ROSS BRENDEL – INVESTING IN PERMANENT CAPITAL VEHICLES – EP. 57

^[redacted]‌ is the cofounder and managing partner of Westerly Group alongside cofounder Rich Littlehale. Westerly Group was founded on the principle of supporting acquisition entrepreneurs with committed, permanent capital to pursue a specific industry thesis over an indefinite time horizon. Groups they’ve invested in thus far have theses in the water industry, mission-critical B2B services, industrial services, and route-based and multi-site consumer businesses. Permanent capital and longer hold periods have become much more popular in recent years and Ross and Rich take an incredibly interesting and unique angle in their study and investing in the model.

In this conversation, Ross and I discuss Westerly’s permanent capital thesis and model, whether buying a business has become harder or easier and how to think about a purchase price with a longer term view, the types of entrepreneurs Westerly seeks to invest in, and nuanced advantages of committed capital in pursuing acquisitions.



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Think Like an Owner Sponsors

Live Oak Bank – Live Oak Bank is a seasoned SBA lender focused on search funds, independent sponsors, private equity firms, and individuals looking to acquire small companies. Live Oak has closed billions of dollars in SBA financing and is actively looking to help more small company investors across the country. If you are in the process of acquiring a company or thinking about starting a search, contact Lisa Forrest or Heather Endresen directly to start a conversation or go to www.liveoakbank.com/think.

Hood & Strong, LLP – Hood & Strong is a CPA firm with a long history of working with search funds and private equity firms on diligence, assurance, tax services, and more. Hood & Strong is highly skilled in working with search funds, providing quality of earnings and due diligence services during the search, along with assurance and tax services post-acquisition. They offer a unique way to approach acquisition diligence and manage costs effectively. To learn more about how Hood & Strong can help your search, acquisition, and beyond, please email one of their partners Jerry Zhou at [redacted]

Oberle Risk Strategies – Oberle is the leading specialty insurance brokerage catering to search funds and the broader ETA community, providing complimentary due diligence assessments of the target company’s commercial insurance and Employee benefits programs. Over the past decade, August Felker and his team have engaged with hundreds of searchers to provide due diligence and ultimately place the most competitive insurance program at closing. Given August’s experience as a searcher himself, he and his team understand all that goes into buying a business and pride themselves on making the insurance portion of closing seamless and hassle-free.

If you are under LOI, please reach out to August to learn more about how Oberle can help with insurance due diligence at oberle-risk.com. Or reach out to August directly at [redacted] in sponsoring? Send me an email at [redacted] Transcript:

Thanks Ross for joining us. I’ve been excited to have you for a while. When Justin introduced us a little while ago, it was around doing a podcast. I’m glad we’re finally there and getting to hear a little bit more about what you do. I’d love to start by your background and then how you got to work with Westerly and Rich alongside you.

Yeah. Well, thanks for having me. It’s been great to get to know you over the last six months. I’m glad we could finally set up and do the podcast so it’s good to be here. My background prior to launching Westerly is a fairly conventional one. I did a couple years of investment banking at Blackstone Group in their advisory group prior to them spitting that out, which it’s now a separate company. That was a very diversified experience. I did real estate, consumer, did business services, did some power and utilities, M&A advisory. Left there in 2013, joined what at the time was a startup private equity firm called Sycamore Partners to focus on San Francisco who had left the year prior to launch their own firm focused on consumer and retail and were building out the investment team in New York, which was a great experience and really appealing to someone who was in my case 23, 24 years old at the time because it was a learning experience both within investing and joining a company that was in the early stages of launching and kind of having a front seat as someone who’s building an investment business not just looking at investments.

So was there for two years, went to business school, came back after business school back to the same firm and spent another couple of years there learning, which I think as a critical learning period, because you’re focused both on the process around identifying and diligence and doing good investments, but also tasked with being more than just an individual contributor and having to have managed people for the first time in your career and be the pinch point in the process. And so that was stressful, but also fun and learned a lot. And then ultimately left there midway through 2019, joined up with a former college classmate of mine, who has a very different background from my own, much more interesting candidly, much less conventional, and we launched Westerly Group in partnership with the family office that’s backed us.

And what we are is we’re an investment firm not a private equity firm, but we invest directly into lower middle market size businesses in partnership with mid-career entrepreneurs and operators. So we look for folks who are kind of in the third, fourth innings of their careers, have a specific set of experiences within a particular industry, and are interested in being an entrepreneur within that industry through buying a business and running it for five years, 10 years, their whole career. We’re kind of tying in different capital. We want to be able to hold for a long period of time if it makes sense, but we also realize that things change and that doesn’t always make sense.

