MATT ESTEP - PICKING LOW HANGING FRUIT OFF THE GROUND - EP. 40

My conversation with ^[redacted]‌ on:

- Starting a go-kart business in high school

- Picking low hanging fruit off the ground at Midwest Supplies

- A struggling portfolio company

- Fireworks and mall Santa businesses

- Taking feedback from board as CEO


Enjoy!


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Thanks, Matt for joining. I’ve been looking forward to having it ever since our first phone call. There’s guests every now and then you come across where you’re like, “I got to get this guy on an episode at some point.” So I’m excited to have you. I want to first hear a little bit about your background and what you’ve been working on, then we can go from there.

I appreciate you having me, and I think what you’re doing for the small business investment community is awesome. So a little bit of my background, I grew up and had no knowledge of buying small businesses or really very limited experiences. Growing up, all I wanted to do was drive race cars for a living. I started racing go-karts when I was a five-year-old kid, and my aspirations were to go race in NASCAR. I probably was more talented than about 98% of the people driving race cars, but not 99.8% which you needed to ultimately pursue a professional career in racing. But that led to a bunch of experiences as a young kid that I think ultimately have led to my success in business. So I took a much different path to go to Harvard Business School than most people.

I started a small go-kart manufacturing business when I was in high school. I went to a community college because I was pursuing this racing career, and then ended up getting a mechanical engineering degree. Not because I had any interest in engineering, but I thought it would help further my racing career. So I never used the engineering knowledge, I barely got through most of the classes, but I did end up getting a college degree. And around the time I finished with college, I had still aspirations to go and race, and I ended up taking a job in a company, a natural gas company in Chicago.

And people often say, “Why did you do that?” It was really simple, they gave you four weeks vacation, which you could take right away. Most places said you had to work six months before you could take vacation, and I needed to be able to take vacation to go drive race cars all over the place. So that’s why I took the job. I had very little interest in natural gas pipelines or engineering them or any of those things, but I ended up working there for four years. I spent about six months in the office doing engineering work, which I hated, and then I spent three and a half years out managing union workforce in the city of Chicago. So I put jeans and work boots on every day and went and managed 150 union employees digging trenches in the city of Chicago.

Well, actually, I enjoyed the work, I enjoyed working in the field with the guys. Partially having grown up working for my dad, and I tell stories of sucking up sludge in railroad yards as a 12-year-old kid. So I could relate a lot to the guys that were digging trenches and fixing natural gas mains. So I enjoyed it, I just knew I didn’t want to work for a big company. And around the time I was getting ready to get married, my wife was like, “Well, if you want to do something entrepreneurial, now is a good time, but you need to learn something about business,” because I had next to no business acumen. So I start thinking about that. I took some classes at the University of Chicago’s Business School as a student-at-large, and then ultimately applied to business school.

I would have never applied to HBS had my wife not pushed me because I didn’t think I could get in and I was too cheap to waste the 225 bucks. But fortunately, I applied and I went off to HBS and I had learned about the search fund model in about 2005 from a friend of my wife’s that had gone to Stanford and done it. And I went to HBS with the intent to doing the search fund. That gets you to the point of me getting ready to go out and buy a small business.

Yeah. Just doubling back just for a minute there, the go-kart manufacturing business in high school, what did that look like? How’d you set that up? What were you actually doing? How’d you get customers? Tell us about that business.

I was raised in go-karts as a young kid, as he said, “I was probably 13 or 14 years old and I noticed that I would go out and win a race and people would want to buy the equipment that my dad and I had. And again, we didn’t have a lot of money, so it wasn’t always the nicest stuff, but a lot of times, my dad and I built it ourselves. So I was probably 14 years old in my parents’ garage, I just started making more of the stuff and selling it, and people were buying it. And I didn’t know anything about bank accounts or accounting, I kept cash in my bedroom, I think.

It got to the point where, I was 16 years old, so I could drive and we were outgrowing my parents’ garage. So my dad helped me rent a building and he started a little business and by the time I was a senior in high school, we had nine employees and the business did just under a million in revenue. I can only tell you that because I went back and had to add up how much cash we deposit in the bank accounts. We didn’t know how to file tax returns, do payroll taxes, I didn’t know how to do any of those things, and I really didn’t have anybody to help me, but the business just grew organically.

I would go to a race in Kentucky and we do really well, and on Monday, the phone rang and people would buy stuff. And half the time we’d have inventory, and half the time, we wouldn’t. And it was a very early experience in entrepreneurship, but very unrefined.

Is it still around?

It is. There’s a gentleman that still runs it and does several hundred thousand dollars in sales, and it’s a great little hobby business for a guy.

Do you own it still? Or did you sell it to him?

I do not. No. An older gentleman who was retired, who just was really passionate about go-kart racing and he still goes to the races. He’s almost 80 now.

That’s fantastic. So then you launched your search fund out of Harvard?

