THE IMPORTANCE OF THE RIGHT INCENTIVES AND THE RIGHT TALENT

SEARCHFUNDER INTERVIEW OF VICENTE ARIZTEGUI LEGORRETA – PART I.

We spoke with Vicente Legorreta of Arpa Capital which acquired 4P/MX in Mexico City.redactedIn this Part I, Vicente discusses making a big culture shift in a family-owned business, managing employees on a day-to-day level, and time management.

From the information I have, your search was about a year long. Is that the case?

It was a little less than a year.redactedWe started searching in August 2014 and acquired April 23, 2015.redactedSo, about 9 months.

Was this a field you had worked in before? Did you pick a niche? Or, did you just get lucky?

I think we got lucky.redacted(chuckles). It was part luck and partly the search strategy that we ended up taking. Initially -- the first month or two -- we started doing the typical brokered search.redactedWe reached out to all the brokers who do M&A and to private equity funds and whatnot. redactedWe started getting some deal flow from them.redactedWe started noticing that the deals we were getting from them were not very attractive.redactedThey were deals that had already been seen by other players in the market, by strategic investors, etc. We were basically the last ones taking a look at these deals.  We were obviously getting the worst type of deals.redactedWe changed our strategy and decided to focus mainly on 4 industries, one of them being financial services.redacted

We were very interested in the financial services industry.redactedWe started reaching out to people that we knew in the industry – such as industry experts and owners of companies in the financial services industry.redactedThat’s how we got our first leads to a couple of insurance companies on the market. redactedWe ended up not liking the insurance model because it is highly capital intensive and highly regulated; it was not the ideal model for a search fund.redacted

A friend of ours in private equity recommended looking at the insurance broker industry.redactedThey had done an investment in Central America and performed a consolidation strategy.  They had been very, very successful at it.redactedHe recommended taking a look at it.redactedThey had been trying to invest In Mexico in that industry, but he did not have the operational arm to execute the strategy.redactedHe felt a search fund might make some sense.redactedWe started doing some research on the industry.redactedMy partner reached out to the person who used to handle the insurance programs at Nexxus Capital, which was my partner’s previous employer. redactedMy partner knew the broker from the customer side.redactedHe reached out to learn a bit about the industry.redactedSurprise, they actually were right in the middle of the process of trying to sell a portion of the company.redactedIt was the perfect timing.redactedIt was a good fit for the search fund model.redactedWe ended up catching up on their process which was already under way.

Did you think, “This is too good to be true.redactedWe should keep looking a little longer.”?

That’s a good question.redactedWe did ask ourselves that question.redactedTo be honest, we really liked the company. It had all the characteristics of a search fund company: low capex, recurring revenue, growing industry. The penetration in Mexico of insurance is extremely low compared to the US. It’s about 2% of GDP in Mexico compared to about 8% in developed countries and 11% in the US. So, there’s a lot of potential in the industry.redactedWe decided it was a good deal and the downsides were limited as it generates a ton of cash flow. You obviously question it. And, doubts cross your mind as you prepare to cross the finish line. It was such a nice transaction that we thought it would be hard to find something as attractive.redacted

How was the closing process for you?

One of the key parts of getting this deal to the finish line was that the sellers had a professional advisor from the start.redactedThey were not sophisticated about finance.redactedThey’re great operators in running the company, but they did not know about structuring a transaction.redactedWithout an advisor, I think the transaction would not have happened.   The advisor was playing it on both sides of the equation.redactedHe helped transmit a lot of the messages.redactedBasically, he helped to educate the sellers on many of the terms on closing a transaction.

The other key part was that we were very aligned.redactedOur transaction was a little particular in that we did not acquire 100% of the company.redactedWe acquired a majority stake with 63% participation, while the sellers remained with 37%.redactedIt makes it a little bit easier given that incentives are aligned.redactedIf they are hiding something or you find something in the due diligence process, you’re going to be sitting at the same table tomorrow. Alignment definitely makes it a lot easier.

