Transcript
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Are basically 3 ways to make money in buyout
that we see.
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1 is you grow the business.
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You grow revenues.
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You grow EBITDA.
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You grow cash flow.
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The second one is you expand the multiple of
that business.
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And there are kinda 2 ways that that happens.
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The first one is completely beyond the control
of us and the GP, and that's interest rates go
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down.
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Usually, as interest rates go down, multiples
go up.
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The other area of multiple expansion work is
and it's something that's really in control of
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our GPs, which is professionalizing that
business, creating a business that has a
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sustained higher level of growth rate,
expanding the investable market, reducing
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customer concentration.
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There's a number of things and levers that
people can pull to improve the value and the
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worth of that business to the next buyer.
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And then the third way to make money and buy
out is debt and leverage.
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Why has the endowment model outperformed nearly
every other institution over the last 40 years?
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The empirical data of greater than
$1,000,000,000 endowment over time is pretty
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compelling.
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If you look over the last 10, 20, 30 years,
that greater than $1,000,000,000 group has
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really outperformed almost every other kind of
institutional endowment foundation group that
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have smaller sizes.
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I think there are two primary reasons for that.
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So Brogan Bro manages 4,000,000,000.
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Break that down for me.
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The firm manages about 4,000,000,000 plus or
minus depending on the day.
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Assets under management are about 60%.
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Private wealth, which is individuals and
families, usually taxable capital.
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And about 40% is our OCIO practice, which is
typically endowments and foundations, typically
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nontaxable capital.
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Given the differences in planning and taxes and
a number of other things, we have teams that
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specialize and manage each each of these
practices.
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From I am on the OCIO team.
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And you mentioned that you always book clients
first.
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What are some practical trade offs that that
creates for the firm?
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From a trade off perspective, I I think it's
just the way that we've always been built at
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the firm.
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I mean, Austin and Jim, who founded the
business in 1970, they were working at at
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larger firms and really felt like they were not
incentivized to put the client first.
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And I just think that whether that was morally,
whether that was business wise, a number of
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different things in terms of longevity of
relationships, I just felt like they they
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thought that the better business practice was
really to to put that client first to really
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extend the life of that relationship for a very
long period of time rather than to use that
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relationship for short term gain and then have
to churn that client because they felt like
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they weren't being taken care of the way that
they ought to be.
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And so if you really think about, you know,
call it the discounted cash flow analysis of a
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client or the the churn of a client that
they're they're you know, they were thinking
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about probably the long term, you know, value
add or long term compounding of that client
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over that period of time and felt like having a
a client that was with you that maybe you
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didn't gain as much revenue off of immediately
but were able to have for a much, much longer
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period of time was was really just a better
business practice, and I think they felt better
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about it as well.
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Taking away the moral aspect, is putting your
clients first a smart long term strategy?
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In other words, does it have compounding
factors?
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We think so.
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I mean, you know, our on the private wealth
side of our business, our our retention rates
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are in in excess of, you know, 95%.
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It's probably more like 98 or 99%.
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So we rarely lose clients, and it's a function
of the fact that we believe that we take care
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of them and produce returns that are that are
certainly, helping to compound their capital
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and and so that they, you know, have to worry
as little as possible.
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They could certainly be involved if they want
to, but if they don't wanna have to pay
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attention to their financial management, they
they know and they can trust that that we're
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doing that for them.
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So you started at Broganbro in the OCIO part of
the business in 2012.
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You joined 1 week after the OCIO business
started.
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Tell me about the portfolio you inherited and
how that's evolved over 13 years.
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As I mentioned, you know, the firm in 1970
primarily managed, private wealth capital from
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that period of time.
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And while we did manage some smaller endowments
and foundations over that period of time, the
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firm really didn't utilize what I'll call the
endowment model at that point, which was made
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popular by David Swenson in in the Yale
Investment Office.
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We had the opportunity in 2012, to begin our
OCIO practice, and I was the first hire in that
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practice that you mentioned.
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I came from the University of Richmond's
endowment, which is called Spider Management
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Company, and we were fortunate enough to begin
that practice with a handful of clients and
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about $600,000,000, on January 1, 2012.
