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The Messier Marketplace?
I revealed last season that Brent was getting set to update his book The Messy Marketplace, and I’d like to think that putting that little bit of public pressure on him was helpful to him getting the project over the finish line. Because he did it! The second edition was published earlier this week, and you can get your copy here.
But why a second edition?
The first edition was written in 2017 when Brent and our team had been at this for about 10 years. Since then the marketplace and valuations have evolved, we’ve all endured a pandemic, and Permanent Equity has made more than a dozen new investments. In other words, we know a little bit more than we did back then and wanted to publicly update our thinking on what it means to successfully do a deal.
As for all that’s changed, well, buy the book! But an example of something we’ve learned is that there are a lot of nuanced reasons why someone might be looking to sell a business and/or bring on a partner. Whereas the original version assumed sellers were ready to exit, or slow down, or were in over their heads, we know now there is more to it than that. So the new edition recognizes some additional profiles:
The Seller: You are ready to personally exit your business both as an operator and as an owner.
The Scaler: You have one or more significant growth initiatives on the horizon and want some combination of diluted risk, more resources, and strategic support to take them on.
The Stabilizer: You have no intention of leaving tomorrow, but want to begin separating your personal timeline from the needs and ambitions of the broader organization.
Every owner wrestles with when to sell, what to sell, and to whom. I can’t answer those questions directly, but I can help you understand the landscape of options available to you depending on your personal priorities and the needs and goals of your company.
The reason it’s important for a business owner to reflect on what kind of seller he or she might be is because if you don’t know who you are and what you are trying to achieve with a transaction, you won’t get what you want out of it. A Seller who misidentifies as a Scaler, for example, will likely end up leaving a lot of money on the table. And a Stabilizer masquerading as a Seller might get forced out of an organization long before he or she is ready.
The challenge with selling a family business is that you’re likely to only get one shot at it, so it’s worth doing research ahead of time to prepare. Our hope at Permanent Equity is that the second edition of The Messy Marketplace is an indispensable part of that process for anyone going through it. So, again, get your copy here and also give it as a gift.
Thanks in advance, and have a great weekend.
-Tim
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Brat Summer Sausage
Something Holly has taken it upon herself to do at our office is make sure that we all stay current on popular culture lest we embarrass ourselves when we are out in the real world. So it went during a recent check-in when she let me know that “brat summer” was officially over.
“Got it,” I said.
But she was skeptical. “Did you even know it was brat summer?”
And I did because I had absolutely heard the term before. That said, I will cop to thinking it had something to do with grilling and was unaware that it was “an aesthetic trend defined by party animal antics, cool-girl style, and lime green everything.”
I guess you learn something every day. But I mention this here not to lament my missing out on the true brat summer, but rather as an example of someone in an organization adopting – and thriving at – an informal role.
The way I think about it, if you work at an organization there is what you do at the office every day, which is your formal role, and then what you bring to the office every day, which is your informal role. And what’s interesting is that while most people are hired to fill a formal role, their longevity and trajectory inside of an organization is usually determined by their informal one.
To wit, I was once witness to a hiring process for a quantitative analyst that ended up landing a technical expert with multiple advanced degrees from a rival firm. With regards to the formal role that needed to be filled by the hire, this was a no-brainer home run. But it didn’t take long for things to turn sour when this person adopted an informal role of being an instigator, a lone wolf and a fault-finder. And while the person’s work as an individual contributor was good, the cost borne by the organization with regards to overall productivity was too great.
This isn’t to say that if you’re fun to hang out with you can loaf at your job (those people are eventually let go as well), but rather that the most successful professionals don’t just do what’s asked of them. Instead, they’re constantly looking for ways to share their talents, knowledge, and passions across an organization in order to make it stronger and more well-rounded. Further, it’s by making one’s talents, knowledge, and passions known and admired across an organization that one’s formal role will grow over time.
An analog to this is that if you see a void in an organization, fill it. Because it may be the case that no one else in the organization even sees it yet.
-Tim
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Unfair Value
If you’re in the business of investing, your product is returns, which is to say that if you’re in the business of investing, returns are what your customer expects. But unlike other products, to the chagrin of customers and proprietors alike in this space, returns can’t be manufactured at scale on an assembly line according to a production schedule. In fact, by trying to manufacture returns, investors often do worse (and/or commit fraud).
Yet if you don’t have a product that you can reliably manufacture at scale and on schedule, you arguably don’t have a business. And since I’m in the business of investing, I was some combination of outraged, amused, impressed, bewildered, skeptical, and cynical when I read about Hamilton Lane, a fund that reported that on one investment of pretty good size they made 39% in a day. And further that they had done stuff like that before.
The trick is that Hamilton Lane went into the secondary market for illiquid private investments and bought something for a price no one else would pay. Then they marked the value of that investment on their own balance sheet not at what they paid (or cost, as the nerds would say), but at a higher “fair value” (which is even nerdier) with “fair value” being what other people who owned shares in that investment thought it was worth.
Of course, people who own things have every interest in portraying them as worth more. An opposing force is that buyers have an interest in acquiring those things at a price that is less. What’s the truth? Who knows?
Because arguably Hamilton Lane shouldn’t have marked the investment at the value others were carrying it at, but rather that the others all should have marked their investments to the value that Hamilton Lane had just paid.
But Hamilton Lane isn’t the only one in this industry massaging returns by citing fair value. To wit, mammoth financial firm Blackstone’s $59B real estate trust is kicking ass only if you are willing to give it credit for the “appraised values” of its investments. What are appraised values? They’re numbers in spreadsheets, not numbers being offered by buyers.
Is this a problem? I think yes and no.
