Today I’m chatting with Peter Bell and Justin Turner from Traction Capital Partners in Tacoma, WA, just south of Seattle. Peter and Justin both reached out over Twitter and the more I learned about their firm, the more interesting to me it became. Traction is a small private equity firm that blurs the lines between a private equity fund and a permanent capital vehicle, which is what made them so interesting to me. They have a handful of long-term investors and seek to buy and hold great companies indefinitely, which gives them the unique ability to make long-term oriented decisions and wait for great opportunities.
We begin with Peter telling me about a content idea he has for Traction and move through the topics of starting a private equity fund, lessons learned, what they look for in both businesses and owners, and a few stories. Peter and Justin are both deep thinkers and have been fun to get to know, and I hope that shows in the episode.
Do you want to chat at all about your “Comedians in Cars” equivalent idea, the video series you’ve thought about?
Peter Bell: Sure, obviously there’s a lot of content production going on right now, some in the form of podcasts, medium articles, you name it. And an idea I had that actually was spurred from my girlfriend was to do a more focused vlog series. She had passed along these videos from this website called Hodinkee.com and they do interviews with celebrities, people in the business world, and they go through their watch collections. So, it’s a really cool, I like how it’s all shot: they can talk about like Patrick Ewing was on it and they can talk about his experience in the NBA and then they launch into chatting about his amazing watch collection.
We’ve thought about a podcast and are working on content but doing something similar to that with business owners where it’s, maybe a less formalized podcast, but more like trying out new IPA, or different whiskeys, or food, who knows. We haven’t formalized it yet but having something to base the conversation around where you have that introduction talking about a new drink or something and then launching into a conversation you’d have over dinner or a happy hour. Maybe do a vlog with it or it could end up being a podcast. So just in the early stages of the idea.
There’s a lot of other PE firms or permanent capital funds that are trying to figure out ways to deliver content or produce it in a way that attracts other business owners or people who might sell them or know someone who could sell the company to them. And I think Brent Beshore does that really well and I think other people are trying to emulate that in certain ways. Is that part of your thought process behind the blog/podcast idea?
Peter Bell: I think getting in front of business owners in the lower middle market space is really challenging. I grew up in a third-generation family business and my dad currently runs a business in the northwest, a commercial doors and frames distributor, and I remember asking him, ‘How would you like to get approached in these situations?’ He happens to be on Twitter and follows this stuff so he’s probably an outlier, but a lot of the owners in his industry talk about how they would love a better way to get this content.
And I think it was Tren Griffin who said something like he’d rather get his message through to a plumber in Akron than hedge fund manager looking to make a couple more basis points. And that message really stuck with me. And that’s where the thought process came for. What content can we produce that some of these business owners might find a little bit more appealing? And always ask them, ‘Hey, you want to go to this new whiskey bar and try out these certain drinks and then maybe we talk about your business?’ might be a better way to get in front of them.
It could be more of a smooth opening.
Peter Bell: Yeah, we’ll see, it’s still in the early stages, I don’t know if I’ll end up rolling it out or not but just an idea.
Speaking of interviews, whenever I listen to a podcast or read an interview of an entrepreneur, the most interesting part of that interview to me is the early days and how they started their business or organization and the trials they went through to get it going. And what I’m looking forward to with the conversation with you both today is that you’re currently in those early days. And the memories and the emotions are very vivid, and you live them every day.
Would you both be able to chat a little bit about your backgrounds, how you got here, and then the early days so far with Traction?
Justin Turner: Yeah, absolutely. I grew up here in the northwest. We’re sitting in Tacoma, Washington right now and I grew up about 45 minutes or so from here. I did my undergrad at a small Christian school called Northwest University, studied finance and accounting up there, and was fortunate that I got an internship with an M&A firm into my junior year, beginning of my senior year. I got a lot of exposure to mergers and acquisitions, to investment banking, to private equity, which all of that was a world that, while I had been studying finance, I didn’t know really even that it existed. I would read the Wall Street Journal and see somebody got bought out, but you didn’t understand what all went into something like that happening.
I did my internship and then worked for that firm for about six years out of undergrad primarily do an M&A advisory work for businesses that had less than $100 million in revenue that were based here in the western U.S. After doing that for a while, realized I wanted to jump over to the private equity side of things.
Largely I felt like in investment banking work, you’re a mercenary. Essentially, you come in, you work on a project for 6 to 24 months and then you’re on to the next thing and what happens with that business you just sold doesn’t have any effect on you. You get paid for doing the deal, but not for actually, in my mind, helping the business.
I started working in private equity, I took a job down in Austin, Texas working for a firm down there. Was down there for a handful of years, learned a lot, but knew I wanted to get back up here to the Northwest. Most my family’s up here, I love the Northwest lifestyle, and so started Traction end of 2017, beginning in 2018 with a couple of other guys really focused around finding great companies that are based here in the Northwest that are probably smaller than what a typical private equity group would be looking for. For us, we say 1 to 10 ($ million in EBITDA) and I would say the majority of the deals we look at or that 1 to 5 range. And coming back from Texas, I really just wanted to have my own firm and work with people I really liked and be able to do fun deals.
