Private Equity Playbook: Mastering Market Dynamics, Business Models, and Team

[00:00:00] Lloyd Metz: Get ready to peer behind the curtain of the private equity universe with each episode of Best But Never Final. Learn the inner workings of private equity and how top business builders shape, transform, and innovate companies to their peak potential. Hi, I'm Lloyd Metz, joined by Doug McCormick. And Sean Mooney together, we'll navigate the quarters of private equity, revealing the uncommon knowledge challenges, successes, and lessons that drive the world of private equity and business forward.

[00:00:37] Let's go.

[00:00:43] Sean Mooney: Welcome to the best, but never final podcast. We're very excited to unveil this new series where we're going to pull back the curtain and share private equity veterans perspectives on the business of private equity, how and why it works, the industry's mindset on continuous, never ending improvement. And then weave these actionable insights for our listeners in a way that they can use them to address top business challenges, opportunities, and trends over time.

[00:01:16] So I'm really excited to have two incredibly capable co hosts here, and then me, one of these two does not look like the other, and Doug McCormick and Lloyd Metz. So Doug and Lloyd. I'm excited to have us all together here.

[00:01:31] Doug McCormick: Me as well, Sean. Good to be here.

[00:01:33] Lloyd Metz: Thank you very much. Sean. Super excited. Still amazed that you thought to include me.

[00:01:39] Right. I figured being a client of BluWave was enough, but thanks.

[00:01:44] Sean Mooney: I've made a career both in private equity and out of private equity by working with people better than me. And so we're sticking with the formula. So maybe I'd love to, let's kick it off and we'll, get introductions.

[00:01:56] So our listeners get a better sense for each of us. So Doug, I love if you could start us off by giving us some of your background.

[00:02:02] Doug McCormick: Sure. Thanks, Sean. And for the record Lloyd and I know that when you say industry veteran, that's code for old, but here goes anyway. So I'm a co founder and managing partner of a lower middle market firm called HCI equity.

[00:02:14] We focus on founder owned businesses where we see transformational growth opportunities. And that's usually related to M and a strategy around consolidation, but also kind of scaling the business. Thanks. By way of background, I started at West Point United States Military Academy, did some active duty time, business school at Harvard, and have been in the finance, private equity world for kind of the last two decades plus on a personal basis, live in Northern Virginia, work in D.

[00:02:40] C. empty nester of two adult kids and active with three dogs and anything outdoors.

[00:02:48] Sean Mooney: That's perfect. And when I said veteran of private equity, I also meant you were a veteran. I stumbled right into that. So Lloyd would love to love to hear the same.

[00:03:00] Lloyd Metz: Thanks, Sean. Lloyd Metz. I'm a partner at ICV Partners, a lower middle market private equity firm.

[00:03:07] We are really keen to find interesting, growing family and founder led businesses, and we've been doing it for a couple of decades now. I've been in private equity, got in right before the internet bubble for those who remember that. So I've seen a few things. It's always been exciting to see what's around the corner in this business and really excited to talk with you and Doug about how we view the world.

[00:03:32] On a personal note, I live in Brooklyn, father of two daughters, got my undergraduate degree from Stanford MBA from Harvard. And I'm a proud Gen X er, I just don't know how to put it any other way and moved around a lot growing up, lived in Texas and Kentucky before my parents settled in the Westchester County, the suburbs north of New York City.

[00:03:53] So really excited to be here.

[00:03:55] Sean Mooney: I love it. And this is something that absolutely keeps me humble. So my role here is going to be the everyday person. And so as I think about your introductions, I remember this Sesame Street song that says, two of these things are not like the other. And so, I'll get into my background.

[00:04:12] So I'm the founder and CEO of BluWave. I'm a recovering private equity partner in, so I was 20 years in PE and then had an idea for a business to start my own company. And now I've jumped into a much bigger cauldron. Serving hundreds of private equity firms who are constantly telling us that their timing is yesterday and we have to be perfect and they'll never forget.

[00:04:33] So questionable life decisions, but so far, it's been great on a personal note. I attended Georgetown University. I went to Columbia business school. I grew up in Austin, Texas, and now I live in Nashville, Tennessee, and I have 2 kids great. A lovely wife who somehow agreed to this crazy entrepreneurial adventure.

[00:04:53] And 2 dogs and a cat and there's probably a partridge in a pear tree somewhere. So,

[00:04:57] Doug McCormick: So I got to just comment relatively bad judgment. I think the only customer set that's more demanding than the investor universe is the private equity universe. So, I think you kind of are going the wrong direction there.

[00:05:07] Sean Mooney: It was a highly questionable decision, but, we live and we learn and so

[00:05:14] Doug McCormick: Lloyd and I are both customers. And so that's why you have us on the podcast. Let's be clear. This is, you're being very nice

[00:05:21] Sean Mooney: once again. Surround myself like that.

[00:05:24] Lloyd Metz: Now, you do a pretty good job, Sean, you got the BluWave team.

