Transcription
You and what I asked you guys to questions, all of you, and just briefly on Monday's class, they showed in the search of unknown. I think you guys have seen the distribution of returns, and I mentioned earlier that that wasn't my experience as an investor.
If you just answered, go down the line and answer two questions: one, what percent of the search funds you invest in do you think get a deal? What percent of those deals do you do? And what percent of those deals work out?
I'll start with myself. My own experience is about three-quarters of the people who start a search fund to find a deal. It's been down a little bit the last two years. About three-quarters of those fields I do, and about 90 plus percent of them ever have a reasonable return of capital. So that was my own experience.
Bob, in terms of percentages, probably a half a dozen deals, searches over the last, she's 23 years or so, never concluded, never found a company. You know, I bet I've turned down at 25 percent, maybe more in terms of the deal. We've conclusively demonstrated that we know how to kill companies. Done that a couple different times. Jim and I did one together.
But most, yeah, I mean, in general, they all produce decent returns. I mean, I know there's a lot of focus on IRR. I just, you know, if I start out with this and I end up with this, and this one's bigger, I usually figure it's a good deal.
Most of them, seventy-five percent, 75 percent and 75 percent, I'd say we're probably 80%. We probably only invest in half the deals that are brought to us, and there are all sorts of reasons that we turn them down.
Then probably 80%, 80% of works out well. So that's a pretty different distribution than a search fund note, and you probably have 65% of the data points or 50% of the data points represented in this room. So there must be something that is pushing people to look to the left.
So, yeah, and which of the three deals did you guys support? I didn't support any of them. What I would have told the searcher is, I think these are three special, you know, true believer, especially consumer market deals. If they wanted to do the Green, was the fertilizer or toys, I could put them in touch with people who knew something about that because I don't know anything about consumer products per se.
I could be talked into the veterinary business, and I thought it had critical due diligence questions that you really could answer, and the other two businesses you couldn't. So I wouldn't have, I would have said shut it down. You know, you play the game well, but sorry.
I love the toy business. I just think this is a great company. It's not, it's really not toys; it's nostalgia products for parents and grandparents to buy, give it to the kid. The kid plays with it once or twice, and it's over by the Christmas tree, and they feel good about having bought it.
It's got a premium price. The manufacturing process can't be that complicated; you can outsource it. There's little or no IP content here. All you really have to, and the sales force is only paid in cash after they sell the product, probably after they collect the money.
So it's a legal classic pyramid structure like Amway or any other company you've heard about. He was an insurance sales, and I can just see. I mean, I don't think that Marks and Spencer, at Marks & Spencer, Marx and Turk should try to manage the sales force.
I think they should go conduct a methodical search with a paid headhunter and find somebody who's probably older and has done this and been very successful in some successful marketing structure similar to this. I think that you can, the IRR is, I think they're underestimating the potential of this business.
I just think that with a little help from somebody who, an investor perhaps, that sees this thing, there's a more attractive opportunity. They can get the IRR up into the range where investors will get excited. Very simple company to operate.
I would start with just thinking about the seller, and from my oral experience, the seller is absolutely critical. Less integral to the business, not involved or terribly much in the customer relationships, not involved in critical functions.
One of the big problems we saw with them, right, so at the toy business was she runs product development. Product development, you know, toy companies are all about product development. So if she goes AWOL on you, you're toast.
And that they may not be terribly in there; they're going to be involved with the people, but you don't want the people to be loyal to them. You want them to be loyal to the company.
Second, that the seller be available. Third, that the seller be willing to leave capital at risk. Fourth, that the seller have a really good reason for selling. Fifth, that they have reasonable expectations.
And it wasn't in 12 with the expectations of either of the first two companies, that fertilizer business or the toy joint company. They both seemed like they were starting out fairly high, and they were people.
I guess the last thing was they were a little more emotional than or creative than rational. I think having a seller, it is an incredibly complex process to buy a company, and you're going to have to talk through a lot of issues.
If you have people who have outsized expectations at the beginning, that's a reason, and may not reason things terribly clearly. That's a warning sign.
So at the end of the day, I came down on American veterinary, like industry growth, six to nine percent, relatively recession-proof, fragmented industry in terms of the company. Good reputation for service and low turnover in the personnel.
