“My first boss told me, if you buy great companies, you never overpay. So what I'm concerned about is, ‘Is what I'm buying really there?’”
That’s Jonathan Meltzer, formerly an investment officer at Sprint Creek Investment Management. In his role there determining whether a target was a good acquisition candidate, one of the more critical considerations was the state of leadership. And it wasn’t just the CEO or founder — which in these cases was often a first-timer heading an early stage or lower-middle-market company — but also the leadership bench.
“We want to make sure that the CEO and the management team are capable of operating the base business, and then we can get to that second phase and say, ‘How can M&A ultimately enhance and accelerate what our initial investment thesis was?’”
Even with a calculated approach, aspects of a deal can be overlooked or not pursued aggressively enough — potential risks, especially with the leadership team, that bring worry.
“What happens if I make the investment and that doesn't work out for whatever reason? How do I get a divorce?” Meltzer asks. “So a lot of it's about trying to figure out, you're entering into a financial relationship with someone you don't know very well. If this was a marriage, you’d be asking for a pre-nup. So what's the corporate equivalent, and how do you raise the pre-nup question without scaring away your fiancé?”
At the Dealmakers Conference earlier this year in Philadelphia, Meltzer, now a principal at Chestnut Street Ventures, talked about what he looks for in an opportunity to assure him he’s making the right investment.
When buying businesses on behalf of Sprint Creek Investment Management, Meltzer says it was a slower, business-building type of approach. That meant deals needed to make sense operationally first, and then financially.
Among the considerations he would make in his deal evaluations were whether there was a cultural fit and whether the acquisition was likely to lead to either accelerating growth or de-risking, say by buying an important supplier or another part of that value chain.
Questions to ask upfront include:
- Is there a fairly straightforward plan with major risks identified that a team can build out, integrate and ultimately build on?
- Who owns those risks?
- Does it make financial sense?
Spend time with the team
In Metzger’s eyes, human capital is of primary importance to a deal. A good leadership team can unlock a company’s value, while a poor leadership team can hold a company back. But leadership can be tricky to evaluate. The questions, then, are how to find out up front whether a company has capable leadership — and not just the CEO, but that next level down.
“How do you get confidence with the bench?” Meltzer asks. “There are two things that we do to try to address those. First is to spend as much time as you possibly can with that team. In a competitive process, that access will clearly be limited, which leads me to the second one. You ultimately want to try to be part of that ecosystem or that environment before a sales process arises.”
Being part of the ecosystem, he says, gives you pattern recognition — understanding, through experience, what type of people are necessary to help the business achieve the results hoped for by an acquirer or investor. In addition, personality tests provide insight into a person’s base-level motivations — Meltzer uses the Caliper Profile.
“You're ultimately backing a team,” Meltzer says, “and replacing a team is a very expensive and risky endeavor, something you really want to get right. So going the next level down really can pay dividends down the road if it helps you make the right decision.”
Akin to the importance of leadership to a deal is the idea of integration. This can include negotiations for earn-outs, transfer pricing and other important details to be worked out before entering into a definitive transaction.
He says that as the primary investor, it’s a balancing act to determine at what point those things should be addressed so as not to scare the potential acquire, but still satisfy the need for certainty. He says determining that is critical to keeping the different constituencies comfortable that they’re moving forward at the right pace and that the deal will get done.
Ultimately, what Meltzer is really trying to understand is the company’s durability.
“We're at a point that it feels like that next recession is coming around the corner,” he says. “And I just want to know that what I'm buying is a franchise that is capable of withstanding that economic shock and that is being run by the right people that are up to that task.”