Corporate Diversification Through M&A

Corporate diversification strategy

So obviously you have your core business, and it could be service lines, it could be in markets, or whatnot, and you're moving away from it for whatever reason. 

In both instances at Marion and EIS Holdings, our core business didn't provide the most value while harnessing our knowledge of the services we offered.

In each instance so far, we've diversified and are still working on diversifying into more attractive markets for the private equity space, as well as public and institutional investors in the public markets.

Drivers of corporate diversification 

Really for us, the main driver is value creation where the company can put capital to work and have the best return metrics. For instance, both at Mariana and EIS, there are very similar strategies. 

The core business might trade at one multiple, but horizontal acquisition opportunities have much higher multiple when going back to market.

One deal focuses on the growth trajectory. At EIS Holdings, we started as an asbestos abatement company. It's a great business from an institutional investor perspective due to low capex, and we have a lot of recurring business with different customers.

However, the growth trajectory is in the lower single digits. Additionally, asbestos is a finite material. We’ve significantly reduced its use compared to 30-40 years ago, but there's still a tail on there. 

We're looking at a 20 to 30-year window, if not longer, where we can continue the growth trajectory we're on today. However, we've identified other markets with stronger and longer growth opportunities, creating more value for the shareholders at exit.

People involved in corporate diversification

It starts with the board and the executive leadership team identifying the need for diversification. Everyone needs to be on the same page about this decision.

The next question is where to diversify. During this time, the leadership team will identify markets that are potentially more attractive than our current ones. At AIS, a big focus was on capturing additional wallet share with our customers. 

We explored adjacent services that we could offer to expand our wallet share and cross-sell between the core business and the new business.

Once we identified the area we wanted to pursue, we brought it back to the board, did the market research, and presented our strategy. After gaining their approval, we were ready to roll out the plan, including messaging to the employees. 

Diversification is a sensitive topic because it implies reallocating resources to a new service line. It's important to communicate that this doesn't mean the value of the core business has become less.

The key message is about the value creation opportunity. If we continue to invest solely in the asbestos abatement business, we have a certain growth potential. But if we diversify and integrate the two entities effectively, with strong cross-selling opportunities, we can enhance value creation significantly.

This ties into capital allocation. If you can take a dollar and turn it into two, that's great. But if there's an opportunity to turn it into three or four, that's where you should be investing. The message to shareholders, especially those not on the board of directors at GLT, is that we have the potential to significantly increase returns through smart diversification and alignment.

Communicating the diversification strategy

The number one step we've found most helpful is showing the value creation of diversification. People care about themselves, and a significant part of that is their money.

The second thing to consider is what opportunities this diversification strategy offers beyond just value creation. We communicate to them that this will open up additional opportunities. It's going to expand the service lines they can offer to their customers, which is one aspect.

Another aspect is the new targets that come with the diversification strategy. They're likely to have a different customer base. This presents another opportunity for our core business to start cross-selling into their customer base as well.

So, we are not only cross-selling service lines but also customer bases. This creates more opportunities for field personnel to earn money and commissions on the projects they sell.

Customer overlaps on deals

There has to be overlaps. Our strategy is purely focused on cross-selling and revenue synergies. There are two slides that I primarily use from our investment deck, important for both our shareholders and our boots on the ground.

The first one is an acquisition sweet spot template. This template lists everything we're looking for, including total enterprise values, EBITDA margins, gross margins, service lines, markets, and other key metrics like bonding in our deals, safety, and more. It contains about 10 to 12 items, each with three to seven subcategories. 

Each is labeled as either “sweet spot”, “opportunistic”, or “avoid”. For every deal, the first thing I do is evaluate how it fits into the sweet spot, particularly focusing on cross-selling revenue synergies and value creation for the company. We have a strict adherence to this plan and will not deviate from it.

The second aspect is our geographic footprint. We've targeted certain regions where we are based today and adjacent markets. We use stars on a map to mark our current offices, regional HQs, and new target markets, focusing on big cities across the southeast and Midwest.

This disciplined strategy is critical in our communication between the board and employees. When they see we are disciplined and sticking to our strategy, it fosters more buy-in from all parties. However, if employees notice any weakness or deviation from the strategy, it can become problematic.

For the diversification strategy, discipline and swimming in the same direction, having everybody go there and understand why you're doing it are the two most important factors.

Capital allocation

So, the capital allocation is a bit different. We know where we're going, as we discussed earlier with our maps and the sweet spot. We're still going to do some abatement deals that make sense, but when it comes to capital allocation, in the private equity world, it's all about the multiples and some of the arbitrage we can get.