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Today, that practice manages 10 clients, and
about 1,700,000,000.
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And if we were a single endowment office, we'd
be about the 75th largest endowment in the
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country.
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So as you mentioned, we began in 2012 with a
portfolio that had been managed by an
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investment committee that really met quarterly
to make decisions.
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And one of the selling points of outsourcing to
Broken Grove was that, you know, the idea we'd
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give these long live pools of capital kind of
the daily attention that they that they
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deserved.
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And so while our initial clients had hedge
funds in their portfolios, that exposure was
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generally through fund to funds, not direct
relationships.
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And other than a tiny bit of real estate, the
clients had really nothing in private
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investment, so very very light on the
alternative side.
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We did a ton of work, with each client's
investment committees around strategic asset
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allocation, and we coalesced around the idea
that the portfolio could and should be managed,
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using the endowment model approach, to better
optimize returns.
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When we last chatted, we talked about the
endowment model, as you mentioned, popularized
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by David Swenson from Yale.
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Why has the endowment model outperformed nearly
every other institution over the last 40 years?
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So, yeah, the empirical data of greater than
$1,000,000,000 endowments over time is pretty
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compelling.
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If you look over the last 10, 20, 30 years,
that greater than $1,000,000,000 group has
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really outperformed almost every other kind of
institutional endowment foundation group of
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smaller sizes.
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And I think there are two primary reasons for
that.
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One is higher allocations to alternative
investments generally, like hedge funds and
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privates.
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The second area, as I mentioned, is having
access or or, you know, to capacity constrained
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or hard to find managers.
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And and the hope is is to that that those, you
know, hard to access things will generally be
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in the top half of that that widespread that I
mentioned or better, over over some period of
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time.
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And so the you know, it's really those two
things that are the the majority of the
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difference over over time.
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There is another third reason, and I mentioned
it earlier, which is skill.
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And, you know, skill is obviously hard to
measure, on an on an ex ante basis, but, you
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know, what we've seen over time is if you have
teams that are culturally aligned, that are
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philosophically aligned, that have generally
worked together for a statistically significant
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period of time, they've often tended to
optimize their decision making around each
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other, and they often will will look at the
team and understand what the core competencies
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of that team are, and they will optimize their
decision making or and and they tend to
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concentrate in those particular areas.
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There's no one way.
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It really depends on the on the skills and and
experiences of the team to do that.
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But we've seen that that that third part, the
skill piece is is important because look.
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I mean, if I say greater than $1,000,000,000
endowments have have had more in alternatives,
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it's it's easier to allocate money to our
alternatives, if you're someone just sitting in
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a in a in a chair somewhere in an office.
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And to some degree, there are plenty of groups
that even can get access to, you know, what
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would be hard to access or or capacity
constrained managers, but there are also plenty
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of capacity constrained managers that don't end
up in the top half of those spreads.
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So it's really that judgment or the execution
layer, of the team to choose among the
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available options that tends to be over time
really, really important and separates, you
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know, even the the the good $1,000,000,000
endowments from the excellent ones.
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And that skill factor, do you attribute that to
just better recruiting, more prestige?
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Why do large endowments have higher skill?
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One of the the endowments that we've tended to
model ourselves after over time is the Notre
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Dame Endowment.
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They've they've generally, you know, hired this
part, we can't necessarily do, but most of
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Notre Dame's offices are Notre Dame graduates.
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They call themselves Domers.
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And most of them in Notre Dame offices is is
Domers.
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So they have that, you know, that passion, that
that alignment from the mission perspective of
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of of, you know, having gone and graduated,
being an alumni from school that I think is
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super helpful, in terms of feeling more like a
vocation than a job.
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And then I think over time, just the the the
alignment of of learning from the the the
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people that, you know, that hired you, it's we
really look at it like a craft or an artisanal
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type of situation where you come in and, you
know, you may have certain skill sets and
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things like that, but you're kinda taught the
way that the various endowments and foundations
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invest, or the way our office invests.