The third key was that it’s a company and industry easy to due diligence – no assets and over 50% of costs are payroll and rent. There’s not a lot of information you have to audit. That was key for us because they had no financial statements and no structure whatsoever.redactedWe had to essentially rebuild all the financial statements from scratch.  Given that it is basically a cash flow accounting business, it made it a lot easier for us to audit the company.

Did the sellers stay on in a work capacity or just a partial ownership capacity?

Both.redactedThey have partial ownership and are operators in the company. They remain directors of the company, mainly on the commercial aspects.redactedMy partner and I took over operations, finance, strategy, M&A and whatnot. These two guys are extremely good salesmen.redactedThis is a third-generation company and they were basically born into the insurance industry. They are experts in the matter.  Given that it was a relationship-based industry, my partner and I decided from the beginning that we would likely only invest if the sellers remained in the company.redactedThere’s been history in the industry where players have acquired 100% of the brokerage and the portfolio evaporates in a matter of months since it’s a relationship-based business.redactedIt was a key part to keep them onboard.redactedThey are still onboard.redactedOur relationship has been pretty good so far.redacted

Sounds like you freed them up to what they do best?

That’s correct.redactedA key part of this is that they were also very open to this structure. redactedGiven that they are very young; they are about our age, 33 and 36.redactedredacted(Their dad was also a shareholder and sold 100% of his stake in the business).redactedThese two guys were very open and knew they needed help running the business. At first, probably our biggest fear – and the investors’ fear -- was whether the partnership was actually going to work. Were they going to be open to all of changes we needed to implement in the company? To our surprise, they were absolutely open. redactedOn Day 1, they gave us control of all of the finance department, operations, whatnot. There was a lot of rotation in the workforce.redactedThey were fine with it.redactedThey knew it had to happen as a cost of doing a transaction with an institutional investor. So, that was one of the key parts of this investment being successful.

How was your Day 1?

It seems like it was a decade ago. (chuckles)redactedDay 1 was a little particular because it wasn’t an immediate change.redactedThe sellers were still running the business.redactedOn the one hand, it was easier because you don’t have to be really quick and you can make more mistakes.redactedAt the same time, it makes it harder because the situation doesn’t force you to make changes as quickly as you should.redactedBecause the guys are still there and the company is still moving along fairly well.

For us, it was a learning curve like for every searcher. We had to learn a lot about insurance.redacted

Looking back, we should have made a few changes a little bit quicker than we did.redactedThere were some things that were very clear we needed to change, but we had to take care of the relationship with the sellers.redactedIt was a little bit of cost we had to take in doing it a little bit slower, smoother, and involve them in the decision making.redactedThat way, they didn’t feel like now they had a new boss who was calling the shots.redactedIt was letting them know that it was a partnership and we were going to make decisions together, rather than start changing things immediately.

What decisions would you have made more quickly?

Most important are people.redactedWe did identify a couple of key positions where the person was not the right fit.  They did not have the culture that we wanted to create in the company nor the skills for the job.redactedWe took a little longer than we should have to make that change. redactedPartly, it was a little bit of fear of not knowing the industry.redactedWe also wanted to get a little bit of knowledge on the company and the industry before making those decisions.redactedIn the end, you realize the company does not depend on these people and you can find much better talent when you are forced to do it.redactedIt took us a little bit longer than expected to make those changes.

