We spoke to Carlos Meza shortly after Legado Capital’s acquisition of Kivuto Solutions, Inc.

Searchfunder member

Searchfunder member

It’s been a crazy 45 days after closing. The 90 days prior to the transaction were very, very crazy too. So, the last 6 months of my life have been all over the place.

Was your search strategy industry focused or more expansive?

Our search was a hybrid. It was an industry focused search but we were open to opportunistic deal flow. So, if a broker sent us a deal that made sense even if it wasn’t in our industry focus, we would look into it. When we had referrals from others in our network, we would look into them opportunistically. We picked probably 3 or 4 big industries and then divided them into subindustries. We looked at 3 different sectors at a time. After we exhausted 1 sector we would move into another. Usually, we would be looking at 2 or 3 at a time.

How did you find your business?

Very early on in our search, we identified IT or technical services as an interesting, growing industry in North America. We were looking at IT services for a while. One of our interns found this company and had it on their list. They were tasked with looking at a specific industry in a particular geography and developing lists from databases, industry publications and industry associations. It was very fortuitous because the company historically has been low profile. The brands are different than the name of company. It was a lucky find to say the least. We had never heard of it. In fact, there are even clients that have not heard the name Kivuto. It was very well hidden.

How many interns did you have?

At times we had 10 of them. Keep in mind, they were part-time, working different hours as they were still in school. We probably had the equivalent of 3 or 4 full time people.

How would you say searching in Canada is different from the USA?

It has its pros and cons. On the one end, there is not as many people looking. So, there is a little less competition in the lower middle market funds, which there are very few of these funds. The mid-market funds are very reactive. They get a lot of deal flow from advisors. So, they don’t care much for proprietary deal flow. So, there’s less competition for the proprietary search in Canada, which is not the case in the USA where you have 50 search funds searching at the same time. You also have independent sponsors and lower middle market firms in the USA, which has much more competition, but it is a much bigger market. So, I would say it’s a little easier to search here in that regard.

On the other end, search funds and even the lower middle market private equity industry is so unknown to companies of that size in Canada. People don’t understand why you are calling them and whether you are legitimate. So, you have those challenges in terms of searching.

Also, there are a lot of resource-based industries, which are not an ideal target for a search fund. For instance, in Alberta where we were searching from, there are a lot companies very tied to oil and gas, mining and agriculture and whatnot. That takes away a lot of the market you would be targeting.

Finally, people in Canada are little more low profile. So, finding information about people is a little bit harder.

Searching in Canada has its challenges but it also has its benefits.

How did you learn about the search fund model?

It’s so unknown in Canada, especially Western Canada and more so in our school. At the end of business school, Jeff and I started talking about our plans post-MBA. We both had pretty good jobs. I was in corporate finance while Jeff was a VP of Engineering at a mid-market sized company in Calgary. We decided we wanted to buy a company and manage it. We knew we didn’t want to do a start-up. We didn’t really know how to do it. Also, we didn’t have the money to buy a company of a decent size.

So, we started to play around with different structures and tried to come up with our own structures. Some people thought we were crazy to raise money without a track record. In all that research, I came across an article in the Financial Post featuring Auxo with Erik Mikkelsen and Robert Cherun. From there, I started Googling about the search fund model and quickly found the GSB site. I told Jeff that here’s pretty much a handbook to do what we want to do. After the research, we felt it made sense.

I think you were one of the early users of Searchfunder, too.

I can’t recall how I came across Searchfunder, but I recall talking to Mark. I think it’s great. It has given us great visibility into search funds and investors along with what is happening in the search community, especially the acquisitions that have been made. It’s an interesting tool.

Did you have any broken deals?

