Episode 38: David Acharya of Acharya Capital Partners on Growing Portcos through M&A

Episode Transcript

Shiv: All right, David, welcome to the show. How's it going?

David: Well, thank you, Shiv. Thank you for having me. It's going really well. It's a nice, beautiful day here in New York City, and I'm really looking forward to having a very robust conversation with you.

Shiv: Excellent. I'm excited to have you on. So why don't we start with your background and your firm and what types of companies you focus on and we'll take it from there.

David: Sure. So I'm the founder of Acharya Capital Partners. We are a New York City based lower and middle market private equity firm. We invest primarily in three industries, TMT, business marketing services and light manufacturing. And when we say lower end of the middle market, you know, we like to think of it as, you know, single digit EBITDA from 3 million to about 20 million being 3 to 10 being our sweet spot. Our investing philosophy is buy and build. We look for a good platform, a good leader, and then supplement that growth through organic initiatives as well as complementary acquisitions. What's unique about our funding strategy, Shiv, is we are known in the industry as independent sponsors. And that means we do not have a committed capital fund. We raise money on a deal by deal basis. We work with a network of family offices, ultra high net worth individuals, as well as, I like to call, institutional, independent sponsor friendly institutional funds. And by rare background, I grew up on Wall Street. I started off as a junior banker, investment banker right out of school. Went through a number of promotions in investment banking with two global firms. But like a lot of bankers, I made the move into private equity just around the dot-com meltdown and doing private equity investing ever since. My passion in life is both transactions and running a business. And those two areas you can get when you work in the private equity firm. So it's been a lot of fun. And after working for a couple of firms and with growing levels of success and promotions. Number of signs from God, I like to say, steered me into starting my own firm. And this is where Acharya Capital Partners was born.

Shiv: That's awesome. And I want to touch on a bunch of things that you shared. First, I just want to understand this independent sponsor model that you mentioned, because it's different than other private equity firms which may have a committed fund. So talk about the details of that more and how that changes how you find and invest in companies.

David: Sure, so when you think about a private equity firm, they go out and raise the capital upfront. So they go to their network, what we call in the business limited partners. They could be pension funds, endowments, charitable organizations, as well as what I like to call ultra high net worth families and other, I would say, firms that source the capital, they give you the money upfront and they entrust you in going out and raising money. Probably about a decade ago, I started seeing a lot of trends among investors where they were trying to avoid what we like to call blind pool commitments or funds. And they wanted to have optionality in investing in various deals. And that's when the independent sponsor model was born. In fact, at first we weren't even called independent sponsors, we were first called fundless sponsors. But you know, when I heard that term, fundless and sponsor in the same sentence, in the same phrase, it's kind of an oxymoron in finding it. 

Shiv: It's an oxymoron, yeah.

David: And it sounded, you know, as an industry godfather that I know, once said, at an event, it sounds like you're kind of homeless. So, you know, a bunch of people got together and said, hey, you know, we're independent sponsors. And so far, the term has stuck. And, you know, there are great things about the model, and there's some challenges. And the great thing is you're not forced to put money to work. You don't have the typical constraints of a fund. A typical fund has a 10-year life. And you don't have necessarily the constraints in holding a company. When you're dealing with a small company, Shiv, sometimes it takes more than three or four years to grow the company and really see the value. In fact, my last portfolio company, which we sold in December, the hold period was a little more than nine years, which is pretty not very typical for private equity. But we took the company from a very small single digit EBITDA company. And we nearly achieved a 15x growth in EBITDA. And I think a big part of it was the fact that we had a lot of time and we didn't have the constraints of a fund. But on the flip side, when you don't have a fund and you talk to bankers about deal flow, you typically get the response, well, how do I know you're gonna be there closing? And that's a hard conversation to have, but between reputation and past history, I'm pretty confident that when we decide to pursue something, we can close. And over my career as an independent sponsor, I've done more than 10 acquisitions where, and these were what I call banker-run auctions. So yeah, it can be a challenge on that front, but between reputation and past history, I think we can jump over that hurdle and get to the finish line.

Shiv: It's almost like a family office where you're describing, but on a deal by deal basis, you're trying to get the funding from these individual sponsors together. Is that fair?

