Episode #29: Building Durable Businesses in the Lower Middle Market w/Maxim Tcherner

Narrator: The Lab takes the ethereal to the practical. Our, uh, podcast acts like a business school case study for private equity professionals, CEOs, operating partners and chief transformational officers. We all know transformation is the key to differentiated alpha. Uh, here's how you actually do it. Our audience tunes in to learn from those in the field getting their fingernails dirty and driving meaningful growth through, through better operations, technology and data. We learned from going to business school, teaching at business schools, and applying these lessons in the real world that case studies actually help the insight stick better. Come join us.

Host: All right, well, welcome to the next episode of the Lab podcast here. Maxime Cherner. We have from Fengate. We love when someone has, you know, years of experience at sort of academy sort of establishments and then says, hey, listen, I think there's a better mousetrap here. So we're excited to dig in here with Maxime. So let's, let's get started. Why don't we sort of give the overview? I sort of gave a little bit of it. But you know, Ontario Teachers is a great spot. It's one of the storied institutions for a lot of reasons. But walk us through. You know, why Fengate. Before we dig into some of the

Maxim Tcherner: specifics here, I'm going to start the story maybe a little bit farther back because I think it helps inform some of the decisions that came thereafter. So I grew up in a first generation immigrant household and it really was a, uh, family business. Our living room was often kind of the headquarters of the business for a long time. And as more time goes on, I'm actually realizing how impactful that has been and how much that has influenced some of the decisions that I've made later on in my life. I went to business school with the sort of, it's embarrassing to say, but with the idea that I was going to become a businessman. And I'm saying that in quotations. And really it was again, reflecting on what I saw that was going on in my household in, I think, second or third year, somebody told me about this thing called investment banking. And it was interesting to me. And the pitch that resonated with me was you. I mean, first of all, it was hard and that kind of excited me. The second piece was, you learned a lot in a short period of time. And I kind of felt like I was playing catch up versus some of the people that I met in university that had been thinking about this a lot longer. And then the third piece, and I'm not really ashamed to say it, it paid well. So I was like this sounds great, sign me up did that.

Host: That's not unique. In that example, I think there's a long list of folks who will come to that same math equation, but they don't admit it.

Maxim Tcherner: They don't admit it. And that's one thing you'll get to know with me is I tend to say things that I feel. And so I spent a number of years at Credit Suisse and enjoyed, enjoyed most of it. Then an opportunity came up as, as you mentioned, at Ontario Teachers and I had a friend who was working there and the thought process was actually quite simple. He's like, wouldn't it be great to work together? I said, sure, Applied was lucky enough to get the opportunity. And then I blinked and a decade went by. And as you mentioned, it was a great experience, learned a lot, got to invest across a number of different sectors, meet a lot of great people, a lot of great investors, and I hold that experience in high regard. I then fast forward to the fall or I guess winter of 23 and I got a call about an opportunity at Fengate. And what really excited me about Fengate and I think we'll get into this a little bit later was that they were focused on the lower mid market.

Host: Mhm.

Maxim Tcherner: And at Teachers, you know, we were focused on large cap. And so very often you're the third or fourth private equity investor and there's a great toolkit for how to invest behind that. I think for me it felt like I was always yearning to be in a position that led to more of an impact. And I equated that with getting in earlier and having the opportunity to work with, you know, companies that were more in their formative years. And so that was a big check for me. I do think there's more alpha in the lower, lower mid market. There's a higher loss ratio for sure, that you have to be mindful of. But I do think that there's the opportunity, especially in today's market, for more compelling returns. And then the third piece was it was a relatively new strategy, private equity within a broader asset manager that's been around for 50 years. BenGate. And so this idea of building something with a group of individuals was really enticing to me. And so that was now two years ago and we've been at it and have had some success.

