In this podcast, Peter Lehrman, CEO of Axial, talks about:
- Biggest challenges facing business owners contemplating the sale their business;
- How business owners can go about finding credible M&A advisors;
- How much time entrepreneurs should spend networking with M&A professionals;
- Obstacles that dealmakers face in completing transactions; and
- Trends in compensation models for investment banking fees.
About the Guest
Peter is CEO of Axial, responsible for driving the company’s vision to be the trusted platform where private companies connect with capital. Prior to Axial, Peter worked in private equity at SFW Capital Partners and was part of the founding team at Gerson Lehrman Group, where he helped build the company’s dominant global technology platform for on-demand business expertise. He earned his undergraduate degree from the University of Virginia and received his MBA from Stanford Business School.
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Read the Full Transcript Here:Noah Rosenfarb: Hello everyone and welcome. It’s your host, Noah Rosenfarb, the author of Exit: Healthy Wealthy and Wise here today with Peter Lehrman, CEO and founder of Axial. Peter is responsible for driving the company’s vision to be the trusted platform where private companies can equity capital and he’s got a depth of experience working in private equity and as an entrepreneur so Peter, real glad to have you with us.
Peter Lehrman: Noah thanks for having me.
Noah Rosenfarb: Well, Axial is really interesting and coincidentally, our last guest on the show was mentioning your company. What gave you the idea to start Axial?
Peter Lehrman: Axial was born out of two experiences that I had. One as an investment professional and the other as prior to my career as an investment professional actually helping my brother who is an entrepreneur himself, he co-founded a company in the late 1990s. The company went on to become quite large, quite successful, quite profitable but had tremendous challenges finding the right financial partners both in the early days as well as in the more mature stages of the business’ life. The business was growing pretty quickly. The business was quite profitable very quickly and I found it very surprising how hard it was for us, for my brother and for his co-founder and for the rest of us who are at the company how hard it was for us to actually go about finding the right financial partner and the right capital partner for each stage of developing the business.
So I had two experiences, one as an operator working alongside my brother and that team there, the company grew from a few people to 500-600 employees and despite that growth and that success, it was still very, very laborious and very, very complex to find the right partners and then I spent some time working as an investment professional at a middle market private equity firm. I realized as part of that chapter in my career that the most challenging part of the entire investment process for a private equity firm is finding the opportunities. It’s not the financial modeling. It’s not the valuation work. Those are all very important and required aspects of pricing and underwriting investment opportunities appropriately, but the hardest part and the part that is the most difficult to solve for is actually the process of finding investment opportunities and so the combination of entrepreneurs struggling to find the right partners and also then seeing how hard it was for investment partners to go about finding the right entrepreneurs which made it very clear that sort of a matchmaking network that could sit in between the two could be very viable to both sides.
Noah Rosenfarb: And so the technology is what’s making this possible or is it just the time and scope?
Peter Lehrman: Technology is very important because it helps people connect with one another more intelligently and it allows data and information to be part of the way in which Axial as a platform helps entrepreneurs access capital and access capital partners as well as access brokers and advisers who can represent their interest. If you want to do it on a very small scale and you want to work with only a couple of companies, you can do that long hand. You could do that with pen and paper, some online internet research, and maybe a spreadsheet. If you want to help lots and lots of companies, you want to help thousands of companies access capital market, you want to help thousands of companies access the right advisers and the right brokers to represent them, technology sort of makes its way into the business model at that point. At the core of Axial is actually a recommendation search engine, not that different from Google search engine or online travel website engine like an Expedia or a KAYAK, and it helps the entrepreneur privately go through the search process of identifying both capital partners as well as advisers who can meet their needs.
Noah Rosenfarb: How does the business make money?