David: Yeah, and yeah, so our investor base, they're ultra high-end individuals, family offices, and what I call independent sponsor friendly funds. The market has really looked at us and said, whoa, this is something special. And there are a number of funds out there that have raised their capital to work with groups like mine. So there is, you know, 10 years ago, it was the Wild Wild West. Now it's I would think a much more acceptable private equity model. 

Very interesting conversation. A few weeks ago, I was at a networking event, was sitting with a very senior partner of a multi-billion dollar fund, multiple offices across the country and a few offices overseas. And he said, man, I really admire what you do with this independent sponsor model. And I'm like, you have billions of dollars of AUM. And he was like, he's like, well, David, we have constraints. We can only invest in deals that is outlined in our subscription documents and our agreements with our investors. And sometimes we are forced to sell when it's not necessarily the opportune time to sell. So it was, I would say, a very interesting conversation that I've had. And it gave me just tremendous confidence in what we do.

Shiv: Different, different model. Yeah, talk more about the constraints here. Just to understand the other side. What are the realities of a traditional private equity investor, that's on their second, third, fifth fund and how does that impact their decision-making that's different than this model?

David: So put yourself as an owner. And I know Shiv, you're an owner of How to SaaS, which is a really big consulting and respected consulting company within your world. You want to, let's say, get some additional capital. And you're sitting down. And you're sitting down with a fund that has a fund three, and you'll be one of 10 portfolio companies. And you're sitting down with me. And the first thing that's probably going through your mind is, well, why am I sitting down with a guy with no committed capital? Well, there are a number of advantages. First is, I don't invest in industries that I don't know, okay? Because I need to gain credibility with our investors. The second thing is, you're not one of 10 portfolio companies. I have a handful of companies which I can, I target a handful of companies where I can focus on growing you without the constraints of having multiple funds. I had this very interesting conversation with the CEO who said to me, he had this very similar attitude and I don't blame him. And he went down the path with a committed fund. I'm sure he got the price he wanted, but one of the things he wanted to do was grow the company. And he said, well, David, I've spoken to you more than I've spoken to these guys and they're investors in our portfolio company. And I only see them three or four times a year at our board meetings. And then they hand off me to somebody else internally to handle all the valuation, the K-1s and all that stuff. And I had, quite frankly, I really have second thoughts and regret going down the path. I really wanted a partner who would be by my side as we pursue acquisitions and grow the company.

Shiv: Totally. I think that one in particular, especially as a founder, you live and breathe your business. And so if you bring on outside capital, you want to basically partner with someone who can do the same with you. And you can kind of strategize and look at different avenues and think about how to allocate your capital and make decisions and be more agile. And sometimes when you partner with a firm that's almost too big for where you are on your journey, you're not going to get that type of a partnership - you'll get the capital, but not necessarily that dynamic that you want.

David: Exactly. And if you look at my firm, I put my last name on the front door. It's literally on the front door. So every portfolio company, CEO and team will deal with me directly. I do have a small team. I have a great associate and I have another outsource team that handles a lot of my support work, but I do on my own diligence. I go through the data room by myself and I definitely lead the diligence calls when we're talking to potential portfolio companies.

Shiv: Yeah, I can totally see how for some founders, that's a really attractive model. I want to come back to this constraint of the fund just because you touched on it just to help the audience even understand is, let's say it is a fund, let's fund for a standard private equity firm. What constraints is that PE firm operating under that is different than this independent sponsor model? You mentioned a couple of those items earlier, like, hey, you have to fit a certain profile. I may have to sell the business before I want to, but just to outline it more clearly.

David: So, one, you have a life. I mean, this isn't your money to invest forever. And typically an institutional fund has a 10-year life. And the investor base, they're managing money on behalf of other people. So pension funds, endowments, universities, charities. When you deal with primary investor base who are families who have built their wealth through actually building a business, they understand that it takes more than three or four years to build a business. So they're more okay with the ride. The other thing Shiv about corporate finance is sometimes your capital has to come in in a different manner than what your fund documents say. So for example, sometimes it may make sense to initially invest the capital as a minority investor with a path to becoming a majority investor. Sometimes it may make sense to lend some money versus investing in the equity. And the funds, a lot of the funds out there on Wall Street have that constraint that they can't do that. I can come in literally any which way I want. I prefer to come in as a control investor because that's where my background, my experience is. But one of the portfolio companies that we had, we initially started off as a minority investment, which knocked out a lot of the competition for us. But during the process, the seller decided it was time to do a majority investment. I guess we really sold them in the future. We sold them on the growth plans. And I think he just saw a much, more, better opportunity. And nine years later, that family did extremely well and they're now partners with a much more larger private equity firm.