Host: Well, it's a great, great example of like, you know, doing it better. Right. Uh, that's the whole point. Like, you know, the world M and A has evolved, private equity has evolved. The process needs to evolve. So when we're thinking about, you know, why is Fengate seeing it differently? I get where you're focused in and around, you know, pharma and payer services and you know, and it's sort of very important and big part of the market. Right. How do you think about avoiding some of the pitfalls of where M and A fails around, you know, alignment and with people who are messy and governance and strategic fit and he often talked about, but never enough integration. So what are you guys thinking about that's different? That sort of says all right, if I'm a, if I'm looking for my first institutional capital, why is the grass greener? Uh, at fent?

Maxim Tcherner: Yeah, no, for sure. So I would say at the highest level, how we think about why we're different at Fengate is we bring sort of institutional quality to the lower mid market. So we are not, you know, an exclusive buy and build, high volume type of outfit. We are very intentional with where we invest and where we play and a number of us bring that experience from working at middle market or large cap opportunities and sort of deploy those tactics in the lower mid market. In terms of your question, I mean the framework that I like to use, that we like to use sort of focuses on alignment, as you said, the fit, the integration. And then the last piece we'll talk about is sort of the risk reward on the alignment piece. There's a bunch of different variables. So there's the alignment on incentives which has been drilled into me from as far back as I can remember. Sort of the classic show me the incentive, I'll show you the outcome. And what we sort of think through is if we can make sure that we're comfortable with that piece. It just takes so much variability out of the equation. But also there's other pieces of alignment. And the piece of alignment that I think we spend a lot of time at uh, Fengate around is the alignment on the business plan and the value creation. And sometimes you can have uh, the same line of sight on governance, the same line of sight on the fact that you want to grow. But if there's an impasse on how you want to go about it, it can create a bunch of issues. And so very early on in our diligence we sit down with our founders and make sure that we're seeing eye to eye with how they're viewing the world in terms of what they want to create. The second piece is around fit and what we mean by that is we rely heavily on is there industrial logic in the opportunity, whether it be and this is mostly, let's say for our platform opportunities where we're starting to build scale. We're not a place that just stacks ebitda. And I think that we've sort of seen how that story's played out over the last little while. And if there is no sort of commercial logic or combination benefits, whatever they may be, to whatever it is that you're trying to put together at some point that catches up with you. And so we try and be really intentional around that piece, around uh, the integration. It's a mix of making sure that the cultures and all of that works, but that also that when we're putting things together in some of our platforms, we're actually integrating them. Right. And they're not sort of a collection of 10 different assets. And we'll spend the time and the investment to make sure that all comes together. Because at the end of the day what we're trying to do is we're trying to build lasting, durable businesses. And that kind of brings you to the last piece of the puzzle. And it sort of touches on what I started with at the beginning in terms of why the lower mid market we try and assess the risk reward and we're very mindful of purchase price and we want to balance that with what is the value creation opportunity. So that's kind of the framework that we use now. How do we do it? We're a little bit different I would say in the lower mid market in that we are very partnership oriented and that starts at the highest level within Fengate. We are a founder led institution. We do have a flexible capital mandate which we feel very lucky around because it helps us sort of find the right opportunities and we are both sector and thematically led so we identify where we want to spend time. And I think that is the crux of what allows us to really come at things like alignment and strategic fit and integration much more thoughtfully. So you know, will we bat a thousand? No. But what we're really trying to do is achieve the alpha that we think is available in the lower mid market while trying to do it in a way that comes at it from a differentiated loss ratio than you would otherwise expect being, you know, exposed to some of these businesses that are more in their maturity.

Narrator: Very good walkthrough of that. I like asking people in your seat how you define value creation because I it is something that everyone says right now, uh, and no one answers it the same way. How do you guys do it? Because it sounds like you're looking at It a little different.

Maxim Tcherner: Yeah. The question that we ask ourselves. So let me say this, the crux of it is we're growth oriented so we want to build businesses and set businesses uh, up alongside our founders. And what we like to say is that ah, where we can come in, accelerate your growth profile, those are the opportunities that really get us excited. Now we don't think of value creation as taking the last turn of leverage or anything to that degree. In terms of structuring, those are important, you have to be thoughtful around those. But where we're really spending time is trying to understand why is a business different. What is the underlying market growth within the sector that they are focused on. Again we can touch on a little bit how we think about that in a healthcare context. But because they're different, they should be able to grow at a different rate than the market. So we're really focused on those founders, those companies that can gain share. And then we add sort of the private equity toolkit around typically focusing on fragmented industries. And so where M and A enables scale, which enables kind of reinforcing why the business is special in the first place, you kind of put all that together and that's what gets us excited. That's where we see the opportunity and that's kind of how we think about value creation.