Returns are what you put in your pocket (hello, beer money!), but an important qualifier is that what you put in your pocket depends on when you decide to pocket it and why. In other words, if you buy or sell something, you may transact at fair value, but more likely you’re not. Because the reason you’re transacting is because the price is a lot more or a lot less. In Hamilton Lane’s case, for example, they may have gotten a great deal (unfair value?) because the seller was distressed and they were the only ones who could wire it money that day and so maybe they were right to then mark it up?
This is why this stuff is confusing.
A better way to think about it is that there are two types of value: Spreadsheet Value, which is an academic estimate, and Real World Value, which is what a willing buyer would give you in cash today. And both numbers are worth acknowledging and knowing because rarely are they the same.
As for which one is “fair,” that depends. And that’s why returns are so hard to manufacture (absent, of course, fraud).
-Tim
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Serendipity Now
“How did you get here?” is an interesting question to ask and be asked. So it went on a recent call when a college student I’d been introduced to wanted to know – because I think he was interested in doing the same – how I had become the chief investment officer of a private equity firm.
“I,” I said, “have a fairly non-traditional background, so take from this what you will…”
Coming from Long Island, N.Y., where I did landscaping as a summer job, I went to Georgetown University in Washington, D.C., because I thought at the time I made that decision that I was interested and had a future in government. But I got an internship in the House of Representatives early on there and realized I had very little interest and definitely no future in government. I also found that I liked my political theory (shoutout Plato) classes far more than my practical politics classes because of the writing and thinking and so eventually wound my way to being an English major with a concentration in playwriting (which is why after I became CFO of Permanent Equity with no classical training in numbers, our CEO Brent would refer to me as the most under-qualified CFO in America).
I graduated from Georgetown in 2003, which wasn’t a great time to be looking for a job what with the economy still recovering from the double shocks of the dot-com bubble burst and 9/11 (both formative events in my life that had occurred before the college student I was telling this tale to had even been born…ahem). Without a lot of prospects, I was expecting to head back to Long Island to landscape and then maybe go on to graduate school. In fact, I hadn’t even received a response from any of the more professional jobs I had applied to, including one as a writer at The White House, which I had applied to at the recommendation of one of my English professors even though I didn’t think I was qualified.
And I wasn’t!
See, the job required a master’s degree, and I didn’t have one. Because of that, I later learned, my resume was put at the very bottom of the pile.
But never underestimate serendipity.
Because they interviewed everyone on top of me in that pile and none of them got the job. So the choice came down to interviewing unqualified me or reopening the process, which meant it might take six to nine months to fill the role. And so I ended up on the right side of the fact that something is better than nothing.
Now, an important thing to know here is that this happened a long time ago and I didn’t yet have a cellphone. So the number on my resume was attached to the landline at the house I shared with a bunch of others on Potomac Street near campus. But by the time this all happened, we had graduated and were moving out. I kid you not that my roommate Doug was about to pull the jack out of the wall when the phone rang with The White House calling on the other side.
An interlude…
Getting a job writing at The White House might sound impressive. You’re probably thinking about memorable lines spoken during grandiose speeches on impressive stages. And there were people who did that.
But what also happens is that the President meets, greets, and receives gifts from a lot of people that then need thanking. And someone needs to write those thank you notes because the President doesn’t have the time for that, but also wants to promptly send detailed thank yous because votes and also because not thanking a world leader for his or her gift might cause an international incident. Again, something is better than nothing.
And that’s how I got hired for that job. Because I was better than nothing. But I’m still not close to telling you how I became the chief investment officer of a private equity firm…
That wheel started turning because I’m a cheapskate. Not as cheap as Morgan Housel (shoutout Morgan…we good?) and not as cheap as I used to be (shoutout past me), but always and still stingy. What’s relevant is that back when I worked as a thank you note writer, I saved everything I could in order to be relentless about investing.
One reason I learned to be relentless about investing is because my Dad was relentless about investing. In fact, he started as a professor at SUNY Stony Brook (now Stony Brook University) around the same time as Jim Simons, the founder of the wildly successful quantitative investing firm Renaissance Technologies who recently passed away. Jim and my Dad shared a relentless interest in investing and allegedly talked shop, but Jim I think pursued that interest somewhat more relentlessly (if measured by financial outcomes and so it goes). That said, my Dad was still relatively relentless about the topic, and I took that in.
So as a young, relentless investor with a small amount of savings near Washington, DC, I inevitably happened upon The Motley Fool (based in Alexandria, VA). Then as I read The Motley Fool, I discovered that they were looking for a writer (and then ended up working there and doing other things).
I’m going to fast forward because this is getting long and attributing things to serendipity seems lazy, but I will say that another question I get asked is: “Should I work at a big company or a small one?” My answer is that big companies might pay you well and give you lots of training and small companies might pay you less and provide minimal training (and the government might…well, I won’t comment on government jobs). You can do well anywhere, of course, but I think something about working at small companies is that you get the opportunity to do whatever you want. That creates variance and variance is upside (unless you screw it up). So if you value the future over the present, the opportunity to do more and earn less until later is always worth more (shoutout lifetime value) than the opportunity to do less and earn more in the present. Even a lot more (unless you screw it up).
Back to serendipity (and whoa is this too long a tale), I got hired at the Fool just as they were recovering from the dot-com bust, so I was a very junior employee at a very small company given the opportunity to do whatever I thought I should to add value while sitting at the same pod everyday as Bill Mann (you’ve met him before) and Fool co-founders David and Tom Gardner.
Serendipity.
I listened first-hand as smart people debated not only what investments to make, but also how to run a business that was at times under stress and at other times very much not. I guarantee you that the people being hired into Amazon or Apple or Goldman weren’t and aren’t being afforded the same opportunity.