And so what we look to do is identify those mid-career entrepreneurs who have a desire to buy one or multiple businesses that fit a specific thesis in whatever industry they’ve been operating in and be an anchor investor for them, provide them with permanent capital and support, and with active board member level of support from folks, and Rich and myself or really their peers in terms of age and position in our own careers, which I think is a little bit different from maybe some more kind of established investment firms.

Yeah, I know permanent capital and long term hold vehicles are certainly becoming more popular. Why do you think interest in longer term hold periods has increased in the last few years?

I think it’s a couple of things. I think, one, if I’m thinking on the part of the entrepreneur, so there’s the entrepreneur side and then there’s the investor side. If I’m thinking on the side of the entrepreneur, the realization that high quality businesses regardless of size are hard to find, and hard to buy well, and it takes time to learn how to run them. I had spent my career after launching Westerly looking at much larger, more institutional businesses where we were looking at them alongside larger strategics or private equity firms and had this really naive notion that once you go down below five million of earnings it was going to be some kind of inefficient marketplace or Wild West, that’s not the case.

There’s a lot of people out there with capital, a lot of people out there without capital who are still looking to buy a business. And the ability to reach those owners, identify those owners, reach out to those owners, and do so in an automated way if you’re looking for a business, has only become easy. And so I think people are realizing that it’s tough to identify former relationship with acquire and run high quality business and that takes time. And so if you are fortunate enough to be able to do that, why would you sell just when you’re starting to really get the hang of things and learn the ropes? What do you do when you sell? Do you do that all over again? Do you try and see if you can kind of find that diamond in the rough again?

So I think that’s one piece that on behalf of the entrepreneur, and also people realizing that, and I mentioned this a little bit, but the process of actually becoming a good CEO and leader takes many years. And once you get there, whether that’s in a year or three years or five years, the job becomes more easy and more fun and you start to really kind of the dividends from all that work you put in and not wanting to have to sell at that time. And I think from the investor seat, there’s that recognition that I just mentioned but then there’s also the recognition that if you can continue to compound even at slightly lower rates of return for an extended period of time, five, 10, 15, 20 years, that just far outperforms even higher IRRs where you’re selling, paying taxes, paying fees, paying transaction frictions, and then having to find someplace to reinvest that money.

Taxes, fees, and reinvestment risk are very large when compounded over 20 years, and are potentially only going to get larger if taxes on long term capital gains start converging more with income tax rates. And so I think on the investor side, there’s a recognition that just in terms of long term MOIC as opposed to near term IRR, there’s a real benefit in holding things for the long run. And also not having to worry about that just reinvestment period, having intelligence new managers, having intelligence new opportunities, it’s just a little bit more scalable, I think, if you’re an investment manager to be able to pick fewer horses and back them for a long period of time.

Absolutely. So if your focus then is understanding that the real earnings and growth and compounding is over a long period of time, just operating a business well for very long hold periods, does that to you mean that an entrepreneur trying to buy a business should be less price sensitive in the company that they’re buying?

So I think, one, in terms of hold period, we view being long term as a feature, a person in our ecosystem who I talked to last week had a great term for this called zero time preference capital. I don’t know if he made it up or if he read it somewhere. But I love that term because we’re not going into anything saying we have to do something for 20 years, that would be foolish and we couldn’t ask people to sign up for something for that long period of time. No one would do that. I wouldn’t do that. But having zero time preference capital means that if we bought something and something changed in our underwriting or someone else came along and did something irrational in year 2, we would certainly entertain that. But if our underwriting continues to hold true for many years, then we have the ability but not the obligation to hold for a long period of time and critically we’re partnering with entrepreneurs who share that same mindset.

In terms of your question on does that allow us to pay slightly higher purchase multiples, I think so, yeah. I mean, we want to be price disciplined and generally are avoiding brokered auction processes and highly prefer proprietary deal processes where you can get a more attractive purchase price. But if you’re talking about a half of a turn or a turn on a multiple, over 10 years that has a de minimis impact on your long term returns. If you were to sell a business in three years, whether you paid six times or four times for it, that can be a material driver of returns but over 20 years that effect is so much diminished that I think for us at least puts a higher premium on business quality and paying a fair price for a high quality business as opposed to what some people continue to do very lucratively which is pay very cheap prices for okay businesses which can be a fine strategy but it’s a little bit different from what we’re trying to do over the long term.

So how do you find entrepreneurs who fit that long term holds mindset and then are looking for those higher quality businesses and aren’t just satisfied with something that’s just okay?