When we think about buying in our core business, we're not going to pay as much from a multiple perspective as we would when diversifying into adjacent markets or service lines. There's an expectation that you're going to pay a premium to get in the door, which is not easy. Getting in the door when you're first starting is tough.

When we get in the door, it's a delicate situation, similar to dealing with our employees. One of the first questions I ask during introductory calls is about their business and what we're offering. We talk about our discipline and focus and deliver the message of what we're trying to do. 

We aim to capture additional wallet share with our customers and cross-sell service lines between both parties. We’re creating an end-to-end environmental services solution for our customers rather than just offering a couple of pieces. When we explain this in a clear and concise manner, it usually clicks. 

They understand it quickly because they know about the market, but they may not have thought about it in the same way. The clearer and cleaner the message, the more they can relate to it and understand it. Typically, about 80 to 90 percent of the time, it clicks right away, and it's probably a five-minute conversation at the start of the call.

As we continue through different stages of the deal, more questions arise, particularly about integration. Being able to describe how we will integrate their company into ours is crucial. It all comes down to being prepared, disciplined, and focused. 

Keeping a consistent message flows not only to the target company but also internally, helping everyone understand that we are all on the same page and easing concerns.

Proprietary deal vs bank deal

A proprietary deal is easier more often than not. We've all had our challenges, especially since a lot of the guys we're dealing with are founder-owners, and it's a completely different process. Every deal is tough, with different obstacles and challenges.

Within the bank processes, we do a really good job of reaching out to people and maintaining those relationships with different bankers to ensure we don't miss deals. Of course, we might have missed one or two, especially in the diversification play, but that happens.

First off, I always have a very clear message for the bankers about what we're trying to do and what we're interested in. And then, talking to the management team is essential. If that's not an option, we're not going to invest in our model. 

We don't have a plug-and-play model and aren't big enough, so we need these individuals to continue working with us for some time. We work on building a succession plan with them if they want to transition out. But if they're focused and willing to work, they're plugged into the company.

We have a slightly different touch, emphasizing that we're in this together. It's a partnership, not just an acquisition. So, we talk to the owners of the business, or at least the CEO, presidents, financial guys, whoever we need to, from the app side, to understand their personal and professional goals. 

It's also crucial to make sure our message is clearly conveyed about what we're trying to do and why we're at the table. If we don't have access to them, we simply won't do the deal. It's impossible to underwrite without that access.

Deal sourcing 

Three avenues for sourcing deals. 

The first one involves sell side investment banks reaching out to us. It's important to stay in contact, meet for coffee when in town, and maintain a good relationship. 

The second way we source deals is through our buy side advisor, who assists with various aspects. We split duties between cold calling, cold emails, and refining our strategy.

However, the most effective method for us has been our internal referral program, which has really taken off. 

Since implementing it, our pipeline has never been more full. It's a straightforward program, primarily for our employees. If they make a warm introduction to a target and we close on it following an introductory call, they receive a bonus. 

For deals with greater than a million dollars of EBITDA, the bonus is $40,000. If it's less than a million dollars of EBITDA, the bonus is $20,000. This amount is significant for our team.

The bonus for our internal referral program is paid directly into our fund's flow right at closing. If we close on a Tuesday, I can have the bonus in our bank by Friday. If it's later than Tuesday, it might coincide with payroll, but that's a minor detail. This program has cultivated a lot of leads and introductions for us.

Patience is key, especially in a diversification play, as it takes time for our team to understand our direction and what we're trying to achieve. We've now honed them in quite well on what we're looking for. 

These are guys out in the field, doing environmental services work, wearing hard hats and boots. They know the market better than anyone and understand who is good to work with.

They bring us great leads, and the program has worked out extremely well for us. Thinking about our current pipeline, we're looking at about 10 deals, with frequent communication. Over half of them are internal referrals from this program.

Closing deals with competition

To be very honest, we've lost deals because it is more comfortable for the target company to work with a company that is like-minded. Culture definitely plays a role. In both instances, the money was the same, or at least that’s what we were told. 

Change is tough, and the guys we look for in our diversification strategy need to be open to new ideas and embrace them. However, this isn't always the case.

These individuals have taken on the challenge of joining the EIS platform and helping to create the consulting and remediation business from the ground up. Whether their company is the first, second, or third to join, they're involved from the ground floor. 

We want to bring in those who will continue to drive and grow the company while bringing new ideas. If someone prefers the comfortable route, I understand. It's easy. You'll get your money and possibly exit sooner. 

Plus, the integration process won't be as challenging. So, it really comes down to one of the key questions we ask upfront: what are your personal and professional goals? This question helps us gauge whether they will be a good fit.

Cultural integration

It's not easy, but the key is to listen. People will tell you their pain points and what can and can't be done. As we move into different service lines and diversify, we can't use the same processes across the board.

