Private Equity’s Guide to Focus: Thesis Development and Deal Sourcing

[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. I'm Lloyd Metz, joined by Doug McCormick and Sean Mooney. Together, we'll navigate the corridors of private equity, revealing the uncommon knowledge and Challenges, successes, and lessons that drive the world of private equity and business forward.

[00:00:30] Let's go.

[00:00:36] Sean Mooney: Hi, this is Sean. Today we have a very special episode replay that addresses where we are in the M&A cycle. Most P. E. and M& A pundits are expecting a resurgence in M& A ultimately happening in 2025. So Doug Lloyd and I thought it would be helpful to go back to the future and shed some light on why and where PE firms choose where to focus on new deals and how they then go about sourcing them.

[00:01:03] For business owners, this will be very helpful in terms of understanding your potential PE firm strategies and how they enact them. For PE firm listeners, this will also give you a bit of a lens into how other top PE firms are thinking about this really important topic. Enjoy. We have another very exciting and interesting conversation today about how private equity decides where to focus and where to spend their time investing. And then how they think about, and actually execute sourcing those opportunities. So I'm really excited to be back together again with Doug and Lloyd.

[00:01:37] Doug and Lloyd, how are you guys doing today?

[00:01:39] Lloyd Metz: Hey guys. Happy Friday. Happy Friday. Happy Friday.

[00:01:43] Sean Mooney: So this, I think this is gonna be a really interesting topic because it's super timely about where the industry kind of has been in this going. And I think we'll once again, kind of demystify a lot of the process that Leads to the success of the industry and maybe to kick things off, Doug, can you maybe set the foundation?

[00:02:01] How do private equity firms think about where they want to invest and then how they develop theses around that?

[00:02:07] Doug McCormick: I think the first thing I would start with is the concept that in many cases, the firms like mine or Lloyd's. You have a right to invest in a mandate that you've articulated to your investors.

[00:02:18] And so I think one important aspect of how we think about sourcing is we're going to do what we said we would do to our investors and stay on target, on scope, on mandate, and I think that's for two reasons. One, I think investors are looking to us to do what we said, because they're trying to create a portfolio of different kind of asset exposure.

[00:02:35] So HCI has a certain competency. We're not going to go do venture, right? They're paying somebody else to go do venture. The first thing I would say is it's within the sandbox of, uh, the mandate that we agreed upon with our investors. And then I think it's in the sandbox of the competencies, which we think we can bring to bear.

[00:02:51] And so we come at it from a perspective that we have competencies in certain business models, more so than end markets. And for us, those business models are technical services, distribution, and basic manufacturing. And with that, we bring Competencies in scaling lower middle market businesses and competencies in executing consolidation strategies.

[00:03:14] So as we think about the areas that we're going to go hunt, if you will, it's in those business models in markets where we can execute a consolidation strategy and support the team growth to dramatically kind of transform the businesses. And then at a very high level, I think we have a reactive sourcing capability where we're cultivating a number of deals through intermediaries.

[00:03:37] And then we're also trying to be proactive about what can we see in the marketplace based on the interactions with our intermediaries and the experiences and other deals to deploy that insight into new areas that are maybe underappreciated in terms of new thesis

[00:03:52] Sean Mooney: development. You said some interesting things there.

[00:03:55] Let's unpack some of that. Why do your LPs care? Where do you focus? Because if you think about the earlier days in PE, There was nothing better than to be able to see every deal that was out there and then picking the one out of a hundred that you liked. Why do LPs care and then why do you care as well?

[00:04:10] Doug McCormick: First of all, I think LPs care because they're trying to put together a portfolio of managers that give them broad exposure to the market and broad exposure to strategies. And then I think I care in terms of delivering on that promise. We focus where we think we have a core competency and an angle to differentiate or deliver alpha.

[00:04:29] And so I think the market's got competitive to the point where it's really hard to be a journalist and be exceptional when you've got specialists who live in certain either markets or business models all the time. It's

[00:04:42] Sean Mooney: spot on point. It's just, How do you find alpha? And it seems like that specialization in areas and picking areas where you have unique competencies is a big part of why the industry has evolved.

[00:04:53] I'd be curious, because I think a lot of us in all of our PE days, we probably started in the generalist posture. How did you end up in the areas that you focus today? What was kind of that distillation process that led you during that evolution? I

[00:05:07] Doug McCormick: think in some ways we're probably modestly ahead of the industry or with the industry.

[00:05:13] I think as capitals come into the marketplace, folks have had to specialize to remain competitive. For the most part, candidly, experience and success breeds new ideas, more competency, more conviction, more differentiation, right? So as you think about like almost a Karitsu, if you specialize, whether it be in an industry or a business model.

[00:05:34] All of a sudden you develop a relevant network of industry execs, relevant network of other PE firms who are in the similar space, relevant network of consultants. And so all of those, uh, networks not only help you source, but help you quickly triage, help you quickly discern what is interesting and what isn't.

[00:05:53] And so I think in many ways you're more efficiently spending your time on stuff that matters. Lloyd, how about yourselves?

[00:05:59] Sean Mooney: How do you decide where you want to spend time investing?

[00:06:03] Lloyd Metz: I think this is a great topic and glad we're talking about it. I agree with a lot of what Doug has laid out and there are a couple of ways to tackle it.

[00:06:12] Just from an internal perspective, being efficient with your time and being focused is key in our business, right? The expression that Doug used earlier, do you have the right To own or the right to compete, to invest in a particular company. Do you have the credibility to convince an owner entrepreneur that you're a good capital partner to them that takes time, right?

[00:06:38] That's a process. And I agree a hundred percent. It comes from where were you successful, whether it was stage of development of company, whether it was industry, whether it was business model or what have you. Whether it was with a particular strategy for growth, organically driven M and a inorganically driven over time, as you started, as most of the industry did as generalist.

[00:07:02] With respect to industry, you start to develop competencies in various dimensions, and based on those experiences and that success, you tended to focus and arrive and land on a particular approach. The second part of the way to think about is, how do you go to market? And. LPs, as Doug said, do want to build a portfolio.

