Private Equity Spotlight: From Assembly Line to Investment Line with John Stewart

[00:00:00] Sean Mooney: Welcome to the Karma School of Business, a podcast about the private equity industry, business best practices, and real time trends. I'm Sean Mooney, BluWave’s founder and CEO. In this episode, we have an amazing conversation with Jon Stewart, founder and managing partner with MiddleGround Capital. Enjoy.
I am extremely excited to be here with Jon Stewart. Jon, thank you so much for joining.

[00:00:41] John Stewart: Absolutely. It's a pleasure. Thank you for having me.

[00:00:44] Sean Mooney: We've had various interactions over time. I remember when we were starting up, in some ways, you were getting this vision of what private equity could be going at the same time.
I remember if we go to the kind of the not so way back machine, how marveled in terms of how I thought you saw the way that the private equity future would unfold and should unfold in getting ahead of that. And something even two years ago, we named your firm as part of the top private equity innovators.
Program that we do the private equity innovator of the year. I'm really excited about this in particular, just because of the way that you all do things in the future that you saw unfolding and getting ahead of it.

[00:01:24] John Stewart: No, we appreciate you noticing.

[00:01:25] Sean Mooney: Yeah, absolutely. And so to kick this off, I think history is not often a predictor of the future necessarily, but it's certainly an informer of it.
And so I'd love for you to share a little bit more. about your backstory, which is quite unique in a very, very good way in private equity and how you kind of evolved into this industry that you're now a leader in.

[00:01:49] John Stewart: My background is a little different and you don't find a lot of founders of private equity firms that dropped out of college and started their career working on the production line on the night shift for a company like Toyota.
It's a unique turn of events. It's just fascinating sometimes just to sit back and kind of reflect on. How all this got started, and you don't realize it while you're in the throes of going through everything. But when you do take an opportunity to step back and reflect on it, it's really interesting how this whole thing has unfolded.
I was in college, and some of my roommates in college were looking to join Toyota. Toyota had come to Kentucky, it was big news back in the day. We all went and applied and I was the only one that got hired and ended up joining the night shift. My parents were really upset because I was like a first generation child to go to college.
You know, I'd always done really well in school. And so they were really disappointed about it and then went to Toyota and kind of just used my work ethic from growing up in a farming community to really Absorb everything that the opportunity they're provided for me. And as I had an 18 year career with Toyota, I was progressively promoted, ended up becoming a general manager for the largest division in Europe that they had the vehicle assembly division and saw that some of our suppliers were being purchased by private equity.
And at the time I was considering moving out of Toyota. I'd been there for 18 years and taking a CEO job at like one of the suppliers, because I wanted to do something a little bit more entrepreneurial, and that was one of the things that attracts a lot of people to private equity, and most of the people in the industry, they're looking for that fast paced environment.
When you come out of a big company like Toyota, and I was running a division of the business, it's a massive company. And no matter how important I thought I was, and I thought I did a really good job while I was there and I had a good career, the day after I left, they still made cars and lots of them and really good ones.
And so your ability to make a difference in a company like that is really limited. And so moving into private equity, where you have that more entrepreneurial angle, and you can really differentiate the individual performance of the company. And you can see The impact that your efforts have on a faster pace, it can be real rewarding, but it also can be really scary at the same point in time.

[00:04:22] Sean Mooney: I really appreciate your background there. And it resonates with a lot of the ways that I grew up in different ways. So, so I grew up in a family that was in the chemical business and so not cars, but we made things and my dad grew up in Cleveland, started off working in steel mills and then getting into the chemical industry and he and his brother ended up being entrepreneurs in the space.
So most of their customers, when I was a kid, they're all from Japan. And so we always had Japanese business leaders coming through to visit us. And one of the ones that actually predated my, at least acknowledgement of the world was a gentleman named Dr. Edwards Deming. And so they would bring him in to really help them think through process and statistical quality control.
A lot of the things that maybe precursors to a lot of, you know, The innovation that Toyota drove through the manufacturing world, repurposing concepts that maybe started here, but ended up much more successfully earlier on.

[00:05:20] John Stewart: Yeah. A lot of people don't realize that Toyota came and studied Deming's processes and systems in the American supermarkets as they were developing the frameworks, which have become the Toyota production system and.
Then would become world famous with lots of companies contributing to the global effort around lean manufacturing.

[00:05:41] Sean Mooney: All of those concepts that really resonate. So my first stop as a kid, I was working in manufacturing plants, wearing steel toed boots and hard helmets, but eventually went to college. And then I got into private equity.
And the first really formative experience I did was investing in the auto industry. And this whole concept of lean Six Sigma was such a, like made this kind of wow moment to me in terms of like the beauty and the simplicity of it. And the elegance. That it brought to any process. And so we give six books out to every team member, two of which are about lean, including the goal that I think everyone should read if they haven't.
And so John's got it on his shelf there and it's no, I was looking for my book.