Shiv: Yeah, I think I think this point about about structure and just the constraints of the fund, you're like, you're on the hook to deliver the fun by a certain period of time. And so you can only write certain check sizes, you have to focus on certain markets, and you have to have a certain percentage or certain structure within those deals, that it really limits the types of companies you can you can go after and be less agile, in terms of what's happening in the market, like even what's happening here in the last, let's say six to 12 months, the market dynamics have changed so much. There's just fewer assets out there up for sale. So there's just so much dry powder sitting out there that investors don't have enough companies to put their money into, but they're maybe limited by the, by the, by the funds and the constraints that are put on them by those funds.

David: Agreed, agreed. Like I said, sometimes when you bring capital to a small company, you have to be very flexible on how that investment comes in. And the independent sponsor model has that advantage versus funded groups.

Shiv: How do you handle when you make an investment as an independent investor or with these independent sponsors, like how do you handle growing these companies inorganically versus organically? Organically, I understand you can buy and hold for longer and pull those different levers, but inorganically, I think it becomes almost like a different decision and you kind of have to get the sponsors on board again, I'm assuming to back that vision.

David: Yeah, so the investor base that I go to, they know that I may come back to them for additional capital. Okay. And so that's key. And I do my due diligence on investors as much as I do due diligence on our companies. And the investments you pursue, Shiv, the growth rate of path has to be both ways, two ways. One is organic, which is, you know, you hire people, you open up new offices, and then you try to offer new products and services. And then sometimes that calls for either building it from scratch or going out and finding a complimentary company that you can acquire, integrate, and then grow from that. And so it's important that investors who back in a Acharya Capital Partners deal, they have to be open to the fact that they may have to put additional capital in as we grow these companies. And the additional capital, at least historically in my career, I've always called an additional capital when we acquired other companies too, or we call add-ons in our business. And that's the investors understand that sometimes you can't necessarily fund the entire acquisition through debt and any kind of deferred purchase price. Sometimes you'll have to do an equity drawdown. We try to minimize that because that helps the returns. But if we need to, it's the right thing to do for the merger, for the acquisitions, the right thing to do for the capital structure.

Shiv: Yeah, I think that makes a ton of sense. And so how often are you layering on acquisitions in the investments that you're making?

David: We start thinking about it on day one. In fact, we start thinking about it before day one because one of the questions our investors are going to ask is, are there opportunities to grow through acquisitions? So we study the competitive landscape. We start targeting acquisition candidates. And the day we close, we start making those phone calls to bankers, to business brokers, and direct to companies. So that process starts as early as possible. Many, many times, my career started actually before the close. 

Our previous portfolio company, Impact XM, which started at another firm, and then I brought it over when we started my firm, we did eight acquisitions during the whole period. And there were good size acquisitions. And it also enabled us to get into certain markets we wanted to get into, certain customer industry verticals. And we picked up a lot of great people. But having said that, Shiv, we never buy, invest in a company that we cannot grow organically, as well as complimentary acquisitions. That is a key and a must for us.

Shiv: And so how do you vet for that, like on the organic side? I don't want to come back to M&A, but just how do you vet that they can grow organically? How are you figuring that out?

David: Well, we look at past history, okay? If we find that, okay, you know, they've only had, you know, four salespeople throughout, you know, the last five years, it seems like they're very hesitant in acquiring new people, in opening up new offices. So past history does take, does give us some good direction. But also it's the conversations with the leaders. Sometimes you're sitting down with the CEO who found their own business and he's like, David, I would love to hire somebody on the West Coast. But it's a big investment for us to make. You have to, between salary and opening up a new office and all the support services, that could be a $300,000-500,000 investment, which it's cash that they didn't have. Well, we're incentivized to do that and we will find the capital to do that. And sometimes it's, you know, making, you know, building it in the budget. And sometimes it is going out and looking for a company that has a presence in that area and acquiring them. So, you know, I always like to say, look at the past history with the management teams, but also have the conversations.