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Each person certainly then brings their own
thing to the table that that hopefully can be
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additive to that process, and and sometimes
different as well, which is great.
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And so but the goal over time is is to utilize
those things to your advantage and to
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concentrate your portfolio in the areas where
you believe those things give you a core
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competency to succeed.
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And I think the other thing that's been
important over time is is not to have too many
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people deciding.
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There's a ton of research around this, but
there's a there's a 1976 study that I often
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refer to that talks about decision making
quality.
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And, usually, the optimum number of team of of
size of the team in terms of optimizing overall
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decision quality is is an odd number between
37.
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And and after 7, it the the the decision
quality actually tends to decline at a at a
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relatively modest rate, and then it actually
increases as you add people.
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We oftentimes talk about succession or the
apprenticeship model among top general
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partners.
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Is there a succession and apprenticeship that
goes into being a top limited partner?
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I do think it's very much an apprenticeship or
an artisanal.
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It's craft in in many ways, I think.
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And and, again, it's not like you're trying to
hire and and create facsimiles of of, you know,
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the people at the that are more experienced and
more senior in the organization.
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I do think that each person brings their own
perspective and and their own tilt based on
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their own experiences that they can that they
can add to what they're learning.
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But, yeah, I think there's definitely a craft
to it, and I think that it's it's something
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that can make its way through an organization
that can improve decision making over time.
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You mentioned when we were chatting about the
endowments that 40 year track record of success
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may be coming to an end.
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Why don't you believe that the large endowments
will continue to outperform to the same level
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over the next 20 years?
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If David Spencer were alive today and you asked
him if he thought he could generate better
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returns at the current scale of the Yale
Investment Office or when and he was in the 19
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eighties when I think the Yale Investment
Office was maybe $2,000,000,000 a 1,000,000,000
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and a half when he started with them.
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I think he felt like he'd probably make more
money when he was small.
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And that statement, again, isn't to take
anything away from the Yale Endowment today,
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where, you know, I think the Yale endowment
does a wonderful job at at this current current
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size, but they have they they do have a lot of
resources.
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Can they do it in the same size that they were
doing it 10 or 20 or 30 or 40 years ago?
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And that that you know, both those to say yes
to is harder because at the size today, a
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$50,000,000 investment 20 years ago might be a
$200,000,000 investment today.
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Let's talk about asset allocation.
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Broken Bro really focuses on small buyouts.
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Why do you focus on small buyouts?
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We don't do only small buyouts.
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That I just wanted to state that upfront.
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I mean, you know, we have a we have a fully
diversified portfolio across all asset classes,
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but we definitely have chosen to have more of
our capital in small buyout.
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And and so it's an area that that we we really
like.
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If you look at the last 10, 20, 30 years, small
buyout has actually had the best risk adjusted
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performance of any private asset class.
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So I will I will say caveat.
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Full full disclosure, venture has has had
higher absolute returns over that period of
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time, but small buyout was still able to
produce what I believe to be very strong
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absolute returns, but they did it with
substantially less observed volatility.
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So knowing that data, we believe that small
buyout helps our portfolio produce better risk
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adjusted returns, which is why we've allocated
more to it.
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But interestingly, like, you know, while we we
talked about the quantitative measure of
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volatility, like, it's really more than than
really than that piece of it.
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It's really what kind of underlies the strategy
that we believe makes it less risky.
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And there's a couple of points to note here.
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I mean, 1, prices paid matter.
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Our typical BiogP, they're buying an industrial
or services business that roughly has 5,000,000
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of cash flow, David, and they're tend they tend
to buy that business for 5 for 6 to 7 times
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cash flow.
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If you look at the data so far in 2024, the
average price paid, for m and a transactions,
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is about 11 times.
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You could argue and say, look.
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You know, that that 4 most of my discount could
be our group's sourcing proprietary deals, and
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00:10:53,350 --> 00:10:54,230
it might very well be the case.
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But the reality is is they're buying a smaller
business too.
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It they should pay less, but they are paying
less.
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And so that that's one.
219
00:11:00,070 --> 00:11:01,664
The second one is lower financial leverage.
