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Update with Justin Turner, Traction Capital Partners

This is my second episode hearing from investors on how they are adapting their companies, this time with Justin Turner from Traction Capital Partners.

Episode Description

This is my second episode hearing from investors on how they are adapting their companies, this time with Justin Turner from Traction Capital Partners. For more background on Justin and Traction, I recommend listening to our earlier episode, episode 4, with Justin and their associate Peter Bell.

In this episode, Justin talks about how his two portfolio companies have performed and what he’s thinking about next. I hope you enjoy the episode.

Clips From This Episode

Deal flow


So do you have just the two portfolio companies now or is there a third one too?

We have two right now. So we’ve got SeaWestern, which is the one that’s focused on providing equipment to the fire departments and then we’ve got the business down in Bend, which designs and sells tools for the metal fabrication industry. And then we were just talking, before we started recording, but we were supposed to close on our third one this month, but we’ve pushed that back a little bit. Just given everything that’s happening.

Are you still able to get ahold of accountants, lawyers and all those different groups?

Yeah, absolutely. I would say our lenders have been super proactive. We’ve been on the phone with them a bunch, not because there’s any issues right now, but just want to understand kind of how the banks are thinking about things, what plans they’re putting in place. Our attorneys for the most part are working from home, but they’ve still been available. And again, we had a deal we were trying to close this month. So there’s been documents flying back and forth this week with everybody working from home. So still have been able to get ahold of folks, it’s just an uneasy… There’s so much uncertainty and it’s kind of just day by day trying to figure out the things you got to do that day to keep everything going.

So how are each of your portfolio companies handling it?

They’ve both been handling it well. So at the business that sells equipment to fire departments, we work Washington, Oregon, Idaho, Montana, Wyoming, Colorado. Montana, Wyoming, Colorado is kind of newer territories for us. But we provide PPE gear, which you probably heard a lot of in the news lately, but a lot of the protective gear that the firemen wear. So, it’s stuff that’s in high demand for sure. What’s changing a little bit is, how we kind of interact with the department. So we’ve got reps that are out in all of those geographies that are typically onsite with departments every day doing sizings, talking about needs, dropping off orders, what’s changed over the last week or so as most departments are saying, hey, don’t come in unless you’ve got an appointment. And even then, some in person appointments are just getting pushed to phone calls or emails.

Haven’t seen a slowdown in orders. I mean, we’ve been quoting more stuff than usual, but at some point we think it will probably slow down a little bit just because we don’t have the reps in the departments every day, but we’re thinking that’s probably 30, 60 days from now. But we’re not anticipating a huge drop just given the nature of the equipment that we sell and kind of moving a step beyond that, we’re a distributor for that business, so we don’t manufacture any of our own products. We’re buying stuff from vendors that we have exclusive, non-exclusive arrangements with. So we’ve been in contact with them saying, okay, what is… What are the impacts of this whole pandemic on you guys and your ability to manufacture inventory and keep your plants open? So, so far, no interruptions. We got an email from one of our big vendors today outlining kind of what their plan is in response to this, what they’ve already done, what they’re doing going forwards, what they’re estimating is going to be some of the issues and how that affects their ability to fulfill orders.

But I think that, unless there’s some sort of net… Well, and even… They would be deemed an essential business, so there’s probably not a likelihood that they get shut down. But so far, that one’s doing okay. Business down in Bend, we closed on that end of October last year. We design on the front end, we design products and tools for the metal fabrication market. We outsource all the production of the tools, the tools get then shipped to our warehouse in Bend, where we do kind of logistics, shipping, sales and marketing, customer service. So while we sell a physical good, we’re not doing any manufacturing there, which I think is helpful. So we’ve got a smaller team that’s down, essentially in a warehouse with some office space. So far, that business is… If we look, kind of beginning of March up through say, March 10th, 11th, 12th compared to… As far as, from a revenue standpoint, as far as where revenue is now from 10th, 11th, 12th to today, we’re talking about maybe two 10 day windows.

