Podcast: What Private Equity Recaps Actually Do, an Interview with Mike O’Neil

By Ryan Tansom
Published: July 26, 2018 | Last updated: April 15, 2024
Key Takeaways

Mike O’Neil shares his industry experience working in private equity to dispell any misconceptions about what a PE recapitalization will do for you.



About the Host

Ryan is an entrepreneur, podcast host of the show Life After Business and the co-owner of Solidity Financial. Having personally experienced the hazards of selling a business, he joined up with his friend Brandon Wood to educate others on the process. Through their business (Solidity Financial), they provide a platform for entrepreneurs called Growth and Exit Planning that helps in exit planning, value building and financial management.

About the Guest

Michael O’Neill joined Stone Arch Capital in 2008. His primary responsibilities include sourcing, reviewing and structuring new investment opportunities for the firm. He also has experience in add-on acquisitions, debt and equity financing and supporting investment management activities from the board level.


Prior to joining Stone Arch Capital in 2008, Michael was an investment banker at Lazard Middle Market. While at Lazard Middle Market, Michael focused on mergers and acquisitions transactions within a variety of industries, including industrial products, oil and gas services, business services, food and agriculture, and technology.

Michael is a graduate of the University of St. Thomas (B.A. in Finance and History) and the Samuel Curtis Johnson Graduate School of Management at Cornell University (M.B.A.).

If you listen, you will learn:

  • Mike’s background in family business.
  • How he got involved in private equity.
  • Who Stone Arch serves and what they offer them.
  • Private equity customers are the investors.
  • How Stone Arch calculates the value of your business.
  • The importance of maintaining a positive relationship.
  • The 3 reasons people seek out private equity firms.
  • Establishing expectations on both sides of the partnership.
  • Why Stone Arch consults market experts before moving forward.
  • The process of “getting the second bite.”
  • The 3 levers that every business needs to pull to make their private equity deal work.
  • The importance of working with the right people.
  • Being in the business of creating goodwill.
  • Mike’s final advice for my listeners.

Full Transcript

Announcer: Welcome to Life After Business, the podcast where your host, Ryan Tansom, brings you all the information you need to exit your company and explore what life can be like on the other side.

Ryan Tansom: Welcome back to the Life After Business podcast. This is episode 103. Today’s guest’s name is Mike O’Neil and he is a partner at Stone Arch Capital, which is a mid-market Midwest private equity firm, and I wanted to have mike on the show today because he and I were on a panel together where we were talking about growth and exit planning and he was representing the private equity side and during his presentation he was able to describe in plain English with very good logic and math how the second bite of the apple works for the business owner. He describes how there’s three levers that need to be pulled once the private equity firm comes in and buys the company and how those three levers that are pulled increase the value of the companies significantly and allow that second bite of the apple, which is the equity that was rolled or kept in the company, could potentially be worth three times the original amount that was going to be paid out to the owner in that first valuation that was tied to the original purchase price. He also describes it very, very clear fashion what the risks are for the business owner from a personal standpoint, from the lack of control, potentially, from the management structure, where you are in the timeline of retirement and your ambitions. So I really hope you enjoy this episode and the clarity that Mike brings to the entire private equity recapitalization and second bite of the apple story. So without further ado, here’s my episode with Mike.


Announcer: This episode of life after business is sponsored by GEXP Collaborative. Their proven process gives you clarity on all of your exit options and how those options impact your financial success. Timing and future happiness, so your company on your time frame to the buyer of your choice at the price you want.

Ryan Tansom: Mike, how you doing?

Mike O’Neil: I’m doing well. I’m doing well, Ryan.

Ryan Tansom: I’m glad you’re on the show. man. You and I are sitting on a panel together a few months ago and I uh, I’ve seen a lot of private equity guys giving presentations before and you know, you’ve got some unique experience that I want you to share with the owners from different family exposures that you- family businesses that you’ve got and then you’re also in the private equity space. So I was excited to have you on the show because of how you explained your world and then the second bite of the apple, which I’ve talked about and had different stories on, but um, you know, for the listeners that aren’t familiar with you or your company, maybe give us a little bit of background on how you got into private equity and then the company that you’re working for.

Mike O’Neil: Yeah, no, that sounds good. I’ll give a really quick background myself kind of our firm and, and kind of my interest in this and then we’ll, we’ll certainly cover the second bite of the apple and all, all that stuff. So real quick, I grew up in a small town, Dubuque, Iowa, about 50,000 people. I came up to Minneapolis to, to school at St Thomas. I began my career originally as an investment bank, investment banker at a firm called Goldsmith, Algeo, Helms, they’re now Lazard’s middle market. Great experience working with entrepreneurs and business owners. Lazard’s full of just super smart, wonderful people, lots of close relationships still. It was a great experience. My interest in private equity and how I got into the space came from a background with family business. So my grandparents were involved in a chain of shoe stores called Orange Shoes in to give context in like 2002.