[00:06:20] John Stewart: Oh, what's the book. The Toyota Kaizen Continuum. It's written for like a shop floor leader on how to implement Kaizen and like their daily processes. It's actually written from when I was at my prior firm and when I went into private equity.
And so there's a lot of examples from the portfolio company, like optimizing the chocolate cake line. At the bakery, pretty interesting stuff. Yeah, I know I authored a book back in 2011, 2012, just, it was always on a bucket list of mine to kind of do that. And so, yeah, we give out a book to everybody when they join.
It's that one.

[00:06:52] Sean Mooney: I'd love to read that. There's just so much beauty to these processes and it sounds maybe odd to say that, but I think it's just the art of making things continuously better and more efficient and containing and narrowing the range of outcomes just kind of speaks to me in some very odd way, I guess.

[00:07:09] John Stewart: Yeah. And see, I was disadvantaged to some point because I just thought that's how you worked because I came up at Toyota in their system. And so that's just like how we did everything. And it wasn't until I got into management and realized that there's this whole industry around lean manufacturing and all of these identifying waste.
And for me, that's how I learned. It was the process that our company used. And so. I actually didn't got really into learning the history and understanding that there's a lot of companies that really contribute it. Toyota definitely has done a fantastic job at it, but Danaher is another really good business that has applied those same principles very successfully.
And there's many of them forward. And now almost every manufacturer uses some version of the lean manufacturing. System. It's as important as industry 4. 0 is today.

[00:08:02] Sean Mooney: I totally agree. And one of the things that I think is still even massively underutilized is these concepts within business services, companies and tech companies and data companies.
So if you think about even our business at our core, we're kind of a data analytics, And technology kind of business, but with a human on the front, but so much of what we try to do is embracing just basic concepts like visualization of performance across each step, value stream mapping, and single place flow.
You can do so much just on the basics there. And so next time you're in Nashville, you got to come by and. I'll get some free consulting from

[00:08:34] John Stewart: you. Yeah, we use all of the principles inside our firm ourselves. We have a five year strategic plan that we digest down into annual plan. And then we align the budgets of our portfolio companies and our internal management company, and we use all of those same principles and.
We just were having a meeting today about going through some of our key performance indicators, our KPIs for our internal business and for deal flow and specifically looking at some of those elements. It's been real advantageous and I always tell people if Toyota made a private equity firm, I would think it would probably look a lot like MiddleGround capital.

[00:09:12] Sean Mooney: I remember when we had that conversation when you were getting going and one of the things that I would always do and I was a partner at his P firm and I'd go. We need to run the business of private equity like a business and it would always Confound me and it's not like I was part of the solution either by the way So it's like at the end of the day you'd put our finger on our noses and go.
I'm not gonna do it and then When I became aware of what you were doing, I forget how we met. I think I reached out. It was like, you're doing what I would always just kind of like talk about on a whiteboard. And I just thought it was so impressive. So I don't mean to uncomfortably flatter you, but it was really something that I noticed immediately and thought was really great.

[00:09:53] John Stewart: No, I appreciate that. The relationship with you guys has been great. I am focused on all the problems that we have going on. That's the way it works when you're taught to. Look at things on a basis of what you're not achieving and celebrating what you do achieve. And got to constantly remind myself that we're just have our sixth anniversary here coming up in May and looking back in almost having 4 billion of assets under management in the six years never was on the radar for us.
So sometimes you got to stop and smell the roses along the way. Probably our worst critics are. The people here at MiddleGround,

[00:10:36] Sean Mooney: I think it's a common genetic maximum, if you will. And people who are drawn to this industry is this, you never cross the finish line. It's continuous improvement. You're always there.
And so I've tried to assign people even here as I bring that similar mindset to a company. Can you someone remind me that I need to like give proverbial hugs and like acknowledgements along the way because it's totally lost on me and I feel badly about that. But it's just that, like, take a look to the left and right and go, wow, kind of look what we've done.
I hear you on there. One of the things that I think our listeners know I'd love to ask this question, and it's kind of a little bit off the wall is. We'd know you better if we knew this about you. What would be one of these things that we'd know, John, better if we knew this about you?

