all right thanks uh for that uh I haven't done anything yet so I don't know exactly why you're clapping but um I'm G to try and make this very interactive okay so ask questions whenever you want raise your hand uh or just ask questions um I'm going to be focused on due diligence but I'm going to take a very broad approach um to the whole concept of due diligence so um this is not going to be an accounting class because I would fail miserably in that um but ready take a broad approach to due diligence and and try and explain to you guys how we look at companies and how we go through the whole due diligence process and evaluating what is a good investment Pro investment and what is not um I'm going to be doing that um on the basis of a investment that we made in a retail business um before I do that let me let me give you a bit of a bit of my background in addition to what uh the professor just mentioned um I kind of came into this business uh in a in a fairly unorthodox way I spent uh many years working for the beneton family and then later also for a gentleman by the name of Les Wexner who um is the founder and majority shareholder of The Limited Brands that owns all these apparel and consumer good companies and uh I was exposed to kind of the whole m&a sector by doing transactions in a corporate setting so we did a whole slew of transactions when we were in the beneton group where the beneton decided in the early 90s to start diversifying and we bought all sorts of businesses including um um infrastructure deals we bought the northern Italian Road networks uh which still is in the hands of the beneton family today um we made investments in Telecom we made investments in consumer good companies um and then similarly at the at the Limited Brands was involved in the similar capacity in a number of Fairly large transactions and I got a lot of exposure to um buying these these companies that were typically kind of Middle Market companies so anywhere between let's say hundred to a billion dollars in revenues and um and the complexities and issues that we dealt with in incorporating these businesses into uh the larger corporate setting so then later uh I went into private Equity after I went back to business school and um to this day I uh continue to be in this business and I have to say that I actually love what I do it's a it's a a tremendously fun and interesting uh business and multifaceted business um I just have to figure out how this thing works here we go all right so I told you a little bit how um what we're going to be doing today um I'm going to talk a little bit about the private Equity core competencies and then really go into due diligence I'm going to try and stay away from kind of the technical stuff with respect to the technical accounting stuff but really conceptually try and explain what we do on a day-to-day basis when it comes to due diligence on the basis of a transaction that we did now this transaction that I'm talking about is a small transaction it doesn't matter however because it had all sorts of interesting aspects to it that um uh regardless of the size you'll deal with in a private Equity context before I start um who is who has any experience in private Equity has worked in a private Equity Firm okay quite a lot of you guys and in just just Fran what what kind of context were you work in private Equity so I was working in a private Equity Firm in Spain my country it's a mid Market company okay we're doing deals from 200 million to 800 million okay and what what were you doing there um so I was an associate so basically I was in charge of operating models and models and I was Hing deps with banks okay and uh helping the the principal in directing the consultants in the in the market andate okay okay good well let's start then with and we'll go through this very quickly quickly what what is it that we do on a day-to-day basis I mean so we're private Equity men and women uh we work we have a lot of uh Capital that we're backed with and what is it that we do on a day-to-day basis and in our offices I mean so we all talk about doing deals but it's not as easy as that right so uh Daniel what is it that we do on a day-to-day basis where does the whole process start um identifying uh potential targets to require and um um add value if possible okay so identifying potential targets to acquire okay so how do we do that um well we usually contact some um investment Banks or firms that have been approached by by firms that want to sell the company yeah uh or do an IPO and uh okay so investment Banks right so we depend on what else what else do we rely upon from finding interesting investment opportunities networking what networking your call colleagues your friends your family you try to reach as many people potential investors and business owners as possible and this is how you ensure a certain deal flow potential deal flow okay so go ahead Consulting reports so just where they look at the company business and where they see if the company has a strong cash flow and like it's well positioned in the industry okay can support the right so we we Source deals uh utam what else you can uh hire a buy side broker if you want to Target a particular segment of Industry you can hire B broker and go to trade shows and have them put together we one of the hardest thing that we do and particularly in this day and age where the markets have become incredibly efficient meaning there are buy side Brokers there are investment Banks there are uh people that have networks and friends and family it is incredibly hard to find proprietary deals so what's the issue of finding non propri if you buy if you get approached by an investment Bank what's the issue with being approached by an investment Bank there be other uh private Equity shops the same deal probably the price will higher exactly so an investment Bank these guys uh you know are probably better in networking than we are and they they have a whole slew of companies that they've developed years of relationships with and they event the compan is eventually up for sale privately held company let's say just for the example and um they show it to a whole slew of private Equity firms they run an process and you end up paying a very Hefty price to be able to close that transaction so sourcing deals and don't forget this is incredibly hard and it's becoming increasingly hard because the markets have become incredibly efficient the private Equity business has become an industry and there are hundreds and thousands of investment banks in Europe and the United States and increasingly so in in Latin America and increasingly so in Asia that are all running after these investment opportunities it's very hard to find interesting opportunities that are proprietary okay so what else do we do so we spend a lot of time trying to find interesting investment opportunities what else is that all we do I mean in terms of sourcing other the things no forget sourcing let's say let's move on to the next uh reporting fundraising did a lot okay fundraising I'll get back to that so but that's a very important point I'll come back to that in a minute what else do we do follow your Investments follow Investments okay so how do we do that you're usually in contact with management of the firms and um you prefer you prefer reports or data for the for the boards okay and uh you assess them also inic issues and financial issues and with the banks and so we're typically when we do an investment we typically um take a board seat in investment so several members of our firm will take a board seat and we oversee the investment and the execution of the investment and we oversee essentially management reports then to the board we we oversee the so that takes a lot of time and a difficult process okay what else we talk about sourcing we talked about fundraising I'll get back to that in a minute um main relationship with lenders so you able to borrow to finance it so we've got fundraising and debt financing okay we're in the business with doing leverage buyouts right and um to finance these transactions we need to have debt the whole process of raising equity and debt financing for any transaction is a very very difficult and very complex process raising a billion dollar fund it just doesn't happen from one day to the next it's a very difficult and arduous process it's very very competitive there are a lot of people trying to do what you do um the LPS and the lp Community whether it's pension Banks whether it's um uh family offices uh uh or or endowments they these people know what they're doing and um they're very good at picking good managers who have a good organ ganization who have a good setup so the whole process of fundraising is a tremendously arduous process it