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00:11:01,664 --> 00:11:05,345
You know, when you buy something for 6 or 7
times, the bank is not gonna give you more than
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00:11:05,345 --> 00:11:08,945
probably 3 turns of leverage on that business,
just because it is a small business, be yeah,
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because they view it as as being somewhat
risky.
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And so, you know, you're you're just gonna have
it be less geared, than a larger private equity
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m and a transaction.
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3, these businesses are kinda boring.
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You know, they're they're stable.
227
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They're they usually are business to business,
kind of providing a valuable product or service
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00:11:25,929 --> 00:11:29,370
that got usually, that goes into some larger
product or service that's also being offered.
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It's kind of a part within within within the
whole.
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00:11:31,715 --> 00:11:34,535
And it's not terribly exciting to talk about.
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00:11:34,674 --> 00:11:37,794
But they tend to have a pretty recurring
business as a result of that.
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They tend to have a diversified customer base,
usually by sector and geography, the threat of
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00:11:42,274 --> 00:11:42,754
disruption.
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00:11:42,754 --> 00:11:45,415
Most of these businesses are right around 30,
40, 50 years.
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00:11:45,529 --> 00:11:49,049
And so, like, that, you know, usually provides
some stability to the cash flows even if
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they're not growing, you know, massively.
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00:11:50,809 --> 00:11:53,610
The 4th point I mentioned is that there's
usually a lot of low hanging fruit with these
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smaller businesses, and there's lots of things
that that can be improved at at some of these
239
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smaller businesses that might not be able to be
improved as much upon if the business were
240
00:12:00,250 --> 00:12:01,309
bigger and more professional.
241
00:12:01,715 --> 00:12:03,815
And then the last one is really just lack of
correlation.
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00:12:04,115 --> 00:12:08,595
You know, one of our GPs noted to us, like,
last week, and said that, below $20,000,000 in
243
00:12:08,595 --> 00:12:12,595
revenues, there are over 4,000,000 businesses
in the United States alone, which is just a
244
00:12:12,595 --> 00:12:13,409
staggering number.
245
00:12:13,490 --> 00:12:17,909
We chatted last time about the attribution of
small buyout managers, and you mentioned that
246
00:12:17,970 --> 00:12:21,829
attribution is 4 times more about the
individual manager than about the brand.
247
00:12:21,889 --> 00:12:22,929
Unpack that for me.
248
00:12:22,929 --> 00:12:26,929
I was actually alerted to this research by a
person in a firm that I really highly respect
249
00:12:26,929 --> 00:12:29,544
in this and that's a guy named Adam Shapiro at
East Rock Capital.
250
00:12:29,845 --> 00:12:34,164
Adam has a group of think pieces on LinkedIn
that he calls, from star to founder, and I'd
251
00:12:34,164 --> 00:12:36,985
highly recommend, any or all of those to your
listeners.
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00:12:37,284 --> 00:12:40,419
One of the posts that that you mentioned
highlights what I think is some pretty
253
00:12:40,419 --> 00:12:44,500
groundbreaking research, which the report
contains data supporting the conclusion that
254
00:12:44,500 --> 00:12:48,980
the individual person that leads a given buyout
transaction is 4 times more important than the
255
00:12:48,980 --> 00:12:52,004
firm that they work for, in terms of the
forward return of that deal.
256
00:12:52,164 --> 00:12:56,565
And so I'm gonna warmly use a quote from Top
Gun Maverick, which is basically that
257
00:12:56,565 --> 00:12:59,304
investment excellence really comes down to the
palette in the box.
258
00:12:59,524 --> 00:13:02,804
And, you know, the data illustrates that there
really are stars in this business that have
259
00:13:02,804 --> 00:13:05,759
demonstrable skill and are likely to outperform
going forward.
260
00:13:05,919 --> 00:13:10,240
And you can have lots of plans and playbooks
and frameworks from some of these larger
261
00:13:10,240 --> 00:13:12,320
organizations, but the plans don't execute
themselves.
262
00:13:12,320 --> 00:13:13,120
People do.