That's always a big issue. I suspect it's at a point of inflection in terms of the corporate staff. They have a big corporate team, and if you do succeed in driving revenues after that, you may find that the operating leverage is very high.
I like the seller situation; it was a guy in his 60s. It didn't sound like he was going to be leaving anywhere. We think someone who's going to disappear the day after the sale is fatal to us.
Seller, the relative growth avenues, adding services, I think JJU focused on that sort of expanding the service offering. Visit declines we were worried about, or I was worried about, but I concluded that if the industry is growing, you're probably, that's probably more an execution issue than it is an industry issue, and something that should be solvable.
Financial systems was a real concern, but it may also be an opportunity. You have to figure out, well, you can get them in place. Once you understand how the different 15 locations are doing, you may find that one's doing something really well that you can roll out to the other location.
So those are big red flags, but things that we could probably get through in diligence. I thought the problems I saw with the other businesses were much harder to address through due diligence.
These ones were things that you could ultimately understand through your diligence and figure out whether you could deal with the risks or nothing.
I think it's less important which companies the three of these investors wanted to back and more insight. Now, Jim had brought me the toy deal. By God, I will listen because that enthusiasm, that enthusiasm and passion and thoughtfulness about it really struck me.
I probably would have turned them down in the end, but it would definitely have gotten my attention because he thought it through onto something. And that's the side stuff, but it's obviously also hinted and fertilized potential liability exposure.
And if I'm running my search, I can't afford some Sacher. In terms of potential liability exposure, how, what I meant to ask you earlier, how to find a great lawyer? And also, how do you go about something that's so hard to quantify?
Well, the fertilizer business, I worried a little bit about the things you brought up. I felt like that on many dimensions, that's a very poor fit. The business of Barratt, very poor fit for an inexperienced search fund entrepreneur or entrepreneurial team.
You've got the, there is some legal risk when you hear that hunter. Well, hunter scares me when I hate when I hear that he doesn't like to see the bosses coming around his shop, his lab.
But more importantly, to scale this company, you've got to triple the infrastructure. You've got to go from two, three labs, from one, six plants, from two, six warehouses, from two. And you've got two years to do that, and it's a tall order for people who have never run a company before.
So I would, but really finding a lawyer, that's pretty easy to do. I mean, you through your network and so forth. But one of the issues here, this is really a startup company that's a few years old.
One of the big mysteries of startups, especially if you get early traction with revenue, you just can't tell if that's low-hanging fruit or if that's really indicative of the marketplace.
One of the things that struck me about this, I mean, you know, organic fertilizers have been around for years, and the people that buy them are willing to pay the price. The premium are really true believers.
It's hard to figure out yet if they're indicative of a big true believer market, and that was the thing that really turned me. Plus, you know, going back to what I said, you know, so if there's somebody in the company who you're critically dependent upon, this guy, the chemist or whatever he is, and he can't be managed, man, you're toast.
If you, I'll throw in my two cents, which is then a good lawyer is really hard to find. And I don't mean that in a pejorative sense. I think especially a great lawyer is very hard to find.
But within your investor group, that's just a perfect. In the second party question about product liability, I believe that there are certain risks, and that looks scary on the front end, but are insurable.
And I think that's, that feels to me like an insurable risk. And I just want to follow up on Jo's question earlier. They're really, really hard, and the time to do a rollup is when you're clearly at the point where you're running the company and it's not running you.
It takes you a couple of years to get to that point, and you've got a culture in a system and a methodology into which you're merging something so that the new companies that you're buying are not going to be changing the culture and the style of your company.
But even with that, there are so many things to consider in roll-ups that if I'm not real enthusiastic about going into a company where the roll-up strategy is cornered, this is sort of pivotal to its long-term success.
It's my own personal view. Yeah, I think, you know, in the American veterinary deal, you're going to be, you're going to have thirteen and a half million dollars tied up in a bunch of stores that don't have any organic sales growth.
So the investment thesis is to go out and buy more stores that don't have any organic sales growth. If you can't get these stores to grow that you got, I don't see how you're going to make a return on this investment by putting more money to work in non-growing stores.