Mike O’Neil: Uh, they celebrated their hundredth anniversary of founding of the, of the company in Lacrosse. At its heyday, it was about eight stores in Wisconsin and Iowa. And when I was working at an, at an investment bank, I remember actually explained to my grandmother what I did, you know, and she just kind of looked bewildered, like why didn’t that exist when we were going through our, our situation. And so also I joined Stone Arch in the summer of 2008 after working three years is kind of a sell side investment banker. Really interesting place in that, you know, the Midwestern values-based private equity firm and we really view ourselves kind of almost as a partnership, private investment firm. We’re taking an investment anywhere between 51 and 80 percent alongside the management team and founders or, or current shareholders and just really great people. I spent a brief hiatus away to go get my MBA at Cornell University and then came back to Stone Arch and I’ve done everything. I’ve been a director. So everything from interviewing industries that are from thinks is interesting. You know actually reviewing the individual investment opportunities. I’m negotiating a transaction. So that’s, you know, price terms, etc. Uh, and then working with the management team over a five to seven year kind of journey as we tackle problems and celebrate successes, it’s, uh, it’s, it’s been a great experience or farm. It was a really special place. Um, you know, we were involved in these transitional investments with owners and to clean the Midwest, uh, which we tell people it’s kind of Ohio to Colorado to Missouri and are really what we’re good at. And what separates us is that, you know, we’re, we’re quite owners want to preserve legacy and culture and that and that for us is what we’re trying to focus on is how do we preserve legacy and culture and help them get the business to the next level. You know, still preserving, you know, all those things that made it great, but, but living past the past the kind of key man risk, if you will, but the, maybe the business holds today, uh, we’re, you know, all things flow through them to a better place that’s um, you know, for all kinds of stakeholders, both the employees come to work everyday, their families depend on those paychecks, the community of customers, vendors that everybody has a better place and in doing so we, we, we generate value for the equity holders.

Ryan Tansom: And I think that’s awesome context and then as we kind of peel into that, because I have it on sit on the panel with you, I believe that you probably are doing those things and I think that, you know, you probably a curious if you agree or not my, but like a lot of private equity firms say that, but it depends on where they get their money and what, like what’s actually driving the motives of buying the company is solely, you know, whether it’s you guys or other firms and how do, how do you know, where do you get your money and what is the goal of your firm and you know, how do you align that up with that and then what should the listeners and entrepreneurs should be, what should they be asking or be concerned about as it relates to what you just said?

Mike O’Neil: Yeah. It’s interesting. So, you know, the private equity model, the traditional model is our customers are investors and so, you know, for far from big institutions, you know, they’ll, they’ll generally remain nameless, but it’d be the universities you’d expect to see and pension funds and endowments and things like that that are giving us, giving us capital and, you know, they’re looking at the asset class in general and saying, you know, you’ve got to beat the industry average, you know, we’re, we’re targeting a top quartile, um, return profile internally. We’re basically saying, listen, we want to know we want kind of 20 percent plus returns and we’re taking a longer approach to it, you know, kind of a five to seven year view on our investments. There’s other folks that take shorter term views or maybe have, have, have different investors. But you know, the asset class, the private equity asset class has really matured from a cottage industry to now a significant portion of, of, um, of the alternative space. And um, you know, for most, most of the private equity firms are trying to grow the equity value by growing the company. Everybody has a different approach to doing it, um, depending on where it is in the life cycle or what their expertise is. I’m not sure if that answers your question or not.

Ryan Tansom: I think it does because it’s very interesting because not a lot of people realize that is the customers are your investors and I think one of the, that’s why who and I’ve ever talked to anybody, it’s like follow the money and find the motivation and I think, you know, what you’d said about partnering up with because now all of a sudden you’re partnering up with companies and people in legacies and cultures and so there’s a lot of people to make happy and a lot of, you know, expectations to be met. So how people, how do you reconcile the two of trying to hit the cash on cash or the return that they people need along with someone that has a specific way of running their company and they’ve hit a threshold or, you know, a barrier that they haven’t been able to break themselves.

Mike O’Neil: Yeah. No, it’s interesting question. I mean it’s no different than say you’re a college football coach. I mean, Nick’s aiden at Alabama is trying to win a national title every, every year and he knows that he does, so his customers, which are ticket holders will buy tickets, but he actually focuses on 17 year old kids and you know, that’s not totally different than us. We need to deliver returns and act in a, in a, in a fashion that, you know, represents our investors um, you know, appropriately and ethically. And if we deliver, you know, top quartile returns, they’ll continue to come back and new investors will knock on our door. Our approach and how we kind of execute against that is we focus on entrepreneurs and family business owners that have a, a view on their legacy and culture and that they’re likely the largest employer in their community and selling to the, you know, Walmart, John Deere of their industry is just off the table. And because their, their social life is intertwined with, with work. I mean there’s some, there’s a lot of gray there. And If they were to sell to a company that closes the facility, they’ve got to move. You know their kids can’t, you know, walk across the parking lot of high school without getting picked on because dad sold the business and closed the factory. so, um, we know there are people out there that are looking for us and we’re looking for them and basically saying, you know, our angle and our, our, the way we do this is partnership with people and you know, working together to tackle problems and to try to institutionalize the company, uh, and grow at and by growing it you generate those returns for our investors. And part of that investor is our partner, the manager team and shareholders that we are investing alongside. You know, every dollar we make, you know, they, they make the same dollar. So, you know, we’re, we’re really working together so that we all do well.

Ryan Tansom: Interesting way of putting it. I think a lot of people run into that situation where the community, especially in the Midwest, as you get into the rural areas where there’s big manufacturers that, you know, it’s, it’s church, it’s home, it’s everywhere. The people that they’re integrated with their companies is all over the place. So let’s maybe Mike as we go through the kind of, the cycle of the finding the company valuation and then how that second bites is structured because it’s not an outright sale. So let’s start with the valuation and how you’re going in there and finding and valuing these companies because I think there’s this, you know, especially with your values as it sounds like is how do you make sure that the owner gets what they deserve, but also knowing the fact that they’ve hit a threshold, right? So there’s value that they have not been able to harvest themselves for various reasons or there’s a timeline or inflection point that they’ve, uh, they’ve hit. So how do you get them what they want and how do you, how do you perceive value in these companies and what are you looking for?

