets to the reconditioning center. Automotive reconditioning is all about appearance.

How does the collision center industry compare with the automotive reconditioning sector? (19:10)

Gina: The collision industry is a very different market. The work is largely being paid for by insurance companies in the collision industry and has nothing to do with dealerships. So, you do not see collision centers doing reconditioning work very often. They are very separate businesses.

What are the value drivers for automotive reconditioning companies? (20:38)

Gina: Value drivers include size, number of employees, scale, and diversification of revenue. Also, process management is an important component.

What are the M&A trends in the automotive reconditioning industry? (22:34)

Gina: We will see quite a bit of M&A activity in this space over the next decade. It is a profitable industry that is important to dealerships. Dealerships outsource automotive reconditioning to several vendors, which is inefficient in terms of process management. Automotive reconditioning companies that can do it all for dealerships will be the winners.

Host Information

Gina Cocking

Gina Cocking serves as the Chief Executive Officer of Colonnade Advisors. She returned to Colonnade as a Managing Director in 2014. Gina began her career in investment banking at Kidder Peabody, was an analyst at Madison Dearborn Partners, and an associate at J.P. Morgan & Co. She was a Vice President at Colonnade Advisors from 1999 to 2003. She left Colonnade to gain operating experience as the Chief Financial Officer of Cobalt Finance, a specialty finance company. She went on to become the Chief Financial Officer of Healthcare Laundry Systems, a private equity-backed company for which she oversaw the successful sale to a strategic acquirer. Gina served as the Line of Business CFO – Consumer Banking and Lending at Discover Financial Services. Gina serves on the Board of Directors of CIB Marine Bancshares, Inc., a bank holding company based in Brookfield, Wisconsin, that operates banking offices in Illinois, Indiana, and Wisconsin. Gina received her BA in Economics and an MBA from the University of Chicago. Additionally, Gina holds the Series 24, 28, 79, and 99 securities licenses.

Jeff Guylay

Jeff Guylay is a Managing Director of Colonnade Advisors. Prior to joining Colonnade in 2000, Jeff was an investment banker at J.P. Morgan in the firm's Mergers & Acquisitions and Fixed Income Capital Markets groups in New York. He also spent several years in J.P. Morgan's Chicago office. Jeff has over 20 years of M&A and investment banking experience and has served as lead execution partner on over 25 M&A and financing transactions at Colonnade. Jeff received an MBA from Northwestern University's Kellogg Graduate School of Management and a Master of Engineering Management from the University's McCormick School of Engineering. Jeff received a BA from Dartmouth College and a BE from Dartmouth's Thayer School of Engineering. Jeff holds the Series 7, 24, 63, and 79 securities licenses. Jeff serves as a director of the non-profit Nurture, an organization dedicated to enhancing the nutrition and wellness of children and families.

About the Middle Market Mergers & Acquisitions Podcast

Get the insiders' take on mergers and acquisitions. M&A investment bankers Gina Cocking and Jeff Guylay of Colonnade Advisors discuss the technical aspects of and tactics used in middle market deals. This podcast offers actionable advice and strategies for selling your company and is aimed at owners of middle market companies in the financial services and business services sectors. Middle market companies are generally valued between $20 million and $500 million.

In previous episodes, Colonnade Advisors has outlined our unique 16-week sales process timeline in four phases: pre-marketing, go to market, management presentations/buyer due diligence, and exclusivity/documentation. In this episode, we will be doing a deep dive on indications of interest ("IOI"), which take place at the end of the go to market phase, and letters of intent ("LOI"), which take place at the end of the management presentations/buyer due diligence phase.

This episode continues our series of "industry spotlights," in which we focus on specific trends and opportunities in middle market M&A transactions.

This episode kicks off several episodes around the finance and insurance ("F&I") products industry, estimated at $80+ billion in size at the retail level. Specifically, this episode is all about vehicle service contract ("VSC") administrators.

Colonnade has extensive transaction experience in the automotive F&I products industry and has been on the sell side or buy side M&A advisor on many of the significant F&I products transactions that have taken place over the last decade. These transactions are complex and require an investment banking team with deep industry knowledge. Colonnade has insider-level mastery of the drivers of valuation, competitive positioning, business trends, relevant metrics, and the right buyer universe, enabling us to provide superior deal execution to our clients.