263
00:13:13,120 --> 00:13:17,220
And this research shows that a single person
matters honestly even more than we thought.
264
00:13:17,759 --> 00:13:22,024
It also underpins why we actively invest in,
you know, emerging funds that are people that
265
00:13:22,024 --> 00:13:25,644
are leaving larger, more established
organizations to to form their own funds.
266
00:13:26,264 --> 00:13:32,105
So I'm sharing here on the screen gross fund
performance across fund size for private equity
267
00:13:32,105 --> 00:13:32,605
funds.
268
00:13:33,209 --> 00:13:34,189
Walk me through that.
269
00:13:34,569 --> 00:13:34,809
Yeah.
270
00:13:34,809 --> 00:13:38,970
So this research was actually done, by the same
group that did the the four x research that we
271
00:13:38,970 --> 00:13:41,689
just talked about, and it's also really pretty
compelling.
272
00:13:41,850 --> 00:13:46,404
You know, if if I spoke to a group of investors
and I told them that smaller fund sizes over
273
00:13:46,404 --> 00:13:49,764
time have led to the opportunity for higher
returns versus larger funds, I think most
274
00:13:49,764 --> 00:13:51,464
people would nod their heads and and agree.
275
00:13:51,845 --> 00:13:56,164
If I then said that this that to the same group
that not only is there a reasonable chance for
276
00:13:56,164 --> 00:13:59,960
higher returns, but that the smaller funds are
no riskier than the larger funds.
277
00:14:00,100 --> 00:14:03,139
I think I had a lot of people questioning me
and and and saying, gosh.
278
00:14:03,139 --> 00:14:06,980
You know, you can't really have the the the
reasonable chance of higher return without
279
00:14:06,980 --> 00:14:07,720
higher risk.
280
00:14:08,019 --> 00:14:11,159
And this chart empirically shows that those
people would be wrong.
281
00:14:11,735 --> 00:14:14,934
So, David, you the the chart you noted, I'm
gonna describe it just a little bit more for
282
00:14:14,934 --> 00:14:19,014
those that are that are listening and not
watching, but but the chart splits the bio fund
283
00:14:19,014 --> 00:14:21,195
world in 4, fund size ranges.
284
00:14:21,575 --> 00:14:25,909
And it illustrates the returns of the top
decile, the best 10%, the bottom decile, the
285
00:14:25,909 --> 00:14:30,070
worst 10%, as well as the mean and the median
return of each of those things.
286
00:14:30,070 --> 00:14:34,070
And the data shows that the smaller the fund
size, the better opportunity for
287
00:14:34,070 --> 00:14:39,535
outperformance, which is noted by a higher mean
and median outcome as well as a much better top
288
00:14:39,535 --> 00:14:42,754
decile top 10 percent outcome versus the larger
funds.
289
00:14:42,975 --> 00:14:46,654
What's really interesting about this chart,
though, is not the upside, but it's the bottom
290
00:14:46,654 --> 00:14:48,195
10% of historical outcomes.
291
00:14:48,654 --> 00:14:52,860
The chart illustrates that the performance of
the worst decile of funds in each fund size
292
00:14:53,100 --> 00:14:55,120
cohort are essentially the same.
293
00:14:56,059 --> 00:15:01,500
So that basically means that the small fund,
has a lot of additional upside for basically a
294
00:15:01,500 --> 00:15:03,679
similar amount of downside versus larger funds.
295
00:15:04,139 --> 00:15:07,684
This this obviously to us seems pretty
asymmetrical and is one of the main reasons
296
00:15:07,684 --> 00:15:09,785
that we've tended to invest in smaller funds
over time.
297
00:15:10,165 --> 00:15:14,404
The average size buyout fund that we have
invested in over the last 12 years is about a
298
00:15:14,404 --> 00:15:15,925
$200,000,000 fund, David.
299
00:15:15,925 --> 00:15:19,524
And so somewhere kinda between the smallest and
the second quartile on the left side of this
300
00:15:19,524 --> 00:15:19,980
chart.