Sales have probably dropped off about 25% but I would say, are in line with kind of where we were last year with that business. So March one, through March 10 we’re running 30% ahead of last year. We’ve dropped 20% down from that. So we’re still doing okay. But again, we’re one week into the craziness, so who knows even what Monday looks like for that. But we feel pretty good about it. The nice thing is, smaller business, really low overhead, higher margin. So we’re not having to do a ton of sales to hit the numbers that we’re hoping for. And that business is primarily sales through our website and sales through our Amazon store. So far, Amazon has not dropped off much. Web sales have dropped off a little bit, so we’ll see. We’re hoping that if people are stuck quarantined at home for that business, that they’re at least buying tools that they can go play with out in their garage.

How are you beginning to prepare each company for continued revenue disruption?

Yeah, so at the business down in Oregon, first rounds of conversations were really beginning of last week, so call it Monday, Tuesday of last week. And initial conversations were, what things do we need to be thinking about and doing to make sure that the employees are okay. One, from a making sure that they’re healthy and not affected, but also if there is a scenario where they’re not able to come into work, we don’t want to just lay them off. We don’t want them to go on unemployment. So, what are we committing to them to be able to continue to pay them the wages that they would have earned if they were working. So with that business, we’ve committed to that. Again, it’s a smaller team, so it’s not… I mean, obviously if your revenue goes to zero, there’s only so long you can survive.

But with that one, we’re committed to continuing to pay wages if there’s not… If they’re not able to come into work. Moving from initial, hey, how does this affect employees? It’s been okay. Let’s look at where our current inventory levels are, what things we have on back order with suppliers, and then where do we need to make adjustments so that we’re not spending a bunch of the cash that we have on inventory that, if there’s a slow down, we’ll just essentially be boxes of cash sitting on the shelves in the warehouse. So really just trying to be proactive on the cash management side of things. It’s pretty lean already, so there’s not a lot of spots where we’re looking to cut costs. And then the other aspect of that business is, okay, one, it’s small. Two, it’s primarily online. Three, everything we’re seeing so far is that, eCommerce businesses are doing okay.

So we’ve kind of put it on ourselves, what things do we need to do to increase our online marketing? Maybe not our online spend, but our online marketing to stay flat or maybe even grow as there’s a lot of people sitting at home on their couch scrolling through Amazon or scrolling through their Instagram. So we’ll see. I mean, all of that changes if Oregon says, hey, only essential businesses can go to work. And then at that point it’s okay, how long do we think that’s going to last? But we feel like we’re fairly well positioned with that one, but just trying to be really smart with cash. Historically, I would say, we’ve paid bills early. I would say, now we’re paying bills when they’re due or maybe pushing it a little bit just to try and manage cash flow and working capital as best we can.

I have been traveling down there a lot up until a week ago. So most of that is on hold, but overall it’s doing okay, but again, there’s so much uncertainty. I mean, who knows what the next 30, 60, 90 days will look like. But trying to be smart with cash, trying to make sure employees are okay and then continue to provide good service to the customers on that one. The business up in Kirkland, again, focused on the fire department, so it’s been deemed an essential business given that we’re a distributor of PPE gear. For the most part, everybody’s been coming into the office that’s on the admin side of things. The reps are primarily working from home and doing kind of email and phone call with the departments. Our expectation is that we’ll slow down at some point. So far it’s been extremely busy with quotes coming in and orders going out the door. So we’ll see.

That one has not experienced an impact yet, but it’s a longer sales cycle. With the business down in Oregon, because we sell on Amazon and on our website, we get immediate feedback on whether or not sales are slowing down. The business that sells equipment to fire departments is a longer sales cycle, so we may not see some of that slowdown for 30 days or 60 days. Whereas, we saw it pretty quickly with the business down in Oregon. So, and then the other side of it is, talking to our lenders, talking to our investors. One, want to figure out best practices that they’re doing, that other people they’re talking to are doing. And then two, kind of communicating to them what our plans are, how we’re thinking about things, what we’re seeing in the businesses already. So far, no issues on the financing side of things. We’ll see.

Are banks still willing to lend and offer revolvers and lines of credit if you needed it?