Mike O’Neil: Yeah, it’s a challenge in part because because we’re not a strategic buyer, you know, we’re not a multinational company that has, does what they do and can look at it and say if it was put on our site, our Model, this is the cash it would kick out. And so to us, it’s only worth the cash it generates and the cash it’s going to generate in the foreseeable future and then risk-adjusted and, and as a financial buyer, that’s the only way we can look at it is in terms of that. And so how I would tell an entrepreneur who’s thinking about a private investor or a private equity firm you’re kind of view is they should be looking at EBITDA, uh, which you can google. There’s lots of information out there on what EBITDA does and how to calculate it. Your certainly, your accountant can help you through this. EBITDA less cap ex, it’s not true free cash flow, but it’s- in most people in private equity, we’d say, okay, that’s, you know, kind of free cash flow your business. And in my experience, companies trading between four and 12-15 million of EBITDA, they generally fall somewhere between six and nine times that number and you know, what pushes it up or down, one way or the other is going to be, is risk. And so, you know, an example like I was writing down is an oilfield service company and a dental service, totally different businesses, right? Oilfield service, good business, but we all know it’s going to cycle and when it does cycle hard, project based, you punch a hole in the ground, you don’t, you don’t continuously punch holes in the ground, you punch one hole in the ground, then you move on, you punch another hole in the ground, you got, you know, a big customer, it could be 30 to 75 percent of revenue. Those companies trade on the lower side of that range because of a number of perceived risk factors to continued free cash flow into the future. Where a dental service business, you know, a dental practice might have a big customer, might be one percent of revenue or less and it’s predictable. You have to go back every year and get your teeth cleaned. And so depending on the risk factors associated with the cash that’s coming next year, you trade on one side or the other of that, of that range. There are certainly companies that trade above and below that range. I just shared it’s by no means, uh, you know, uh, a complete picture, but it’s an 80-20 rule I guess.

Ryan Tansom: So, and I think you put it in a very clear way. And so when you’re looking, let’s say you’ve got these people that- family-run businesses or it’s a one or a single, I’m assuming they’re not VC-backed a lot of the people that are going for, right? It’s a lot of people that have carried the risk and have done and built this business that’s integrated in their family and their community, might have a couple of partners. How, you know, how well are they running? These two come in where like in where do you meet in the middle of what I’m saying is it makes sense as in like they’ve gotten to a certain point and then there’s a lot of value that you can help create. So how are you going in there and making sure, because a lot of people I think perceive private equity are coming in, they’re like real estate and real estate investors. They’re going to flip it, right? They’re going to find all of our weaknesses. they’re gonna exploit them. And then do, you know, do all their tactics, how do you reconcile that with the legacy and all the other, like you said, that the, the real human parts of that and then also getting the value that you need to go forward?

Mike O’Neil: Yeah, so a couple thoughts. One for us, you know, when we make an investment, we tell people to call our prior partners, you know, hey, call, call the companies we partnered with the past and asked me how we’ve operated in the good and the bad and asking how we operated in, in ’08, ’09. And so that’s, that’s, that’s key. And most people, when they’re going through this process where they’re talking to a private equity firm, you know, at a certain point they should do that. Um, you know, kind of around your LOI time frame. If you align your, you should be asking what can I talk to? Two or three guys or even more? Can I talk to everybody. And uh, so, so that’s important. If you think about what that means though, it means that if we can’t operate like we’re building a pirate ship because we need positive references. So we need the experience to go well for the people we’re partnering with both financially, but as well as, you know, during the time that we’re partners. Um, so all that’s kind of running in the back of our mind is our future success is dependent on how we treat people. So that, that’s part of it. The second piece is economically we tie ourselves to our partners. So if we come in and buy 60 percent of the business and, and uh, you know, the founding family owns 40 percent, how we’re different than say a real estate investor, you know, flipping house because we’re not buying 100 percent of the house from them and then flipping it and selling it to make a profit. We’re partnering with them and saying, no, together, these are the things that if we do these levers that we pull, the company will be worth more and it’s worth more for us and for you.

Ryan Tansom: So. And I think that’s a great way to put it in. Let’s peel that back a little bit on how like getting to the value in getting to the different spectrum of how you come to that 64 dear, like you said, 51 to 80 percent was literally literally submit into the deal structure because it you’re not going into the outright sale and so what are the, some of the reasons that someone would go your route or a private equity route and how do they get to the determination of how much money should they get upfront or overtime, how do you structure it and then getting to the percentages and then what the relationship looks like going forward?

Mike O’Neil: Yeah, so there’s a lot of kind of personal, intangible, strategic reasons that someone should think about a private equity firm, I would say if legacy and culture important to you, you know, private equity is worth exploring. If your team’s important to you and you want to give them a shot at making kind of real, life-changing money, private equity’s interesting. If long-term financial planning is important to you – and I encourage people to talk to their wealth advisor. There’s lots of really sophisticated techniques. Um, trust grads, class, etc., private equity’s interesting. You might ultimately choose a different path, but you should at least consult with several of your advisors, your accountant, lawyer and a lawyer who does M&A and uh, uh, you know, they would have an M&A department or they would have, you know, several deals that they’ve done and a wealth manager, wealth manager, again, kind of that’s not your insurance salesmen, that’s an actual wealth manager, but talking to those people about what’s private equity like, and should I do it assuming that those things are interesting to you, assuming that you probably have over 3 million of EBITDA, there is a private equity firm out there for you. You just have to find them. And uh, right. I don’t know if that, if that answered your question as far as his private equity, you know, what, what attributes know, do you have, if, if the asset class is interesting and then certainly happy to talk about, you know.