Peter Lehrman: It’s 100% subscription based business and so we have both members on our network who are using our free tools and then we have members on our network who are using our subscription based tools. From a business model perspective, the simplest analogy that most people tend to understand is LinkedIn where a certain percentage of the functionality is available for free. You can have a profile, you can search the network, but if you want to connect with people, if you want to message with people, if you want to manage process from start to finish, those are paid tools on Axial similar to paid tools on LinkedIn. Obviously, LinkedIn is focused on jobs and Axial is focused on helping private companies access capital markets but the business models are similar where a portion of the user base is using our free tools and a portion of the user base is using subscription based tools.
Noah Rosenfarb: So my clients that are thinking about selling their company and they are trying to interview brokers and figure out which investment bank is best to represent them, they are always concerned about confidentiality. How does Axial play into that?
Peter Lehrman: Well, I think confidentiality is obviously crucial when you’re selling a business. I think it’s one of the things that distinguish selling a business from selling real estate for example, which is a much more listings oriented business model. Axial operates as a private search engine. If you are a business owner and you log in to Axial and begin to use the search tools, that entire experience is private and all of the recommendations and all the information that our product makes available to entrepreneurs is, you know, that’s all it is. It’s information. If they decide that they want to then reach out and connect with a broker, connect with a banker, or connect with a capital partner, they could do that but the process of using the tools that we’ve built to just search for and gather information, those are all private and confidential searches. They are not subject to being publicized or anything. With the way that we set up the privacy model is at the end of the day, the entrepreneur decides when they want to reach out and connect with someone and if they decide not to reach out and connect with someone, it just remains a private search.
Noah Rosenfarb: And then on the adviser side, if I have a listing, you know, I’m representing a manufacturing business in South Florida, what can I share with the other members?
Peter Lehrman: You have discretion over that as well. So really, if you’re an adviser and you are managing the process on behalf of a client, you are representing the business, you are the one in charge of sharing information on the business and the desired outcome from a transaction, you can present that information to a number of different recipients on the network. You can present it only to people that are interested in manufacturing, you can present it to everybody who searches for manufacturing opportunities, or you can actually decide specifically who you want to share it with. I only want to share this opportunity with the following seven strategic buyers or the following four private equity firms, or the following family offices. So there are different tiers of information sharing and the tiers are essentially chosen by the business owner in partnership with their adviser. So you want to run a very broad process, you want to share the opportunity with everybody interested in manufacturing, you do that. If you want to run a very targeted process and only share it with one person on the network, you can do that too.
Obviously when you’re selling a business, we’ve never seen a business where the success in terms of selling the business or financing the business wasn’t in some way correlated to the quality of the process and the quality of the outreach. If you only reach out to one organization, you only reach out to one or two people, the likelihood of a successful outcome is much, much lower just because there’s always some conversion funnel on these processes. If you reach out to 10 people, probably 3-5 of those people of genuinely going to be interested and then maybe 2-4 of those are going to get even more serious. So you have to be thoughtful about how many people you reach out to at the beginning knowing that at the end of the day, it’s difficult to get a significant number of highly qualified buyers to compete for the business at the end of the day.
Noah Rosenfarb: What do you see is the biggest challenge right now for the owners in the traditional model of, you know, they get the phone call from the investment banker that’s calling a list of thousand of entrepreneur and saying, "you know, you’re thinking about selling your business." They invite them in and then they hire them, and then there’s an offer sheet and then there’s a book that goes out and then there might be an auction process. What’s wrong with the process now? What’s broken?
Peter Lehrman: I think the challenge with that process is twofold. There hasn’t been a well codified approach for entrepreneurs to evaluate the suitability of one investment banker or one M&A adviser versus another. It’s not common knowledge among entrepreneurs historically. These are the questions that you need to ask. This is the way to structure your fee agreement. This is the way that you want to think about doing reference checks. There isn’t a large and well established body of knowledge that is advising and guiding business owners on the selection process for an investment banker. Because it’s such an important decision and because you’re going to be, as the owner, you’re going to be selling the most valuable asset that you’ve developed in your professional career, you don’t want to make the decision with real scarcity of information or real scarcity of best practices.