With the fire business, we literally yesterday got our line of credit doubled by the bank, so we went from having $1 million line of credit facility to a $2 million facility with no usage on it. So we’ve got the full 2 million to help if things did pop up. We’ve got line of credit facility at our business down in Oregon that’s fully available. The banks, given the drop in federal funds rate, the bank has come back to us and said, “Hey, we’re going to be low. We have a floor set, an interest rate floor on our loans.” The bank is in the process of redoing all the floors to help customers like us, take advantage of the lower rate environment. That’s kind of their initial thing that they’re doing. That’s not… I mean, obviously it’s better to pay lower interest, but it’s not a… I mean, it doesn’t move the needle a ton, contrary to what other firms do. We do use debt in our deals, so if revenue goes to zero, we still have term debt payments that we’ll be making on these companies.

That makes it a little bit more challenging. But so far, the banks have been great and been proactive, trying to smooth things over for the businesses. But in talking to the lenders, there’s already been clients of theirs that have had to close all their facilities. One was a fast casual business here in the Seattle area that is still doing takeout and to go food, but for all intensive purposes, that business has shut its doors and for who knows how long and who knows how long they can keep going, which is super tough.

There’s been untold stories here in Seattle of the restaurant groups that are laying off 90% of their employees because they just can’t afford to keep them on. Yeah, it’s just… It’s going to be unfortunate, it’s going to be really hard for a lot of folks and it will certainly be tough for us as well. So far we haven’t experienced that, but I have no doubt that, that’s going to be coming. I didn’t learn about this in school, so it’s… Yeah, it’ll be interesting to see what happens over the next couple of months.

So how about on the deal side, is that process kind of slowed to a halt in that sense? The deal you wanted to close today, obviously that’s not happening. Is the rest of the process kind of getting slowed down as well?

We’ll still look at stuff that comes across the desk. We are… Again, we raise all of our financing, both debt and equity, deal by deal, so we don’t have a fund that we’re trying to figure out how to deploy, which is good and bad. We are not out beating the street looking for new deals right now. The one that we just pushed off, we still really like the business, we still want to get the deal done. Our communication to them was, hey, probably 30 to 60 days at least just to try and figure out… Again, there’s just so much uncertainty and I feel like I keep saying that word, but we want to give things just a little bit of time to kind of smooth out and see what the new normal actually looks like. Try and get a gauge for what the impact is on the revenue side of the business.

That business re-manufactures transmissions. We communicated this two days ago. We had a call with them today, talking through everything and today’s call was really about, hey, how are the employees of the business doing? They were asking about our other employees. They totally understood why we were pressing pause for a little bit, but they were jokingly saying, now we get to actually prove out whether or not our countercyclical thesis on remanufacturing businesses, whether or not that’s true. And we talked about it somewhat jokingly on the call, but that was one of the things that we really liked about the businesses. We felt like it would do… Continue to do well in a recessionary environment and we’re going to get to test that out here for the next couple of months to see if that’s actually true. Now, this is maybe not what we were thinking when we talked, thought about recessionary environment, but it’ll be interesting to see. So we still want to get that deal closed, we still really like it. Our investors still really like it, the bank still wants to do it.

The groups behind you, behind each deal, are still ready to do a deal if that was to happen. It’s more about the deals themselves that you’re nervous about.

So our investors that we work with are typically folks that made their money owning, running, operating businesses that look a lot like the ones that we’re investing in. So on the one hand, they’re extremely familiar, they understand the risk profile and they like those types of businesses and they know you can make a lot of money owning them. On the flip side, they made their money doing that and now their money is in a lot of things, some of which is in the public market, which has had a challenging couple of weeks.

And there’s some of them that are still running other businesses. And so their communications have been to us, hey, we still like the deals you guys are looking at. We still want to do the deals, but we think it’s good that you guys are saying, hey, let’s hold off for 30, 60 days. So they still liked the deals. I think it’s more, again, I keep going back to uncertainty, but just this is such a crazy scenario for everybody. Let’s just take a deep breath, figure out what is going to be the government’s policy response to this. What is going to be the impact on these kind of mid-market, unsexy businesses and is there going to be a quarantine? Is it going to be a shelter in place for the whole country for two weeks? I would like to do a deal this year. I would like to do that trend, the deal that we were talking about, the transmission deal this year and hopefully that all works out, but who knows what the next 30, 60, 90 days…

And talking to other investors that look at deals like the ones we do. Some of them are saying yeah, we’re still pushing ahead. We’re trying to get stuff closed. Some of them are saying, hey, we’re really… We’re looking at a lot of stuff but we’re not actively trying to get a deal done. It will be very interesting to see. I think M&A across the board will drop off at least for a couple of quarters, but who knows? They could announce the vaccine tomorrow.