I also think that you're going to pay more for the stores you buy than it would cost to open them by a huge margin. But you are getting some even top, but it's not growing.
I think I'd probably look at opening new stores and see if I could make some money. If you made me do that deal, I would look at opening my own new stores. They're real good.
That's a classic make-buy decision. If it's an industry that has been around a long time and it's still fresh, better know why.
The one other thing about roll-ups, and I spend a fair amount of time doing them with Brentwood Associates, and one of our most successful investments is a rollout. But one of the real issues, actually, golf courses, trade magazines, number of course.
Right now, we've got a company that's in methadone clinics, but one of the real issues is the management complexity. Because if you, and it's probably one of the bigger negatives to me about American vet, but I think it's overcoming it.
But you generally, you have 15 locations. They're probably the top-paid person, who's your P&L manager, is making $50,000. They don't have a lot of education, don't have real management experience. They've kind of grown up through the ranks, and that person is your front line, that's your front line P&L manager.
We had this problem in spades in the golf course business, and you can set up all sorts of fancy incentive structures that they don't. We gave them all equity; they didn't understand what equity meant until the day they cashed the check.
And it was, I mean, it worked out splendidly, but it was almost despite that issue, not because of it. It's tough. I can see a path, Miss Pina, 30 times dealing. You can see that how contracted that, but doesn't even ever consider, or I probably turn it down just because it's a specialty consumer deal.
I just don't know. I mean, every time I've done something like that, I've lost money, which tells you, that tells tilt would tell you and me that, you know, I don't know anything about it, and I can't bring anything to the table besides money.
I could probably introduce you to some people who could. So if you had a group of, as in the toy case, you know, if you had a group of investors who really understood that business and can figure out how to help you be successful, that's what you want.
But I just wouldn't be that person. We have a much shorter time with I grow her high, really high risk with high reward situations. We're not venture capitalists; we're buyout guys, and much more focused on, you know, get a good business that you think you have high confidence you're going to make some money on.
Then hopefully, the way you make a lot of money on it is by getting it into an adjacent industry that really, where you can get that growth but with relatively low risk.
Based on my experience, when you talk to someone or you know, you say, well, you shouldn't say, like most of them will say, you know, yeah, at the right price, you know, of course. But like, what's the strategy? Or in your experience, what's been the most successful strategy?
Like, like determining, you know, who actually is realistic? I'm like getting down to it because a lot of times it seems like, you know, they're willing to have a conversation. You can spin your wheels for a while.
In that case, what are the tactics that you have seen that have worked the best? Take a step. So, just to be clear, I don't make that many phone calls, and every one of them that I make gets answered about a person that I want to talk to.
That is my whole purpose in life when I'm searching because I've done it. I've knocked on doors, door to door selling life insurance, and I hated it. I've made a hundred calls a day, and I hated it.
So I've just, I want to have these warm introductions where they, hey, so you know Joe Schmoe, and we talk about their fishing trips and all that kind of stuff. So it's a much more pleasant search.
But there's a lot of time between those calls, so you got to do something. So you might as well look at opportunistic deal flow coming in and over the transom.
Qualifying sellers is not an art; it's not a science, and there are all kinds of things that you can look at. I don't have a laundry list of, you know, if you do these 10 things, you're home free.
I mean, first of all, if the seller's old, it's better than if they're young. If they got kids who want nothing to do with the business, it's better than if they have a son or a daughter who's already in the business.
If you can get the wife or the spouse to know how much money is involved, and they think about spending it, that's good. If the seller is willing to immediately introduce you to his employees as, you know, the potential new owner, that comes down longer.
If they're willing to let you talk to their customers, all of those things are kind of signs that they're serious. If the amount of money involved, if you know enough about their personal financial circumstances to suggest that the amount of money involved is something they really can live with.
You know, you're going to run across a lot of businesses. A ten million dollar business, the entrepreneur has taken a couple of million dollars out of here, and he's going to get eight million dollars in cash.
But that ain't going to work. No way you can invest eight million dollars after taxes and make two million dollars a year. I mean, so there's a whole bunch of things like that you sort of need to get your arms around when it comes to figuring out if the person who's going to sell is real.