301
00:15:20,220 --> 00:15:23,980
It is interesting to compare to something like
venture capital, this kind of chart where you
302
00:15:23,980 --> 00:15:25,899
would have these extreme tails on the upside.
303
00:15:25,899 --> 00:15:29,120
You would have funds returning 5, 10, 20 x in
extreme cases.
304
00:15:29,419 --> 00:15:35,259
And you would have, I imagine, the bottom 10%,
maybe a 0.75 or below, losing substantial
305
00:15:35,259 --> 00:15:35,759
capital.
306
00:15:36,054 --> 00:15:36,215
No.
307
00:15:36,215 --> 00:15:37,014
I I think that's right.
308
00:15:37,014 --> 00:15:40,695
I mean, the the the outcomes piece is actually
what's really attractive to us, and we talked
309
00:15:40,695 --> 00:15:44,134
about how it is the, you know, the kind of the
best risk adjusted asset investment on the
310
00:15:44,134 --> 00:15:44,615
private side.
311
00:15:44,615 --> 00:15:48,215
And like what you said, I mean, you know, we'll
get into the anatomy of perhaps the returns of
312
00:15:48,215 --> 00:15:52,250
small bio, but, you know, you're you're not
gonna have the same power law outcome as
313
00:15:52,250 --> 00:15:55,850
venture necessarily on on an individual outcome
or even a fund level, but you can still have
314
00:15:55,850 --> 00:15:57,230
some really, really good outcomes.
315
00:15:57,370 --> 00:16:00,750
The converse of that is is that chart we just
showed doesn't have that many zeros.
316
00:16:00,970 --> 00:16:04,964
And so, you know, in the in the average venture
fund, you might have a portfolio of half your
317
00:16:04,964 --> 00:16:09,044
things that go to 0, and and you still end up
with a 5 or a 10 x fund because of that power
318
00:16:09,044 --> 00:16:10,164
loss aspect of it.
319
00:16:10,164 --> 00:16:13,044
The distribution of and the attribution of
returns is is actually quite a bit different,
320
00:16:13,044 --> 00:16:15,704
but you can see how it underlies a better risk
adjusted return.
321
00:16:15,764 --> 00:16:19,889
When it comes to the alpha for small buyout
managers, are they making it on the purchase,
322
00:16:19,889 --> 00:16:21,750
on the sale, and how do you attribute that?
323
00:16:21,809 --> 00:16:24,769
Definitely, there is there is some value that
can be had on the purchase.
324
00:16:24,769 --> 00:16:27,970
I mentioned, you know, when you're talking
about a a 3 to $5,000,000 cash flow business,
325
00:16:27,970 --> 00:16:29,110
there is more opportunity.
326
00:16:29,330 --> 00:16:32,210
We mentioned there are over 4,000,000 of those
types of businesses in the country.
327
00:16:32,210 --> 00:16:36,264
There is a greater opportunity to source
proprietary deals that are not banked, that are
328
00:16:36,264 --> 00:16:38,105
with with you know, they're family owned still.
329
00:16:38,345 --> 00:16:41,865
And you you you go through a process over
sometimes a period of years where you build
330
00:16:41,865 --> 00:16:45,544
trust with that entrepreneur and that founder,
and and you can buy that business at a at a
331
00:16:45,544 --> 00:16:49,065
better price than the market would generally
allow for if you it was in a fully banked
332
00:16:49,065 --> 00:16:49,384
process.
333
00:16:49,384 --> 00:16:51,700
So there's definitely the ability for that.
334
00:16:51,700 --> 00:16:55,620
It is it is not certainly not not a given, and
it it takes a lot of hard work to do that.
335
00:16:55,620 --> 00:16:58,039
But but, yes, you can make money on the on on
the buyout.
336
00:16:58,740 --> 00:17:02,259
Outside of that, there, you know, there are
basically 3 ways to make money in buyout that
337
00:17:02,259 --> 00:17:02,579
we see.
338
00:17:02,579 --> 00:17:03,779
1 is you grow the business.
339
00:17:03,779 --> 00:17:04,500
You grow revenues.
340
00:17:04,500 --> 00:17:05,140
You grow EBITDA.