After more than a decade of doing that (and a short stint managing Morgan), I got introduced to Brent Beshore (because of Morgan…it all comes full circle), saw what Brent and team were building here in mid-Missouri and thought it was pretty smart, and was paying attention when he told the world he needed someone “with a breadth of financial, accounting, and tax experience to help lead our team.” Even though I had little of any of that, I sent him an email saying that I thought I could be helpful, we met, and here I am. So the answer to how I got to be the chief investment officer of a private equity firm is: I was curious. I learned from great people. I worked hard. I took risk. And I got lucky (because I don’t think I ever applied for and then was offered a job I was qualified for).
And curiosity, mentorship, work, risk, and luck is a helluva equation. But I’ll tell you, I often think what might have been different if Doug had unplugged that phone.
-Tim
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Get Activated
It seems like tradition now to start off each season with a learning from the u12 (now u13!...where does the time go?) girls soccer team, so here we go…
We had a subset of the team play recently in a 3v3 tournament. What you need to know about 3v3 soccer is that it is a fun and fast-paced game, but played on a small field with small goals and no goalies and in very short duration. So whereas the girls were used to playing on a big field with big goals with goalies for 60 minutes, now it was the opposite compressed into 24.
Which sets the stage for variance…
We won our pool games going away and so therefore all of the other teams had their sights set on us. Come the semifinals, we came out complacent against a team that didn’t. They got an early lead and our girls didn’t help themselves either by being errant on some shots on a small goal that might have gone in on a bigger goal. And starting with about 10 minutes left in the game, the other side started clearly trying to run out the clock.
It worked. Our girls lost 3-4.
Facing a dejected group ahead of our consolation match, I said, “Hey, is this field bigger or smaller than normal?”
“Smaller,” they replied.
“And is the game longer or shorter?”
“Shorter,” they replied.
“So if the field is smaller and the game shorter, does each touch and moment matter more or less?”
They kind of looked at me funny.
“Guys,” I said, “on a small field with short time, every touch and moment matters more. So get activated. If we come out flat, luck and chance are going to decide the game. But if you’re activated and play the way I know you can, you control the outcome.”
And I think that resonated because the girls won the consolation game in lopsided fashion.
I’ve said previously in this space that sometimes it feels like the world conspires against us. And while it can certainly feel like that is the case, I think what’s more true is that the world is full of competing interests and also that there are a finite number of outcomes, which means that we all don’t always get what we want. Further, it may be the case that the field is always smaller and time shorter than we would like. So if you’re complacent and come out flat, you might get an unpleasant surprise.
This isn’t to imply that everything is zero sum like the outcome of a 3v3 soccer match, but rather that if you’re not activated, you should be and particularly so when (because?) fields are small and time is short.
-Tim
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The Dots are Off the Beach
If you’re new to Unqualified Opinions, or maybe even if you’ve been reading since the beginning, you may be wondering what the heck the deal is with the Dots. The answer is: It escalated quickly. It really got out of hand fast. It jumped up a notch.
Looking back at my notes, it started when SarahBethGDub and I were talking about what to call this thing that didn’t yet exist way back in January 2023, and (after we nixed “From the Trenches”) I suggested Unqualified Opinions (an audit and accounting joke). She said she liked that and so I asked her to come up with some branding to put at the top of the email that “was a little irreverent and maybe incorporates your dot people somehow.” Next thing we knew she was putting hats on Dots and making punk rock Dots and investing icon Dots (sometimes both at the same time) and now, for better or for worse, we have legions of them (see the beach party scene below that evokes Seurat’s 1884 pointillist masterpiece A Sunday Afternoon on the Island of La Grande Jatte).
Between you and me, I thought about not bringing Unqualified Opinions back for a fourth season. It seemed like it had had a good run and done its job, and I have some trepidation about becoming boring and/or didactic and/or repeating myself (and Danny-didn’t-get-a-glass has accused me of at least one of those things). But then SarahBethGDub made the new Season 4 nameplate with Swaggy Dot above, and now I’m all in (and hope to live up to expectations without being boring, didactic, and/or repeating myself).
So the deal with the Dots is that they’re fun. And if you’re going to do anything for an extended period of time, you need to have fun. Dots are fun. I hope you’re having fun. I’m having fun. Let’s have some fun.
See you Monday for Season 4.
-Tim
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¡Adios Amigos!
The Ramones released ¡Adios Amigos!, their last album, in 1995, nearly 20 years after they released their debut, Ramones. Johnny Ramone, the band’s guitar player, rated it a B+ saying, “Some of our albums would have three or four really strong songs, and then the rest would be pretty weak. But on this one, even the lesser stuff is decent.”
(And I hope that you would at least say the same about this third season of Unqualified Opinions.)
The reason this is relevant is that one fascinating video you can find on the internet is a 16-plus minute compilation of The Ramones playing their hit “Blitzkrieg Bop” over the years at faster and faster tempos. What started as a 175 beats per minute jam in 1975 accelerated to a 252 beats per minute screamer by 1996. That’s fast! And it’s relevant because it’s a simple-but-elegant illustration of a point I’ve been meaning to write about for a while, but haven’t been able to find a way to do so without it seeming didactic.
Namely, that there is no substitute for reps.
How do you play “Blitzkrieg Bop” at 252 beats per minute? By playing it for 20 years straight at less than 252 beats per minute, but pushing the envelope a little bit more each time you do.
How do you find more than a few mushrooms? By spending years looking for and not finding them.
How do you build a portfolio of good investments? By analyzing thousands and thousands of bad ones.
This, of course, isn’t a new idea. Even since before author Malcolm Gladwell coined the “10,000-hour rule” in his book Outliers, everybody knew that (deliberate) practice (informed by feedback) made perfect. Yet I’m always surprised by the frequency I turn to Brent or someone else in the office and we say almost simultaneously, “Huh. It turns out reps matter.”