[00:05:27] Sean Mooney: Oh, thank you. I appreciate it. And we're privileged to work with two of the best firms in the business as well. So. Now that we've gotten like patting ourselves on the backs beside us, let's jump on in and maybe just to set the stage for our listeners. Over the first few episodes, we're going to talk about some of the fundamentals of how top PE firms and the investment leaders there and really think about assessing opportunities before making an investment, including evaluating the key fundamentals, forming hypotheses, what the company is, and very importantly, what the company could or should be, how they believe they can create value.

[00:06:05] And then building confidence before they make an investment on not only all of that, but how there's going to be a successful exit. And so for this specific kickoff episode, we're really going to focus on the fundamentals of what makes a company quote unquote, good. And maybe just to frame our worldview for our listeners for this episode and episodes to come is there's a lot of different ways to assess companies and build companies and each of venture capital and public market investors and private equity investors.

[00:06:38] Tend to look at similar things, but often put different coefficients of importance in front of the various elements of value that they're looking at. And so what we're going to do is we're going to tackle this worldview from the perspective of private equity investors, which typically looks to establish companies that are, and have been cashflow positive and have the opportunity to go from good to great.

[00:07:03] So does that does that make sense? Doug? Let's do it. All right, let's kick it off. And so maybe to start at this foundational area that we talked about. I love it. Doug. If you can talk about some of the major categories that P firms look at when considering. Whether a company is good and if it can be great for an investment.

[00:07:24] Doug McCormick: Sure thing. And so let me acknowledge that. I think, an M and a process is very intensive. And so there's a lot of various different work streams. And so I think the best way to think about it is kind of go high level to major categories or buckets that the activity sets fit into. And 5 major categories.

[00:07:40] And the first is market that the business competes in. The second is the business model it employs to service its customers. The third is the team that's managing the business. And those are the three that we're really going to focus on today. I think that there are two others that kind of come into play that we'll, explore later in the podcast.

[00:07:58] 1 is what the firm intends to do with that business in terms of how it can change it, how it can grow, how it can, what's its angle to add value? And then the last is how to think about exit. Who are the buyers? What a reasonable valuation expectations. So, like I said, there's a lot to unpack there, so I think we're going to kind of just start with the basic 3.

[00:08:17] market, business model, and teams.

[00:08:21] Sean Mooney: Absolutely. And this is going to be a journey that I think we're going to dig into sequentially deeper and deeper for our listeners. And hopefully really kind of will add value for everyone in terms of not only how the PE industry thinks, but why they think that way and how that'll add value to not only investors, but also people who are building companies.

[00:08:38] And it's because it's a mindset that's been kind of chiseled out of a thousand mistakes. And Tens of thousands of hours and sacrifices that I never was going to look back and say, I wish I worked harder, but let's kick it off.

[00:08:50] And so maybe Lloyd as a way to get this started, one of the things we're talking about is digging into how and why the private equity industry kind of looks at this market idea. First, the areas in which a company competes and serves. And so like, why does market matter to private equity investors and really, what does this concept of market mean?

[00:09:13] Lloyd Metz: Yeah, it's the big driver. If you do the work of a lot of returns in private equity, a strong market carries all participants and drives a lot of the growth, right? think about it like swimming upstream or swimming downstream, right? You want businesses. That are participating in a market that has growth that has demand drivers that has really strong tailwinds, right?

[00:09:42] You want to be swimming downstream. It just helps carry your growth that much further. You start with that and from personal experience, having invested at times in businesses that are in markets where it's pretty stable, or there are a lot of currents and eddies swirling around and you get hit with headwinds and you're swimming upstream, that's a much tougher environment to operate in.

[00:10:08] So as private equity, you want to set yourself up for success and invest in markets where you have tailwinds. Now, the question is, what's a market, right? You can have international markets, national markets, regional markets, local markets. And you have to figure that out as well, up front, as best as you can, because it does affect your economics.

[00:10:31] Bigger isn't always better, bigger markets aren't always better. Looking at a market from a macro level, oftentimes you might miss some of the niche markets and pockets in a market that Are pretty rich and are worthy of mining and can generate pretty amazing returns if you get it right.

[00:10:52] Sean Mooney: maybe one thing I'd love to get your perspective, we're going to do a much deeper dive in future episodes on market. Cause we could spend hours on this. It seemed like every time I ever got a, what I think casually called a SIM or a confidential information memorandum from a banker, it was always a 20 billion market that was growing at 20%.

[00:11:12] And because they'd always make it really big as a P investor. What do you do when you see that in a SIM for a 20, 50 million revenue company?

[00:11:20] Lloyd Metz: So, as we're trying to get better at our firm about doing this, but understanding the market, the market structure, the landscape, the trends, the composition of that market, right?

[00:11:34] Is it a seamless national market or are there parts and pockets? Within the market, we're trying to get better at doing that work to figure that out before we see any marketing materials of a specific company. So once you get that figured out, can establish where you want to play. What does it mean to play in this pocket or this piece, or where is this trend of growth really happening?

