In M&A, having a set of core principles to guide your thinking is essential…
Ken Heuer of Kidd & Company is here to share the firm’s 3 core principles and how they make business decisions simple.
We also discuss
● What Kidd & Company brings to the table for the lower middle market
● The emergence of a new reps & warranties product to protect sellers
● And more
Mentioned in this episode: ● http://kiddcompany.com ● firstname.lastname@example.org ● https://www.linkedin.com/in/kenneth-heuer-6b16b3/
Ken Heuer: Thank you, Patrick, very happy to be with you today.
Patrick: So before we get into Kidd and Company, let’s talk about you. What brought you to this point in your career?
Ken: Well, I’ve been at this for a while now. But I guess, you know, with the benefit of hindsight, what I’ve come to realize is that, over my career, I think I’ve really developed a knack in understanding complexity. And not only being able to simplify that and explain it to others, but come up with solutions that help solve problems. So that started way back when when I majored in engineering, undergrad, and really out of love for math and science. But I knew pretty quickly, I didn’t want to go into a hardcore design or engineering field.
So my first job was in a consulting environment. And I spent a lot of time you know, working with clients and solving problems, and did that for about five years before going back to business school, and really, you know, focusing more on corporate finance and my desire to get more into the business world. So that parlayed into initially investment banking, where I worked for a few years, and then, ultimately, a stint in venture capital, before I joined Kidd and Company in the private equity world about 15 years ago.
Patrick: I love the fact that you go ahead and you do what I really respect with people, is taking complex concepts and ideas, and simplifying them. That always impressed me where you have people that live off of complexity, and others can really resonate with people making it easy for them to understand.
Ken: Well, so many engineers get a bad rap for sort of being in the weeds, and really not being able to kind of extract you know, practical applications and solutions out of out of that complexity. And so that’s something I really wanted to distance myself from early on in my career and going back to college, where I minored, in writing and became very self-aware enough that you know, oral and written presentation skills are paramount in whatever we go into, and obviously, we all use that on a daily basis now.
Patrick: Okay. Now as we look at Kidd and Company, founded in 1976, there were not very many private equity firms, if any back then. And we fast forward to today. Now, there are over 6000 PE firms. Clearly, you guys have seen a lot in these years. Talk about Kidd and Company, you know, then now, and you know a little bit about your commitment to the lower middle market.
Ken: Well, for the then part, I was six, so I won’t be able to offer much perspective. But, you know, realistically, the you know, what, what Bill Kidd set out back in the mid-1970s, to do was really, almost by chance, where he had an opportunity to invest directly into a family-owned and operated company. And while it was a small endeavor, it really got him in the business of being
able to invest directly for his own account, money to help grow founder-run companies. And that’s really been the premise of the firm for 40 plus years now is, you know, where, you know, we think there are hundreds of 1000s of businesses that fit the profile, that could be good investment opportunities for us.
And, you know, again, the idea of partnering with founder-owned companies in the next phase of their growth and be able to leverage the things that they’ve done well, you know, the product or service expertise, the customer relationships, and provide them not only capital, but a way of thinking and the resources to grow at a different scale and different level than they might be able to achieve on their own.
Patrick: Well, what I really appreciate by having, you know, highlighting Kidd and Company here is there are so many owners and founders out there where they get their business to an inflection point where they’re, you know, they’re too big to be small, but they’re too small to be enterprise and how do they get to that next level or get don’t exit.
But a lot of just want to get to another level. And without knowing about organizations like Kidd and Company, they’re either going to default to, you know, a strategic out there or an institution which won’t necessarily serve them. It’ll cost him a lot of money, but may not get them to where they want to be.
So the more people know about Kidd and Company, the better which I really appreciate. Now, let’s talk about what Kidd and Company brings to the table to the lower middle market because you haven’t gone upscale or up market, you’re staying grounded down there in the lower middle market.
Ken: Yeah, I think, you know, from an investment perspective, we think the lower middle market is still the most inefficient place in terms of valuations and pricing. So said another way, you can buy good small companies at very reasonable valuations with a game plan and investment thesis to grow them, both enhancing their organic growth, as well as looking at fragmented industries that lend themselves to M&A as a means to grow more quickly.
And with that playbook in mind, you know, once you’ve reached that critical mass or scale, that is eventually going to be attractive to a strategic buyer or a larger financial buyer, you achieve a level of valuation, you know, in the form of, you know, multiple expansion on top of what at the time are, you know, higher or faster-growing earnings. Again, that’s a pretty compelling way to, to think about the investment opportunities and the arbitrage that we think the lower middle market lends itself to.
Patrick: You mentioned when we talked before about Kidd and Company having three core principles that guide their philosophy. Talk about those, please.