takes a tremendous amount of time it cost a lot of money as well and you can end up empty-handed too so the whole process of fundraising um and also raising debt financing for transactions particularly in these markets and I'll get back to that at the end of this lecture is a difficult process okay what else do we do so that's it so we raise funds we Source deals or what else execute on the deals we Source okay so we execute on the deals that we Source right um which is what due diligence negotiations okay due diligence and negotiations um do you have any experience in negotiating private Equity transactions yes okay so tell me a little bit is that an easy process is a hard process it's very challenging because often times you need to rec between the expectations of the management or the owners or whoever is rning the business and as a fund the return requirement risk Prof five and so on and so forth right so negotiating transactions is another it's a pretty complex type of business you have to have it a little bit in your fingers the sellers have to like you you have to come up with a good bid it's not only about price I've actually won auction processes not by paying the highest price but having the best structured deal having the best relationship with the management team having the best developing the best relationship with the sellers and coming up with a transaction that is really doing right by the business and doing right by the company and really um uh uh uh ensured that the sellers felt happy to whom they were selling the business to now private Equity uh business and particularly in Europe by the way we do transactions in Europe as well um has developed a very bad name um the whole concept during the last five or six years the whole concept of doing these leverage buyouts where you would um buy a business um at a at a high purchase price multiple and kind of Justified that high purchase price multiple by using tremendous amount of Leverage and two years into the into the whole investment you're breaking through your covenants and in the worst case going bankrupt so these types of uh structures and transactions people are becoming much more Savvy about that and negotiating and uh structuring transactions in um in a way that uh in in in in an effective way that you can actually make the acquisition of the business is is becoming increasingly more difficult and and and competitive all right so I'll just quickly go through that so we talked about sourcing we'll get back to about due due diligence due diligence is incredibly important due diligence is not only financial due diligence it's much more broader then and we'll get get to that in a minute but we spend a lot of time uh on due diligence now just a minute about uh valuation um H how do you know what you pay for a business um Sylvia what should you pay for for if a company walks or an investment banker walks through the door it gives you all sorts of information about the business so how do you determine what the valuation should be for the business so you you want do some Market based valuation you may do some coms you see what other companies paid for the business you will run your lbo model seeing what your return is because you know what your return requirement for your fund is so you have the maximum level how much you can pay right you look you look at that number compared to what other transactions in Market went for to get some kind of estimation of value okay and so how do you determine that ultimately what price you should be paying for the business I mean you can do all that work but so what so you have all this all this information what I mean what are you going to pay for in the end for the business what really truly determines what you what what you end up paying for the business depend on the competition if there's other bers in the process it will bring price up if there's no competition there you will try to as slow as you possibly can get yeah and go to get your return up this competition there it will determine how many how many RS there are they will tell you you need to BU a little bit more to the next round you do it okay finally at the end and then you will get some guidance from the banks where you stand within the bidding and then based on that you decid it's forth for you to make spend more time to find synergies to find other ways to spend to pay more for the business and the return okay Diego you you wanted to make a comment was the same thing that's your walkway and you should try to increase your your return by providing other sources as you said you know by having a relationship with the management and bringing ways that you can to the business to pay as lowest as it could okay the the whole concept evaluation has gone completely haywire and certainly during the last four or five years the uh people have been overpaying for these assets for years and somehow justifying uh the price by using a lot of Leverage that whole game has changed now um the the debt financing that these companies used to be able to get for for justifying these types of deals are no longer available so it's becoming increasingly more difficult to justify a high valuation a high purchase price for a particular business um Financial modeling so just just very quickly so how how uh who who's who's run leverage bu up models uh here in the past in the private Equity context so you guys here utam to tell me a little bit about okay what's what's really the concept of a leverage biot model the key concept is uh basically for free cash flow and and figure out how much of their debt can you pay down and what would be the U what kind of what kind of abda would you have when you're trying to exit the company and and and and what would be the final return to the equity holders is the basic constru of okay it's a very simple concept right you basically look at the cash flows of the business you kind of try and identify how much debt and what kind of capital structure this business can sustain over over the years and and it spits out uh what what what what does it spit out at the end the return to the equity holders the cash and cash and and the IR right so the cash and cash return and the iri and the and the irr um so a lot of people will understand how to do this and develop leverage bio models what's really the important part of that to figure out what are the key uh growth drivers what are the key drivers of the business activity okay and and model the business uh if there's seasonality then you figure out what is the right time period if there are other structural drivers then you to identify what those are and what are the drivers behind them okay so the whole concept of of Leverage buyouts is not so difficult to understand and and actually running leverage buyout models is not that difficult the whole point is is what you're really putting into that and if you really understand the underlying asset the underlying business how the the financial operation of the M of the business and what the future cash flows of the business are going to be and if you get that wrong you can very very quickly um the whole investment can go south and before you know you can go bankrupt uh we talked about debt and Equity financing uh we talked about negotiation and deal structure um a little bit about exit planning um it is I have come across many many investment opportunities where we were kind of talking about an investment opportunity said well should we do this yes or no and um and we were very much on the fence about this particular um investment when you make an investment have a very very clear idea of actually what the exit is going to be because if you're on the fence of it uh about this particular investment opportunity in Good Times um and you want to sell it in five years from now and the business has done so so um you're going to have a hard time um selling the business down the line so don't buy businesses that are unsellable um uh just because you uh are desperate to get a a particular transaction done or um don't underestimate uh the the difficulties that you might run into if investing in certain companies and certain businesses um where it's very difficult to um exit out of the transaction because the business is virtually unsellable um and there are certain companies that are very very difficult to sell go ahead so in your opinion because if if we're talking also about at the largest of the the largest number of competitors that you have in an auction your price is going to be high yeah so it means that if you have a business that is difficult to sell and you have the opportunity of analyzing that business maybe um you're going to get a better price but you're going to have some more problems in the exit planning yeah so