Growing through Multiple Roll-ups

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1:46I'm Kisan Patel, and you're listening to M &A Science, where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies, and what actually happened during M &A deals.

2:25M &A role openings and other resources as we build the greatest community of forward-thinking M &A practitioners. Again, that's mascience.com. I'm your host, Kisan Patel, CEO and founder of M &A Science. Joining me today is Sam Yosef, founder and CEO at Valsoft Corporation. Valsoft is a company that acquires and grows vertical software businesses that provide mission-critical solutions in their respective nicher market. Today, we're going to talk about roll-ups in the software business. Sam, how are you doing today? Very good, Kisan. Thanks a lot for having me on your podcast. Hey, thanks for taking a break from doing all these deals to teach me a few things here.

3:04Can we kick things off with a little bit about your background? I've been an entrepreneur since I'm a teenager. I've had a bunch of businesses that I've started, sold some around web marketing. And then in 2010, we got together, my partners and I put$20 million together. and started an investment company called Valsif Capital. And then Valsif Capital started investing in the stock market. And then we started learning a lot about the world of investment and how to compound capital and what type of businesses were good and what type of businesses were bad. And we invested in more and more businesses.

3:37We fell in love with the software industry. Throughout that study period, we were investing a lot in acquisitive companies because we found they tended to be undervalued in the market because a lot of the value they brought was through M &A. And the market doesn't have a good ability to predict that into the future. So it didn't discount it properly in the price. So a lot of these good acquisitive companies tended to be undervalued by the market. So we got to learn a lot about companies that do roll-ups. And we studied many of them. And then in 2015, we decided to do our own. So we bought our first software company.

4:12And then three more the year after. And then eight more the year after. And this year, we're going to buy 30 of them or so. You went through your life story so quickly. That was like a minute and a half. But you went from the teenage entrepreneur, which we could probably unpack in a whole interview there. And then you went through some exits in that process, got together with some folks, put together some capital. And it seems like there still was a lot of learning there to come to this conclusion or an area to focus on with acquisitive companies. What started it? What was their first business?

4:43We had a few businesses all focused on affiliate marketing and advertising. How old were you? You said you were a teenager back then? No, I was in my early 20s. From 2004 to 2010, we started many businesses, ad networks, a few different web marketing businesses. A lot of that knowledge came back later in our lives when we also have another business that buys web companies called Valnet. But our primary activity today is software companies. We buy software companies. And we still actively trade the equities. So it's really a passion for investing. It is. The part I'm trying to point out is these parts in your background that lend to this pedigree that I think you look at M &A a little different because when you understand how a business really operates in and out and even ground up as you built one, I'm just curious of how do you look at that?

5:35We'll get into the investment size, but functionally of buying and growing companies through acquisitions. You know, Warren Buffett said, I'm a better investor because I'm a businessman and I'm a better businessman because I'm an investor. I think I found that to be really true. And it's my experience that my knowledge of business has helped me invest better. And my knowledge of investment has helped me manage our businesses a little bit better. So in that period from 2010 to 2015, we really learned a lot. I used to maybe read something like 2 ,000 pages a week of 10Ks, analyst reports. I used to listen to earning calls.

6:12And I used to really deep dive into companies to understand their economic characteristics, what made them great, what made them good companies, to be able to predict which companies are likely to do well into the future, because that was my job at the time, and then invest in them. When I studied roll-ups, I found that a lot of them that did well, the underlying businesses they were buying were businesses that lent themselves well to a decentralized investment strategy. Or by bringing the businesses together, they had the tremendous competitive advantage to roll up the next business. But in every case, they sort of had a clear reason why they earned the right to acquire.

6:53And then there's a lot of other companies that engaged in acquisitive activities and just wasted shareholder capital because they were putting businesses together with no real purpose and they hadn't earned the right to be an acquirer. You earn the right to be an acquirer by managing the businesses better than they were previously managed because you could drive more growth out of them or you could drive more profitability out of them or you have something to bring to these businesses that will make them better in one way or the other. And we advised our strategy around that and our investment playbook around that.

7:26We tried to buy companies that are intrinsically very good businesses. Then we tried to run them a little bit better than they were run previously. So you looked at all kinds of companies' investment strategies, came to this realization, the companies that did good acquisitions were better investments, undervalued. It's almost like they kind of have this forward trajectory that you found to be a little more predictable. Is that fair to say? I was personally comfortable with it because in my life and in my business career, I found that people drove outcomes in business. If I could predict how somebody thinks, how the management team of a company thinks and how they're likely to behave into the future through looking at what they've done in the past and M &A was part of their past and they added a lot of value to that, then I was able to look into the future and I was able to underwrite that into my price at which I'm ready to buy the company.

