The Complexities of Smaller Deals

Focusing on smaller deals

It's not to say we don't do larger acquisitions. For example, HFF was a 2 billion dollar acquisition and transformative for our capital market's business. But real estate, no matter how global or large a firm you are, it's still inherently a local business.

That means you have a few goliaths like JLL, CBRE, and Cushman, but it's also very fragmented with smaller regional boutique firms that are just ripe for consolidation. So acquisition of smaller regional boutique firms has been a great way that we've found scale and regional expertise.

It is unique to JLL in the real estate services industry, and we certainly make larger acquisitions as well. And like many firms, we're on a digital journey right now and have a JLLT group, which also focuses more specifically on larger technology acquisitions and investments.

Access to innovation

We operate within business segments and have market advisory, work dynamics group, capital markets, and our JLL technology group. So our business globally is segmented into those parts, and for each one, of course, we'll take a different strategic lens to their acquisitions. 

What is common most often within market advisory and, oftentimes market dynamics, market advisory would typically encompass brokerage, as the best example of our market advisory business. That's where you see a lot of regional boutique firms, which would be on the smaller side compared to something like HFF, which is a much larger acquisition for us.

It's very strategic, and there's an entire group dedicated to our technology strategy. For example, in our largest and most recent acquisition, there was a building engine, so it adds a lot of capabilities in the technology space and allows us to realize a lot of cross-synergies between our core services and then these new capabilities that we're either acquiring, building, or investing in.

Sourcing deals

There has been an interesting mix. Lately, we've been getting a lot of deals through more of a competitive process, up until lately, it's been a frothy market. A lot of deals are being shopped by investment banks and going through a competitive process.

Historically, at least on the services side of things, we've been much more successful with deals that have not been through a competitive process. There's a number of reasons for that. Certainly, the deals we've been looking at in terms of doing an initial due diligence review, the majority as of late have been competitive, although I would like to see more outside of the competitive process.

Cons of a competitive auction process 

Obviously, price can be an issue in a competitive process. That's not a big surprise, but one aspect outside of the price that's always really an issue with us that we need to navigate through is the timing. 

A competitive process is usually set up with very tight deadlines. And in my opinion, those timelines are set up to force you to make a decision, but not necessarily the right decision. 

We're not an M&A shop like a private equity firm. We have:

• Multiple stakeholders that need to be involved
• A governance process that is set up for a very specific reason to make sure that we're being very prudent in the decisions that we're making.

And I also need to make sure that on my end, I'm not pulling in internal resources from all the different functional teams that need to come together to ultimately execute on a transaction. I need to make sure that I'm not pulling them in prematurely and then have them not take me as seriously when I really do have a deal that needs to move fast and we need to push through the execution.

My team handles as much of the pre-due diligence as possible, and I need to make a very calculated decision in terms of when we accelerate and pull in more resources. Unfortunately, the competitive process is not really set up to cater to that as much, so that can be difficult.

Another big problem is that the competitive process often lacks the personal interaction with the principals I am looking for. One of JLL's greatest selling points is our culture. When bankers are in the middle of that process, it's very difficult for either side to get a true sense of the culture.

Historically, we've been most successful with deals that are not through a competitive process and I would attribute a lot of that to the personal interaction that we're able to establish and that rapport, which is just harder to get to through a competitive process.

The timelines in the competitive process that we've seen are just very rushed. Integration is critical, especially for us when we're looking at services deals where talent and retention are so important. 

And when you rush through the process, it doesn't necessarily enable you to put that level of thought and consideration into it that you otherwise would have been able to. If you could have just slowed it down a little bit, make sure you're getting the correct stakeholders to discuss that.

It's a game of telephone, and the banker is in the middle. There are competing priorities and interests there and so it makes it much more difficult.

Pros of a competitive auction process

On the good side, when it's a competitive process, and you have bankers in the mix, bankers bring an added level of sophistication and analytics. It's all packaged up very neatly and tightly for you. On the flip side, they stand in the middle of personal interaction.

The other thing too that I didn't necessarily hit on before but is a function of a competitive process because you're working with bankers; understandably so, their objective is to drive the higher price.

But when you look at the CIMS they put forward, it's more often than not, almost every single instance, just a completely unrealistic growth forecast. It's a classic story of the hockey stick growth and they're right on the precipice of achieving that.

We just need to take a step back from that, basically throw it out the window, honestly. Then we need to go back to the drawing board, do it all from scratch again. You just don't get the unfiltered view from management in a more of a personal process. It's going to that investment banker lens.

So you need to go back to that drawing board and that can just take more time. It can cause more confusion amongst people internally working at the same materials, so that's tough to navigate.