It’s not really a tangible measurable thing but that kind of career outlook and alignment is one of the first things you can screen for. I mean, back before COVID hit, we could actually sit with people in our office and in front of a whiteboard together just drawing up that curve that you’ve seen all the time around how long it takes to the percentage of returns and the percentage of profit dollars that are generated post year 10 if you’re compounding in 15 or 20 to 25%. Putting that up on a whiteboard and just kind of seeing if that clicks with folks like, “Yes, 90% of the returns here could be generated post year 10 in this investment if we find this gem that we’re able to continuously reinvest into.” And so that’s a bit of a just kind of a mental alignment and a first filter that we apply.

We do look for teams generally. We found that is at least historically within search returns that has led to slightly better returns. In our case where we’re backing entrepreneurs to buy oftentimes more than one business, we find it’s useful to have someone who can focus at least in the first couple of years day to day on running a business and someone who can focus on growth and acquisitions. It also over the long term provides a little bit of risk mitigation for each of the other entrepreneurs and ourselves because people’s life and circumstances may change over time. So we look for those types of teams and we look for teams who have ideally complimentary skill sets not just in terms of their work experiences and their basis of knowledge but in terms of their kind of jobs to be done managerial abilities, you can have personal abilities, someone a salesperson, someone else’s kind of a more introverted heads down person, kind of the classic visionary integrator dichotomy in the entrepreneur operating system. That type of thing really can be really helpful versus two people who bring the exact same thing to the table.

You mentioned a little earlier about the process of buying a business is difficult of course and if you finally get into the seat, you should ideally stay there for as long as you can. Do you think it’s gotten harder to buy a business over the last five or 10 years?

There’s some things that have made it easier and there’s some things that made it harder. On the easier side, it’s never been easier and it’s continued to get easier to find those businesses, to identify who they are, where they are, how to reach out to them, to build a market map of thousands of businesses to run an email campaign, it’s automated, that can kind of loosely customize things and get your name out there, to do outreach, to build content. All of the wonderful things about kind of the internet and the aggregation of data have lowered the barrier to entry there, I would say. 15 years ago, the actual sweat of building a list and that was much more proprietary in doing that outreach is much more proprietary and there was a lot of kind of value that was accrued in doing that work, whereas now the barrier to that is much lower.

Likewise on the easier side, there are so many more service providers that exist nowadays both in terms of small brokerages that are kind of either focused on a particular niche that if you want to look at, can help you kind of understand that marketplace and give you a pulse on all the deals that are going on there. Or that are more general service providers that you can pay a fee to to help you look for business, specialized banks and accounting firms, and all of these types of things, there’s just more of them now that can help you out along the way. Outsource CFOs, outsource controllers, you can outsource anything and you can kind of run a business very leanly now. And I think that that goes to a lot of the pieces of finding a business as well, a lot of the skills that you might have had to do yourself previously. So from that perspective, it has gotten easier, or I should say the barrier to entry, probably more appropriate, the barrier to entry has gotten lower.

On the harder side, which in my opinion, I don’t know if there’s any scientific way to prove this, but in my opinion, what has outweighed that on the harder side, is just that. It’s that because the barrier to entry is lower, it is easier for people to kind of do direct outreach and so there’s just a lot of noise now. If you’re the owner of a $2 million EBITDA business that has some kind of attractive B2B service component to it, you’re probably getting emailed weekly if not daily by someone who is looking to buy your business oftentimes in a very transactional way. And so there’s just a lot of noise out there, that as a searcher or as any entrepreneur trying to find acquisitions that you have to overcome. If I were to just put random numbers out, if the amount of people looking to buy businesses has doubled, then kind of what I’m saying is, I think that the amount of outreach and the noise would have multiplied by way more than that, call it 10X, because it’s become 5X easier to actually do the outreach.

So I think that’s a challenge and an opportunity for people who have some differentiated outreach method. Because regardless of that level of noise and regardless of the lower barrier to entry, the actual opportunity set of businesses to acquire far exceeds the amount of people who are trying to do that. I mean, the Bureau of Labor Statistics publishes businesses by number of employees on a semiregular basis. When we were looking at 20 to 500 employees, there’s 760,000 of those businesses in the US. So you’re excluding all these single member LLCs, you’re just focusing on kind of 20 to 500 employees, which is probably around the sweet spot of one to five million of earnings generally. And there’s almost a million of those out there, far and exceeds the amount of people are searching.

So it’s about how do you cut through that noise, which I think provides an opportunity to people who are focused, who are kind of willing to experiment more, who are willing to take a longer term approach. Because if you are just looking to buy a single business and you’re looking to do that in a discreet period of time, and then looking to sell that business, what you end up doing oftentimes, it’s like building this super elaborate sourcing mousetrap, spending a year plus of your life building up databases, building out a skill in outreach and a skill in developing relationships with people to buy one thing and then when you buy that one thing, you’re kind of just discarding all of that IP and work that you’ve done versus if you’re doing something over a longer period of time.