I did. And like I said, my entirety of my time there was spent interacting with search fund investors, learning about the model, I spent a year and a half working with Will Thorndike. I remember saying to him, I would empty the trash cans just to try and learn from him. So I launched my search fund in September of 2008, I moved back to Chicago from Boston and started searching. And I’ve said to people many times, I was the least qualified guy ever to go out and do a search fund. And the reason I say that, a lot of people look at what I’ve done and then they think, “Oh, you’re just being humble.” Or, “That’s not true.”

The reason I say that is not because mechanically, I didn’t know how to buy a business. I didn’t know what an ROI was, I didn’t know what due diligence was, I didn’t know all those things. Those things are easy in my opinion, somebody can teach you how to do that. The bigger issue is, I just didn’t know what I was looking for, so I didn’t know what a good business was. So it took me a really, really long time, like 12 or 15 months of my search to figure out what was I actually looking for? Like what was a really good business? And that’s the reason I say I was the least qualified guy to go out and do it at the time.

How does that look over the course of your search? What did you start to either cut out or what eventually became your filter?

The biggest shift was I initially was trying to find a cheap business, but it may have been a horrible business, and I would try and structure these deals that were creative that would allow us to buy a business for three times EBITDA, but at the end of the day, it was a three times EBITDA business. That was the biggest mindset shift that evolved over the course of my search, was really looking for a business that had attractive characteristics that would be a good business for a really, really long time period.

So then how’d you find Midwest Supplies? And tell us about that acquisition and time.

It took me 27 months to end up buying a business. I was scared to death of failing, I spent no money almost to a fault during my search, just trying to extend the runway as long as I could. Midwest Supplies came from a broker, I submitted an indication of interest, flew up to Minneapolis to do a management meeting. And at that time, I probably toured nearly 100 businesses, it was about month 23 of my search, and it was one of the first businesses that I wandered around the facility and walked into the parking lot and said to myself, “I could run this business today, at least as well, if not better than the owner.”

So that was one of the things I have, and people have heard me say this before is, there wasn’t low-hanging fruit, there was fruit hanging on the ground, it was sitting on the ground and our job was just to pick it up before it rotted. But the business had grown 35% year over year for five years prior to us buying it right through the economic meltdown in 2008, so it was a good business that had been growing rapidly. That felt like there was a ton of opportunity in it. But there was a broker, I think, five groups that got brought up for a management meeting, not the highest bidder.

Ultimately, at the management meeting, I vividly remember this, the owner was there and I asked him one of my questions I ask business owners, what’s an ideal transaction? And I don’t mean dollars, like you sell your business, then what happens? What is ideal? And he looked at me and didn’t respond, and I was like, “I don’t care what the answer is.” Genuinely wanted to know the answer, he looked at his broker and begrudgingly the broker’s like, “Well, okay, go ahead and tell him.” And he responds, he’s like, “Well, when I learned about selling your business, I’ve learned that you have to transition and I have to sign up for 12 months or 24 months, but ideally, I thought this was like selling a piece of real estate, we’d get the closing, sign a bunch of documents, and I would push the keys across the table and walk away.”

And I responded and I said, “Well, I don’t know if you can leave the day at closing, but what if I let you leave on day 30?” He’s like, “Oh my gosh, that would be amazing.” So one of the things I try and tell people when they’re out trying to buy a business, I think is really trying to understand what is the owner’s motivation for a transaction. I think that’s really, really important, and I think it can be a huge differentiator. The reality was, he agreed to work full-time for 30 days, part-time for 90 after that. He came in on day 21, he was absolutely miserable, he and I went to lunch and I was like, “Dave, if you don’t want, you don’t have to come back.” And that was it, he came back but never to work again.

Nice. I know you talk about fruit being on the ground, can you give us a few examples of what that looked like in the business?

The business would have been growing rapidly, they used no data in the business. So when you ask the owner, how did he know if the business was doing well? There was two things he looked at, how much cash was in the bank account, that was one, and then how big was the stack of orders to be fulfilled. And the thing that he didn’t realize was the stack of orders was growing. Yes, they were coming in more rapidly today than they were yesterday, but the business operationally was such a disaster, they just couldn’t fulfill them. So the orders were never going out. So there was a ton of opportunity just to grow sales, but really just operationally improve the business. And that was abundantly clear walking through it.

For an example, if they sold a bucket that you used to brew beer and that bucket was located in five different spots in the warehouse, so when they were fulfilling orders, one gentleman who was fulfilling orders would pick it from bucket spot A, and the other guy would pick it from bucket spot Z. And there was no rationale for anything in the warehouse, there was no flow, there was no organization. The business had 55 employees and one gentleman managed all 55. There was no organizational structure in the business.

So you talked about the warehouse when you went through these different systems, what system was the hardest to implement of the fruit that was on the ground in the business?

That question is very easy, and the reason I say that is, we had no idea how much inventory was in the business when we bought the business. The owner thought it was somewhere between a million and three million in EBITDA, and when we sold the business 26 months later, we still had no idea how much inventory was in the business. I remember when they were doing an inventory account the night of closing, and there was a number in the working capital peg. And I just remember the CFO coming to me at about 11 o’clock and saying, “Hey, we’re at 4.4 million in inventory.” And I was like, “Well, you better go find another million and a half.”

