The Complexities of Smaller Deals

24:27But if you're able to look a target into the whites of their eyes and make a connection with him or her and say, this is why you should come to JLL. This is what we think your company is worth and why. And we think it's fair. We're not looking for 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 get by coming to a place like JLL. I need to be able to look someone in the face typically to do that. I agree. There's a lot there. And just that story alone. Well, you had the bad story about losing the deal in auction.

24:59But even if you won the deal in auction, it's still not as good of a story as building the relationship and that whole journey together. And just there's a lot. There's a lot of how well you put the deal together because you put way more consideration into it that lends to a better story, better deal. Absolutely. Absolutely. It's just a better deal at the end of the day, usually. Which is a better story. When you buy a company, you get a 5x, 10x return. Those are great stories. Can you tell me about working with the founders? How do you approach educating them? I can shepherd them and guide them along in the process.

25:30I've been asked by them sometimes, do I need to get a banker involved? This won't surprise you, but my answer is no, you don't need a banker involved. What I do tell them is you absolutely need a lawyer. I think a good lawyer is worth their weight in gold. Frankly, I can provide a lot of the same guidance that a banker would be able to provide 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 really help tremendously.

26:03Question about the lawyers. So the expectation, there's obviously pure legal work, but then there's negotiating commercial terms. And I'm curious, because if you don't have a banker, there's obviously some guidance around that, the negotiation part. But have you seen them be able to pick up some of that aspect of negotiating the commercial terms or sort of weigh in on it? Or where do you draw the line in working with the lawyer? I can only speak from my own personal experience on working with the lawyers on my side of the house. My interaction with legal is they are very much partners and strategic thinkers when it comes to the deal, the commercial terms, etc.

26:41I have a very good relationship with our counsel. And I'll oftentimes give him a ring just to think through something, just to talk through certain complexities and incentives that are being created in a deal by wording it a certain way in the agreement. I can only assume, again, if you're getting a good lawyer, that's what they should be doing. And on the sell side, if you're getting a good lawyer, they should be there as someone to help you navigate the complexities of not just this word means this, but also this is what's in your best interest. This is a term that you should be willing to give on because there's a back and forth here and there's a number of different deal points that need to be worked through.

27:16In short, lawyers do help on those commercial terms. At least I think the good ones do and JLL is good ones. That sounds fair. That blends back to why you should have a good attorney, knows your space, worked on similar size, shape deals, probably your best bet. Yeah. What's the next biggest challenge around educating these founders? You went through the bankers, make sure they get a good lawyer. Anything else? There's a lot of education that goes on outside of the deal and how it's structured and why. Beyond that, there's a lot of education of just JLL, the company as a whole. How would we come together?

27:48What does integration look like? How can we realize the most value together? What is the organization that they're going into? How will they possibly help to shape that, to mold that? Those are all things which a lot of founders find very intriguing and interesting. 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 and I frankly can't be an expert on every single business line in an organization, nor should I be the one that necessarily speaks for them. I bring in the correct sponsors to a deal to have those conversations and instill the confidence that is needed going forward.

28:29And of course, I can answer questions for them as well. But I think it does far more value coming from the other leaders that they're going to be working with after the deal's done than it does coming from me. When do those two leaders get connected? Because it sounds like you're coming in with very few people up until LOI? Almost immediately. Frankly, I am very hesitant and likely won't really push forward with the deal to the point of negotiating any sort of terms, whether they be high level or more specific, without a deal sponsor, someone within the business sponsoring it. So it's almost immediate.

29:06And a lot of times it is the business itself that's bringing the target to me. They have the relationship. Again, going back to the fact that real estate is very much a regional business at the end of the day, that means that it's a lot of regional relationships. Sometimes it's some buddies that grew up together, then one buddy wants to sell his business and the other buddy works at JLL. That's how the connection gets made. And then I'm brought in to help shepherd the deal along. It's from the outset, regardless. On negotiating these deals, valuations, I was thinking that would be one of the harder reasons.