Lastly, because we have certain specific considerations as we're trying to retain talent, we try to structure our deals a certain way to ensure that we provide the most protections as possible to JLL while also ensuring that the target is sharing in the upside. But the process in that banker setup and the way they are incentivized typically is not that conducive to the structure that we feel is more beneficial to both parties.

If it's a services firm, there's a lot of talent, and that talent that has made the company so successful is at the top. If we're not being careful about retaining that leadership, and we're just writing a huge check and giving it to them on day one, and they've walked away, we've already lost a ton of the value we had underwritten and hoped for.

We typically structure our deals with a deferred component as well as an earnout component as well. Bankers don't love that in their deals. They're driving a competitive process and typically towards the maximum amount of upfront possible,which is difficult for us to get comfortable with and rationalize.

Cons of a proprietary deal

Proprietary and smaller deals are a lot harder in many respects. There's typically a lot of education that goes with those. I'm somewhat conflating smaller deals and proprietary deals because that's typically the case.

These are smaller shops. This is probably their first time selling a business or even being tangentially involved in the sale of a company so you have to explain that process to them, and you have to make sure that you're comfortable in understanding that you're leading them along in the process and being as open and transparent as possible.

A lot of times, because they're smaller, their books may not be as clean as you want them to be. And that's what an investment bank will do a lot of times. They come in and package things very nicely and do more of an audit. But a lot of times, at companies where they may not be audited, sometimes they manage their financials off of Excel.

So, it's incumbent upon my team to filter through that information and ensure we're getting to the correct financial analysis to start with the correct baseline. 

There can also be a lot of emotion involved. There's emotion involved in every deal, whether it's big or small, but with smaller deals, proprietary deals, there's perhaps more emotion. At smaller companies, they may know every single employee at that firm and if they have good cultural alignment, they should be invested in what's best for those employees as well. So those emotions can certainly get elevated as you get to signing and closing.

And then, retention. You're buying a company because of the talent in these situations. If the equity structure is not aligned with that talent, you need to thoroughly understand what kind of retention package you need to sell aside for other members. 

That's going to be dilutive to the purchase price that goes to the owners. But it's ultimately a critical part of our value proposition and how we're getting comfortable with the overall valuation to begin with. That's something we can struggle with.

Lastly, valuation and deal structure. On smaller deals, a miss or a mistake on underwriting can sometimes loom larger, so we need to be extra thorough and diligent. We have specific reasons why we structure deals the way that we do and that is something more important critical on smaller deals. And if it's a proprietary deal, we have an easy time explaining that to them. That's why I tend to see more success there.

Pros of a proprietary deal

The main pro, if it's a proprietary deal, is that I can get it done. We don't have the game of telephone and the biggest pro, which outweighs any of these cons, is that I can develop a personal relationship with those owners/principals.

I heard on one of your podcast interviews that companies aren't bought, they are sold. It's ultimately the decision of the owner where they want to go. And I think there's tremendous benefit in going to a strategic, tremendous benefit in going to JLL largely because of our culture and all of the upside and potential we bring to elevate careers across that target's platform.

That just doesn't always come through as much in a competitive process. I'll take all of those cons for just that pro. Just the ability to develop that relationship and have the greatest likelihood of all the way around.

JLL believes in total honesty and transparency, which goes in all business aspects. But in particular, I take that to heart in acquisitions and leading that process.

When I go to explain the process to the target, I will explain it from start to finish and all the lifts it will take. I want to make sure they have the resources available to pull off this type of information and get it to us in a timely way.  

Also, these are the general methods we've used to come to a valuation. I'm not going to open up the book entirely, let you see the model and ask if it looks good. But it's an open conversation about how we value their business, the adjusted EBITDA, reasonable adjustments and why, and coming through that alignment.

From there, establishing that level of trust from the outset carries through the rest of the transaction, because you'll come across numerous issues as you move through the process. 

 I've never worked on a deal where it was an easy deal. There are no easy deals. They all come with some level of complexity, some last-minute curveball, and if you've established that level of trust from the beginning, you will have much more success working through those issues later on.

Relationship problems

Culture is always a really difficult thing to assess. It's that intangible that is probably the most important, but it's intangible, and sometimes, it comes down to a little bit more of a gut feeling. And that's not to say if there are any bumps in the road, it should be a red flag, it shouldn't. As I said before, these deals are inherently emotional.

These people have put their blood, sweat, and tears into building a business they're very attached to. Sometimes, it's a family business, so there's a family connection there and you need to be sensitive to that. So there's going to be bumps in the road.