341
00:17:05,140 --> 00:17:05,835
You grow cash flow.
342
00:17:05,994 --> 00:17:09,115
The second one is you expand the multiple of
that business, and there are there are kinda 2
343
00:17:09,115 --> 00:17:10,474
ways to that that happens.
344
00:17:10,474 --> 00:17:14,394
The first one is completely beyond the control
of us and the GP, and that's interest rates go
345
00:17:14,394 --> 00:17:14,894
down.
346
00:17:15,034 --> 00:17:16,954
Usually, as interest rates go down, multiples
go up.
347
00:17:16,954 --> 00:17:19,994
And, you know, there was a period of time over
be really a 30 year period of time where we had
348
00:17:19,994 --> 00:17:23,710
a bull market in bonds and and with, you know,
as as interest rates went down, the multiples
349
00:17:23,710 --> 00:17:27,089
of of private equity transactions in the
overall stock market, improved.
350
00:17:27,230 --> 00:17:30,750
But whether it's whether it's controllable or
not, you you could certainly private equity
351
00:17:30,750 --> 00:17:33,410
funds can benefit from from that piece of it,
from multiple expansion.
352
00:17:33,710 --> 00:17:37,664
The other area of expand of multiple expansion
where we're probably more interested in the
353
00:17:37,664 --> 00:17:41,664
first is is and it's something that's really in
control of our GPs, which is, you know,
354
00:17:41,664 --> 00:17:45,825
professionalizing that business, creating a
business that has a sustained higher level of
355
00:17:45,825 --> 00:17:49,309
growth rate, expanding the addressable market,
reducing customer concentration.
356
00:17:49,309 --> 00:17:53,230
There's a number of things and levers that
people can pull to improve the the the value
357
00:17:53,230 --> 00:17:55,410
and the worth of that business to the to the
next buyer.
358
00:17:55,549 --> 00:17:59,710
And then the third way to make money and and
buyout is is debt and leverage.
359
00:17:59,710 --> 00:18:03,765
And and, while it's definitely true that when
used properly, leverage and debt amplifies
360
00:18:03,904 --> 00:18:05,444
equity returns, for sure.
361
00:18:05,585 --> 00:18:09,744
And we're not opposed to attributing some of
our GP's returns to debt pay down, but we tend
362
00:18:09,744 --> 00:18:13,424
to focus on, you know, the growth part of the
business, growing revenues, cash flows, and
363
00:18:13,424 --> 00:18:15,350
EBITDA, and then know, multiple expansion.
364
00:18:15,350 --> 00:18:18,630
While we'll certainly take multiple expansion
from interest rates just going down, we really
365
00:18:18,630 --> 00:18:22,070
focus more on that growth and
professionalization of the business over time
366
00:18:22,070 --> 00:18:25,370
to to improve the overall multiple of that
business where where you're demonstrably
367
00:18:25,430 --> 00:18:27,690
improving it to the point that it is a more
valuable business.
368
00:18:27,845 --> 00:18:31,365
And we believe those things are much more
repeatable than kind of the change in interest
369
00:18:31,365 --> 00:18:33,865
rates and the availability and price of of
leverage.
370
00:18:34,164 --> 00:18:38,825
Given the attractiveness of the asset class,
why aren't more LPs focused on small buyout?
371
00:18:39,605 --> 00:18:42,549
So I do think that small buyout is becoming
more popular.
372
00:18:42,549 --> 00:18:45,349
There's a research report that we can put in
the show notes that it's publicly available
373
00:18:45,349 --> 00:18:49,190
from RCP that they just did a they're they just
did part 1 of a 3 part study on the case for
374
00:18:49,190 --> 00:18:53,029
small buyout that where they're really kinda
highlighting the durable nature of of business
375
00:18:53,029 --> 00:18:56,365
building and risk mitigation that we've kind of
already mentioned in discussion of small
376
00:18:56,365 --> 00:18:59,884
buyout, but but we are hearing of other groups
that are kinda meandering down the fund size
377
00:18:59,884 --> 00:19:02,845
spectrum, you know, into where we've been for
roughly a decade, I would say.