Peter Bell: I grew up in Southern Oregon and I came up to Tacoma to go to University of Puget Sound where your little brother’s currently playing football.
Peter Bell: I got to play football and golf there and then ended up getting an internship at a local boutique investment bank here in Tacoma. I worked as an analyst there for a year and then had an opportunity to join BlackRock in the Seattle office where I worked on their valuation team. I really enjoyed the big company experience, but I was always pretty drawn to coming back to this space. My dad as I said runs a third-generation business, my mom has been a business owner and an entrepreneur, my grandma has been a business owner, and so I always knew I was going to come back to the space, I just didn’t really know what it was going to look like. I had worked with Jake, Justin, Dale, and Brian previously and through my time at BlackRock this opportunity presented itself and then it just made more and more sense.
I think the big thing is we’re looking for great companies. We have a lot of fun as a group and we get along really well, and each brings something a little bit different to the table, and so we’re really excited about this first deal that we got done and are looking forward to the next ones.
Justin Turner: To piggyback on what Peter said, there’s four of us that started it, myself, a gentleman named Jake, a gentleman named Brian Haynes, and then a guy named Dale Payne. And of the five of us that are here now, Dale and Peter head the operations side of things for us so once we make an investment, Peter and Dale are really the ones that are in their day to day figuring out where do we need to improve processes, where do we need to add staff, and then what are the things that we can do to start growing the business?
And for us the biggest thing to understand is the business would’ve been successful whether or not we made the investment. So, we’re trying not to screw it up is basically the goal from day one. And then once we start to get our arms around and move more to try and figure out where we can help and actually start driving some of the growth side of things.
With your small investor group, the goal was primarily to find these small companies. Do you also view traction as a way to offer a service to owners who are looking to retire? Do you feel like you’re offering those services and that’s a big part of Traction?
Justin Turner: I think depending on the entrepreneur. With the business we acquired in October, we bought about 75% of the company so the two prior shareholders, which is a brother and sister, they still own a chunk of the business alongside of us. The sister, her goal with the transaction was to fairly quickly transition out to focus on being a mom. She’s got a couple of younger kids, which we totally were in support of. The brother Steve, he’s continuing on to drive the sales side of the business for us going forwards and he’s aligned with us to help grow it over the next couple of years.
I think a lot of times when you hear private equity, you think ‘OK someone’s going to acquire my company, they’re going to cut as many costs as they can, they’re going to try and grow it a little bit, and then hopefully sell it at a higher multiple with a bigger EBITDA number.’ And they’re trying to do that in a compressed time frame so they’re trying to do that in three to five years.
For us, our goal is to hold these businesses indefinitely. We want them to slowly grow over time, but we don’t have a mandate where we have to sell them at some point to return capital.
Is that a factor of your investors having equally long time horizon?
Justin Turner: I would say yes. We would be what’s called a fundless sponsor, or an independent sponsor, where we don’t have a fund that we’ve raised that we can call on to go do a deal for us. We’re going out on every deal that we look at and raising equity both from ourselves here internally and then also from typically high net worth individuals and family offices.
Most of our investors are people that made their money from running and owning businesses that look a lot like the ones we’re trying to acquire as a buyer. They’re very comfortable with the risks associated with those businesses and they’re very comfortable with the types of returns that those businesses can generate. They understand the dynamics of managing a smaller group of people and trying to get them to coalesce into a team that’s focused on accomplishing something. They see the value in being long-term owners and in all of our materials that we’ve shared with them it’s their understanding is they’re going to be along for a really long time.
Now they’ve got the ability to have us buy them out after a certain period time, but the goal is for everybody to be involved with these things long term.
So, it’s the group of investors, along with your own capital, that’s buying these businesses. Is there ever a plan to have primarily your own permanent capital buying businesses. That way it gives an option for investors to leave if they need to, or if they want to do something else?
Justin Turner: Great question. If we look five years down the road, our vision is for all of the equity dollars to come either from the businesses that we’ve acquired and the cash flow that they’re generating, or just from ourselves so that we have flexibility. One of the things you’ll hear with independent sponsors is this term called ‘certainty to close.’ When we’re looking at a business, if we’re making an offer and a fund that has a committed pool of capital is making an offer, the business owner and the advisor that are on the other side are going to come to us and say, ‘We know this other group has the money to get the deal and you’re going to have to go raise the money once we sign the LOI. What is the certainty that we have that you’re going to be able to close on the transaction?
So, if we look five years down the road for Traction, having our own pool of capital that’s all of us internally, where we don’t have a team that’s giving the yay or nay on doing an investment, that gives us significantly higher certainty to close. On this deal we completed in October, about two-thirds of the equity came from our office and from one of the families that’s involved with us here, Brian Haynes’s family.
So, two-thirds of it came from us on this first one, I think that will gradually increase over time to where we’ll be able to do it 100% internally. We’ll probably still invite some of our original investors to be a part of the deals going forward, but the goal is to get to where it’s all our own capital.