I've had very few deals fall apart on that basis because a lot of the ones that I get done are done in that spirit. You can't always understand everything. There's certainly been deals where they're acting a little bit different than they perhaps did during the negotiations. But again, that's why you try to structure deals so that incentives are appropriately aligned.

You can't understand and protect everything. All you can do is your best and put the protections in place that'll help mitigate it.

Proprietary deals vs auctions 

Proprietary deals are more fun to work on because those are the deals that I've had a lot more success with. I enjoy more of the direct person to person interaction.

In terms of the deal process, I can explain everything an investment banker will be able to explain in terms of the process. I can help shepherd them along, in that regard. I think I can develop more of that rapport with them, more of that transparency, and that's what's fun to me: personal interaction, getting to know people, getting to know their motivations, and at the end of the day, those interests and likes of mine are well aligned with actually getting a deal done. So win-win.

I have too many competitive deals where I've slaved over a CIM, gone through the process, and gone back and forth, only to lose to a private equity firm that puts forward the full upfront with infinite upside. And it's hard to compete against that, but if you can look a target into the whites of their eyes and make a connection with him or her and tell them about your company and how they'll be valued, and you think it's fair.

We're not looking for a discount bargain deal here. We want to pay you fair value for your company, but these are the reasons why we think it's fair. And this is the upside you could get by coming to a place like JLL, but I need to be able to look someone in the face typically to do that.

Educating founders on the deal process

First off, I can shepherd them and guide them through the process. I've been asked by them sometimes. Do I need to get the banker involved? This won't surprise you, but you don't need a banker involved. 

What I do tell them is that they absolutely need a lawyer. A good lawyer is worth their weight and gold. So I can provide a lot of the same guidance that a banker would be able to offer them in terms of the process. But I'm not a lawyer, and navigating the legalese in documents can be quite complicated and overwhelming.

That's where a lot of deal fatigue can come in as well. But if you have a good lawyer by your side, that can help tremendously.

Working with lawyers

I can only speak from my experience of working with lawyers on my side of the house. My interaction with legal is that they're very much partners and strategic thinkers regarding the deal and the commercial terms.

Oftentimes, I have a very good relationship with our council, and I'll often give him a ring just to think through something, and talk through certain complexities and incentives that are being created in a deal by wording it in a certain way in the agreement.

If we're getting a good lawyer, I can only assume that's what they should be doing. And on the sell-side, if you're getting a good lawyer, they should be there to help you navigate the complexities. 

Not just the words, but also what's in your best interest and what term you should be willing to give in on because there's a back-and-forth here and there's a number of different deal points that need to be worked through. In short, I think that lawyers help in those commercial terms.

A lot of education goes on outside of the deal, how it's structured. Beyond that, there's a lot of education about:

• The company as a whole.
• How would we come together?
• What does the integration look like?
• How can we realize the most value together?
• In the organization that they're going into, how will they possibly help to shape that?

Those are all things that a lot of founders find very intriguing and interesting and there's education that needs to go with that.

Now, I bring in other partners in order to really help facilitate those conversations. It's not me alone, we're a big organization. I frankly can't be an expert on every single business line and organization, nor should I be the one that necessarily speaks for them.

So I bring in the correct sponsors to a deal to have those conversations and instill the confidence in the target that is needed going forward. I can answer questions for them as well, but there's more value coming from the other leaders they will be working with after the deal's done than it does from me.

Leadership connection 

The leaders should be connected almost immediately. I am very hesitant and likely won't really push forward with a deal to the point of negotiating any terms, whether they be high level or more specific, without a deal sponsor–someone within the business sponsoring it.

It's almost immediate. And often it is the business itself that's bringing the target to me. They have a relationship. Going back to the fact that real estate is a very regional business, that means it has a lot of regional relationships.

Sometimes, it's some buddies that grew up together, then one buddy wants to sell their business and the other buddy works at JLL. So that's how the connection gets made, and then I'm brought in to help shepherd the deal along. But to answer your question, it's from the outset regardless.

Valuation

One of the other things to educate the founders is valuation. That goes hand in hand with the deal structure as well. Just the transparency in the education process about what the process is going to look like in terms of timing and the methods we use to value a firm.

We don't use multiples to value firms. We use a traditional discounted cash flow analysis, and a thoughtful review of our expectations for the forecast and the multiple is just an output. The multiple is a function of what that analysis yields as a multiple of EBITDA. And the revenue multiple is typically a function of the margin percentage. A higher margin percentage business is gonna get a higher revenue multiple as a result.

I need to do a lot of education on that, typically, because one of the big pitfalls of coming into a negotiation or target is that multiples are being thrown out there from various colleagues that they've spoken to or another friend who sold their business, and you just can't value a business like that.