[00:12:00] Right? Because a 20 percent growing market may not be uniformly growing across all participants. There could be some participants who are growing at 40 percent and the others declining, right? So you need to figure that out when you're doing your job right. You figure that out before you get any Sim.

[00:12:18] Doug McCormick: Yeah. I think I would just before we kind of go into some of the individual characteristics highlight. A couple points. The 1st is a lot of this assessment, whether it be the market or the business model, or the team is really in the context of the firm strategy.

[00:12:33] Right? So you could be a value investor. You could be a growth investor and market has different implications there and a lot of these attributes. They can be solved with price. So price is an important way to. Address for market deficiencies, et cetera. So that's point one. And then the second is, I do think private equity, because it's a long term asset class market is particularly important because the longer you hold an asset, the more returns are driven by growth as opposed to entry multiple or kind of one time things you can do to the margin profile that don't continue to compound.

[00:13:05] For us, as long term investors, we're really trying to drive multiple investing capital. I think this market dynamic is a super important one and I do think if you kind of peel the onion on what market is, I think there are a couple of interesting attributes that would be fun just to kind of bat around amongst us.

[00:13:22] So, the 1st is market size and Lloyd kind of talked about that, but. Just to paint two extremes at HCI, we're focused on consolidations. And so for us having a relatively big market where we think we can dramatically grow the business through M& A is an important part of our strategy. So it would be very difficult for us to buy a platform in a market that's a couple hundred million dollars, or even a billion dollars probably.

[00:13:49] Having said that, I think it's a very reasonable strategy for some to say, I like a small market with a very dominant player with significant barriers to entry because that's a different thesis, different drivers of value, probably equally effective for the right firm.

[00:14:06] Lloyd Metz: This episode is brought to you by HCI Equity Partners, a lower middle market private equity firm, focused on partnering with family and founder owned manufacturing service and distribution companies.

[00:14:20] ICV partners, an innovative private equity firm, supporting management teams of leading companies at the lower end of the middle market and BluWave, the business builders network, connecting the most proactive business builders in the world with the best of the best service providers for critical variable on point and on time due diligence and value creation needs now back to the episode.

[00:14:49] Sean Mooney: So I love both those. Perspectives here and it's kind of interesting in my prior life, I was in 2 different kinds of firms. 1 was a, what I would say was good enough to good firm where we were value investors and we could not only play with returns, but also structure.

[00:15:04] And then the next be firm that I was with was a great to greater P firm. Like, we're gonna start with a great business and make it even greater and 1 was like, we're going to buy low multiple and we're going to put structure and securities and we could kind of work our way into return and protect ourselves even against like an okay market, but the great to greater firm market had to be good.

[00:15:24] So I think both of your points are super spot on, but I always go back to, like, if you think about the differences between. Maybe P. E. and V. C. V. C. is always gotten that market part, right? Because they have to, if they get that wrong, it's a wipe out and this kind of market and recent thing. It's like, the market always wins and usually that's the case, right?

[00:15:44] A good market lists, the boats, a bad market, you have a great team. You're not even going to win. If you have an okay market, okay, team, you'll still do. Okay. But, Doug, to your point, like, you can still solve a lot of problems by price and structure. But, at the end of the day, if you get market, right, and you have a great team boy, does it make things a lot easier?

[00:16:02] Doug McCormick: Sure does. And the one thing I would say is, if you get market wrong in the private equity business, which implies you kind of got the business and you overpaid because you thought it was a great market and then it wasn't, like, financial implications can be challenging that way too.

[00:16:17] Sean Mooney: Absolutely. And Doug, on that end, do you have an example of where it kind of all went right? Where you got a great market, a great team, and then just kind of like magic happened.

[00:16:31] Doug McCormick: Well, so we just sold majority interest in one of our platforms. It's called Tech24. We're still in the business.

[00:16:37] And so we're still meaningful owners and excited about where we can take the business from here. But we got into that business right on the front end of the pandemic. Tech24 is a food service equipment repair business. So, think about a worse business to get into right in the beginning of a pandemic when all the restaurants are shutting down.

[00:16:54] But our view was that value proposition is durable. The demand profile in the long run is going to be fantastic. So we got in at a really interesting entry point very quickly put a team together because we had conviction. This was a big, big business because of the fragmentation and the opportunity to do serial lemonade.

[00:17:12] We ultimately did 16 acquisitions and really scale that business and, posted just a great return in terms of selling, a partial interest, but also continuing to ride the long run. And so I think that's a great example of really attractive market defined as stable and growing. Absent a pandemic, but also really attractive market from a ability to add value through M& A.

[00:17:36] And it's one that, can't at least not a rapid grower in normal environments, probably GDP plus a little bit, but tremendous growth opportunity to grow well beyond market rates, given the M& A opportunity.

[00:17:47] Sean Mooney: I think a perfect example. Lloyd, how about you? Do you have anything kind of similar in this idea where everything kind of serendipitously came together?