Ryan Tansom: I think you answered it. Maybe expanding on the because they’re not, you can’t just walk away. Right. And I think maybe I think a lot of people going, oh, I’m done right. And so by that time can, you might have to sell to Walmart and got your company move. And so there’s like these different levers that you can’t have everything, right? Because it depends on how well your company is run. So when you guys come in there, you know, what is the other additional intangibles of partnering up with you guys and what you guys should expect from the owner or the management team then and going for it. And then we can kind of dive into like actually how you’re structuring the deal of the, of the deal.

Mike O’Neil: Yeah. I want to make sure I caught that. So what, what do you want me to answer first?

Ryan Tansom: So I think, you know, maybe just sort of your exposure of when you’re sitting down and talking to, you know, whether they’re, they’ve been clients of yours or not or what you’ve seen Mike of the mentality of like the owner’s going to have to probably still continue to work. Right? and you’re, you’re relying and like your expectations of them and their team…

Mike O’Neil: Sure, sure, sure, sure, sure. I’d say this: at the heart of disappointment lies expectations. And when we’re looking to make a partnership with somebody, it doesn’t have to be that they’re day-to-day CEO forever. We, we likely don’t have anybody on our staff, uh, nor does the company have somebody who could be the CEO on Monday morning if we close on Friday, because if they did that they may not have this issue and need to talk to us. You know, our model is partnering with people, not running their business for them and so we don’t have the person on staff. So before we end up wiring funds and we’re spending kind of, you know, 60 to 90 days together, I’m going through diligence. We’re having that discussion about expectations, you know, what are you looking for over the next five to seven years? Likely you picked us because you’re looking to get out.

Mike O’Neil: People generally pick us for one of three reasons. They’re either a management team trying to buyout an absentee owner and they don’t have the money. Is there a person in their sixties or seventies that wants to retire? And their kids aren’t going to be 45 and ready to run the business anytime soon or the or maybe the light switch isn’t on, you know, what am I going to do? Or they’re a 50-year-old business owner, let’s see, something on the horizon they want to pull off, uh, and they just can’t take on the risk of doing it, you know, buying a competitor or buying into an adjacent market, what have you in any of those three were having a discussion about expectations over the next couple of years together. And oftentimes people are saying, no, I’m picking you because I want to retire while knowing that this company’s in a good spot on the other side of my involvement and that I kind of have a big say in who the next management team is or the next person in charge. So we get involved in that conversation up front. How long do you want to be the day to day CEO? That might be six months. That could be three years. That could be four years. Um, and uh, in some instances it was, I want to be the CEO the whole time and now on the other side of it they said, gosh, you know, without having this 800 pound sumo wrestler sitting and my chest every night, um, I really, I really like this and I’m going to keep reloading and go private equity to private equity firm and keep getting bigger and I’ll keep rolling my 20 percent and do well. So we’ve, you know, we’ve seen everything and, and, and certainly people can change their minds. We just, we need a plan. And so we spend some time up front talking about what’s that plan, what’s the next five years look like when you want to start to dial it back. And then we have, you know, we build a relationship with a person so that, you know, we’re talking regularly if something changes or accelerates or slows down that they just tell us.

Ryan Tansom: Where do you see like… bucketing those three helps a lot of clarity I think. I think, how do you start in me in get on the same page with the owner’s vision? So I think the retired or the person that kind of wants to sunset over a period of time, I think obviously the private equity partner’s mentality and what they want and once they get comfortable with you and your vision, then it’s like, okay, I’m going to kind of unwind here. But let’s say there’s an owner that also has some of these bigger aspirations, you know, do these different structures or these different visions impact how you structure the deal and how much they roll and…

Mike O’Neil: Great question though is they certainly can. So you know, somebody who’s saying, gosh, I want to buy two competitors and opens new locations. I want to do all these things, but I don’t want to take on as much risk. You know, they’re sitting down with their wealth manager and they’re talking about, you know, how much is enough to put behind the fence and then how much is the risk appetite. Most likely they’re wealth managers thrilled because they want to put something behind the fence and not keep it all at risk every day. But, you know, for those people, maybe they keep a little bit more in, um, as far as the ownership percentage where the person who’s 70 and thinks, gosh, I should’ve done this 15 years ago. Um, you know, they might be looking more at like, you know, grandkids trusts are really what they’re rolling. I’m gonna roll 10 percent, uh, you know, I’ve worked with my both manager and lawyer to set up a bunch of grads and flats and stuff like that. So, you know, maybe it’s, maybe it’s some philanthropy I’m going to do is really what the equity role is. Um, and, and like legacy stuff, um, but the, the, I want most of the cash now so that, you know, my wife and I or my husband and I, whatever it is, you know, we can start to think about retiring and, and really dialing back. And then that situation, that expectation might be day to day, six months, maybe a little bit longer. If it takes us longer to promote somebody internally or hire somebody, you know. But as soon as we get a capable CEO in here, I really want to become an active board member, you know, we just, we just try to figure all that out upfront and frankly we just have pretty candid conversations with people. We’re a, we’re, we’re pretty agreeable. People were nice and friendly and, and uh, and maybe are peers in some of the bigger cities are kind of harder to have that conversation with. But know for us, we just, we just ask them.

