The Deal Process & Evergreen Fund Structures

Colin and Brent discuss micro-pe deal process, evergreen fund structures, and investing in funds.

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Colin: [00:00:00] So hello and welcome back. This is Colin Keeley here,

Brent: [00:00:02] I'm Brent Sanders.

Colin: [00:00:04] and we are two guys buying and building wonderful internet companies.

Brent: [00:00:08] Yes, indeed. And we found a new company. I don't know if we've talked about this. We started the process of an LOI, or I guess we sent an email with a w, which we're finding is not the common way to do it, but basically made an offer on a company that was ,  informally. Excepted in started the LOI process on a new company that, we'll, I'm sure talk about it a little bit more as the process goes and starting diligence, as soon as that LOI is signed and now things feel like they're getting a little bit more serious because this is a bigger company.

It's a second deal. And ,  I think getting to the stage where we need to raise some funds because maybe we could. Cash in our break, our piggy banks and try to do this, but probably not the most ,  reasonable idea. I think the point of what we're doing is to maybe put a bit of a fun together.

So yeah, it's exciting spot to be, but ,  now it's starting a little more serious.

Colin: [00:01:01] Yeah. so a few different things there. So we stumbled into this space. So we didn't, I haven't worked for like a private equity fund for years and years. We worked in venture capital. So we're making it up as we go. And some of our processes, are a little different than the norm. So I was on the micro choir podcast a couple of weeks ago.

It launched this week, my episode, and do that process. I realized ,  art. System of offering is a little weird. So basically it starts with, initial email ,  Hey, love your business would be interested in talking more or something like that. Do a little due diligence. And then that gets us comfortable and to the point where we could make an offer and I've been doing the offer by email and you justify with numbers and everything.

And then the people think about it. You clarify the offer. And then once they accept that offer, which is the stage we're at on this other business, then I drop an LOI, which apparently is different than everyone else. A lot of other people just throw out LORs to start and throw out these legal documents and to make the offer.

And I'm of the thought ,  I. Don't really want to use lawyers. Like you have to use lawyers to like paper these deals, but I just want to come to an agreement with the other person. And then once the agreements made, like the agreement is what it is, and I don't really want anything major to change after that fact, after that point ,  

Brent: [00:02:14] number one thing with attorneys is make sure you and your deal partner have a strong understanding or else that it's going to slow down with the attorneys, because they're going to throw a bunch of. Curve balls at you and be like, what happens if this happens? Which is what you pay them for.

But I, it seems like your way of going about it is the right way in my mind. I don't know what the downside would be, but yeah, you gotta have a confirmation from your deal partner that at least the points, the business side want ,  are covered.

Colin: [00:02:42] Yeah. So I guess like more aggressive, private equity would throw out an LOI with a a really enticing number and a pretty high offer. And then You enter a deeper due diligence. They lock you up and they basically negotiate you down from that point. And mine is this is the offer. Like I have no secret terms.

Like nothing else is going to change. We're just going to move forward and assuming everything's good. And the numbers are what you say they are. It's like thumbs up, we move forward and it's all done. So just like significantly more straightforward, I guess then traditional, but I didn't even know what traditional was.

Brent: [00:03:13] Yeah. There's part of this. That's that's kinda, I get it. Why you'd want to do that? Cause it's like, Hey, assuming here, our assumptions, we think everything's pristine. Here's the price you get for a pristine business. If everything looks good and it reminds me of doing a deal on a house or something where it's yeah, here's the offer.

And then we're going to do our inspection. And now we're going to nickel and dime me, which when you're a seller is like the worst feeling like that just sucks. And you end up hating this person. Cause every little thing they find. They're going to ding you for, and they're going to do it in a way that's generally feels unreasonable where it's the water heater is old.

We're going to need to replace it with a $10,000 water heater. It's like what? It's ,  it doesn't create. I think what we're striving to do is to be ,  I don't want to confuse like an easy. To work with partner with a pushover. Like we don't want to overpay for deals. We don't want to do something where, we're getting, shafted on deals.

But at the same time, I think we want to just approach it from a more reasonable, as if we were on their end of things. It's one thing to get a great deal in a huge amount of cash coming in. But at the same time, I really want something that's fair and walking away, feeling like they won.

