Buyers and Builders
00:24:42 · Mikk
Now their take was that don't blame the bad investments, only look at at at themselves, look at yourself. Because after these failures, CDR realizes they had gone too far up the risk curve. And around this time, Jack Welch joined the firm after spending decades at GE. The idea was that they didn't bring Welch in to run individual portfolio companies. They wanted him to look across the entire portfolio and helping the firm think about strategy. And they then create two things, an operating review and then investment screening committee. The operating review is they put portfolio company management teams in a room with seven operating partners who had all previously been CEOs of a major international businesses. So if you really imagine a CEO and having seven former CEOs sitting across from you going through your business. And the second part is the screening committee, basically quality control before they do a deal. And I think the lesson for them is is pretty simple here. After making those huge mistakes with those investments, they applied the same philosophy to themselves that they applied to their portfolio companies. Joseph saying, in many respects, we as a firm did what we ask our companies to do, respond to changing circumstances decisively and effectively by making positive strategic changes. That's a good operating principle for any business. When when something stops working, don't just explain the failure, Change the system that allowed it to happen, and they did that in a big way. And here on the page 46, this page page is basically Joe Rice reducing decades of private equity experience down to down to five lessons. The first one is probably the most important. Labor hard at the front end of an investment. And in other words, do the hard work before you own the company. Understand the structure, understand the operations, not just the financials, and don't loan the business with so much debt that one bad year kills you. He specifically says to build the balance sheet with plenty of liquidity cushion for tough times. Then he... Another piece of advice or a lesson, go beyond the numbers. I think this connects to everything else in the chapters we covered before.
00:27:18 · Mikk
A spreadsheet can tell you what happened in the business, but it can't necessarily tell you whether the management team is good enough, what operational problems are hiding underneath or what opportunities haven't been exploited yet. Third lesson, be prepared to turn on a dime. Lexmark is his example. They had mature technologies producing cash, and instead of just harvesting that cash, they used it to fund the emerging laser printer business. The old business essentially financed the thing that eventually transformed the company. There's another one which I really like. Look in the mirror. Don't only demand change from your portfolio companies. Be willing to change your own firm. Change the people. Change the processes. Admit when something isn't working. That goes back to CDR's own failures earlier in the chapter where they didn't just blame the investments. They changed how they operated. And the last one is much more personal. It's be passionate about your vocation. And here, I want to read you the page 35 where what he learned earlier on his career, and I read it this to you. I learned years ago the importance of natural talent as prerequisite for success. After graduating from Williams College, I enlisted in the Marine Corps, then went to Harvard Law School and ended up practicing law at Sullivan & Cromwell. At this great law firm, I had the good fortune to work for a born lawyer, John Rabin. He had a very prospective legal mind. John could see all the issues, turn them on their side and view them in a way no one had thought of before. Clients respected him tremendously. He was a great lawyer and everyone knew it. I recognized that my chances for becoming a lawyer on a par with John fell somewhere between slim and none. That motivated me to look for a field in which I too would have that natural ability. One of Sullivan & Cromwell's clients was an institutional research firm called Laird and Company. Its corporate finance practice was the deal business, bootstrap deals, we called them. Laird would find companies they wanted to acquire, then go out and raise the financing necessary to do the deal, which is called bootstrapping and bootstrapping themselves into position to make the purchase. As I grew to understand that business, it appealed to me. When a position opened at Laird, I left the law practice and went to work doing deals.
00:30:05 · Mikk
And very quickly, I found I was a better deal guy than I was a lawyer. Over time, I learned the craft of deal making. I'm not a great financial analyst, but fortunately, we have plenty of partners who complement my weaknesses. So if you listen all this, it's it's very obvious. But he got this lesson where be passionate about your vocation. And Rice is saying great lawyers, managers, and dealmakers might actually be born rather than made. His point isn't that you don't need to work at your craft. It's that you should pay attention to what you're naturally good at. And he ends with follow your heart and your natural talent to achieve success. Do not remain in a profession that seems a poor fit. And I think that's a pretty good way to end this chapter. Do the work before the deal. Don't let the numbers become the whole story. Be willing to change quickly. Apply the same scrutiny to yourself that you apply to your investments, and then spend your career doing something that actually fits who you are. Now the next master of Private Equity, Warren Hellman, and he's the cofounder of Hellman Friedman. He founded the firm in 1984, which is forty two years ago with Friedman. And this book was written in 2007. So years in private equity, '25. And at that time, they had 25,000,000,000 in assets under management. And on March 2025, they had 107,000,000,000. And their headquarters is at the Salesforce Tower in in San Francisco. What makes him an super interesting individual was how hardcore he was with with... Obviously, his work, but things outside of his work as well. He was waking up every single morning, like, three forty five, ran, like, 16 miles. And I will I will get all all into this why he was doing this. And he was a massive fan of playing Pancho, and he created this festival. And the lesson and the quote shared on this book, all potential investments should be considered guilty until proven innocent. Warren Hellman came from one of California's great banking families. One of his most important investment lesson... Investing lessons came from a very simple conversation with his father. And in 1959, Hellman had just started his career at Lehman Brothers, and Wall Street was in the middle of an IPO boom. And the atmosphere was familiar. Markets were running. Optimism was everywhere. And it felt as though the old rules of investing were become obsolete.