Have any of your investors had any conversations with you about the current deals with you that they’ve been invested in?

There’s certainly been some. I mean, they’ve wanted to know how those businesses have been performing, what types of things are we’re doing to try and strengthen stuff. We’re having conversations internally on, does it make sense to basically go out to our investor base and say, hey, we want to raise $1 million or $2 million or whatever the number is, just to have as dry powder in case there is some challenges with these businesses. Because again, we haven’t seen too much disruption, but I’m sure it’s coming and we still really like the businesses and we think once everything smooths out, whether that’s three, six, nine, 12 months from now, they’re still business we want to own. And so, does it make sense to try and raise some money right now that, in the event that things do drastically slow down, that we’re not forced to shut the doors. There’s been communication, nobody’s been freaking out. Nobody’s been saying, hey, I need to get my money back, but again, we’re a week into this. So we’ll see.

Yeah. Do you have a good sense for what a two to four week quarantine would do?

So for the fire-related business that we have, that’s been deemed an essential business based on being a distributor of PPE gear. So full quarantine, that business will continue to largely operate as it does right now. The business down in Bend, if we have full quarantine for 30 days, that business will be fine. We’re going to keep paying employees, it’s got plenty of cash in the bank to weather a couple of months of full zero revenue. Now, could we do six months full zero revenue? Probably not. We’d probably have to be really creative, but 30 days full stop, we’ve got plenty of cash to be able to weather something like that. Where we’re trying to think and try and figure out where there’s going to be risks is, what happens to the supply chain for the business down in Oregon if there’s a quarantine. We think that would be a bigger challenge.

And so, trying to make sure we’ve got plenty of inventory in stock and part of it depends on what the full quarantine looks like. Is it just… Is it full stop, everything’s closed. Is it skeleton crews? Is it… Who knows? And the other thing we’re trying to wrestle with on that one is, if we go full quarantine, do we keep our… Again, it’s largely Ecommerce business, so do we keep our website up, do we keep accepting orders and just have it be explicit on the page that hey, you’re welcome to place the order now, but it won’t ship until the quarantine period is over. Still wrestling with how that will work and what we’ll do in that scenario.

This is all pretty wild.

It is. It’s, again, they don’t teach you this in school. How to run a small business through a pandemic.

If there were opportunities that came across, do you think you would have any difficulty in closing them if you wanted to and they looked like good businesses?

I mean, I think it depends on what the business looks like. I think… I was on the phone with an investor today and it’s, how do you do due diligence and how do you look at any… I mean, everybody’s financials up through February, there’s going to be no issues. They’re going to look great. They’re probably growing business as usual. If we’re talking about buying a business six months from now, how do you think about the March 10th through October financial statement. There was people on Twitter talking about COVID adjusted EBITDA, but it’s the reality. It’s how do you… I would love to see a business that just, there was no… Literally just financials were flat through March, April, May, June. But that’s not going to be the reality.

There certainly is some folks that we know that have said, hey, we are still very interested in doing you guys types of deals if you see stuff that’s interesting. So I think if it was the right deal for a strong business or a business that we really wanted to own, once things do go back to normal, I think we could get the financing in place, but it’s not going to be… I’m not going to say it was easy before, but it’s certainly going to be more challenging than it was before.

If earnings dropped in a company by say, half, during the coronavirus time, how would you value that company? Would you value it off of a normalized number or some average? What do you think you would do?

I think in scenarios like that you’re going to have a lot more, what we would call, structuring, quote, unquote, in the deal. Where you’re trying to come up with a solution that says, okay, we think your business, in normal times, is going to be X, call it $2 million, but if it’s dropped to a million dollar run rate over the last six months, you probably will have some sort of either performance bonus or earn out or contingent seller note as part of it, to try and get them that full value of what they would have done if the business was still performing, in the hopes that when it does come back, they’re able to get fully compensated for that. But it’ll be a challenge. It’ll definitely be a challenge. I mean, I’m always going back to okay, what is your TTM EBITDA?