[00:07:24] So they kind of want to know how do you do what you do and how do I put you and think about you in my portfolio amongst other managers? So yes, doing what you say you do is important. A footnote, Sean and Doug, you've probably been around the block long enough to have seen this style drift with the private equity firm, as it relates to your LPs is really bad.

[00:07:44] Like you can get into trouble drifting out of your competencies. And getting into trouble means losing money and going out of business ultimately. So that's one thing that LPs are super sensitive to. And I think Doug, you've probably heard some stories throughout your career, firms who have done that. So you definitely want to stay in your lane, however you define it and do what you say you're going to do.

[00:08:07] Doug McCormick: One thing you said that totally resonated with me and I came at the question in such a. personally focused way. Like I talked about why we were focused on how to deliver alpha. And you brought up the fact that part of the reason that people specialize is competency and credibility with entrepreneurs.

[00:08:26] And I think it's just important to highlight, like at the end of the day, our business is a sales business where you're not only paying the high price, but you're positioning yourself as the best partner. And imagine two private equity firms competing for an asset, one who knows the industry has a lot of competency and expertise and can be a value added partner, and the other one who has capital.

[00:08:46] The only way the guy with capital wins is he just pays more. This whole specialization is really also an important credibility factor in the context of the counterparty you're dealing with.

[00:08:57] Lloyd Metz: Exactly, that's what I meant by how do you go to market. Entrepreneurs tend to think industry, my business, my market, do you understand my business, my market.

[00:09:07] Investment bankers, intermediaries, lenders tend to be organized by industry. So it helps as a private equity firm goes to market to be organized around industry, or at least have an industry orientation. And sometimes that can be just outright, clear, explicit focus of the firm. Or it could be articulating this is a group, or this is an area of our focus, or this is an investment thesis that we're investing around, but you have to communicate some degree of specialization and it becomes a self.

[00:09:41] Reinforcing dynamic when you do have focus. You can call it specialization if you want, but I think of it as focus when you're focused in an area. You start to attract opportunities. You build presence and share of mind with the intermediaries in that space. You find executives who can help you think through opportunities or spot opportunities, and it becomes self reinforcing, which is a pretty cool thing.

[00:10:06] Sean Mooney: I think these are all. Extremely insightful and interesting points. One of the things I'd love to get your perspectives on is, as you think about the business of private equity and your businesses as businesses, as you all were evolving into the areas in which you spend more time and focus, did you all ever think about what's the size of this addressable market?

[00:10:26] Do we have enough there to focus in this place? Just like you would with a portfolio company and say, Oh, We're going to focus here. We can make a lot of money, but there's not a lot of opportunities or, or, Oh, yeah, there's great companies. We have know how and it's a big enough market that we can.

[00:10:40] Meaningful dollars over time.

[00:10:43] Lloyd Metz: Yeah. I mean, I don't know about you, Doug, but at the lower end of the middle market, in our view, those are companies at the lowest end for us, 25, 50 million of revenue up to whatever, 150, 200 million of revenue, There are tens of thousands of those companies in the United States.

[00:11:01] And so from our standpoint, there's plenty of opportunity. So we kind of took a look at the addressable market many, many years ago. And I don't think that dynamics going to change materially anytime soon. So we tend not to spend too much time thinking about that. If we're looking at a specific market niche with a company or function or a market that we think is interesting, and you do look at it from that perspective, like how many players are they?

[00:11:30] How, how concentrated is the market? What are the growth trends, but just from a macro level, as, as we think about our firm, as long as there's whatever, a hundred thousand or so companies in that size range, ballpark, I think that's plenty to work with.

[00:11:46] Doug McCormick: I agree with Lloyd. It's, we kind of look at it as sufficiently large.

[00:11:49] And once you've answered that question, you're kind of in a decent place. The one other thing I would say though, is I think when you think about specialization, by definition, some firms that specialize have significant like industry concentration, right? So for example, if you're a healthcare specialist, you're going to ride the healthcare wave, good and bad through those cycles.

[00:12:09] And so one of the things we like about our strategy is you can put together a portfolio that has pretty good diversification. Because you can have distribution businesses in a variety of different end markets. We think about the diversification of the businesses we can get exposure to and M& A is an interesting strategy because you can kind of dollar cost average over the cycle.

[00:12:30] So that influences the way we think about our business, but probably not deal by deal.

[00:12:36] Sean Mooney: Yeah, I think it's a good point in terms of you think about how P firms are specializing. You're right. Whether it's a technology or a consumer or a business model or an industry focus, they all have kind of pros and cons.

[00:12:48] And I remember, I think about just my own journey. I started off at a private equity firm where we could invest in virtually any security, any market, any industry. In the early days of PE, it was amazing because you'd have a hundred companies line up and you pick the five you like best and you kind of set the terms.

[00:13:10] And then the industry got really, really competitive and being good at everything got harder and harder and harder. And then that firm eventually kind of refined their focus area, but I'm buying everything from a mezzanine debt with warrants deal for a packaging company to a buyout of a Chinese heavy duty truck part company with.

[00:13:32] 13, 000 employees scattered throughout China to like talk about like stretching yourself thin and then they focused and we focused. And then I jumped to a very specialized firm where we were just doing the information value chain, industrial technology, information, data related software. And that was like such a, some ways a liberator because we could be so much better at fewer things.

[00:13:56] But in other ways, there was this temptation because like, I'm good at assessing companies. And I had to make a lot of decisions about where not to invest. Did, have you all gone through that as well, where it's like, you still probably know what a good company is. We've talked about that. And there's probably a lot, you're like, Oh, I could do great with this.

[00:14:10] But it's just, how do you think about the art of saying no?

[00:14:14] Lloyd Metz: We're still going through reps and evolutions and at our firm on that, Sean. Some of my colleagues know this painfully, but I'm telling them more and more, like just saying no to opportunities and take that time and that mental space to go find something that you're excited about, right?

[00:14:32] So to me, if you're not hell yeah on an opportunity, then that's basically a no, right? The worst thing, in my opinion, is to be just ambivalent, lukewarm about an opportunity, whether it's a specific company investment opportunity or specific space. You might as well just kind of pass, right? That's a dangerous place to be because you can spend time and energy and effort, and God forbid you actually make some investments in that type of opportunity.

