• Laurie Barkman

E08: Addressing the Transition Dilemma - Joe Bute, Hollymead Capital



When there is no successor within the family, how do owners move to the next level of finding someone to buy and operate the business?

On this episode, we focus on liquidity options for family owned businesses facing a transition dilemma. Laurie Barkman was joined by Joe Bute, Managing Partner of Hollymead Capital.


Listen in as Joe shares his strategies for investing in family-owned companies, considering liquidity options, avoiding transition pitfalls, and staying resilient through challenging times.


If you're considering ways to transition ownership of your company, you'll benefit from these insights.



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Full Transcript


Laurie Barkman:

Welcome to Succession Stories, insights for next generation entrepreneurs. I'm Laurie Barkman. I've spent my career bringing an entrepreneurial approach to mature companies struggling with change as an outside executive of a third generation, 120 year old company, I was part of a long-term succession plan. Now I work with entrepreneurs, privately held companies, and family businesses to develop innovations that create enterprise value and transition plans to achieve their long-term goals. On this podcast, listen in as I talk with entrepreneurs who are driving innovation and culture change. I speak with owners who successfully transitioned their company and others who experienced disappointment along the way. Guests also include experts in multi-generational businesses and entrepreneurship. If you are a next generation entrepreneur looking for inspiration to grow and thrive, or an owner who can't figure out the best way to transition their closely held company, this podcast is for you.


Laurie Barkman (00:58):

On this episode, we focused on liquidity options for family owned businesses. Laurie Barkman was joined by Joe Bute, Managing Partner of Hollymead Capital. Hollymead focuses on small businesses that have enjoyed a history of success, but have begun to plateau in their markets. Joe shared stories about closely held companies in the second or third generation of ownership where family members were no longer involved day to day. He discussed how his firm evaluates investment opportunities, the pitfalls of an auction process, benefits of alternatives like employee stock ownership plans or ESOPs, and the importance of employee relationships and accompany transition before and after the deal closes. If you're starting to think about taking on outside investment or transitioning ownership of your company, I think you'll find these insights helpful. Thanks for tuning in


Laurie Barkman (01:45):

Joe, thanks for joining me on the Succession Stories podcast. We were introduced by a mutual contact and she described you as someone who keeps legacy businesses alive. I thought that was a really interesting description. Can you tell me the short story behind that headline and why are family businesses important to you?


Joe Bute (02:05):

My resume includes about 20 some years in the world of lower middle market investing, mostly with publicly traded companies. Not a significant amount of that investment was actually in family owned and closely held businesses even though they were a bit larger than what I work with today. Even before that, I got acquainted to this whole world of the succession crisis, or the legacy business crisis, when I was working for the State of Pennsylvania. We were involved in a project back in the mid early nineties to create a statewide manufacturing retention network. And one of the things that we looked into was the challenges that were presented by ownership. And it turned out that when we pulled down the Dun and Bradstreet data, that 60-70-80% of all the small manufacturing companies in the state were actually family owned businesses.


Joe Bute (02:58):

And nearly more than half of those were in second generation ownership and a significant number were in third generation ownership. The data on this is pretty grim, which is that once you get past third generation and the ownership of a small business, the likelihood of it going into the fourth generation is pretty minimal. So since our mission working for the state was to find a way to retain business capacity, manufacturing capacity in the state, we began to realize that unless somebody did something about this whole question of succession that you're going to lose a lot of businesses over time just simply by attrition and the change of ownership. So that was on my resume before I got involved in the world of investment banking and private sector investing. And I took that with me and we found similar experiences when we were doing a lot of the lower middle market investing. Again, second and third generation businesses. When I left that world and started a new company called Hollymead Capital, we focused on this whole question of closely held businesses and how do you deal with this question and how do you address the question of how people move from one family member to another. Or if they don't move to another family member, how do they move to the next level of finding somebody else to buy and operate the company?


Laurie Barkman (04:12):

Not an easy thing to navigate as you said. And the success rate has been traditionally low. So businesses like yours work with companies on what transition options are. Sounds like a pretty good experience and great for the community. Can you tell us a little bit about Hollymead Capital? Where did the idea come from? From your own personal experience? Did you have any entrepreneurial roots in your family?


Joe Bute (04:34):

Yeah, that's a great question. So I grew up the only child of two parents that were very entrepreneurial. Ever since I was in kindergarten, my father had a high school education, but he was determined to do something with all of his ideas. And my father had a lot of ideas. When I was a kid growing up, he always had a project or two projects in the trunk of the car that he was taking to somebody to sell something. But growing up in that environment, the first business my dad owned that I remember as a kid was owning a small coffee shop in Northbrook, Illinois, which was the town I grew up in. I spent almost all my years in Northbrook until college. And that whole experience was sort of imprinted on me. This whole idea of the idea of small business was not out of my experience and childhood memory.