29:37Yeah, certainly educating them on the valuation. I guess that goes to me hand in hand with the deal structure as well. Just the transparency in the education process. So this is what the process is going to look like just in terms of timing. This is the methods with which we use to value a firm. I say this repeatedly, and this oftentimes requires some education, but we don't use multiples to value firms. We use a very traditional discounted cash flow analysis and very thoughtful review of what our expectations are 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.

30:19And what the revenue multiple is typically a function of what that margin percentage is. A higher margin percentage business is going to 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 they hear multiples 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. Understand their business model, economic environment, how it's structured is all going to influence the growth forecast for that business.

30:57and that in turn is going to impact the valuation. How do you negotiate these deals? It starts with, again, the education, explaining to them how we came up with the valuation. That's usually for me, at least this is my preferred method of negotiating a deal, I should say. Come to them with transparency in terms of this is the value we see in the business. I tell them we don't expect a response now. Digest it, come back with any questions you have. But ultimately, the other party needs to be engaged in the back and forth there. You need to understand where they are That serves as a bookend. But before I even go too far down into the numbers, because that's just a back and forth and a trade-off between what's going to get them comfortable, what's going to get us comfortable from a deal structure and outlining all of the different role points and why they're important for us.

31:42Which ones could we potentially give on and which ones we couldn't? And it becomes a little bit of a game theory there. The other thing which is a little bit more intangible, which I think is really important, is what are the other value drivers for them? What's important to them? Obviously, price is important. That's kind of 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 little 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 within JLL.

32:19And frankly, I am living proof of that. 15 years working my way up into different roles, different levels of responsibility, and being challenged at every step of the way. Highlighting that to them, just 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 them? If you get too focused on just the numbers, it can just become very robotic. And you may end up giving 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.

32:57It sounds like it's almost if I spend more time on the other, it'll benefit me on the other side. Absolutely. Yeah. Spend the time developing those relationships and it'll pay big dividends in multiple ways. How do I correlate that with my effort on my financial offer, where I feel like I got a really strong alignment on the vision and potentially empowered that way that I could cut my offer in half? And is there some kind of way to balance that? Is that like a gut feel or is there an actual calculation there? We're not looking to drive some huge discounted valuation. You are, but I am. That's what I'm trying to do here.

33:35I think when you hit a certain size of balance sheet, then you tend to want to balance it out for the long run. But when you're a really hungry, scrappy startup, then you're trying to squeeze everything you can. Yeah, you want to maximize it. Yeah, you need to have a realistic discussion in terms of 20 times EBITDA, it's just not going to work, right? You just need to level set your expectations here. Maybe for providing them some educational materials on what the market is doing. Again, we don't value based on multiples, but multiples do serve a good purpose in terms of making sure that you're within the guardrails.

34:07Helping them understand this is ultimately a fair value at the end of the day. And maybe to segue into something else that I know that we wanted to talk about, Kisan, the earnouts do provide. is something we utilize a lot, but it provides that additional upside to help bridge the valuation gap, give them additional upside, something that they can share in with that strategic vision. But earnouts typically are a way that we ultimately bridge the valuation gap. Let's role play that out. Say we got the 20x EBITDA expectation and you're at 10x EBITDA expectation. How do you start conceptualizing using an earnout or fixing it in when making an offer?

34:44First off, those multiples are crazy to begin with. We can roll with the hypothetical. We're being very optimistic. Like we're talking about a couple of decades out. That's very optimistic. All right. So now we're doing AI. What's the regenerative AI? We're on the buzziest thing right now. Okay. So we're throwing out some good buzzwords here. The multiple is ticking up. AI, slap AI in there, multiply it goes up. Sure. Technology enabled, all of that good stuff. So here's the way that I typically approach it. There's a value that we are very comfortable with paying guaranteed. And that needs to be based off of some very reasonable and achievable growth target.

35:22I 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 guarantee can act as a bit of a retention mechanism, which again, as I said, 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, but what if it grows at a 30 % CAGR? Fair point. I think, frankly, we're probably enabling that to a large extent or bringing a lot of synergies that help to drive that forward.