[00:15:01] You don't want to be lukewarm about it, right? I don't think you can have a lukewarm mindset in private equity because you're illiquid, as we talked about in previous episodes. You're usually invested for three, four, five, six years in these opportunities. They need to have dynamics and characteristics that you're excited about, that you want to own the business, that you want to partner with the leaders of that business.

[00:15:26] So that's one of our current big screens. Like we've always had business characteristic elements to our screen size, margin profile, growth profile, industry position, et cetera. Then we've layered on some industry focus and investment thesis, which I guess we'll talk about a little bit. But ultimately the person advocating or leading that investment opportunity got to have some energy conviction.

[00:15:54] Got to be wanting to lean in on the opportunity.

[00:15:59] Doug McCormick: Sean, you know, you say, Hey, I had an underwrite businesses and I would argue. Yes, I agree with that. But if you're not pretty deep in a market, I think there's a different question of how do you efficiently decide what you have to pay and what fundamental value is.

[00:16:13] So, yeah, I can tell it's a good business. I'm not sure I'm really tuned into what the market is. The second thing is we keep talking about how the markets come increasingly competitive. So I think it's harder and harder to make money on the buy and you're really making money with what do you do with the asset during your ownership period.

[00:16:28] And that does require some competencies, the industry and the business model to bring value. We talk about ROE internally and it's ROE return on effort, not return on equity. And you think about, like, what's the effort associated with this activity? And boy, we all know tough deals, hard deals, deals that go sideways are the ones that eat you up internally from a capacity perspective.

[00:16:51] So it's not just the wins and losses from a financial perspective. It's some thought about firm resources and your ability to triage challenging situations.

[00:17:02] Lloyd Metz: Yeah. I like that, Doug. Return on effort. I like that.

[00:17:06] Doug McCormick: You know, I'm lazy, so I'll, uh, I'll have your turn on low effort.

[00:17:10] Sean Mooney: But that's the ultimate limiter in private equity is the time of your team.

[00:17:15] And we all know in private equity, you find time, you find that 25th hour in a day, but that's still your constraint. And so I agree, Doug. That's a really good, like, how do you make the most out of every one of those precious few hours that you have to figure things out?

[00:17:31] Doug McCormick: So let me play devil's advocate just on the other side a little bit.

[00:17:35] There's also this. Challenge of we've all got to innovate, right? And we've got to figure out what we learned today and how to maximize the applicability of that in the new situations, new markets. And so I do think there's some element of R and D in all of our businesses where I say, I understand this distribution business and what tangential markets are available to me where I can go hunt for new opportunities.

[00:17:59] Cause I've run this play, right? It's done. I don't have another angle here. And so there's this. challenge of staying close to home and doing what you said you did and then also being creative and innovating and trying new things and incrementalizing your way into new situations that are underappreciated at this point, right?

[00:18:18] But will become appreciated shortly.

[00:18:21] 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. 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.

[00:18:53] Variable on point and on time due diligence and value creation needs now back to the episode

[00:19:02] Sean Mooney: So i'd love this show Gold rush and so my son and I when he was growing up we'd watch this thing and it's about this kind of young ambitious person and a bunch of others who are trying to Get gold in the Yukon and it's just really hard and really tough.

[00:19:17] And in some ways it kind of made me think of like what it was like in private equity, where you're just trying to find creative ways to get on the gold. They hit this hot streak and they mine it out and they get on this big run. But then Doug, to your point. Eventually they mine out the vein and they got to find a new one, kind of to what you're talking about with that kind of metaphor in mind, how do private equity firms then think about, okay, we've done here that kind of maybe the arbitrage or the efficiency or the insight, the edge is diminished.

[00:19:48] How do you then think about forming these theses about here's where we're going to go. We're going to be in the same plot of land that you're focusing on, but how do you find the next cut? If you are.

[00:19:58] Lloyd Metz: Yeah, I think Sean, that's a great question. I think ultimately to be successful in private equity, you have to.

[00:20:05] Be a learning type of person and fundamentally you have to pay attention to the world around you, right? So I guess my answer to your question around gold rush would be okay What consumables are you using as you mine out that gold are those maybe better? Businesses than the actual mining of gold and then pull on that thread and maybe you wind up like Levi Strauss, right?

[00:20:31] I'll supply clothing and other consumables to the gold miners as opposed to actually mining the gold.

[00:20:38] Sean Mooney: It's a quick aside. Lloyd. Some might say that's what I did. That's

[00:20:42] Lloyd Metz: my

[00:20:44] Sean Mooney: game. So sorry about the quick aside.

[00:20:48] Lloyd Metz: That's exactly right. That's exactly right. And so sometimes you wind up developing a thesis because you see adjacent.

[00:20:56] But related opportunities and you pull on that thread, you do some homework and you decide to like. Go down that track. We've invested in businesses that on their face offered a particular value proposition in the view of the business owners. But when we wound up getting to know the customers, we realized that the customers were buying something different than what the company was selling.

[00:21:20] So for example, judgment. So we spend a lot of time on business services companies, and there's a particular set of pieces that we're going after where, what the clients are buying is the judgment of those business services companies, as opposed to a particular report or. The set of information or data, what they're really buying is the judgment of those professionals and we came to like that business because it allows you to do interesting product strategies and pricing strategies and it can provide a pretty interesting amount of operating leverage.

[00:21:55] If you get it right. It's an evolution, but it comes from paying attention to the companies you actually do invest in, the competitors, the clients, or customers of those companies. And you can find a lot of interesting opportunities just if you're paying attention.

[00:22:10] Sean Mooney: So you're not just jumping around the Yukon if we stick with this and just like punching holes and things, you're sticking in areas, you know, and then you're going to the left and the right and up and down and staying in the neighborhood, but finding areas around.

[00:22:24] Places that you already have kind of preordained knowledge and insight and expertise. Is that it?

[00:22:28] Lloyd Metz: Exactly paying attention. Hey, once we mine this gold, where does it go? Is somebody processing the gold? Once we sell it off, how good of a business is that? Should we go upstream or downstream? I always get those mixed up, but get into ore processing or something like that, or the transportation of gold or the security and storage of gold.

[00:22:50] You're just going to have to be a curious person and kind of pull on some threads.