So the inventory system, the order management part of it was easy, most of our sales were via the internet, so that part was easy, but keeping track of inventory in a fast moving business that was growing rapidly, which had all kinds of conversion issues because we were assembling brewing kits that had 13 or 14 components in it. Oftentimes, you’d buy a 55 pound bag of grain and break that down into one pound or four ounce packages, keeping track of that was very, very difficult. And I’d love to tell you, we did a great job, but we had no idea two and a half years later, how much inventory we had. So unequivocally, that was the hardest system.

Was that also the most beneficial though, or was there something else that had a greater impact?

The biggest impact in the business, there was two, a lot of our success with growing revenue was just doing what I’ll call e-commerce one-on-one. So back to something I see often, you’re competing in an industry that most people didn’t know existed, so we had 1,200, very small, relatively unsophisticated competitors, most of whom were really passionate about brewing beer, and I’m just passionate about building a good business. And I think that delineation allowed us to do things like hiring the best resources in e-commerce company that other people just weren’t focused on.

So that broadly is what allowed us to be successful. I think the thing that had the most impact in the business was hiring the people we hired at the various roles that were much higher caliber than you’d normally have at a 10 or 20 or $30 million revenue business. And getting those people on the bus and having them help us drive the bus is what really allowed us to be successful.

And so the different positions you were hiring for, what were some of those positions and how did they allow you to grow the business?

In every one of the businesses I acquired, in most that I’ve been an investor and as a search fund investor, just investing in small businesses. Almost all of them, the finance function has to be upgraded in a pretty material way. That’s a common theme we upgraded it there. The second thing we had to upgrade was just around the IT and the technology piece of our business. So as I said, the vast majority of our sales were on the internet, and I can remember the early days of buying Midwest Supplies, I was staying at a super Super 8 Motel because I hadn’t even moved up there yet.

And it was like 2:00 in the morning, and I’m on the phone with Rackspace because our website was down. I didn’t know the first thing about websites or servers or anything. So that business, we may have bolstered our IT function before we did the finance function. I actually don’t remember thinking back now, but those were the two biggest that we had to do just from a blocking and tackling perspective.

And you eventually sold the business, right?

We did. We sold it about 26 months after we bought it. About 12 months in, we tried to buy our largest competitor and they got acquired by a private equity firm out of Philadelphia. We thought we were actually going to buy our largest competitor, and in the 11th hour, he changed his mind. The seller of our competitor sold to some guys in Philadelphia who he thought were better equipped to run the business than we were. Shortly after they bought it, we reached out to them and said, “Hey, we should strategically put these businesses together, they’re the two largest sellers of product or wares in the home brewing business.”

And I think initially they looked at us and thought we were 28-year-old guys, didn’t know what we were doing, and just give them time, and they would eat our lunch. And over the course of the next year, we successfully grew our business and they came to us, just said, “Hey, we really want to buy your business.” And when we originally got into the home brewing market, in the back of our mind, there was always a concern that was a consumer fad, and I think over the course of the first 12 or 18 months of ownership, it became abundantly clear that the growth was a consumer fad and that the new customers that we were acquiring didn’t look like this stable base of customers that ordered brewing supplies once a month.

And when that became clear to us, at some point, the music was going to stop with this growth, and we had this, what appeared to be a very interested buyer on the other side. We ended up selling to them, we never hired a banker, we weren’t looking to sell, but I can tell you, through the entirety of diligence, it became abundantly clear we should be selling the business. So the growth rates, again, the business was still growing, it’s just the rate of growth was declining. And that was clear to us, I don’t know that it was clear to the buyer. that was standing the fact that they own our largest competitor.

And it’s still listed as a portfolio company on your website, do you still own a portion of the business?

I did for awhile. I don’t anymore. I don’t anymore. I just follow it. I’m a fan of it. I looked at buying it back actually, it got sold. It’s been sold now. So the original private equity firm sold it to the venture arm of Anheuser-Busch, and then the venture arm of Anheuser-Busch recently sold it again. So through the course of those transactions, my ownership has gone away.

Do you know how it’s performed since you sold it? Did that thesis of it being a fad and topping out, did that play out?

It did. It did not perform well. Two reasons, and it’s easy to be a Monday-morning quarterback, but a lot of those people that we hired to work for us that I think were really high caliber, when the original buyer, the private equity firm acquired us, a lot of people opted out and they left. And while we were in the same industry, the two businesses were pretty different and there was a belief by the operators of the private equity firm that whatever was being done with their business that was the best would overlay perfectly in our business, it didn’t work out that way for them.

So you had some operational stabbing of their toe, I’ll call it. And then as you said, the growth rate was slowing and there was a huge emphasis on growth, so they invested massive amounts of money into marketing, trying to grow the business in a scenario where I think they were running uphill, so to speak. So the combination of operational challenges and marketing challenges ultimately led to not a good outcome for the original buyer.

And talk about the time after this acquisition or sale, and you’ve continued to acquire companies. Are you looking for the same types of niche, small companies, or what do you look for today?