[00:17:55] Lloyd Metz: Yeah, I'm thinking of a couple of our portfolio companies right now where we were super intentional about. The market trends, both from the demand from customers and clients and from costs. And for a couple of these businesses, right. As I'm thinking about it within the first year to now we're going on a year and a half, they're up 50 percent revenues profits.

[00:18:25] And it's just not even looking like it's going to stop, The challenge is how do you build more capacity at these companies to handle The demand actually three of our companies I'm thinking about where we have come out of the gates pretty, pretty rapidly because we were intentional about harnessing those tailwinds.

[00:18:46] So I can talk in more detail later if you like, but. There are three current portfolio companies that are going through it right now.

[00:18:53] Sean Mooney: No, just makes everything easier. So I think about CEOs in these spaces, it's like, if you're not in a good market, try to find the adjacent channel.

[00:19:00] To the earlier anecdote about, going downstream, like go where the water's flowing. Don't try to fight it. since I'm no longer a P investor, I could admit that I've actually made bad decisions. And so will never ask you guys to talk about bad things because P investors have never had a bad investment.

[00:19:16] But for me, I could never.

[00:19:18] Lloyd Metz: That's a whole other episode. That's the, get on the therapist's couch and confession time. Right. But that's not today's episode, right? So

[00:19:27] Sean Mooney: I'm liberated now. So I'll talk about the bad stuff,

[00:19:32] Lloyd Metz: But to your point, Sean, even if you get the market, right, and you're swimming downstream, we're still competitive people.

[00:19:40] Most of those. Management partners that we invest behind are competitive people. So you still care about how well you're going to do, right? You want to PR every, chance you get.

[00:19:51] Doug McCormick: Just curious. It'd be a little bit controversial here for a second, but so we all agree, great market rapidly growing.

[00:19:57] That's super attractive, but in my mind, it's also ridiculously hard. Right. So if you said to me, how fast is the market or my company going to grow next quarter, next year, I go, okay, think I could do reasonably well in giving you a Kentucky windage on what that looks like, but if you said to me, what's it going to look like in five years and what's the forecast for the five after that, that the buyer of my business is going to look to, I think it's really, really hard and we take some comfort in trying to identify it.

[00:20:29] The contributors of growth. So, just to share with you from our perspective, betting on an underlying trend, that's pretty predictable. Let's say it's population growth. Let's say it's demographic growth. Let's say it's even outsourcing growth to me. Those I can get more conviction in than assuming the Internet's going to grow at.

[00:20:48] 30%, 20%, whatever. So that's just style for us internally, but we find this to be a really hard topic.

[00:20:55] Sean Mooney: Think it's a great point. And whether you're operating a business or investing in a business, we're all playing three dimensional chess and nothing happens in a vacuum.

[00:21:03] And just because a rising market that's really good, probably attracts a lot of competition and Mm-Hmm, . But I'll tell you like the example I have in my head is. On a shrinking market, we're at an investment in space and there was a change in the market. And no matter what we did, we just could not dig out in the tide just kept on going up further and further and further.

[00:21:25] And we figured out a way out of it, because we, it's like being caught in that rip tide, taking you out. We swam to the right against this, but I think it aged me like, supernaturally my hair's all gray now, but I mean, it's a great point. And in some ways, like, none of the stuff's going to be in a vacuum, and there's always going to be differences and.

[00:21:45] To both your points, I'd be curious, like, in some ways, the bigger sin that we would always look at for, for ourselves and our opportunities, like, how did we do against the full potential of that company versus what it did? And so I'd be curious on your perspectives there.

[00:21:59] Lloyd Metz: That's an interesting question. What could have been, or should have been, or might've been the full potential. I like that framing. I'm not sure I have a clear picture on how, you. Figure that out, right? Because you can ask yourself, was my initial view of what this business could have been or could be?

[00:22:20] Was it realistic? Right? So that's what we do. We compare your initial upside base case, whatever set of scenarios for your underwriting with what actually happened. So we actually document at the end of every investment, right? What went right? What went wrong? Compare the numbers compare some things so that we can have a review and a conversation about it.

[00:22:47] Doug McCormick: Yeah. So 2 observations and this is probably an indictment on my personality, but I have never had a business where I thought we got 100 percent of what the opportunity was. And, my personal is a little bit like, congratulations. You just broke the record for the 1 mile and I go, well, can you take another 2nd off?

[00:23:02] Right? So, I think there's always this dynamic of pushing ourselves to do better. and I think try to be more focused on did we do the things that we could control as opposed to what we got lucky because I want to get lucky and you got to stand in the field and get hit by lightning to get lucky, but that's not a strategy. And so we try to think about it in the context of if we had a value creation playbook that we executed, if we were building a team, did we build an effective team and then the market and the capital markets are often kind of going to do what they're going to do.

[00:23:35] Sean Mooney: Yeah. Think both of your points there really kind of illustrate why we've called this podcast best, but never final, right? It's this idea that you're kind of never a finished product in the PE world. And in some ways, at least, as I think about myself, it's almost a sickness. I can't be content.

[00:23:50] It's a journey, not a destination in life for me. Yeah, I think that's right.