Because most things are not rocket science. If you show up, put in the effort, and learn from failure and feedback, I all but guarantee you will develop an enormous competitive advantage in your chosen field. You, in other words, will be playing “Blitzkrieg Bop” at 252 beats per minute when everyone else struggles to get over 200.
There. That’s my observation that reps matter. It still seems didactic, but since this is where I am going to end Season 3, unsubscribing will do you no good. Yes, I know we published through Memorial Day last year, but we’re hosting our first ever Partner Summit in Columbia, Missouri, next week on Monday and Tuesday and then a few hundred more people for the fifth annual Capital Camp on Wednesday and Thursday. In other words, next week is pretty chock full and then the lazy days are here. But if you’re looking for a more dramatic finale than this one, go back and read Day 2. A bunch of people told me it made them cry.
Have a great summer and thank you for reading and writing back.
-Tim
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The Long-Awaited White Paper
Thank you for bearing with me as I spilled my thoughts about portfolio construction out onto the page. It turns out that writing a cohesive white paper is difficult, particularly when it’s on an abstract topic with the goal of being both in-depth and in plain English.
But here we are, and I am proud to release Portfolio Construction and the Lower Middle Market to the world. (Click that link or this one to get your copy.)
If you read the working on the white paper series in this space, there may not be much that’s new, but I think each section benefits from being together in the same setting as the others. For qualified investors, we are working on an expanded version that includes data around Permanent Equity’s portfolio and its returns over time, but we can’t put that out into the wider world because the SEC would frown upon it (spoilsports!).
Hopefully, you find our weird way of thinking about the world helpful.
-Tim
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Explore, Exploit, and XNPV
I’m not fishing for compliments, but it’s hard work to write everyday (except on weekends and when I arbitrarily decide to take two weeks off for spring break). And it’s not so much the writing that’s the hard part, but rather the generating of ideas to write about. Of course, that was the whole point when I started doing this: I challenged myself to find something interesting to say everyday.
And again, not fishing for compliments, but based on the responses I’ve received from you all to the things I’ve said everyday (except on weekends and when I arbitrarily decide to take two weeks off for spring break), I think that’s mostly been the case. But I can’t take all of the credit for that because along the way I discovered a hack for being able to say something interesting everyday, and that’s to respond to something interesting said to me. That’s why so many of these start with prompts from you.
With that as background, here’s what I heard back from Daniel after I wrote about hunting for mushrooms(!) in a business-like manner: “This reminds me of the explore-exploit paradigm in computer science. Great post.”
Now, did I include “Great post” in the quote there because I am fishing for compliments? Maybe, but more importantly, explore-exploit! I vaguely recognized that terminology, but it had been a long time since I had heard it and I have zero computer science background, so I looked it up. Here’s what I found on Wikipedia:
The exploration-exploitation dilemma, also known as the explore-exploit tradeoff, is a fundamental concept in decision-making that arises in many domains. It is depicted as the balancing act between two opposing strategies. Exploitation involves choosing the best option based on current knowledge of the system (which may be incomplete or misleading), while exploration involves trying out new options that may lead to better outcomes in the future at the expense of an exploitation opportunity. Finding the optimal balance between these two strategies is a crucial challenge in many decision-making problems whose goal is to maximize long-term benefits.
I feel seen.
If you want to be crass, I think you can reduce a lot of business, and perhaps the world, to the explore-exploit paradigm. Or as I say, because I live in the world of spreadsheets and not computer science, everything is a present value-future value problem (shoutout XNPV). But a crucial nuance that explore-exploit calls out, that present value-future value doesn’t, is that when making a decision, your current knowledge of the system may be incomplete or misleading. But “may be” may be being generous there. That’s because it may be the case that when making a decision, your current knowledge of the system is incomplete or misleading.
I say that because after I wrote about your colleagues having an outdated perception of you, Brent wrote me back and said simply “Perception is a lagging indicator for all things.”
And I said, “If that’s true, then perceptions are always wrong, which is humbling.”
To which he said, “Yessir.”
And while I am tempted to end it right there, the point is, and this is a recurring theme this season, that you or the world is always moving on, so you will never have or have processed the information you need to ever make a bullet-proof decision about what to do next in business or anything else. So explore as you exploit, but also exploit as you explore, and thank you to Daniel for bringing that to my attention.
-Tim
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Don’t Skimp on the Swag
We were meeting with the owner of a blue collar business recently and he was curious if he did a deal with us, what types of things might change. For example, he’d heard that a lot of private equity firms like to identify and cut unnecessary costs post-close in order to increase profits and pay down debts. He said he probably had some of those, but if that was us and we did a deal together one thing we most assuredly couldn’t get rid of were his boots.
Curious, we asked what he meant by that.
Well, he said, every year the company buys each employee a nice new pair of boots and outfits them with new branded shirts and jackets to wear in the field. Further, the employees had some say over the brands and styles purchased for them provided what they wanted was up to safety specifications. The program, he went on, cost about $10K per year.
Before we could interject, he held up his hand and said hold on. Sure, he could make his employees buy their own gear (in fact, his competitors mostly did) and sure, boots and swag could last more than a year, but he thought the investment more than paid for itself.
He held up his hand again…
Because of all this great stuff, he went on, his employees happily complied with his uniform policy. This meant they had uncompromised steel-toed boots, had reflective material where they needed it, and were always dressed appropriately for the weather. This, he thought, meant they were always able to take their time and do a good job regardless of conditions, which also contributed to his company’s pristine safety record.
Second, it was great for morale and culture. These were not items these employees might splurge on for themselves so that meant they were not only happy to receive them, but also that they proudly wore them outside of work. This, he knew, helped with customer acquisition and retention as well as with hiring.
So, he concluded, no matter what happens, we are keeping the boots.