Joe Bute (05:20):

And in fact I was thinking about this the other day because I was thinking this question as we were talking about it and I realized growing up in Northbrook in the 1950s that 90% of all of the people I knew were either working for or own small businesses basically in Northbrook. This was a small village of about time we'd lived there, maybe 10,000 people that'd be generous. And so most of the time you're doing business with people that own their own businesses, whether it was the shoe repair guy or it was the local grocery or the big chain in Northbrook was the Ben Franklin Five & Dime. So this is growing up in a small town in kind of almost like Lake Wobegon. And it was a period basically before there were, and before there were big chains and before there was Walmart and all that other jazz.


Joe Bute (06:01):

So my whole point of reference was small business. Fast forward, my mom and dad left the Chicagoland area back in the 1970s when I was living outside the country. I was living in Canada and they moved to a place called Charlottesville, Virginia. Charlottesville is where the University of Virginia is. And my dad opened up a pizza shop there. This was probably his third pizza shop in 10 years. He got pretty good at that and they had a pretty good idea about where to put them. And it turned out they were the first one in Charlottesville, miraculously in the 1970s. My mom managed to land us a small farmhouse that was located in the middle of the subdivision and she converted it into a country inn which was called Hollymead. And so the farm that was called Hollymead turned into the Hollymead Inn. Then my mom and dad put that together, and for about 17 years they ran what you and I today would call a farm to table restaurant. They didn't call it that because they just didn't know any better. They sourced all of their meat locally. They sourced all their produce from local farmers. I mean it was all that kind of good stuff.


Laurie Barkman (07:03):

So Hollymead Capital comes from your own influence-- your family’s influence-- in entrepreneurial endeavors. It's something I hear quite often that even if it's not a business that has continued and passed down from generation to generation, there seems to be an entrepreneurial gene and it sounds like that you have that as well.


Joe Bute (07:22):

Yep.


Laurie Barkman (07:22):

I want to go back to talking about Hollymead Capital itself and it's focus on working with family businesses that are facing some sort of dilemma. And one of those dilemmas you talked about was the transition dilemma. So what do they do when there is no successor within the family? And it seems that that's been an area of focus and opportunity as you've gotten into Hollymead Capital and working with them on different options. So can you talk a little bit about that? What's the focus of Hollymead Capital from the types of companies, maybe geography, industries, and how do you start working with an owner?


Joe Bute (07:58):

Yeah, so a couple things that I think are important in what we do. One is you have to pick your spot. If you try to be a generalist and be something for everybody, it's very difficult to navigate with small businesses. So if you try to be an investment company that does everything from injection molding to retail, to white manufacturing, to food, to whatever, and then there's a logic behind that, which is that when you look at most of the unsuccessful succession business planning organizations, they try to be generalists. And that becomes difficult in terms of establishing credibility with the owners. So we picked our spot because of my own life experience and what I thought was important. We focused on food and businesses that are in the food space that was our priority. And so that's what we spent a lot of our time, our formative years, basically spending looking for food companies.


Joe Bute (08:48):

I was involved early on in 2014 in leading the acquisition for a little company here in Pittsburgh, Uncle Charlie Sausage Company, which was a second generation owned business. The second generation actually died tragically in an airplane accident. And so the first generation had to come back and take over the company and the owners were in their late seventies early eighties and so they didn't have a logical transition plan for that. And so we worked with the advisor to them and we found a way to basically buy the company and keep it going. And then in 2016 we did our second family owned business acquisition, which is a company called Tomanetti Food Products, which is based in Oakmont, Pennsylvania. And it is a commercial par baked pizza crust company. It does about five to six million crusts a year. So it's actually bigger than it looks and it's a very complicated company, which we'll get into later as we talk.


Joe Bute (09:39):

But again, family owned, this was on second generation two. Siblings that survived the transition when their father had passed and then their brother had passed. And both of them were doing other things in their lives. They were both professors at colleges and so they had been professionally managing the company and we came in basically to offer them an opportunity to sell the company to us and that we would continue to operate it where it was located. You made another good question, which is geography. I'm a firm believer that if you're going to be good at something, you have to do it relatively close to home. It's very difficult to work with small businesses far away and so if you're looking for business opportunities in the space that the advisor or the investment company really needs to sort of spend their time getting good at looking at businesses that are probably within about a two hour, three hour driving radius of where you're located because you have to be closer to the company that you can be responsible for getting out there.


Joe Bute (10:31):

So, location matters. I think focus matters as far as industry is concerned. I don't know that size matters a whole lot. I think that at the end of the day, the underlying principles in a company like this should be that they have a defensible space in the market, that they have a reasonable chance of improving their margins and growing their sales, but they don't necessarily have to be a rocket ship, which is not the norm in the world of private equity. Because I spent a lot of time, obviously with private equity folks and they're always looking for companies that can grow at some multiple of two and three and four small businesses typically don't do that. So you have to be comfortable with making the investment on the strength of what the company is capable of doing and growing it incrementally. That's a difficult investment proposition for some people.