[00:23:55] Doug McCormick: And honestly, I don't know that it would be as rewarding if it wasn't as hard, right? Every business we've been involved with, it has its hiccups and it's ugly teenager years. And that's just kind of part of the journey.

[00:24:06] Sean Mooney: And as I look at it, I love that you all do this retrospective because. Yeah. It was always very scary for me to look back at investments because I don't think a single investment I made over 20 years, did we get to the finish line for the reasons I thought we would, but we would always get there, but it was just like tenacity and grit and left turns and right turns and left turns.

[00:24:26] And so I'd be curious, if that's kind of a similar experience.

[00:24:30] Lloyd Metz: No, absolutely. can't think of situation where it worked out as we scripted a hundred percent or even 80%. But this is, the subject of a future episode, I feel right. Because to your point, uh, getting lucky does play a role, but you can take steps in your control to increase the likelihood of getting lucky.

[00:24:53] Right. So like you said, standing in the open field right before the storm, or, there's some bloggers out there who are talking about, increasing the surface area for luck. Right. But. The different things you can do to increase the likelihood that good things happen to you.

[00:25:08] Sean Mooney: Absolutely.

[00:25:09] So let's, maybe turn page to the next one where, you've got a market that you understand you have confidence that it's a river that you can swim in to stick with our analogy, or at least, you know, what you're getting into.

[00:25:22] And so. Now you're trying to say, do you have a business model that can be successful? So, Doug, how do you think about the business model? What does that mean? Why does it matter now that you're kind of comfortable with the market?

[00:25:37] Doug McCormick: To me, a business model means. How does the company deploy its resources to service customers?

[00:25:43] How does it offer a sustainable value proposition and compete in the marketplace? And just to share with you a little bit of like my personal underwriting style, I have more conviction in being able to underwrite the durability of a business model candidly than I do the market growth that we just talked about.

[00:25:59] So this is particularly important for a couple of reasons in my mind. The first is business models have financial profiles that can vary wildly. So you know, a software business, 50 percent profit margins versus a distribution business at five. I think the other thing is it has very different competencies.

[00:26:18] So if you're underwriting a distribution business and trying to grow that, it's a very different skill set than, kind of the software business. And so just again, making sure that the organizational capabilities of the private equity firm are well aligned with that business model. I think a key trend that's evolved over the last decade or so.

[00:26:37] Lloyd Metz: So for us business model, I agree with Doug a hundred percent. And again, just a little framing, right? We're looking at companies that are very profitable. So margins, EBITDA margins, well in excess of 10%. Some of them well in excess of 20%.

[00:26:54] Companies though are fairly small, 50 ish million of revenue to maybe 200, 250 million of revenue. So they tend to be playing in niche markets. If their founder and family led and built, There are elements of the business model where some elements are stronger, other elements are weaker, and that's okay.

[00:27:19] We look for that because that's where some of the opportunity lies, and we'll get to that in another episode. But fundamentally, what we try to figure out is, if you're generating these high margins, What is it about your business model that allows you to generate that? And once you figure that out, the other pieces, does the leadership team, does the management team understand how they're generating those margins?

[00:27:48] Do they get the value proposition? Or is there something special about their go to market strategy or special about their product design or what have you, we try to spend as much time as we can, figuring that out because that's where a lot of magic can happen. Like right now, I personally am really keen to invest in businesses where the client is buying judgment.

[00:28:15] From the company, right? When you cut through it all, they're looking for judgment. And so that's a hard service line or product line to really squeeze on price.

[00:28:29] Sean Mooney: That's the ultimate ROI business, right? Right. Decision maximization tools. Right. it's like infinite money.

[00:28:37] Lloyd Metz: So you may be buying a service, you may be buying a widget, but if part of what is being bought along with that is the judgment of the designer, the engineer, the consultant, the advisor, what have you, and that is valuable to the customer or the client.

[00:28:54] I like that business model a lot, really neat. Things can happen when you, when you find those.

[00:29:00] Sean Mooney: It's really interesting. That's the hardest thing to kind of discern. So when I was in PE, you'd get, hundreds of these Sims or confidential information memorandums that would come in and they're all passing the weight test.

[00:29:12] They all have to be really heavy and have a hundred pages. And, it's Sunday at noon. I just kind of plug myself into my office and just start reading. And I developed, some kind of like yardsticks. How do you know, like measures that say this thing's probably got something to it.

[00:29:27] I'd be curious for either of you. Do you have any kind of like financial or numeric measures that you would look when you, this SIM comes in, that you look and say, is this company's business model doing something interesting or could it, or should , are there anything that you look at in there when you're flipping through the exact sum and the financials and say, oh, there's something here.

[00:29:46] Lloyd Metz: So like I said, we like high margin businesses. So on first past. what is your gross margin looking like, and what's the trend been there? What's your EBITDA margin looking like? What's the trend there? And again, you keep talking about sims, Sean. So the adjustments, I ignore those. I look through those.