my question is how you can make a business that is not very sellable into into a you know convert it into a a sellable business in in a time period of four well that's exactly where your due diligence comes into is is is evaluating this business and thinking and being creative in your thinking and thinking okay what is the likelihood of taking this business and setting it up for a a much more interesting business a much more interesting operating model um healthier cash flows um a better management team uh and what is the likelihood of succeeding in let's say a matter of four or five years and and to whom might we be able to sell that business and you'd be surprised how many businesses bought with people not thinking about how they're going to exit and um uh there are I have come across hundreds of companies that are owned by private Equity firms that they've had for 10 years and these companies come up every two or three years and they hire another investment bank and they try and sell the business again nobody wants to touch it don't underestimate it you could be stuck with a business that's doing you know $5500 million in revenues and it's just a a business that um an investment in an industry take an industry I mean we were talking about it earlier about the printing industry printing industry is going through a tremendous demise there are hundreds of private Equity firms that made big investments in the printing sector because they you know they had the wrong strategic approach now so now these companies are owned by by these private Equity firms nobody will touch them and so they're continuing to hold them you know they still cash flow they've PID on the debt but they can't sell them go ahead is it more indust and sector or there are also certain aspect or characteristics of a business that when you see you should run away it can it can be uh it can be a structural I'll give you an example uh we're actually looking at a business right now in the Aerospace and defense sector it's a business that um um and these businesses can be actually very very good and we've got some very very good advisers in in this sector but they're in the business of uh buying and selling parts to airplanes okay uh not commercial airplanes but actually military planes and this company has bought this huge inventory of um of parts of military aircraft uh from wide variety of European and us uh manufacturers um the problem is that there are two problems with this business the ownership structure make it very very complicated there are a number of um investors and a family office that's involved in this company um that and the family is running the business and secondly um the um inventory um hasn't been properly cataloged so they really don't know what they have it's actually fairly big business it's a big business that has a huge amount of inventory that is actually um cash flowing quite nicely um but they haven't cataloged their inventory and we're talking about millions and millions and millions of parts and so they're trying to find somebody who has the guts basically to step into this business to make a valuation of the business to spend a huge amount of money in inventorying all of these spare parts of these planes and making a bid for the company it's not so easy you know you have to have somebody who's willing to do that anyway there are many examples like that of these quirky companies that can actually be large but they're very difficult to sell or to buy okay uh okay so we talked about so what we do on a on a daily basis from a from a private Equity perspective and um and actually all of these facets of any type of deal making make this business tremendously fun and interesting this guy um called me and he said look you know I have this uh this this idea um there are all these luxury Optical retailing stores here in the United States and um they're incredibly profitable it's a very fragmented market and um I know all the owners of these stores because I've sold stuff to them over the years and um you know I think that you guys should take a look at this uh with me and back me about um and potentially making an acquisition of a number of these companies in the luxury Optical retailing business so and he's told us a little bit about the about the sector uh and about the business and sounded like a pretty interesting idea we were stores all across the United States potentially even in Europe they had um pretty high margins it was a uh fairly fragmented market so we said okay what um let's let's take a look at it so where does this process ready start so what do we do next so we have this idea we have this guy who walks through the door with this idea and he says well I have relationships with a number of these uh owners of these types of companies and uh you know you you guys should back me and doing this so what what would you do next uh Gus where we uh where you in my shoes well I have to ask for a business plan what is he doing with I don't know he wants money are his plans for the money right and so you can really assess if his plans are worth your time and your money and yours okay so it starts with you know doing a little bit of due diligence on this industry right so um what this guy said there were all these stores all across the United States uh in this this this little group that he was talking to was like 25 stores so it starts with kind of a due diligence process so what what is it what we're trying to do with with due diligence what does it really mean uh Aaron you're trying to verify I mean for this specific case you'd probably be trying to verify the economics of the store and you know what what he thinks is achievable whether that can actually be achieved okay but it's it's it's think of diligence in kind of like a more broader concept and what is it really we're really trying to do through due diligence go ahead I mean that's it comes to that by the way I mean obviously we we have to do kind of the financial analysis of and the the uh the the understand let's say the economics of these stores but what else uh in a broader Broad View I think you're just trying to confirm your investment thesis and exact what you're evaluating at right so due diligence is really kind of um trying to understand the benefits and and the liabilities of proposed um investment and and and trying to understand kind of the past the current situation of the business and where it's going to go in the future right and in addition to that you're basically trying to understand um really get a a a a a a very very thorough understanding of this business um how it operates in its environment and um and use that information to come to an accurate Val valuation of the business and um and and develop predictable Financial models so and this this is really one of the hardest things that we do in uh in the private Equity business there are so many businesses that we see on a daily basis now we must have looked at probably about 500 transactions um in 2009 okay so we looked at 500 500 transactions and so we're constantly seeing these these uh these opportunities across a very wide range of different indust Industries and sectors in the consumer and the Industrials and Manufacturing Aerospace and defense sectors and there's certain um similarities between companies in each of these different um Industries however every single company is different and it's it's very difficult to develop a nose for what is a good company and what is a Bad Company um what is a sound uh Financial operator model and what say a bad one it's not that easy and you can't look at Financial um statements of a company and just say well okay this looks pretty good you know pretty good EV down margins pretty good cash flows you know it's it's much more complex than that and it's and and it requires also a certain intuition with respect to um the business but also being able to put together all of these different due diligence aspects that you're looking at not by yourself but with a wide team of people and boiling it down to U your understanding of the business and evaluation okay so what it really involves is um from top to bottom looking first at the macroeconomic environment so we've got this uh Optical retailing business and uh it really starts with doing a macroeconomic analysis and how these businesses and industries kind of develop um uh with uh in in fluctuating macroeconomic environments okay so so from the macroeconomic environment what what what what's the next step where do we then go into Carlos the industry what in terms of next what what what other due diligence elements are there uh apart from kind of Mac economic environment seeing how the industry performs in a particular macroeconomic environment sure so once you've assessed