Really critical because in a search fund, your biggest enemy is time that you have to do your search, and it is easy to burn nine months on a deal, which is a happy chunkier search fund.
I mean, in the end, the guy was never going to sell or was never going to sell under terms that were reasonable to you. And it's funny, you got a chuckle when he said get the people to spend their money.
But when I bought my first company, a guy that was an advisor to me, who was very, it was a very, very big deal savvy, and he ended up being our attorney. It wasn't an investor, and he said, the guy, the seller's name was George.
He said, get George and Karla, his wife, to start spending the money in their head. And I did, and I asked him, so what are you going to do afterwards? And they talked about buying this ranch and arrows in and what happiness is.
I could see that they had moved on, that he was actually in a different place, and he wanted to get to that place mentally. And that convinced me that, in fact, it was a seller.
Just exit one quick point, and that is, you know, it's been years since I've seen this survey, but typically when you ask somebody who are you, they answer by giving you their title and the company they work for, which is the wrong answer.
Most sellers are intimately identified with their company, and so you're trying to figure out just what David said, that they're willing to separate.
I've seen, I can think of three deals that busted at the very end because the seller just couldn't, in the end, imagine themselves not running that company. And that's what you got to figure out as quickly as you possibly can.
So, you know, we should have just ignored it because he might, but we should have really had plan B. If you don't leave that, I'd go see because I don't make many calls.
I can afford to go see everybody that I get in contact with. If I don't leave that first meeting with a pledge from him to send me his financials, and he or she haven't given me some broad range of what their EBIT is and the number of employees and that kind of stuff.
If not, hand me the financials on the way out the door, then I really don't take that much further because there's really not anything to discuss.
I know so many searchers that have spent nine months courting sellers who never get to first base with them. And how do you think about the perspective, the commitment you're making?
And I had that conversation with the searcher, waking the best of them initially because it's obviously very challenging for the searcher to have a company and have attempted syllables best years who, for whatever reason, decided not to participate.
The assessment surgery perspective and a seller's perspective, Brad, way around saying I have these people who will give me money in the future. What role we play in the selling in the acquisition process?
Actually, we have a couple of times been asked to go out. One time we were asked to go out and visit with a seller, a couple of number of times talked with a seller to give them comfort that we were serious.
We never say we're going to back the person in whatever the deal is; that would be nonsense. We don't know what the deal with the transaction, the company, etc.
What of the numbers? I think we turn down the most deals that are presented to us. It isn't that we just say no goodbye. We have usually along the way tried to say, you know, here are our issues.
If you can address these and deplore diligence and mitigate the risks, we're going to take a hard walk. But so we're trying to give the searcher a lot of questions, know what is it that would make it a good deal or a bad deal.
And Toria, so that they're not usually really is someone surprised by what our response. We've telegraphed it along the way by the questions, and if they can answer them, we're all ears.
If they can't, it's great. We've got to maintain a good relationship for their investors and keep them apprised all the way along. Don't surprise them at the end of the deal.
But in the real world today, you're going to have a gap in a, the banks aren't where they used to be. So, you know, you've got a problem there for all kinds of reasons.
I mean, 20 years ago, I could say with absolute confidence any deal I was involved in, you can get it done with the investors around the table. There was enough debt financing available; markets were a lot different.
Today, that's not true. So I think you just, it's a matter of making, having good communications with your investors. I talk to sellers on a regular basis on this issue to convince them that, you know, this particular option or has a very smart group of investors who know how to get these things done.
And if the due diligence proceeds properly, as you just mentioned, you know, that will be there. He hires required. Nobody just never thought this person was well.
If that hire is going to be made right away in the calculation of the EBIT multiple, I like to see that person's salary in the EBIT that calculates the multiple.
If it's a small company and that takes EBIT from a million down to seven hundred and fifty thousand dollars, and we're now paying fourteen times EBIT, I don't like that.
If it really, if it's, you know, two million dollars and it takes it down ten percent, then that looks different cosmetically and substantively.
Well, that might be so you okay if, on the other hand, this isn't one of about eight things that have to get done in order for this deal to work out, then I would be less likely to do it.