You need to look under the hood. Every business is different. Understanding their business model, economic environment, how it's structured–it's all going to influence the growth forecast for that business. And that, in turn is going to impact the valuation.

Negotiation

My preferred method of negotiating a deal is: First, it starts with educating them about how we came up with the valuation. Then, come to them with transparency regarding the value we see in the business. We won't expect a direct response, but allow them to digest it and return with any questions. Ultimately, the other party needs to be engaged in the back-and-forth there. You need to understand where they are and that serves as the bookend. 

But before I even go too far down the numbers, because that's just kind of a back and forth and a trade-off between what's going to give them and us comfortable from a deal structure and outlining all of the different structural points and why they're important for us. Which ones could we give on and which ones we couldn't? And it becomes a bit of a game theory there.

The other thing which is more tangible and is more important is what are the other value drivers for them? What's important for them? Obviously, price is important. That's a given, but the other things that are important are potentially removing the administrative burden that has just been such a drag on them for so long. So, can you focus on that a bit more and make that more of a selling point?

The long-term vision and opportunity for their employees. Explaining to them how much opportunity there is for them within JLL. Frankly, I've been living proof of that, 15 years working my way up to different roles, different levels of responsibility and being challenged at every step of the way. 

Highlighting that to them, just a larger strategic vision for the company. Do they have a real passion behind what they're doing and therefore joining a firm that helps accelerate that vision? How important is that to 'em?

So, get too focused on just the numbers. It can just become very robotic, and you may end up giving up on more things than you really need to, because you haven't spent enough time understanding all of the different pain points for the seller, not just price and focusing on those as well. Spend the time building those relationships and it will pay big dividends.

In terms of correlating that with your financial offer, you would want to maximize it. You need to have a realistic discussion. You know, 20 times ebitda is not going to work. You just need to set your expectations here, maybe by writing them some educational materials about what the market is doing.

We don't value based on multiples, but multiples serve you a good purpose in ensuring you're within the guardrails. Making, letting, helping them understand what is ultimately a fair value at the end of the day. 

The earnouts do provide and is something we utilize a lot, but it provides that additional upside to help bridge the valuation gap, give them additional upside, and share in something that they can share in with that strategic vision, but earnouts typically are a way that we ultimately bridge the valuation gap at the end of the day.

Earnouts

Typically we approach it this way. There's a value that we are very comfortable with paying guaranteed. And that needs to be based on some very reasonable and achievable growth target. I can't take some hockey stick, crazy growth forecast and base what I want to pay as a guaranteed value off of that. And guaranteed value for me can be in the form of upfront and deferred typically.

Deferring part of that guaranteed act is a retention mechanism, which again, is very important to us. So the way that we structure that is important. 

So first, establishing how I arrived at what that guaranteed value is, and then it typically turns to a conversation of what if it grows at a 30% CAGR? That's a fair point. We're probably enabling that to a large extent or bringing a lot of synergies that help to drive that forward. But we present what we'd be willing to share in that upside if they did achieve that 30% CAGR growth.

Frankly, we expect to receive a little bit more of a return in that scenario as well. We're not giving away a hundred percent of that value. We should see more of a higher return in that upside as well. But the seller will also be very happy with seeing more dollars in their pocket and achieving a higher overall multiple than they would have if we just use the baseline level of growth expectation.

So, it comes down to education, walking them, and shepherding them through that. But a lot of times, they will have a number in their mind and typically we just need to paint the picture that you can get there, but there needs to be some contingency behind that.

We tell them why we think they can do it because we're really going to accelerate their platform and show them how we're going to help throw gasoline on the fire, so to speak so they can get comfortable with that being very much a reality.

Even in a competitive process, when we put forward an indication of interest, we'll put in that indication of interest the maximum value that we think for your firm, but we think that x percentage of it will be guaranteed and x percentage of it will be subject to an earnout.

Now another thing with being transparent and honest here is that that upside right is not going to be based off of some insane growth forecast. Going back to the crazy hockey stick growth numbers that we get from investment bankers, which you yield to astronomical valuations, we don't want to put forward some insane value but 90% of it will be subject to an earnout because it's so aspirational.

We'd rather put forward an upside, an earnout target, which we feel is achievable. Because if it isn't achievable that the target can quickly get out of the money, and then they're no longer motivated by the earn out, you don't want that either. 

You want it to be an achievable target where they are appropriately incentivized to continue to push toward that growth number. And if you make the number too large, frankly, I don't feel it's honest, but it doesn't appropriately line incentives.

Earnouts are really tricky and we utilize them quite a bit, and we've been successful doing so. A few things make them difficult.