Peter Bell: And if I can add to that too, for broker deals it’s one of the first questions that gets asked: ‘Hey, you guys have a fund that you’re pulling from.’ While that might look in a negative light from the start for getting these deals done, I think it’s an advantage at this point because we don’t have the pressure of a fund to get a deal done. We can be more opportunistic, more selective, and eventually we will hopefully have a fund that we’re really running, but it’s our own capital that we’ve harvested from these businesses, or just through the connections that we have.
So right now, it’s I think it also as we’re looking at new deals, that tells us what the owners are looking for. So, are the owners looking for a big payday and want to get out? We might not be the right partner. We want to pay a fair price. We really want to partner with the owners that have been in there and want to stick around. It’s a question that investment banks use it to weed out private equity groups and we can gauge what the owners are looking for based on the same question.
Justin Turner: I think to piggyback on Peter’s point, the valuations for a lot of these businesses right now are what we think are too high.
If we had a fund where we had a timer for having to deploy capital, we’d be forced, I think, to pay a higher valuation for some of these deals just because we needed to get money out the door into a company.
Even this week we had a deal we were looking at where we were probably half a turn low from a valuation standpoint in our LOI, just to get invited to the management meetings. From LOI submission they’re going to take three to five people to actually do meetings with the ownership team and then from that same point they’ll ask a couple of people to make additional offers. We were low even to get to the management meeting standpoint and we were already at a multiple where we were like, ‘I don’t know if we want to do this.’
I would say three to five times (EBITDA) is probably where the majority of the businesses with $1 to 5 million in EBITDA should trade at. The business we acquired in October had $2.3 million in EBITDA and we bought it for a little under four times. We felt pretty good about that valuation.
The one that I just referenced that we missed out on, we were at six times and we were still low to get invited to the next round. GF data is not necessarily proprietary, but it’s a database company that sends out information on done deals by private equity groups and it breaks them down by size category. I think end of 2018 for deals that were between $10 and 25 million in purchase price, the average multiple was under six times. But if you looked into 2017, a year prior, it was six and a half/seven times, so the multiples have come down but they’re still on average higher than what we would like to see. We end up passing on a lot of transactions just because we think you make a lot of your money based on how you structure the deal on the front end and the valuation you pay on the front end.
As you started Traction and it’s a little over a year and a half, now close to two years, what have your experiences been in lessons learned? Maybe you came in thinking one process would be really easy and it turned out to be much harder than you thought or vice versa? Do have some stories from that time?
Justin Turner: That’s a good question. I think I’ll let Peter talk about lessons learned from once you actually own the company. My job is largely on the front end so I’m sourcing businesses and doing our analysis and I’m putting together a lot of our materials for the banks and the investors and then I’m managing that process all the way up through close. Once we close Peter and Dale come in, and they’re involved on the front end of the process as well, but they come in and they’re the ones that are really there day to day where once we close on the business, my role becomes more of, ‘Hey, can I help with this project or can I do this specific thing,’ rather than being there every day to do something.
And I think on the deal side of things, which is where I spend most of my time, it really is an ebb and flow of you may have three or four businesses you’re looking at one time, you may have none and you’re just sending out e-mails to investment banks trying to get some deal flow. There’s times where you’re super busy, and then there’s times where you leave the office early to go hike or snowboard or whatever it may be.
Peter Bell: Yeah learned quite a bit so far.
Justin Turner: We threw Peter to the wolves! We mentioned this earlier, we knew Peter when he was first undergrad doing investment banking for a firm here in the Northwest. And at Traction, as we were starting, we really needed a younger analyst to work with us and we kept reaching out to Peter and he kept saying that maybe once we actually got our deal closed. He came on and really has been in on the operations side of the business, really from day one.
Peter Bell: I came from BlackRock and coming from a company that size, understanding the systems and the efficiencies, you go in to a smaller business and feel like you need to get hands dirty and want to change things and build new Excel files for the sales team and build these systems that they can use to be more efficient. I realized, just as Justin said earlier, these companies would operate just the same and be just as successful if we don’t aren’t there. At this time, we’re there for these owners who are sticking around in this case. The sister was running the back office and had a really good grasp on that, the brother was the head of sales and really driving the revenue and the sales of the company on the offset.
What I’ve realized is just how important the people are in a small business. So, in a bigger business like BlackRock, yes the people are extremely important, but it’s also the systems and the efficiencies that are built. In a smaller company, often those efficiencies aren’t there yet and so it’s driven by the people. We were really lucky with this first company to have great people, so that’s been fantastic.
I think number two is that great business can still be done on paper. There are literal paper trails in the office and they’ve done this for 30 years. They know how to get stuff done and so we’re looking into new systems and software to basically just help everyone out. That’s one of the first questions I asked getting in there: ‘How can we help you guys out? What can we do from day 1 or day 90 where your life is going to be easier and everything’s going to be working more efficiently?’
Justin Turner: I think a lot of times when people hear ‘private equity,’ they immediately think of a headline they saw in the WSJ or something where a PE firm buys a company, fires all these people, cuts all these costs, and we’re coming in saying, ‘we want this business to continue to be in the community that it’s been in long-term. We want to continue to employ the same people as employed.’ And to Peter’s point, it’s not even that we cut costs, it’s where can we add people, or where can we add new infrastructure to help make you guys job easier so that we grow and we have to add more people?