Ken: Well, it really stems from, you know, having a well-thought-out investment thesis. I mean, we’re generalists in terms of the industries in which we participate. So we have to, you know, look to uncover industry insights within the businesses we buy. As I mentioned, there’s typically a product or service expertise or know how within these family-owned and operated companies.
So we’re looking to, you know, identify industries that are undergoing some sort of change, where the macroeconomic environment may be providing a tailwind, that we can step in and partner with those business owners really to, again, leverage what it is that they do well, allow them to spend more time doing that. And then really look to provide them with the additional resources to both make their life easier, as well as to professionalize and, and really top grade the entirety of the organization to kind of position it for a new level of success and growth.
So, you know, it comes from understanding operations, it’s really understanding investment and deploying the right capital structure. But again, you know, we look at a transaction with the business owner, not necessarily as an exit, or a sale in their eyes, but really try to position it as a partnership, where they’re going to be intimately involved with us going forward.
Yeah, they’re going to have a liquidity event on day one, and they’re going to realize, you know, a pretty significant monetary event. But ideally, they’re self-aware enough to realize that there are opportunities in their industry larger than they may be able to, to seize on their own. And we provide a solution other than just an outright exit or sale or, you know, flip the keys to the new owner on their way out the door, we really are not looking for, for that sort of exit opportunity for a founder.
And so you know, where there are opportunities that align with that way of thinking and business owners that are looking to stay involved in some capacity with us, as well as the shareholders along with us, that’s really in our eyes, the keys in terms of a recipe to career success.
Patrick: So among the things that you’re looking for, are founder-owned businesses where they’re not looking for an exit, you’re generalists. So long as there’s industry niche or specific need, that they are meeting, lower middle market. What other elements of the profile are you looking for? Is there a regional limitation for you guys?
Ken: Really we’ve we’ve invested in businesses all throughout the US, you know, we would say North America is where we’re focused today. You know, over the years, we’ve done some things outside of the US and I’d say our hit rate there is a little lower. So I think we’ve learned, you know, through the years really to stick to what it is we do best we end up spending a lot of time with our companies, we don’t have very many eggs in the basket, but the philosophy is watch those few eggs very carefully. And that’s easier to do, you know, certainly if you’re talking about domestically.
But you know, we’ve had, you know, investments on the west coast, you know, in the south, certainly in New England. So, you know, we really travel anywhere, you know, domestically really to find the best opportunities and I think there’s no lack of potential opportunities and hunting ground by staying in the US. Again, Canada’s is certainly something we’ve spent time looking at over the years as well.
Patrick: We like the US. I think there’s there’s plenty of opportunity here for growth and no shortage of number of good companies out there, you mentioned, you know, 1000s to hundreds to 1000s of potential targets out there. And one of the things that’s really assisted companies in you know, growth through acquisition is finding ways to transfer the risk of an acquisition away from the parties outside. And the insurance industry came in with that years ago with a product called reps and warranties insurance. And the purpose of it is essentially, the insurer rather than the seller will assume the indemnity obligation to the buyer.
So if there was a breach of the seller reps, and the buyer suffers financially, they don’t chase the seller, they go to the insurance carrier, so the buyer has certainty of collection, seller has a clean accent. And it has enabled the pace of mergers and acquisitions transaction to accelerate to unseen levels. But you know, don’t take my word for it. Ken, good, bad or indifferent, what’s been Kidd and Company’s experience with rep or warranty?
Ken: You know, I think it’s been certainly a learning process. But I view it as another tool in the bag that we can, you know, go to a potential seller with and offer it. One thing that’s a little unique about us is, in days prior where rep and warranty really wasn’t a solution. We weren’t big on requiring sellers to leave behind, you know, 10, 15% of the purchase price in an indemnity
escrow account. And that’s predominantly because our sellers are typically rolling anywhere from 20 to maybe 40% of the purchase price in equity along with us going forward.
So we kind of looked at that as already a bit of an insurance policy. A, they’re staying involved, operationally, typically with us. B, we’ve got the equity that if push came to shove, we could we could start there and go after that. But we’ve certainly as a buyer, you know, employed rep and warranty insurance when it can help distinguish us in a competitive environment. And we’ve certainly enjoyed the benefit of rep and warranty when we’re a seller and don’t have to, you know, leave behind a certain percentage of the purchase price for the buyer of our businesses.
So, again, it’s a great tool, some of the companies we look at are going to be too small for it to be really relevant for at least based on my understanding. But I think there’s always creative solutions being developed all the time to really fit kind of where the market is, and what types of deals are getting done.
Patrick: Well that was perfect segue into a recent development in the industry, which is the emergence of a new type of product for deals that are priced between a million and 30 million in enterprise value. These are simpler, smaller companies that just are in the blind spot for buy-side rep and warranty, okay. And it’s just one of those things that has emerged where, rather than the buyer, the seller is the policyholder.