If you’re doing a programmatic acquisition strategy so you’re not necessarily just buying a single business, but you could be buying a business in year 1 and then continuing to acquire over time, you’re able to invest in your outreach and relationship building because you’re able to, in a kind of cost efficient way, build a relationship with an entrepreneur who might not be selling for six years. And that can be very valuable in six years. So I think it’s become, I would say, harder to get through the noise overall, because of the lower barriers to entry. But if you have a longer term approach, if you’re able to invest in kind of content or relationships or things other than just direct outreach, because you’re going to be in the market, you’re going to be talking to people not just for some discreet upfront period of time, then that can be really differentiated versus everyone else out there.

So if it’s become so much easier to get in front of owners or at least send them a message, not necessarily get in front of them, but what are some of the more unique ways you’ve seen searchers or entrepreneurs look for companies to buy?

Well, I think focus is a key one, because with focus, you’re able to devote the energy to actually learn someone’s business model. So if you’re reaching out to people being able to speak the language, not at their level, but instead of being an inch deep in a 10-foot deep pool with your foot deep, being a foot versus two or three-foot deep probably doesn’t make a difference, but being deep enough to actually kind of understand and converse with someone in a way that they’re used to conversing with someone in the industry, I think is a really big one, just in terms of being able to do the research. But in terms of specific outreach methods, social media is a great tool. You have a great platform. I think people who are focused on a particular industry, they can actually create content related to that industry, whether it’s media like a podcast, whether it’s content like a weekly newsletter, a monthly newsletter, whether it’s building a following on Twitter, whether it’s picking an area of focus that they’re trying to find a business in and joining all of the Facebook groups about that, because a lot of people, maybe not a lot of younger people in their 20s who are looking to buy business, but a lot of people in their 40s and 50s and 60s are on Facebook a lot and they’re in these groups.

And so things like that, having an actual kind of outbound content machine, which takes time. So if you’re trying to find a business in six months, it’s probably not worth to make that investment, because it will take time to develop that following. But if you have the time to actually build that mousetrap, that can be pretty useful.

Yeah, I totally agree. Can you tell us about a few of the entrepreneurial teams that you’ve backed so far at Westerly?

Yeah, absolutely. So we backed three teams thus far. And they’re all a little bit different, but they all definitely have that long term orientation, kind of the values alignment, complimentary skill set, and kind of are each operating in different but very interesting industry niches that candidly Rich and I didn’t really have any idea existed or have any plan to go out and buy business in those spaces before we met these teams.

So the first thing that we backed is out in California, two folks who have spent the bulk of their careers in the water and wastewater space, and are looking at very durable businesses that are involved in kind of advanced water treatment. There’s kind of a regulatory mode aspect of it. There’s a technology mode aspect of it. They’re often kind of route-based service businesses so there’s kind of a benefit of regional scale aspect of the businesses that they’re looking to acquire. But just super talented operators and investors that we met through friends of friends and built a relationship with over the course of eight months before ultimately deciding to partner together.

Another team that we’re backing is out in Arizona, and they are doing a roll up of overhead crane servicing, which is a yet to be penetrated by private equity, but probably in the early stage of that. Relatively small niche market, but one that is, again, it’s going to sound a little bit like a broken record, but like a mission-critical service, where the cost of the downtime is much more valuable than the cost of the actual service. And so the business that they own and are looking to consolidate is providing OSHA mandated inspection and maintenance to pretty intricate overhead cranes that exist within manufacturing distribution facilities. So think the crane that moves the Teslas around the Tesla Factory, that California says needs to be inspected on a monthly basis. If that thing breaks down, Tesla could be losing 200 grand an hour versus the 1500 bucks it costs someone to come look at it. And so that’s perfect kind of business for us in terms of being that mission-critical service.

And then the third team is in the search phase still out in Texas. And they’re looking at kind of technology adjacent manufacturing businesses. So businesses that are incorporating technology and interesting ways into stayed old world industrial manufacturing businesses generally located in kind of the non-coastal state. So areas that are a little bit less sexy, less picked over by conventional private equity or even searchers, where their combination of investing in technical background and background within kind of that part of the country is differentiated, and will allow them to kind of acquire what could be a more kind of old world manufacturing business or industrial business and implement technology into that to make it more efficient. Think like industrial internet of things. They started looking at businesses to kind of fit that theme at the moment, I’m excited to see what they come up with.

With all three of these entities being or having committed capital as part of the structure of them. Can you talk through some of the reasons that the three of them are committed capital and some of the perhaps benefits or advantages of that element?