Communication and listening are crucial, especially with new targets. We need to understand how things work and operate in their side of the business and why they do it that way. A lot of this information can be gathered during due diligence, but people only know what you tell them. Once you're in, you can figure out a lot more on the ground.

The first step is ensuring that they feel listened to. If you try to force a square peg in a round hole, it's going to upset everyone. The newly acquired target won't want to do it, creating friction between them and the corporate team. 

However, if you can sit back, listen, understand their processes, and then come up with solutions together through communication and brainstorming, it leads to a much better outcome.

The downside is that integration will take longer. We all want to complete integration quickly, especially in smaller deals within the private equity space, typically aiming for a 90-day plan. 

But especially for the first one or two deals in a new area, it's going to take longer because you're dealing with different processes, systems, regulatory matters, licensing, permits, and so on.

Taking a step back and saying, 'Let's understand this together and find a solution,' might take longer, but it helps blend the cultures more effectively. It fosters a culture of inclusion rather than an 'us versus them' mentality.

Additionally, you have to be agile. Very agile. It's essential to check your ego at the door. Remember, these businesses have been run by people for a long time, and it's their livelihood. 

You must be willing to make changes quickly and responsibly, but not just for the sake of change. It's crucial to ensure that any change is the best solution for the company as a whole. Whatever you have to do to ensure that outcome, that's what you should do.

Handling resistance

A lot of the process involves conversations, data, and patience, which is interesting considering we're trying to do something quickly. But it always goes back to listening. What are your pain points? 

Like in sales, if someone tells you their pain points, you can address them. However, if you're always the one talking and trying to be noticed, it's not the right approach. You need to understand these people have problems, which they'll share if you let them. 

Then, you can bring them back to the same page. For instance, I can show data on why companies in a certain space sell higher. Here are 10 companies that sold for X, and here's another 10 in our core space that sold for Y. X is greater, and this approach is going to work.

Another example is selling to field and sales guys. They could sell just one service, like abatement, to any real estate developer. But now, we can also offer soil and groundwater remediation at their sites, providing more opportunities for the salesperson to upsell to their customer. 

The benefit for the customer is having one point of contact for any issues. If something goes wrong in a project, they can call EIS. They don't have to call different companies for different services; EIS manages it all. This makes it easier on the customer and also provides opportunities for our employees to make more money, grow, and put it back in their pocket.

Measuring success

For us, actual revenue from cross-selling has been significant. We've had multiple projects on both sides of the business, between the abatement and the consulting remediation side, where we wouldn't have seen the project from a bidding perspective. 

However, someone had a relationship with the customer and could offer our asbestos abatement services. 

For example, with our underground storage tanks work, we've seen opportunities where our abatement team recognizes a need and realizes we have a group that can handle groundwater mediation on the same site. So far, this approach is working out quite well.

Projecting revenue synergies

To be very honest, we don't budget many revenue synergies at all. We focus mainly on the core business, and the opportunities the transaction presents. However, we can track them through the business development team and business unit leaders, who all have targets for cross-link opportunities. It's about training the salespeople in the additional service lines and executing on that as well.

We push these targets down to business development and the business unit leaders to help execute them. Even more importantly, we use bonuses. We offer additional commissions on projects for the project managers. 

If you refer the project to the other side of the group, you get a portion of the commission. For example, the person who performs the work gets 75% of the commission, and the one who referred it gets 25%.

We pay all the good players. We're trying to get our team to achieve something, and it doesn't feel right not to reward people for doing the right thing. They're creating exponential value for us, so we want to make sure they feel appreciated and recognized for their contributions.

Earnouts

I'll start with the easier topic first. Regarding seller notes, we don't go that route since we have private credit backing us. It's simpler to have cash flows go to the bank, which keeps them happy. 

Our typical deal structure is a 20 percent rollover into the larger EIS organization and 80 percent cash. This approach helps keep the owners engaged because they're growing their business and their investment simultaneously. 

Ideally, that 20 percent can double in value, resulting in a significant return for them.

We occasionally use earnouts, but I'm not a fan of them. They often lead to frustration when targets are missed. We're not upset about paying them out, actually; we prefer it because it indicates the company's growth. 

However, the process leading up to it, especially the document negotiation, can be quite painful. Document negotiations tend to slow down significantly. We aim for standardized documents as we try to acquire four or five companies a year, if possible.

If somebody wanted to take an all-stock deal, I'd consider it, as I believe anyone would. However, in the environmental services industry, which is currently very competitive, we need to provide attractive options for individuals, especially since they are stepping out of their comfort zones.

We usually start with a basic 80/20 structure. We've had more rollover in one or two deals and less in others, but that's always our starting point and what we consider standard in the market.

