Building a Partnership Between the Investment Sponsor and Operating Sponsor

‍Text Version of the Interview

Partnership Between an Investment Sponsor and Operating Sponsor

For us, that relationship is really symbiotic. We are very focused on giving the operators of our businesses independence and encouraging them to go out and acquire and use M&A capitals. 

The partnership between the M&A team, the corporate development team, and the operating sponsor is critically important. 

We have a pretty structured approach in our M&A program where we have a pretty detailed funnel and stages of a deal. And at each stage, there's a different level of partnership between the corporate development sponsor, the investment sponsor, and the operating sponsor. 

We like our deals to be originated by the operating sponsor. Certainly, if it's going to be something that they are going to operate, they're the ones who will come up with the business plan, they're the ones who have to live and breathe the business and they're also experts in the sectors that we operate.

So on the corporate development side, we put a lot of faith in their experience and knowledge to go out and find the right acquisition for them in the right sector, with the right trends. 

We are very fundamental focused. We will pay close attention to the free cash flow of the business and the sustainability of the business, and we're also helping our CEO, CFO. Ultimately our board makes capital allocation decisions. 

We are trying to line these opportunities up in similar digestible ways so that you can compare one opportunity to another and decide where to allocate the capital because there is a finite amount of capital. 

Evolution of their Relationship

The way that we're set up, we have sourcing relationships by individuals within my group. 

In some cases, I'll spend time with the general manager of a business outside of a live deal context, just once a week, checking in on what's going on with your business. What can I do to help you develop an opportunity?

It's nice to have that dialogue and relationship outside of a live deal context so that when something sparks, and you've got an actual opportunity, we huddle as a broader group. 

You bring in other members of the corporate development team, the stakeholder group, and the operating unit to assess the acquisition. You start the discussion, and if there's a positive response, you do your negotiating. 

Then every day, we have conversations between the corporate development team and the operating sponsor figuring out where we're going to prioritize our time.

One of the things that you have to embrace and enjoy is, being willing to debate an opportunity, ready to poke holes in a thesis, and defend holes that others are trying to poke.

And I think the best example of the relationships that we have between an operating sponsor and a corporate development sponsor is being able to work well together and have constructive debate and tension that helps lead to the best outcomes. 

What is an Operating Sponsor?

It's basically a CEO or a mini CEO. Someone whose title may be general manager, and it's someone ready to operate the P&L of the business that we acquire. And all of them have sector expertise. 

At our company, we have a lot of different themes. We've got cyber security, we've got digital publishing, we've got digital health. We have gaming entertainment. We have e-commerce. 

And within each of these sectors, executives have been in the space for years and know how to operate within this sector. That is the operating sponsor, it's effectively a mini CEO, the sector expert. 

Evolution to Deal Sourcing

Let's walk through our recent acquisition, "Retail-Me-Not," that just closed. It's an asset that we have known for over 10 years, and it's a business that our CEO evaluated as an operating sponsor with a private equity fund before. So there is a deep familiarity with the business.

It came to market through an investment bank, which we know well. They reached out to me and our CEO to tell us that they're bringing the business to market. We were a natural prospective buyer. 

This is certainly something we should take a look at, and we will be able to move fast. So, they go in and run a lot of their process while we circle our resources internally. 

Our President was closely involved as a sponsor, and the general manager of this media group too as an operating sponsor. 

It was a large deal and needed multiple operating sponsors. We had three levels of operating sponsorship and three levels of corporate development sponsorship. 

On the operating side, you have our CEO, who knows the business very well. And it's a business model that he's had a lot of success with. 

You've got the CEO level view, you've got the division president level view, and then you've got the GM, who is designated to run the business after we acquire. So we have very different levels of view surrounding the acquisition. 

On the corporate development side, you've got me, and you got a VP and associates who are involved. There's a similar architecture that mirrors the operating side of it. 

And as you go through the process, each of these two sponsorship groups pulls in resources from all across J2. We're pulling in tax advice, HR experts, Inside and Outside counsel, etc. 

Once we agree on price, I think symbiotic is the best way to describe it in terms of the relationship between the operator and the investor. 

Debates on Deals

The performance marketing space is a space that we were early to and knows well, and many people have rushed into that space now. And a lot of the questions we were asking ourselves is whether it's too late to get back into that. 

We discovered that this "Retail-Me-Not" platform adds a level of scale that we don't have in terms of the gross merchandise value that is sold on that platform.

Separately, as we got into it, we realized there are some pretty easy things that we can do to optimize this business, in maybe a counterintuitive way, to help it catch up to where we are.

Even though, in many ways, this is a larger business than our historical affiliate commerce and performance marketing business. We were ahead of that business in many things like, take rate and commission rate and optimization of the business model. 

So we quickly got comfortable. We had a healthy debate, and we got to a great place as a result. 

Keeping the Alignment 

That's what the corporate development team is paid to do, is to organize all of those moving pieces and ensure alignment. Make sure that every side of the equation understands all of the parts of the deal. 

The most challenging part about it is taking all of those pieces and distilling them into something digestible for the board. 

These are complex businesses that we look at, and the level of detail that we go into in our evaluation and diligence is painstaking in detail. 

Boards certainly don't have the time, it's not efficient for them to go through every line item of detail. But they must get the best summation and understand all of the risks and upsides and opportunities and business plan and integration plan associated with an investment. 

Our CEO and our CFO keep the board up to date regularly along the way. It culminates in a presentation at a board meeting where all of the details are presented, and the risks are clearly identified, and we're in a position where we can move forward if they approve it. 