And then you kind of roll forward. And with kind of March 10th being that change over day, for lack of a better term, it’s going to be really challenging, especially for businesses that have had a disruption. If their businesses dropped quite a bit, it’s going to be really challenging trying to come up with evaluation that makes sense for us as a new owner, but also is a number that gets the existing owner interested in actually selling. That’d be very interesting.

I think there’ll be deals that get done, but it’s going to be a lot more challenging. I would imagine there’ll be a lot of sellers that maybe were in the early stages of taking their business out to the market for sale, that are just going to say, hey, I’ll keep it for the next three, six, nine, 12, 18 months and try and let the economy get back to a sense of normalcy and then sell it. So I think there’ll be a lot of folks that just say, hey, I’m just going to wait. In scenarios where somebody has to sell, whatever the reason may be, that’s where it’s going to be a lot stickier, as far as coming up with a number that everybody is excited about and onboard for.

Are there any other things that you’re thinking about within, either your businesses or you’ve seen other investors do that are trying to prepare their businesses the best they can?

You’ve got to communicate with everybody. I mean, we’re chatting every day with the leaders in our businesses, both about what they’re seeing, but also running through potential scenarios. So you’ve got to communicate, you’ve got to identify and if there’s costs you can start cutting right now, you probably need to start cutting them right now, just to be smart. And if you’ve already got a really lean business, then you have… Then you’ve got harder decisions to make. If it’s now starting talking about, your only costs you can cut are employees. Because for us, we’re trying to keep everybody on, we’re trying to keep wages the same, we’re not doing anything drastic like that. Communication, having a plan and then, on the sales and marketing side, okay, we get that it’s going to be hard, but what creative things can we be doing to try and offset some of the slowdown that’s going to happen.

And then outside of that it’s, what are the KPIs in your business? And you have to be watching the most leading indicators that you can, whatever that is for your business. You have to be looking as far out in the future as you can, trying to make decisions based on what you’re seeing. So, with our fire business, our KPIs of meeting with customers, our in person visits are going to drop off quite a bit. So while we’ll still be making sales because we’ll still have phone, email, all of that, we know that because we’re not in the departments every day, there’s going to be a slow down at some point. And that’s probably going to be starting to see it in the sales numbers maybe 60 days from now.

But we know that, that’s going to be a reality coming down the pipe. With our Ecommerce business, it’s more real time because you can see, what does your traffic look like, what does your traffic look like compared to historical periods, what does your conversion rate look like? Was does your conversion rate look like to historical periods and then to balance all that out it’s, okay, what do we got to do to drive more people to the website? Even with a lower conversion rate to try and get close to the same number of sales. That’s where the trying to be creative on the sales and marketing side for that business, really comes into play.

Yeah. I think I saw on Twitter, there was a liquor store that was offering booze bonds or something like that, where if you paid $75 now it will be $100 credit at the end of this period of closure, where you can now buy $100 worth of liquor, which is a pretty creative idea.

I’ve got a membership at a co-working space in Seattle. Obviously, given the shutdown in Seattle on pretty much everything, you can’t go in there and work, you can’t go to the restaurant that’s in there. And so all of the monthly dues that you’re paying right now are going towards, basically food credits essentially, once things get back to normal. I would say, on a personal level, I live in Seattle, I live in a fairly walkable community where there’s lots of little restaurants. So I’ve been trying to just order take out from those folks that can’t do their normal operations. But I think a lot of the community here, in the little neighborhood that I’m in, is obviously being smart, cleaning the dishes, all that, but trying to go out and support the local businesses that are around here.

There’s a little pizza shop that’s just two blocks from where I live. Walked down there at 7:30 or 8, a couple of nights ago just to get a pizza to go and they’re like, “We sold out of everything.” And I love that. I love that the community is coming around and saying yeah, we’re going to continue to order from these restaurants we like, even if it’s not the same dine in experience that we maybe would have preferred. So it’ll be cool to hear some of the stories like that, of the restaurants that did do creative stuff to actually make it work. And like your story of the bar that’s doing the liquor bonds, that’s great. I love that.

Thanks Justin for your time. Really appreciate hearing about what you’re seeing and what you’re talking about and thinking about. I really like hearing your feedback.

Appreciate having me on. Hopefully it at some level, was coherent. It’s been just a crazy couple of days trying to think through and work through and talk to a lot of people that are way smarter than us about this stuff. So appreciate you having me on.

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