378
00:19:02,845 --> 00:19:06,204
But I do think there's also a reason why it's
happening now versus some other time.
379
00:19:06,204 --> 00:19:11,089
And the reality is is that over the last, call
it, 10 to 15 years, the return difference
380
00:19:11,089 --> 00:19:14,869
between large buyout and small buyout actually
hasn't been that dramatic, not that different.
381
00:19:15,170 --> 00:19:17,410
And both have actually been pretty good in
absolute terms.
382
00:19:17,410 --> 00:19:21,414
But if you start looking at the anatomy of how
those returns were produced, that is where I
383
00:19:21,414 --> 00:19:24,855
think the forward returns of small buyout are
more attractive than large buyout.
384
00:19:24,855 --> 00:19:29,015
So if you look at the anatomy of returns of
large buyout over the last 10 or 15 years, most
385
00:19:29,015 --> 00:19:33,414
of that has come from multiple expansion of
interest rates going down, a a bull market and
386
00:19:33,414 --> 00:19:36,750
bonds, and then from the availability and the
price of leverage and debt.
387
00:19:36,829 --> 00:19:39,490
Those two things were a a fair amount of the
return.
388
00:19:39,789 --> 00:19:42,990
Well, you know, I would argue that the growth
and professionalization of the business,
389
00:19:42,990 --> 00:19:43,950
there's certainly some of that.
390
00:19:43,950 --> 00:19:47,549
I don't think it was the majority, like, we
tend to look for in our small buyout managers
391
00:19:47,549 --> 00:19:49,569
where it's much more kind of operationally
focused.
392
00:19:49,714 --> 00:19:52,994
At the same time too, to be fair to to those
larger buyout businesses, the businesses
393
00:19:52,994 --> 00:19:56,835
they're buying are are already a larger and
more professional business, so there is less to
394
00:19:56,835 --> 00:19:59,494
do, functionally with some of those businesses
as well.
395
00:19:59,714 --> 00:20:03,075
But we're in the dessert environment, and when
interest rates were low and debt was freely
396
00:20:03,075 --> 00:20:07,299
available, those larger firms took advantage of
that the most, and they produced really good
397
00:20:07,299 --> 00:20:08,680
returns, and business was good.
398
00:20:09,059 --> 00:20:12,740
But if you look from this point forward and you
look at where the absolute level of interest
399
00:20:12,740 --> 00:20:17,460
rates are, where the relative level of lending
the capacity of lending is on a go forward
400
00:20:17,460 --> 00:20:21,484
basis, you would argue that some of those
sources of attribution of return from larger
401
00:20:21,484 --> 00:20:24,545
buyout might be more challenged going forward
than they were in the past.
402
00:20:24,684 --> 00:20:29,164
At the same time, you know, we believe that our
GPs, you know, kinda control their own destiny
403
00:20:29,164 --> 00:20:33,250
because we are more focused on kind of what we
believe are these repeatable and durable, you
404
00:20:33,250 --> 00:20:37,409
know, processes of of growing and improving
these businesses, and making them, you know,
405
00:20:37,409 --> 00:20:40,549
functionally better better operating and and
better functioning businesses.
406
00:20:40,849 --> 00:20:42,289
That piece is repeatable over time.
407
00:20:42,289 --> 00:20:45,250
It doesn't really depend on so many things that
are really kind of out of out of our GP's
408
00:20:45,250 --> 00:20:45,674
control.
409
00:20:45,835 --> 00:20:48,174
Well, Chris, thanks for jumping on the podcast.
410
00:20:48,315 --> 00:20:48,875
Thanks, David.
411
00:20:48,875 --> 00:20:49,755
Really appreciate the time.
412
00:20:49,755 --> 00:20:50,654
Thanks so much.
413
00:20:51,115 --> 00:20:52,235
Thank you for listening.
414
00:20:52,235 --> 00:20:56,975
The 10x Capital podcast now receives more than
a 170,000 downloads per month.
415
00:20:57,035 --> 00:21:00,015
If you are interested in sponsoring, please
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