There are some founder-owned businesses that will say, you know what, David, we can handle the West Coast from our East Coast office. Well, maybe initially, but eventually you're going to need to have somebody on the ground there in order to help grow the business. And if they're really pushing back hard on that, maybe you have to spend some time trying to convince them that, hey, you know, we may have to, and I don't want to call it a leap of faith, but we have to make an investment in somebody out there to help grow the business in that part of the country. So I would say a conversation, it is your conversations with the management team, it is the past history, as well as my track record of opening up organic offices and having some success. So it's those things, Shiv, that helps you gain confidence in order to build a company organically.

Shiv: How often, as you find these companies that have good organic potential, how often are you layering on M&A with those investments?

David: With all of them. With all of them. Yeah, part of our strategy is buy and build. You need to get scale pretty quickly. And, you know, scale gives you a tremendous amount of benefits. And as much as, you know, you try to hire one or two people there in another particular part of country, sometimes it may make sense to buy, invest in a team and hopefully bring more than a handful of people with established relationships with an established reputation. And that can certainly help you get in scale a lot more quicker than hiring a single person here, a single person there, and waiting for something spectacular to happen.

Shiv: And given that you're kind of in this independent sponsor model, you know, integration with these companies is a difficult challenge, right? Because you often are layering on add-ons and bolt-ons, sometimes there's some overlap in the customer base or the product that you're selling. It's a complicated thing to figure out. And so how do you navigate that on your side as an investor when you're planning for these acquisitions and layering them on with the platforms that you're investing in?

David: So most, I would say for my entire career, every portfolio company I was involved in, I played a key or leading role in the M&A. And it's my responsibility and I have to share responsibility to my investors to make sure this goes okay, it goes all right. And so I have a lot of M&A experience as well as integration experience. Now, that doesn't say that the management team is wholly involved because they have to execute on it. So the first thing you have to do in any type of merger, what we call add-ons, you have to make sure the management team is on board. Sometimes you may see value that they don't see, and sometimes they see value that you don't necessarily see. So you have to make sure that management's on board because they do a lot of the day-to-day merger work, integration work. And as a board member and as somebody who's done this quite often, I typically provide strategic guidance and making sure that the KPIs are met as well as the fact that the milestones are met. So it's key that you get your management team up on board. And the way to do that is, one, when you do an acquisition, a number of things happen that they don't necessarily think about, particularly if they haven't done an acquisition. One, you expand your customer base very quickly. And the other thing is if they have a product or service that you don't necessarily offer, you have significant cross-selling opportunities. The best customers are new customers as well as existing customers that you can sell new products and services. And within these two, you enhance your market position. You get closer to being considered a leader or having an enhanced or niche market position. And then that drives a lot of innovation and development because now you have different perspectives. You have better representation of your company across the country. And you have, I would say, high levels of penetration with your customers as well as new customers. So all these are key. And this is the communication that you need to have with the management team before you pursue an acquisition.

Shiv: And I guess in that way, you're relying on the management team to really lead the integration process. Is that fair?

David: Yes, that's absolutely because they're there day to day. Their job is to run the company. And like I always like to tell every CEO, if I'm there every day, something went wrong. Okay. And that's the situation you're trying to avoid. And you obviously, you know, as an investor, you want to let the management team do what they do best, which is manage a company, which is run a company. And so they had the responsibility of executing on the integration plan. But I'm there from an experience standpoint, as well as making sure that the milestones on that, because if it goes wrong, the investments go sideways. And it changes your perspective on the investment very quickly. And you have to get what I call the train back on the train tracks quickly.

Shiv: And how do you prevent that from happening with these acquisitions? And is there a way you're vetting add-ons and bolt-ons? Like some investors like to buy overlapping companies and just kind of merge them together or sunset one product and move customers over. And in other cases, investors are trying to find cross-sell, up-sell opportunities or strategic opportunities between integrated platforms. So like, how do you see that? And you see one working out more successfully than the other so as to make integration more successful.