Ryan Tansom: And that makes a ton of sense. So how low, you know, what challenges do you see for an entrepreneur? Like let’s say one of our listeners is sitting down in front of you, they want to buy into their competitors and want to do all these things. They’ve got all these aspirations. How do you guys get on the same page with that vision? Less so because I think, I mean obviously you’re coming in and this can maybe dovetail into the deal structure, but you know, you guys are buying controlling interest. So I think there’s this fear, okay, now you’re, you’re literally an employee. You’re an investor side-by-side, but you know, they’re an employee, so the changing of the vision and the management team and who you hire and they’ve got a lot of people to talk about that stuff with instead of just pulling, you know, pulling the gun and just doing whatever they want. So how does, how do you get to a point in what should the owners be concerned about or what should they do to make sure that the vision is extremely clear and understanding their role in that decision process going forward?

Mike O’Neil: Yeah, I mean, it, it, it, it doesn’t just happen. It’s very rare that we knock on somebody’s door, they knock on our door and three months later we’re partners. Um, so there’s a lot of discussion and back-and-forth, you know, for us, we don’t believe that we have all the best ideas. Um, we’ve got a really big network and we’re, we think we’re pretty good decision makers. Um, you know, but really our expertise is seeing, seeing business models, that seem show back up in different industries and the same challenges and opportunities and being familiar with those and then having a really big network and being wise enough to draw on that network and bring in a subject matter expert to solve some problem. And that’s kind of, you know, what we’re, what we’re trying to do. So when somebody comes in to us and says, hey, I own a flexible packaging business and I want to acquire, you know, three of my competitors and get into this adjacent market and here’s why. We’ll listen to that and you know ask them lots of questions about, you know, why they think that would work and what’s going on in the market, et cetera. And then, you know, after that meeting, you know, the group of us were picking up the phone and we’re talking to people who are experts in packaging and saying, hey, we just met with this, uh, in this great, this great family. And they were talking about this business and here’s some of the stuff they’re thinking about doing. So there’s no names that are exchanged, but we’re saying, you know, hey, we’re trying to basically stress test with people that know what they’re doing is what we heard real and is this interesting. Um, and then we’re circling back, uh, so, you know, we, we, we, we draw on our network to verify ideas and also to then come back and say, hey, you know, we, we, we ran the traps on, on what you were saying. Everybody’s saying that those two things you want to do that you should be doing, but this third idea kept coming up. What do you think of that? And then we shut up and we listen.

Ryan Tansom: Well, I mean if you’re going to be making decisions together, it’s a natural process that. And that makes sense for that. I’m assuming just like any other partnership, if you get someone that doesn’t listen and is used to being the dictator, it’s not really advantageous to partner up.

Mike O’Neil: Yeah, that Hugo Chavez partnership doesn’t work.

Ryan Tansom: So um, let’s say, let’s say you have someone that maybe lets pick a random example of whether someone wants to unwind or maybe somewhere in between there where they want to accomplish a couple of things and then unwind. So let’s kind of, let’s talk into the second bite because I think a lot of people talk about it but don’t necessarily get it. And you explained in the panel that I saw and you explained it very well on how that works. So I don’t know, maybe I’ll just kinda tee it up and say, okay, well how does the, how is the deal is structured and then how does that.

Mike O’Neil: So I wrestled with how to walk through this and I was trying to think about is a house analogy good with a mortgage or talk about business and you know, the house is easier to talk about. You don’t think about like, you’re, you’re, you’re buying a house with the people and you’re gonna rent it out. But I thought it doesn’t get any personality so I’m going to try my best I to to, to give an example. We’ll use some numbers. And so I’d encourage your listeners to rewind if they need to and make notes and there’s going to be a little bit of math.

Ryan Tansom: If you’re willing to give some of the, you know, a couple of those graphs or something like that. I could throw those in the show notes for the listeners.

Mike O’Neil: Sure, sure, sure. I certainly can. There’s gonna be a little bit math and some people grab your pens and pencils. But. So we’ve got a business owner we’ll call her Wendy and Wendy is a second generation family business owner and she’s deciding what to do with her business. Her company does 30 million in revenue and five of EBITDA. So even as, or even the margins, sadly in the mid teens and her company makes fire hydrants, right? So we not going to do widgets, have some random company. So Wendy’s business fire hydrant business, 5 million of EBITDA. So Wendy had kids later in life, she’s in her fifties, they’re in middle school. They’re not going to turn 40 anytime soon to take over. She sees lots of opportunity on the horizon. She’d like to expand into making other metal valves, maybe acquire one of her friends’ businesses from, you know, different trade shows that she’s gotten the note that said at different point in her life. And she’s trying to out what do I do? Uh, so we meet Wendy and we think she’s great team, super hard working. She’s honest. It was great people on our team. Um, she sees her employees as her extended family. Uh, so we negotiated a deal with Wendy and we’re going to be her partner. And so the deal we strike is we’re going to buy 60 percent of the company. So the price we agree on, and this is for easy math so everyone can fall. So we agree at a five times EBITDA valuation of $25 million dollars. Uh, so EBITDA’s five, five times 25. So we, Stone Arch, we coordinate with a, with a lender we go to, we go to the bank and we get a three times EBITDA loan. So we get a loan for $15,000,000.

Ryan Tansom: Can I pick it up from the pause there? I love the context. So explain to the listeners a lender, because I think there’s, there’s, there’s this, there’s less, there’s less exposure for owners. They’re normally dealing with the up-and-down-the-street bankers who may or may not be friends or enemies. Who are you guys doing? Where does this loan for that chunk of money come from?