[00:11:19] John Stewart: I just turned 55 this year, which like to some of your listeners, maybe is really old and some of them it's young.
I don't know the demographic, but a lot of people don't realize that I'm a proud father of four children. I have three sons and a daughter, and I also have four grandchildren and everybody, you Of course, tells me I look young for having grandchildren, or they just tell me that. I don't know which it is.
And I try to spend as much time with them as I can. I may be a little biased, but I think my grandkids are probably one day solve every problem on the planet. They're really smart for their ages and the kids now that are growing up with like technology and their ability to do things. I remember growing up and half the people that had.
VCRs didn't know how to change the flashing 12 o'clock, right? Now these kids can operate iPads from the time that they're a year old or two years old, they're growing up with technology and learning and they're handicapped in some ways because we're seeing a generation that's not really good at communicating, but I think they're geniuses.
Like these kids are always. Amazing me by the things that they come up with and the things that they ask about, and they're just really, really smart. And like every grandparent, uh, think that they're all going to end up doing something really great for society and humanity, but it's a lot of fun to have grandkids.
And I think a lot of people that have grandkids would say they wish they could have just had grandkids because you can kind of wind them up and play with them and do all that kind of stuff. And then you. Get tired and you just hand them off to somebody else and go home. Are they kind of in your drivable geographic area?
My oldest son, John, he works for me. He runs all of our marketing. So all the videos and stuff that you see, he does that with his team and his wife runs all of our offices worldwide. So I get to see them and their kids. And I remember when we first started the firm up, we had no investors. We had no portfolio companies and it was before John and his wife worked for me.
their son Elliot would come to work with me. He was always in the office. And if I was on calls, he would mimic me in the remote control and act like he was on a call. So they have grown up alongside of MiddleGround. And as we've gotten more mature, wouldn't be able to see them mature as well. But yeah, they're constantly around.
All of them live really close to me.

[00:13:50] Sean Mooney: That's great. And by the way, for those of you haven't seen MiddleGround's kind of engagement with the world through marketing and through content that they produce. It is really good and differential. So John, your son is doing a great job. It's something that I think is another one of those areas that the world of private equity is evolving to that you guys kind of jumped to naturally.

[00:14:10] John Stewart: He got his degree in film and media, never thought we would actually work together. And then I recognized early on that media is a really good tool for communication. And in this world now, we're People are getting their content in these 22nd TikTok and Instagram videos. I always knew my son was smart.
Didn't ever question that. But I remember the first time he did one of these, we do these kind of MiddleGround made video series. When we buy a company, they'll go in and film it and talk about what they do. And I was watching the first one and I'm like, John, did you get someone to write this? This script is like spot on.
You guys were there for a few hours and you were able to grasp everything that the company did. on a manufacturing basis and your timing's perfect. You're talking about a welding machine and you've got a welding in the video and all that kind of stuff. It's really good to be able to work with your children and to see them do what they love and be really good at it.
I'm just really proud of the work they do. And then my other children as well. My daughter owns a business with my ex wife and it's a dog boutique business. And then my other son is, uh, a school teacher and his wife is just graduating med school. And then I have a 23 year old that's just trying to figure life out.
I try to help him with it, but he's in for me. He's got to do it all by himself.

[00:15:28] Sean Mooney: Well, a job well done so far and as a father of a soon to be 17 year old and a soon to be 14 year old. Right now I'm still, I'm very much on the fringes of knowing anything. So,

[00:15:42] John Stewart: oh yeah, you don't know anything at that age.

[00:15:44] Sean Mooney: So I, but I hear there's hope.
So let's fingers crossed.

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[00:16:08] Sean Mooney: John, one of the things I love to get insights from on people like you, and one of the things I really like about the industry that you're in is there's this commonality of encountering challenges, taking them on, working through them and acknowledging that's the continuum of life that just happens. I'm curious maybe what is one of the things that has been a challenge That you've worked through.
And how did you think about overcoming the difficulties at that time?