We sold Midwest Supplies in 2013, and I moved back to Chicago the end of 2013, early[redacted]Didn’t really know what I wanted to be when I grew up, but I wanted to keep buying small businesses. I actually loved running a small business, but I didn’t like the prospect of moving. At the time we had two small children, I didn’t want to move my family all over the country over and over again, so I settled on a model where I wouldn’t take money from investors to search to find the next business. And when I acquire businesses, I would go out to friends and say, “Hey, do you want to invest in this crazy idea?”

There’s three things that I look for when I’m buying a business, and it’s pretty simple, but hard to find. I want businesses that I think will be around in 30 years, I want businesses that are simple enough and I can explain to my mother in two sentences or less what the business does. So those seem easy, and it’s actually pretty hard to find things that fit that characteristic. But then the last point, which I think is the most important is, I have to really like the seller of the business, because at the end of the day, these small businesses just are microcosms of the owner.

And as I mentioned the owner of Midwest Supplies, he was a wonderful person. And while he was gone after the first 20 days, anytime I needed him, I actually just talked to him recently about something else, he would take our phone calls, and he wanted to see the business be successful. And I think when you find an owner who wants to see their legacy and their business be successful, they’ll do anything they can to help you. And having that in your corner, I’ve found that to be paramount to your success at running these small businesses, because the transition of these businesses is actually very, very hard. Most of these small businesses are really, really fragile.

So those are the three things I look for, a business I think will be around for a long, long time, a really simple business model, and an owner that I like. And oftentimes people ask me, they’re like, “Well, do you like the owner because they’ll sell you the business for less than it’s actually worth?” Yes, that is true, but that’s actually not what I like about them. They do that because they care about the business and whose hands they’re handing it over to or who they’re giving their keys to, and that in and of itself is a thing that I think is really, really important.

And have you found that since your time with Midwest, that there’s been an internal compounding of your ability to buy and operate these businesses, or is each business so different that there’s still a huge amount that you’re learning with each one? Or effectively, do you feel more confident today buying businesses because of your time with Midwest?

That is a great question. And part of the reason I say it’s a great question, I think people too often fall into the trap of being successful and that muddies your judgment over time, I think. I’m certainly more confident in the mechanics of buying a business, and I think I’ve become better over time at filtering out the noise about what matters and what doesn’t matter when you’re buying a business, so trying to figure out the one or two or three things that actually matter. So I try and keep things really simple, and I think that’s something that’s evolved over time. I would love to tell you I’m more confident in my operating prowess of these businesses, and I don’t know that that’s the case.

The businesses I own today, several of them are functioning really well and we have one that’s struggling, and I think I’ve learned a lot through the management challenges of that business and just the challenges. It was struggling pre-COVID, it really is struggling with COVID. And they think you can be introspective and acknowledge what caused those. It can be a good learning experience for you. But I think just by taking experiences from a first success and then layering that on to your next business and saying, “Hey, I did this there and it worked,” I think is recipe for disaster.

Yeah, to be a little bit flexible. Are you willing to chat a little bit about the business that’s struggling or would you want to put that off for another time?

No, we can talk about. The business is called LAW Publications, it’s based in Dallas. We acquired in[redacted]We provide educational materials to police departments with which they disseminate at schools. Think about the DARE program, drug education materials for students. We bought the business, I traveled back and forth initially quite a bit, trying to help oversee the operations of the business. The business serviced 900 police departments when we bought it. Within the first 18 months, we were servicing 1600 police departments, so it grew wonderfully. But I was never going to be the longterm CEO of the business, and ultimately, we brought somebody into the business and I ended up just as a board member.

I was a very active board member, but I was a board member, nonetheless. And the individual we brought in had some thoughts and ideas about taking the business in a different direction, and in many ways I differed. Unlike when I’m on a board of a search fund business, I think you give the search a much less latitude or leeway. The individual that we brought in to run the business was more experienced and further along in their career and had run a business with very similar dynamics, and I think I just afforded the individual a ton of latitude. They had never run small business like this though, and I think that was ultimately what led to the demise.

So there was some pretty significant management challenges, both with the CEO, but also across the leadership team that manifested the business taking a massive decline over time. And it took us as a board and me as a large owner of the business a long time to really understand that. And ultimately, we made a change to the entire management team and had to reset the business. So we reset the business in the middle of last year and were getting it going on a pretty good path again, and then COVID hit. And because most of the information gets disseminated in schools and schools aren’t open, the business is off about 65% right now.

Oh boy, just one thing after another. So you said it was growing though, so what did management struggle with in that growth?

It was growing but there was a belief that the growth wasn’t sustainable, in that a lot of times when I buy these businesses, one of my mentalities is like, “Hey, you bought the business for a reason. Don’t screw it up.” And I know everybody says that, like your job, when you first buy these things is, don’t screw it up. So we just did more of what they had done historically. There was a ton of white space with more police departments and we thought, “Hey, we can do that.” And I shared the belief that the CEO had, of like, “Hey, this is not a sustainable model. We need to shift the business model away from what they were doing.” And it was some of these business model shifts.