Mike O’Neil: So there’s, there’s, there’s generally two places that loan comes from. It comes from either a depository institution. So you know, US bank, CIBC, uh, uh, First Merchants, I mean somebody who is a bank that the people would know, Wells Fargo, et cetera, or it’s coming from a fund and there’s lots of senior capital funds that exists, you know, Mass Capital Funding will be one, Monroe, there’s a number of others. Um, there’s lots of others. Um, so that’s who’s generally coming up that we’re going to and saying, we liked this business, here’s why, you know, there’s lender packages, et cetera. We work with them and we get a loan. What’s really unique about this is that Wendy no longer personally guarantees that debt. So when, when most business owners are looking at debt and, and, and, and it’s scary, it’s often because they’re personally guaranteeing it. So, you know, they have looked at It like, yeah, I get 15 million bucks but I have to guarantee it. So why do I want the risk? Um, w with us, they don’t personally guarantee at anymore.

Ryan Tansom: It’s interesting too because there’s an underwriting process right here, right? Now, you know, with the listeners should really take away is this is why the risk of the cash flow is so important because there’s a lot of people taking a lot of bets on it.

Mike O’Neil: Yeah. So they, the, the lender is going to go through a significant process where they’re looking at the same thing we are, you know, kind of risk to cash. Now they’re, they don’t care as much about growth. They’re looking at, I’m going to loan us money at this interest rate and I want it back. Where for us. We’re saying we’re going to, we’re going to put this money in and if all we do is get it back, that’s a nightmare for us. So we need to see it. We need to see that equity grow two or three times and the only real way for that to happen in a meaningful way is, is to grow the business and I’ll walk through kind of why that is a little bit later, but… the underwriting process to the lender is how do they get the money back. For us, the underwriting process is risk-adjusted cash flow, but also growth.

Ryan Tansom: Awesome detour. I think it was relevant. So let’s go back to. So you go back and you’re, you’re, you’re, you’re working with the lender.

Mike O’Neil: Yeah. So we’re working with a lender to get a loan lined up from Wendy’s business. They’re comfortable at three times even to our $15,000,000. So if people are looking at the numbers, they’re writing down in front of them. It’s value of the company. Twenty five, the loan that we can get 15 and so that delta is 10. 10 million of equity that needs needs to come up with. Now we want to buy 60 percent of the business from Wendy, so we need to come up with 6 million of cash from our fund. And so what Wendy’s going to receive is $15 million from the kind of levered recap of the business and $6 million of equity from us coming in. So she’s going to get $21,000,000 and still own 40 percent of the company. Because of the leverage that’s on there, the debt, she’s able to take 21 of the 25, which is 84 percent for the viewers at home, the total value and still keep 40 percent of the equity. And that’s what’s unique about our firm.

Ryan Tansom: So the difference between that and taking the four million off and I think this is where I have not really understanding what they want and why. So if she wants to continue doing this. So she’s rolling $4,000,000 versus going in selling to someone else that will give her a check for potentially $28,000,000. So like why, why would they roll that money in when they could potentially do something else?

Mike O’Neil: Yeah. And so this goes back to their own personal situation, you know, do I, do I have a desire to stay aroun? DoI have a desire to take care of and be part of how the future of this kind of company moves forward strategy, who’s going to run it, you know, do I see something on the horizon, do I want to, do I actually want to involvement in it as a board member or a or an executive still? All those questions are going to influence if you take the 25 or 28 as you kind of said it with a strategic buyer or the or, or a little bit, you know, the 25 valuation but, but you know, 21 of cash from us, somebody has to make that decision. We can’t make it for them because you can’t, you can’t go back. I mean once you go through it and you do it, you can’t go backwards.

Ryan Tansom: So now that you’ve got that structure and they’ve rolled four million bucks, you know, explain how the bank gets paid, how you hit your numbers, how they could potentially, you know, how the second bite actually works, because I can’t remember how you articulated it Mike, but It was, it was only a couple of levers that you can pull for everybody to hit their goals.

Mike O’Neil: Yeah. There’s three levers that we can pull in, um, as a private equity firm and, and how you pull those levers… there’s infinite numbers to pull them, but you can grow the company, you can grow the multiple and you can pay down debt. That’s it. Those are the three things you can do and if you try to walk through really quickly. So if you know 5 million of EBITDA at a five times multiple is 25 and you can grow the business to 6 million of EBITDA, um, and sell for five times you created 5 million of value. How would we go about growing a business? So people are always going to ask, okay, well that’s the lever, but okay, you know, you can’t write it on a PowerPoint and say it’s true. How do you actually grow a business? Um, you know, a lever we might pull is bringing in a sales manager. So not a salesperson, but an actual sales manager or helping assist with the hiring of great salespeople, helping even know the right person to bring in to interview salespeople, to weed through charlatans from real salespeople. I think most business, uh, business people appreciate that there’s a lot of really bad salespeople out there that market themselves as good salespeople and it’s hard to tell in just an interview if they’re any good at it or not. There’s lots of tests they can take to actually demonstrate, do they have any idea what they’re doing? Um, you know, giving people professional training, even knowing the right person to bring in to offer training, um, you know, possible rebranding effort, marketing dollar spent wisely, uh, develop a new product development processes. You know, we, we leverage a lot of resources in our network to help them to develop and execute on plans that we come up with, with our partners.