Finally given the chance to speak, we wholeheartedly agreed. In fact, we told him, we do the same thing at Permanent Equity. See, our founder and CEO Brent had an insight a couple of years ago that while we had purchased a lot of swag, people didn’t seem to be wearing it. So we brainstormed about what we might do about that (throwing away ideas like forcing people to wear it or making them get PE tattoos) since what good is swag if it just sits in a drawer? What we finally hit on is that we’d give each person a generous budget to buy whatever swag he or she wanted to wear and then have a PE logo put on it.
Within months no one was not wearing PE-branded apparel, and we’ve continued upping our swag game (shoutout James) from there, spreading the love to spouses, investors, portfolio companies, friends of the firm, etc. Now if you come to our office today, not only will you see almost everyone in PE-branded something or others, but you are likely to go home with a PE-branded something or other yourself for all of the reasons the owner of that blue collar business cited. Or as the great Deion Sanders says, “Look good, feel good. Feel good, play good. Play good, the pay good.”
-Tim
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Are You Being Chased by a Bear?
Something I do now is walk over to Stankowski Field in the middle of Mizzou’s campus early in the morning before the students are out and take the old man VO2 max test that I read about in The Wall Street Journal on the track there (which they say is one-third of mile in circumference, but is definitely shorter than that). That test consists of running as fast as you can for 12 minutes and then seeing how far you got.
I like it because I like benchmarking, the test is not too long, but not too short, and it’s been fun to see progress. And sometimes, to stay motivated, I imagine that I’m being chased by a bear.
Wait, what?
Well, after I wrote about creating a sense of urgency at work in order to drive accomplishment, I received a note back from Joe R. He said that one of his first bosses believed “that you never run faster than when you are being chased by a bear.” I thought that was a funny mental image, so I adopted it during my next old man VO2 max test.
As a practical aside, if you are being attacked by a bear, don’t run away. If it’s a black bear, fight back, but if a grizzly, play dead – and hopefully you have enough wits about you right as you’re about to be attacked by a large predator to know the difference. I digress…
While imagining a bear chasing me has helped me run faster and farther, it wasn’t a good management strategy for Joe R.’s first boss. Because in actualizing it he “motivated people with fear...in an environment of low communication…[and] remains the worst boss I’ve ever had.” Because, in Joe’s words, while “you run fast when being chased by a bear…you can’t run a marathon that way” (leaving aside the fact that it might go viral if somebody tried).
Of course, Joe is no longer in his first job and has moved up the organizational chain of command to lead others, so I wanted to know what he does differently as a result of that terrible experience. Here’s what he said:
I’ve found that you should recognize that everyone has an extra gear to up their productivity, innovation, etc. As a leader, I try to engage that gear regularly, but not frequently, and to do it by giving goals to people and teams that are hard but not impossible. I deliver these goals with the message that “I am confident you will figure out how to reach it, and I will help you to do so. I believe in you.”
And I liked that advice. After all, you can accomplish a lot during sprints, but if and only if you recognize that you need to rest in between them.
-Tim
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Return of CIMple Truths
If you’re a more recent Unqualified Opinions reader (and most of you are), CIMple Truths was a gag I pulled out on Fridays back during season one to highlight ridiculous things seen in deal teasers called Confidential Information Memorandums (abbreviated CIMs sounds like “sims”). I stopped doing it because as interest rates rose and deal flow slowed, people stopped making so many ridiculous claims (just not the Trump SPAC). But sufficient ridiculousness has accumulated since then that I thought I would run CIMple Truths out for a curtain call ahead of the weekend.
So without further ado, here are some things that recently made us scratch our heads.
Tech-forward organizations…
That is some cutting edge stuff.
Very humble brags…
Wait, is that a good thing?
Creative addbacks…
There’s probably a story there.
Non-core business…
Well, that was unexpected, but aren’t they all? Have a great weekend.
-Tim
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Becoming Predictable
I was talking to someone the other day about measuring investment performance and we got on the topic of volatility. I mentioned, with some frustration, how volatile and unpredictable the performance at some of our businesses can be and my interlocutor said, “I didn’t think you would have cared about that.”
“What do you mean?” I asked.
“In my view,” he went on, “measuring and worrying about volatility only matters when it captures the risk of being a forced seller at a bad time. At a firm like yours, with your horizon and mandate, it doesn’t seem like that would be a problem.”
And he’s absolutely right. The fact that unpredictable volatility exists together with our ability to tolerate it is what creates one of our biggest competitive advantages as an investment enterprise. After all, you can’t leverage and flip unpredictable volatility (or you can try, but you shouldn’t, unless you want to risk blowing up spectacularly), so we’re able to make investments others simply can’t.
Yet despite it being what puts food on my table, unpredictable volatility is still frustrating because staying prepared to weather it is an impediment to performance. Every dollar we reserve for liquidity, for example, is one that’s not generating return, and everything that happens for a reason we can’t explain is something we can’t reliably repeat in the future.
And it’s that last bit that’s so frustrating and that also raises important existential questions such as “What are we doing here?” Because if you, as a business, lack agency, do you really have a business at all?
It’s in recognition of the fact that an answer to that question is “No, that’s more of a hustle than a business” that one of our strategic priorities with our businesses is to help them become more predictable. This can mean taking on lower margin, higher volume business or signing longer-term agreements. But you also have to be careful here because becoming more predictable is a slippery slope. Certainty is expensive and if you fill up all of your capacity with guaranteed low-margin work, you’re not going to do very well either.
Where does that leave us?
One widely used investing metric to analyze risk and volatility is the Sharpe ratio, which basically says that something is good if it has positive returns with low volatility with volatility here measured using standard deviation. In other words, something is considered volatile in the Sharpe ratio if it goes down or up a lot and going up or down a lot is bad. But then Sortino came along and said “Wait a second.” Because if something goes up a lot in investing, that’s good! So Sortino put forth his own ratio that only cares about how volatile something is when it’s going down with the goal of finding investments that go up a lot when they go up and only do down a little when they go down.
