Buyers and Builders
00:39:32 · James Andersen
[00:39:32] S1: I think one of things that happens in private equity a lot is there's a lot of really smart people in private equity, and it's amazing how often they have disdain for the founder of a business. Like, yeah, this guy doesn't know anything. We don't think like that. I mean, we need to be humble. I'm never going to know the business as well as the founder does. But I've seen a lot of business models, and we've seen things that are applicable from, take healthcare even into manufacturing. Sometimes that happens. So what we try to do is help the founder understand what his blind spots might be, and try to say, Look, the way we think about a business is, we're trying to help you do the things you need to do today, for what you want to be five years from now. Because what we found over and over again in founder led businesses is and again, this is very different than big market private equity we're not going in there to cut costs. We haven't done it once. We've done, what, 45 platforms? I can't think of a single time when we made any big part of our return by cutting costs. Because almost always, these companies have been underinvested in. They haven't spent the money they need for the systems and processes and people they need to be double and triple the size, which is why a lot of these founder led businesses stall. You know, if you think about founders, most of them, when they started, they didn't have any money, right? So they like we did, like we would do everything we could to save $10 on a plane ticket, because we had to. You know, when we went to buy that first company, Via, we found a $19 hotel room to stay in when we went to visit the company. Dollars 19! Because you know what? $29 was $10 more. Like, we didn't have it. But that's where most founders come from, so it's hard to change their mindset to, let's take a bunch of your cash flow and invest it in something that's not going to pay off right away. But that's our job. That's what we have to do, is to help these guys think about, here are some areas where we can help you. But we're not trying to sit next to you every day, and manage the day to day, which is why, I just wrote something about what I call to OP or not to OP. We've chosen not to use operating partners, because we don't want to micromanage the founder. We want the founder to do what they do really well, which is operate.
00:41:56 · James Andersen, Mikk
We want to help fill in the places where they don't have great experience. Our job is to build a relationship where they trust us enough to listen to us and to work with us. It's worked very well for us. [00:42:08] S0: Okay. Okay, let's move forward. I'm a bit harsh here, but the great private equity illusion. And you wrote an article, There will be blood. So again, you've seen a lot thirty years in this space. Interest rates has changed. It has become more competitive. So could you again elaborate your thoughts on what you've seen and where we are today and where we're heading to?
00:42:34 · James Andersen
[00:42:34] S1: Yeah, I think, you know, I have enough perspective, having done this for thirty years, like it's been, it was basically a forty year period from 1981 to about 2021, where, you know, it wasn't a perfect straight line, but the regression line fits pretty well, and it was falling interest rates for forty years, particularly low interest rates post 2009. And I don't think there are enough people who appreciate what that has meant for a private equity investor. So, if you invest at a time, and you buy a company, and five years later, rates are lower, that company should sell for a higher multiple. It just will, and that happened for forty years, and people were taking advantage of that. That was exacerbated by the fact that so much capital poured into the private markets over that period of time, with those low interest rates, that drove up multiples even more. So you could do almost nothing to a business and get multiple expansion of one or 2x over a five year period. Well, that makes a huge difference to returns. Absolutely enormous. But those days are over. Higher interest rates are here to stay. There's no way interest rates are going back to zero, one, 2% when the US government is gobbling up all the capital on the planet just to fund its own, you know, imbalanced budget. So I think what you're seeing now is a lot of companies, you know, they've talked about all these zombie companies. They're zombies because we, collectively as an industry, especially through eighteen, nineteen, twenty, twenty one, paid very high multiples for businesses, because money was cheap. Money was free, basically. Very, very inexpensive. But now, with higher interest rates, the companies that we bought at high multiples can't support those multiples anymore. So that multiple expansion that we all it was a wave everybody rode for years is over. It just is. And I think, if anything, it may now be the reverse. It could be a headwind. Now, look, there's still lots of money in the private markets, but one of the reasons zombie companies haven't been sold is because they get sold at lower multiples, which just crush returns.
00:44:49 · James Andersen, Mikk
So I think that's something that we need to understand, and there will be blood, because these companies are going to have to get sold, And there's not going to be a buyer at that level of multiples, and a lot of capital is going to get crushed because of that. I think that's just a fact. [00:45:07] S0: But if we take the lower middle market folks who start now or has recently done an acquisition, for example, maybe a year ago, maybe eighteen, twenty four months ago, and now going forward, what are your thoughts when it comes to generating alpha in these market conditions?
00:45:23 · James Andersen
[00:45:23] S1: Yeah, look, I think I still think the true lower middle market, I'm talking like 3, four, five, 6,000,000 EBITDA businesses, I think it's still possible to buy reasonably well. Now, you got to understand, too, one of the reasons you're buying well is because these businesses are riskier, Right? We just said they don't have the processes and systems and infrastructure that that less risky businesses have, but that's opportunity. Right? So I still think you could... You you can still do that, but you start getting around 10,000,000 EBITDA, and almost everything's an auction. And there's so much money out there that all it takes is that one person who needs to put money to work, or has just this huge degree of conviction over a single business to drive the multiple to a crazy place. But I think smaller businesses, still, you can find better value, you can buy at lower multiples, and you can still ride the way that's always been there, which is bigger companies tend to sell for higher multiples than smaller ones. I think you can still do that. I don't think it's as easy as when I started. The advantage we had was it was a relatively immature business when we started all the way back in whenever the hell it was a long time ago. You know, it's 1999. It's just a more mature industry, but there's still opportunities for smaller, in the lower end of the market for certain.
00:46:46 · Mikk, James Andersen
[00:46:46] S0: But on your own case, if you could see potential deals, what is your risk appetite when it comes to debt and equity ratio these days versus something you've done like deals you've done ten, fifteen years ago? [00:46:59] S1: Well, I mean, there's more capital for debt as well. Like, you know, we used to do deals at two times, two and a half times, maybe as much as three times. That would kind of like, oh yeah, that would make us uncomfortable. But now, like four times is kind of more normal, or even more. But I think that becomes less easy to do with higher interest rates. It was much easier to do in 2020, 2021, when interest rates were really low. [00:47:29] S0: Okay. And now the next phase for you. You're not so involved day to day anymore. Can you maybe elaborate a bit like your thought process? I'm sure it started many, many years ago, this idea of actually doing it soon. So maybe you can share more on how you thought, and how you made it happen.