[00:16:40] John Stewart: Whenever you start a business and you know, this as well, you take a lot of risk. I left a job where I was making seven figures and went from no income and money going in the bank to money coming out of the bank and writing checks on my personal bank account to get everything up and running and taking all the.
Risk of signing for all the leases and all of that stuff. And never really thought about it at the time. Just always assumed we were going to be successful, but looking back now, as I was preparing for some of these discussions was if you think about having to balance your personal life while trying to be an entrepreneur and build something.
Especially something in an industry like private equity. That's just, I tell everybody it's an industry of nose. We hear a lot of no, all the time. Like we look at a hundred deals for every one deal that we do. You get no is the answer a lot of times, but you're never focused on the nose because you're defined by the yeses.
You've defined by the deals that you do. Like the investors, they very hardly, rarely when they come in and are doing diligence, like, Hey, tell me the last 10 deals you passed on. They're not really interested in that. Examining Decisions that we've made and where we invest in capital. So everybody focuses more on the yeses and the positives.
And when people look at me today and say, Oh, well, you start as an hourly worker and making 10 an hour and now own a private equity firm has been successful and you seem to have like all this stuff going on and I think this is true for a lot of entrepreneurs, but people see the end result and say, Oh, you're successful, but the success.
That MiddleGround has was paid for with a lot of personal and professional failures. I was married for 33 years, and I never would say that MiddleGround caused my divorce, but it's hard not to process getting divorced as a failure, especially given my Christian background. But at the same time, I can't call spending 33 years with somebody that I cared about and loved deeply, and my children or my grandchildren call that a failure either.
Things happen in life and I never thought I'd be one of those people that was ended up divorced, but unfortunately that statistic is one that's really high and especially high for entrepreneurs because of the sacrifice that you have to make. The entrepreneurial journey has its rewards, but people don't see what it takes.
They don't see the difficult times. People look at Jeff Bezos today, but when he tried to sell books, getting started, lots of stories about people that wouldn't even give them the time of day. He doesn't have that problem today. And my dad always taught me that nothing worth having ever really comes easy.
You have to work for it. And people, again, they're focused on the success that we've had. And they're always, well, I don't understand how you've been so successful so fast. And I'm like, well, depends on how you want to like measure success. Yeah. There's a lot of measures where people would say we're successful.
Our funds have done well, our firm's grown. We're good assets under management. A lot of things to be thankful for. Yeah. But it's more like if you've ever had a hamster and you've seen them running on the little wheel inside the cage and you look at their head and the body, they're like stable and you think, Oh, well, he's not putting up a lot of effort, but then when you look at his feet and how fast the wheels turn and like he's moving, and so there's a lot of effort that it takes to be successful.
Of course, we try to show the appearance of, Hey, we got this all under control, but there's a lot of organized chaos. You overcome these situations just like anybody in life that faces any kind of challenge is just getting out of bed every day, even when it's hard to and just facing those challenges head on.
And this reminds me of a story. I think there's a movie being made about this. Back in 2009, there were some Tampa football players that were fishing. And one of them had bought a new boat and he wanted to take his friends out fishing. It was a center console. And like a lot of people, if you've ever been fishing in the ocean, and I know this, cause I'm a fisherman, MiddleGround capital, our logo is a grouper.
And the Florida MiddleGrounds is where we get our name. And I can't tell you how many anchors that I've gotten caught because like the good spots to fish are around the reefs and the artificial reefs and there's a lot of structure, but when you drop an anchor down 50 or 75 feet or even further, You want to get it snug so that your boat doesn't move around.
If you get it hung in the wrong space, you've got a thousand dollar anchor that's like stranded on the bottom. And these guys got their anchor hung up and the captain was inexperienced. Like it was his first boat. And so he thought. I can just pull it out. I got this nice big motor on the back of this thing.
I'll just jerk it out of the ground. And so the, he kind of got a run and start, went to jerk it. When he did the boat flipped over and capsized and they were thrown into the water, they all had life jackets on. It's warm. They're in Florida. They're athletes. So they're in really good physical and mental condition.
Mentally tough and physically tough to do what they do. And the seas were rough and just over a span of a few hours. Two of them actually took their life jackets off and just let themselves drown. Just a tragic, like, situation and they probably handled the situation better than most, but the point is, is that it's really hard to try when it seems like everything's going against you.
Everybody looks at MiddleGround as success and they think, oh man, everything goes right for John. Look at how the success that they're having. It's not always what it seems. When it's bad, like when there's bad days. It's hard to get up and be motivated and go to work, but you have to do it. There's nobody else is going to come do it when you're an entrepreneur.
And I tell people, especially students, I'm real involved with university of Kentucky, their finance program. And I tell the kids, I'm like, this is a tough industry. Like 2 percent of the kids out of college that want to get in private equity actually make it, that's not very different statistics than making it into the NFL.
And so when I went to raise my first fund, I had everybody tell me, John, your name is terrible. MiddleGround. Sounds like middle of the road. Like nobody's going to give me any money. The fish logo is terrible. You can't be located in Lexington, Kentucky, John. There's no private equity. You don't have a finance degree.
Nobody's going to give you money. And I could have listened to everybody and just said, okay, well, I'm not even going to try. But when I went and raised my first fund, I ended up with 22 investors in my fund. And everybody says, Oh, well, you were successful. It took 350 initial meetings to get 22 people to say yes.
So when you look at like these stories and my story's not unique, what kind of person am I? I'm the kind of person that. People told 328 times no, and I still got up and went in there to get the 22 people to say yes to raise my first fund. You just have to have that attitude that I'm not going to give up, I'm going to make this successful, and you got to have this insane level of focus.

[00:23:44] Sean Mooney: I really appreciate that perspective and it resonates on so many levels. And so for our listeners who haven't been inside the belly of the beast so much, I was talking with a friend of mine, who's a investment firm manager, and we were talking about what's the difference between doing a company in a private equity firm.
And I said, you know, when I was in private equity, it felt like I was just like in this constant middle, right, or burn, if you will, because the highs and the lows would across a portfolio offset themselves. And it was almost like noise canceling headphones where you're kind of like just in this middle because you get the high but it immediately something else in a portfolio would go wrong the other thing and you have to address that.
And so you're just in it. And that was, in some ways, you're just kind of used to it. Like if anyone's had like chronic pain, you're just used to it. You don't even realize it. And that's what I felt when I was in private equity. And then I go, but then when I went into starting a company, which was terrifying, it was the hardest thing probably I had done to date.
What was different about it was when you're at a single company, it's more like instead of noise canceling headphones, it's just like a song where the notes go up and down and you experience the high notes and the low notes sequentially. And so it's just a different experience, but you notice them and you feel them.
Whereas like when I was in your shoes, I just couldn't feel it because it was just, they cancel each other out. And maybe that's some of the reasons why I have a challenge of like, just noticing the two.