Challenges

We have to expect the unexpected in any transaction. We err on the side of over-communicating with all stakeholders involved, and frankly, over-communicating with the other side.

I think that can ensure avoiding some speed bumps and roadblocks.

We have M&A in our blood. There is no problem getting momentum going and getting everyone moving in the right direction at the right speed. At the same time, we are very disciplined. We will walk away from a deal that's not good for us. 

Now to try to avoid a situation where we're walking away, post exclusivity, something we rarely do and hate to do, we are pretty rigorous on the front end before that LOI. 

We do a lot of work with the operating sponsor, certainly with the CEO, CFO division president, to ensure that this is the right price. This is something that when we flip the switch, we can run faster cause that's the speed that we operate at. 

We like to close quickly once we have an agreement on price, but that means your price better be right. So we're very cautious and disciplined when it comes to making sure that we're paying the right price.

Integration Handoff

When you're getting to the point where purchase documents are near-final, handoff really begins in the late stages of a deal. We will work on the integration plan with the operating sponsor.  

We will be helping them think through milestones, but the operator is the one who's driving them. 

Right about the time that we're getting to close, we will transition our investment model to an operating model that's run by the equivalent of the CFO for the operating unit. 

Then, they will fold it into their budget and track it with their budget. Post-close, the operating sponsor is responsible for executing his or her plan again. 

We certainly monitor the performance of investments, and we try to learn from each investment, whether it's learning from our mistakes or learning from the things that we got right. 

After that handoff to the operator, we are more in observation and analysis mode than really driving.

KPIs 

Certainly, free cash flow, revenue, and EBITDA will vary by business. 

We acquired that continuing medical education business a few years ago, which is all about grants and awards for CME programs. So we track how many grants we are awarded in a given year and the win rate. 

A subscription business may be subscribers, ARR, or MRR. We are tracking relative to the model and for J2, which is well-diversified in several different categories. 

The KPIs are going to vary by the deal. But they're certainly going to be in each deal as there should be a handful of operating metrics that aren't pure financial metrics that we're tracking. Understand why the financials perform the way they're performing relative to the plan. 

Partnership Model 

I think many people compare us to private equity, and there are a lot of programmatic buyers out there that are good comparisons for us. But there are also a lot of companies that are shifting more to our model, which is that symbiotic partnership model between operator and corporate development or investment team.

The conventional mindset would be, the M&A practitioner lives within the operating unit, or maybe in a private equity world, you hire an outside consultant who lives within the private equity firm while you're evaluating the deal. 

There are not a lot of groups like us that have truly melded the two functions together. It works out well, allowing you to move quickly and decisively.

And what makes the relationships strong is the volume of the deals we make. There's just a level of trust that comes with all the repetitions. This is not a group where the corporate development team works with an operating group once a year. 

We have a good understanding of both sides. Our operating leaders have a good understanding of how we work. Likewise, we need to be open-minded about working with the operators. 

They are driving the ship when it comes to their business. My group and I are very conscious of that; we need to try our best to understand what they're trying to accomplish, what their plans are, and help them accomplish that. 

Steps in Building the Corp Dev Program

In the quarter that I joined, we closed five transactions. So it was a little bit of trial by fire. Being forced to build a structure amid a live situation was probably the best thing that could have happened. I think I would have built the wrong program, had it not been built under the stress of a real situation. 

I relied on the feedback of the team to help me think through the framework and what the right stages are and right levels of approval are and the right time and resources at every stage. I built up the process in my own mind then memorialized it. 

We have an M&A playbook that is now biblical in proportion, but it walks through all of the details of how the program should work.

The next important step was to build out a devoted corporate development team which should be a group with a diversified skill set that complements one another well. 

What are You Looking for When You Bring People In? 

There's certainly a minimum aptitude and technical skillset that you have to have to succeed. You need to be comfortable with financials and have been in and around deals before. 

You can get a lot of that training in a law firm, investment bank, or even a consulting firm that focuses on the deal side.  

Once you pass the technical skillset, there's the positive attitude, perseverance, and resilience. You have to be resilient to survive in a high-volume M&A world. 

That's the secret sauce to being able to engage in the debate full force, step back, reflect on the debate, and understand the right decision, which may not be what you were arguing for. 

That's the type of person that thrives well, certainly in our environment.

Value Leak in a Deal

It can leak everywhere, and it's something that we are constantly guarding against by getting the price right and making sure that you're paying a price that can afford some leakage. 

Certainly, in charge documents, value can be leaked an infinite number of directions through the reps, warranties, covenants, indemnities, caps, and baskets. But the real risk is after you close. 

After the target business is under our ownership. At that point, there's leakage potential everywhere. So it's making sure that you're prepared when it comes to the ownership transition to run with it, without the leaks, and to have plans for the leaks that are coming. 

To repair the cracks in the foundation immediately and understand when your roof will be too old and plan for replacing it. 

That's why the caliber of the operators within our portfolio is critical. We're so fortunate to have such good ones because they do a pretty good job of identifying and managing where those potential leaks could be. 

Best Advice

Being friendly helps. It's surprising sometimes the number of prickly characters you can run into in this world of deal-making. You have to be non-combative and not paranoid that everyone is out there to get you. 

Another thing would be to have an insatiable appetite for learning. It's rare, if not impossible for me to walk into a room and be the smartest person, and I'm always looking to learn from others in the room. 

That can help anybody. Just your willingness to embrace other perspectives and learn from people in business settings, personal settings, and everywhere. 

I'm a big believer in throwing people into the deep end and seeing if they swim. They go figure it out through training and mentorship, which may not be the most conventional but let people struggle to figure it out a little bit.