8:18And then we were able to buy companies that the market thought were expensive, but we thought they were really cheap because we were underwriting capital deployment that was going to be accretive into the future. Companies like Custard, companies like Transdime, companies like Constellation Software, companies like Berkshire Hathaway, a lot of those companies sort of framed our investment model for what we would later build. Yeah, it's interesting. So you look at this element around acquisitions, you distinguish between good acquisitions and bad acquisitions. Yeah. They're bad acquirer, They're not creative in acquisitions.

8:51Not a good thing. You want to weed those out. But on the good acquirers, do you distinguish with the strategy? Because it sounds like part of what you're referencing is they could be very focused on more of an economies of scale or doing a traditional roll-up or being more strategic in nature. Do you distinguish between those two? And it mainly would be those two and look favor one over the other. No, we looked at both and we invested in both. For example, you look at a company like Salesforce, a very strong requirer. What they would do is that they had a base of customers and then they would append product that would add value to these customers and would make the customers more sticky.

9:32And they would leverage these customer relationships and provide them more products that they needed. So every time they bought a company, it looked very expensive. They paid for it versus the revenues and profits the company had at the time. But then you expose this product to the large customer base of Salesforce and their revenues would go up a lot. So then it would become cheap. And then this is one of the strategies that's allowed Salesforce to compound at a very high rate for a very long time. And it's not very different than the strategy that a company like Microsoft employed for many years.

10:05But then you look at other acquirers. Let's say you look at Transdine, where the companies would keep running independent. So they weren't necessarily have a lot of synergies with each other. the products, but develop expertise at running these companies in a way that allowed them to extract more revenues. They had best practices through learning from 50 different acquisitions that every time they bought a company, they're like, this is the playbook we run to make this company more efficient, higher revenues, higher profits. And they had earned the right to be an acquirer. Every time they made an acquisition, it would add value to their shareholders.

10:40Whereas a lot of other companies, they would just buy companies to grow the revenues. but they really would not add any value to the shareholders or to the customers or to the companies they were acquiring themselves. We don't invest in those and then we invest in the former. So regardless, it's either you're looking for their capability to drive synergies off the revenues or an element around the operational efficiency? Yes, one of the two. Okay, ideally both? Ideally both. That's how we sort of studied acquirers and determined which one are likely to do well. And we did really good with that.

11:14How'd you figure out the segment? And maybe you can help me get a sense of even company size that we're talking about, because it sounds like there's a spot, I remember what I was talking about before, that you really laser in on. First of all, if I get to software before I get into the size. So we were studying these companies and then you're investing passively into businesses on the stock market. You're looking for companies that have certain characteristics. So you want a lot of predictability because you're not managing the company every day. You want to be able to model in your head a spreadsheet.

11:44What's this company going to look like in a few years? So we found software companies had a very high level of predictability. A lot of them had pricing power due to the fact that they were very important to their end customers. They had a low churn rate, enabling us to start next year with 98 % of the revenues we have this year. It's a much easier business to manage than if you start from scratch next year. So this made us really focus on software. And then we start studying a lot of software companies and we invest in a lot of software companies. And then we're like, OK, maybe we could do that on our own.

12:18So then we start looking, where can we add value in the marketplace? Where is there a gap in the market that we could fill where we would earn the right to be an acquirer and make good acquisitions that would add value to our shareholders and to the whole constituencies, companies that sell to us, the employees of the companies that sell to us and everybody else. In the vertical market software, there's about 30 ,000 of those companies. Most of them tend to be in the$2 to$20 million range because the vertical markets themselves are small. Then there's a few bigger companies, maybe 1 ,000 of the 3 ,000 are larger companies.

12:53The larger companies are, to a certain extent, usually easier to manage. If you have a large revenue base, you leverage one R &D budget across much more customers. And they're usually in bigger verticals that tend to attract venture capital and private equity a lot more. So we didn't feel that we would bring tons of value there. But in the small and mid-sized markets, they have to be operated a lot more efficiently to bring value. And we felt within Valsoft, by learning how to operate those properly, we would become a good exit strategy for these companies. We would provide something valuable for these entrepreneurs that have those companies.