We sent out 6 LOIs. For 3 of them, we didn’t get them because of price. For two of those, the sellers had ridiculous expectations. Even though we had chatted about price before sending the LOI, they still wanted way more. It was a result of a very hot market in the USA and in technology. So, those two didn’t go through. There was another one that we put in a LOI for a brokered deal and we were the only players at the table. We thought we could take advantage of that and decided to really low ball the offer. We weren’t too crazy about the company. We liked it but weren’t 100% convinced. If we could get it very cheaply, it would make sense. We went back and forth a few times with our offers. The broker kept us warm until he could get a better price from a strategic. On our end, it was an experience in being naive on our part in trying to get a company for that low. Maybe, if we had thrown in a couple million more, perhaps we could have gotten it. It all worked out in the end as we found a way better and bigger company.

We had another company in Calgary that we really liked. We worked on issues with the seller and with a particularly difficult counsel as well. After going through several iterations, we signed the LOI and started looking at the diligence materials. The numbers were really down for the year, like 25%. The seller did not want to adjust price. We said we cannot pay you what you want, the value is not there, especially in such difficult industry. The company was in the oil and gas industry. It was far removed from the well head where a lot of price fluctuations happens, but still the industry is facing a lot of headwinds that wouldn’t justify the price we had offered originally. We subsequently learned the seller had try to sell the business 3 or 4 times before but he hasn’t been able to do so due to crazy expectations. It was more of a “him” problem than an “us” problem. Luckily, we discovered fairly early on in the process that this deal wasn’t going to work.

Did you have challenges in your final deal?

In our ultimate deal, we had tons of problems. It was a very hard process. One of the problems was that we have an above average business in terms of complexity. In that sense, we diverted from the traditional search fund principles of looking for a simple business. With the greater complexity, it took a while to understand it and then to get the investors and banks to understand. We also had a very difficult lawyer on the other side. He put a lot of grief into our deal. He made everything difficult. The seller was smart and fairly sophisticated, but inexperienced at selling his business. On top of that, while he and his family owned 70% of the company, he had 45 minority shareholders that made life a little more difficult. Further, we tried to push the seller to work with a big or recognized law firm but ended up working with a firm that didn’t understand the M&A market for a transaction of this size. In the end, you end up paying a lot more in fees. We were able to work through the issues. The seller was also dealing with health and emotional distress related to the stress of the sale. We were successful in managing it, but there were a couple of occasions when those emotions almost broke the deal.

Was that because he was essentially selling his baby?

Yes, selling his baby. There was some internal conflict with his second in command, who was the president of the company at the time. That was one of the triggers as well. The president was about to leave and he wanted to be able to cash out some of his options. He didn’t really want to continue working with the seller. There were a lot of internal dynamics. Both were great guys, but different ways of seeing the world. It was good for us because we were able to jump in there and solve the situation with the acquisition. But also, there were difficult dynamics since we were dealing with both, in a sense, “Who’s team are you on?” We were just in the middle. Sometimes, each seller felt like we were just working with the other guy. That almost broke the deal a couple of times.

The emotional part and personal dynamics were a big thing. The lack of experience on the seller’s side and his advisors put a lot of difficulty into the deal.

Given the greater complexity of the business, what kinds of conversations would you have with investors about the company?

We tried to explain the business as succinctly as we could and why it made sense regardless of the complexity. We highlighted where the industry is going the strength of the company, its unique position in the marketplace and that it had a lot of big contracts. The numbers really helped. The company had beautiful numbers. We had a very interesting story. We put together an extensive PPM to explain the business in and out. We put as much information into it as we could. It wound up being 140 pages with lots of graphs, visuals and explanation due to its complexity. We put a lot of time into the PPM and on the phone with investors. We visited a few investors in person. We had all of our interns working on different sections of the PPM. We had about 8 people working on the PPM.

I would say that we were very communicative. One of our investors said that every communication from us was always a mouthful (chuckles). But, they were happy with it that way because they received a lot of information. The investors indicated they needed to set aside an hour to review our materials because it was always a lot. We explained things in detail so that people could understand the business. The reality was that it was a complex business to understand.