Laurie Barkman (11:16):

Yeah. And so let's talk a little bit more about that. How do you as an investor evaluate these opportunities? As you said, they look different, right? They behave differently and they’re potentially in a niche industry or vertical that you've gotten to know well through your own industry experience. So what's the best way to evaluate maybe telling some examples perhaps? Was it Tomanetti, how did you get to know them? How did you get to understand whether that's a good fit for Hollymead?


Joe Bute (11:48):

So Tomanetti obviously was in the pizza business and I grew up in the pizza business. I felt like I understood something about pizza. That sounds kind of silly, but the truth of the matter is that when you look at the food industry, pizza is still the number one most consumed product basically in the food industry. Chinese food probably comes a distance second, we consume more pizza in the United States probably than any other particular piece of the food system, right. So that was good. You got a feeling like it had resiliency that it had sustainability, that the market wasn't going to go away from you. The second thing that you take a look at as you look at vulnerabilities. One of the things that I have always been concerned about when I look at these small businesses is what's their codependency relationship with their customer. An unrelated life experience for me was when I was working for another company called them American Capital Strategies, which was investment company specializing in lower middle market.


Joe Bute (12:40):

We looked at an injection molding plastic company that was family owned and we are comfortable with the ownership, but the thing that never got us very comfortable and it turned out we were right, even though we didn't get hurt on it, it hurt him. That was, he had a significant amount of concentration risk with Proctor & Gamble. And that can change suddenly on you if there's a change and you don't have any control over that environment. And if that happens, you're screwed, right? So that gets to the core question of resiliency. So are your customers resilient? In the case of Tomanetti’s, one of the things that jumped out at us arguing in favor of making the investment was that they did business with 65 different wholesale distributors and that gives you a lot of comfort that if one goes down, you've got 64 to work with and anecdotally in the food space you have to take a look at that a lot these days because there's a lot of consolidation among food distribution, wholesale. It seems like there's almost a merger every month basically between two distributors for one reason or another.


Joe Bute (13:36):

The small ones get merged by the midsize ones, and the midsize ones get merged with the big ones and all is very disruptive. And if you're the manufacturer, you're the supplier to that distribution channel, then you've got exposure. If you're 85% exposed to Sysco, for example, if Sysco, gets into them failed merger with us food service, which is that approved, which actually did happen several years ago. Then all of a sudden everybody who's supplying Sysco gets disrupted. And there's all kinds of challenges related to that. So you look for that. So you look for is there a trap door or a way to get out based on some reality? Of course we're facing that right now with COVID-19 where everybody's being disrupted all at once and you know who in the world was anticipated at a 35% unemployment rate happening - going from a full employment economy, theoretically three months ago, to 35% which is unheard of.


Joe Bute (14:30):

It's higher than it was during The Great Depression. That kind of takes your breath away. And so you try to figure out how you navigate those things. But at the end of the day, that gets to the other question about how do you make a decision about what to invest in? And I think a lot of that has to do with investing in things that people are always going to want and need. So one of the things we talk about a lot at Hollymead Capital, and if you go to the website, you'll see that we talk about basically addressing the question of businesses that are addressing basic needs. Food is one of those categories. Shelter would be another one, energy would probably be a third. And I would imagine that you can take a look at health and wellness, but I think definitely food is one of those things where we always laugh at that and we say, well, at the end of the day, no matter how bad things get, people are still gonna eat. Which actually it sounds stupid, but it's true. Right?


Laurie Barkman (15:17):

Well that's what certainly what we're seeing right now.


Joe Bute (15:19):

The one thing we're all doing right now is eating. I said that to a friend of mine the other day. I said you know about three months ago, all the industry trade magazines were talking about the end of grocery as we know it. And now three months later everybody's like, thank god we've got grocery stores.


Laurie Barkman (15:34):

Yeah. And in some cases restaurants are now serving as grocery stores.


Joe Bute (15:38):

Exactly. So we have to be nimble, right? You have to be agile when you're in business. And one of the nice things about small businesses is that ironically, they actually have more agility than big ones. It's harder for a big company like a Sysco to change direction as a distributor as we saw, because it's probably a pretty good examples of Sysco 85%- 90% concentrated in the food service space and not doing anything in grocery. And overnight the big need was for distributors to service the grocery chains. And literally they had to reengineer Sysco over about a 30 day period to figure out how they could start to take what they had in inventory and move it into supermarkets and grocery stores. So you look at that and you realize that that's a credit to them, that they actually figured out how to manage through that process. But there will be folks all across the country who weren't able to figure that out. And they sat there and they had an enormous amount of loss for what the inventory was that they had on hand. And we see that a lot.