13:32and that want to move on or the companies need to go to their next step, we would buy them and we would help them make that transition. They're in different phases of their life cycle. Sometimes they're operating in a market that's saturated. So deploy money in R &D and sales and marketing, but there's no new customers to grab because everybody's vended. They all have software solutions. So you have to go get them from your competitors, but these competitors have sticky solutions just like you do. So the company has reached a point in its life cycle where it's blocked from growing and it's mature.

14:06In a mature company, you tend to lose your best employees. It tends to be less fun to work there when there's limited growth. So we come in, we'll buy these companies and we'll be like, okay, you know what? Now we'll give you money and expertise to go buy your competitors and then acquire your growth and then create a dynamic company where you have a much bigger customer base to which you could sell more product. And then we'll go buy other adjacent product that serve that vertical and create a really dynamic mini conglomerate around that company we initially acquired. And that we found brings a lot of value to the employees of the companies we acquire, the owners of the companies we acquire, and our shareholders and employees at Velsa.

14:49I like how you explain it. It's simple to understand. It gets me fired up. It makes me want to go find a sector to roll up. Yeah, it's worked well for us. We've scaled the company significantly over the last five years. We've completed over 60 acquisitions. Now, when you look at that 60, are there a number of platforms that you look at saying, hey, here's a platform play and then you did all your add-ons around it? Yeah, we're usually going to enter a new vertical with a platform company. In vertical market software and software in general, you're building one product and you're selling it to many customers.

15:22So if you have a lot of customers, the same R &D budget gets levered across much higher revenue base. So if you start with a very small company in a new vertical, you're starting weak. So you have to start with a company that has a little bit of pedigree in a vertical. You enter strong, you have staying power in that vertical. And then you look to buy companies that have interesting customer relationships and you bring those into your platform. and then you could buy companies that have interesting products and then you could sell those to the bigger base of customers. And there's a lot more you could do and that's our strategy.

15:59But all the companies that we buy independently, we usually manage them in a decentralized fashion, meaning we keep most management teams in place. All the companies we buy, we need them to be mission critical to their customers. We need them to have a certain level of strength in their customer base, meaning they've been around for a little bit of time and shown that they bring a lot of value. to their customers. And yeah, the companies by themselves have very interesting economic characteristics. We bought a company this year that had been around since 1955. So this company is a small company and independently, they've weathered.

16:34Think about what's happened over the life cycle of this company, seven years, and it's remained independent and it's remained successful and it's weathered every attack upon its domain. So there must be something about this company that's special, right? Yeah, big common point. I'm seeing in your approach is around this operational efficiency and driving value out of improving that. And then as you acquire companies, when you start with your platform, then you start looking for those revenue synergies. Is it something adjacent that gives you an opportunity to cross-sell, upsell solutions to create the additional revenue?

17:11First of all, we got to buy the company at a price that makes sense. We underwrite each acquisition on a standalone basis. And we underwrite it to our unlevered IR that we will get from this acquisition. So I've studied, like I said, the amount of information we've gathered on successful and unsuccessful acquirers is our IP. It's the IP of our investment group. It's what's allowed us to be successful across two roll-ups so far and a third one coming. a lot of acquirers are going to be like, my stock is trading at 15x EBITDA. I could buy companies at 10x EBITDA. This is accretive to my shareholders.

17:52I'm making a good deal. My stock is going to trade up on the news. Let's do it. Those always fail. In the long term, those will always fail. Why? What your stock trades at is a moment in time. This could vary, very widely. And when you're purchasing an asset, this is a long-term investment you're making with your shareholders' capital. You need to make sure you're making a good deal standalone. You need to look at the IRR of this investment on a standalone basis, modeling a very conservative terminal value, because the further out you're modeling, the less certain it is, because the world changes a lot in five, 10 years.

18:29I haven't heard the term IRR in the last five years. It's a new concept for me again. Yeah, you know what I mean? A lot of people don't use that. The market is hot. It's been that crazy. Yeah, right. Yeah, the market is hot. So we buy and then our stock trades up. But you know what? Now it's not trading up anymore. And now you're on the road 3 % that now your debt is going to move to 8 % when you refinance it. And what happens to your investment then? Did you really make a good investment with your shareholders capital? We operate by the philosophy that opportunity is sure to come back, but destruction of capital is permanent.

19:01For us, you need to be really careful in M &A. The way we do it is we need to have a lot of looks. So we have 60 people full-time in M &A, always looking for opportunity and looking all around the world for good opportunities for us to deploy our capital. And at any moment in time, we have over 20 due diligences, projects ongoing. The reason we do that is to be able to really be selective in which companies we invest. If you're looking at three companies and you're looking to do M &A and the pickings are slim. You don't get to choose your opportunity effectively. So for us, we want to make sure that if we do M &A, we'll do good M &A for shareholders.