Tell me about the managing culture of the company?redacted

The biggest challenge we have had so far and the challenge we thought was going to be much easier than it actually was: redactedThe culture was that of a family owned business. People were accustomed to coming to work 9 to 5.redactedThey were not measured on performance and no variable compensation.redactedThere was a huge gap in middle management.redactedTwo guys and their dad were calling the shots. After that, there was a big, big gap between this and the next level in the company.redactedThe company was essentially run by 3 people.  Trying to change that mindset and create a culture of teamwork, responsibility and accountability, we implemented variable compensation for over 80% of the company and with KPIs for everyone.  It was a drastic change in the culture of the company. It was really hard.redactedWe thought people would be happy with the changes. In reality, when people are accustomed to doing things one way, it’s very, very hard to change the way they work.redactedIt took us more than a year to start seeing the results of our pushing and pushing on changing the culture.redactedIn the end, the only way we were finally able to accomplish it was to bring people in from the outside, from institutional companies that knew how to work with that mindset.redactedWe started attracting talent from large insurance companies and brokerages, like AON and Marsh. Those were the key guys at the management level who started to help us out in pushing on the culture.redactedIn the beginning, my partner and I were pushing and pushing, but couldn’t get our message through to the rest of organization.redactedIt was – and still is – the biggest challenge we have had in the organization.

What is a normal day like?

Whew, I spend 70 to 80% of my time with people. It’s amazing.redactedWhen we joined the company, we had all these ideas and strategies about what we would implement.redactedOnce you come in, you realize how much you are required to spend time with people and building the right team.redactedAt first, it’s a little frustrating because you are feeling like you are not getting things done.redactedIt’s Friday afternoon and you didn’t do all the things you wanted to do during the week. It’s frustrating to feel like you’re doing nothing during the day.redactedOnce you start seeing the actual results of giving people feedback, letting them know what to do, and how to work, it’s great to see how things start to happen without us having to execute them.

It is one of the biggest surprises and lessons learned of this process.  In your previous experience, you are doing all of the work – all the modeling, analyzing, and implementing.redactedWhen you come into the company, you think it’s going to be the same way -- that you’ll be able to do everything, get involved in everything and implement all the ideas and projects that you have. You very, very quickly realize that you aren’t going to have enough time. If you do it, the company won’t be able to scale.redactedTo me, it was one of the big learning experiences.redactedIt’s much more important to hire the right talent and dedicate the necessary amount of time to incentivize them, keep them happy, and help them with obstacles to their actual work.redactedTry to bring on people who have the knowledge and skills to implement.redacted

For instance, for the first few months, I was very involved with operations to the point where I was in touch all day with insurance companies and processing policies, which is clearly not my expertise. So, when we hired a manager who came from the industry and knew a lot more than me, the change was immediate in the department.

It’s very important to find the right people for the right roles and the right jobs and spend the right time to keep them incentivized and aligned.

What do you wish you had known on Day 1 that you know now?

How much attention people need.redactedI say it in a positive way because people like to be praised and like to have visibility for their good work.redactedPeople like asking for advice and receiving feedback.redactedI was not very accustomed to it.redactedredactedIn my previous jobs, I used to work with triple A guys, A-type personalities and overachievers.redactedThese are guys who basically praise themselves. They do not need someone patting them on the back and telling them they are doing great.redactedWhen you are running a business, it’s really different. People really need that pat on the back all time.redactedThey really need feedback and guidance. You need to be behind them.redactedAt times, it’s hard. redactedYou have a lot of problems and things going on. redactedPeople approach you with the smaller details and the smaller things that, in your head, do not merit you dedicating so much time to them.redactedIt’s so important to them that you have to do it.   Otherwise, they are not going to do the work or the job the way you want them to do it.

Anything else you wish you had known?

I would say three things I wish

I had known: (1) culture which we’ve touched on; (2) people and how important it is to work on relationships; and (3) time.  Time management is key.redactedOn paper, it just seems so clear and so easy where we have to take the company.redactedTime is never enough.redactedRunning a business is different than being an investor or an advisor.redactedYou have things going on all day, all the time. You have to be very selective and really focused.redactedChoose the 2 or 3 things that are most important for you at that moment for that week or that day and get them through. Otherwise, you’ll get swamped with 20 or 30 other things and will end up not accomplishing anything.redactedI wish I had known how important it is to dedicate the time to the right things.redacted<o:p></o:p>