Yeah. So the advantages of that are, one, when you’re talking to any owner or intermediary, especially as a first time acquirer, having fully committed capital is valuable. People are going to take you more seriously just to get the look and when you have a deal in tow and you’re able to get an ally, you can focus on diligence in the business as opposed to spending the lion’s share of your time out fundraising. So from a credibility and transaction execution standpoint, it’s valuable.

Two, you get to choose your investors upfront, which is an advantage because you can take the time to find the people that are most aligned with what you want to build, both from an industry perspective and from a time horizon perspective, and put together that group yourself as concentrated or non-concentrated as you want it. We prefer not to be a single investor. We also prefer not to be one of 30 people on a cap table. We think having a somewhat close-knit group of larger investors that have each of them material skin in the game themselves, they’re not viewing this investment like one option in a portfolio of options is valuable for the teams we back as well, and gives them the support. But if you’re the entrepreneur, then you have the ability to take the time to actually pick your own investor group outside of the constraints of a deal process.

And then I’d say three, you can spend that time with those investors even before doing initial acquisition, setting up your company structure to try and solve for as many of the long term conflicts of incentives or interests that might arise as you can. So you’re never going to be able to pre-legislate any potential issue that could come up five or 10 years down the road, but there are some common things that if you have the benefit of kind of setting up your structure from the start with a kind of focused and aligned group of long term investors, that you can solve for.

So one being liquidity and removing incentives to sell businesses early. One of the most powerful incentives to sell a business early if you’re the entrepreneur, is if your ownership or promote or shares or however it’s structured is paid out after some preferred return that is either a high hurdle or continues indefinitely and requires you to constantly send cash out of the business in order to satisfy that not have that continue to grow in front of you. We set up our structures such that that is capped and that after a period of time, call it five years, that does not grow and does not create the incentive to consistently send cash on the business.

We set up our structures to the companies not funds and so the entrepreneurs who own these businesses, own shares in the businesses from the starter. It’s a cap table just like any other company, and there’s investors, and there’s the CEO and president and whatever the titles are, the entrepreneurs on the cap table with shares, which I think is both financially advantageous and from a psychological perspective is advantageous as well because you are a position in a waterfall that is getting paid out in some order of operations. You have shares in the business.

And when you have shares in the business, you can do things with those shares in the business, which means you can sell a portion of those shares in the business even if the business hasn’t sold. You can borrow against those shares in the business from the company or from an intermediary, share-based lending is very commonplace nowadays, and not paying taxes on those shares, just borrowing, gets them paying without it to actually get tax credit for that. So setting things up like that, that remove a lot of the incentives to sell purely for the sake of kind of harvesting games for non-long term reasons, creating methods for both the entrepreneurs and the investors to get liquidity down the line in the absence of a sale.

My partner and I are peers with the teams we back. We’re not 10, 20 years older than them. We have the same personal issues, where five years down the line, 10 years down the line, we may want to take out funds to send our kids to college or to buy a house or something like that but we don’t want to sell the business. Having the ability to get liquidity for a portion of our ownership or a portion of their ownership in those situations, I think is valuable long term such that we’re not sitting here in year 7 saying, “Look, we haven’t taken a dollar out, now we got to sell the thing.” And so solving for those types of things upfront or as many of those as you can, with an aligned group of investors would be the third advantage I’d say of raising a committed capital pool.

And you also mentioned how each of these groups is in an industry that you may not have gone after if you hadn’t heard of it initially or perhaps you hadn’t even heard of the industry before, which by the way is kind of the fun part to me of exploring the small companies is you find all these industries you never knew existed. Is that something that was intentional, you intentionally took a generalist approach to things or are there some industry theses that you would like to find entrepreneurs executing?

Yeah, it’s a great question. And it kind of goes back to when we first launched because I came from more conventional private equity background. And so when we launched Westerly, was very much in the mindset of what are some popular roll ups, consumer services, healthcare services, whatever, let’s go out and start building relationships with brokers and let’s go start looking at deals. And let’s effectively operate like a lot of other kind of lower middle market private equity firms and just look at businesses. And what we found after doing that for a couple of months is, you can do the deals, you can find companies, you can find deals to do where we’d be kind of getting into the second stage of a lot of these processes and be kind of talking about it during weekly investor meetings and say to ourselves, “Look, we’re never going to buy this business without a team that we have diligence and that we feel incredibly confident around backing to run the thing.”

And most of the time, unless there are some unicorns at the side where there’s a professional management team is coming with the business, but more often than not, that’s not the case. And so we were never going to move on any of these deals. There was no strong narrative even in a space that we’d looked at for a reasonable period of time and built that thesis and for us to be kind of the topping bid or prevail in a lot of these processes without high quality executive that we had kind of built a relationship with or vetted and so we thought, “First of all, why don’t we just start with the team then? Because that’s the ultimately most important thing.”