19:41And we have no problem not doing any. Capital discipline is a big part of this, which I like you stick to the values of IRR and the stuff that really makes sense despite market fluctuations. I was thinking about negotiations on this stuff. when you are engaging with these companies and you have this sizable team, are they engaging with the owners directly? When do you get involved? My job at this point is more of a risk officer. Just making sure that at the end, when we write a check, we're making a good decision. A lot of our M &A activities are done by our investment partners. We're one of the few companies that has a decentralized capital allocation strategy.

20:23So we have investment partners that each run their own investment organization. They each have a portfolio of assets and they're responsible for the returns, the growth and the deployment of capital for that portfolio of assets. They are the ones that speak to owners, they make deals. And occasionally I'm going to get involved when it's a bigger deal and I want to know more. But generally speaking, our investment partners, investment directors are the ones that are making the investment decisions at once. So I was going to ask you, how do you differentiate yourself from PE firms? First of all, the smaller the company, the harder it is for a PE firm to run.

21:00So it's rare we see PE firms coming in the sub$20 million market because often putting one of their management teams and the way they run business, there's not going to be enough scale to warrant the effort when you have$5 billion to deploy. So we run into them less. And also in our field, we provide a very attractive exit strategy for owners. We keep our businesses forever. You sell to us. Very rarely are we ever going to sell a business, only if it's the best thing to do for the business. But as far as Valsoft is concerned, we want to keep all our businesses. And basically, we buy, we hold the business, we invest in the business with a 40-year horizon.

21:38We make investments that might not pay off for five years. And we buy businesses that we expect to stay around for a very long time. That's a very different strategy than a company that's going to, an IP firm that's going to buy a business with the goal of selling it in five, six years, you're going to make very short-term investments. You're going to make cuts in staff. You're going to run things very differently than we would, given our model. It's like a bootstrapped model at scale, because you're really disciplined about how you run those businesses. We have a Valsoft system. So a playbook that we apply and we have best practices on how to manage these companies.

22:17and we have leadership summits that we run to educate all our CEOs on how to better run their businesses. Also, this is something, a lot of that we learned from our own experiences. Like sometimes running a company is a very lonely experience. You're at the top of the company and everybody listens to you and you don't really have the peers to run things by. And we bring these companies together and we give them like a network of peers that can help them. It makes their lives and their careers more interesting. Like I've had this saying here, people make decisions based on what makes their lives better, not necessarily always what puts the most money in their pocket.

22:55So a lot of owners care about money, but they also care about their employees, their future, their careers within the acquirer. So there's a lot of things we bring that private equity doesn't necessarily bring to the table. I get a sense of some of that, that you focus on the smaller deals. The financial structure, I'm still a little lost on because you You said 40-year horizon you're investing on. I'm familiar with the firm operating on a structured fund, investing in with the time horizon to exit. Then you have more of these sponsored activity. You got a search fund or a fundless sponsor. And you're a little more ad hoc about putting the capital.

23:32And I've seen some interesting things around that, where people find their approach of getting the Visa investor money. They populate and fund on more of an ad hoc basis and then realize the value on the individual exits of those deals. But you have a really long-term strategy. What's the mechanics behind that? I'll tell you a little bit about it. Sold a few businesses. I was 27 years old, 28 years old. Got together with our partners. We're like, we retired. We were retired for like six months. Hated it. Absolutely hated it. So we're like, we want to work. We want to do something with our lives.

24:04The sense of purpose that work gives you is sort of important. And we're going to put this company together. And our advantage is going to be our time horizon. We're going to do things that other people, given their capital structures, cannot do. We started these investment activities. A lot of things we do, other people can't do because we start everything with our own money. So it was all our own capital. We started buying these businesses within Valsoft with the intent to keep them. And then these businesses would make us money and we would buy other businesses with them. And then we got an external investor in 2020, February of this year, that came into Valsoft.

24:40and then Valsoft now makes its own cash flows. There's no need for incremental capital. The cash flows the company makes is enough to fund the acquisitions we make. Eventually, we'll take Valsoft public, we'll retain a very large stake in Valsoft and Valsoft will keep deploying this long-term capital allocation strategy where we seek to build value for our shareholders for the very long term. The goal is not to sell it. The goal is to eventually bring it public. Whomever wants liquidity could have it. Valsef will retain most of its stake and will keep working at deriving value for shareholders.