the industry you probably want to dig into the specific aspects of the firm both the firm's operating um performance and then the management team okay all right so we look at the the the the financial operating model the operating model of the business you look at comparable and precedent transactions um and then we obviously do Financial due diligence right um in addition you look at management it's very very hard um to uh do a proper evaluation of management I've done I've made so many mistakes with that where you can have great management teams that are great PR people when it but it really comes down to really running the business uh they may may not be uh as good as they um as they claim to be so it's very hard to do a proper determination of how good the management team is with a particular company go ahead yeah I have one question so in the situation described it seems like was a case different from you know what the company you're going to acquire and you jump on it and you do whatever you need to do now it seems like there is a theme that you I mean your friend thinks it's interesting and you're going to explore so how do you go about this particular phase of establishing a strategy how to go about a certain you know interesting theme rather than looking at a specific company and try to dig deeper on it well I mean what we we did this guy walked into and it often happens like this um this guy but even if an investment banker comes to you with a a cim that thick you you still have to take a step back and you have to say Okay how does this this business that we're looking at how does it perform in a particular industry right so um where is the company positioned uh according to its competitors and how does it perform how does this industry in general perform in the US market or in the US European and Latin American Market okay so you have to always have to kind of take a step back and say and look at the industry and is this a viable industry that you want to invest in and what is the competitive set in this particular industry pretty you know you you guys have done this 100 times of four but people sometimes forget to do that so they look at they become myopically focused on the financials of the Business Without kind of taking a step back and said well should we really even be looking at this industry in the first place so with this Optical situation we kind of looked at the industry we looked at at um and I'll come to come to you know some of the work that we did uh in in a minute and we decided actually well this could be a really interesting situation okay so Financial due diligence you look at management um legal um big mistakes are made in private Equity type of in Investments without doing proper legal due diligence so I don't do that we get a whole slew of lawyers our lawyers are at Kirkland Ellis and they um evaluate the transaction structure but they also evaluate the assets that we're buying and you can make some big mistakes with respect to buying these type of assets where you find out that they are huge liabilities um I'll give you an example um most most um uh uh uh recent example that we dealt with is we looked at doing consolidation playing kind of gas station type of um businesses so these are gas stations across the United States they have you know 200 300 gas stations um three or four different companies um with maybe a total of about a thousand gas stations notoriously difficult uh business when it comes to liabilities and um um environmental liabilities because these gas stations turns out are leaking gas into the ground right so these gas stations have been around for 25 years or so they have these kind of Tanks they leak gas into the into the ground and before you know you've bought a thousand of these things and you're dealing with huge huge legal and um and environmental liabilities that you didn't foresee um this is a more kind of obvious example but they're less obvious examples that if you haven't done your legal due diligence and your environmental type of due diligence properly um literally you can get notice from one day to the next and your investment is gone because you didn't foresee something properly so spending the money on due diligence but also managing the due diligence process effectively is incredibly important and what we do is we already manage this process I mean we're not you know doing the legal the the legal due diligence ourselves we hire people to do that um we have a whole team of 30 40 people working for us in a particular transaction that do all of these different aspects we have KPMG working on the financial d or certain aspects of financial due diligence um um the uh the management assessments there and here again this makes private Equity investment investing in the United States a little bit easier there's a whole industry in um people who do management evaluations you know what it's it's always been worth spending the money on these types of situations and in a minute I'll give you an example um uh how we made mistakes sure go ahead interiew when is the right time to hire a outside firm for a du J or legal and financial du J after you sign OU or any agreement for you to be the only beer when do you bring them board well actually this is a very good question because um one of the things what keeps us alive and what keeps our business alive is um the management fees that we get from PS right and um hiring Kirkland analis and um the accounting firms is an expensive proposition and when you do aund hundred million transaction before you know you're spending $10 million in due diligence fees so um the you have to be careful as to when to decide that you pull the trigger on hiring all of these people on a retainer basis on a particular transaction that said you can't wait too long because you have to show the sellers that you're also committed enough to actually spending the money so um and this goes back to kind of the negotiation uh process in some cases we've actually uh hired our um due diligence team earlier on in the process because we were very eager for the particular investment to show the sellers and the investment bankers uh and the lending institutions that we were very committed to this particular transaction so if you further along than your competitors and the other people that are bidding for the transaction um that can actually help you uh getting getting the deal done uh earlier and sooner ahead of the time that some of your competitors are so timing is a is a critical issue in this game because particularly the investment bankers uh but in in many cases also the sellers want to get the deal done as soon as possible so one of the things that you see for example is um I don't know if how how familiar you are with the process of doing um private Equity transactions but um it typically starts with signing an NDA then you get a um investment memorandum from the Investment Bank um then you submit an indication of Interest which is basically an indication of kind of the valuation range that you guys are that that you're interested in bidding for the company and then you're selected with a smaller group of people you're left on the basis of the valuation that you put um forth in your indication of Interest you're left with a smaller group of biders and then you have to make your final bid in the form of a letter of intent now the difference between a letter of intent and an indication of interest does anybody know what that is what's the core difference between a letter of intent and the indication of Interest a portion of letter of intent is binding once the once the LOI is executed uh I just make sure that I got that right Loi has two sections like Le the ones that we drafted the one section is a binding okay you portion of the other one of the Lo contract an indication of interest is say okay we'll probably you know we'll pay you this this for the business more or less a letter of intent is actually contractual agreement so there's a portion of it that is indeed binding and um the the the other important aspect of a letter of intent typically is that you have exclusivity meaning that nobody once they've both both parties have signed it nobody else you basically are protected to spend all your money on due diligence um to be able to uh work towards a closing without being outbid um in the process okay is that clear go ahead um so more and more they're you know like the bank and mckines of the world they sell like you know business with diligence two funds do you use that a lot or do do you do it absolutely and I mean these bus these businesses are around not because you know some some publicly listed Corporation needs help to uh uh you know to figure out what their strategy is going forward not only that