Colin: [00:04:17] Yeah, I think this is optimizing for working with good people. It's definitely not optimizing for price. So maybe these like super aggressive private equity folks would give them a better price, but they're going to be pretty horrible to deal with. Yeah. we're going to give you a fair price And we're going to be excellent to deal with and like super straightforward.

There's nothing shady here and we'll protect your baby on the long-term. And figuring out how we do that is ,  the thought of raising a fund has come up and we were Initially the plan was my plan at least was to do independent sponsor deals. So basically raise money as deals come through.

Probably do three more this year was our initial thinking. And then I've been having discussions with LPs. You've been having discussions with LPs and they're just pushing us more and more like, why don't you just raise a fund in an effort? That's been said enough times that I think we have to put some serious effort and explore it further.

Brent: [00:05:10] Yeah. And so we were both a part of music, more so on the end of the process. Of raising a venture fund of roughly $200 million venture fund. So I got access on the venture side of things to like, what does that process look like? And my takeaway was it takes a long time, a long fucking time. Everybody thought it would get done in six months.

And I think it was like two years. If I remember maybe a year and a half to two years where it's just you're rounding up. And this is a totally different profile and we're not looking for 200 million, but at the same time, I think that's the first thing that comes to mind is okay, if you want to do that, it's going to take time.

It's probably going to take more time then. It would take for us to close this deal. We roughly would close this in 30 to 60 days, but ,  and then there's all these other things. The mechanics like carry  you have this whole two and 20 thing. It's like all these things start floating back into how.

Economically funds work, which is an interesting business. I don't know. I I never thought I'd be in this business, but  it's a structure. I think that makes sense. You're incentivizing people in the right way ,  but yeah, going back to the feedback we're getting has been. What's the point of me giving you, a hundred thousand, $200,000.

It's like, why don't you just raise a serious amount and knock these things out of the park and make them really meaningful, which is not wrong, but it's also, maybe not where we were going because we don't have $10 million sitting around ,  at our disposal or at least not in pocket.

Colin: [00:06:42] I think that's an obvious thing to do. I think there's monster opportunity here, and it's far less competitive than venture. Not saying it's easy, but it definitely is a huge opportunity. There's obvious way to make like significant money. And there's a lot of capital like searching for a home. So it's natural that people see us as a potential home.

Like, why don't you just go do this? We'll give you money to go do it. So figuring out terms, I am ,  of the idea basically working backwards from. I want to be the best person to sell to in the best way to offer that as I will protect your legacy. Definitely I'll keep your team in place. Not fire everyone, not put like crazy expectations on them.

And so if you, that is the end goal, the way you back into that is with an evergreen fund or an open-ended fund. So it's not that you have to sell everything in three to five years to the next private equity firm. It's that you keep it, you grow it over the longterm, which is basically constellation software ,  which I've written a lengthy blog post on that we're working on for like probably six months.

I'll launch it this week. It's pretty far along.

Brent: [00:07:46] yeah, I only learned of, is it the founder or the CEO or the president? The dude in charge of who started it and , super impressive, like in a cool way in terms of. I should get this, like on my wall as opposed to what was it like, manage it management through advocation.

Colin: [00:08:03] Yes, that's his thing. He's. So maybe next episode we'll dedicate like the full 30 minutes to him and I'll tell the story from front to back and how they operate. But ,  as a little teaser, he was, he went to college for seven years. In Canada, he played basketball and rugby. There he's 6, 5, 280 pounds and he has a big Gandalf beard and there's I found three images in existence of him.

And he's just, monsters guy with a huge gray beard. And so he is like the bad boy of private equity. Like he was a grave Digger. He was a Mason. Eventually he ended up in venture capital, decided you were passing on all these amazing, small software companies just because they don't have the chance to be multi-billion dollar companies.

I'm just going to raise a $25 million Canadian and go buy them up and hold them for longterm. Cause it's such amazing businesses. And then that's exactly what he's done. And so now his company is worth 30 billion plus dollars. He's a multi-billionaire and he's done zero press ever. So I've done all this research.

I'll we'll talk about it next week in greater depth.

Brent: [00:09:07] It's good to have an idol.

Colin: [00:09:09] Yeah. You gotta put on 50 pounds and then I'll be right there. Grow my beard out. Yeah.