In this episode, we answer the following questions:

• What is a VSC?
• What types of car problems are covered under a VSC, and how does it differ from car insurance coverage?
• What is the F&I products ecosystem?
• What are the economics of a VSC?
• What is the value of VSCs to consumers?
• Who are the major players in the VSC administrator industry?
• What are the consolidation trends in the VSC administrator industry? 
• How are VSC administrator companies valued?

What is a VSC? (02:30)

Gina Cocking:  A VSC is like a warranty but cannot be legally called a warranty. OEMs can only offer warranties. Essentially, a VSC is covering any mechanical failures on a vehicle, which can range from problems with the engine, electronics, windows, and others.

What types of car problems are covered by VSCs? (02:38)

Gina Cocking: Different VSCs cover different car problems. Some have full coverage, and others are more limited. Car buyers may also buy a tire and wheel contract, a key fob contract, or an appearance protection contract. There is a whole slew of products that can cover mechanical failures, which are noninsurance-related problems.

What is covered by car insurance versus a VSC? (03:00)

Gina Cocking: Collusion damages, such as if a driver gets hit by another car or runs into a stop sign, are covered by insurance. VSC covers all mechanical failures.

How often are VSCs purchased with cars? (3:40)

Gina Cocking: About 51% of cars sold in the United States through franchise dealerships are sold with a VSC attached to that car.

What is the F&I products ecosystem? (03:46)

Gina Cocking: Dealerships are the primary distribution channel as they are selling the F&I product to consumers. Third party marketers also sell VSCs.

The VSC administrators adjudicate the claims. For example, when a consumer has a mechanical failure, they will contact the VSC administrator, who will work with the repair facility to ensure that the repair facility is paid for any claims. If it is an administrator obligor, they are responsible for the payments for the claims.

F&I agents are the intermediary between the administrator and the dealership.

What are the economics of a VSC? (05:16)

Gina Cocking: VSCs are profitable products for dealerships and other sellers. For example, if a dealership sold a VSC to a consumer for $3,000 (VSC usually costs $2,800 to $3,500), the administrator probably sold it to the dealer for $1,000, and $500 was paid to an F&I agent. Therefore, the dealership is going to make a $1,000 profit on the sale of the VSC. Part of the $1,000 paid to the administrator covers administration costs, and part of it goes into the trust to pay for future claims. VSCs are typically a five-year contract. The funds held at the trust will earn out over five years and will be used to pay future claims. Any excess funds in the trust are remitted back as profits to the dealership or whoever owns the trust.

What is the typical F&I product penetration rate on vehicles sold? (08:04)

Gina Cocking: Public dealerships have shown F&I product penetration rate greater than 100% on average per vehicle sold last year, which means they are selling more than one product. Penetration rate continues to increase primarily driven by returning customers who have had good experiences with these products and dealerships' increased marketing efforts around these products.

What is the value of VSCs to consumers? (10:53)

Gina Cocking: There is a correlation between the increase in sales of VSCs and other vehicle warranty products and the rise in consumer electronics. If consumers have a service contract on their phone, they should also have a service contract on their car, a valuable asset.

The peace of mind component of service contracts, particularly VSCs, is why consumers are adopting these products. It is an excellent financial management product, but it is not necessarily a product for everyone. For example, some people do not need a VSC because they essentially can self-insure (i.e., have the funds to pay for repairs). However, 40% to 50% of Americans do not have $400 of assessable cash at any given time to pay for an unexpected repair, so these products are a necessary financial planning product to protect one of the most valuable assets, a car.

In the past, VSCs have had a bad reputation due to claims being denied. What are some of the top reasons claims are denied? (13:42)

Gina Cocking: Generally, what I see are when claims are denied is that they are usually made during the blackout window. Most VSCs will have a 30-day window post-purchase where you can not make a claim for anything that happens in the first 30 days. The reason for that is adverse selection. The other reason is that it might not be covered by the VSC, which is usually pretty clear in these contracts.

Who are the major players in the VSC administrator industry? (16:52)

Gina Cocking: The two largest VSC administrators that are non-OEM are JM&A and Safeguard. Other administrators include RoadVantage, IAS, and APCO. In addition, there are insurance companies that own administrators. For example, Fortegra owns Smart AutoCare as its warranty administrator, Assurant owns the Warranty Group, and AmTrust owns AAGI.