but um these these all of these consulting firms have huge private Equity operations where they help uh people like us do do dig work and in fact what they do uh Bane does uh growth and strategic analysis type of opportunity you say okay we have this company it's grown 10% uh the 10% % kager over the last five years okay pretty good growth numbers it's a $500 million in business how can we take this business from 500 million do in revenues to billion dollar in revenues over a period of five years okay and what are the problems so we hire Bane to do a whole analysis and figure out and do a very very precise and careful analysis uh on on you know what the likelihood is and to mitigate some of the risks there um and and and to to ensure that we have a good plan Place go ahead uh back to this the growth I don't know if this is within growth and strategic analysis but uh consolidation is a common uh type of thesis you'll have in private Equity uh do you when doing a consolidation play such as this that depends on multiple Acquisitions do you how do you go about understanding if it's actually feasible if those owners will sell uh if you actually have a chance to get it's it's a very good question and consolidation plays is is there's a lot of jargon in this business and a lot of kind of oh yeah consolidate we're going to do a consolidation play in this industry consolidation plays are incredibly incredibly difficult to do and a lot of them fail um and I'll get to that in a minute there's so many things that you can diligence on a lot of your Consultants work by the hour how do you think about whether that marginal dollar or marginal hour of time should be spent or is this enough we need make a decision well that's the art of what we do and no it already is and that's a very good question I mean why should we be spending you know $500,000 on Bane to put you know a thick report together of something that we could probably do ourselves well we couldn't do we definitely couldn't do it as good as Bane does it um what I've what I found out is is typically if you're managing a process like this where there's so many moving elements and there's so much to think about it is typically better to have more due diligence information than less and and and because what you're getting is really you're getting on one particular aspect of the transaction an outside opinion and you can disagree with them and by the way we often disagree with our consultants in these deals we often disagree with our uh with KPMG on a report that they put together we we we disagree with Bane we disagree with um our our Consultants our operating advisers on these particular transactions um but but it does uh in the end mitigate some of the risk and it doesn't leave it what it what it what's very important is that it it it leaves you with a situation that you're not caught by surprise uh and things will never work out in the way that you actually expect them to to there's always something in a particular transaction after the trans after you've done the transaction that it doesn't just didn't work out the way that you expected it to or um you come up come up some sort of surprise happens in the transaction that you didn't expect by doing the due diligence and covering all of these aspects and working with people who already know what they're talking about and working with people who are very thorough and give you outside opinion you mitigate some of the risks and um you eliminate some of the surprises go ahead question part of diligence is also done to get the lending community over some of the hump yeah to understand some of the risks can you comment on how that's changed from their perspective post the crisis so are they looking more for deeper business reports or deeper analysis yeah it's a it's a very good question and it has changed actually um I would be amazed sometimes in kind of 2006 2005 how easy the banks were and um just as a little sideline the the use of Leverage in these types of transactions is a dangerous game right you're playing with fire because the more leverage you use the the the thinner the margins are between being able to service the debt um and your and your cash flows and if you get it wrong and if you caught and if you haven't done your due diligence properly you'll find yourself in a situation that you don't have sufficient cash flows it's as simple as that you don't have sufficient cash flows to service the debt right and you blow through your covenants and it all gets very very ugly very very quickly right because the banks will have you uh by the nuts and they it's it's really an unpleasant experience I mean I've been through it and it becomes a very very nasty game because the banks are basically I mean you know you have good Banks and you have bad Banks but you know typically if you really over lever the transaction you really get into into into serious problems um in kind of 2005 and 2006 I I was amazed sometimes how easy the banks were and how laconic they were with respect to financing transactions it was amazing I mean they were throwing money at you and I actually uh and believe it or not we uh did a number of transactions um whereby we went back to the banks and said well thanks for your offer in leveraging this at a four times leverage multiple but we'll only take three and they couldn't believe it they said well you should take four you know we're offering you four why you wouldn't you take it and by the way 95% of the private Equity firms would take four um so this this the the and the banks were were laconic with respect to and bad in their due diligence process they basically kind of followed the lead of the private Equity firms and kind of towed to the line of what the private Equity firms were telling them that has changed now and um you know the banks are becoming smarter about who they lend to who they work with from a private Equity perspective and how thorough their due diligence is and uh the banks what happens is the banks work with a combination of the work that you provide them so it's sometimes good I mean if you want to get a bank on your side it's good to have you know a thorough Bane report and a thorough KPMG report and a thorough management report done by uh uh um um a uh Human Resources firm and and um you know a thorough environmental report because it gets the banks over the over the over the hump to to lend you a large amount of capital for the transaction so it has changed and the more thorough that you're due work is the easier the process is okay go ahead Banks still uh the banks are still relying on on your of your due diligence or are they trying to get themselves into the data Eng their consult well I mean you have the banks have have have three sources of information right they have the information that they get from the investment Banks which is usually worthless I I hate to say it I don't know who's an investment banker here there you are so we're we're typically Erica and and don't but we're we're you know we take the cim and we love kind of like um getting on the phone with the investment bankers and kind of saying well that doesn't make sense or you know I'm really kind of grilling the investment bankers um but if we didn't start there where would you end up of course of course so um and and by the way there are definitely um I'm making a grow jaliz but but there are definitely investment banks that do really really great jobs and it's not actually the big investment Banks necessarily that do great jobs in putting cims together there are some smaller investment Banks like Middle Market investment banks that are incredibly thorough incredibly reliable in the information that they give us so the bank the banks work with three sources of information they work with materials from the Investment Bank um and the due diligence material that the Investment Bank puts together for the debt providers as well as the um private Equity uh as well as the buyers and they work with materials from the private Equity firms and in some cases if the bank is thorough they do their own due diligence work but it's very limited and it it doesn't cease to amaze me how limited um the work typically is from uh from the bank you know they get on the phone um they take all the material in they do their own analysis but they don't spend money themselves on doing their own due diligence work typically they don't go ahead I mean each fund has its own way up to a business and is there any item your check list that's like black or white just it's an overal like for instance if you don't like management you can go like oh change management orsone else there there an item that's very sensitive or that are more sensitive than the rest well in your way of doing business well what we um