Brent: [00:09:16] But yeah, in terms of. What is the profile of this type of fund versus a venture fund? I think that the big thing is we're looking to provide more of an annuity. Like we don't want to sell these businesses. At least I don't think we do. I think the model we're looking at is buy, hold, improve ,  put in great operators and keep these things rolling and growing.

Growing at a rate of 10% a year ,  is great outcomes, right? And it's To me. I've always been more partial to farming over mining, using that metaphor of we, we want to be farmers. And when you look at these buyout funds, these structures where it's, Hey, we're going to come in, buy a bunch of businesses and try to sell them within a three to five-year period.

It feels like you're strip mining, right? You're optimizing them, which nothing against that. That has a place. And maybe you could even find a way to use the farming analogy for those. You're optimizing for a very specific time crunch period. And ,  that doesn't suit my interests as well.

Also. I don't know all the taxation around it, but it seems like you're going to have a much like lumpier ,  income, but.

Colin: [00:10:16] inefficient tax wise because you're basically ending a fund. You're paying everyone out and then you're like, Hey, we're going to do this again. Give me that money back. So you basically, passing that onto the government for no reason to give the money back to the same  GPS.

Brent: [00:10:30] yeah. Yeah. It, I like the idea. Now the question for us is okay, how do we structure this? Again, the carry and management fees, that all make sense. To me, maybe to our listeners, not so much. Could you explain Carrie? It's an interesting way. Carried interest is an interesting way to incentivize ,  fund managers.

Colin: [00:10:49] The Carrie ,  I wish I had a better explanation, but I think it started back in wailing times. This was the initial venture. Capitalist is you would finance a whaling boat and they would go out and they would go kill a whale. Sadly. And then harvest it and bring it back. And I think Carrie initially was like, I don't know if this is a true story or not, but it's how much, a blubber that you could physically carry off is like your profits or the wailing chip ,  apocryphal.

I think that's the term. I don't know if it's apocryphal or not, but anyway ,  so it's. It's the standard two and 20 models. So it's assets under management, you take 2%, is it like a management fee? And that pays salaries for you and your team. And then 20 is the carry. So that's their a take of the profits basically.

And so I have some terms, but in the private equity world, there's always like this 8% preferred rate. So you basically you're guaranteeing investors that they get 8%, at least annually. And then above that, there's a catch-up. It gets you to your portion and then you take 20% beyond that.

Brent: [00:11:52] Yeah ,

Colin: [00:11:52] And then the two still seems like it stands the 2% management fee.

Although for these like multi-billion dollar funds, people like you don't really need 2% of this. So it's 1.5% or less. And that's the basics, but so for this evergreen fund model, It's a little different and there's a lot of talk of them. Evergreen funds are open-ended funds where you basically don't have any intention to sell, but you need some way for investors to exit if they want to.

But if you continue compounding, not many people are going to try to push for that. So I did find one ,  evergreen funds terms and all this is public. So I found it publicly. So I could talk about it. They have a four year hold period, roughly. So that is a two year deployment period where they raise this pool of capital.

They invested over two years and that is ,  they're not exactly held to that. And then after that last check is written a two year clock starts. And so during that two year window, they  LPs can take money back, but you have to do it at a severe discount or I guess, severe haircut. And then after that clock expires, LPs can ask for a redemption of their capital.

And basically the way you allow that to happen is you set a quarterly ,  value of the portfolio, which is a bit of a sticking point. Cause you there's not like an obvious value to all this stuff. You could value it in different ways. So I think you have to bring in a third party to do that. And so after that step, If LPs want to ,  redeem and get out, they ,  the firm has a right.

of first refusal to buy out the investors that are fair market value.

If the firm passes, they can go to other investors in the fund to buy them out. Then if all those investors pass, they could go find someone else to go buy that equity. And then of course the fund can improve or not all those potential investors as they come. Other terms, note. Yeah, it Seems like a good situation.

It's not common. Like they definitely innovated and came up with this. Other rules is no trading above or below the value that is set by the fund. And this is like an interesting mix of like permanent equity long-term thinking and like the ability to get out. If you, I don't know, for whatever reason you needed the money, you're buying a house or something.