And we acknowledged that it may take the business back to go forward. And in many of the businesses that we acquire, we almost always, inevitably, I’m really good at taking five million of EBITDA and turning it into three. I’ve made a living at that. Now, eventually you hope you’re making investments in the business and you go the other way. But in this instance, we will be taking both a revenue and an EBITDA and the combination of those things was like a nuclear bomb, let’s put it that way. So you had revenue going down, you had expenses going up, and it quickly eroded EBITDA.

So what about the model wasn’t sustainable at the time?

The sales force in the business was all 1099 contractors and still to this day is all 1099 contractors. And there was a belief that we could increase the quality of sales force and the relationships with police departments and the customers if we control the sales force, vis-a-vis, they were all W2 employees. And in doing that, we alienated a lot of our best salespeople, and in a business that’s very sales focused when your top three of your top five salespeople leave, it’s a pretty big hit. So the shift in the business model of changing contractors to employees and in doing that, a lot of the people who are contractors didn’t want to be employees for whatever reason, whether it was taxes or just autonomy or whatever the case may be.

And as I said, I got calls from a couple of really, really good sales reps who I had a relationship with saying, “Hey, this is horrible. This isn’t going to work.” And for awhile, I just said, “You know what? We hired a CEO and the CEO’s charge, but I should’ve listened better to the employee base.” What’s one of the things I think over time, I’d like to think I’ve gotten better at. My wife might tell you otherwise, but just listening to the employees, employees know the problems. They may not know how to fix them, but they know the problems.

So what was it that some of them loved about being a contractor or at least preferred over being an employee?

The biggest thing I thought it was like a financial thing, they could write off expenses and things like that. It actually wasn’t that it was autonomy. Whether it was real autonomy or perceived autonomy, there was a belief that if they were a 1099 contractor, that they could just say, “Hey, I don’t want to work this week.” And it was that, when you started to put structure around the sales force and try and build a “professional sales force,” a lot of these people didn’t want to be professional salespeople. I refer to them, and I don’t mean this in a negative sense, almost like gypsies. They would go from one town to the next, they drive 800 miles in a week, but the reality was, they were really good salespeople.

And when you started to force them to be on daily calls or weekly calls and use salesforce.com and things like that, they just didn’t like it. I’m raising an issue here with this business, which I think is with a lot of businesses, is, how do you integrate? When you start to put systems and processes in these businesses, how do you do it in a way that you don’t alienate the people who are really valuable to your business? And that’s ultimately what caused the challenges at LAW Publications.

Do you think there was something else you could have done with those employees to bring them into more formal systems that they would have been more excited about?

Yes, because now we’ve subsequently done it. It’s having them more involved in the process. The onus of this entire situation falls on me as the guy who was overseeing the proverbial ship. Again, I wasn’t on the ship, but I was watching it from afar, and I turned a blind eye several times to things that intuitively didn’t make a lot of sense to me, but I was like, “You know what? We hired this gentleman and he’s done this before, and we’re going to let it play out.” I think my approach to putting systems in any of these businesses is really straightforward, and so you have to get the buy-in of people who are going to use them or don’t even bother doing it.

And it’s funny, there are two or three employees at every one of my businesses that are incredibly valuable to the business. I talk about them ad nauseam in the various businesses. In many of the cases, I’ll make exceptions for those employees. And people say, “That’s just horrible management. Everybody’s got to fall in line.” And the reality is, when you have people who have done things for 20 and 30 years and they’re really, really good at it, forcing them to use a CRM system is probably not the highest and best use of your time. Figuring out how to accommodate those individuals is incredibly valuable. You build up a ton of goodwill because it’s really easy to do like the private equity firm that bought Midwest Supplies, where they come in and say, “Hey, it’s our way or the highway.”

And I think the thing that is not appreciated enough with these small businesses is the value. At the end of the day, all of these businesses are dependent on a handful of really key employees, and doing everything you can to try and help those employees is really what leads to success in my opinion.

So what other things do you do to make sure that those really great three to five or two to three employees stay in your business and stay with you and don’t take jobs and offers from other businesses?

All of the time when you buy a business, everybody is nervous. And you can stand up in front of the employees, and the best thing that I found to do is just acknowledging that they’re nervous, trying to tell them, ‘Don’t be nervous,” just isn’t going to work. The only thing that’s going to allay their fears is just time. And the first thing you better try and figure out is, who are those key employees? You may have an opinion of it before you buy a business, but oftentimes it’s somebody different that you didn’t even realize because it’s probably not the one that’s knocking on your door asking for a raise. It may be, but it’s not always. So the first thing you have to do is figure out who those employees are.

I joked about this a second ago, but I think being a really, really good listener and just trying to understand, taking an interest in people, a genuine interest in the employees in the business, you start to learn about, what do they care about? And most of the time, these people that I referenced that are the really, really… And all the employees are valuable, there’s some that are just far more valuable than the others in these businesses. Oftentimes they’re really passionate about the business and they want to see it be successful, and the thing you can do to win them over in my experience is figuring out, what are their pain points in the business? And then just helping them do their job better.