The two things that are potentially broken about it are there’s a limited amount of information and best practices that are out there on how to go about identifying and selecting and interviewing different investment banking candidates and then there’s also a limited amount of information on just the standard evaluation, the means by which to evaluate them. The websites from one investment banking firm to the next are all highly variable. Some have really well developed websites, others don’t. Sometimes it’s difficult to obtain unbiased endorsements, testimonials, or references and so it’s just challenging when you’re making such an important decision to not have both the information on the efficacy of that investment banker and their history of successful transaction. It’s also hard to sometimes network and find the right ones. A lot of times, business owners don’t know who the best investment banker is or who the top 5 investment bankers might be for them. They really are just responding to inbound.
You can get lucky. You can have exactly the right adviser reach you as the owner and do a great job, and that’s’ fantastic but it’s a very important decision. There are a lot of chips that are going to be on the table so you want to set up tools and resources that help give you the best chance of making a good decision.
Noah Rosenfarb: What do you see as the major changes that we’ll see over the next 10 years in the way the owners are selecting the banker? How much education do you think can be learned in this next decade?
Peter Lehrman: I think a fair amount. I mean, we have sort of one message for owners at Axial which is that every year, you should spend 10% of your professional time developing relationships with investment bankers and potential capital partners for your business. The reason that we recommend 10% broken up into the four quarters of the year is because we found through some survey work and some survey research that we did of business owners that the majority of business owners are spending less than 1% of their time on it even though it is a very monumental set of relationships and very important set of relationships that they need to have when it comes time for them to finance their business or sell their business. It will really make a big difference if owners have those relationships before they really need them.
So we have this one message which is spend 10% of your time each year developing relationships with the investment banking and business brokerage and capital partner community and do it before you’re anticipating a transaction or a business transfer or an exit. It’s a reasonably straightforward message. We’ve been championing that message in social media, in webinars and podcasts that we’ve hosted, in speeches and presentation that we’ve been giving in different entrepreneurial communities and I think that just speaking with a simple message like that where as the CEO of your business, you spend 10% of your time focused on developing these relationships, I think that that’s something that can easily sink in over the next decade.
I’d say the other thing that will change over the next decade is I think that more and more information on the quality and the appropriateness of a given investment banking professional or a given private equity or a mezzanine landing professional, I think more and more of that information is going to make its way online and that will make it easier and easier for business owners to do private online research on these professionals that they ultimately invest a significant amount of trust and a significant amount of their life’s work in. I think the only thing that will change over the next 10 years is more and more of that information will get codified and that will create tremendous opportunities for the best investment banking professionals, the best boutique business brokers, the best private equity firms because their reputations will be amplified online and the professionals who have done a less satisfactory job partnering with an advising business owners will probably have the less satisfactory job that they have done amplified online as well.
Noah Rosenfarb: Does Axial aggregate any of those data points on number of deals retained, number of deals closed, average sales priced, average whatever else there might be?
Peter Lehrman: Yes, as an investment banker who joins Axial as a free part of your profile, you actually can detail all of the closed transactions and other milestones that you achieved as a professional. You can link to the CEOs and business owners who you have advised. So as part of the free profiling tool set, you can link to all of that information and make that all highly available. You don’t have to disclose the terms of transactions and stuff like that. A lot of times, that information is very sensitive but the profiling tool makes it easy for investment bankers to highlight the successes and the closed transactions that pays the adviser on.
Noah Rosenfarb: In all of my travels, one of the things that you said that resonated with me is the 10% of your time dedicated to getting to know capital partners and bankers. I have one CEO in my whole career that I’ve met that spend 25% of the time and he said, "I think that the single most important function I have is getting this business ready to sell for the highest price when the time is right and I do that by constantly meeting with people that have their finger on the pulse and are giving me data points so I can reference what is going on in the industry, what’s going on in the market, when is the right time for me to pull the trigger."
It was great to hear it and then on the flipside, I’ve had three clients in the last probably 60 days who have likely spent less than 1% of their time and they hired an investment bank that has a track record of closing deals based on some awards they have been given but when you talk to the people in the industry, they tend to say, "Well, they’ve got such a high volume of potential transactions that the closed transactions might only represent 10%. So if you could get their batting average, it might be terrible," and the league of owners, you know, they take that cold call, they go to the seminar, and there they are at the end of the day signing a listing where they are not quite sure who they are hiring. It would be great if we could solve that problem.