Or things go south and you there's a way to get up. So not saying we go with those terms, but I was just very happy to find them on a podcast as an option because no one talks about this and even like good lawyers, they don't have exact terms for me in mind. It's we can do whatever you want to do.

So trying to figure it out is not the easiest thing.

Brent: [00:14:15] Yeah. So I guess that's like the, one of the valuable parts of this podcast that I enjoy is nobody is publishing this stuff because obviously it's different. It's like all these different deals or snowflakes, but it feels like this stuff is gate kept a little bit like, and maybe because it is a small, this is not Hey, how do I run a carwash?

This is a very specific thing, but it's just hard to find this information, which makes it that much harder to. Get into this world. And, you have to navigate your career and find your like, like I fell into venture. I fell into kind of all these different situations by chance and maybe some decisions I've made, but ,  yeah ,  I, this stuff, I don't know that they teach it in school.

I don't know you went to ,  to business school, but I don't think this stuff really gets standardized and clarified and published all that often.

Colin: [00:15:04] for sure. This is a much kg or world, and this is the whole idea with this course is like you're blowing it open. And I would love for people that were going to be buying businesses from, to take the course and know like exactly our playbook and how we operate and get everything nicely prepared for us.

It would just make the whole process easier and both sides are educated. The deals will be fair. I had one other thing. Oh, the other big update is you see on Twitter, like all these people raising rolling funds in venture capital funds and it's cause these rules change, freak it advertised publicly where before you never could.

And I was asking lawyers like, I'm going to be going on some M and a podcast. Can I talk about this? Like, where am I going to breach the sec? And lawyers are going to descend upon me. But yeah.

you could talk about this. So you could talk about your raising buyout funds or private equity funds publicly now, but I've actually never seen anyone do it on Twitter.

So maybe it will be the first, bio fund raised on Twitter

Brent: [00:15:59] Yeah,

Colin: [00:16:00] or.

Brent: [00:16:01] yeah. There you go. We have had an investor interest, I think, from. Your Twitter feed or this podcast, or I know you've had some people sign up and express interest in investing. I've seen a lot of and I don't know what their structures are, but I have seen a lot of funds after they've raised people talk about, oh, I'm part of this.

I'm, I'm know, I'm part of this group or that group, I get the emails. Was it Tyler and earnest ,  which is also a really cool model ,  that I haven't really followed, but I appreciate Other people in this space that have been making this more accessible. So it's not a bunch of white dudes at a country club.

It's Hey, this is what's going on. And if you follow these people get access to it. It's

Colin: [00:16:35] white dudes on a podcast instead.

Brent: [00:16:39] yeah, pretty much. But. It's accessible to everybody. It's not behind, some gate or something. That's the thing I think that's interesting about this day and age, which is Hey, information is out there and, I like the idea of allocating spots for, so I guess when it comes to fundraising, how are we thinking about different investors?

How are we thinking about, if somebody wanted to put a small check-in. The thinking is does it make more sense to just find one or two individuals that could fund the whole thing or, when you have a bunch of smaller checks, the thing that I remember from the venture fundraise was like  th you still have to pay for the legal fees to get that check in.

And the thing that was told to me when we raised this ,  venture fund was like, Taking a smaller check is it comes a little bit of risk because those tend to be the less experienced investors. And they tend to be a little bit more persnickety when it comes to wanting to like the bigger deal.

They know what the terms are standardized and they're not going to actually be as noisy or painful. So I wonder if that kind of comes with the territory though.

Colin: [00:17:42] yeah.

I wasn't a part of your fundraise at the fund, but I, Yeah,

I've heard all the stories and talked with everyone involved. So you guys raised some mostly pension funds or a lot of punch in funds is like bigger and that's like a pretty different thing than we're going to be doing, especially for a first time fund.

It's very rare to get that money. So it's definitely a headache, but I would like to get more people like around the table, like rays from bootstrappers that will also be able to refer deals and like potentially jump in as CEO's for us. I think there's a big advantage to getting those people  cheering you on and aligned with you.

So I, I don't know. You got to figure out what the minimum is because it is a bit of a headache. But I would love to bring more people on and set the minimum, low enough that you could get a lot of people around the table helping you out.