Laurie Barkman (16:34):

Yeah, we're starting to definitely see some amazing transition stories and there's a lot of reactivity happening right now for the right reasons. It'll be very interesting to see which companies stay the course that they've been on, and which ones have added into their portfolio. De-concentrated or diversified that risk so to speak because the taking on new types of customers and obviously we all want to get out of this recession that we're in and move forward. So I was curious to talk a little bit more about options for business owners as they contemplate transitioning ownership. You talked about mergers and acquisitions and a buyout. You and I had also spoken before the show about another option, which is ESOP, which is an acronym. It was wondering if you could talk a little bit about that. What is an ESOP, how does it work, and why might it benefit a company to take a look at that option?


Joe Bute (17:31):

Sure. So ESOP for your listeners, ESOP stands for employee stock ownership plan. What that means is that it allows the owner of the company to transfer the equity of the company to the employees. Shortest definition I can come up with. It is regulated and it is governed by the US Department of the Treasury.


Joe Bute (17:50):

They are covered under ERISA and the Department of Labor covers them as well. So they're basically a qualified retirement plan if you think about it that way. So the same rules that govern 401k’s and all that stuff. And pension funds also tend to come into play with ESOPs. So you've got at least two federal agencies that sort of pay attention to this as far as the rule making is concerned. And now why would somebody do an ESOP? Well, the biggest advantages, let's assume all of your net worth is tied up in your ownership of the company, which is fairly typical of small family owned businesses that they're all fortunate, so to speak, is based in the intrinsic value of the enterprise that they own. And it's not because they have other assets, other where other locations, most of it's there.


Joe Bute (18:36):

So, and when you think about it from a tax standpoint, then you think about it, what's the basis for this stock? And of course they created the company so the basis was virtually zero and now when they go to value the company, just like you would do an appraisal on a house, the stock is worth something. And whatever that stock is worth, you can sell that. Well of course the minute you sell it and the tax code, you have a significant capital gains exposure and that becomes problematic for a lot of closely held companies because the owners now are facing the fact that a significant amount of the money that they would have gotten selling the company to an outside third party, they're going to be paying back in terms of taxable gains. So that becomes a challenge for them. The idea behind ESOPs was that the employer would be encouraged to sell the company to the employees in a qualified plan and they would get back whatever the cash value of that was at the time of the sale.


Joe Bute (19:29):

They can do that through either self-financing that sale or they can do it through getting bank financing. Banks actually have a lot of experience in financing ESOPs based on fair market valuations and qualified plans. And once they do that, so long as they roll over those proceeds and they invested in any US domestic security and that's pretty broadly defined. That could be a fund managed by Federated Investors for all intents and purposes. You don't need to invest it in another company per se, but so long as you invest into what's considered a domestic security, the reality is that you are then deferring your taxable gain for the life of the investment. So in effect, you're able to take your money out of the company and not be taxed for it. And the company then can be transitioned in part or whole to the employees and some type of plan. I just said something that is embodied in probably about 2000 pages of legalese.


Joe Bute (20:22):

So anybody that's thinking about doing an ESOP needs to talk to a qualified investment advisor who specializes in ESOPs. Don't go to anybody that thinks they know something about ESOPs and they don't do it for a living. There are a number of them and you can Google it. There's ESOP Associations, there's multiple trade associations that look at ESOPs. The rules changed a few years ago. They're very favorable for sub-chapter S corporations, which is very typically the way a lot of these family owned businesses are owned. Have been for years. But the rules changed so that it's more favorable to do this through an S corporation than it used to be. Because it used to be you had to convert to a C corporation in order to actually convert to an ESOP. They greatly simplified this process. Owners can sell. They don't need to sell a controlling interest in the company in order to do an ESOP.


Joe Bute (21:10):

They can actually maintain a control of the company and they can share the equity ownership with the employees. So like I said, it's definitely something that people can take a look at. There are certain minimums, like you have to have a certain minimum number of employees in order to make this work. You can't do it for you. You can't do it with a company like with five employees. I mean, it has to be 25 employees, I think is the minimum or more. And again, there's the rules that govern this in terms of what the voting rights are for the shareholders and a lot of other things, which are too much to get into here.


Laurie Barkman (21:38):

So for the right company, an ESOP could be a good option, especially if an owner is really concerned about the continuation of their legacy and their story going forward without a transition to another family member.


Joe Bute (21:52):

Yeah. And I think there's two elements to that. We talked about this before this conference, but there's two ways to think about who are the logical owners of the company outside of the family immediate owners. The first one is to tell family and business owners to take a look at their management teams. And it is kind of funny.


I've met with a lot of companies, I think we talked over 400 companies when I was at the Steel Valley Authority. And I have to say maybe 30 or 40 of those owners basically thought enough of their management team to think that they could actually be the owners. But when you would talk to the management teams, most of them told you that they would love to own the company. So there was a disconnect between what the owner thought of the people that work for him or her and what the people that were doing the work thought.