I didn’t bring up Sharpe and Sortino here to wonk out on risk management metrics, but rather to draw a parallel to what it ideally means for a business to become more predictable. This is to take steps and do things that gradually make bad months less bad without also limiting what makes good months good. Because while bad months frustrate me like they would anyone else, if not for them, there might not be any good ones.
-Tim
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The White Paper is Almost Done
If you remember our joke about being in the business of shaving hair, then you probably remember the business we reached out to that had botched an acquisition and gone through some rough years as a result. The reason we did that was because what was oddly impressive about this situation was that despite years of losing money trying to integrate a botched acquisition, the core business had been able to fund those losses for so long. Ergo, the core business might actually be a good one.
So we reached out and floated a valuation and structure to suss out interest and receptivity. The valuation, we thought, was competitive and down the middle, but the structure was admittedly conservative since the valuation baked in righting the botched acquisition and then also refocusing on the core business to grow it.
As for what made the structure conservative, our offer was to pay half of the consideration at close and the other half a few years later contingent on those things (righting the botched acquisition and growing the core business) coming true. Our rationale was that the business was worth one amount if the obvious problems were fixable and a different, lesser amount if they weren’t.
Of course, 50% is a pretty big haircut and the upfront consideration probably undervalued the core business on a standalone basis. But the reason we weren’t comfortable offering a consideration equal to the standalone fair value of the core business upfront is because the core business wasn’t standing alone. Its management was distracted, its cash flow wasn’t 100% distributable, there was the potential for conflict in deciding what to do next, and taking steps to help the core business stand alone would be expensive (severance and lawyers and liquidation processes add up).
All of these things are risks and if you are going to take them, our view is that you need to be compensated for doing so. How do you do that?
In our line of work we see a lot of what academics would call “idiosyncratic risk.” These are risks that are unique to a situation and so therefore aren’t captured in the risk premia assigned to more widespread factors such as illiquidity, small-size, or equity risk. Examples include:
Inaccurate information risk: We’ve seen businesses that track their inventory in a spiral notebook and also lost track of inventory “back in the 90s.”
Slow feedback loop risk: We’ve seen businesses that don’t close their books until six to eight weeks after the end of the month and others that only do reconciliations quarterly.
Whim risk: We once saw a business whose sole supplier was wholly-owned by a hostile foreign government and another whose sole customer was a big box retailer. In either case, the reversal of course by the counterparty would cause the business to disappear overnight.
Rural risk: It’s really hard to relocate talent to small towns.
Relationship risk: Are customer relationships with the business or with an individual?
The list goes on…
Now, some of these, like whim risk, could metastasize overnight, while others, like rural risk, manifest themselves as more incremental long-term headwinds. But you can take any of them (and we have taken some, but not all of these) provided you are compensated for taking them. Now, if you asked a firm to do an independent valuation, they might look at these idiosyncratic risks and bucket them into an “Additional Risk Premium” that they add to the discount rate when valuing a projected stream of cash flows. And that’s one way to do it, and we do increase our required rate of return as we identify more and more idiosyncratic risks.
But structure is another useful tool in making sure investors are compensated for taking odd risks because thoughtful structures can more effectively account for the potential timing and magnitude of the impact of a specific risk materializing.
For example, in the case of whim risk, the business might disappear overnight. To be compensated for that might mean negotiating a deal structure with a shorter payback period and perhaps attaching a put option as well.
For something longer-term like rural risk, you might ask for some kind of hurdle or preferred return that bakes in the expected growth rate in the event it doesn’t materialize.
To return to our offer of 50% guaranteed at close and 50% contingent and deferred to invest in a turnaround project, we felt that our offer was fair because it compensated the seller appropriately for what had been achieved to date, but also recognized that they were offloading significant risk to us. But offers aren’t made in a vacuum, and in this case we got blown out of the water by someone who offered more than us all guaranteed at close.
Now, that’s a great offer if you want to get a deal done, and in terms of immediate feedback loops, mission accomplished. But is that buyer being compensated for the longer-term risks they are taking or is it the case that we wrongly perceived more risk than was real? Only time can tell on that.
-Tim
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You’re Different
I usually take everything that’s written in the Harvard Business Review with a grain of salt, but this piece about “When Your Colleagues Have an Outdated Perception of You” resonated. That’s not only because I think people have had an outdated perception of me in the past, but also because I’ve been guilty more than once of having an outdated perception of someone else and seen people I respect and admire have their career paths impeded due to others having an outdated perception of them.
For example, I recorded a podcast recently with some guys who work with some guys I used to work with. In order to make that happen, we exchanged emails with the customary pleasantries. One of those jokingly closed with “We’re looking forward to having you on. A lot of folks think very highly of you…[but Person A] warned me to avoid you on the basketball court.” As Shakespeare wrote, there is truth in every jest.
Because was I once a competitive monster on the basketball court? I will cop to that.
Am I still? Not as much!
But the perception persists.
As for how this works in the working world, that HBR article relates the story of an entry level employee at a company who grew to manage a team responsible for $22M of revenue, but was still considered unqualified for the role of chief sales officer when it opened up. I had a similar experience in a previous job when I was trying to hire for a role whose primary responsibility would be measuring, reporting, and providing feedback on the performance of others – which therefore required a lot of collaboration and conversation. I identified someone I thought would be perfect for the job, but was warned by his manager that he was too stubborn and single-minded to do well in such a role, citing, when I pressed for information, an experience he’d had 24 months prior (the guy ended up doing great).