David: Yeah, so Shiv, that conversation starts way before, it starts at the first meeting, which is typically a management presentation. And you're sitting down with the management team and sometimes you'll see a founder, owner slash president who'll say, listen, David, we did a great job in building this business, but we see a lot of synergies on being part of a larger organization. One of the reasons why we like you your firm a lot is because that portfolio company has a service that our clients would love to have. And we just find it very hard to develop that service internally, we'll be part of a larger platform. We can actually grow the company by using that type of service. So it really starts when you meet the other side, so to speak, as early as possible. And then you can also spend a lot of time reading them. And sometimes you see during the diligence process, which happens pretty close, that, hey, you know what? We just like to run our business like the way we've done it before. And if it so happens that we can grow it, it's okay, but we like to grow it. It's like, okay, well, then why are you selling yourself to a larger company? And we can see very quickly that way that things will go sideways. And the last one of the acquisitions add-ons I did for a portfolio company in 2023, this is a founder-owned business. She did a terrific job in growing the business, but she felt that she needed to be part of a larger company to further expand her business. And we had the services that she need and she had the services that we need, and combined I was pleasantly surprised on how the revenue synergies occurred as a result of this acquisition. And sometimes you meet a company and they're like, well, David, we want to sell ourselves. We want to diversify our net worth. And we really want to be kept separate. Well, we're not the right investor for you.

Shiv: Right. It's almost like the people or the leaders that are involved in the transactions need to believe that vision for it to even be possible. Because if the leaders are kind of pushing the other way, it's counterproductive.

David: Yeah, that's absolutely, you know, key, Shiv. And I always like to say, I think a very successful private equity investor can read the room really well. I mean, we can all do analysis, we can all read legal docs. But if you can't read a management team really well, you can have a very difficult time in our industry.

Shiv: Right, right. Yeah, I think that's a really understated component is just the human element of transactions and the end of it all, like beyond spreadsheets, you're going to be working with individuals and leaders inside each company and you all need to be on the same page and operate as if you're one team to actually be successful.

David: That's a great point. And one thing I tell sellers, and I know sometimes I don't know whether it works for me or works against me, depends on the situation. But I always like to tell sellers, you need to do your due diligence on your future partners as much as we do due diligence on you. So I always ask for references, track record, do the Google searches, but also do a background check. Okay, you are gonna be partners with this person for the next five years or so. And, you know, I also emphasize, you know, the human component of our business because guess what? We're gonna be working together for the next five plus years. And if we can't work together, nothing good comes out of it. So that is key.

Shiv: Yeah, this reverse diligence is something that I think business owners and founders don't think of as much, but it is, it is, it actually came up on the last podcast too. So, it's funny to hear you say the same thing. 

In your experience, what are some deal killers? You mentioned just the attitude of the people in the room, but let's say you've made the deal and now you're trying to integrate these companies. Like where do you, where does failure usually happen or, or what are some of the major challenges that you have to overcome?

David: So we try to identify the deal killers before we close the deal so we can walk away from it. And I've been very fortunate in my career where I never said this was a mistake. Now, having said that, cultural integration is key. So for example, we make sure that when we acquire a business or an add-on, that senior leaders, of the portfolio company fly there to spend time with the team. Okay. And kind of, and not just say, hey, this is how we do things, but hey, how do you do things? Okay. Because I make it very clear that I want to make sure that we learn something from them. Because if that integration does not occur, Shiv, unfortunately the deal killer, things start circling the drain and you don't want that. So as soon as we close, there are a few things. First, everybody has the same email address. On day one, just as the press release goes out, all the new employees have updated email addresses. They're part of the same internal phone system. They're all on the same servers all their data all their programs have been brought on over their benefits package has already been upgraded or is in the process of being upgraded and we expect you know our management teams to spend time there Including you know, not just one-on-one meetings were group meetings, but also town halls. And once you get that message across, the integration process becomes a lot more easier.

Shiv: Right, right. Totally. I think this concept of just being one company, right? And perceived as one company is something that we hear a lot in integrations. And as the CEO, you're like the cultural leader to make that transformation happen. And it can be something as simple as the email, like you're saying, or it could be launching with a new brand that unifies everything together. It could be a new website that communicates these platforms coming together. All of those things kind of add up to building that feeling that this is now a different company than it was before the transaction.