Joe Bute (22:38):

We used to laugh because owners would be spending half of their time down in Boca every year, and the company was being managed perfectly well by people that weren't there, and weren't immediately their relatives. But they never thought of those people as being the people that could own and run the company. So one of the things that we always advocate at Hollymead Capital is to definitely take a look at that option, which is to sell the company to the management group and management groups can partner with outside investors pretty easily. So long as everybody has an agreement on what the ground rules are. I say that with some caution because the minute you start talking about bringing in outsiders, you're also exposing the company to some risk as far as sharing important financial information about the business.


Joe Bute (23:22):

Whether it's a management led buyout that includes an ESOP, or it's just straight up a management buyout, or without the ESOP, either way, those are options that an owner should definitely take a serious look at. And then if the management team wants to make it happen, there are people like us out there that would help match them up with investors that would like to partner with them on the outside. And that's a tricky process. But so long as we have a willing seller, then that's the key. Something else, it’s a bit of a cautionary note, which is that I think family owners of companies sometimes have this idea that somehow they're going to get this huge payday when they sell their company. And so they tend to inflate the value of the business.


Joe Bute (24:10):

Then they get trapped by a lot of people in my business, unfortunately, that are on the bank, on the brokers side. Business brokers and investment bankers are notorious for constantly calling up owners of companies and asking them if they want to have them help them sell their company. And I always worry about this because this is something that we've seen a lot, which is that companies tend to drift towards doing things like running an auction. In our business what that means is that you bring in an outside financial advisor who does work, sits down and does a valuation, what he/she thinks the company is worth and they run an auction, which is literally an auction. They put a two page memorandum out to a wide audience of people that are either strategic buyers or who are in your business, or private equity buyers, or others.


Joe Bute (25:04):

And then you'd get a whole bunch of people in there to kind of bid the price up because the owner has this feeling that I don't know what the value of my company is unless I hold an auction. The downside risk there, which is something that I worry about a lot with these guys, is that I know from having been in the business as long as I have is that the minute you run an auction, everything about your company basically becomes publicly available. Now, I've been on the other side of this a lot. I mean, we all sign nondisclosure agreements and we all promise never to tell anybody what you said in your memorandum. And we promise never to share your financials with anybody. But then in this day and age, those financials end up mysteriously in the hands of a whole bunch of people who now know what your business is and know what your margins are.


Joe Bute (25:50):

They know who your primary customers are, they know who your suppliers are. Everything that's important about your business basically ends up on the street. It's a tricky game because the third party advisor is basically promoting to them the idea that they're going to get them the best possible price. And that's not to say that they're wrong, but I've probably been involved in more busted sales than I have been in completed sales. And if you think about this for the moment, let your mind sort of go forward to the point where you say, boy, you know, this isn't working out the way I want. I'm not getting the buyer I want or I'm not getting the number I want. You're six months into a process, you've disrupted everybody in your company because whether they know it or not, everybody in the company knows that you're trying to sell the company.


Joe Bute (26:37):

And we've kept it really quiet. Nobody knows. And it says, yeah, but you got all these guys with ties that are coming through, you know, with briefcases and they're all taking pictures of the plant. And it's like, so are we on a tour or something? Is this like a new tourist attraction in town? You know? And of course if the employees didn't know it, they hear it from the people like the banker in town that he's having lunch with the guy who was the manager in charge of purchasing. He says, oh, I didn't know your company was for sale, Fred. And Fred was like, I didn't know it was for sale. So pretty soon everybody in your work or everybody in your company, one way or another knows you're for sale. So that changes their whole attitude about what they're doing there. And they start thinking about it. And if you have some, particularly if you have some people on your team that are pretty critical, like they have a critical skillset or they're important to the business, they start thinking about someplace else to go with their critical skillset to ensure the fact that they don't end up on the cutting room floor with the merger partner, whoever that is.


Joe Bute (27:30):

So we've all been there on that. The other thing that happens is that now your competition knows a whole lot more about your business than they did before because they've seen this information. And they know, not only do they know who you're selling to, but they know what your go to market strategy is. And by that I mean they pretty much know whether or not you're selling on price, or you're selling on quality, or selling on uniqueness and whatever. And quick story, I'll tell on that. One of my partners back in the day, we were looking at it, we had invested in and bought a door company in Cincinnati, Ohio. This is a company that made traffic doors in grocery stores and fast food restaurants and all that other stuff.


Joe Bute (28:12):

And their leading competitor was a company named, I want to say Ellison Door. And Ellison was probably the biggest player in the franchise space. Every Subway had a traffic door that was built by those guys. Well, they were, it turned out, we found out they were for sale. Now this is our leading competitor. And so one of our senior managers in the investment company called up my partner Paul and said, boy, we really ought to make a run at this and try to buy the company because it's for sale. And Paul said, no, let's let some private equity fund and go spend way more than they should for this company because that's the only way they're going to get it. And after they do that, they're going to leverage it up. And once they leverage it up, they're going to have to raise their prices and we'll go in and we'll beat them on price. And pronounced six months that's what happened. Some private equity fund bought the competitor and they were absolutely locked in on whatever it was they were selling it for because they had to assure the bank that they could make the debt service payment based on their margins so they could price compete with big customers. And we were eating their lunch within six months to a year and picking up market share.