one thing is that we stay away from kind of the financial engineering trickery okay so doing overpaying for businesses and using High of Leverage and kind of thinking you know what we can wing it um we stay away from that type of stuff and that's kind of a Traders mentality to doing private Equity it's like buying an asset just for the sake of buying it and and assuming that you're on kind of the growth curve and thinking that you can flip it in two years a lot of transactions were done that way okay so you buy a business for 10 times and you'd use a a seven and eight times leverage multiple in the transaction and think you know in two years we can sell it again because we're in a high growth market and you know a a exuberant uh uh m&a market and as long as we stay on that growth curve we can make money that way we've stayed away from those types fortunately stayed away from those types of transactions what we do is we really focus on the operating side of these businesses we have about 60 to 70 ex CEOs of major for Fortune 500 companies ex CEO of Coca colola ex CEO of um um ipco ex CEO of uh Campbell soup uh uh ex CEO one of the largest uh um spare uh Aerospace and defense spare parts type of business um we bring these people in in an advisory capacity to transactions that we do in particular sectors so we're very very kind of strategic focused operating focus and we want to buy businesses to create bigger better more profitable businesses so um we're not in the financial engineering game we're about supporting actually and you're talking about management supporting management teams to take a $500 million business to a billion dollars in sales and how do we get there and then support that growth plan with an equity infusion now uh as far as management is concerned you have to do your due diligence management because particularly in the Middle Market sector if you get it wrong um with respect to man management it is a huge headache to change management in the process I've actually just bone gone through one in one of our portfolio companies and thank god it worked out fine but we made a mistake we did not do thorough due diligence we actually did not hire the people that we should have hired to do an evaluation of the entire management team and we thought you know what that's I think these guys can can do it and and turns out they couldn't and we had to change management we had to change the CEO and it was a huge problem and you know it's incredibly destabilizing to a business if you're doing if you do that to a a five billion doll business or 101 billion dollar business it's different because there's a huge organizational structure typically in that business that is very very difficult to destabilize so the CEO you know maybe it's you know people talk about it but it's not going to be incredibly destabilizing to the business if you're dealing with a $500 million business it can be and you know there's some magic between the whole management team and the whole operations of the business if you change the CEO then somebody else leaves the CFO leaves because they were friends and you know before you know know you know before you know it you have a big headache on your hands go ahead so just I'm just curious as to your Vis and your experiences and how you evaluate management it seems to me to be one of the most toughest parts to really get your heading uh I'm just curious as to what guidelines you follow or what you suggest in order to make sure you don't make you a bad M well I mean the easiest thing is is just to look at their their track record right so what type of businesses have they managed in the in the past and what happens is what you typically find is that the management team of a of a $500 million business um that you look in their past and they've been there for 15 years and they've grown the business from $100 million to $500 million but can they manage A2 billion doll business and the answer is probably no unless you um give them a lot of guidance and sometimes we do that so sometimes we make the bet on the CEO or the CFO for that matter but when we give them a lot of after having run the reports and and after having these due diligence people come in interview them and making an assessment of their uh core um um abilities um sometimes we need to complement their skill set with adding all other people or in some cases even giving them trading as we go through the process so so the and you know the the firms that do these types of reports uh and these are the typical head hunting firms that have also a p whole private Equity um uh business to their to their services to their consultancy services they do these types of evaluations and they come up with a whole report and they say well we think that this CFO has these types of skill sets but if uh if um if you want to get um take this business if you were asking us if if he can manage A2 billion dollar dollar business um the answer is uh is no but there are some solutions that we can provide rather than actually changing out the CFO okay any other questions all right so uh that's the uh a quick quick overview of kind of the the the the due diligence work that we're constantly uh faced with on a day-to-day basis and how incredibly important it is we started doing some research and we said wow this this Optical retailing business in the in the United States is huge it's like a 20 billion Doll Market it's a very cyclical business um the uh incredibly competitive business but dominated by LensCrafters and Pearl and then also later on by Walmart that have you know if you walk into a Walmart you have these you can buy a pair of pair of glass you can actually have your eyes checked and walk out of there you know spending $60 or so and you have a pair of glasses um uh iare Centers of America is another huge uh uh consolidator of kind of mid-market optical uh retailing stores in in the United States um L these stores are typically very large with an eye doctor on on uh on the premises and um fairly low average ticket price and actually this this has gone substantially lower also with the Advent of Walmart and sales per square foot of about $400 per square foot um um and these businesses were typically kind of high volume type of businesses with low margins low store EA margins okay so not really an attractive business you know it's very competitive why why the hell would we want to get into this so but then we did some more research and when we looked at the luxury Optical will be uh retailing sector there was a subse segment of the of the optical retailing business here in the United States also in in Europe for that matter where um it was a very small sub sector was about $400 million in sales only 3% of the total Market um very fragmented ownership there were these mom and pop type of Stores um very small type of boutiques very high sales per square foot um and the very high average ticket price and Incredibly high gross margins okay so these were mom and popop operations that were selling CER and kind of proprietary these very small proprietary Brands and people were walking in there and spending $1,200 for a pair of sunglasses okay so or or spending $2,000 for you know gold rim diamond encrusted special zece lenses type of uh glasses and um very high store IA margin and also what you notice is that these businesses were non cyclical um uh that the people that frequented these stores were true luxury uh buyers that would buy um were willing to spend uh High dollars on these fashion accessories what would have already become and um and regardless of uh the macroeconomic conditions these stores typically did well so said okay kind of interesting opportunity so we started getting intrigued about this opportunity by looking at the industry um and the competitive set and we said well you know what this could given the fact that there's such a fragmented ownership this kind of reeks of you know potentially an interesting consolidation play opportunity okay so what are the car who asked a question about consolidation play earlier okay Carlos so what what what are the characteristics of a good uh consolidation play uh uh opportunity what does it mean in consolidation play why the hell would you go through a cost consolidation play uh generally you have to believe that well first putting together these individual assets that you'll have more advantages bringing them together either from the cost side or Revenue side okay so there is value to add to consolidate the industry um but what what so what just be specific so what what kind of so you're consolidating these businesses whe regardless of the industry what kind of benefits you have by consolidating them so you can have um in terms of suppliers so you can have just one centralized