I’ve lost track of how many phone calls I’ve gotten of employees either really upset or in tears because the business isn’t performing well, and I don’t mean the business isn’t financially performing well. And I see this across all of my businesses, they’re so passionate about seeing the business be successful, they’re upset that operationally we’re screwing up or they’re upset because we’re not invoicing or because we’re writing bad reports or whatever the case may be. And the way you keep those employees, in my opinion, is help build and grow the business and give them the autonomy to do whatever their role is in the job.

Do you have a few examples of some pain points that you’ve helped employees ease within the business that they’ve pointed out?

I’ll give you an example. We own an elevator components business. And when we bought the business, we kept having back orders and out of stocks. And at the end of the day, if you need an elevator part, it’s probably not because you’re just doing weekly maintenance, it’s because an elevator is broke. And there’s employees in there who are dealing with customers on a regular basis, and when a customer calls on a Friday and says, “Hey, I need this pump for the elevator at O’Hare Airport that’s broke.” If that’s your customer, you want to be able to fulfill the order. So when we came into the business, there just wasn’t enough inventory and we were constantly running out of stuff. And a lot of these parts were coming with really, really… 16 week lead times.

So if you were out of them, you might be out of them for eight weeks. So early on, as long as you have money in the bank, my solution to the problem was very simple. I was like, “Just don’t ever run out.” So the people ordering, I genuinely said like, “I don’t care if you have 32 weeks of inventory, optimize on never running out.” And so when you have somebody in a sales role, they just want to have the product to sell. So there’s one example, we didn’t have enough inventory. The second is operationally, the business struggled mercifully. So if you ordered a component that we had to manufacture, in many cases, the lead times were 16 weeks, they should have been like 16 minutes.

There was no reason for it to be 16 weeks, that had just happened over time, the business had grown and operationally they couldn’t handle it. So there again, you have people who are able to sell products and they’d have to tell a customer, “Hey, it’s 16 weeks.” So in that instance, it really is just fixing the operational problems in the business, which we did. It took time, I’d love to tell we did it perfectly, but it took awhile.

It almost sounds like the previous owner was optimizing inventory for something other than just not running out, is that the problem, or was there some system issue that prevented you from being up-to-date on inventory or is that going back to the warehouse software-type issue?

This is a company called VMI that elevated loans business, so a couple of things, one, the business has just grown over time, organically had outgrown the system. I don’t know what it was originally, it was probably a notepad and somebody would wander out and check inventory every so often. So there were certainly system challenges, in the mentality of the former owner was much more around cash and how much money was in the business, and he viewed five extra pumps from Italy as being cash. So he certainly was optimizing more on working capital, he wouldn’t have called it working capital, but then again, we were optimizing on solving the problem for the people selling the product.

Now, over time, we then put an operational process in place so that we could optimize on working capital, but the initial thing was just solve the operational problem, so just buy a lot more of it. And again, we had issues with the supplier, it wasn’t all within the four walls of our building, the problem.

Yeah, because you were talking about the 16-week lead time. So is the supplier just slow to get parts ordered for you?

The 16-week lead time was on another component, but we just had so many orders and our capacity was only we could make, I don’t know what it was at the time, probably 30 gates a day. And when you get orders for 35 gates a day, the backlog continues to grow every day. So we had people that were working three and four weeks straight and we still weren’t keeping up. And there was a gentleman running from the warehouse shortly after we bought the business, he had worked 28 days in a row. So the business was just growing and the operational systems and the manufacturing systems couldn’t keep up with it.

And that product with 16-week lead time, that was completely self-inflicted. There was no outside force in that.

The fun theme about these businesses has been looking through your portfolio and just talking with you. These businesses are ones that I’d never heard of or thought existed, and I know we’ve talked about that before, and it’s been a fun point of discussion around investing in small companies is you just find these random companies. Is there a few recently that you’ve come across that you really enjoyed learning about?

It’s one of the things I enjoy the most about looking for new businesses, is actually just finding this little niche businesses that you didn’t even know were businesses. So recently we’ve been spending a ton of time looking at the fireworks industry, which again, you’re not going to find an IBIS report, you’re not going to Hoovers and download a report on fireworks. So some of the enjoyment I get out of this is getting on the phone with a business owner, a guy who sold his business, or he’s a fourth generation fireworks guy, and just learning about the industry that way. And I think that’s a lot of the enjoyment I get out of this, is getting to see all these little cottage industries that aren’t even real industries.

Yeah. We talked about how the cost of the fireworks is pretty low and it’s all within the summer months, but how do you manage a business beyond just employees? How do you manage inventory, and accounting, and systems around a business that does most of its revenue in such a short period of time? That sounds as tremendous challenge.

It probably is a tremendous challenge, and the bad thing about it is your feedback loop is 12 months. So if you get it wrong, you’ve got 12 months to think about it again, try again. It isn’t like our elevator components business where you get orders every day. I think that creates a challenge. My current thesis is that, that also creates an opportunity. It makes it much more difficult for somebody to get into the business because you just get one shot to do it, and if you get it wrong, you could probably crater your entire business. But I think that’s a lot of the reason, at least, again, this is still work in process.