00:32:54 · Mikk
And his father came to visit him in New York. As we discussed the economy, my father confessed to me how troubled he was by the French state of the markets. I feel as if I don't understand the markets anymore, said Marco Hellman. The things that I have always believed in most implicitly fundamental valuation metrics such as price earning ratios, price to book value, free cash flow, none of them mean anything anymore. And Warren said, you are absolutely right. You just don't understand at all what is going on. It's a whole new world out there. It wasn't long after his visit that the stock market crashed, and along with it, my proud portfolio of high technology IPOs. In a phone conversation soon afterwards, my father reminded me how much he had enjoyed our conversation in New York. Clearly, one of us didn't understand what was happening and it wasn't me, he said. Periodically, the markets go through a phase where the old economics seem completely outmoded. In the last decade alone, we have seen this happen twice. During the dot com boom, profits themselves seemed a quiet way to call value, rather true value was all about eyeballs and cost per click or so the thinking went. More recently, we experienced the leverage frenzy that came crashing down in mid two thousand and seven. These events led to the ultimately collapse of my own Wall Street Alma matter. In the end, there is a little new under the sun. Companies that have lasting franchises, which meet the need or provide a mission critical service that are run by high caliber managers whose interests are aligned with shareholders that produce strong free cash flow and don't require significant capital investment to grow, those are the ones that will always last. And my firm seeks to invest in companies that possess these traits. And this part actually, this this became the foundation of Hellman Friedman's investment philosophy. Look for lasting franchises, strong management teams, strong free cash flow, and businesses that don't require enormous amounts of capital to keep growing. They learned over time that they preferred businesses that, again, didn't need huge amounts of physical assets or constant capital investment to grow. He says, tough time and experience. We have focused on companies with fewer physical assets and lower capital costs. Hellman keeps coming back to people.
00:35:41 · Mikk
Even if every number looks right, somebody still has to run the company. I also believe it is impossible to overstate the people quadrant in the investment decision. And rather than buying companies and immediately replacing management, H and F preferred to back a management team they already believed in and then give those people meaningful ownership. We change management teams if we have to, but we prefer to invest behind and support an existing management team that we believe can execute the joint vision and will be motivated by their own significant equity stake in our deal. What I find interesting is that they didn't even need majority control. They were comfortable owning minority positions if they had the right business and the right people. And this leads to probably Hellman's most memorable investing rule. Every potential investment should be considered guilty until proven innocent. And what he means by this is don't start the assumption that you want to do the deal. Make the business prove that it deserves your money. Hellman had been an investment banker, so he knew firsthand how dangerous the opposite mindset could be. A smart financial person can find a way to construct an elaborate capital structure that will justify almost any investment. You can make the spreadsheet work, you can change the leverage, you can structure the security differently, but none of that turns a bad underlying business into a great one. And their discipline didn't end once they owned the company. Tully and Warren would periodically go back and re underwrite the investment from scratch, reassesses the original thesis, the expected performance, and whether they should continue holding it. They learned that lesson painfully with mobile media. And at one point, mobile media was worth roughly three times what H and F had originally invested. Then the paging industry came under severe pricing pressure. The company collapsed and eventually filed for bankruptcy before H and F could get out. An investment that had been three x on paper ultimately become a loss. Hellman says, we learned several key lessons from the mobile media experience. Among them were the vital experience of investing in high quality defensible businesses and being proactive in determining when to exit an investment.
00:38:23 · Mikk
He also said, the errors have hurt, but without them, we would not have learned the vitally important lessons by which we have built a track record of success. Same thing, I was listening to the podcast with Fred Wilson, the legendary venture capitalist and cofounder of Union Square Ventures, and arguably one of the the best VC investors we have ever seen. And what he said, super interesting. He said that one of the biggest risks is actually not investing. You can invest in company and lose your money, but in a business, missing one exceptional company can be far from costly. That's why Wilson believes investors need to play offense and accept that getting some investments wrong is simply part of the game. Why it's interesting and why I'm bringing this out is we can see two of the massive private equity firms today, Hellman Friedman and Clayton, Dubilier Rice. They both had deals which went to zero in in private equity, which is... This was surprising for me, and that's... That made this book so much better, I would say, because in in mobile media case, like, on one one moment, they had this three x on a paper, which again ultimately become a loss. So it seems the Fred Wilson advice and lesson from from his career is that sometimes it's the biggest mistake by not investing. Warren Hellman himself came from a family with a remarkable history in finance. His great grandfather, Isaias Hellman, founded Farmers and Merchant Bank in 1871 and later bought Wells Fargo in a distressed sale in nineteen o five, helping turn it into a major bank financing the growth of California and the West. The part I love a lot on what Warren says, he... What he inherited from him, the desire to own businesses outright rather than just work for them. And his great grandfather had an even simpler way to putting it. I don't run businesses. I own them. That mindset seemed to run through Warren's entire career. Think like an owner, not an employee. Hellman's time at Lehman became a lesson in what kind what kind of firm he didn't want to build. He and Pete Peterson, and Pete Peterson eventually became a cofounder of Blackstone together with Steve Schwarzman. Him and B. Peterson too controlled during a difficult period and worked relentlessly to turn it around, at one point cutting workforce from 1,300 people to five fifty people.