[00:25:10] John Stewart: Yeah. I have like the George Costanza rule. I don't know if you're a Seinfeld fan.

[00:25:15] Sean Mooney: I love Seinfeld.

[00:25:16] John Stewart: You remember when he was working and he came up with the idea that he had a good idea and he was just done, he was over.
So like. He was in the meeting, he came up with a good idea. Like, Oh, good idea, George. He goes, all right, I'm done, I'm out. He leaves the meeting. And so if there's like something really good that happens, sometimes you just got to say, you know what? I'm done for the day. I'm out. We got to go celebrate this and everything else must be on fire.
We're going to celebrate this one because if you don't stop, I mean, we've got 19 portfolio companies, 180 factories around the world. There's always a problem to me. I don't have any problem with problems or issues or CEOs resigning, major customers leaving, unprofitable months, cash flow issues, labor union disputes.
Things happen and you just have to work through them and they're not going to get any better by complaining about it. And I'm the kind of person that would rather just start doing the work and go through it and it's going to get done. Sometimes you just got to. Take your lumps along with it and go on.
But every once in a while, I'm like George Costanza, like something good happens, like we closed the fund and we get all the fund capital raised. Or when we closed the CV last year for the banner transaction. And I was like, all right, out, we're done. Let's go all going to go celebrate and have that George Costanza moment and just feel like geniuses for a moment.
And then come back to work next day and find out that the rest of the portfolio is on fire.

[00:26:44] Sean Mooney: I'd really like that approach. Cause I resonate with Costanza particularly since everyone accused me of having a Costanza wallet for so many years, but now I've moved to money clinics. My wife made me move cause I was starting to walk sideways.
But you know, it's that whole idea of like, I'll also appreciate that it's like, just continue taking a step forward and just in some ways just move and you can get through these things.

[00:27:07] John Stewart: It's that simple. You ask these people that do these impossible things, you seem like impossible I went on a health retreat and got on a kick and went on a health retreat a couple years ago in Switzerland and I got tricked into climbing a mountain.
They told me I was going on a nature hike. I just wore like regular tennis shoes, shorts, t shirt. I show up and the instructor is getting out of his car and he's got climbing poles and ropes and all this stuff and I'm like, where are you going? He said, oh, we're climbing this mountain over here. It was like 5, 500 feet, which it's pretty tall.
And. We start climbing this mountain and I'm the kind of person, like when I start something, I'm not stopping, I would have died with a heart attack on that mountain and they would like had to bury me on the mountain before I was going to stop. And plus my guide was like 70 years old and we're moving along at a good pace.
And. He's just taking, like, these short strides, these real measured steps, and I'm like, Come on, we gotta go, we gotta go, and he's like, Nope, there's no reward for getting up there the fastest. It's just about getting up there, and then when it starts to get really hard, and then I remember getting to this one point, it looked to me like, literally, it was like a sheer rock cliff, and I'm like, How in the world are we gonna walk up this cliff?
And he's like, One step at a time.

[00:28:28] Sean Mooney: There's the advice. There's so much wisdom to that.

[00:28:31] John Stewart: You don't focus on how you're going to climb up the sheer cliff. It's where are you going to put your foot? The next step.

[00:28:37] Sean Mooney: That's such a great takeaway. It's like when you go into these tough things, just one step at a time.
So John, one of the things I'd love to dig deeper on here is your firm's approach to value creation, which I think is pretty differential. So. Can you talk about how your firm approaches this concept of creating value in businesses and the resources that you bring to support your companies on that really kind of one step at a time journey that they're on?