So that’s kind of what led us to pivot more towards the team first strategy that we’ve been focused on over the past year and a half. And it is fairly generalist from industry perspective if you’re thinking about the NAIC codes, there’s probably a couple of those we could scratch off a list that we’re not going to look at and not really focus on all things in financial services or energy, those types of industries just to name a few super heavy industry. But it’s not as general as it may appear because there are definitely kind of business model filters that we would apply to any team’s thesis that we’re backing or any company that we’re backing.

But to your point though, it is a bit more reactive from industry standpoint because if we’re focused on the team first, the initial question we’re trying to answer is, are these entrepreneurs that we would want to back hopefully for their careers? If yes, then let’s dig into what they want to focus on. And from that sense it’s a little bit reactive. But we do spend a part of our time more proactively focused on one or more industries that we are really excited about, where we’d love to find a team and a business potentially kind of together but where we would like to devote time in a more concerted way than just the team for a side of it.

So we’re a small firm, there’s two of us, we can’t look at five industries at once so we’ll generally pick a space for a period of time to focus on. In the case of the past year, it’s been early education, which we were starting to look at even before COVID and over the past year has been a space that’s gotten hit hard by COVID because it’s all in person, but has only highlighted how critical that service is. As being a parent of a one-year old and seeing how unsustainable it is, especially if both parents are working to have kids at home, that’s been a space that we’ve been looking at much more proactively over the last year. Whatever we do in that space structurally will be similar to the other investments that we’ve made, the only difference there is we’re kind of, again, we’re practically focusing on the industry first as opposed to letting the teams guide us to the industries and business models

So what happens if you back an entrepreneur and that entrepreneur starts to get into a thesis that you initially backed them to execute in and they start finding out that that thesis or that industry isn’t nearly as attractive to them anymore? Do you help them look for another industry to investigate or how do you guide that journey if they decide to go off the initial thesis that they presented you with?

We’re backing the people not necessarily a narrow thesis. And so we are very supportive of pivoting and changing our opinion when the facts change or the situation changes. And that was actually the case with the first team we backed in the water industry is that we were starting with a specific business model that they had a lot of experience and knowledge in and there were a lot of transactable deals, but after looking at a couple of deals in the space we realized that it wasn’t a super sexy service as we thought it was, a lot of these businesses were more project-based, kind of building treatment systems, as opposed to kind of doing recurring service on those systems and they were much more attractive water and wastewater related businesses then to acquire. And so after a couple of months we’ve since pivoted away from the initial kind of subsegment within the water industry and the business model that they’ve been looking at very successfully and have been finding much more high quality deals and just frankly a larger opportunity set outside of that.

So very supportive of pivoting and I think part of our model as I said before is being a meaningful investor in all the teams that we back and vice versa, those teams being a meaningful investment for Westerly. There’s this mutual relationship where they’re super significant to us and we’re super significant to them and so none of these are options, they all need to work as we say to ourselves every single day. And so we’re very supportive of kind of helping teams if they’re pivoting their strategy or their area of focus, because they’re what we’re backing first and foremost.

You’ve talked about having a business model filter, does your long term view horizon or the zero time horizon investor idea, does that give you a little bit more flexibility in terms of the business models you go after, so maybe you’re not just service business models but you can expand to others as well? Does that have that flexibility or are you still primarily focused on a lot of what typical search funds look for?

So we do like the initial search fund filters. There’s a reason why investors have used them especially when backing first time CEOs because they generally wouldn’t sell us the high quality businesses that are going to continue to operate near a status quo after a leadership change. But having a longer time horizon I think does open us up. So both two things, both having a longer time horizon and being more concentrated open us up to a wider range of industries.

Starting with the second piece of that, because that wasn’t your direct question, I think when you have investors that have made 30 or 40 or 50 investments, they have to be very formulaic about how they view things just from a time and scalability standpoint. You kind of have to have your criteria and you have to stick to them, you have to be zealous about it, because you don’t have the ability to say, “Oh well, this is an interesting industry I didn’t know about. I’m going to spend three months just getting to know it.” You can’t do that if you’re making 30 investments. If you’re making three, you can. And so you can take the time to learn something that’s not kind of just down the fairway of a traditional search deal. So having the concentration is probably equally as important as having kind of indefinite time horizon of being able to do the work on a space that is probably outside of the fairway for a lot of traditional search investors.