[00:22:55] Doug McCormick: So I think sometimes this can also happen pretty organically, right? Let's just say, for example, in distribution businesses, there are some common competencies like supply chain management, purchasing and freight management, inbound and outbound are critical.

[00:23:08] Pricing, given that you generally have a very broad product category, you can make a lot of money on how you think about pricing and ERP, good quality information to make sure you have. Real clear visibility on profitability by product category and by part is really important. So if you think those are skills that you developed because of an asset you've owned, then that begins to be applicable in a variety of situations.

[00:23:32] So in my own personal journey, I think I've been involved in more than 30 distribution businesses. But if I told you that one was a forklift business, one was aircraft components, one was industrial containers, one was food service consumables, one was industrial distribution of fluid transport, What do those businesses have in common?

[00:23:51] Their end markets are radically different. Their products are radically different. So the expertise was not directly related to end market, but the competencies I mentioned early. All very relevant as you think about underwriting and building a business scale.

[00:24:06] Sean Mooney: If you think about a business, there's products, there's process, and there's customers.

[00:24:10] And within that diagram, the process is probably very similar, I'm guessing, in terms of like, how you can manage these things effectively and efficiently.

[00:24:19] Doug McCormick: Well, and said differently, in some cases, it's the customer competency, right? So, we've looked at a number of DOD or federal government related businesses, and I would argue it's the contracting mechanisms, the vehicles, understanding how DOD buys things that is probably one of the key elements of success there.

[00:24:37] Sean Mooney: We'll stay on this theme here. And once again, for our listeners, we're talking metaphorically about gold, maybe that someone's on in thesis, but we're probing about this as a metaphorical example. But as you think about, okay, now you're starting to probe into an area that's adjacent to where you already have expertise.

[00:24:53] How do you go about that first part of testing that hypothesis that this is an interesting area that we want to spend more time in the future? Or the things that you do to kind of get up to speed and use the scientific method a little bit to say, is this what we think it is?

[00:25:08] Lloyd Metz: Ultimately, Sean, I always start with Google.

[00:25:12] I think I use Google almost as much as water, air, and toilet paper. It's like the most useful thing I can think of. It's my go to, right? But you do a bunch of Google searches. You talk to different people in your network. You've got to talk to a lot of people, talk to people outside of your network. So you talk to executives, you talk to business owners, you try to find Customers to the space, users of the space or their participants in the market, and you ask them about trends, you ask them about what they value, you ask them about perhaps what's missing that they would love to see offered by the people, the companies that are participating in the particular market space.

[00:25:57] But you wind up talking to a lot of people and at times, once we talk to enough people and get a sense that there is a sustainable demand for the service or the product, you can do a lot of tabletop research to understand some of the historical trends, you go to trade shows, you read a lot of trade magazines or trade publications, blogs, or whatever it is.

[00:26:22] To get a sense for what's coming forward in the future. And then you may ultimately hire a consultant to try to help you structure and find the specific sub markets or niches in. In a particular market space or that are participating in a particular investment trend. We did a similar kind of exercise a couple of years ago in food ingredients, which is a pretty broad category.

[00:26:48] So we had to chop it down to actionable handful of sub markets or uses or functions. But that's how we do it. It's an evolution.

[00:26:57] Sean Mooney: It's a great response to that. Cause one of the things that I think makes both of your firms successful, but the industry successful as well, is this idea that. You all just don't go running down tunnels and wondering if the light at the end is a train or a light, you know, you take the time up front to kind of to learn.

[00:27:14] And that was certainly one of the things that we did. This is a really dated reference, but there was a gentleman who liked the razor so much he bought the company. And so we, we were big consumers of a company that founded really the expert network industry. And because it's like, we're going to talk to experts all around there.

[00:27:31] And it added so much value because we could get up to speed so quickly, we ultimately ended up acquiring the business and because it was so powerful to get these insights and Doug going to your point about return on effort, we could very quickly, at least at like a 30, foot level, kind of test the hypothesis and then move on or keep on going.

[00:27:53] And so I think that's really important, Lloyd, what you pointed out, not only just do you think about private equity, but just businesses in general, when they're probing new markets, take the time to learn it before you start plowing ahead with the good to great Jim Collins, like fire some aiming rounds in your cannon before loading up the big shot.

[00:28:10] I think that resonates on a lot of levels and certainly within the customers that now use BluWave, it's been really interesting to see this innovation occur, repurposing products that were mostly used later in the process. So a commercial due diligence, where you bring in a consultant to do a market study that was almost always used only LOI, it's not inexpensive or a voice of the customer study.

[00:28:37] Or senior advisors and what we're seeing happen in so many issues, we're getting calls now, or it's like, no, we're going to use the same group that we would only hire to help us understand a very specific target. We're going to use them just on an idea that we have. Because the ROI is so profound if you get that right.

[00:28:55] And then you have a whole new vein that you can mine. We're seeing voice of the customer getting pulled forward. We're getting senior advisory, getting pulled forward. Everything is starting earlier and earlier in the value chain, at least as we see it. Because it's more competitive, right?

[00:29:08] Lloyd Metz: Yeah. So Doug, Sean, I got a question for you.

[00:29:10] Sorry to interrupt your flow, but something you said just. I've always been curious about it. How do you guys tell the difference between information and insight? Because at least in my mind, there's always data. We're swimming in data. From the data, you try to extract information, but ultimately what you're looking for as an investor is the insight.

[00:29:34] How do you guys tell information from insight or insight from information?

[00:29:40] Sean Mooney: I benefited tremendously from having mentors in my upbringing in PE. Where we took a very much of a scientific method approach to doing things. And we would literally start structuring our hypothesis much like a scientist would.

[00:29:53] Like we think it has this attribute. We think the company has that attribute. We think country has that attribute. And it would be scripted in a very deliberate way. And then we would very purposefully test each of those elements of the hypothesis to say is that true. So we were targeting information geared around a question that says, is this true?

[00:30:16] We would search out and seek information very specifically, and that would focus the aperture of the lens. And that's the same thing we do everything at Blue Egg now. Everything is a hypothesis and a test, and then you fire maybe an aiming round to invoke Jim Collins. And then if it's right, then you load up the big shot.