[00:30:06] To a large extent on the first pass. I also look for customer concentration because the presence of one or two or three very large customers could skew the economics, right? So when you think about the growth away from those large. Customers, you're trying to figure out, okay, will my economics improve or worsen as I move away from them?

[00:30:31] You look at CapEx, right? A lot of people are fixated on the income statement. CapEx and working capital also matter a lot, right? Since you talked about it, the lead of the episode cashflow, right? So CapEx matters. And working capital matters, working capital intensity. So we look at the trends in the working capital intensity.

[00:30:53] And then you think about as we grow, if the composition of your customers or clients changes, how will that affect your working capital, right? So if I'm going to be growing with larger customers that have more power than we do, well, then they can stretch your receivables. Or are you growing with government agencies that pay their bills on time, right?

[00:31:20] Versus large corporations that pay in 120 days, no matter what your billing practices or contracts say, right? So you start to try to imagine what that future growth might look like. And will there be a material change and shift in the client base? So those are the things I look for. And then lastly, and sims are notoriously bad generally in this.

[00:31:43] Is understanding the value proposition. There's so much jargon and investment banker obfuscation. It drives me nuts, right? Like, what does this company do for its clients and customers? Can we just spell that out, please?

[00:32:00] Sean Mooney: Marketing gobbling.

[00:32:02] Lloyd Metz: Like talk to me, like I'm a sixth grader, right? Like. How hard is that?

[00:32:05] Doug McCormick: So, Lloyd, you nailed it. I'm so glad that you took that answer versus me. I think I would add this whole concept of customer retention. do I have to go win my customers every year? Or can I build off a base? And I really like the way talked about not only margin, but capital intensity.

[00:32:25] We look at return on tangible capital is like, 1 of the absolute kind of best ways to think about comparing really different business models because it kind of takes into account both margin and kind of capital intensity. And I'm struck by just, I think about the application of the metrics you just talked about in today's environment.

[00:32:43] It's so interesting to me because, like. That used to be the big question was, what's the multiple people are paying? I think in today's environment, the question is what's right? Because of the pandemic, because of inflation, because of supply chain disruption, it's so hard to really get conviction around sustainable margin profile today.

[00:33:02] So, just interesting to think about evaluating the business model in today's world.

[00:33:08] Sean Mooney: All of this has been incredibly, I think, spot on in a couple of things that I take from this one for our investment Baker listeners who are doing EBITDA before expenses. They're not falling for it.

[00:33:22] Don't throw everything into there. Like, everyone's doing right now to I love that. Both of you reflected on this concept called cash flow. Suddenly it's become in vogue again, this idea that you got to eventually have to make money.

[00:33:35] Lloyd Metz: To this point, and again, maybe this is part of the benefit for being a Gen X, or I was just having this conversation with the a junior colleague this morning explaining that EBITDA came about because it was supposed to be a proxy for cashflow.

[00:33:50] Now we find ourselves today where it's become a poorer proxy for cashflow. And you just got to remember, it's supposed to be about the cash flow. Don't get fixated overly so on EBITDA and all the adjustments. But whatever that is, how well does it reflect the cash flow generated by the business?

[00:34:11] Literally had this conversation earlier this morning.

[00:34:14] Doug McCormick: You're such a curmudgeon. Dare to be great . Dare to be Great. Come on. Who need, who needs cap? Are you sorry?

[00:34:20] Sean Mooney: Are you making 'em subtract CapEx from your ebitda? That's Well, sometimes, yeah. You wanna cut the enterprise value in half. Just, just maintenance

[00:34:28] Doug McCormick: CapEx.

[00:34:28] Just maintenance

[00:34:29] Sean Mooney: CapEx. Yeah. Yeah, exactly. That's, that's how you get past this. Just, you know. No, I'm with you. That makes sense. When I sell BluWave, there's no CapEx on this thing by way, , and there'll be lots of add-backs. So don't hold that against me. A couple other reflections that I got from this kind of master class that you guys just summarized is the marketing gobbledygook point that you guys said in the Sims and the life hack I learned a long time ago that I think everyone does, but read the sim and then read their website and see how closely they're aligned.

[00:34:58] Like very often you find the truth on the website. Great advice, good advice. So I think we've covered and once again, these are all topics we can delve and will delve much deeper into. But this goes to, I think we're finishing with the big one. this whole idea that, people matter, surprise, surprise.

[00:35:17] And so one of the things that we talked about in this framework is looking at the team. And so maybe to kick this off, Lloyd, how do you think about looking at the team and a company? Why does it matter? Because I think chat GPT is just gonna do everything now, right?

[00:35:33] Lloyd Metz: That's definitely way over my pay grade To comment on chat GPT right now.

[00:35:39] I gotta tell you getting the MBA was great super useful It's been super helpful But sometimes wish I had like a PhD in psychology Because we spend a lot of time trying to figure out what's going on between people's ears and the people I'm talking about are the leadership and the management partners of the companies that we invest with, right?

[00:36:05] Because if you are trying to approach things like Doug was saying earlier. All right, you set a personal record, can you shave more time off of that, right? We kind of think like that, but not everybody does and not everybody responds well to that. So trying to understand how leaders wired in a company that you're interested in?