Peter Bell: I think those have probably been the two buckets. Owning a business is a lot of hard work. You think you have an idea and then you get to hear from the past owner. Dale Payne has taken over as the CEO of this business and I realized it’s all the department, H.R., finance, accounting, everything bundles up unto a CEO and so it’s a ton of hard work. I have huge respect for those that can make it work but it also is a really fun, challenging, and it’s been rewarding to see the successes and to see people grow, even in such a short period of time. Lots of learning so far.
Justin Turner: I think one of the things that’s been cool for Brian and Jake and I that are in the Traction office most days and not out at SeaWestern is seeing, even just in the couple of months, the growth of Peter. We’ve got big plans for him as part of Traction, but it’s been fun seeing him really dig in on the operations side of the business and work shoulder to shoulder with Dale to try. And to his point, when he came out of Blackrock, which is I don’t know how many billions or trillions of dollars they have but they have this huge business, to a company that’s got less than 15 people where they’re now asking Peter, ‘What do I do here? Or, can you help me with this?’ And so it’s been really cool to see him dig in and really start to weigh in on the operations side of the business and learn what the things that we can do in the future with companies to start pulling the levers to create efficiency and grow the companies over time. That’s been a cool thing to see for sure.
That is what interests me in private equity as well as is it seems like an industry or business that’s perfectly designed for really curious people who are just learning machines. Is that a lot of what you look for in hiring other people to join your team and also in the businesses you acquire?
Justin Turner: I don’t know that we necessarily look for that, but I think one of the things that’s fun about our work is we’re always seeing different types of companies, different types of industries, different types of business models, and so you do get that opportunity to constantly be learning, constantly be asking questions, constantly be thinking, ‘I’ve seen this in this other industry, what is this company and do they do it that way or another?’ So, from that standpoint, it is a lot of fun and I think to be successful you have to be curious. You have to want to learn and you have to be able to do it pretty quickly because we’ll get a package on a company and we’ve maybe got a week or two to get barely familiar with the industry of the business enough to say, ‘do we want to spend $15 million on this business?’ You have to be curious and you have to learn really quickly, and you have to be comfortable with changing pace.
We were really going after that business that we mentioned earlier down in Oregon. We found out Tuesday we lost out on it, so it’s pencils down, that project is over, it’s on to the next one. And you’ve got to be comfortable with that.
Is that hard sometimes putting a lot of work into a potential company and one email ends the process?
Justin Turner: Early in my career it was, it was very frustrating especially, and not necessarily the stage we were at with this one, but you would get an LOI signed and you’d get down the road with a buyer. And at that point you and the seller and the buyer are all pretty emotionally attached to that transaction happening and until money actually changes hands, there’s no guarantee that the deals are going to happen. In 2009 we were trying to close three transactions on, and this was maybe poor planning on our part, December 31st.
And one of those businesses closed one of the deals blew up on the 30th, the day before we’re supposed to close, and one of the other deals blew up and then closed again in March of 2010. It’s tough but back to Peter’s point, for me I feel like I’ve gotten used to it. It still sucks when they when they go away but it’s not it’s not the end of the world. And that’s just part of doing deals. You’re going to fall in love with companies and they’re going to fall out of love with you, and that’s just part of how it works.
Peter Bell: It’s part of the business and it’s hard not to when you get really excited about a deal or a space that you really like, and you start checking boxes as you’re going down like, ‘This is what we’re looking for, we like this’ and to not cross the finish line with it. But it’s a part of the business.
Justin Turner: I think the part that’s frustrating still now, maybe not emotionally as hard but as frustrating, is when we get down the road with the business and we start spending money with attorneys and accountants and then to have the deal fall apart. It’s always frustrating writing that check for a deal that didn’t happen. But that, again, is part of part of doing deals.
Switching gears to the industry overall, Traction isn’t necessarily a formal private equity fund with a full-on group of investors, but what do you think the floor is for private equity funds in terms of, how low can a private equity fund invest in terms of an EBITDA range? And is that an advantage for searchers or people on the smaller end that’s going to hold for a long time? Or do you think that floor for private equity is going to get smaller and you’re going to start to start to see private equity firms directly competing for some of these smaller deals?
Justin Turner: I think we’ve started to see firms move down market. I would say when I was doing investment banking, deals with less than $5 million EBITDA it was like, ‘oh geez, there’s not a big group of buyers for these types of companies.’ I mean that was only 10 to 12 years ago.
I would say if we think about traditional private equity, the size of the deal really depends on how big their fund is. Funds will have limits on how small of a check they can write and so that limits how low they can go to pay and how big their fund is.
If you’re thinking of private equity as we’re going to invest in a business and we’re not going to be day to day operators of the business, it’s probably in that $2 to 3 million EBITDA range and that is probably the lowest because a business that’s smaller than that, not every time but most the time, is going to be so incredibly dependent on one or two people. They’re not going to have the systems in place so that if you pull that owner out for the business will still be successful. I would say probably $2 to 3 million in EBITDA. There’s certainly exceptions to that, but I would say that is probably the lower end and I think for firms like us, and you mentioned search funds, search funds are where somebody is looking basically to buy a company and then run it, I think they can go down to $1 million EBITDA or maybe even lower, depending on what their investor base was comfortable with.