Laurie Barkman (29:24):

So that's a good illustration of the risks associated with an auction. So an option might be able to get that price that brokers and investment bankers are saying maybe there, however, there could definitely be a downside to that. So an auction is an option. An ESOP is an option. And it also seems like the buyout option that you've talked about where the management team is in place, either again through the mechanism of where maybe some employees have ownership, maybe they don't. How do you as an investor, you talked about some of the factors evaluating, but isn't there an inherent risk when you really don't know what you're getting until you're in there? So if you have the management team in place, then you're kind of inherently de-risking the investment. Am I right?


Joe Bute (30:11):

Yeah. This is true. The thing that, the thing when you're buying a company from the outside is that you don't know why they were something until the day after you closed. Right. I mean, that sounds kind of simplistic, but it's true. And you can spend, and I've been on some fairly big acquisitions for where that was even more true than not, and we had a lot of very smart people going around and doing the underwriting and doing the analysis. So at the end of the day, we didn't know everything we needed to know about where the company was relative to its competitors in the market. When you go in together with the management team, then you can anticipate that better. And they’re pretty much blocked from being able to tell you all that stuff during the front end of that process because unless they're partnering with you.


Joe Bute (31:00):

So when you come in from the outside to buy a company, the management team is all under strict nondisclosure, so they can't talk to you. But if the management team is actually leading the acquisition and the investor knows that the management team can share that information with the investor group because the investor is supporting the management team to do the buyout. So I think it reduces the risk from the investor perspective. I think it improves the likelihood of a successful outcome basically for all parties. So that's definitely something to think about. And, and I wouldn't minimize the challenge for the seller getting stars in their eyes because they've gotten some number in their head that they think their company is worth and they're not ready to back off on that. But they're not thinking it through all the way.


Joe Bute (31:45):

They're not thinking about the downside risk. And by that I mean there's several, right? One is that you're running an auction and you don't get to where you want to end up. Now your competition knows a lot more about your business than they did before. So that's a risk. But the other one is kind of sentimental, and this is very Jimmy Stewart of me. But I think that people who have built family businesses or maybe even if they're second generation and the name of the company is going to stay on the door, that if they do a lousy job of transitioning the ownership of the company, they're going to feel bad about it for a long time. And if they continue to live in the town that the company is in, they're going to really feel bad.


Joe Bute (32:32):

It's not going to be a positive experience for them. And they're going to be very frustrated and they're going to have all kinds of challenges basically with the people that they know, or they grew up with, or supported a part of the business. I mean, if it doesn't matter to you, it doesn't matter to you. But you know, I would say this real quickly, we saw this at Tomanetti’s. I mean we bought the company but the gentleman who is a professor at Pitt [University of Pittsburgh] who grew up in the business, still comes over to Tomanetti and he still talks to the employees there because he knows most of them because most of our employees have been with us for more than 10-15 years.


Joe Bute (33:09):

And then when he's walking down the street, there are guys shouting out the out the window of their truck. And coming up from another plant who we used to work for him as a driver at the Tomanetti plant. And so they stay connected. He's not going through this kind of emotional roller coaster. What was it like to let go of mom and dad's business to a third party that doesn't seem to care about it and he cares about it. So I think that’s something you shouldn't dismiss lightly. And the money doesn't necessarily solve all problems.


Laurie Barkman (33:42):

Yeah, you're right. And I think there are some surveys out there about satisfaction of owners after a sale and the percentage that say that they weren't satisfied with the outcome is higher than you'd think. And so maybe that does have something to do with it, where there could be some regrets on one side or the other of that situation.


Joe Bute (34:00):

Seller remorse.


Laurie Barkman (34:02):

Yeah. There's another option that I wanted to talk about and explore, get your thoughts on, which are search funds. It's something we'll spend some time on in another episode for sure. And I think that there could be some interest there potentially for privately held companies too. Look for successors that are not part of the family. And then also as an investor, there's a potential for de-risking. Are you familiar with search funds?


Joe Bute (34:27):

Yeah, so search funds then this is kind of a business school movement that's grown up, I would say, within the last 10 years. Most of the major business schools in the country have search fund groups or networks or clubs, what have you. So real simply what is a small group, most of these funds function around MBA candidates that are in schools like the Katz Business School, or Tepper, Stanford, Harvard or whatever. And they're not buying into the idea that their path is success is either a getting involved in a fast growth tech company or their other future is basically to go work for a Fortune 1000 company and be part of a huge management group that figures out how to climb the ladder of success.