But part of the reason you have these fourth and fifth generation businesses in the fireworks industry is because of that, because it’s so hard to do it only once a year, that knowledge that gets built up over 20, and 30, and 50, and 60 years is what you need to be able to get through 95% of your sales in four weeks. Again, still a work in process, but that’s what we be like during the Christmas tree business, it’d be the same type of seasonality, I would imagine.

Hey, you were saying, you looked at a Christmas tree farm. How was that business?

It was also very seasonal and very weather dependent. So there was that. The other business that I’ve seen with such seasonality was a business that provided all Santas for kids to go get their picture taken with Santa. And that’s probably one of the most unique businesses I’ve ever… Again, I had no idea that was a business, I never thought as you walked through a mall and there was a Santa, I just assumed that every mall just found a Santa, I had no idea there was a business that provided them to everybody. So yeah, there’s all kinds of random businesses out there. It’s awesome to get to see all these ways people have created great businesses for themselves.

The Santa one is definitely one of the most interesting I’ve ever heard of. I guess for that business to run, you need employees and train them on how to be Santa. You got to have your inventory of costumes and whatnot, but what else is in that business that is required to keep it going?

Unlike a fireworks business or a Christmas tree business, you’re not dealing with children and parents, so I think you’ve got this workforce issue, which I think is probably very difficult. I don’t know what the profile of a mall Santa is, but I can imagine that’s a difficult profile of person defined. I would imagine, again, I don’t know for sure, but on the other side of it, you’re dealing with these giant mall operators. The spectrum of people you’re getting to deal with is giant Fortune 100 companies and all Santas. So I think some of the challenge in that business is being able to relate. I think that’s challenging to almost all small businesses, and the thing that differentiates a really good operator from a mediocre one are the people that can bridge the gap between the CEO of a Fortune 100 company and the individual that’s sweeping the floor or cleaning the bathrooms. And I think there are really, really good operators of these businesses that can do that.

Yeah. And you said that business did Santa Claus, but it also did Easter Bunnies. So was is it still that high concentration or did they find other ways to have-

They tried? They try and do Easter Bunnies in malls. They were doing Tooth Fairy somehow, they were trying to get into a host of other things, but the vast majority of the business was small Santas. Again, that’s still today one of the most interesting businesses that I’ve come across.

That’s fantastic. I want to get into a few closing questions just so we don’t run up on your time here. What class would you teach in college if you could teach about any subject you wanted?

I think I would teach a class on grit, and I think I would try and just teach people to be resourceful because I think in life, which I think is a microcosm for buying these small businesses, if you can just operate in a world with a reasonable amount of uncertainty and very limited resources and just figure things out, and there’s no textbook for running a small business, you can graduate from any great business school, and does that prepare you to actually run a small business? I don’t know that you’re more prepared than somebody that just finished their undergraduate degree, to be completely candid.

But I think people that can operate in worlds with a fair amount of ambiguity, relate really well to people, and just work really hard, can be successful in small business or in big businesses. So I think grit is a characteristic that I think you can teach a resourcefulness aspect of it, that would be very, very valuable to people in college.

How might you set up your semester or your curriculum?

It wouldn’t be with textbooks. I think it would be putting people in situations and having to do critical problem solving with limited resources. So I don’t know, put them somewhere where they don’t know where they are and tell them to figure out how to get somewhere or go and get something done. It would be much more action oriented. It’s one of the things I liked about HBS was just the case method, and I think forcing people to be giving people the ability to be creative in what they do, but forcing them to think outside the box, I think would be thesis that I would be trying to convey to people.

I like it. What’s the belief you used to hold strongly that you’ve changed your mind on?

I don’t know if it’s a belief, it’s probably more of a mindset that’s changed over time. I think, and it has to do with how I just, this is me personally, just receive feedback. I look back at my experience with Midwest Supplies, the first business I owned, just as I said to you, I was the least qualified guy ever to run a business, I also think I was a horrible CEO to deal with for the board. And the reason I say that is, I remember going to the first board meeting and my mentality or mindset was like, “These board members were coming to fire me.”

So I was extremely defensive, I didn’t take feedback well, I was really, really difficult to deal with. I know the first board meeting, the second board meeting, I vividly remember it was like a six-hour board meeting, and again, we had a business that was growing rapidly, by all accounts, was very successful. And one of the board members, a gentleman named Jeff Stevens who I think the world of, is very involved in the search fund community, had incredible experience, we get to the end of this six-hour board meeting, which I felt like I had just boxed 12 rounds with Mike Tyson, and he’s like, “Well, we’re walking out of this hotel room conference room,” We didn’t have a conference room in Midwest Supplies.

And he’s like, “Was that helpful?” I remember looking at him straight face, I didn’t say anything. I was like, “No, to be honest with you, Jeff, it wasn’t helpful at all.” And I walked out of the room. I was not good at taking feedback, I wasn’t great at listening, I was extremely defensive earlier in my career. And I think over time, that has shifted and made me a much, much better business operator, manager, leader or people.