36:00But here's what we'd be willing to share in that upside if you did achieve that 30 % CAGR growth. And frankly, we expect to receive a little bit more of a return in that scenario as well. We're not giving away 100 % of that value. We should see 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. It again comes down to education and walking them and shepherding them through that. A lot of times they will have a number in their mind.

36:37And typically, we just need to paint the picture that you can get there. But there's going to need to be some contingency behind that. And here are all the reasons why we think you can do it. Because we're going to really accelerate your platform. And here's how we're going to help you throw gasoline on the fire, so to speak. And they can get comfortable with that being very much a reality. So let's say$200 million business is expectation. And we think it's$100 million. I understand where they feel they're at and understand why and those parameters. So you can at least know exactly where you got to be.

37:09But when you're thinking through adding the earn out in, I'm still stuck on how do you supplement your current offer? Is it, hey, we're going to be able to add those accelerators in and then use that to justify increasing our price? Or is it showing them more on that outcome? They're going to be able to get that value, but it's going to be tied to these accelerators. More the latter. You're increasing the total value, but it's all total value means total with those accelerators. I get it. So then there's a whole down the road view that you got to do because it's not the upfront cash that you're getting.

37:41So you are giving it to them. It's just it's all factored out over a period of time. And that's where you're increasing your offer ultimately. Exactly right. Even in a competitive process, when we put forward an indication of interest, we'll put in that indication of interest. Here is 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 earn out. Another thing with being transparent and honest here is that that upside 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, we don't want to put forward some insane value and say that, yeah, but 90 % of it's going to be subject to an earn out because it's just aspirational.

38:27We'd rather put forward an upside, if you will, an earn-out target, which we feel is achievable. Because if it isn't achievable, then the target can quickly get out of the money, if you will. 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 towards that growth number. And if you make the number too large, it's just, A, frankly, I don't feel like it's honest. But B, it doesn't appropriately line incentives, in my opinion. Yeah, it's interesting. It's like a whole art to get really good at structuring these earnouts so that they work and don't lead to a big fight.

39:03Easier said than done. What are the reasons people fight about? Is it the same stuff or is it different every time? Earnouts are really tricky and frankly, we utilize them quite a bit. And I think we've been pretty successful in doing so. A few things make them difficult. For one, the timing of them can be tricky. I think that both sides, frankly, in a lot of cases, want a shorter earnout. The buyers oftentimes want a shorter earn out because earn outs can be an impediment to integration. They 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 you feel will maximize value.

39:40So there's that. And obviously, the seller wants their money as soon as possible. So that's one thing. But typically, if it's a longer earn out, you are able to bridge a larger valuation cap. So there's a tricky balance there. The other thing is that whatever KPIs you're putting out there to measure and earn out, you need to make sure that they're measurable, for one. Be careful about throwing out KPIs and targets, which maybe I can measure that. I'm not sure. We'll figure it out. And then you're in a situation where there's just a lack of clarity in terms of how that's being measured or what the numbers are that are coming in.

40:13So make them easily trackable, such as revenue and EBITDA being two of the most common measures. But with EBITDA too, you got to be careful because there are a lot of expenses which may be out of the seller's control, which ultimately get added to a P &L post acquisition. We're very careful, but if we're going to use EBITDA as a measure for the earn out, it's not really EBITDA at the end of the day. It's an adjusted margin for purposes of the earn out, if you will, that strips out a lot of expenses that we don't think are something that the target can manage. We want to avoid that dispute as much as they do.

40:47That's a lot. You're making me scared of these earnouts now. You know, when you do enough of them and you do them right, you really 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're not going to get into a dispute. And there's been lessons learned along the way. 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.

41:20And it led to a dispute. But we've learned our lessons there and have found more success as a result going forward. What are the things you can do to make earnout successful? Yeah, it's the inverse of what I just said. It's avoiding those things that make them difficult. Just being really thoughtful about what those KPRs, 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, you want him or her to take on a bigger leadership role. That's beyond just the scope of what their business is that we're acquiring.

