00:19:15 · Brian Neider
[00:19:15] S0: I think that you really have to separate the two. And when you think through what makes for a good investment, that's sort of at the center. And on one side, you have the quality of the company, and on the other side, you have the quality of the valuation or the structure by which you're investing. And the nexus of those two things makes for a good investment. So each of those dynamics come into play. I'll give you like an analogy that'll probably dumb it down a little bit, but but bring it to life that I think anybody could really understand. Right? Which is, let's say that you're looking to buy a new house, and you're walking down the street, you're trying to identify which house you want to buy, and you know that that's a street that you want to be on. You sort of look around and you say, oh my gosh, look at this. I've got this house on the right. It is the most beautiful house I've ever seen. It's got exactly what I want. It meets all my criteria. It's got a white picket fence. It's on an acre. It's got a big flat yard. It's got a swimming pool. That would be the equivalent of like a great company. It's exactly what it is that you might be looking for. The problem is, let's say that on that block, all of the houses were, you know, roughly similar to that, not quite as good, but roughly similar. And in the last year, five of those houses on the block all sold for, I don't know, $1,000,000 each. So, okay. Fine. Well, what should this house that I'm looking at be worth? But let's say that that house was for sale for $10,000,000. Herein lies the issue. Right? The house should be attainable. It should be around the price that everything else sold for. It's probably worth a million, million and $0.5, but it's grossly overpriced. And so you have a situation where you have kind of like an a plus company with an F minus valuation, which makes for an investment that's probably not all that great. So for us at Lead Edge, what we end up doing is we try to pick where our quality bar is. For us, it's like kind of B plus or above type companies that meet a certain number of the metrics that we care about. And then based off of that, we're evaluating the potential valuation and structure that we could get into those investments at. And we want that to be kind of pretty solid too, such that if you combine the two, you're in a good place.
00:21:23 · Brian Neider, CJ Gustafson
It's not to say that every time you do that, it's gonna work, and it's not to say that there can't be outliers on either end. So you can have a situation where you have a company. It's the best company you've ever seen. The valuation feels insane and nuts, but it just works. It just keeps getting better. But on the whole, probably it'll be difficult. You know, you could have difficult situations, of junky companies that might be unbelievable investments. So you can have, like, an f minus company. Let's say an f minus house. You could have a house on that block that you love where it's totally dilapidated. Nobody's lived in the house for a really long time. It's just completely run down. But you're willing to do the work. You're willing to do the remodeling, and now all of sudden it could be pretty compelling. And so in that case, maybe I have sort of like an f minus asset, but you're getting in an a plus price and you're willing to sort of do that because that's the type of investment that you're looking for. And so really what it is is it's a framing of what is generally the quality bar that you wanna get over in terms of the quality of the company that you might be evaluating, and then where does that need to intersect from a value standpoint to get you excited? [00:22:33] S1: Which of those two offsetting scenarios where you may have really good on one side, really bad on the other? Are investors or even yourself more willing to get into bed with and take a chance on?
00:22:33 · CJ Gustafson, Brian Neider
[00:22:33] S1: Which of those two offsetting scenarios where you may have really good on one side, really bad on the other? Are investors or even yourself more willing to get into bed with and take a chance on? [00:22:46] S0: Completely depends upon the investment firm and their mandate. I would say more often than not in the growth equity ecosystem, you're gonna see funds that are willing to take on really high quality businesses and just pay up for them. I think that if you go into, like, the industrials ecosystem or, you know, you look at some of the buyouts that were done in, the nineteen eighties and, you know, businesses like that, you're gonna see a lot of interest in doing deals that are... There's a lot of hair on the asset. There's a lot of problems with it. But, man, there could be some excellent underlying value there. And then, you know, imagine you could throw some leverage on it. You could make some really, you know, exciting returns. [00:23:25] S1: How has your own definition of expensive changed over the last fifteen years?
00:23:25 · CJ Gustafson, Brian Neider
[00:23:25] S1: How has your own definition of expensive changed over the last fifteen years? [00:23:29] S0: It's hard. I think that we've maintained relative consistency, but it vacillates. Right? There's points in time, like, you look at how the market's traded, where, you know, the multiples were for SaaS companies in 2020 or 2021 relative to where they might be today. There are periods of time where things get really expensive all at one time and then get really cheap all at one time, and you have to have some opinion as to where you are on the continuum to be, you know, ultimately investing. But for us, I think we've been relatively consistent underwriting an investment opportunity. You could pay a lot higher price if you're gonna assume that on the back end five years from now when you're exiting the investment, you're gonna exit at 25 times revenues or something like that. If you keep it consistent and, you know, no matter what the market looks like, you're kind of underwriting to a six, seven times outcome because that's what it's always been. You feel comfortable that that's where it's gonna be in the future. I'm not making any proclamations in that regard, but if you felt that way, you might have a more consistent underwriting framework and a more consistent view on value.
00:24:32 · CJ Gustafson
[00:24:32] S1: Brian, we have this friend of the show. Their names are and they do some amazing stuff on the audit and consulting side, and they encourage me to ask better questions. So I'm gonna try to ask a better question here. This one, I don't know if this one will get by the auditor. So I actually consider myself somewhat of an EBITDA historian. Maybe you could even say an archaeologist. I run around the house wearing my Indiana Jones hat. You had written about this one company that was simultaneously a 58,000,000 cash EBITDA business, also a $38,000,000 EBITDA business, and arguably a 25,000,000 business after capitalized expenses. How should an investor decide what to take here and what's real?
00:25:15 · Brian Neider
[00:25:15] S0: That is a really good, and I've gotta tell you a very, very difficult question to answer. So I have my own beliefs, which is you sort of wanna look at the EBITDA minus any legitimate add backs to get to some type of adjustment, and then you want to subtract out some of the capitalized expenditure... You know, capital expenditures to the extent that you think it's warranted. I do think that a lot of investors want to suspend disbelief to some regard, and it allows them to kind of jam things through their investment committees. So it's funny, like I've I've talked to friends who, you know, very large firms in many cases, when they talk about these businesses, it's like you spend a bunch of time talking about the merits of the business, but you're not really getting into the weeds on it. And what you're doing is you're relying on evaluation relative to an EBITDA multiple, but the EBITDA like isn't real. It's just sort of a made up number. And I think a lot of times, especially at firms where younger investors are trying to push things through, I think that it's often easier for them to like use a bigger number and it just looks better, it looks cheaper, it looks more reasonable. But to me, part of this is like, you know, you have to be reasonable about it. You have to understand and pick through all of the adjustments. You have to understand really where the cash is actually going. And that's the funny thing. You know? I I can't tell you how many companies we look at that are not actually levered because, you know, once a company's levered, then you've got situations where you have significant interest expenses, and you gotta really understand what's going on there underneath the EBITDA line. But I see a lot of companies that are not levered, and they had significantly positive EBITDA metrics for, like, years, but they've never produced a dollar of cash. Like, you look at the balance and it like never grows, and they've never issued a dividend. And so there's some of that... It's sort of like tied up or eaten up in working capital or whatever it might be. Over some period of time, it just... It's like wonky accounting, And you've got to say to yourself, like, what is actually going on here? And those are the most frustrating ones to me.