[00:29:04] John Stewart: I mentioned earlier, my background, my partner, Scott as well, came from Toyota. He came up on the engineering side. I came up in the manufacturing side. We were together at Toyota for 12 years at the prior firm, nine years. And then here as well, I couldn't imagine a better person to have in your work career.
And so we've always worked really well together, but neither of us have a finance degree. He's an engineer. I ended up getting a business degree while I was working, but none of us have a finance degree. And then here we are co founders and managers of a very successful private equity firm. And one of the ways that we have been successful is because we're not buying like consumer product companies.
We're not buying services businesses. We're not buying high growth businesses. We're not doing venture capital. We're buying companies that we know how to manage. We're buying industrial B2B companies, specialty distribution companies, companies that. We have the skill set to be able to manage these businesses, know how to identify opportunities, create value in the companies beyond just like traditional financial levers of a typical LBO model.
And a lot of people just stay away from these type of assets, don't like them. When we're underwriting the deal, we're looking for the things that we can do based on 17 years of now working in private equity. And these middle market industrial companies that we can execute to drive value based on things that we know that we've done before.
Like for example, there's only like 30 people when you get down to the mill level that you can buy steel from worldwide. And when you're an insanely focused industrial guy, you know, all 30 of those people. And so when you go to a company and they have 200 million of steel buy, When you look at what terms they're getting from their vendors, how many vendors they have, the different grades of metal, what their pricing is, and you can compare that to buying two and a half or three billion dollars worth of steel in the rest of your portfolio.
It gives you a lot of insight and a lot of repetitions over 17 years of looking at these businesses. I mentioned we look at a hundred deals for every one that we do. And so we're able to see how all these companies are able to execute. And Using all of that data and information and our learnings of owning and operating these businesses, we're able to develop this plan.
And then our team construction is different because about 40 percent of our professional staff are people like myself, people that came out of factories, people that know how to execute at these companies. They're working alongside their traditional deal team roles from private equity. But the unique factor is they're a hundred percent responsible for the execution of the plan after we buy the company CEOs, we retained 65, 70 percent of the CEOs and CFOs when we buy a company.
So there's some turnover there, but our team is there no matter what. And so they've got to not only just underwrite these things, they've got to be able to execute these things. And so when we're underwriting using the typical model, we are also underwriting the value creation plan fully into our model and for us to make that final choice of whether it's a MiddleGround deal in the company that we want to own, it has to have the equity value creation of 25 percent or more.
From the value creation plan. So the things that we're going to do to influence the outcome of the company has to generate 25 percent or more of the return and the higher that percentage is, the more return that we're able to get from the things that we can do and for us that de risk the transaction, because these are things that we have a high degree of certainty that we've been doing for 17 years.
And so we know that we can execute them and having the resources to be able to do that. And we never really thought of it this way when we started the firm, but it's been real beneficial for us to have this model because when you're looking at the typical LBO model, like you generate equity value by.
Generating cash flow, paying down debt, growing the business, the top line, and EBITDA, and sometimes getting multiple expansion and different things in there. But we have this added benefit of being able to underwrite these things that we can do that we have a high degree of certainty around. And so, when you look at the typical model of how you're creating, Equity value, everybody uses leverage.
That's why it's called LBO. And so we use leverage to a less of an extent because we are relying so much on the things that we can generate from the BCP to create value. And so we're less reliant on debt. So over all of the transactions we've done, we've averaged over 50 percent equity in every deal that we've done.
We've done four transactions with a hundred percent equity still underwrite until a three X return over five years. And it's because of that differentiator of the value creation plan. And ultimately people might like us or everything, but it's that differentiation, that edge that I think really drives investors into investing with us.

[00:34:16] Sean Mooney: I think that's a great way to not only address the, where the market of private equity is today and where it's going, but also the competitive realities of the industry. And so for listeners who are less familiar with the inner workings of the industry today, good companies, you'll have. Large number of potential buyers that are vying for this business.
And it could be sometimes like 200 of these companies. And let's just say it's a 20 million company. And the management team says it's going to be 40 million. A lot of the P firms, they'll run their models. And the question is how low of a return do they want to take to win it? And what you're articulating is, well, we actually know everyone else thinks you can take it from 20 to 40.
We think we can take it from 20 to 55 because we can do all these things and where I know we can do it. And actually that 20. Very quickly, we can take that to 27. And so you're going to be able to kind of overcome the gravity of economics 101 in ways that others can't because you've built all this into the system.

[00:35:17] John Stewart: And the other thing it does, it gives us downside risk protection, right? Because the thing I tell every LP is probably not great for fundraising, but I tell them anyway is every model we make is wrong, like every one of them. There's not one deal. They all want to see the investment memo, and then they want to look at like, where did you create equity value?
And you know what? It lines up okay, but it's when you get into the details. We're never right. It never grows the way we thought it would. We're able to get exactly what we thought, but we're looking in bands, and we're really good at executing within those bands. And so, if the company doesn't perform the way it should, I mean, I'm 17 years of doing this.
I've never went into a management presentation that no matter what the historical performance was, the company wasn't growing at like a 15 percent Kager for the next five years. You know, that's not going to happen. And so yes, you might get comfortable, do your business diligence. You underwrite to four or five, 6%, sometimes good companies, eight, nine, 10 percent annual growth.
But you know, it's not going to be straight line. You know, it's not going to end up, you know, in private equity It just matters where you start and where you end everything in between really doesn't matter It's where you end and how you get there. We're never right. We're always wrong So we're 100 percent wrong if you look at it on an individual case basis but if you look at the percentage of right, we're probably 90 percent right, but we're never 100 percent and so You're always kind of looking at those margins and those situations.
And so being able to adapt, think on your feet and having these extra levers that we can pull gives us downside risk protection in the investment, because we're not just relying on growth and debt pay down to create equity value.

[00:37:00] Sean Mooney: And I love that. And that's another area, once again, that I resonate in nearly 20 years when I was in P.
E. I don't think I had a single model that was right. You know, we always kind of got there, but it was a series of left turns and right turns and breaks and hitting the gas and going back to your original parts of our conversation. It's kind of that tenacity and grit and kind of one step at a time that kind of gets you there.
And so one of the, maybe the next things I'd love to tap your brain on here, John, is Are there any kind of piece of advice that you and your colleagues are offering your portfolio companies today to manage through this kind of washing machine that we're in right now?