Host: Well Maxine, if I'm a uh, business owner, I'm in the right size, I'm in the right industry. Of course I want a collaborative partner. Of course I want to have you bring tools to the proverbial collective toolkit that I don't own myself. What do you find some of the stories that you're talking to these owners about that resonate the most? Because a lot of firms will say we're collaborative, we're going to partner with, partner with you. You know, maybe they do or maybe they don't have a flexible capital stack. Majority, uh, minority. But you know, that being aside, what are some of the things that you think resonate the most where an executive says all right, well I feel like I'm going to make money today, but I'm going to make a lot more money the second bite of the apple down the road. Because you know, sort of Fengate and Maxine and Maximum Team are able to like really help me do something that I couldn't do before?

Maxim Tcherner: Yeah. So you know, one of the, it's more than a talking point. One of the realities that really resonates is when I'm able to communicate that we're a founder led investment firm and so Many of the trials and tribulations and challenges and successes that you have experienced in your business to date and continue to experience are sort of very familiar to how our founder built Fengate. That goes a long way and I love telling that story. I think you pair that with, because we are sector led, we spend a lot of time really trying to understand the sectors that we want to invest behind. And so why we do that is to really be a good thought partner to our founders. And you know, we are not the type of investment shop that shows up, uh, you know, four times a year and joins a monthly call. Like we're, we're building and supporting these businesses with them. And we believe in order to do that we have to have a certain level of familiarity around the industry, what the drivers are, what the history's been, where the opportunity is to, to capture growth. And so we have found that when we show up and we do our homework and we pair that with some of the intangibles that we bring, it resonates quite well. It also helps that we, as Fengate Private equity, are effectively a lower market startup within a $25 billion asset manager. And so we can bring a lot of tools and capabilities to our portfolio companies that I don't think many other lower middle market funds have. So as an example to that we have a fully dedicated IT team that can help work through with some of our portfolio companies how they think about cybersecurity or how they're thinking about the impact of AI on whatever service or technology that they have within their business. We have a talent acquisition team that you know, last year helped uh, one of our portfolio companies bring on actually a chief HR officer. And so some of these types of uh, benefits of, of kind of being the uh, the startup in a really large entity definitely plays well when you can deliver something to a founder that they can't find somewhere else.

Narrator: Yeah, I mean when I talk to other lower middle market firms, sometimes it's a handful of people. Right. And they're doing it all. They're the value creation team, they're the deal sourcing team, they're on the board. You know, if you guys have those capabilities at the ready and you can offer that, that's a differentiation. I meant to ask you this earlier, I don't think it'll sidetrack you too much. But going from upper market to lower middle market, what's like one of the beliefs or biases that you thought that you would have to deal with down market that you have or haven't had to.

Maxim Tcherner: Ooh, that's a good question. A lot of people, when I was sharing what I was doing, uh, said to me, ooh, are you sure you've thought about what that uh, transition means? The opportunity, if you apply the right playbook to create value is there. The cautionary tale that I haven't experienced is a lot of people led me to believe that I would have to roll up my sleeves to the point where it felt like I would have to run these businesses. We have the opportunity to partner with exceptional founders who we leave the day to day execution to run their business and they've got their, they're visionaries. That takes me out of that equation and allows me to focus on broader strategic opportunities and how to scale the businesses and how to help them continue on that growth thesis. That piece has been helpful because it aligns better with my skill set and to anybody else that's considering the transition and feel that they want a bit more of an entrepreneurial experience. You definitely get that, but not to the point where you actually have to run the opportunities that you're investing behind.