Joe Bute (35:21):

They actually want to own and operate something. And so they're looking for existing operating companies and what they're doing is they’re scanning the landscape of companies that are closely held for the most part and talking to them about bringing their skill sets, which whatever they might be, marketing, social media, production improvement processing, or production process improvements, whatever. And approaching the owners of the company and say, I'd like to come. I come, or several of us want to come work for you, and learn how to run this company with you. And then at the end of this process we would like to buy this company from you. And there are investor groups that have been forming behind the search funds that are prepared to make investments through the search fund in order to complete the acquisition. And you can find them.


Joe Bute (36:12):

They're searchable, if you will, on the internet. They have a national association. I know most of the business schools have their own structure for this. It's a really cool idea I think. It allows people that are sort of thinking about doing something different with their lives and what they do with this MBA when they get out of college and how they can actually get their hands on a company and run it and grow it and improve it. Again, it's not for everybody, but I think for an owner that's trying to find a way to segue to somebody that could bring some significant value and allow them time to test out the proposition between the two groups. It’s a good idea. Typically these involvements probably take anywhere from two to three years where somebody is actually learning on the job, how to run the business and be the CEO and eventually it gives the owner of the company an opportunity to begin to slow down and smell the roses or move on and do something else with their lives.


Joe Bute (37:11):

I think it's a good option and I think we're going to see more of that. I'd love to see somebody begin to work on figuring out how to run a search fund type structure for something even more mundane than what we see. Cause you think about it, what a business school group was going to look for. I think we ought to see it at the community college level or we ought to see it at the undergraduate level in schools like Pitt and Penn State and do them in neighborhoods like New Kensington or small towns in Pittsburgh where you could get somebody to come through that system and then help them and help enable them to own a company as simple as a dry cleaners or a laundromat or a marina or something. So it hasn't gotten to that level and the funds are typically looking for somewhat higher rates of return, but it's definitely a trend I think and we'll see more of it because it gets you out of this sort of high growth, high bust rate strategies that come out of the accelerator space in tech, particularly around technology.


Laurie Barkman (38:13):

Yeah, it could be a great solution. As you said, for even smaller businesses. People don't always want to take the big, big, big risk. Maybe they want to start small and grow along with their experience. So that's a really interesting idea that you're putting out there. Maybe that's something that in your next, next, next, I know you're already working on your next with Food 21 as a new venture for you. So you're not certainly not hanging up your sneakers yet. You're in your next phase of entrepreneurial endeavors and you've got an incredible amount of experience in your career. So congrats to you on that. As we start to wind down this discussion today though, there's a couple more things I wanted to cover. So with the time of incredible uncertainty that you talked about earlier with COVID-19 pandemic, 80-90% of all the businesses in the U S are small, right? And there's this huge impact on small businesses and some of them won't recover. Some of them will probably close. The ones that are determined, resilient and nimble and agile, will hopefully, turn the corner and start to focus on the future. They're certainly very focused on the now. So what advice do you have for those businesses that are starting to look forward coming out of this time of incredible uncertainty?


Joe Bute (39:28):

Yeah, that's a terrific question. Of course I absolutely have the answer to that. No, I don't.


Laurie Barkman (39:33):

It's a tough question.


Joe Bute (39:35):

Well, let's think about the time that we're in. If people are approaching this eyes wide open, which is what you're sort of suggesting, and we want to get brutally honest with where we're at. We have not been here since 1929. In terms of the global economy, the COVID-19 crisis has swept the entire global economic system. And it is going to have those kinds of impacts. It's going to be Depression like impacts and who knows how long that's going to take to fix. Because right now, as somebody once said the other day, we're all Keynesians now. So everybody would talk, laugh about John Maynard Keynes saying how antiquated he was and his whole approach to dealing with a financial or an economic crisis was outdated because you just can't throw money at these problems.


Joe Bute (40:30):

And well, guess what? Even the most conservative of conservatives right now in the United States and internationally are saying, we got to throw money at the problem because we have to restart the economy. What I don't think that those folks understand is how hard it's going to be to start back up again. I hear this every day when they do those insidious briefings, which is that, Oh, you know, we just got to get the economy rolling again. It's going to be a V curve. It's like, no, it's not. This is much deeper and it goes far, far, far deeper into the system than you're giving it credit for and it's going to take longer to figure it out. So the first piece of advice is be patient because you're not going to get there all at once.


Joe Bute (41:16):

The second is we need to make sure that there are some pretty smart people at some level of the system that are thinking about how to apply the stimulus that's coming out of the government. I worry for the most part that we don't have people that understand that very well, and they don't. And the devil's in the details, right? I mean, I could allocate $2 trillion and everybody's like, see, problem solved. And then you realize, but the infrastructure to move that money from Washington and the Treasury to a small business in Cranberry doesn't really work very well and the banks are overwhelmed. Everybody else is overwhelmed. So there's going to be a lot of learning curve and people are going to have to be patient about figuring that out.