[00:37:39] John Stewart: Yeah, look, I mean, it's the old saying, cash is king.
It really is true. In 17 years, that's the one thing that I've always learned is that you need to focus on actual EBITDA and actual free cash flow and understand like what the company's done historically with pro forma adjusted EBITDA. Yeah. There's a whole industry around quality of earnings. You have to do a quality of earnings because the earnings aren't the earnings.
And, you know, look, you have to buy companies that way. That's what the market is. You have to recognize what that is. So I'm not saying that I'm against like pro forma adjusted numbers. That's the industry. That's how it looks at these things, but you can't pay down debt on pro forma adjusted numbers. You can't return capital to investors based on pro forma adjusted numbers.
So you have to know what actual is and what the actual free cash flow is. And you can't get fooled in these companies. I remember when I first started in this industry and I didn't know anything about LBO as it wasn't my background, we got these really smart young people and they're developing these models and they're really good in Microsoft Excel and putting all this stuff together and it all looks good on paper, but it never unfolds that way.
And. At the end of the day, when you're buying, especially these types of assets, you gotta be able to rely on something and that something is your ability to actually generate free cashflow. If you have pro forma adjusted EBITDA, but your actual EBITDA is. 50%. So there's 50 percent of the EBITDAs coming from adjustments.
And then you model in those pro forma adjusted numbers, and then you start factoring in growth rates and everything on those pro forma adjusted numbers. You're counting on 100 percent of those adjustments converting to real EBITDA and real cash flow in your model. And that never happens. I can tell you 100 percent that the pro forma adjustments never flow through at 100 cents on the dollar.
So You have to understand what your actual cashflow is. And so if you really want to understand your business, your numbers, you've got to look past those pro forma numbers that are used for acquisition. And when you own companies, actual cashflow is what matters and actual EBITDA. And so being laser focused on that and understanding what that looks like.
Those are the things that get me excited. I'll look at a company. We're looking at financials. Like I said, we have 19 different portfolio companies right now and everybody's like, well, how do you focus on all those? Well, it's because I got 16 of them that are Performing really well And I got three of them that at any given time are the ones that we're focused on and we have the metrics So that we're able to see it the pro forma numbers in those three probably look as good as the other 16 But when you got a company that tells you that they're generating positive EBITDA month over month, but their debt balance isn't reducing You There's a problem.
I forgot about their balance sheet. You got to look at that. And so it was a metric I've used for my whole career and something I developed when I was an operating partner. I look at revenue and EBITDA and I'm probably looking at that more on a quarterly basis and looking at how it is performing year over year.
That's probably more important to me on a month over month basis. I'm looking at how much debt is the company paying down

[00:41:04] Sean Mooney: the end of the day. It's so true. And I used to get this point back when we used to have economic cycles that would happen every 6 to 9 years versus this. 15 year mega cycle we went through I would call it EBITDAI, when you go to the top of the cycle and transition to the bottom of the economic cycle and EBITDAI was essentially Every investment banker book that would come in, it was essentially earnings before interest taxes, depreciation, amortization, and expenses.
Like every expense that they did, like they would just add back and you're like, well, everything's one time, but when you have

[00:41:35] John Stewart: 5 million of one time expenses every year,

[00:41:38] Sean Mooney: recurring, non

[00:41:38] John Stewart: recurring one time expenses.

[00:41:42] Sean Mooney: Yeah. And then so many people, and I think this is something that, you know, particularly like junior professionals coming up in the industry, take some time to learn is that, If it does not equal cashflow, if you're losing track of what capex is, particularly manufacturing companies in working capital, both advantageously and disadvantageously, you're missing a huge part of the equation.
And then what I did realize was as a young emerging VP is. If I wanted to get my model through, I could just tweak the last year of the model and start pulling in working capital. And then I could hit my IRR to get through investment committee. Don't do that. Don't do that. If you're a young associate to bring things full circle here, John, I'd love to start tapping just a little bit more of your wisdom and, uh, One of the things that we all know is that really successful business people are great consumers of other people's knowledge and often share books, trade books, read books.
Cause it's like, if you have to recreate that wheel every time, or at least if I had to, I'd be in a lot of trouble. And in your case, you actually took time to write it down too, which I hugely applaud. So we'll put the link to your book in the notes here for those who want to read it as well. I'd be curious in addition to the wisdoms that you put down in your book, maybe what's something else that you've been kind of.
reading and kind of takeaways and how do you kind of impact that into your life