So I would just put it in the basket of operational risk that you're taking or executing. Look, and say the other thing is it just depends what the position is.
If you're trying to hire a CFO, that's going to, we would be a lot more sympathetic to that than if you're trying to hire someone to replace the product development person at the toy company.
That we would worry a lot about. It just depends how mission critical it is. We're smart either that or we do a great job of culling out the ones that are least likely to succeed and work out.
There are two different things that you really just never know what you've invested in is going to work out, which are going to be the winner.
So, but it's pretty easy to spot the dogs. Why don't we take these in two chunks? Let's talk first about the ability, if there is an ability to spot a successful searcher when they're raising their search.
And I'll begin with, I'm sort of in Jim's camp. I think it's literally hard anymore to identify after a meeting or two whether someone's going to be successful.
But there are a half a dozen questions that I asked, and I bet the panelists have their own half a dozen questions that allow me to weed out some obvious problems.
Bob, just on the issue of the search fund, yeah, it's one of the mysteries and thrills of doing this because, I mean, I'm not going to name names, but I can think of some people who are, you know, if I invest, I've concluded that this person is capable of doing this.
But, you know, the moon shots have been surprises. In fact, a very well-known professor in the business school, when I now, who used to give me some detailed evaluations of students, now would say to me when I call him and say, of course, you know, I no longer make predictions.
And it's just because it's really hard. And so you try and make the best judgments you can, Stanly, the data that's available, and then you put work in with the entrepreneur to help them be successful.
Search button, yeah, tip to me, the critical thing is, does a person, do I think this is someone who really wants to run a small business, actually get in and wrap their arms around that, and who's going to like managing people of all different backgrounds?
So for me, it's much more a screen. If I don't see that, or if I sense anything that tells me this guy would be much happier working for Goldman than running a business, that's a huge red flag, and we'll walk away.
Guys out of the military or girls out of the military are actually a pretty good sign for us, a good favorable sign because they have made decisions, they've led people, they've managed people, they've got people, blue collar, white collar, everything.
They deal with it, and that's a big plus to us. So, well, I know that the vast majority of companies in the 22 search funds that I've been in that bought companies and have exited, they had really good corporate governance.
They had one or two strong directors on their boards that took them to task at every meeting on the important issues and made sure that in the early years they focused on important things.
That's one common thread. There's luck plays a role; they ended up choosing good industries. So you're talking about of the ones that worked out that I invested in and worked out, yeah, so not the ones that I avoided because I called them out industries.
And you said, you said which of those industries just don't make sense, and you pulled them out. I think you would immediately to the right, absolutely.
I don't feel it. Most of that is explained by industry. The second piece, which is a cousin of that, is explained by opportunistic search versus an industry search.
And I think if you just change those two variables, you have a very different outcome. Research funds, I want to just have a couple of closing remarks.
And first of all, we've got great, we had a great opportunity here to have these three people. I don't always clap.
All right, in the middle of the rest of my life, I walk in a dark wood where the true way was wholly lost. From midway upon the journey of our life, I found myself within a dark wood.
The straightforward pathway on me, a hard thing it is to say, but with the sport savage rough concern, which in the very thought renews the peer.
So bitter it is, death is a little more, but of the good to treat, which I dare found speak. Will I of the other things I saw there, I cannot well repeat.
Ah, there I entered so full, I was a slumber at the moment in which I had abandoned in the true way. But after I had reached a mountain split at that point where the valley terminated, which had with consternation pierced my heart.
A word I looked, and I beheld his shoulders best and already with that planet's rays which leadeth others right by every road.
There is a temptation, I think, in human existence to base your life on contingency, to only take that first greatest step when all the conditions are perfect.
When your list of criteria have been fully met, and the same can be applied for your personal criteria. I'll step into the ring after my student once I have operational experience, when the market improves, after I get the down payment on my house, my kids get in school, after I graduate.
It says if we could completely control the climate of our existence, get the temperature just right, only when we have a full sense of freedom, then I'll take that courageous step.
But I don't think that complete control over your life and the variables in your life ever really exist in the real world.
So in the middle of the rest of my life, I walk in a dark wood where the true way was totally lost.