Joe Bute (42:04):

That said, I think if your business is in a space where it has a purpose that it meets a basic need that people have, I think that survival is almost assured because people are going to come back to you one way or the other. It's going to take longer probably to get there, but you're going to have to figure it out. It's sort of like the whole country is going bankrupt all at the same time, right. And so typically a bankruptcy involves a long period of negotiation and clarification and documentation and people being patient about when they're going to get paid, and all that other stuff. And we're going to have to figure that out as well. Those are some of my initial thoughts. I think that one of the things that this is also really telling us, which is something that we do need to take seriously all the way down to the local level, is that the tide went out, and the tide exposed a lot of fundamental problems in the way we allocate resources and compensate people and treat people in the community.


Joe Bute (43:10):

And that has to do with safety nets. Safety nets are really important and we've been walking away from the safety net argument for 10-15 years. And we need to get back to focusing on that. Everybody that I see that we're working with in our work, like at Food 21 and Hollymead, are all talking about helping people deal with day to day problems, like having enough food to eat and getting transportation to someplace and adequate healthcare and all that other stuff. So all those things that have been talked about but not acted on need to be back on the table. You can't stay in place if you don't have a place to stay. Right? I mean, I've said this before. Well that's great advice, but if I don't have a place to stay, I can't stay in place.

Joe Bute (43:56):

And then if I don't stay in place, then the chances are that you're going to not like that because I could infect you because I'm not staying in place and I have no place to stay. So what do we do now? Right? So housing becomes an issue. They were going to have to address all those sort of fundamental issues. I think we should learn from The Depression and we should learn from the New Deal. And we should learn from the fact that what was the biggest focal point of the new deal after 1930-31 with Roosevelt was to basically focus on making public investments in infrastructure that people needed. Whether it's housing, public transportation, amenities, healthcare, education. I mean all those kinds of investments that go to the underlying social capital and real capital of the economy. And you've got to address that.


Joe Bute (44:41):

The best news, I think coming out of this from my perspective is that the one thing that didn't collapse in this process was the financial system. I think that is almost entirely due to the way we saved the financial system in 2009. If we hadn't put all those safeguards in with the banks and talked about too big to fail and required liquidity tests, all the banks, when we were going through this whole go go period in the last four or five years in the economy, those banks would have been as screwed up as everything else. And they're not. I think people should take some comfort in the fact that we actually have a private financial system that did not cave in as a result of the collapse of the bigger economy in the respect because of the pandemic.


Joe Bute (45:34):

So, which is good news for small business, right? Because at the end of the day, small businesses are going to require and need to get much more familiar with their banks and their banking partners and banks are going to definitely have an interest in wanting to spend a lot. And I've heard this from so many bankers. I mean they are absolutely redoubling their efforts to figure out how do they work with and spend time and support small businesses in the communities. Because at the end of the day, we're in this together and I think the banks are going to emerge as the big heroes in the private sector as far as the recovery is concerned because they have assets to allocate and they have a vested interest in seeing businesses come back to life. And in communities like Pittsburgh and anywhere else in the United States, I think it's important.


Laurie Barkman (46:24):

Yeah, that's a great point. And I like how we can end on a point of resiliency and hope there. And one last thing is I like to ask all my guests, if you have a favorite saying about entrepreneurship that you can share.


Joe Bute (46:36):

Yeah, I'll use the one that you and I talked about earlier, which is when I was working in California, there was this one project that was being done by the state and it was to look at what businesses were successful, and why were they successful. And it was looking at very small businesses that was part of a project that under Governor Brown was underway- for first time around for Governor Brown, which shows you how old I am, so that's really sad. One of my friends, a guy named Lloyd Lee who was doing the research, they were looking at small businesses outside San Francisco in the East Bay. And they found this flower shop, and the flower shop was doing phenomenally well, way better than its peers. And so they came in and they met with the guy that owned the flower shop and they said, why are you so successful?


Joe Bute (47:28):

Well, it they thought that there was going to be some secret sauce and what he did as a florist. And apparently when he was asked that question, he thought about it, and said, “You know, you really gotta love flowers.” And that was it. That was that.

I guess my life lesson is that when you're in small business, if you don't love what you're doing, then you shouldn't be doing it. And you should love it enough so that when it's time to move on, you should also care about who ends up next in line to take that business on. Because it's a little bit like this is your baby and you're graduating it to the next level. And so I think, we should do what we love. We shouldn't do things we don't love as a general rule. If we're not having fun doing it, why are we doing it? And even in a crisis, it's better to do what you love doing then not do something other than that. And I think that we should also take care of the things we love, so that we think about what the next generation is going to do with them that matters.

Laurie Barkman (48:25):

Thank you, Joe. Thanks for being here. Thanks for sharing your insights about transitions for small businesses and how they can stay resilient and look forward to the better times.

Joe Bute (48:35)

Yeah. Thank you for having me.

Laurie Barkman (48:40)

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