[00:36:26] How do they interact with each other? Are there organizational dysfunctions? So our firm just had a retreat earlier in the month in September, and we spend a lot of time on the dysfunctions of teams and where the origins and where those dysfunctions come from. But we try to figure that out up front because that sim you keep talking about usually has pretty aggressive growth, right?

[00:36:51] Are these folks wired for growth? Are they? Signing up, are they mentally, psychologically, emotionally ready to sign up for five years of personal PRs every year? Because every year in that sim is going to be better than any of the historical years. That's literally, literally is what that's showing.

[00:37:12] Doug McCormick: But I don't know.

[00:37:13] You only sell off your record here. Right. You only sell off your record here.

[00:37:16] Lloyd Metz: But so fine. But are you of the mindset to get out there and work on your craft? As a CEO and your direct reports to be better every year, because that's what that SIM is showing. And so, unfortunately, not everybody thinks about it that way.

[00:37:34] So we're trying to figure that out as early in our process as possible. And I think we've gotten better at it, more sophisticated about it. And I can talk for a long time about the things we are doing.

[00:37:49] Sean Mooney: Hey, this is definitely going to need another whole episode that we'll. Dig deeper on, but Doug from kind of high level framing of this topic.

[00:37:57] What are your thoughts here?

[00:37:57] Doug McCormick: So Lloyd and I think about this topic very similarly. I think it's. If there's an art to the business, it's this part is art. The other stuff I think you can boil down to more science and analytics. It's taken me a while to learn this, but I think. Financial performance is a lagging indicator to teams and leadership and to me, this is a pretty holistic set of topics.

[00:38:19] It's individual capabilities versus team capabilities. It's a question around alignment and incentives. It's a question around culture. And honestly, one of the ones where I'll say for myself , I feel personally weak at, and we're trying to really invest in as a firm is getting smart on organizational design.

[00:38:39] Like how do you design an organization that's built for the transformation? You're going to try to execute. And then the last one is just acknowledging this is a moving target, right? So the team that managed the business you bought versus the team that's going to manage a business that you hope to triple or quadruple in the next five years.

[00:38:58] That's going to look very different, not because the team wasn't great before, but it's just a different level of complexity and a different level of capabilities required to manage the business you hope sell.

[00:39:08] Sean Mooney: think those are all 100 percent spot on and it's interesting as I reflect back. A coming up in private equity, maybe it is a preamble there's this almost like an East Coast West Coast thought on this where East Coast is like strategy wins West Coast as culture wins and growing up in East Coast private equity is a young, kind of overeager pop coming up.

[00:39:29] I'm like strategies what matters and then we can just plug people in. And then as I grew in my career in PE, I, started thinking, well, people really are important, but, strategy, I'm still strategy. And then I got into this startup, which became a company notwithstanding all my worst efforts here.

[00:39:45] And I realized as I reflect back on is, so often life, I was making these four choices. It could be strategy or execution. And at least after learning every lesson 10 times, I've come to realize it's both. gotta use the word and it's strategy and culture and when you get both right, kind of magic happens.

[00:40:03] And that was a big kind of mindset change when we started the company here was just intentionally and purposely spending lots and lots of time on what are our values gonna be, what's our call gonna be like? And what it's caused me to like learn is if you can get the culture and the values and how people write work and get the right people in for the CEO, it takes the weight of the world off your shoulders because everything is just so much easier, but you still need to have a good strategy.

[00:40:30] Yeah. So you can't have, it's not either or.

[00:40:31] Lloyd Metz: Yeah, no, it's interesting, Sean, when you started your east and west coast framing, I thought you were about to talk about rap and hip hop for a second, but, I think it is the power of, and right, because, you hear these sayings, right?

[00:40:44] Culture eats strategy for breakfast and execution eats strategy for lunch or whatever it is. It's important to get all of that, right? So strategy is important, but I don't know if it needs to be optimized at the diminution of a stronger culture than otherwise and stronger execution. So I would absolutely put a premium on.

[00:41:09] Better execution and stronger culture. And I'll take an okay average to above average strategy. But if you execute it well and have a strong culture behind it, I think that you can still win with that. don't know if you had a great strategy, but mediocre execution and mediocre culture, that's problematic.

[00:41:29] I think.

[00:41:30] Doug McCormick: Totally agree. Totally agree. One observation just as I hear you guys talk about it, I'm intrigued by the culture carriers, as you think about scaling a business, what I've observed is we're often buying businesses from family and founders and it's relatively small and the culture is a by product of the founder where the employees in the team get to watch decision making by that founder every day.

[00:41:55] And so they know the culture because they've seen it in action. And then you, like, grow the company by 5 or 10x, and the employees don't have a good reference point. So, it's a process of being very intentional about communicating what is our culture in a way that they know what the right decisions are without supervision.

[00:42:12] And I find that to be, like, really hard but powerful if you can force folks to be explicit about what our values are.