[00:43:05] John Stewart: again, just trying to Adapt in an entrepreneurial environment. You're always looking for the extra minute, right? Yes, if I had more time to like do this or do that I could do this and you know I could grow my business like this if I had more time I could focus on this And I came across this really interesting book by tiago forte called building a second brain and I considered that I had a lot of like processes.
I have all my email, like automatically gets routed. It automatically is going and prioritizing in the different folders and all kinds of automations and stuff and like how I do things and I thought I'd done things really well. I still was this guy like to carry the notebook around with him and take notes.
And cause I just remember it better if I write it down and then being able to recall it. And then you got notebooks all over the place. Yeah. I made the transition into an iPad and found a couple of really good apps. One is Asana, which is a project management tool, and we use it to track everything, like decisions that we make, our investment process.
And then GoodNotes, if you're a Mac user, which I am, and use an iPad or an iPhone, the apps like Sync, and they're always continuously updated, and you can share these folders and files and documents with one another. But it's a, basically a note taking an organizational app. And this whole book is about how to use the technology and how to store it and store all of your information so that you can easily access it because you can have all of this data and information, but if you can't put your fingers on it quickly, it's just inefficient for you to be able to do that.
And so it kind of walks you through like this whole methodology. That he uses and it's almost like a reference book. I've read the book multiple times over the last three months. I usually read three to four different books a month, but I keep going back to this one as a reference and keep making some adaptations and changes.
And one of the things I like about the tools that I use in GoodNotes, it's really neat. You can actually search and it'll search your handwritten notes. So like when you search for a

[00:45:16] Sean Mooney: word, you must have good handwriting.

[00:45:19] John Stewart: Handwriting is terrible. Really? No, but the technology is really good. Of course it'll do like your handwritten text in the type text if you want to be organized, but.
What's really good is being able to have that search function. And when you go to search something, it's able to search your handwritten notes and like point you in the right direction. And so having all of that information at your fingertips and being able to use the tool to like capture information.
And so I'll go into a management presentation and I've got the SIM pulled up on one side of my iPad. I've got my good notes pulled up on the other. I'm like clipping images out of the SIM. It helps me with every aspect of everything that I do inside the firm. And then all of our meetings are like captured and a lot of people don't like to record like on zoom and those types of things.
And we do that. We record all the meetings that way. If somebody is not there, they can rewatch the meeting that way. If. We agreed on something and someone says, we didn't agree on something. We can go back and check the tape, the red flag moment.

[00:46:23] Sean Mooney: Oh, no, no, no. That's a good one. It's got a flag in their pocket and they get to throw

[00:46:26] John Stewart: it.
It's a great book. I highly recommend that because being more efficient and embracing technology, a lot of people, they have this really powerful piece of technology, their phone in their pocket, and they don't really utilize it as well as they could. Right. Even young people, I find that young people are very slow to adapt some of these like technologies that make their lives easier.
I grew up in the world of Franklin Covey. Yeah. Yeah. Of course, the little notebooks. Yeah. The little notebooks and all that. We kind of went through that organization phase. They have everything kind of already digitized. And being able to bring all of those both worlds together and being able to like really have the power of all of that information, all of those notes, everything, all in one place where you can search and index them.
And when you need to go to look for something, it helps you to do that. So it's a really good book and I recommend it to everybody.

[00:47:22] Sean Mooney: I love that idea in that book, and particularly from a personal perspective with each year. We're actually not that too far apart on age, and what I found is with every year, the leak at the bottom of my bucket, it seems to let more and more water go through it in terms of the flow of thoughts every day, so the leaky bucket is getting leakier, and I need something exactly like that.

[00:47:45] John Stewart: No, I can't tell you how many times I wake up from a really vivid dream because I keep my iPad right next to my bed, and I gotta. You get that information down when it hit me and wherever it hit me and being able to have that, that you can take across all your devices and have it synced and then also share it with other people.
It's really good tool, but

[00:48:05] Sean Mooney: I love it. So I'm going to one click that right after this thing from our good friend, Jeff Bezos at Amazon. All right, John. Well, this has been a tremendously insightful, but be very generous of you to spend time with us in our collective group here to share a lot of things that I think you're going to be really impactful for a lot of people.
So thank you. I've learned all sorts of things I wish I knew before. I think we're all a nice, certainly I'm better for it. So thanks so much.

[00:48:32] John Stewart: Yeah, no, I appreciate your guys interest. Thanks for all you guys do for the industry. We really appreciate the partnership that we have with you guys as well.

[00:48:39] Sean Mooney: Absolutely. 100%. Thanks, John. We'll talk to you soon.

[00:48:42] John Stewart: Thank you. Bye.

[00:48:52] Sean Mooney: That's all we have for today. Special thanks to John for joining. If you'd like to learn more about John Stewart and MiddleGround Capital, please see the episode notes for links. Please continue to look for the Karma School of Business anywhere you find your favorite podcasts. We truly appreciate your support.
If you like what you hear, please follow, rate, review, and share. It really helps us when you do this, so thank you in advance. In the meantime, if you want to be connected with the world's best in class, private equity grade, professional service providers, independent consultants, interim executives that are deployed by the best business builders in the world, give us a call BluWave.
net. That's B L U W A V E. And we'll support your success. Onward.

Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company.

BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.