We’ve looked at stuff that’s in that $1 to 2 million range, but I would say it’s hard for us to get comfortable with that. There’s got to be a pretty clear path for that to grow to $2 or 3 million, just because when we come in we’re going to add costs from the standpoint of we’re probably going to need to hire a handful of people, so that EBITDA is going to go from $1 million to 700,000 just because we’re going to bring a controller and an operations person and our services to the table, which is going to burden that company.
While I think there’s opportunity to buy companies like that and grow quickly, it’s tougher for us to get very far down the road on a smaller business.
Peter Bell: And if I can add to that too I think going back to search funds, I think we fit in right in the middle between the two because I think we bring the resources of a private equity group to the search fund space. You have traditional search funds where they’re going to go and look to operate the company maybe in that $1 to 2 million range, but most the time it’s just one searcher by themselves. And then you have on the other end of the spectrum a private equity group that may go down to the $3 to 4 million range, but they have a couple more operating professionals.
I think we sit in the middle and we want to be in that space, maybe a little bit above the search fun space, but we’re also going to bring the resources of a private equity group. Every one of our partners has had operating experience and so I think we fit in the middle between the two and there’s some advantages to that. Dale, who we’ve referenced a couple of times, his background is largely as a CFO and CEO for privately held companies and he’s worked in businesses that are our size, which are typically in that $10 to 30 million range up to $750 million revenue companies that are privately held and so he really digs in on the operations side of things.
That’s a huge help with the types of companies we’re looking at because typically that’s where they need help. It’s from a financial controls perspective and it’s from an operational management perspective. A lot of times we hear from the business owners when we’re talking to them that, ‘I started this thing in my garage’ or ‘at my kitchen table’ and at first it was ‘I had a skill and I could do this thing and it turned into a business’ and then it turned into ‘I have 20 employees and I am good at doing this thing, but I don’t really want to have to manage all these people.’ And a lot of times when we come to the table we say, ‘we can take all of the management and operation side of things off your plate so that if you do want to continue to work, you can focus on being really good at building something or serving something or moving something and we’ll handle all the headache of actually managing, running, and owning the business.
And is that part of how you differentiate Traction from some of the other buyers they may be in contact with?
Justin Turner: I would say how we think about differentiate for ourselves is to be long-term owners. We know if we’re talking to a business owner they might be talking to a private equity group where the private equity group is saying, ‘We’re going to come in, we’re going to grow it, and we’re going to sell it,’ and we’re coming in saying, ‘We do want to grow the business, we don’t want to buy businesses that are going the other direction, but we want to grow it and own that business for a really long time. And we want to provide opportunities for your employees and we want the business to continue to be in the community where it’s been.’ I think those are probably the things that are differentiators for us and we’ve seen that resonate with business owners that we’ve been chatting with, even over the last couple of weeks.
We’re certainly not a fit if a business owner solely wants to get the highest price. We’re not going to be a good fit.
What would you say is your optimum business owner who’s selling to you? What characteristics do you look for the owner to have in particular?
Peter Bell: It’s a good question.
Justin Turner: It is a good question, and we want people that are passionate about the company that they or their family has built and really cares about their employees. I think that type of business owner is more concerned about, maybe legacy is the wrong word, but more concerned with what happens to the business after they sell a portion of it than the person who’s saying, ‘I want the business to be successful going forward, but I also am filtering all these offers for what gives me the most money.’
We love business owners like Steve that we partnered with on SeaWestern that we closed on in October. He’s a perfect example. He loves selling equipment to fire departments. I mean his family started the business in the 70s, his sister had been running it now for the last 10 years or so, and he loves what he does. We told him, ‘We’ll take everything off your plate that you don’t want to do so that you continue enjoying that piece of it.’ That, to us, is perfect.
To your experience at SeaWestern, is that similar to what you’ve seen?
Peter Bell: I think the passion is huge and taking a lot of pride in the business. We really make a focal point during the due diligence that they’re, just like Justin said, focused on their people and the business and less on making sure they filter for the highest price. I think that’s where we come in as long-term partners.
My other experience is my dad runs that family owned business in the Northwest and around the similar size and what he brings to the table and what I would hope to find in other business owners like him is a very similar stance. And also, being able to hire the right people so that their job is more focused on the capital allocation side. It’s a new term (capital allocation) sometimes for business owners, but it’s very easy for business owners to want to wear every hat in the business. It’s nice when you come across an owner that is able to differentiate what their specialty is and what they want to do and be able to hire the right people around him.
Justin Turner: I don’t know this is necessarily characteristic of the business owners, but for the size businesses we’re talking about, if we come across a business where the owner has been able to take themselves out of operations, a lot of businesses will try and tell you that the owner’s there a couple hours a week and it’s just to say hi to people. But if you can find a business where the owner literally is not involved in the day to day, we would love for those businesses to call us here.