Brent: [00:18:26] Yeah. Yeah, totally. I couldn't agree more. It's going back to this, like for us by us kind of model ,  the FUBU model. Of a FUBU model of ,  of buying companies, but that's really is what it should be. It's we're trying to create a, an easy way and furthermore, with the course, right?

It's like you have this course, you understand how we operate and like a pie in the sky goal would be if we could even start to standardize some of the terms, standardized some of the legal docs, so we could have more of a, an ORIC or sort of Stripe Atlas. Model or, I think you were saying that the dude from Mike require was trying to tackle this, which is is there an easy way to, to create a business to business, like an asset purchase that is standardized.

We talk about all the time on this podcast, but that would be an awesome sort of extension of the course is if you structure your business in a certain way, get things tied up in a certain way. You can actually transact for $500 and right. And you can pocket the difference that, the 10 to $20,000 that you might have to pay to an attorney.

So anyways, that's where I'd love to see this eventually go beyond even the, fundraise.

Colin: [00:19:34] I want to get that done at the lawyers I've been talking to are very hesitant to help me

Brent: [00:19:39] they are.

Colin: [00:19:40] templates. I'll find it want to eventually do it, but yeah, I, in this first iteration Of the course I think we'll throw up some templates for like educational purposes. But I don't know, like in time maybe we could be the people to be define it as this is fair to both parties.

Like this is the safes of private equity for these small deals, but ,  yeah.

Brent: [00:19:58] I think it's phrasing it. Cause to me, this feels exactly like talking to a Greybeard engineer about low code. It's yeah. Yeah. But low code and they're like low code. There's no such thing, you try to change one thing and, or myself, I shouldn't even say graveyard.

Like when you talked to me about low code, I roll my eyes and say, yeah. But if you were to say. W, what about abstraction? What about abstracting? This code out so far that it just accepts a couple of parameters and then I would be like ,  maybe. Yeah.  That's the goal of what we're trying to do here is make code that's reusable and can just accept some parameters and function in a black box.

And so I think we just need to learn how to communicate with the attorneys in a way where it's like, what are the parameters that go into this. Okay. Let's abstract those out and put them into a form and then I will generate the language around that. But yeah, it's it reminds it's like low code legal.

Colin: [00:20:47] Yeah.

they really don't like it. And I don't know the ones we've been talking to. They're doing really well. They have a lot of billable hours. And so they're like hesitant to spend too much time on marketing ,  like non-billable hours. So they're going to give me some time. They'll do one lecture in the course, but I don't think they're going to be like a huge participant at least initially, like over time.

I think when they got some free time, they will.

Brent: [00:21:09] Sure I get that.

Colin: [00:21:12] one last thing is you're saying that Ernest was raising money. So they raise their kind of interesting one. They're doing this seal, which is like a mix of. Basically debt and equity for bootstrappers basically giving these people that are making, I dunno, 10 K a MRR, and like here's a hundred thousand dollars or more and you can go full-time for the next year.

And what could you do with that? You could probably get it to the point where you're paying yourself a nice living. And we'll make a nice profit on that.

but what they did the super weird. So they did a crowdfunding, but it was basically for the management company. So what people were buying is basically a percent of the carry going forward.

And right now it's like an ,  very high. Like they would have to return a lot of money. Like they've only had three tiny funds so far. So you basically betting that it's going to become much larger than it is. And they're going to pay you enough, carry over time to make whatever investment you're doing worthwhile.

It was a pretty weird, it's almost like a huge bet on the person and their future earnings, more so than investing in a typical fund.

Brent: [00:22:17] Yeah. Yeah. I didn't know that. I had never really dug into the structure or I didn't have a ton of interest in investing in it. Too busy doing our thing, but  that's kinda wild. I get it. That's, I like the philosophy behind it.

Colin: [00:22:31] I think Arlan Hamilton, backstage capital did the same thing. But I would say as low, as far as like expected value, those investments don't make any sense, like investing in a portion of the management company's future funds when the management company has been very small to date, but I think it's just like a culture personality that people are investing in our lender, Tyler Dingus or whatever.

Brent: [00:22:54] Interesting.

Colin: [00:22:54] Yeah. Anything else you want to cover?

Brent: [00:22:56] No, this has been great.

Colin: [00:22:58] Cool. Until next week, talk to everyone later.

Brent: [00:23:01] Thanks for listening.

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