Mike O’Neil: Um, you know, much like you use an accountant to help you with your books. We’ve got an expert in all sorts of functional areas that we can bring in to help us partner, develop and execute a plan. So that’s one lever we can grow the business. The second one is grow the multiple and that’s typically done by removing risk. So a deeper management team, great systems. So CRM financial system, KPIs, reporting a sales team versus an owner-operator that’s being the salesperson, a chief operating officer, you know, doing all those things themselves, having a real team. Helping think about, you know, growth. Are we going to grow, you know, towards our existing customer base. Certainly we don’t want to turn down, you know, money coming to us, but active business development efforts away from industry concentrations. Removing customer concentrations, right? Hiring salespeople and saying, bang the phones and find us additional customers because if we can pull a customer concentration and industry concentrations down, the company has less risk and the multiple goes up. So that’s the second one. And the same math would apply right? At 5 million of EBITDA but, but with less risk might trade at six times instead of five times. And you know, there’s 5 million of value that just showed up. And then the, then the third one is paying down debt. And so, you know, when the earlier in this call I talked about EBITDA less cap ex, and that, that number is essentially cash flow that can be used to service debt. And you know, for us, we’re looking to generally pay off half the loan in about a five year period. And so that $15 million dollar loan over five years being paid down in half, you know, that that creates an extra kind of seven and a half million of, of, of equity value. And so, um, you know, there’s, there’s a lot of, uh, there’s a lot of value to pulling all three of those levers at the same time.

Ryan Tansom: Well I was just gonna say, and then you pull them all at the same time, like magic.

Mike O’Neil: They’re interrelated. I mean, that’s the best. But the best part about our job is that if you grow a company, you hire great people. Typically all three of these levers get pulled. And if you, if you just walked through the math real quick, so 5 million of EBITDA and if five times value is 25 million bucks and you know that $15,000,000 loan is, is how we’re getting there. So the, the owner is getting 21 million today and retains 40 percent of the company. So we pull three levers. We grow EBITDA that is six from five. We increased the multiple from five to six because we add management depth and systems and reporting and new customers. We can basically answer questions when people are diligencing the business. And then we pay off half a loan. So now there’s only seven and a half million of that remaining. Not, not at 15. We do all three of those things. The enterprise value of the businesses, no longer 25, now it’s 36 and we only have seven and a half of that on the books. So we have 28 and a half of equity, you know, Wendy with her fire hydrant business owns 40 percent of that. So she gets a second check for 11 point 4 million bucks. So all in when he takes on $32,000,000 over five years and had a, had a, her, her fingerprints are all over who’s the next CEO, where’s the direction of the company? All those things. And, and financially she, she wins.

Ryan Tansom: Which I’d say is a pretty good return. Which is why you do it, which is why they should do it.

Mike O’Neil: That’s how it works.

Ryan Tansom: Well, that’s why I wanted to, I was excited to have you on the show because how you articulated this mike, I mean like I’ve interviewed a lot of people and I know a lot of people in our work space and there’s not as many people that are clearly say. I mean it really boils down to this and I think it’s just interesting because owners need to look at this stuff anyways and it’s just, it’s really only these three things. So one of the questions are gonna come from the context of one of these three areas. You know, that’s why you’re going to be doing certain things. A couple other random questions about this stuff is like, one is how do you… because think you had mentioned at the beginning or towards the beginning about executive teams? So how, how do you integrate… So for example, I mean, I honestly, I think about this, I think you and I talked about it like we were ripe for a situation like yours, but instead we sold it outright to a third party and had all the things happened that I wish I wouldn’t have, right. Whereas in life, but you know, it was like, oh, I don’t have enough money, you know what I mean, because it’s my dad’s cash flow. And so it was this whole question and not like how do you get executives who are crucial to the business into this mix and to give them, you had said have them create substantial wealth or to eventually get teed up to buy it?

Mike O’Neil: Yeah. So, so the, the management teams, uh, that, you know, they’re a wealth creation event is, you know, when we’re doing a deal, all of those individuals generally have the opportunity to put cash in, you know, to, to buy into the business as kind of hard equity. And then secondly we put in, so we generally like LLCs versus C-corps and so it’s not a stock option plan because the only relevant for a c corp, but it’s a unit appreciation plan. We generally have a unit appreciation plan in place for motivating management team members to think about the business in the shower.

Ryan Tansom: Can you explain this?

Mike O’Neil: Yeah so think about business like an owner. Okay. So yeah, unit appreciation plan basically means we put a percentage of the business up for grabs based on hurdles for people like the CFO, head of sales, chief operating officer, maybe the president, if we hire, promote somebody, all those people have a chance to own a piece of the business and that ownership vests. So let’s just assume there’s a five percent unit appreciation plan and five percentage, five percent of the company is up for grabs. And if you think about what that means in my example with Wendy, you know, seven and a half million dollars of debt on the books, you know, five percent of 28 and a half at the end of that deal is possibly up for grabs, for the, for, for the, you know, a couple of people said that’s real money for somebody who might be used to making 180 grand to get a check for a couple hundred thousand dollars as a… And then that cash can be used if we’re selling our ownership to another private equity firm to, to roll into the next deal. And so for some of these people, there’s an opportunity to continue to roll proceeds and realize either deal bonuses or you know, kind of stock option plans or unit appreciation plans and continue to roll that, that cash into equity as, as the company goes through new partnerships.

Ryan Tansom: So when you’re an owner listening to this, what would you say to someone that says, “well, hell with it, I’m just going to do all this stuff myself?” The difference between them and someone that would be a good candidate?