Peter Bell: And maybe even to add on top of that is if the moat doesn’t live completely with the owner, it’s maybe not a characteristic but a business characteristic, that how defensible the business is making sure that moat doesn’t live completely with the owner. The owner being able to take a part of their moat as the owner and take that moat and put it into the business versus carry it all themselves.
Justin Turner: One of the questions we like to ask during due diligence is, ‘What’s the longest you can go without answering your cell phone?’ Going on vacation is one thing, you can still have your phone or your computer on vacation and still answer questions. But how long can you go without responding to an email or answering the phone for something related to your company? And that’s a good sign of how much someone is actually extricated themselves from the day to day running of the company.
That leads to discussion of what are some red flags that you see with businesses? You’ve seen a lot of deals at this point. What sort of thing do you see that turn you off from an owner or a business in particular?
Justin Turner: We try and avoid scenarios where the owners want to transition out, I mean immediately. That’s really apparent even in the initial conversations of, ‘We want to sell the business and we want to be out in six months to a year.” When they say six months to a year, it means two months or three months or a couple of weeks. I would say business where the owner wants to exit really quickly is a red flag for us. When we’re structuring a transaction, we try and get either some seller financing or some seller rollover in the transaction, so businesses where the owners are completely opposed to both of those things, and initially they may be opposed because they don’t understand what those things actually mean, but if they’re opposed to doing that, that’s a red flag for us.
And outside of that, customer concentration, low margins, no growth, depending on the industry too. There’s a lot of things.
Peter Bell: One on the business owner side is an owner who has a very high technical experience and aptitude. If we run into a business where the owner is a technical expert in whatever their field is and then they’re saying, ‘I’m looking to transition out, we need some new owners to come and do what I’ve been doing,’ that can be a little bit worrisome.
And then from a business perspective, we don’t want to get into a business out of our circle of competence. I think, I don’t have a whole lot of experience in running businesses, but more old school economy manufacturing and distribution businesses where we can come in with good experience and add value to is our circle. Maybe not necessarily red flag, but let’s really think about this one before we move on to due diligence and into the office stage.
Do you have some stories where maybe on the onset the company looks pretty good, but as you do due diligence things come up like maybe own a secret plane that’s through the business, but they use it personally all the time, or maybe they run a lot of personal expenses through the business that you didn’t know about initially? What sort of things come up initially with diligence that make you go full stop?
Peter Bell: I was going to say we’ve run into planes, but they’re not exactly secret.
Justin Turner: No, they’re not, and unfortunately it’s an excluded asset. So that’s a bummer. There was a deal we looked at that was in the transportation space and we knew they were a unionized shop. What we didn’t fully understand was the pension liability they had. It was not reflected on their financial statements and initially was communicated to us to be significantly different than what we thought it.
And it was a bummer for both sides. For us we’re like, ‘Man, there’s this huge liability that needs to get paid off if we’re going to do this.’ But it was also, from our standpoint, we felt bad for the business owner because he hadn’t fully understood what that value was either. And when we were presenting our offer and walking through what his proceeds would be, the pension liability was going to be 80 to 90% of that. It’s like, ‘We’re paying X millions of dollars, but really what you get is 20% of that because there’s this thing that’s not on the balance sheet, but the company still is responsible for that. That was just a bummer. That was frustrating for both sides.
He was very bummed the day that he was explaining that to us.
Peter Bell: I think you get in to businesses all the time and you may think that they have something proprietary that they’re doing, but the further you get under the covers you may realize it’s actually not a proprietary process or proprietary product or it’s literally like third party parts that they’re assembling when they’re telling you it’s a proprietary product that they’re manufacturing. Stuff like that is good to find it out before you buy the company, but it’s still just a frustrating part of due diligence.
At least since I’ve been with traction, we haven’t run into any big ones where it’s like we uncovered something through due diligence that really threw us off. I feel like we’ve done a pretty good job at the beginning stages of due diligence.
Justin Turner: One other example. When I was working in private equity down in Austin, it was pretty recent that I was on the job and I had sourced this deal that was a pipeline services company. Being in Texas there was a lot of oilfield related stuff, and it was doing non-destructive testing on pipelines and we really liked the business.
We’re working on an LOI and somebody in the office said, ‘Hey, did you guys Google the guy’s name?’ And it come up that he had this, not long rap sheet, but he had gotten in trouble for some things that were off putting and so that deal very quickly died.
Is that on your checklist now?
Justin Turner: We typically will google search and maybe do a background check now.
How has it been working with other intermediaries through this process of buying companies? You’ve obviously both had experience being intermediaries and doing it yourself, but as the buyer and the one to executing the deal, is your perspective changing on how that relationship works?
Justin Turner: I don’t know about changing necessarily for us. We’re focused on businesses that are based basically Colorado and west. We’re continually working on building a database of who are the intermediaries, whether it be investment banks or attorneys or business brokers, that are in the major metro areas of those states so that we can be, as frequently as possible, touching base with them on whether or not they’ve got transactions that fit the types of companies we’re looking for.