41:57They are going to be the lead for the entire Midwest, for example. Then you can't just structure an earn out that is on just their small piece of the business. A, you may not even be able to track it that way. But B, you don't want them to be solely focused on just the numbers that they impact their earn out and not the bigger picture and the growth of the entire Midwest market. Well, oftentimes what we'll do in that case is a combined earn out where we're combining our legacy business with their business and then putting together a growth threshold based off of that so that they're pretty clean and different in terms of where the revenue is coming from.

42:32They're incentivized to grow it in either place because it's all going to add to your earn-out contribution metrics. Yeah, that's actually a good way to think about it. Make sure that you look at the whole picture. And don't make them overly complex. Gosh, I've seen some crazy math written around earn-outs. 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 earn-out as a result. How is retention with the smaller companies?

43:04Is it easier or harder than bigger deals? I don't know if it's easier or harder. At the end of the day, it's similar type of mechanisms. I would maybe 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're probably going to have a smaller bench of talent, someone that can step in and take up the leadership mantle. The consequences of having a principal lead that is driving the bulk of the business in a smaller deal, it's going to impact a big or small deal.

43:41But in a smaller deal, it just may be less of an engine where the impact to the value could be much more significant. Just take us on a heightened focus for me on smaller deals. Yeah, it is. They're very, they're different. I guess there's a way to look at it. It's not an apples to apples comparison. Are there any specific best practices you lean on to retain people? Yeah. Again, I'm going to put money to the side here because that's the low-hanging fruit. Obvious one is making sure that you're identifying the correct rule and setting an appropriate carrot of dollars aside for that if they aren't equity holders, that is.

44:17First off, make them feel very included in the new culture or make them comfortable that it's not going to be an immediate disruption to the culture that they hold dear. It's just that it's going to be different. And here are all the reasons why JLL culture is great and helping 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 and 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 JLL presentations.

44:53And I mean, all of that goes a long way. So that's important. You need to start off on the right foot. Emphasizing the opportunity for growth, I've hit on that a couple times already. But 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 just so many different opportunities, so many different paths you can go internally. And I think that's just incredibly exciting to most individuals that come on board with us via an acquisition. Lastly, at the risk of stating the obvious here, don't screw up payroll and benefits.

45:28That's numero uno on any integration checklist. And we've always done a great job of that. 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. Yeah, it sounds like a lot of this is related to HR. It's like you're essentially onboarding all these people, making sure they're a really good experience and get them off to the right start. Yeah, absolutely. What's the craziest thing you've seen in M &A? This has happened on a couple of deals, actually. Working with a target who maybe has some legal background and think that they're best suited to represent themselves.

46:02It's never a good idea. If you're a lawyer representing yourself, you're not getting as much as you'd like to think so, the best advice. You need that more impartial third party. Where they want to represent themselves all the way? Yeah, all the way through. And one or two deals like that. Yeah. It's crazy. They're like, how hard could it be? They're not even necessarily an M &A lawyer, but they just think it's all transferable skills. That's a terrible analogy, but it's like worse than DUI. Yeah. Right. Yeah, it's not a good idea. Like way more just collateral damage value there. Yeah, get an independent third-party legal counsel.

46:36Anybody, like at that point, Uncle Bill, he could do it. Sometimes it hasn't been them who their legal counsel. There's been a couple other deals, frankly, where he used that exact example. My brother-in-law or my brother is a lawyer. do they do M &A law? No, he's a divorce attorney. But I really think that I could just save the money and use him. And I'm like, please give that a second thought. You want someone with an expertise here in M &A, you'd be surprised how often that comes up. That's crazy though. Kevin, thank you so much. This has been a good conversation and I appreciate you helping me become a better M &A scientist here.

47:13Yeah, no, my pleasure, Kisan. Thank you for having me. Hey, those of you still with us, till next time, here's to the deal.

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