Navigating the World of Business Acquisitions: Insights from Sequoia Bergman

The Independent Sponsor Model

Sequoia Bergman, an experienced business acquirer with 19 acquisitions and two exits under his belt, operates under what's known as the independent sponsor model. This approach differs from traditional private equity in several key ways:

• Funding is raised on a deal-by-deal basis, rather than through a predetermined fund
• There's no set lifecycle for investments, allowing for more opportunistic acquisitions
• The model provides flexibility in holding periods and exit strategies

Bergman explains that independent sponsors are essentially sponsoring the acquisition of a company, but doing so independently of a traditional fund structure. This allows them to be more nimble and tailor their approach to each specific deal.

Anatomy of a Deal

To illustrate how a typical acquisition might be structured, Bergman walks through a hypothetical example:

• Target company: Commercial carpet cleaning business
• Revenue: $20 million
• EBITDA: $3 million
• Purchase price: $18 million (6x EBITDA multiple)

The deal structure might look something like this:

• Senior debt (bank financing): $9 million
• Subordinated debt or seller note: $3 million
• Equity: $6 million

Bergman notes that in today's market, leverage ratios have come down somewhat, so the exact proportions may vary. He also emphasizes the importance of closing with some cash on the balance sheet to ensure smooth operations post-acquisition.

Investor Returns and Expectations

When it comes to investor expectations, Bergman suggests that returns in the high teens to low 20% range are generally considered reasonable for these types of investments. This takes into account the illiquidity and higher risk profile compared to more traditional investments.

To model potential returns, Bergman's firm uses typical leveraged buyout models, creating base case, upside, and downside scenarios. However, he cautions that these models rarely play out exactly as projected over a 5-10 year hold period.

The Role of the Seller Post-Acquisition

One key aspect of many deals is having the seller roll over some equity and remain involved with the business post-acquisition. Bergman typically aims for around 20% seller rollover, which serves several purposes:

• Keeps the seller invested in the company's success
• Provides continuity and institutional knowledge during the transition
• Helps mitigate risk for the buyer

However, Bergman acknowledges the challenges in keeping a seller motivated after they've received a large liquidity event. He emphasizes the importance of understanding the seller's true motivations and goals to ensure alignment.

Differentiating Legitimate Buyers

With the proliferation of would-be business buyers, including many inexperienced or undercapitalized individuals, Bergman offers advice on how sellers can identify legitimate, serious buyers:

1. Look for warm introductions through trusted advisors or networks
2. Be wary of cold, spammy outreach
3. Check the buyer's track record and completed transactions
4. Evaluate their professional presence (website, LinkedIn, etc.)
5. Consider working with an experienced M&A advisor to vet potential buyers

Bergman emphasizes that legitimate buyers will be upfront about valuation expectations and have a clear understanding of what they can realistically accomplish.

The Importance of Trust and Alignment

Ultimately, successful acquisitions come down to trust and alignment between buyer and seller. Bergman looks for sellers who genuinely care about their company's legacy, employees, and future success - not just those focused solely on maximizing their payout.

He advises sellers to be honest about their motivations and goals, as this allows buyers to structure deals and transition plans that work for both parties. Whether a seller wants to stay involved long-term or make a clean break, being upfront about these desires leads to better outcomes.

Challenges and Risks in Acquisitions

While acquisitions can create significant value, Bergman is candid about the challenges and risks involved:

• Transitioning leadership from founder to professional management
• Navigating economic cycles and industry-specific downturns
• Managing leverage and meeting bank covenants
• Balancing growth initiatives with maintaining core operations

He notes that even in a portfolio of successful acquisitions, there are often one or two "problem children" going through challenges at any given time.

The Future of Business Acquisitions

Looking ahead, Bergman sees both opportunities and potential headwinds in the business acquisition landscape:

• Increased competition from search funds and ETA (Entrepreneurship Through Acquisition) graduates
• Growing interest from individual investors in lower middle market deals
• Potential for multiple compression after years of expansion
• Need for buyers to focus more on operational improvements vs. financial engineering

Despite these challenges, he remains bullish on the potential for creating value through thoughtful, well-executed acquisitions in the lower middle market.

Conclusion

Sequoia Bergman's insights provide a valuable window into the world of business acquisitions, particularly in the lower middle market. His experience highlights the importance of:

• Structuring deals that align incentives between buyers, sellers, and management
• Focusing on businesses with strong fundamentals and growth potential
• Building trust and open communication throughout the acquisition process
• Understanding and mitigating risks through careful due diligence and planning

For business owners considering an exit, as well as aspiring acquirers, these lessons offer a roadmap for navigating the complex but potentially rewarding world of M&A.

Article created from: https://www.youtube.com/watch?v=4N3aCfWpWQ8