I would say that has always been challenging, but given the fact that we don’t have our own fund, we’re fairly new in the market, we’ve only done one deal with the four of us under the Traction umbrella, there’s a question in any intermediary’s mind: ‘Do I really want this firm to be one of the firms that I’m presenting to my client as a potential buyer, just because we don’t have the track record and we don’t have a $100 million that we can just call to do a deal?’ I think that part’s been challenging, but on the flip side of that, being able to communicate our story and why we think we’re different and pointing to our track record of how we are able to get deals close is helpful but certainly the sourcing has been a growing and learning experience for us.
Do you think there eventually be some sort of snowball effect where, after a certain number of deals, you have a track record, you have references for owners to look back at, and eventually it’ll be a bit smoother?
Justin Turner: I definitely think so. I think the track record will definitely help. Peter’s 25, I’m 31, Jake’s mid 30s, Brian’s 40s, Dale’s mid 50s. I’m a lot of times the first face that they see, and I am 31 and I look like I’m probably younger than that. So that can be a little bit of a challenge for us sometimes. But I’ve also done investment banking up here for a long time, so I have known a lot of these people for 10 plus years and that has helped get us over that hurdle. But I think getting more deals done and getting bigger deals done will definitely make things easier going forward.
Peter Bell: It’s a huge part of content in a way for a smaller firm like us. We’re still such in the beginning stages of how we want to look to potential investors to potential companies and so having that experience closing deals is huge.
Brian and Jake have worked on some companies outside of Traction, I’ve done deals outside of Traction, Dale’s been involved in deals outside of Traction. We can talk to all these things but when we say us five at Traction, we’ve only done this one transaction. Now, it’s better than it was six months ago, six months ago we were just saying, ‘yeah, we do deals, but we don’t actually have a company that we’ve acquired yet.’ So actually getting one done has been huge.
There’s a lot of people, and we were this up until six months ago, that walk around talking about doing transactions and being independent sponsors and wanting to be that and a lot of them never get a deal closed. We were fortunate and it’s hard work and stressful and we were fortunate to get one done. Hopefully the first of a lot, but getting one done and then continuing down that path will make it easier going forward for us.
And then, maybe this is a question that’s asked too early in your process, but do you see your future deals going upmarket or do you think you would stay in this EBITDA range and just expand the number of deals you look at? Have you thought about that at all in terms of a long-term vision for Traction?
Justin Turner: I think it’s easier for firms that start small to scale up and look at larger deals. I think it’s harder for firms that start with $10 million EBITDA plus and don’t look at anything below that, it’s harder for them to scale down.
I think if we look 5-10 years down the road we will, my guess, is look at larger deals along the way. But I think we’ll always be interested in companies that are in that $1 to 5, 1 to 10 million EBITDA range, just because there’s a tremendous amount of opportunity, the valuations are lower, there’s a lot of what we call ‘low hanging fruit’ in the businesses and, to Peter’s point, we like unsexy companies. A lot of times they do things on pen and paper and we can come and say, ‘What if we had a software program that would do all of this for you and you didn’t have to have stacks of paper everywhere?’ With the size companies that are in that $1 to 5, 1 to 10 million EBITDA range, there’s a lot of those types of very easy things that we can help and move the business forwards.
If you could go to college, any college, and be a professor of a class, what would you teach you? Peter, I remember we talked about Charlie Munger and you’re almost a walking encyclopedia of Munger, what would your curriculum look like?
Peter Bell: I think I threw that out on Twitter at some point, doing Munger’s mental models class. I think I’d need about 15 years more studying to teach it!
It’s a really good question. I think I would want to do something similar to that, or another idea I have is getting students ready for the different jobs that are out there. It is a wildly different role when you’re at a large 11,000 employee company compared to a 15-person company. And I think sometimes it’s easy to get caught up in wanting to do the big route and going down the that path. And often there are opportunities in the smaller space. I don’t know if I can make a whole curriculum on this, but there is tremendous opportunity out there at smaller companies that have great people and opportunity for growth and mentorship. Maybe it wouldn’t be a full curriculum class, but I think that’s something I really want students to know: that there’s a lot of other opportunities out there than choosing the big company, the path that a lot of people end up taking. Which is fine, it’s just there’s other options out there too.
Are there a few mental models that you use particularly often through your work?
Peter Bell: I think maybe accidentally I do. I tend to be more math data focused and so I learned quite a bit on that side with Excel quite a bit up at BlackRock, and so I’ve been able to take that and apply it to the smaller company space and SeaWestern and that’s been pretty fun.
I don’t know if I can clearly communicate what it actually means, but just what I’ve learned and gained through my experience and being able to apply it and then explain it to people. I’d say data on probability and understanding different scenarios and opportunity costs, like pretty simple ones. But I’ve noticed in a smaller company, you realize as you’re explaining these options and making decisions that when questions come up and you have to explain them, it forces you to realize I am using that mental model or that’s something that’s just ingrained.
Justin Turner: Harvard has a class on the search fund model. I think back to being an undergrad and I would have loved a class on the search fund model, but how buying a business works and then what you do with a company once you actually acquire it. I went to a small Christian school, so our business school programs shouldn’t be compared to a lot of other programs, but when I think about the things that we learned in our finance and accounting programs, it was geared towards working for a Deloitte or KPMG or working at a bank. It wasn’t geared towards how you actually use your finance and accounting skills to drive value and grow a company.