negotiation with an important supplier okay uh you so what does that do reduces your cost of good sold right um you can have lower marketing cost because then you can have a unified brand and you can so you can hit same number of customers with only one grand uh else what else so Us in marketing said Gross margins marketing what else benchmarking within the store just like knowing what works and what doesn't work okay you you mentioned something also Revenue so you can transfer best practices yeah and has incre overall Revenue so best practices gross margin marketing what else and you reduce competition right you can get your back office in terms of GNA cost you can really reduce that there's a huge amount of Leverage um and just I mean there's an intangible aspect of it which is just by having more of these stores located everywhere and you create a brand awareness that potentially leads you to to be able to charge higher prices okay all right the the the thing you have to realize with consolidation plays that bigger is not necessarily better with consolidation plays it makes businesses more complex you really need to know what you're doing the the whole the opport unities that we were just talking about are not necessarily always there and in fact in many cases are not but in this particular case in and particularly in the retailing business and the luxury retailing business and luxury op Optical retailing business we kind of discovered by doing the due diligence that we were doing that you know what this actually meets all of the um aspects of what good consolidation plays really about it's a large fragmented Market they're no dominant players very important there are so many consolidation plays that have been done here in the United States and in Europe during the last 20 years where they do consolidation plays while there are a couple of dominant players in the market why the hell would you do that oh no just because we can be create a bigger we have a bigger share of the pie well but if you're doing that with a dominant player in the market you're dead in the water so consolidation plays are actually in the in the true sense of the word they could uh should be done when there's no dominant player in the market when you have a fragmented market and by consolidating that you become the D the the dominant player and the biggest player in the market in this business it turns out if you really looked at the luxury Optical retailing business as a Subs sector from Optical retailing business because these two businesses the midmarket type of business had actually nothing to do with each other it sold different products it was a whole complete different game so you could look at the luxury Optical retailing business as actually a business that is a business as its own and by doing the consolidation of a bunch of these operators you could actually become the dominant player in the market okay so very important um not to do consolidation plays with our dominant players because there's no point um so consolidation will create an immediate market leader a large um uh the other thing is is to find um acquisition platforms that are relatively large meaning doing consolidation plays with hundreds of little players can be an absolute nightmare because the process of actually consolidating companies is very complex very very difficult and um um the sum of the parts uh you end up with a with a with a with a bad business um that that that um has um uh uh is virtually like creating a new business um inefficient Market very very important very very hard to find typically these businesses that operate in these businesses know everything about each other okay so it's very hard then to do a consolidation play because they all start talking and when they start talking what happens what's what's what's the problem of having a very efficient market and trying to do a consolidation play in an efficient market what time start with each other exactly they start they start talking to each other they literally pick up the phone and say hey were you approached by these guys yeah so was I so you start colluding and it happens trust me it it happened to us it happened to us in this situation so now it didn't happen in in such a bad way that we couldn't do the deal but um okay gross margin opportunities have to be clear cost of good sold opportunities there are many consolidation plays that are done and people talk about um consolidation about uh cost of goods sold uh opportunities because we're bigger player and we can go to the suppliers and we get bigger discounts well if there's a dominant player in the business you go to your suppliers you say well so what I don't care if you you've got you know I don't care if you're double the size or triple the size um you know you're still not my most important customer and the discounts that you're asking for you're not going to get them and end of story okay because it's actually one of the most important aspects of the consolidation play that you have immediate gross margin improvements okay um economies of scale and operating expense opportunities clearly by consolidating businesses you need to have a clear and wellth thought out plan and you need to have done your due diligence and get people involved that really know what they're talking about when it's when you're discussing operating expense improvements and um uh benefiting from the e economies of scale such as um sgna uh um um uh opportunities when consolidating all these businesses on the One Roof because if you do it badly it actually ends up costing more rather than less okay just kind of curiosity in the look luxury Market how do you kind of press the supplier that where their brand is also extremely important and where you already have kind of a 65% gross margin because in this case by we were betting on the fact that we would become the most dominant player and I'll get into some of the aspects uh as to why we were the most dominant player after the consolidation but take Cartier for example right they have they want to be in the highest end stores in the United States well there are only a handful of them you know they 10 kind of major cities here in the United States they may have you know one or two kind of really high-end stores and CER wants to be in those stores if you own all of those stores trust me they'll talk to you okay go ahead go yeah one question um one of the most important issues in the luxury business is Inventory management and when you have much bigger scale it's much easier so how do you factor this in your analys if if gross margin is not possible to improve through this scale well gross margin is is possible assuming assuming assuming you'll get just a little bit uh I'm not sure to what extent the fact that you have a big scale kind of helps your invest see this and I'm asking to what extent is okay I'm going to get back to your question because it's actually the most one of the most important aspects of this deal that we discovered why we're doing due diligence while we're doing the financial due minutes H 20 minutes that's it okay all I'm talking too long and too much all right so the what we uh I'm going to skip this you already understood that this was a a consolidation o opportunity uh you guys have done this a 100 times Porters 5 forces analys analysis don't forget it's really important it really is it may may seem mundane but we do this stuff every single day bars to entry supplier P buyer P relationships with suppliers and you'll see down the line that it's a very important uh aspect in any case when we uh Financial due diligence so we look at the balance sheet income statement and the cash flow statement of the business obviously and um in uh one thing not to forget is who is doing really the financial statements there are thousands of privately held companies in the United States uh large companies that are un audited okay so who's ready doing the financial reporting if major major red flag if they don't have audited numbers uh Beware and get some really really good uh accountants to do the financial due diligence for the firm because you'll find a lot of mess and a lot of problems in those books and you'd be surprised how many companies are out there that don't have large companies uh that don't have audited financials okay um in any case when we're doing the financial due diligence uh of this business and when we were looking at the balance sheet um we discovered some interesting things um you were talking a little bit about the inventory um the biggest asset in this business this is uh is obviously the in inventory right this we're not talking about a steel steel manufacturing plant that has huge amounts of assets and um needs um a large amount of assets to