[00:30:34] If it's not, you take a cannon and go elsewhere.

[00:30:37] Doug McCormick: Boy, there's a lot of good stuff to comment on here. So to me, Lloyd, with insight, you get conviction. And I generally find that conviction is derived from really understanding the context of the circumstance. So to me, any one particular insight or one particular fact doesn't really drive my conviction in the investment.

[00:30:58] But if you can develop 10 or 15 data points that give you really good context, then I think you get the conviction to kind of take action. We say this jokingly, but there's always kind of truth in jest, this whole concept of If you're migrating into a new market, right, you're trying to evolve and find things that are relevant for you and you win the first bid, you have a problem, right?

[00:31:19] And so I think we got to acknowledge the value of being in the market and learning from the interactions with industry participants. So we always like we want reps all the time. We want to figure out ways to get in front of management teams. Because we're evaluating them on the business, but we're also developing our catalog of knowledge on the industry and how we may apply it elsewhere.

[00:31:41] And I think there's always this tension, we all think we have such great original ideas that we don't want to share them. But the reality is you can't get good feedback unless you're just openly sharing. So my view on the private equity business that we're participating in, later stage mature businesses, there are very few new ideas.

[00:31:58] Right. It's really about creative execution, better execution, being opportunistic when opportunities present themselves, but I'm not worried about sharing ideas because somebody is going to copy me. One more thing I would highlight is the business model and the sourcing apparatus creates such wonderful market data about trends and actionability and this like repopulating the vein, if you will.

[00:32:25] So just to throw out a couple stats, we're a relatively small firm. We look at between 2, 600 deals a year. We on an annual basis, we'll see deals from between four and 500 kind of industry intermediaries. And that to us is a huge wealth of information about the way people are positioning their businesses.

[00:32:47] What markets are hot, what markets are not based on deal flow is a great source of R and D to kind of look at that deal flow and aggregate and discern where we want to play in it. And you get the luxury of going to meet teams and going to learn about the industry through those processes, which I think is critical.

[00:33:05] Lloyd Metz: I like your philosophy on sharing your thoughts, right? And don't worry about people stealing your thoughts. Reminds me of a quote, what's, uh, Howard Aiken, a Harvard physicist. He said, don't worry about people stealing your ideas. If it's really good, you'll have to force it down their throats or something to that effect.

[00:33:20] So, so your comment resonated, Doug.

[00:33:25] Sean Mooney: Doug, I also like your point about if you had a home run on your first at bat, you're probably A, playing in the wrong league, but B, there's some sort of catch. And we used to always have this conversation, it's like, we called it when the oil and gas deal makes it through all of Texas and Oklahoma and Louisiana and shows up at my desk in Greenwich, Connecticut.

[00:33:43] You got it. Something's wrong. Run. There's something very wrong with that deal. Oh, true. That's true. So that makes a lot of sense. So I think we've set a good foundation here around like how we think about where to invest, why to invest, how that develops over time and evolves over time. Let's turn the page a little bit here and talk a bit about.

[00:34:08] Okay. Now that you kind of know where you want to play, how do you go about then sourcing these opportunities?

[00:34:15] Lloyd Metz: Sean, this is a people business and you have to have some decent people skills. So you got to build relationships with intermediaries of different types. So whether it's investment banks, the large ones, the midsize ones, the regional ones, one or two person shops with the shingle, you got to go to trade shows and walk the floor and go buy booths because you'd be surprised at how many times the owner, the founder, the entrepreneur is at the booth at a trade show.

[00:34:49] Can't be afraid or shy to pick up the phone and call people, send them emails, reach out on LinkedIn. You got to do all of those things to get in the flow of opportunity. And ultimately, as a good friend and mentor said, you have to earn the right to pursue certain opportunities, you have to earn the right to be a partner to a successful founder of a business or the entrepreneur or CEO running a business that you think is interesting, and that takes effort and time to build.

[00:35:22] So you got to do all those things.

[00:35:25] Sean Mooney: I'd be curious as you think about the variety of flows, and if we kind of double tap on one, the biggest traditional source of deal flow or opportunity flow for private equities has been investment bankers or intermediaries who are bringing deals to market. There are companies that are explicitly for sale.

[00:35:43] And as I think we all go back to the earlier part of our career, we wanted to see every deal in the market. Is that the same today? Are you, do you go to your investment bankers and say, give me every single deal or is there a different approach now that's evolved?

[00:35:57] Lloyd Metz: So a couple of things, the investment bankers still traffic and control a significant amount of deal flow.

[00:36:03] And for us, we've always told them the business characteristics we're looking for. And we have to make sure they keep that top of mind and they remember that. We don't want to see every deal that they have. We want to see the deals that they have, that they're bringing to market, that kind of fit our spec.

[00:36:21] Then we kind of look at those and then decide how much time, if any, we want to spend pursuing or even examining or reviewing those companies. The other thing I will add though, is a friend of mine, who's a successful long time investment banker. Also told me it's like, you got to beat me to the deal, right?

[00:36:40] So we can be passive and wait for Sean Mooney from XYZ investment bank to bring me a deal. But my friend was saying, you got to work harder and beat me to the deal. Like you got to go find that company. You got to get to know that company. You got to know that company is about to hire me to bring them to market.

[00:36:59] Sean Mooney: That's a great. I

[00:37:00] Lloyd Metz: took that as a personal challenge. Now, it's hard to do, but I'm still working on it, but I appreciated him saying that, right? Because at the time, it felt like he was kind of brushing me off a little bit, but it's that kind of tough advice that I appreciate and respond well to. He's like, You're supposed to know when that CEO is, or a founder is looking to hire a banker.

[00:37:23] And if you're really on your game, you'll know the bankers he's talking to before I get hired. Right.

[00:37:29] Sean Mooney: That's a great point. If the company is meeting you for the first time at the management meeting, you're probably behind already the other people who have one of those 10 to 15 seats in a management meeting.

[00:37:40] Because they already have that relationship built and going to your point, like, this is still a people business, no matter how much everyone thinks chat GPT is going to be our robot overlords, still might happen, who knows? But for the foreseeable future, you got to have that relation. So

[00:37:54] Doug McCormick: in some ways, I think, as you think about Our business, I could argue we have three different customers or at least constituents.