How do you view board meetings now? Has your mindset shifted to open up to feedback?

Some of it is I have the benefit of sitting on both sides of the table, so I’ve had the benefit now of sitting in the chair of being the CEO, and I’ve had the benefit of sitting there being a board member. So when I’m serving as a board member, I’ve walked a mile in the shoes of the individual that’s running the business, which I think can be very valuable and I try and be much more empathetic. And I think that was some of my critique of the board originally was, it felt like there was never any acknowledgement of the things that we had done well, it was all acknowledgement of the things that were wrong.

And I viewed that as meaning, hey, they didn’t realize we did all these good things, but the reality was they didn’t care about the good things, they cared about trying to help us, that’s genuinely what they were trying to do. It was not be critical of us, even though they were very critical and rightfully so. I think when you’re sitting on the table of a board member of these small companies, I think there’s an aspect where being empathetic to the CEO is really important because at the end of the day, there’s a very personal aspect to this for a young entrepreneur that’s the CEO that I think if you just focus on the numbers and what’s getting done and never acknowledge how this individual is living and sleeping and breathing this little business, the message gets lost, and I think over time that turns people off.

So as I’m sitting as a board member, sitting as the CEO of a business, now the guy responsible for a bunch of businesses, I’m certainly much better at taking feedback, I’m a much better listener. I viewed it as almost a personal attack on me when things weren’t going well, and I think I’m just more comfortable in my own situation where I don’t view it that way anymore, it’s much more productive. Even by the end of Midwest Supplies, I think they would say I took feedback a lot better and I internalized it and acted on it.

Is some of that too, being a board member, phrasing your critique or your comment to the CEO in a way that acknowledges and empathizes with the good work that they’ve done?

I think it is. Again, I think the amount of blood, sweat, and tears that goes into running these small businesses cannot be emphasized enough. When you buy these things, this is your life for the first six, and 12, and 15, and 18 months, where your work-life balance is horrible. And I think just acknowledging that that even if things aren’t going that well, as long as the individual is A, trying really hard, which almost everybody is, but B, listening to feedback, and course correcting along the way, that’s more important to me than the actual outcome of the actions they’ve done because ultimately, I think that will lead to success over the long term.

But I think if you just show up at the board meeting and say, “Hey, listen, you projected revenue would be 15% up, and it’s only up 4%,” and focusing on that, is not overly valuable for the searcher or the CEO.

Excellent. What’s the best business you’ve ever seen?

I have an affinity for businesses that have created almost a monopoly for themselves, for a host of reasons, that could be regulatory reasons or just they built a brand over a really long time. I think the best business I’ve seen has a similar monopoly, but it’s not because of regulatory environment, it’s a ready-mix concrete place here in Chicago called Ozinga. And so they have ready-mix concrete plans in the City of Chicago. So if you want concrete in the City of Chicago, there’s nobody else that can get you concrete because the other plants are too far away. So they have a great business, it’s got a ton of CapEx and people would dislike it for that, but I think it’s a business that they’re in the fourth generation, I bet it’ll be around for the next 30 generations as long as people need concrete.

Wow. Do you know the business personally?

I know of it, I don’t know them. I know the gentleman that’s running it today is the fourth generation. And they’ve got, I think, 19 or 20 locations. And again, they’re not all as valuable as the ones that are right in Downtown Chicago, but those locations will, every time you need concrete in the City of Chicago, that’s where it comes from.

That’s very impressive it’s gone to the fourth generation. Is there something in the business that you’ve seen that has allowed it to transition smoothly to each proceeding generation?

I think some of it has to do with, when you build businesses that are almost impossible to break, you build a moat that is that significant, which is like, hey, then your competitor can’t get ready-mix concrete within 30 minutes of Downtown Chicago, it’s really, really hard to screw that up. And I think that’s not to say you couldn’t screw it up through this passing down generations because you’ve seen it many, many times, but I think when you have businesses that are really sustainable and have an incredible foundation with the underlying business, it makes the transition a lot easier, but obviously, as these families grow and get bigger, the likelihood that they blow up is higher and higher.

Are there any lessons from that business that you think you can apply it to something your own?

As I said at the onset, I think I love businesses where there’s some type of regulatory or requirements that allow business to operate in an otherwise unlevel playing field, you don’t have competition and you see that… One of the businesses that I own, it services railroads, there’s two or three companies in the entire United States that are able to have the capability to provide the services that we provide. So again, there’s nothing that prevents anybody from getting into that business. They would have a very difficult time with the equipment or with the experience needed to do it, but I think my biggest takeaway and what I focus on more today when we’re proprietarily looking for businesses is just that. So finding businesses that have a massive moat or advantage on the competitors, and to lead to just really, really fun businesses.

Excellent. I like it. Thank you so much, Matt, for joining us. I really enjoyed this time with you, and just want to thank you for sharing your time. I really enjoyed it.

Thanks. I enjoyed it. And like I said, I think you’re doing an awesome thing for anybody who has an interest in going to buy a small business.



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