And the time horizon is an important factor as well. We haven’t yet but you could, and a lot of people have done this successfully that are kind of longer family office type vehicles, being able to invest in industries which are more cyclical in nature. I was talking to an entrepreneur last year who is built a shipping holdco which is very impressive and it’s been a family thing over many decades. That is a very capital intensive cyclical industry, but if you don’t have a multiple many decade time horizon is tough to be successful in, that’s not something we’re doing. But having that longer time horizon allows you to play in things that are potentially more cyclical. We have the ability to write out the business cycle if you’re not highly levered, being able to invest in things that might have higher upfront capital costs and upfront investment to scale.

If something has a high capital cost indefinitely, that’s just a lower quality business. But something that has a higher initial capital cost, initial required investment, that can decline over time but wouldn’t make sense if you’re only investing for five years. That’s something that we can look at. And looking at opportunities where you can really invest in the processes and the technology of a business in a way that you wouldn’t if you’re only going to kind of dress it up and sell it in a few years.

I mentioned a team we’re backing in Texas. Technology is pervading every industry. Technology as an industry it’s a piece of a business model. And so every type of business is going to have to incorporate technology in some respect and so being able to buy any business and make investments in systems and data and how those all talk to each other is something that you can do and is cost effective if your whole period is 10 years or 15 years, that might not be if your whole period is a couple of years. So things like that, I think, broaden our aperture in terms of the type of opportunities that we’re able to look at and the types of kind of initiatives that we’re able to underwrite over a longer term.

I was curious if there’s any other models for searching for a business that you found that are particularly interesting to you or you want to see become more popular?

There’s probably four paths at the moment. Maybe there’s more but four options come to mind if you’re looking to buy business. One is that traditional model of raising search capital by selling units in a search fund to a group of investors who then have a pro rata participation right at preset terms in your deal that you find. Another one is the self fund grant, don’t raise any capital, find the deal, and then when you have that set your own terms and raise that from whoever you want in conjunction with the deal. That probably limits you in terms of the size of business that you’re looking to acquire. Given terms above a certain business size or above a certain equity check size, you’re going to start to converge much more like search terms so you can buy a smaller business, own a bigger chunk of it, or you can end up finding a business that’s the same size as a traditional search fund size business.

Self fund fundraise there would probably end up in a pretty close spot in terms of terms, but it gives you more flexibility. You can find something suddenly in a cash flow and that can make a lot of sense for you, own a bigger piece of that, whereas in the traditional model, it’s not going to make as much sense for you or your investors given the terms.

The third piece of that is similar to the traditional search but more of a entrepreneur in residence model where you have a single investor, whether that’s a family office who has backed you and is kind of covering your overhead, whether that’s an accelerator model. And ideally there’s some value-add that you’re getting from that single LP that you have, but they’re able to be a sole investor that creates ease of execution on your part, ideally, less hassle around deal execution and fundraising, but comes with its own set of considerations.

And then there’s what we’ve talked about that we’re doing which is kind of a concentrated set of investors with a pool of committed capital to go do one or more than one acquisition over time. A commitment that’s drawn over time too, it’s not just funding the first deal but you have called five years to draw upon that entire commitment if you want to. And so at the top of my head, those are the four kind of big bucket paths, I think, that exist nowadays for most people but there’s always different variations on those.

How do you think you’re going to continue to find these entrepreneurs and these teams? Is there some consistent formulaic way you’re going about looking for them or do you think a lot of it is just going to be opportunistic and more by chance meetings?

That is a great question. It’s something we talk about all the time. There are some pools of talent that are more discrete, where it’s possible to really touch bottom on kind of networking and meeting people in so obviously, the MBA community. There’s X amount of top MBA schools and Y amount of people within those who are interested in entrepreneurship acquisition. And so you can kind of be in the right conferences and places and get in front of people in the right clubs and everything and meet those folks like fairly discreetly. Takes time, and you have to build relationships and it’s a full time job, but that is a discrete pool of people.

The kind of more mid-career entrepreneurs, like the first group I mentioned, they could have MBAs, they could not, that’s not really a critical factor for us. That one is a bit more morphous, and I think a tougher nut to crack. As far as we know, there’s not a programmatic way to reach people who have valuable skills in a particular industry, are entrepreneurial-minded, want to build a business over the course of their careers. And kind of we’re not sure all of those four options that exist, exactly what the benefits and tractions of each of those options are.

So today, I mean, it’s just been like in any business you’re building a lot of kind of grit and unstructured conversations and continuing to pull the strain on relationships and networking to just meet more and more and more people and grow your network that way. One of the things that is a priority for us now that we’re kind of midway through year 2 is to try and think about a way to do that in a more scalable or programmatic way through creating content and outreach to kind of identify people online or identify people just through newsletters or through content that we create to educate them on those options and to introduce them to ourselves and teams that we backed. So that’s a party for us, because I think that talent pool is super strong and really interesting, especially people who bring years of relationship that they’ve built within a particular industry, it’s incredibly valuable.