• The timing can be tricky.
• Both sides, in a lot of cases, want a shorter earnout.
• Buyers often want shorter earnouts because it can impede integration.
• It can slow down integration.
• focus isn't necessarily where you want them to be
• there's less flexibility as the buyer to move the pieces around and structure it in a way that will maximize value
• the seller wants their money as soon as possible

So that's the thing, but typically if it's a longer out, you can bridge a larger valuation gap. So there's a tricky balance there. The other thing is that whatever KPIs you're putting out there to measure an earnout, you need to ensure they're measurable.

Be careful about throwing out KPIs and targets which you're not sure you can measure out and avoid a situation where there's a lack of clarity in terms of how that's being measured or what the numbers are that are coming in. Make them easily trackable, such as revenue and EBITDA, being two of the most common measures. 

But with EBITDA too, you must be careful because there are a lot of expenses which may be out of the seller's control, which ultimately get added to a PnL post acquisition. We're very careful, but if we're going to use EBITDA as a measure for the earnout, it's not really EBITDA at the end of the day. It's an adjusted margin for purposes of the earnout that strips out a lot of expenses that we don't think are something that the target can manage, and we want to avoid that dispute as much as they do.

When you do enough of them and do them right, you can see the benefit of using them. We've had a lot of successful earnouts where they've really been pushed to achieve that growth. They've received the full payout and we feel great giving it to them. If they're hitting that earnout and you structure the KPIs in such a way, you won't get into a dispute.

And there's been lessons learned along the way. For example, we've structured deals where there was a dispute because we did include more expenses ultimately, that the target argued were not within their control, and it led to a dispute. But we've learned our lessons there, and I have found more success as a result going forward.

Making earnouts successful

Avoid those things that make them difficult. Be really thoughtful about what those KPIs are, are they aligning incentives? You don't want incentives to be misaligned. Maybe a good example of this is that if you're acquiring a target and you want the leader of that business to take on a bigger leadership role that's beyond just the scope of what their business is that we're acquiring.

They are going to be the lead for the entire Midwest, for example, then you can't just structure an earnout that is on just their small piece of the business. You may not even be able to track it that way, but you don't want them to be solely focused on just the numbers that they impact their earnout and not the bigger picture and the growth of the entire Midwest market. 

Oftentimes, what we'll do in that case is a combiner now where we're combining our legacy business with their business and then putting together growth thresholds based off of that so that they're frequently indifferent in terms of where the revenue's coming from. They're incentivized to grow it in either place because it's all going to add to their earn out contribution metrics.

Don't make them overly complex. I've seen some crazy math written around earnouts. The simpler you can keep them that ultimately align incentives appropriately, and you're avoiding silly things that could be disputed, like expenses that are completely out of their control, then you could really have a successful earnout as a result. 

Retention with smaller companies

I don't know if it's easier or harder. It's a similar type of mechanism. I would say that it's more to a certain extent. I just put a little bit more weight in it when it's a smaller company, because typically if it's a smaller company, the talent is going to be a little bit more concentrated. They will probably have a smaller bench of talent, someone that could kind of step in and take up the leadership mantle.

The consequences of having a principal leave that is driving the bulk of the business in a smaller deal, it just may be less of an engine where the impact to the value could be much more significant. So it just takes us to a heightened focus on smaller deals. 

Best practices to retain people 

I'm going to put money aside here because that's the low-hanging fruit. An obvious one is making sure you're identifying the correct pool and setting an appropriate carrot of dollars aside if they aren't equity holders. But first off, make them feel very included in the new culture.

Make them comfortable that it will not be an immediate disruption to the culture they hold dear. It's just that it's going to be different. And show them all the reasons why the company's culture is excellent, and help them understand the benefits of that. 

You don't want them to feel like they're on an island. You want to make them feel included and a part of the team. And that starts with a very clear integration plan.

• Working closely with your HR team to set up kickoff meetings
• Day one, having a huddle with the newly acquired team
• Getting them in a room and giving all the presentations

All of that goes a long way. You need to start off on the right foot, emphasizing the opportunity for growth. When you're at a smaller company, especially a company that's just maybe focused in one specific area of commercial real estate, there's a lot fewer avenues for growth.

JLL has so many different opportunities and paths you can go internally, and I think that's incredibly exciting to most individuals that come on board with us via acquisition. 

And, lastly, at the risk of stating the obvious, don't screw up payroll and benefits. That's numero uno on any integration checklist, and we've always done a great job of that, but I've certainly heard horror stories in the industry of that not going well on day one. Talk about a way to start off on the bad foot, that's a good way to do it.