Host: And maybe we take that same question and flip it towards a business owner. Right, so you've been doing this for a couple of years. This end the lower middle market, there's going to be consistent lessons learned. What are some of the things that your now portfolio company executives are uh, we're surprised about. Not, not necessarily with Fengate per se, but just with the change of maybe the founders, the CEO who's also had a bd, who's also the head of resources, who's also, you know, do an M and A, like what are some of the things or uh, one thing or whatever that you see consistently in this where you, if you could give advice to someone who would be a potential portfolio company of yours, be aware of this or be thoughtful of that.

Maxim Tcherner: Yeah, what I would say, what I'm consistently reminded of every day is that this is a people business. At the end of the day you don't earn a return on a spreadsheet. We've all heard that and that is true whether you're in the large cap, small cap, mid cap. But I think that you see, you know, you're closer to it in the lower mid market where you know, you might have an impact or you know, as you mentioned, there might be a couple critical people within the business that might have an impact. And so I think what we sort of talked about early on, ensuring that you have that alignment across all the different facets that we Spoke on the incentives, the value creation plan. That's critical. I would say don't kid yourself where if you feel like that there is any type of misalignment early on, take a second and address it because that will only create havoc later on for you. So to me that is the core crux of how we look at many different things and how we've actually avoided a number of situations. So that to me is most important. I'd say the other piece that I've observed over the last couple of years is just this idea of momentum. I mean momentum is so powerful now. We're not in the business of playing market timer and I think anybody that's ever tried to play market timer has probably lost that game over a long enough time frame. But you know, operating in this sense of urgency where you, you go after it and you capture the opportunities. I think the longer you do this, you, you, you, you feel like you're in these windows. And I'll example, we was advising a small business at the time which was roughly 3 million of EBITDA. It was kind of April of 21 and it was, I was helping out with a family friend effectively and we sold it for a high single digit multiple. That business had no, it was a, it was effectively a contract machining business, had no business selling for that price. But the backdrop to it was there was a SPAC at the time that was sort of amalgamating the space and the SPAC was going to go public at uh, whatever, 10, 11 times. And so I only say it uh, in that process we moved very quickly because it felt like there was just this incredible moment. And so momentum is this double edged sword. And where I would tie that all back to is again as I said, you can't play market timer. So just focus on building businesses the right way, focus on making sure that they're enduring and durable and I think you'll always get rewarded for it at the end.

Host: Yeah, don't, don't worry about market timing. Unless there's a spac, then you move at pace. Right. Because they've got that window. We all know it. Right. Sounds like you missed your calling as an investment banker. Finding the right buyer because that's sort of right Back in the day we

Maxim Tcherner: uh, like to do this exercise relatively early on in our investments where we chat with some of our trusted relationships, some of our uh, investment bankers and we talk about what are the three or four things that we have to get right in order to create an opportunity that is really attractive. To the next buyer. And that helps just organize and prioritize how we think about investment over our hold period. Now, again, it's not a contradiction to what I was saying in terms of build great, durable businesses, but I actually think it helps align the decision making along the way and helps. As I said, we have found focused founders as well.

Host: Yeah, it's great that, I mean, you've seen, it's nice to see. We've seen our end. You've seen this earlier in yours where you've got the benefit of a larger institution, but the, the focus of being precise and where you want to spend your time. So I'm sure that resonates well with the businesses that you're looking to buy. And listen, that's the point of this podcast, is how do you have some case studies if you are looking to sell a business? How do you get that information before you go through a process? Because experience takes time, sadly. And so, you know, knowing what you guys are doing and how you're creating value in, in a, you know, unique's, uh, a tough word, but a differentiated manner just helps the families, uh, who you're parting with create value. So I'm excited to have you on. I really, we've seen it firsthand. I'm excited have you on as a guest and, you know, thank you for joining us, giving us your take on, you know, sort of what you're doing, why it's more compelling. Uh, and hopefully the listeners got a lot out of that because there was a lot of golden nuggets in there for them to jump in on.

Maxim Tcherner: Yeah. Thank you both. I really enjoyed the conversation.