A recurring theme this season has been that either you or the world is always moving on. My hope for you is that you’re always moving on and in more interesting and productive directions. A funny thing about that, however, is that even if you are, others may not see or understand the change. To combat that, the article makes two recommendations:
Have a “conversation strategy” with your coworkers that enables you to receive immediate feedback.
Delegate tasks that may make you feel productive, but that you have outgrown.
Now, even if you do that, perceptions of you may linger, but if you’re getting transparent feedback and always seeking out your highest and best use, my experience is that you’ll achieve tremendous personal growth and that the world will catch up to reality eventually. That’s because, as I wrote when I was talking about high-performers, the world is more merit-based, and more people want it to be so, despite injustices, than it appears.
-Tim
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Growth and Feedback Loops
One of our portfolio companies recently completed our second tack-on acquisition, and we are hunting for more. That hunting, however, is not broadly across our entire portfolio, but only at companies for which tack-ons make sense. The reason that’s so is because growth is risk and if we try to do a tack-on at a company that is not prepared for it, then the complexities associated with finding, evaluating, closing, and then integrating an entirely new, different, and potentially messier operation might derail the core business.
In recognition of that, we developed a simple checklist to help us gauge when we might pursue tack-on acquisitions on behalf of one of our portfolio companies. For us, the company needs to have:
Demonstrated stable business performance;
While generating timely and accurate financial statements;
With trusted leadership in place that is likely to remain in place; and
Resources available to oversee integration.
Our view is that absent these characteristics, a business that makes a tack-on acquisition is:
Unlikely to know what to do with it;
Unable to manage it; and
Without any idea how it’s going (or, worse, liable to have hallucinations).
And that, for us, is a recipe for disaster.
Recently, we’ve started putting the many business models that exist in this world into two buckets: fast feedback loop and slow feedback loop, with a variety of factors determining the pace of the feedback loop of a business. In other words, if you make, sell, get paid for, and watch your customer consume your product all on the same day, that’s a fast feedback loop. If that happens over a period of years, on the other hand, that’s a slow feedback loop.
Our experience is that slow feedback loop business models are dangerous because you can’t have a precise idea of how you’re doing at any given point in time. You know how you’ve done and how you might expect to do in the future, but things could go off the rails at any time without you being aware that they have for quite a while.
To bring this back to tack-on investments, the point of our checklist is to make sure that any of our businesses that do one have the conditions in place to make sure that the feedback we get on the deal is fast. Because if it’s not working we want to know that as soon as possible in order to right the course and if it is, we want to know that too so we can try to do another one.
Because while organic growth is great, inorganic growth, done right, is a cheat code.
-Tim
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Be Kind, Not Nice
Maybe it’s semantics, but recently around the office we’ve been talking about the difference between being low-performance nice and high-performance kind. This came up the other day because a CEO we know reached out about one of her senior employees. This person, who has been struggling in his role for some time, expressed frustration about having not received a compensation increase for some time. What, he asked the CEO, did he need to be doing differently?
The CEO sought our advice because, while this was not a critical employee, it was an important one. Further, her assessment of the reason for his struggles was more fit than attitude or skill, but unfortunately the business did not have a role to offer that might be a better one. So if she told him the unvarnished truth, she was not only worried that he might leave, but that in this tight labor market, he would prove difficult to replace. Might it be better for everyone, she wondered, if she said she thought everything was fine and encouraged him to just keep working hard?
Given that context, what we’ve been talking about around the office is that the latter seems like the low-performance nice thing to do. It doesn’t rock the boat, it closes down the conversation, and it doesn’t make anyone uncomfortable. And the fact that it doesn’t make anyone uncomfortable – neither the CEO nor the employee – is a key point. It’s relatively easy to be nice, and being nice enables one to be done with a hard conversation. In other words, being nice is about protecting you to the disadvantage of the other.
If something is easy and conclusive, of course, it probably means it is also lazy and settling (except for no-brainers). Hence the low-performance part. Because those aren’t the characteristics of a good business or, more importantly, a good relationship.
So if that’s the low-performance nice thing to do, then what’s the high-performance kind thing to do?
Now, nice and kind are often used interchangeably and certainly what they have in common is that a person who is those things is polite, careful with words, and cares that the people they are interacting with have a positive experience. With that as a given, the high-performance kind thing to do here would seem to be to explain to the employee the situation he finds himself in that is in some ways through no fault of his own. And then to take time to figure out where the employee sees himself in the future and ideate paths forward that might help him get there. Another high-performance kind thing to do would be to offer support, but not subsidy.
This, of course, is harder than being low-performance nice. Not only does it take more time and thought, but if the conversation doesn’t go well it also potentially leaves the CEO in the lurch. Yet if it goes well (and why wouldn’t it if you truly have one’s best interests in mind?), everyone ends up better off. Put another way, kind is about helping the other, which should end up being better for both of you because it’s always the right thing to do to help people get where they want to go (just don’t ask me about the time some West Virginia fans asked me how to navigate the DC Metro after their team had defeated Georgetown in basketball).
So be kind, not nice, and have a great weekend (and sorry to those West Virginia fans who got on the wrong train).
-Tim
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Average Deals
Someone asked me about Permanent Equity’s average deal the other day, so I pulled the numbers. On average, I reported back, when we make an investment we buy 75% of a company, write a $20M check, and pay six times beer money.
But, I said, you may want to be careful with how you use this information because we don’t own 75% of any company and have never written a $20M check nor paid six times beer money. Instead, we own anywhere from 51% to 100% of our portfolio companies, have stroked checks ranging from $5M to $68M, and paid (leaving aside the nuance as to how some of these investments were structured) as little as two and as much as 12 times beer money.
Now, when I tell people about this deviant behavior, the reactions are not down the middle either. In fact, one potential investor declined to continue chatting with me, saying “your deals seem funky and capital deployed is too intermittent.”