Peter Lehrman: Yeah I agree. That’s a really tough problem to solve obviously but I think that one of the ways to do that is to give entrepreneurs a resource on the internet where they can share information about their experiences with transaction professionals. The key challenge obviously is to design that community and design that resource in a way where the information is reliable, validated, and reputable, and it doesn’t turn into a sort of a community on the internet that’s sort of a pissing contest, for a lack of a better word. That’s obviously an important challenge and that’s part of the reason that we’re trying to be really thoughtful about it. Our general approach at Axial is to invite people to link to and to provide reference to their successful transactions because at a minimum, that allows entrepreneurs to pick up the phone and call those CEOs and say, "Hey, what was your experience working with this professional? What was it like having them run the transaction?"
But your point around the batting average is obviously a good one and I think that one of the questions that we recommend every business owner ask every investment banker who they are interviewing is, "Can you put me in touch with someone where you had a less than ideal outcome?" I think that that’s a really important question to ask because I think there isn’t a single investment banker out there who is great and is amazing in what they do who hasn’t had a deal go sideways for one reason or another. It just doesn’t, you know, deals don’t close 100% of the time. It’s just the way it is and sometimes, it has nothing to do with the investment banker. Sometimes it does have something to do with the investment banker. There’s a whole host of factors out there that can contribute to a deal going sideways. I think a reputable, confident investment banking professionals understand that. They are aware of that and they don’t hide from that. They are more than willing to make introductions to CEOs who they have worked with who have had a deal go sideways and they had to struggle alongside the entrepreneur to make the best of the situation.
Noah Rosenfarb: I’ve heard that 60% of deals that get a signed LOI don’t close. I know 62% of statistics are made up on the spot.
Peter Lehrman: I think the challenge there is it depends a lot on the market and the type of transaction. For example, when you sign a term sheet in the Silicon Valley venture capital community, when you sign a term sheet and the financial partner reciprocates and you fully execute the term sheet, usually in that world, the conversion from a signed term sheet to a funded deal is very, very high, very, very high. When you move into the private equity community, it tends to be lower because there tends to be a significant amount of due diligence that the private equity firm does after signing the term sheet. So then it can be and then the sort of percentages can be all over the map when you’re working with different kinds of strategic buyers with different kinds of diligence processes. I think that that percentage is a little bit misleading just because I think it varies so much based upon the community of investment professionals that you’re working with and the nature of the transaction and just who is on the other side of the table.
I would say that you really want to drive that number, as the entrepreneur, you want to drive that number way, way, way down because you really don’t want to be subject to something like that and so the key thing there for an entrepreneur is just everything that you could do to cross the T’s and dot the I’s before you sign an LOI you absolutely must do. For example, if you haven’t had your business financials audited and you don’t have an audited summary of your financial performance prior to signing a term sheet, that’s an easy win for an entrepreneur and if you don’t have it audited before the LOI, then an auditor comes in and does the work and they come up with a different financial analysis of your business that can really send things sideways, and that’s the kind of thing that a good entrepreneur who is advised by good banker, they are going to try and get those boxes checked before signing an LOI and going into exclusivity.
Noah Rosenfarb: No doubt. What do you think are the biggest challenges that dealmakers have like getting deals on?
Peter Lehrman: You know, some of that is obviously cyclical and I think some of that is just longer term changes and trends. I think for deal professionals, I’d say that there are a couple of things right now. I think there’s a significant amount of competition right now maybe more than ever that is the result of the private equity community significantly growing in terms of its size and the number of active participants over the last 10 years. In addition, you had a very, very low interest rate environment now for many, many years which creates real significant amount of appetite from lenders who lend against cash generating companies. We have a significant growth in the size of the industry and that just creates more competition. You also have a very liquid debt market which is able to increasingly lend that higher and higher thresholds and for lower and lower prices, and that just all creates both valuation expansion and multiple expansion for entrepreneurs.