generate its cash flows and its profits this business um the the only asset the only real asset that the business has is really apart from some intangible assets is really the um the inventory now turns out unlike the uh Middle Market sector uh um or the the the the um the mid-tier kind of optical retaining business is the way that these guys were financing their inventory was incredible I I I couldn't believe it when we were doing the financial D due diligence we discovered that these guys had 250 to 300 days payable outstanding on their balance sheet what does that mean what exactly so they're basically getting their inventory for free until they sell it it turns out that the luxury Optical retailing business has this kind of age-old um business practice that you buy the inventory but you don't pay and you don't pay unless you've sold it so these guys all had we started looking at one for the next acquisition Target and turns out that all of these guys are in the same situation we couldn't believe it they all had like 200 250 and we would ask them said well why haven't you paid your bills I said no no they never bother us okay great so we these um so what essentially was happening is that they were buying the inventory and they weren't paying for it not only that if they didn't sell the inventory Within 250 days they would literally get a box they would wrap up the Cartier frames put a big sticker CER srl wherever it was and send it back and they get a credit go ahead so that's obviously an attractive thing but I would be worried about that as a buyer because um you know if they figure out that they own the inventory and it's just a matter of finding a customer then I would think that there would be a lot of uh potential for competition from web- based um you know e-commerce sites that could sell that inventory for them in other words it would sort of disintermediate the retail no because this is such a high-end type of uh business um that the inventory that was taken back by the by the suppliers was actually destroyed go ahead to adan's point actually there's another risk factor which is if the industry practice starts to change then your working capital most like P froms like try to include the working capital uh margin over time but if the suppliers start pushing down the AP days from 260 to 250 to 200 that would have that can have an immense impact on the cash flow of the business yes so that would be a risk factor and you know what you hit the nail on the head because this is what happened so we went through all this financial due diligence and it's in the interest of time I'm not I can't go through all of it but you kind of identified the key um aspects of this um this we were going to do this consolidation play where we're going to have substantial benefits from a gross margin perspective now just one little side note here it's very very difficult to predict what those gross margins are going to be because you just don't know right so in your financial models and your kind of predictions of where the business is going to go you don't really know so here again the due diligence and getting expert opinions and getting outside information and outside opinions in this whole process is very very important to narrow it down and that you really um m miate as much as possible some of the errors that you're bound to make in making these predictions in consolidating you know 10 or 20 of these businesses so uh but we were pretty comfortable that we were going to get these gross margins improvements and in fact we did we got we got our predictions pretty right from a financial perspective we had KPMG in there we did we we didn't find any red flags and if we did find them we kind of dealt with them we did a very very good transaction we negotiated very very cleverly it was a beautiful transaction so in any case I've kind of jumped through this uh this whole due diligence process but um the the point I'm trying to get across is is that when you do your due diligence work and people have the tendency to think oh it's all about financial due diligence it's not it's due diligence really is a much broader concept it's understanding the business understanding the environment in which it operates and truly um understanding the business's operating model and the people that are managing your business and if you think of due diligence in that concept and you get the right people involved because you can't do it all by yourself there's no way that you can do it by yourself because ultimately what we do is we are the managers of this process we lead the process we are the the the leaders of this team of you know 40 50 people that are working on a particular transaction that all know really what they're talking about and and putting all of those pieces together and if you look at due diligence from that perspective and not think about only the financial due diligence then you're on the right track and and it will mitigate uh some of the risks and it will uh ensure that you don't make big mistakes that you're inevitably going to make in this business and you learn from your mistakes um so we talked about the management and by the way just we had brought in into this transaction a an incredibly smart guy uh Bernard Andrews who's the former CEO of IA Centers of America which was one of the largest players in the midmarket type of sector and he was incredibly valuable to us in how we structured this transaction um this was I was just talking a little bit about how we projected the business going forward how we were going to grow the business it was a combination of organic growth and new store openings and also um Acquisitions we did a very thorough uh analysis of the exit uh considerations for this business uh there were a lot of strategic buyers in the sector um that were very interested in buying a Consolidated platform and that remains True to this day um and uh we still haven't exited this opportunity but um we will uh someday soon here are some of the uh the comps that we ran at the time um okay in the interest of time I'm going to skip forward and um just talk about two uh last things um when you do a uh leverage buyout Transaction what are kind of the key and I really want to leave leave leave this with you um because this is really so important the whole structuring a leverage buyout transaction is not that uh or let's say the concept of the leverage bio transaction is not that that complicated um you're leveraging cash flows you're buying a business leveraging there by leveraging uh leveraging the cash flows um but what are what are the four key drivers of any leverage buyout model what are the four key drivers of your irrs tell me I TR to think of five but I'll try to put four one is sales growth second is profitability yeah third is free cash flow conversion fourth is leverage and then five I think is multiple orbit okay uh right now what what are the what is the single single most important one of that of those five growth what generally operational growth because that gets multiplied okay but what does that lead into Ted yeah okay just mentioned back sorry um of these of these four you mentioned five um what is the uh well they're correlated um what is the single what what's the single single biggest driver of you return of your irss I mean if you're doing a leverage buy up model and you're playing around with the numbers when you look at leverage that's generally a onet to one gain when you look at the growth in your free cash flow right there's a multiplier effect to and so that's really where the growth comes from your operational growth I would say it's multiple Arbitrage okay where the G listen if you have the discipline of buying companies on the cheap and really being disciplined in that sense it's your single biggest driver of your returns and um what I'm trying to leave with you guys is just do yourself a favor and don't overpay for businesses because if you overpay for a business you're going to be stuck with it for years and even if it's a good sound cash flowing business you uh you try and sell it and you're still going to be disappointed with the returns of the business because um you overpaid for it and multiple expansion and multiple Arbitrage uh by creating bigger better more profitable businesses and by really doing some hard work and spending the money on improving the business and really making a great company out of it that's where you really get your multiple expansion because people want to buy great businesses people will buy great companies people will buy companies that are well-run and if you find companies that are run so so and you can really fix them and improve them and make them bigger and better you're going to make a lot of money in the whole process and