[00:42:21] Sean Mooney: I think both of those points are great. And as I think through this own kind of like praise, right? I did the exact opposite of most people. I started in P and then went to become an operator and.

[00:42:30] Most people call it like the world's worst midlife crisis in PE. But as we got into this, when we first went into this journey here, all the people who are mentoring me on how to do the business. Like, get the culture, I get the culture, right? And then I was like, well, we got to get strategy to and Lloyd to your point on execution.

[00:42:47] That was 1 of our big kind of like, aha moments because we very purposely established our values as a company. And, Doug, your point it's not a religion. It's not an ethos. It's a philosophy. It's how we commonly respond to situations. And that was a big kind of exploration for me. And when we first started, the values were work as a team, have good values, be good people and have a growth mindset.

[00:43:08] We're always trying to get better and learn. And then what we realized was in the first year, like something's missing. And then we sat around the table the next year and year two, and we sat around like, what's missing. And we figured out that, this whole execution thing, like, we got to win.

[00:43:22] And so we added win to this whole culture of, it's like, you go further together. We're going to be good people. We're going to grow. But we're also going to do what we need to put points on the board, which comes down to execution. And when we figure that out, then it just like took off. But to your point, I think a symphony of things that have to work in business and life versus just one. So any other final perspectives on these topics? We've covered a lot.

[00:43:48] Lloyd Metz: Yeah, and you mentioned that word mindset and a growth mindset, I think you mentioned. So for any of the listeners out there who haven't read Carol Dweck's book Order it immediately from Amazon. It is a must read, but I think that is the key unlock is if you can get alignment of mindset between the leadership and the key business leaders and marry that with an appreciation for execution.

[00:44:15] Really interesting things can happen.

[00:44:18] Doug McCormick: Yeah, this is a little bit on the team human capital side. just don't think you can. Underestimate the value of grit and so I would argue of all the things we talked about. Very few of them are fatal. You can miss a little bit on upfront diligence and you can miss on market a little bit.

[00:44:35] But if you keep moving forward, just 1 step at a time, even through the tough stuff. perseverance goes a long way in this business because it is a long term game. And so it's about, kind of staying alive for the next day. Markets change, people change, business dynamics change in a way that it kind of works.

[00:44:50] Lloyd Metz: And Doug we're trying to figure out how do you assess up front for someone's ability to withstand discomfort and have that grit and perseverance because growth is not up and to the right in a straight line. There are going to be kinks in it. There's going to be recessions or interest rate spikes or commodity spikes or whatever the heck right is that person and is that team capable of gutting it out and getting through it or are they a fair weather, sunny day minded temperament oriented team, in which case tough times come and they don't know what to do.

[00:45:28] So we're trying to figure out how to. Assess that up front, like right now, as we speak, because that's that forward looking mindset.

[00:45:39] Sean Mooney: I think that is the perfect bow on this episode, this kind of grit, resiliency, tenacity, however you want to call it. going back to the beginning of this episode, we're talking about how none of our companies ever got to the places they ended up for reasons we thought they would in the beginning.

[00:45:56] At least certainly none of the ones I invested in. And the reason they were successful, because they had really gritty, tenacious, resilient people, where something got in their way, they went left or right, where I think a fair bit of humanity gets comfortable just stopping. And so that might be the ultimate kind of thing that leads to people being successful and a really.

[00:46:17] Kind of, like, top top group of great people is this idea that we're just going to continue figuring things around and so. I think that's a great way to kind of frame this and kind of bring this together, particularly as we think about our next episode. And so I think we had a great kickoff episode here up next.

[00:46:34] We're going to talk about. All right, you've figured out this investment, or at least what it is now is what's the art of the possible. How does private equity even before you make this investment, start thinking about value creation planning and start figuring out what this company could or should be before you've even.

[00:46:50] Cut a check to this, amazing entrepreneur who built the company in the first place. Does that sound like a good plan? Guys? Awesome. Absolutely.

[00:46:57] Lloyd Metz: All right. Looking forward

[00:46:58] Sean Mooney: to it. All right. Well, we look forward to the next episode. Thanks so much for listening. A

[00:47:06] Doug McCormick: special thanks to HCI Equity Partners, a lower middle market private equity firm focused on driving transformational growth through consolidation strategies.

[00:47:15] By partnering with family and founder owned manufacturing services and distribution companies. Learn more at hciequity. com. ICV Partners, an innovative private equity firm supporting management teams of leading companies at the lower end of the market. Learn more at icvpartners. com. And finally, BluWave, the business builder's network connecting the most proactive business builders in the world with the best of the best service providers for critical, variable, on point, and on time due diligence and value creation needs.

[00:47:51] Learn more about BluWave at BluWave. net. For further information on HCI, ICV, and BluWave and relevant topics discussed here in the episode. Please see the episode notes or links.

[00:48:04] Sean Mooney: The views and opinions expressed in this program are those of the individuals and do not necessarily reflect the views or positions of any entities they represent.

[00:48:12] Moreover, no investment advice is given herein.