It’s a good thing obviously for entrepreneurs who are selling their company but it makes it difficult for any given private equity firm or corporate buyer to be the winner for that sort of one challenge. I think there’s always a challenge in the deal business there’s always these sort of peaks and troughs between feast and famine where all of a sudden, he’s got two or three or four live deals all at the same time and you figure out which one you really want to pursue and which business owner you really want to work with the most. The deal business is not a business that scales up in a very easy way. You can’t do hundreds of financial transactions a year as a small investment banking brokerage or private equity firm. These are really, really time intensive transactions.
There’s always this feast and famine where you go way down the line as a banker or as an investment professional trying to get a deal done, spend a tremendous amount of time on it then for some reason, it falls through and meanwhile, your business development pipeline has completely dried up because you’ve been spending 110% of your time trying to get a deal all the way across the finish line and sometimes it closes but sometimes it doesn’t close. So I think another challenge is how do you maintain a more predictable pipeline of deal flow as an investment banking professional or as a private equity or other type of investment professional given that when these deals go live, they tend to consume a tremendous amount of time. Really, the only way to do that is to have somebody inside your organization whose full time job is business development, right, and maintaining a pipeline regardless of whether or not the rest of the team is focused on live deals or not.
I’d say the third thing at least for the investment banking professional or for private equity firms that are selling their portfolio companies, I think it’s always very difficult to get the ideal set of buyers to the table and get them to the table more or less at the same point in time. There are a lot of buyers out there, there’s a lot of private equity buyers, a lot of corporate buyers, a lot of international buyers, there’s a lot of family offices entering the market and figuring out as an investment banking professional how do I get these different parties to the table? How do I get them to the table more or less at the right time and in the right time frame and timeline? It’s hard. It’s a lot of work. You’ve got to have a lot of relationships, and you’ve got to be able to orchestrate a reasonably well coordinated process and find that period of time. The more fragmented the market of buyers get, the more complicated it is to sort of bring in all the right people to the table. Those are the three things that we see a lot of our customers talking us about is those challenges and it’s a big part of sort of how to we think about trying to help them.
Noah Rosenfarb: You mentioned how difficult it is to get a deal closed and most bankers are relying on closed deals to get the vast majority of their income even though their effort may be spread out across multiple deals, some of which never get to a closing and never of which really remunerate them for their efforts. Do you see compensation changing over time for some, you know, more of an effort based compensation from a success based compensation or are you seeing any trends?
Peter Lehrman: I am not seeing any trends that are that radical in their nature. I think that it’s a really complicated compensation model to perfect. On the one hand, you obviously don’t want a tremendous, as the owner of the business, you obviously don’t want an investment banking professional whose interests are not aligned with yours but it’s a lot easier said than done to really create perfect alignment there. On the one hand, you want to make sure that you compensate them sufficiently on a retainer basis so that they know that you’re serious so that you get their attention but you don’t want to provide them so much economics in a retainer format that they are not as acutely incentivized to sell the business as you are as the owner of the business to exit the business.
On the other hand, as the owner, you want to be thoughtful about the incentive that an investment banker has to sell your business to anybody versus selling it to the right person because it doesn’t matter if the investment banker helps you sell the business for $10 million or $20 million. $20 million from one buyer is, you know, provided all the terms are the same, is the same as another but that’s not necessarily the way an entrepreneur thinks about it. An entrepreneur thinks about the company, the brand, the team, the employees, and the culture. Even if everything else is the same - the earn outs are the same, the purchase price is the same, the escrow is the same - all the things are identical, selling it to one buyer versus selling it to another buyer, it matters for an entrepreneur. It doesn’t necessarily matter from an economic perspective for an investment banker so that’s really tough part of the whole sort of economic system for investment bankers and business owners is getting that compensation aligned in a way that’s ideal and I don’t see business owners ever being comfortable with all of the economics going into effort based nor do I see them being comfortable truly on a success only basis.