The policy protects the seller, and is triggered when the buyer sends a written demand to the seller saying there’s been a breach, there are damages, we are either absorbing your escrow or we are going to commence a clawback. And the seller just takes that demand, forwards it to the insurance carrier, the sell side policy. Sell-side underwriters will come down and negotiate with the buyer and settle loss. So it’s that one extra step. What’s nice as is it’s available for the smaller, simpler companies that aren’t heavily regulated and at a cost of between 15 and $20,000 per million in coverage. I mean, there’s no underwriting fee, so it makes financial sense.
And what’s nice is that the buyer can go ahead and just empower the seller to say, hey, here’s your peace of mind. And now we know that it particularly in cases like with Kidd and Company, where you’re rolling that management team over, you get to avoid some real uncomfortable conversations if there is a breach. Because now nobody’s pointing fingers. They’re just reporting it to the carrier. So I think it’s an elegant solution. And it’s one of the newest evolutions out there that was just emerged in the last year.
Ken: Yeah, I’m really looking forward to spending more time with you learning more specific about how we can deploy that for some of these opportunities that we look at because that’s right in the wheelhouse of the size transactions. Really enterprise value between, you know, 10 and 100 million is kind of in our sweet spot for investing. And so having that as another option just to give us peace of mind that we’ve got that, I can think of examples where that would have come in handy.
Patrick: Yeah, and I think that what’s nice is for change. When you know the topic of insurance comes up. People tend to get a little roll their eyes. I just like the ability now that we’re part of a wave where we could contribute to lowering the temperature in the room during the negotiations and that’s always a nice place to be. Now Ken as we’re coming in here we’re wrapping up 2022. What do you, what trends do you see for 2023? Either respect for Kidd and Company or macro M&A?
Ken: Yeah, I mean, there’s some macro trends that I don’t think are unique to kind of the specific time where we are. And that’s just the general, what I’ll call the graying of America. So business owners that have been involved in their companies for 20, 30 years. I mean, that really
hasn’t changed. But I think the number of companies continues to go up that fit the profile of, you know, still being run by the founders. Founders haven’t fully thought through what their exit opportunities might be, they might not have next of kin in the company that they’re going to transition to.
So really becoming self-aware enough to say, alright, well, I lived through the last recession of 2008, 2009. I’ve now hopefully, you know, lived through a pandemic. But you know, running a business on your own is challenging, and having a partner and a sounding board and additional resources to really pursue opportunities that might avail themselves in your industry is, I think, being pretty well received by business owners that no longer want to take all of that risk on themselves, or see the entirety of their net worth tied up in the illiquid asset that is their company.
And so, you know, if anything, I think everybody’s you know, trying to handicap when the next you know, downturn or recession is going to come. You couple that with, you know, just the evolving, you know, political climate, nationally, internationally, the global supply chain issues, there’s just always something that you’re dealing with, in running a small company. And again, having that partner that can come in and offer you a liquidity event, but really be a resource to help you grow your company and get that second bite at the apple, as we call it, which is the monetization event that we all realize down the road if we have a successful exit.
So that’s always being well received. And just if anything, as a generalist, knowing where we should be spending our time is, you know, as much the challenge for us, but you know, I look at, you know, some of the trends like I’ll call it the repatriation of manufacturing. You know, that’s been going on for, you know, even before COVID.
Really the past probably five years, you’re seeing, you know, less of a disparity in wage rates and other challenges around quality or transportation costs or other things that things used to be manufactured overseas or in the Far East that a lot of that is coming back home. I mean, you’re seeing it with now that the talk of building semiconductor plants here in the US, just so we’re a little bit more self-sufficient.
That’s, you know, that the lower middle market is not immune from those sorts of trends. You know, the service economy remains strong. One thing we’ve seen, really is people investing more in their homes, so services to the home is something that we’re exploiting through a number of different opportunities that we’re in or continuing to explore.
So those are just a couple of kind of macro trends that, you know, we think there’s, you know, opportunities to pursue investment targets, where they’re fragmented industries, and we can partner with the right business owners, as well as supplement management to really, you know, take advantage of some of those.
Patrick: I agree with all of that. I think that also, when you’re in the lower middle market, there are a number of the macro headwinds in the economy that don’t impact the lower middle market or the micro market directly. And so they’re gonna keep chugging along and I think Father Time if anything’s a constant, Father Time is marching on. And I think owners and founders are not getting any younger. So that bodes well as well for you. So Ken Heuer from Kidd and Company, how can our audience members find you?
Ken: Well, I’m fully employed at Kidd and Company and my email is kheuer. That’s KHEUER@kiddcompany K I D D company.com. That’s probably the best way to find me and I’ll try to be as responsive as I can.
Patrick: Well, fantastic. Ken, it was great meeting you great having you on as a guest and all of
the good luck coming into 2023.
Ken: My pleasure, Patrick. I enjoyed the conversation. Thanks for your time