Regarding earnouts, they make me uneasy because they can significantly complicate the negotiation process. Normally, we can negotiate a document in a couple of weeks, but with the added complexity of earnouts, it could take twice as long. The frustration of not achieving earnout targets can lead to dissatisfaction, so we aim to keep things as smooth as possible.

Letter on intent exclusivity

Sixty to ninety days is our typical timeline, depending on the seller. No offense to anyone watching, but we can often gauge how quickly we can finalize a deal with the sellers based on the initial diligence. 

We have a pretty strenuous upfront process compared to most, so by the time we enter a deal, we're well-prepared. My investment deck is ready, reviewed not only by the executive leadership team at EIS Holdings but also presented to Sun Capital's executive leadership, and this is just to get to a Letter of Intent (LOI).

Once we reach the LOI stage, it's game time. We transition from the 'dating' stage, and I give sellers some space, moving at their pace, with friendly reminders to check in and keep a good pulse on them. However, once it gets to the LOI and we start investing resources, the dynamic changes.

At that point, we begin to push, setting a target of 60 days to finalize things, and I make sure to focus and support them through the process. If necessary, I'll be on a plane at seven in the morning to pull documents – something I believe most of us in this field have done at some point.

Combining diligence with integration using DealRoom

When I first started in the deal room, all I did was manage the data room, and the requests were overwhelming. I spent many nights updating information to send back to people. However, this process soon became tedious. 

So, we started building on it. We had our request system and data room, and then we integrated our pipeline into it. The latest phase we've implemented is integration with you, which allows a much quicker transition from the deal team to integration.

I'm always ready to answer questions and assist, but it can be frustrating to repeatedly receive the same questions when the information is readily available. Now, I can simply click a button to move a phase from due diligence to closed, and then from closed to integration. 

We've set up our entire integration checklist with assignees, gone through the integration process, and outlined every step they need to take, complete with a timeline for responsibilities.

This system also makes everything we discovered during diligence accessible to our integration team. So, instead of having to rely on an Excel sheet with comments or downloading data from a website into a shared drive, all the information is streamlined and easy to access. 

This efficiency allows me and Rob to focus on more deals instead of fielding integration questions. The team has clear execution instructions, and I can monitor integration progress, keeping track of what's being done, updating statuses, and identifying who's falling behind or moving ahead. 

This thorough overview of the integration process helps us complete it more quickly, so we can move onto the next deal.

Using DealRoom with sellers

I tell them we're using my tool. Even at the early stage, what I'll do is before pre LOI, i'll just run the data room myself. Honestly, we don't really use it pre LOI. I'll use whatever. Fine. But once we're signed, here's the data room. 

Here's the process. I expect you to answer these requests. I'm not going to respond to your Excel sheets. This is it.  So it's my way or the highway. 

Same with bankers. I tell them this is how it's going to be. And I will, if I have to, talk about the benefits to the seller on that. And really ties around the seamless integration transition of hey listen, it'll make your client's life easier going through here. 

It's all in one location, my people know where to go when it's done. And the seller will know where all the information is as well.

This might be a little bit more pain on you guys, I really don't care, this is how it's gonna be, this is what we have to do to get this deal done quickly and in a timely manner, and then allow for successful integration. And really just put it out there, it's not gonna go any other way, besides this way.

Advice for practitioners doing corporate diversification

Don't rush into what you're doing. Set out a plan and don't deviate. You got to trust it. It's going to work. And if you show any signs of weakness, everybody picks up on it. So it's, you got to stay focused, stay disciplined and stay the course. It'll happen. It's tough. Otherwise, everybody is doing it.

Cliché, we can cut the cliché. And just make sure you have buy-in. If you can have buy-in from the company, top to bottom, it will work. And that's the most important thing. Make sure you're staying on top of people. You can sell your message very well and what you're trying to do, and then that'll lead to success.

AI in M&A

I love it. I'm not some wizard yet, but we'll do a lot of deals in different or adjacent geographies, I guess, and so a lot of our projects are funded with regulatory money, whether it's from the state, federal, whatnot, and so each one, they'll typically fund a lot of our projects out of a trust fund managed by the state.

And so, that being said, we'll use that all the time. How does the state's fund operate? What are the rules that we need to know as investors is a little ChatGPT stuff, right? What's the balance in the funds?

That's helped answer a lot of questions, and then just I mean general regulatory questions to ChatGPT where I don't know, you go sift through the internet for two or three hours and try to find something and it just brings it back to a concise manner.

So really a lot around market research, not just market research, but just research in general and typical questions. I had one yesterday. I'm trying to remember what it is. Nevermind when related to M&A, but those are a lot of the uses I'll get out of it.

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