Dealmaking is not a zero-sum game for O2 Investment Partners’ Jay Hansen.

“It’s got to be a win-win situation,” says Hansen, co-founder and managing partner at the private equity firm. “You have to be able to understand what it is that the other party is really trying to get and what they’re trying to accomplish in order to come up with the right solution. There isn’t anything we’re doing that is rocket science. It’s based on some level of experience and skill that we think we can bring to a partnership with an entrepreneur to help get their business to the next level.”

O2 invests in lower middle-market manufacturing, niche distribution and select service and technology businesses. The firm’s sweet spot within those segments is entrepreneurial and founder- or family-owned businesses.

“We look for businesses where the seller places significant weight on who they’re selling the business to and who they are partnering with, not solely the highest price paid,” Hansen says.

In this Dealmakers feature, we spoke with Hansen about how he evaluates potential acquisition targets and the value of having strong M&A counsel — on both sides of the negotiating table.

Identify your target

As a founder or family business entrepreneur, it’s typical that a significant part, or perhaps all of their net worth, is tied up in that business. So they’re looking to get a little financial diversification by taking some chips off the table. They’re still very passionate about the business, and they have a very clear vision for what the next stage of development for that business looks like and how to get there. They’re just looking for a partner to help them help them do it.

We look for businesses that have a defensible niche in whatever industry they are in. Do they have above-average margins in the business or industry sector they are in? What’s their historical growth look like? What are the company’s growth prospects for the future? Can we see a clear path to how we can help grow that business? What does the business need to be able to scale, grow and, for example, double its revenue in the next three to five years? When you look at it from that perspective, you will identify areas where they have a defensible niche, but maybe they need to round out a product line or invest in technology in order to reach that goal. 

We’re leery of a company with a customer base or a method by which they do business that seems less sticky and less defensible as a niche for the business. In other words, it might be more of a commodity space where the switching costs are low for a customer and that revenue could go away pretty easily. Another thing we use as an initial filter is the plans of the entrepreneur, post-transaction. If the person who built the business and who has been a very integral part of the company simply wants to cash out, there’s a risk that a lot of the tribal knowledge and perhaps customer relationships may go with him or her. For a lower middle-market business, that can have a very significant negative impact. We're very careful about those kinds of situations and try to avoid them.

Invest in closing the deal

Investment bankers typically do a pretty good job of preparing the seller for what the sale process looks like, what to expect and what a realistic valuation for the business would be. For these types of companies, where they view the business as their baby or as a child that they have raised, there’s a huge emotional investment in the business. A good investment banker will guide the owner through the process to get them to a point where they’re emotionally ready to go through with the transaction. If they don’t have an investment banker and a qualified M&A team to represent them, and they’re going through some of these things for the first time, it can be rough on them and on the buyer.

We did a transaction where the owner hired an attorney who wasn't an experienced M&A attorney. As you’re going through this process, including diligence and documentation and the whole gamut of what you go through in an acquisition, it becomes very painful for both the seller and the buyer if there isn’t experienced counsel on both sides of the transaction. In this particular instance, it kept dragging on because the attorney didn’t understand the issues. To solve this problem, we suggested that, in addition to their attorney, they retain M&A counsel. We said we would pay for the first X thousand dollars of fees up to a cap in order to facilitate getting the deal done. They did it, and we ended up getting it done, ultimately within the deadline that we had both agreed. But it was painful.