[00:38:01] We've got our limited partners, which we've talked about what they're looking for. But I think investment bankers, we kind of view as customers in some ways. And then our entrepreneurs, there are potential partners we view as customers. So as you think about the investment banking community or the intermediary community as a customer, I would highlight a couple of things.

[00:38:17] The first is a tight message. Which puts you top of mind when they have a deal that looks like an HCI deal, right? So HCI does these three business models, consolidation and large fragment markets, North America. Hopefully that's burned into the mind of the investment banker as he thinks about a deal that fits those criteria.

[00:38:36] And while you can have a really tight message, you've got to find ways to, like, what I characterize as stimulate that group of intermediaries. We do it with email blasts about things we're looking for. We do it with assigned calls so that we have relationships that are assigned. So somebody has a responsibility to be interfacing with the bankers that are well aligned with our industry.

[00:38:57] And then when you get a deal that you're involved with a banker, I think you've got to make them look good and be efficient with their time and their client's time. And when I say make them look good, what I really mean is don't surprise them, give them quick nose and quick feedback on what you're focused on and get through the diligence process in a way that this is a repeat business and they are willing to advocate for you the next time because they trust you because you've dealt with them fairly and competently.

[00:39:27] Sean Mooney: Yeah, I really like how you talked about the investment bankers as a, is certainly a stakeholder constituents, a customer of yours almost, and the fact that you're out talking to them over and over and over again, like, here's who we are, here's what we want. And not only just once a year when you, or wherever it is, it sounds like it's an ongoing process through multiple means of communication.

[00:39:47] Doug McCormick: Yeah, and I think you build up political capital, right? So you're bidding and maybe you're not the high bidder, but it gives you the chance to say, listen, I have a lot of conviction. I can find more value and I'm not going to surprise you because we've done this together 10 times. And I think those, that kind of relationship matters.

[00:40:04] And I think it's also absolutely in the path of they're providing a service to their client because they're leveraging that knowledge and relationship to get a good outcome. And what

[00:40:15] Sean Mooney: about one of the big kind of evolutions, even within investment banks is they have someone on their team called the sponsor coverage banker, whose job is to Similarly, no, you all, not only for bringing new deals, but also the potential to have the opportunity to sell in your companies, how do you work with them to maximize the outcomes and build these relationships over time?

[00:40:41] Lloyd Metz: Ultimately you have to have the sponsor coverage folks, almost like a partner to your firm. So you share with them what you're looking for. You share with them what you're thinking. So for example, we're talking about all this investment thesis stuff, right? So. By definition, oftentimes this will be, as you're starting out pursuing a thesis, businesses you don't own yet.

[00:41:03] So, you gotta start sharing with them, hey, we're really interested in this space, or this theme, or companies like this, we're really keen to go own one. So, you gotta share that with the sponsor coverage folks, and they can help you navigate the different industry banker groups within the firm, and also, they're also part of the information flow.

[00:41:25] So you definitely have to build a more partner like relationship with those sponsor coverage folks.

[00:41:32] Doug McCormick: I've found huge value in the sponsor coverage role for a couple of reasons. One, it's like one point of contact for the entire firm to engage the resources that you need to go make something happen. And in our case, we may have exposure or interest in eight different industries.

[00:41:49] And so to manage all those eight different relationships can be hard. I think the sponsor coverage guy is also kind of the guy, if you do it right, is the no bullshit person who can speak truth to the ongoing relationship as opposed to deal by deal, because every banker believes they are the best qualified to represent you in an exit process.

[00:42:09] And they'll never tell you otherwise. Where I think the sponsor coverage guy is managing the broader relationship, and he can help you think through how to engage the resources that are most compatible with what you're trying to get accomplished. So I think that's just a critical relationship.

[00:42:25] Sean Mooney: I think that one of the really valuable roles that they play, if you build that relationship and you work and you have mutual trust with these professionals, is about return on effort, it's saving you that time where you can have an open and honest conversation.

[00:42:39] Like here's where we're kind of, we think we're going to be. Should we move forward or just throw in our cards and go on? And they can be really valuable in that. It's like, I had a very brief career as a wide receiver in high school football, very brief. And, but the one thing the coach would tell you is like, you're coming up to the line and you always talk to the ref and you're like, Hey, am I offsides or am I at the line to kind of move further up?

[00:43:02] Do I need to go further back? And if you did that, the ref would tell you and you're never offsides. I don't think they teach that in the NFL these days, but, uh, They did in high school in Texas. If I was a Batman, you needed every inch you could

[00:43:14] Doug McCormick: get.

[00:43:16] Sean Mooney: this is a very brief career. I became very good at like getting beat up during, you know, scouting team offense.

[00:43:25] Started studying a lot harder.

[00:43:29] Sorry, kids. You inherited my genes on sports, but it's a whole different conversation.

[00:43:34] Doug McCormick: I tell my kids, but I'm smart. Does that help? Does that, yeah, does that compensate for my lack of height?

[00:43:42] Sean Mooney: All right. So let's talk about, so there's the deals that are explicitly for sale. And the great thing about, you think about return on effort is, you know, they're for sale. And maybe because they've hired an investment banker, the advisors, they're going to go through a process. And there's a relatively high, maybe ROE return on effort because they're committed to a process, but there's a lot more competition.

[00:44:03] So how do you all think about also the ways of maybe directly sourcing opportunities that maybe have more effort, but less competition?

[00:44:13] Doug McCormick: So I think one way for us to talk about sourcing that we haven't kind of gone down the path is I would argue the sourcing for add on acquisitions is dramatically different than platforms.

[00:44:24] Thank you. And I would just tell you realistically, while we always want to find proprietary deals and we always want to source outside of a process, our success rate for platform businesses is somewhere between relatively and very low. So call it maybe 10 percent of the platforms we buy or less is outside of a process.

[00:44:46] But I think more than half of the deals we do are outside of a formal auction process. Maybe they got an advisor, maybe they got a broker, but it's not really a process. And that's because you get a platform and you have a different level of credibility. You have a different level of relationships. Your management team have relationships that they can monetize with you.