What have been the consolidation trends in the VSC administrator industry? Why are companies integrating, and what are the benefits? (18:35)

Gina Cocking: Vertical integration brings synergies and distribution. Administrators are locking up distribution channels by buying F&I agencies and buying other administrators. When administrators acquire another administrator, it could increase the geographic footprint and bring in a new market.

Insurance companies are buying administrators because there is some vertical integration by taking out part of the cost structure. Part of the cost structure is called Contractual Liability Insurance Policy ("CLIP"). An insurance carrier provides the CLIP, which is essentially a backstop to the funds put in the trust to pay for future claims. If there are not enough funds in the trust to pay for claims, the CLIP will ensure that the insurance carrier will provide the funds to pay for the claim. There is an expense associated with purchasing a CLIP, so an administrator that vertically integrates with an insurance company will take out some of the expense in the cost structure and recognize some synergies.

The number one driver of M&A activity in the industry is private equity firms, which have been investing in the F&I products sector for over ten years because of the dynamics of the industry. Favorable industry dynamics include large industry size, industry growth, high margins, and high cash flow. Private equity firms often acquire an administrator then make add-on acquisitions to increase distribution and recognize synergies in the expense chain by taking out a layer of the cost structure.

How are VSC administrator companies valued? (24:51)

Gina Cocking: Administrators are valued, typically not on GAAP, but modified cash accounting basis. GAAP accounting matches expenses and revenues with the life cycle of the product. Under modified cash accounting, revenues are recognized at the time of sale because these products are rolled into an auto loan, and the administrator gets payment upfront. The expense associated with reserve for future claims and the CLIP, all the contract-related expenses, are recognized at the time of sale. For a growing business under modified cash, earnings will be higher than under GAAP accounting.

There is real value to the insurance funds in the trust to pay for future claims for an administrator obligor. The products are structured to a certain loss ratio, which is claims divided by the premiums remitted to the trust. Income from the trust should be included in the value of the company.

Other drivers of value in this industry include geographic reach, concentration with dealership groups, and size. Client concentration is important because most private equity firms will not invest in a company if greater than 15% or 20% of its revenues come from a single source.  Size matters because bigger companies are worth more than smaller companies.

Host Information

Gina Cocking

Gina Cocking serves as the Chief Executive Officer of Colonnade Advisors. She returned to Colonnade as a Managing Director in 2014. Gina began her career in investment banking at Kidder Peabody, was an analyst at Madison Dearborn Partners, and an associate at J.P. Morgan & Co. She was a Vice President at Colonnade Advisors from 1999 to 2003. She left Colonnade to gain operating experience as the Chief Financial Officer of Cobalt Finance, a specialty finance company. She went on to become the Chief Financial Officer of Healthcare Laundry Systems, a private equity-backed company for which she oversaw the successful sale to a strategic acquirer. Gina served as the Line of Business CFO – Consumer Banking and Lending at Discover Financial Services. Gina serves on the Board of Directors of CIB Marine Bancshares, Inc., a bank holding company based in Brookfield, Wisconsin, that operates banking offices in Illinois, Indiana, and Wisconsin. Gina received her BA in Economics and an MBA from the University of Chicago. Additionally, Gina holds the Series 24, 28, 79, and 99 securities licenses.

Jeff Guylay

Jeff Guylay is a Managing Director of Colonnade Advisors. Prior to joining Colonnade in 2000, Jeff was an investment banker at J.P. Morgan in the firm's Mergers & Acquisitions and Fixed Income Capital Markets groups in New York. He also spent several years in J.P. Morgan's Chicago office. Jeff has over 20 years of M&A and investment banking experience and has served as lead execution partner on over 25 M&A and financing transactions at Colonnade. Jeff received an MBA from Northwestern University's Kellogg Graduate School of Management and a Master of Engineering Management from the University's McCormick School of Engineering. Jeff received a BA from Dartmouth College and a BE from Dartmouth's Thayer School of Engineering. Jeff holds the Series 7, 24, 63, and 79 securities licenses. Jeff serves as a director of the non-profit Nurture, an organization dedicated to enhancing the nutrition and wellness of children and families.

About the Middle Market Mergers & Acquisitions Podcast

Get the insiders' take on mergers and acquisitions. M&A investment bankers Gina Cocking and Jeff Guylay of Colonnade Advisors discuss the technical aspects of and tactics used in middle market deals. This podcast offers actionable advice and strategies for selling your company and is aimed at owners of middle market companies in the financial services and business services sectors. Middle market companies are generally valued between $20 million and $500 million.