Okay, then.
But this particular investor said, “That’s great. The fact that you all have done such a wide variety of deals shows that you’re taking advantage of the flexibility of your fund structure and lends credibility to your claim that you’re always trying to do things that make sense.”
Exactly.
See, no two deals are alike for us and there is no average deal. That’s because we view sellers of businesses as our customers and our product as capital. And since money can easily become a commodity where the only better is more, we try to offer our customers differentiated and personalized products that best achieve what they are trying to accomplish. In some cases, yes, that’s money, but in others it can be things like partnership, certainty, legacy, or peace of mind (or some combination of all of the above). That doesn’t mean we win every deal, of course, but we find that since our offers tend to stand out, they usually garner presentation and at least some consideration.
And since nothing gets done without first being considered, here’s to never being average.
-Tim
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I’m Gonna Finish this White Paper
Something I first read a long time ago, but that took a while to understand and appreciate was this special feature from the June 2000 Bank for International Settlements Quarterly Review. Called “Evaluating changes in correlations during periods of high market volatility,” it makes the case, using math, that when things become more volatile, they also become more correlated.
Now, if you’re among the legions of people more intuitively numerate than I am, you might be saying, “No duh.” But for me this was not intuitive. That’s because it seems like one way to think about volatility would be as difference. For example, if lots of things are zigging and zagging all the time, it seems like it should be the case that all of that zigging and zagging would be more random and therefore less correlated.
But another (and the right) way to think about volatility is as magnitude. In other words, something that’s volatile isn’t necessarily zigging and zagging a lot, but rather has the potential for explosive zigs and catastrophic zags. And as the math in that paper shows, while there can be a lot of relative difference between a lot of events in a clustered distribution, extreme events are fewer and a lot more alike relatively speaking precisely because they’re extreme and so they are much more highly correlated.
This is a problem for business and investing because Modern Portfolio Theory posits that you can earn better returns with less risk by doing things that are uncorrelated. But if it’s true that things become more correlated when they start going really badly, then the benefits of being diversified are reduced at precisely the time you need them the most.
And this is a reality that has proved to be true during significant market dislocations.
This National Bureau of Economic Research working paper, “Long-Term Global Market Correlations,” was published in November 2001, just as the bursting of the tech bubble and 9/11 terrorist attacks were wreaking havoc on global markets. It remarked that “the diversification benefits to global investing are not constant,” that “diversification potential today is very low compared to the rest of capital market history,” and that “periods of poor market performance, most notably the Great Depression, were associated with high correlations, rather than low correlations.” Global correlations increased again with the 2009 financial crisis, and during Covid everything went way down then way up together.
In other words, it’s clear that when people panic, they’re likely to panic about everything all at once.
And while there is less academic research into how this propensity manifests itself in small operating businesses, I can tell you from experience that when something starts to go poorly at a small operating business, a lot more is likely to go poorly alongside it. A business that loses a bunch of money on a project, for example, might see performance suffer at other projects as it repurposes its best people to deal with the crisis. Then its controller, stressed out by the situation, might decide to retire a year earlier than expected, leaving a massive hole on the leadership team right when accurate numbers are most important. And seeing deteriorating prospects and a lack of appetite for growth, a star salesperson might then leave for a competitor. Heck, it’s when morale is low that office supplies even start to disappear.
When it rains, as they say, it pours.
So if the lesson is that the world is more correlated than we think, an implication is that we can’t engineer our way to stability when constructing an investment portfolio or building a business. Instead, we have to accept that there will be instability and that when it happens, there will be a lot of this at once. The two ways to handle this are (1) temperament, i.e., know ahead of time what you’ll need to do to keep your cool and (2) structure, i.e., your agreements with others and liquidity requirements can never turn you into a forced actor.
-Tim
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Skateboarding Non-Competes
AThe thing I miss most about living in the city is skateboarding to work. See, because if you live one mile or so from your office (and not on a gravel driveway in rural Missouri), a skateboard is the ideal form of transportation. That’s because:
You get where you’re going faster that if you were running or walking; but
You don’t sweat through your work clothes; and
You can keep that mode of transportation under your desk; so
You can commute home quickly in the evening even if traffic is backed up into the parking garage (true story).
But the problem with skateboarding to work back when I lived in Alexandria, VA, was that it was illegal. Skateboards were not allowed on the roads, nor in the bike lanes, nor on the sidewalks, which made for a bit of a kerfuffle about where they were allowed. And while very few police officers enforced those limitations, few is not zero, and so therefore I had a number of awkward encounters with badged men with strong opinions.
Thankfully, nothing ever escalated to the level of prison. But I mention this all here in reference to the recent FTC decision to nullify and ban non-compete agreements.
Bear with me…
I wrote that one way I’m inspired to write these missives is by talking through things with my son on the way to school in the morning. And so this came up the other day when we were listening to NPR and Morning Edition reported on this story in between reporting on how abortion restrictions are contributing to global warming (I kid, I kid). He was interested in the issue (non-competes) and knew that it had relevance to me and asked what I thought about it. I said something like, “Most non-competes are unenforceable anyway, but that said I’m all for free markets, but that also said, I’m also for contracts.”
I get, of course, that the idea here is that some number of these so-called non-competes have been thrust on people who don’t understand what they agreed to and also may not have the firepower to litigate them (and therefore are already unenforceable!). But provided there is thoughtful negotiation between informed parties, what about leaving us negotiators alone? Because I didn’t see anything in the FTC’s ruling about reducing compensation or severance for eliminating the non-compete even though those things would have been agreed to right around the same time. And if that’s true, this would be a long-term drag on wages and business valuations (particularly for those whose main asset is intellectual property) even as it might be a near-term election year talking point win.
Imagine that.
-Tim