[00:45:05] And so we think about those two situations as distinctly different. And just acknowledge if you want to make a play in a market, you're probably going to have to compete in a process to get access to an asset of adequate scale to go run your label.

[00:45:20] Lloyd Metz: Yeah, that's right, Doug. I agree with that a hundred percent.

[00:45:23] It's a different dynamic when you're now. Talking about add on acquisitions. Absolutely.

[00:45:29] Sean Mooney: Yeah. Every year in private equity, we would go through these conversations. Do we want to go for the companies that are for sale for the platforms, or do you want to try to do direct sourcing? And it was really hard for us, unless you were geared for that, where some PE firms that have.

[00:45:46] Really, really built out dedicated calling engines where they've got analysts that are calling every executive. And that certainly had its impact on the industry because you talk to most CEOs are like, I get a call every day. And so I think you're right. The idea, particularly for platforms, there's something about getting a position to start with a company that's actually for sale.

[00:46:08] Doug McCormick: Yeah. I also think that calling effort works better. In the earlier stage, growth equity kind of venture world, my take, and maybe I'm off base there, but especially if it's a junior person that's calling, like, if somebody called any of my CEOs before we had gotten involved and it was an analyst, I don't think they'd have got much time.

[00:46:28] So, I think that's a tough, tough model, personally.

[00:46:32] Lloyd Metz: To Doug's point, Sean, judiciously. It's kind of a mix, right? The direct outreach versus the companies for sale. And we're experimenting and trying the direct approach, but counterprogramming. So if you have outsourced callers to companies or you have junior professionals calling companies.

[00:46:50] Having a managing director call or send an email or personal email or LinkedIn outreach can, we think, kind of cut through the noise a bit better and be a bit more effective. It doesn't feel like some mass blast or casting a wide net just to get you on the phone, right? So we're trying it and we're having different levels of success with it, but you got to try.

[00:47:16] Sean Mooney: It's really interesting. I'll tell you just even from my vantage as the CEO and owner of a business where I get those calls all the time. Someone's coming and it's a, it's a, someone two years out of college, they come and they're usually all quite thoughtful in it. And you have to think about, do I want to take that?

[00:47:33] And the complication I have is because they're usually also clients. And so I guess I have to take this call. But it is, it's hard, and I think to your point, like, there's something different if you get someone who's a partner, an MD, the senior level, where you know that they're going to be your partner as well, but there's only so many hours in a day, so how many can they dedicate to doing

[00:47:57] Lloyd Metz: that?

[00:47:57] That's right. Now, I want to go back to something I think, Sean, you mentioned. Where you talked about a less competitive approach. I guess I just personally don't believe that there is no competition. I always assume there's one or two other people who've come to the same view that XYZ company or XYZ market space is an interesting space.

[00:48:20] So I always assume there's competition because all it takes is one or two more besides yourself and you got a competitive process, right?

[00:48:29] Sean Mooney: I think you're a hundred percent right. And a lot of times you have that direct conversation, you've built it up, you're ready to go. And then next thing you know, they introduce you to their investment banker.

[00:48:37] And

[00:48:39] Lloyd Metz: then that's another piece that I also personally believe in, right? If the company is a leading company, has great prospects and has built a business that's wonderful and there's future growth opportunities. Odds are that the person and the team that built that business aren't uninformed, AKA stupid, right?

[00:48:59] So you find those businesses and to expect that they will put a sign in the front yard for sale by owner. Yes, that can happen. But our assumption is at some point, they're going to go hire an intermediary. If for no other reason, then their friend at the country club or their YPO form mate was like, what are you doing?

[00:49:18] Go hire Sean Mooney and have him sell your business or whatever. Right. So, I always assume that's coming, that you have a good business.

[00:49:26] Doug McCormick: Hey, just on that, I often see like, I think you can make arguments, that's a positive sign. Right? Because what it says is, I like this partner, I'm interested in a transaction, and I want to make sure that I'm being represented competently on value and term, and you got to acknowledge that seems pretty reasonable.

[00:49:44] Right? That to me sounds like a constructive opportunity to get a deal done.

[00:49:48] Sean Mooney: I think this dovetails nicely with what we were talking earlier, the value in that world, acknowledging it is what it is. And in many ways, it's good that they do that. What you've done though, by getting to know that owner, that CEO beforehand is you've built that trust based relationship.

[00:50:04] So when you show up at that management meeting, you're not meeting them for the first time, which has all sorts of benefits for both the buyer and the seller of the company going through that process.

[00:50:15] Doug McCormick: Yeah, and Sean, I do think I see situations where they'll even bypass the management presentation because that kind of implies they came back and said, Hey, listen, this is interesting.

[00:50:26] We're going to go build a book. We're going to go like get a data room together and we're going to go run a process. As opposed to hire an advisor to help me get to a deal with a partner that I think is potentially interesting. I think that can happen.

[00:50:39] Sean Mooney: I think that's spot on. And so one last thing that I'd love to get your perspectives on, and this is like peering, maybe the lens, not so much for what the industry and where it is today, but where it's going.

[00:50:52] And one of the things that I at least have a pretty strong perspective on is this kind of idea of the industry. In order to go back to the future has to really invest in its own marketing, its own brand formation. So that companies are calling you as much as you're calling them. And they're calling you because they know you as an informed value added investor, who is going to not only provide capital to them, but also some form of expertise that will make them better.

[00:51:22] And then that has to be communicated. And for so much. Of the history of the industry of private, because we talk about a lot on here to the first words private, right? And so we keep our heads down. We don't use our words. Discretion is a better part of valor. And we don't go out and say, here's who we are.

[00:51:36] This is what we stand for. We're going to wrap that in a brand. And then ultimately what that means is someone's going to call you again, like it used to happen in the late nineties. What do you think about that? Is that something that's going to take place that should take place? Even

[00:51:50] Lloyd Metz: it's possible that that could happen.

[00:51:52] I think in private equity, that's particularly lower middle market, private equity that happens to some degree. I don't know if that becomes the predominant dynamic in the lower middle market, when you're talking about much, much larger companies. When you're talking about some of the more upper end of the middle market, which 3, 4, 5 billion funds are playing in that space, but when you're up into the multi, multi billion dollar fund space and the companies that they're trying to invest in, I think that dynamic is more prevalent, right?