Mike O’Neil: Well, listen that, I, I, um, you know, I trade on goodwill, um, so I meet with a lot of people in and spend time talking to people about um, you know, their business and, and um, you know, what they’re looking to do and, and, and a challenge they’re facing and I might point them in the right direction that’s not, not our firm because I want to create goodwill so that they give us as a reference or, or, or, or, or refer us to somebody. It was a lot of business owners that go on hunting and skiing trips and, and hear from another friend, you know, Bobby and Jenny don’t want to take over the business. So if I can help somebody think through something and, and, and, and be happy and treat them fairly, potentially they’ll refer, you know, that hunting buddy to me and say, hey, you know, you should meet this guy Mike O’Neil. He’s, he, he shot us straight and helped us out. So I would generally tell somebody, yeah, you should try to do all this stuff on your own if you can. What stops people from doing it is risk. So imagine you own a business and you have some salespeople, but they just kind of make phone calls and they’re more business development. They’re not out, you know, meeting with 30 percent of your revenue every day. And the risk that the owner has in having that salesperson out there is that,if that salesperson steps on their tie and really screws up, they just have to go interview for a new job and they can paint any picture and tell any story by why it didn’t work out. But the owner has to figure out, okay, I just lost 30 percent of revenue. My profits just got crushed. And there’s all these families that depend on this paycheck. How am I going to make this work? Right? So that’s the risk. Now the opportunity for them is that they hire those kinds of salespeople, they might triple the size of the business and, and be on the other side of that conversation. You know, gosh, I’m doing great. I’ve all this cash to hire really smart people to help me out with this because I have these salespeople that can go, you know, generate sales. So for us, I look at it like not having salespeople is risk, um, but for them they’d say having salespeople is risk or you know, depending on who, where you sit, somethings sound terrifying and other things sound exciting.

Ryan Tansom: It just depends on whether that they want that 800 pound sumo wrestler chest every night and a top layer and having a sumo wrestler sitting next to you. Or do you want. Exactly, how strong is your chest? Exactly. Exactly. Man. I’ve really enjoyed it and I love how you kind of walk through all this stuff. You know, if the listeners want more information and we’ll try and put some of this stuff in the show notes, but if they want to get in touch with you want more information with the best, what’s the best way to get in touch with you?

Mike O’Neil: I’m on LinkedIn. I’m Michael O’Neil in Minneapolis, Minnesota, and uh, you certainly can, can, can find me. My contact information’s on there. You can send me an email. I’m at my stone arch email, which is [email protected]. Even my Cornell email, you can contact me and just say about something or I want to bounce ideas off somebody or who, who should I go meet with or speak to? We, uh, we trade and goodwill and so we’re, we’re, we’re trying to regularly help people out so that, you know, the right opportunity presents itself to us because we don’t need to make a ton of investments. We just need to make the right ones.

Ryan Tansom: Mike, I really enjoyed having you on the show, man.

Mike O’Neil: Appreciate it. Ryan. Thank you so much and best of luck, everybody, as you’re thinking this through. It’s um, you know, it’s a big decision and so it’s not to be taken lightly and just the more information you can get, the better prepared you are.

Ryan Tansom: Well said. Normally. I actually forgot what is the one thing, if you know, if you were to leave the listeners with, and I think you kinda just did, but like if there’s one thing that, because we talked about a lot, if you maybe highlight something or if it’s something that we didn’t talk about, what would be the one thing that you, you’d kind of leave them with?

Mike O’Neil: You know, it’s putting together the right group of advisors. You know, you probably have a buddy who’s your attorney that maybe you were a fraternity brother with or sorority sister with and it’s not to say that they are ever going to lose the business, but you should have a, an attorney who’s very, very well versed in M&A, um, whether they have a M&A division inside their, their law firm. You know, and Ryan, that’s how we met. We met with. We met because there’s a boutique law firm in town, but they’re very, very versed in M&A. And so folks like that would be, you know, people to talk to. Those people, then your accountant, your tax and as well as your audit person who tax person because they’re going to help you build, think about some of this stuff and then a wealth manager and you want people to communicate with one another. The more that you silo everyone off and don’t let them talk and no the worst information and advice they can give you, you know, frankly you’d call meeting and have your, your attorney there and your accountant there and your wealth manager there and say, I’m thinking about exploring alternatives. Tell me more about private equity or tell me about what I should think about doing and they’re going to be able to provide you with advice and having them disagree in front of you is probably a good thing. Right. You know, having the, you know, give the pros and cons of all the, all the different options.

Ryan Tansom: Well said. Been there, done that, seen it. You hit on a bunch of good. Very, very good points. Well, I really appreciate it, Mike. I really enjoyed it.

Mike O’Neil: Sounds good, Ryan. Appreciate it and thank you much.


Ryan Tansom: I hope you enjoyed the episode with mike. I really enjoyed how clear he articulated the math behind the second bite of the apple, but also the risks as a business owner, when you’re thinking about what is the potential exit options that are available and you are looking at ESOPs or third party sales or private equity or internal buyouts, all these different things are so many options and then even if you narrowed it down to a private equity firm, there’s still a ton of options for how much money you need down, how much of your company you want to actually sell, where you’re at in the spectrum of still wanting to work and pursue your ambitions and why you’re actually selling the business. Is it to recapitalize and get additional resources and people or is it to unwind because you want to go towards retirement? Because I just think there’s so many things to consider that thinking about all these questions and just even being exposed to the different scenarios should hopefully spark some ideas. So I hope those ideas are starting to flow.

If you’ve got any questions, go onto our website, GEXP We’ve got a lot of information about these different types of scenarios. Feel free to go back and listen to a bunch of the other episodes that are covered, the different exit options, or go on to iTunes and give me a rating because I hope you enjoy this show as much as I enjoy doing it. I will see you next week.


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Written by Ryan Tansom

Ryan Tansom

Ryan runs industry-specific podcasts on his website which pertain to mergers and acquisitions, and all the life lessons he wish he had known then. He strives to bring this knowledge to his listeners in a way that is effective and engaging by providing new material each week from industry experts.

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