I think the least imperfect system is the one that tends to be most used which is a portion of the economics are retainer based to demonstrate that you’re serious and then the lion’s share of the economics are associated with getting transaction over the finish line. I do think, Noah, that if transactions can become easier to do if the financial information of private companies becomes more standardized, more normalized, easier to understand, if the nature of the transactions and the way that they are structured becomes more repeatable, if company like Axial and other companies that are trying to help solve this problem too make it easier for both entrepreneurs and their advisers to find the ideal capital partners, I do think that you will have higher close rates and I think that you will have higher certainty of closed transactions. But you really need to get all of those pieces pulled together in order to have the closed rates go up. If the closed rates go up, then that really starts to really impact the overall profitability of the industry and that would be a very good thing, but there’s a lot of work that still needs to be done in order to get the private capital markets to that level of efficacy.
Noah Rosenfarb: Well, the time we have left, I’d love it if you could share some of the stories that you’re most proud of about what Axial solved for some owners and advisers?
Peter Lehrman: We’ve got two that I’ll talk about. With business owners, business owners down in Washington, DC runs a defense consulting firm. He’s actually a former senior ranking officer from the US Armed Forces and set up his own private defense consulting firm looking to add on another 20 full time employees to scale up his defense consulting and defense outsourcing business but needed to raise some substantial amounts of working capital in order to scale up that way in order to fulfill some of these government contracts and through Axial and through engaging both an adviser as well as set of lenders on the platform, he was able to triple his lines of credit, triple the dollar availability of lines of credit to scale his business. That’s a nice example of someone using Axial and not selling any of the business, just increasing the debt leverage of the business, have available to it but this entrepreneur was able to access that capital without actually selling any equity in his business and just accessing the debt capital markets more effectively.
Another entrepreneur on the network is, it’s interesting, this former investment banker from UBS, the Swiss Bank, and he’s building out a healthcare information business right now that provides information and informatics and data products to American hospitals. He raised an equity round of capital for his business using Axial and one of the major investors in the financing round ended up being a hospital. So that hospital ended up being one of his first customers in addition to being an investor. Again, when you make good connections with relevant people in your markets, all kinds of good things can happen from it. In this case, he not only was able to complete the financing but he was also able to get a very significant high lit customer on board through the network.
On the advisory side, this one is actually on our website. It’s actually completely public. There’s that boutique investment bank up in Boston named Progress Partners and their investment advisory services primarily focus mostly on technology companies. They joined Axial largely to see if they could build out a better pipeline of customers and they signed up a technology company in the Boston area that they have never heard of and signed up a new client within the first 12 months to become a member, so obviously, a very happy customer there. They signed up a customer and went on to lead a deal for selling that business. So we’re working both with the advisory and intern cases as well as in other cases working directly with the business owners.
Noah Rosenfarb: Terrific. Well anything else you’d like to share with the listeners before we end today’s podcast?
Peter Lehrman: I think the most important concept in my mind is this notion of entrepreneurs really understanding that the 10% rule is a really good rule of thumb. You should be spending 10% of your time as an entrepreneur developing relationships with investment banking professionals as potential sources of funding for your business because by the time you need the capital or by the time you need those relationships, it’s already too late. So if you are developing those with some sort of recurring predictability year in and year out, you’re just putting yourself at a disadvantage when you want to do something important with your business. That’s the most important concept that I just really want to hammer into the entrepreneurial community because I think it really will serve all of the world’s entrepreneurs really, really well. If anybody wants to get in touch with me, I obviously have a very visible online presence on LinkedIn and other channels. My email address is Peter@Axial.net. If anybody wants to reach out to me, I’d be delighted to hear from them.
Noah Rosenfarb: Great, well Peter Lehrman, the founder and CEO of Axial, appreciate having you on the show.
Peter Lehrman: Noah thanks so much for having me.
Noah Rosenfarb: For all our listeners, thanks for joining us, we hope to have you with us on a future podcast. Take care.