[00:52:25] But it's still a short list. It's still a competitive, even with your branding, you may be one of four or three or five that get invited to the party.

[00:52:35] Doug McCormick: I would say a little differently, which is. I think it's unrealistic for smaller firms like mine, and I'll put Lloyd's in this category to have high awareness in a marketplace, but I think we can build great brands, right?

[00:52:48] And so my test is when an entrepreneur that's considering taking capital goes on our website or references us, however, the information is distilled, he comes away with a clear strategy, a clear mandate, and a perception of we're good people to work with that are competent, that can be value added partners.

[00:53:07] And so that I think is very achievable and you've got to do to differentiate yourself, but for me to be like a lower middle market firm that's well known, I don't buy that. I don't

[00:53:18] Sean Mooney: know. I mean, because we are seeing lower middle market companies kind of taking those first steps and in part because the tools are getting so actionable for almost anyone, whether it's getting the data from a data provider, you can go to zoom info.

[00:53:34] Even something like iContact or name the email marketing kind of system. You don't need to necessarily have like Marketo or Eloqua. You can do these things in a way that just put the content out there in a relatively targeted way. And so that would be the one thing I would just be curious to see if it does evolve because what we see is what happens in the upper market kind of works its way down over time.

[00:53:57] So I'm going to be really curious to see how this evolves in the days ahead. And all I know is like, if I were ever to start a private equity firm, I would probably one of the first things I'd hire would be a head of marketing.

[00:54:09] Lloyd Metz: So I agree with that. So despite my earlier comments, I do think we need to work on your firm identity and making it as clear and bring it as much into focus as you can.

[00:54:23] And to your point, Sean, the tools, putting out your positioning, if you will, of your firm, both the LPs, but more importantly to the founders and business owners has gotten easier and more sophisticated. We certainly need to do a better job at our firm and it's on our minds and we got to get on it because I do think you're right.

[00:54:45] Ultimately, it just is better for your efforts if it's clear to all of your constituencies, whether it's the investment bankers, the business owners, your LPs, who are you? What are you? What do you do? What are you good at? And why should I work with you? Right? So ultimately, I'm agreeing with you, Sean.

[00:55:03] Doug McCormick: I'm not agreeing yet.

[00:55:04] Lloyd, I'm gonna, I'm gonna push on a little bit. So, Sean, just, how do you think about, like, if you're developing awareness, if you said to me, Hey, Doug, I think it's possible for you to develop awareness relatively cheaply with the investment banking community, or my limited partner community, I buy both of those.

[00:55:21] Do you think that I can make this, uh, basically a B2C business where I'm engaging directly with the capital taker? Yeah,

[00:55:30] Sean Mooney: 100%. So what I would do if I were kind of back in the seat, what I would do is I would go to ZoomInfo, I would go to PitchBook, and then I would say I want, Every company in my target market, and by the way, we do all this at BlueWife.

[00:55:45] So we spend quite a bit of dollars every year buying data. And then what I would say is I'm going to segment that and say, here are all of the CEOs, CFOs of all the companies that are interesting to me, and it's probably going to be in the tens of thousands. And then what I would say is we're going to put them in a CRM.

[00:56:04] We're going to then target content that is interesting to them, not even selling what I did as a P firm, I would say, here's things that can make you better and help you learn more and teach you something about your industry in ways that you don't know about it at the very least once a month, maybe ideally once a week, sending them something just so you're not even selling them something.

[00:56:27] It's just, here's people that are teaching me things. And then eventually you're going to see that they're engaging with your content. And then that's going to show you a signal that they're interested in it. And then it goes back to the idea of like, can you have proprietary discussions? And you know that because you're seeing digital signals, that what you're saying is resonating.

[00:56:47] And if it's not resonating, you're going to see in a very actuarial way. Your engagement levels decline. So you're like, Oh, we got to make our content more interesting. It takes work. It takes effort. And then the ultimate question is, will it generate ROI? Yeah, no one will know until they try, I guess. And so I don't know that because I haven't done it at least in this context, but I've seen others starting to do it.

[00:57:07] Doug McCormick: So that all resonates with me. And I think it almost brings us full circle to That works better the more specialized you are, I believe, right, because the community is more aligned with the content that you can come up with. Yeah,

[00:57:19] Sean Mooney: no, a thousand percent. You can't be everything to everyone, for sure, and it's really a hypothesis.

[00:57:23] We talked about in the beginning, it's like, do I know it'll work? I see a couple people doing it. But will it work in great success? The hypothesis that I have is that I think it's going to have kind of pretty big and growing impact, particularly in a world that gets more and more competitive. And you need like every angle and element of edge to generate alpha.

[00:57:42] But once again, a

[00:57:43] Doug McCormick: lot of times I'm way wrong. Hey, Hey, Sean Lee, we can't put that on the podcast because I don't want anybody else to hear that. It's too good. Just, just me and you.

[00:57:55] Sean Mooney: So, I think we've covered a lot here, once again, really kind of terribly interesting insights from Doug and Lloyd. So I appreciate you guys kind of weighing in here. Thanks for moderating

[00:58:06] Lloyd Metz: Sean. Yeah. Good conversation. A lot of fun. Can't wait for the next one. All right. Thanks guys. Have a good weekend guys.

[00:58:14] Doug McCormick: A special thanks to HCI Equity Partners, a lower middle market private equity firm focused on driving transformational growth through consolidation strategies 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.

[00:58:44] Learn more at icvpartners. com. And finally, 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 and on time due diligence and value creation needs. Learn more about BluWave at BluWave.

[00:59:05] net. For further information on HCI, ICV, and BluWave, and relevant topics discussed during the episode, please see the episode notes or links.

[00:59:15] Sean Mooney: The views and opinions expressed in this program are those of the individuals presenting, and do not necessarily reflect the views or positions of any other persons or entities, including those referenced herein.

Join Doug McCormick from Oridian Capital Partners, Lloyd Metz from ICV Partners, and Sean Mooney from BluWave as they explore timely private equity topics and offer their seasoned perspectives on crucial areas of focus within the industry. Gain valuable insights from these industry experts in this engaging podcast tailored for PE professionals.