PE Models discussed with David Haintz.

I recently chatted with David about Merchant Wealth Partners activity here in Australia. Below is part of that discussion. Cheers, Kev

David, can you give us a brief overview of your career background for context?

Kev, good to chat. Sure, a high-level background, for context. 33 years in 30 seconds. I started my own small financial advice firm in 1989, which grew solidly (both organically and inorganically). We were early adopters in aspects – examples being self-licensing (1995), changing the CVP to ‘above the line’ (1996), becoming fee based (1999).

In 2008, we merged 13 firms script for script simultaneously, to create the national firm Shadforth Financial Group. We listed that in 2011, and got taken over by IOOF (now Insignia) in 2014. We recognised the collective was worth more than the sum of the parts, and that was exactly the case.

We were able to grow Shadforth from $25m EBIT on $80m revenue, to $58m EBIT on $160m revenue and got taken over for $670m. I know your subscribers are more tax and accounting focused, but I’d make a couple of points. Firstly, we acquired a tax and accounting firm with circa $18m revenue in 2012. So I am familiar with integrated wealth. Secondly, some of the principles that are important to designing success for professional services firms remain common across industries. Since Shadforth was taken over in 2014, I have been advising advice firms globally (B2B), in all matters from growth, CVP, internal programs, advisory boards etc – anything that will help make their ‘boat go faster’. I call it a Value Creation Plan or a VCP.

Can you expand a bit on this notion of a VCP?

Sure, a VCP is exactly that – a structured, designed, and focused Value Creation Plan. The sale of Shadforth for $670m didn’t occur by chance. It was designed with intent.

Part of any decent VCP must be to address the four key levers of (i) increasing revenue, (ii) maintaining or decrease expenses, (iii) appropriate balance sheet leverage, and (iv) prudent multiple expansion.

Most businesses just address (i) and (ii) above ie. to increase their EBIT.

Lever (iii) – appropriate balance sheet leverage - Debt provides leverage – growth from a higher starting point (provided the debt is used wisely). Debt can be purchased at say 8%, and if you buy at the suitable multiples, you should achieve an ROI of > 15%pa.

The concept is not rocket science. Find an aligned target, execute and integrate. The math is simple. You’d do it every day of the week. Until you run out of risk appetite or debt runway.

Level (iv) – multiple expansion – broadly, higher multiples apply when removing personal exertion, key person risk, and non-resilient income. Margins are expanded for ASX-listed companies, growth companies, larger companies, and strong and growing cashflows.

So, the perfect example of the VCP is Shadforth. Shadforth got taken over for 11.8x EBIT on double the EBIT of the underlying founders – effectively > 20x.

As I have said, my background and expertise is wealth. Interestingly, you may be aware, there is a huge arbitrage with Australian and offshore multiples.  For example, an Australian wealth firm, or integrated wealth firm may be valued in a range of say 5-7.5 x EBIT. Listed companies are higher – I have given you the Shadforth example of 11.8x EBIT. In the US, these multiples are significantly higher – depending on multiple factors it could be in the 15x to 23x EBIT range.

Further, there are circa 35 PE firms in the US that are set (or looking to get set) in wealth, or integrated tax & accounting, and wealth. Why? Well the sector has strong margins and cashflows, is highly regulated, increasing affluence of the population, and the built-in tail wind of the stock market. And, in Australia, we have compulsory superannuation mandating growth as well.

So is that why you decided to bring PE to Australia?

Well, yes, there are some pretty good reasons stated above. But for me personally, I was busy consulting, and when consulting, issues come up for clients you need to try to solve.

Most M&A models in Australia are majority controlling, meaning, they are effectively a sale or take over. That suits some, especially if they are older principals and looking to exit.

But that scenario aside, I don’t believe turning entrepreneurs to employees works – certainly over the medium to long term. I haven’t seen any evidence of this working successfully. So in these majority controlling sales, what happens in the future when key people have their money off the table? I haven’t seen it work yet across professional services firms, other than setting up and exit for the principal(s).

So if you take the VCP opportunity (particularly appropriate leverage and a focus on multiple expansion), along with offshore arbitrage; and overlay a new (to Australia) minority, non-controlling model, with a ‘tag along’ into US multiples, it just made perfect sense to me to bring the model to Australia.

Where is expansion capital different from other PE models?

Sure, there are many ‘M&A’ (and separately, capital expansion) models in professional services, and wealth management. Between us, I suspect we have seen most of them. Some work. Some have flaws. As I said, after searching for a model to help a Sydney client with, I have decided I like the model so much we have brought it to Australia. Expansion capital is exactly that – helping entrepreneurs with ‘dry powder’ to expand. (New shares are typically issues, and funds sit on the balance sheet providing growth runway via M&A).

Sure, these younger growth focused entrepreneurs have access to debt, but expansion capital partners often bring added benefits such as IP, new investment opportunities, M&A and other expertise, access to a ‘tag along’ into offshore multiples, all helping with the win for all stakeholders – clients, team members, and shareholders.

An in some cases, they have access to long duration capital ie. the investment capital does not sit in a fund with a 7-year ‘shot clock’ ticking.

In the case of the model we have brought to Australia, Merchant have the following key attributes and points of difference. Merchant are:

• not backed by an asset manager or product manufacturer

• not an aggregator or looking to aggregate

• take significant minority stakes of typically 20-25% (not controlling or 100%) for expansion capital, founder transition, liquidity (access to further debt / capital as required) and growth facilitation

• don’t require a board seat

• partner firms are offered a tag along into US market multiples

• partner firms get a second (or third ‘bite of the cherry’) whereas in most M&A models, any upside resides with the acquirer

• leverage M&A expertise to help entrepreneurs to grow

• offer long duration capital looking for yield and growth (not a PE/fund with a defined timeline)

• offer a cross-sharing community supporting entrepreneurs

• offer a collaborative ecosystem

• are Platform / custodian / investment philosophy agnostic

• founders maintain autonomy and control

Obviously, there are ‘horses for courses’ – and this model is different and unique in its own way. But for the right entrepreneurial growth focussed firms, it’s a great model. And frankly, based on the offer, it self-selects.

Who are the firms you are more suited to work with?

Yes, good question. Based on the model, it is best suited to groups with the following attributes:

• Entrepreneurs focusing on growth (not ‘white flag’ businesses looking to sell)

• as a result, typically the business partners are younger, not older – with some runway and vision

• Enterprises / emerging enterprises

• typically the businesses have some size and scale (and growth vision)

• typically they have been active in inorganic growth also, as a result, typically they have some debt on the balance sheet, and with rising interest rates, would like a capital partner as well

• We invest in people and character – must have the right mindset and vision

• No min EBIT - examples of backing start up entrepreneurs at lower levels (we are more focus on character, entrepreneurs, business models)

• Aligned values – Integrity, Collaboration, Entrepreneurship, Alignment, Vision, Perseverance

Thanks David, any final points you’d like to make?

Sure. I’d like to highlight the need to for growth. Growth is not for everyone, but for many, it solves multiple issues and delivers for the firm principals as essential stakeholders.

Risk and return are related – firm principals take on risk as business owners and must be rewarded for that.

Growth can come from organic or inorganic means, but as you get your model right and expand, significant growth rates from organic alone are difficult.

I recommend that you develop your own VCP.

One way or the other, the advice mid-tier is coming. They will have strong, recognisable brands backed by a sharp service and value proposition. When they arrive, small generalist businesses will become even more endangered than they already are.

---

MORE ISSUES