David: Agreed, agreed. You know, we, one of my past portfolio companies, we acquired a company in Southern California. And on the day of close, the CEO sent me pictures where our logo was already on the building. Everybody had the same email address. Everybody was part of the same internal phone systems. Everybody had the same software packages, the servers, and the benefits programs were all integrated on day one. And then sometimes, you know, I like to read case studies of situations that don't work and you know, you find out, well, wait a minute, that add-on company did not get their updated email address until like six weeks later. That doesn't make sense. You know, the integration process starts once your comfort and confidence in the business starts growing. And that usually happens just around the LOI time.

Shiv: How extensive is your integration checklist when you're bringing these companies together?

David: Wow. It's pretty long and it covers everything from legal, financial, human, HR, taxes, it's a pretty broad list. And every area of expertise develops that list based on what they understand on the diligence. And then we combine it. I've never worked on an integration list that was less than five pages. And you're talking about a few hundred check marks. So, I've outlined some of them, email addresses and making sure everybody's on the same phone system, business cards and all that. But some of the difficult ones is what happens if there's overlap in covering certain customers? So you have to make sure you keep both salespeople happy. When the accounting team merges the books together. They have to make sure that the GLs all match together. And so when we do our analysis on it, we understand where the data is coming from and we're all looking at the data the right way. So that integration checklist, Shiv, is very, very customized. 

Shiv: Yeah, we've seen extensive ones as well. And I think the best investors have a playbook that they're running through during that integration process. And that checklist is such a critical component of it. I have one question just operationally, who's managing that? Because the CEO obviously doesn't have enough time. So is it you who's the project manager of that checklist or is it somebody else internally that you appoint as like the main lead on the integration process?

David: Yeah, so you know, Shiv, on this, while people think it makes sense by having me do it, the reality is I don't necessarily know all the employees and who does what. I know the company from a board level, from a strategy level, but you do definitely need somebody at the company and you need somebody who has the authority to make decisions. So it's typically somebody with a C in their title, and somebody who holds periodic meetings with the other side. And I'm part of those meetings. So I want to make sure that things are tracking appropriately. And sometimes even listening in, there's a perspective that you can bring in. So for example, you know, hey, we're having an issue with a particular supplier. Well, guess what? I know some competing suppliers that we can go to and hopefully squeeze out some operational savings as well as finding somebody who can deliver on the project.

Shiv: When run effectively, how long is that transformation period that you've seen? Because it's different when you're folding in one company versus multiple companies. But on a company-by-company basis, how long does that process take? Is it three months, five months? What is the regular expectation here?

David: Yeah, so my expectations has always been between three to six months. Sometimes it does take a long time, particularly when you're dealing with outside parties. For example, if you have to upgrade payment processing services with your clients, you have to make sure you get the right person at the client, they get the updated information, that gets integrated. Sometimes that takes some time. Ideally, if you are doing this right, I like to say, you know, by the end of six months, that acquisition should be a memory, you’re working on looking for the new one.

Shiv: I think that's a really good barometer or goal to set inside these acquisitions. So I think that's great. And also I think it's a good place to end the episode. But before we do that, if there are founders listening and they want to learn more about what you do and potentially partner with you, how can they get in touch?

David: Sure, so it's very simple. If you type in David Acharya at Google, it takes you straight to my website, but you can go to www acp-co dot com. You can reach out to me directly, D Acharya, D A C H A R Y A, at acp-co dot com or look me up on LinkedIn. Love to talk to owners of businesses with at least a minimum of $3 million of EBITDA and primarily in TMT business marketing services and light manufacturing. And if you are interested in dealing with a private equity firm to help you grow, I would definitely enjoy and welcome a conversation.

Shiv: Awesome. Well, that is a great way to sign off, David. So thank you. We'll include all of that in the show notes so folks can get in touch with you. And with that said, I appreciate you coming on and sharing all your insights and wisdom. I think it was a great piece of content and I think a lot of people will learn a ton from it. So thanks for doing this.

David: Well, thank you, Shiv. I really enjoyed the conversation and good luck and hope to see you in person.

Shiv: Yes, we'll meet up soon for sure.