And I think if you’re coming out of undergrad with at least some concept of what the levers are that you can pull to drive value and grow a business, I think you’re going to be significantly more employable to the smaller companies that Peter mentioned. If you’re going into a huge 10,000-person, firm probably not as relevant. But I think for the smaller firms, if you can come in and actually demonstrate like, ‘Let’s look at our margin by product type, or what are our actual cost centers?’ If you understand that coming out of undergrad, you’re going to be years ahead of your peers coming out and will be much more valuable to the business that you’re working for now.
It may not appeal to all the students, but when I think back on my time and what I have ended up doing with my career, that would have been a great class to be a part of.
What would you consider to be the best or most fortunate in that to happen to you that was entirely by chance?
Justin Turner: I’d referenced earlier that I got an internship at the end of my junior year, beginning my senior year in undergrad, at the investment bank. I was a part of a church over where I’d grown up and where I was living during the summers back where my folks were out, and we had this program called Business as a Mission which was focused on business leaders that were a part of the church and facilitated small groups for those people. A number of the guys in that said, ‘If you’re going into finance, you need to meet this guy named Michael Weiss.’ And I literally went up to him after church one Sunday I said, ‘Can I have like 15 minutes? This is who I am. This is what I’m doing. I’m studying finance and accounting. Can I come by your office for 15 minutes sometime?’ And he said yeah, sure.
When I went to his office, we ended up chatting for a couple of hours and coming out of that he paid for me to go to this conference that was put on by ACG, which is Association for Corporate Growth. They do a big finance and growth conference here in Seattle every July. And I was 20-year-old kid, I barely even knew what private equity was like I had to google the term, and he paid for me to go to this conference and it was a full day of sitting on panels on deal structure and finance and leverage and this is what we’re trying to do with our companies once we acquire them.
I’m coming out of that meeting being like, I have, whether it’s with his firm or somebody else, I have to work in this world because it’s fascinating to me. I wasn’t expecting him to take me to that thing. But looking back that was a pivotal moment for me and one of the nicest things that that somebody has done for me for sure.
Peter Bell: It’s a really good question. I’m a big believer in randomness and optionality and paths crossing sometimes for completely random reasons, and so I was really fortunate to get the internship that I did after school working for this investment bank Merit Harbor Capital and where I got linked up with this crew. Honestly, this position I’m in right now in this role, I feel extremely fortunate for. I didn’t know what my career was going to look like getting back into this size and space and so I feel extremely fortunate to have this group behind me and believe in me. It’s been a wonderful opportunity to start, but I’m really looking forward to what we can do with it and what Traction is going to turn into.
You trace back how you got to a spot and tracing back to getting to Traction now, I was very fortunate that luck was on my side getting to know this group.
Justin Turner: To Peter’s point, I feel like I’ve always worked for people that have been advocates of the next wave and the younger generation and really pushing people that maybe didn’t have any experience, maybe shouldn’t have been in that board meeting, or maybe shouldn’t have been at that table, but people gave me the opportunity to experience those things and do those things and have always pushed and encouraged me. I’ve been the benefactor that I think Peter, hopefully he’ll get some of that from us as well. He’s not that much younger than me, but yeah it’s fun to be 25 and 30 and thinking about and working on these things and having the ability to dictate what we actually turn Traction into. I think we’ve been really fortunate and hopefully we’ll be successful with it going forward.
What is the best business you’ve ever seen?
Justin Turner: One of the first deals I worked on when I was doing investment banking was a company in Nebraska, in Kimball, Nebraska which is in the middle of nowhere. And it was a company called Castronics and we were the investment bank representing the seller, so we were working on behalf of the owner of Castronics.
And the owner had a crazy story, he dropped out of high school, started working in the oilfield, and eventually built up to where he had from five to ten companies this was like the smallest one that he had. The business had some proprietary pipe threading technology that they would do on tubular goods in the oilfield and business made. I think it made $2.5 million in EBITDA, good little business.
They had like a 5 or 10-acre piece of property where all their customers could use to store pipe for free, like not even if they were working on it, just would let their customers store pipe for free. We sold the business to a search fund and the first thing the search fund did was just reach out to everybody who had pipes stored on premises and ask, ‘Is there anything we can do to that pipe for you?’
They bought the business, I think for $8 million and sold it three years later for $38 million. And it was these little low hanging things like reaching out to the customers that have product at your facility already.
I remember we sold the business and I remember the headline saying they sold like three years later and I was just like, ‘We should have bought that company.’
That’s one of the ones coming to mind. And maybe not the greatest business model but that deal comes to mind for sure.
Well thank you both for joining us. I really appreciate your time and thank you for sharing some of your experience. This was a really fun conversation.
Justin Turner: Appreciate the opportunity to sit down.
Peter Bell: Really appreciate it, we had fun.
Absolutely! I’m looking forward to chat with you guys again soon.
Justin Turner: We’re looking forward to it.
Peter Bell: Sounds good as well.
Traction is a small private equity firm that blurs the lines between a private equity fund and a permanent capital vehicle, which is what made them so interesting to me.