And going back to the discussion about the noise and insourcing and looking for those great businesses, that is a huge leg up, having institutional expertise in relationships with owners and operators and intermediaries in a particular industry. So we’d love to find more people like that and it’s just a question of how can we do that in a more programmatic way?

Moving into some closing questions. What class would you teach in college if you could teach about any subject you wanted?

I would teach what was my favorite class in college, which was Cold War history. The class that I took was taught by kind of this legendary historian who is an authority on the subject and had written a bunch of books on it. But I like the class because, one, I think history and learning history is incredibly important. And being able to see through other people’s eyes and appreciate historical context is a valuable skill not just for learning history, but for most careers in life, in particular investing, being able to see outside of your own experience and other people’s and take things in context. And so I think that’d be a really fascinating class to teach. I think it was a truly global event that shaped almost every country in the world for over 50 years. And it’s one aspect of history you can actually know what people were thinking and feeling because it is so recent as opposed to studying the Greeks through the writers.

And so I would love to teach that class partly because of just personal interest in the person who taught me and partly because I think that that skill of seeing through other people’s eyes is more and more valuable and something that I think is getting a little bit lost today in our climate.

It sounds like a lot of what interested you in that class was the professor. What was the professor like? And what made them such an effective teacher for you?

He was just a legend. So he had lived through the material that he was teaching himself. And when he’d get to a subject about what was the president of Indonesia thinking at this point in time, he would say, “Well, then I asked him, what are you thinking now?” Being able to draw on his own personal experience going through this whole period of time, I think was pretty cool. And going back to the fact that this is recent history. It’s something that happened over the last 75 years and so there’s media. Every class was not just textbook learning, half the class was watching news from television and other media that was produced. And so being able to actually see it live was pretty cool.

It does sound pretty cool. I’m unfortunately too young to remember the Cold War, but that sounds like it would be an interesting time to live through. What’s a belief used to hold strongly that you’ve changed your mind on?

So I think the belief that you have to be strongly opinionated on something especially when you are younger or earlier in your career. I think when people are trying to prove themselves and are kind of coming up in their careers, there’s probably a desire to stand out and to show that you’re smart or show that you’re hardworking or show whatever, and to take aside to view things through a black and white lens. And I’m definitely not old and still in the early stages of my career, and a lot to learn, but I think that you don’t necessarily need to take a side, the benefit of being, another term that I heard from a good friend of mine that I love and that I always appropriate is being an incrementalist. Looking at things through the lens of incremental change. Changing a little bit to the left or the right, not wildly swinging to the left or the right, but not needing to have a firm perspective on something to be smart.

Again, going back to kind of the Keynes quote from earlier, when the facts change, change your opinion. Having the maturity to actually try and do that, definitely not perfectly, but to have strong opinions loosely held, and not feel like you necessarily have to be pitched on one side of the other to be smart or to stand out or to get recognized.

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

I’m going to pick something that is not the technology, or it is kind of technology business, but it’s not the mainstay of just huge technology compounders or the ones that would immediately come to mind. I’m going to go with Domino’s Pizza. This one, it’s funny, Domino’s and Google IPOed within a month or two of each other in mid 2004 and until October of 2020, I Googled upfront a little bit, were completely neck and neck and Domino’s is actually slightly ahead in terms of total shareholder return over that subsequent 16 years, which a lot of people don’t know. Domino’s has 26Xed in value, in price, over 16 years, and 25% ROI per year. Those are just the stats.

But what I think is super special about Domino’s is that they took a pretty simple, generally undifferentiated business model, and turn themselves into an undisputed industry leader delivering great products to their customers, delivering great outcomes for their franchisees, delivering great outcomes for their shareholders by making long term investments in technology and infrastructure. And I think that’s pretty cool in a business model, a franchise business model, that has nearly unlimited ROIC. So you don’t have to really invest much to grow by growing your franchisee base, super asset, super high ROIC. But over the past 15 years, they have invested in technology and allocated capital towards technology and share repurchases in an incredibly efficient way that has allowed them to have 80 million unique users of their digital ordering app and get 75% of sales just through digital ordering. And so I think that’s super impressive. Being able to do that in something as boring as pizza delivery and building a business that’s multiples larger than next largest competitor in a franchise model with super high ROIC is pretty cool.

And then on a more personal note, when I was in Australia five years ago, they were already delivering pizzas via robot in Domino’s Australia five years ago, whereas everyone else just kind of in stone age. So I think that’s a great business. It’s a case study. And regardless of what industry you’re in, if you’re investing for the long term, and you’re allocating capital smartly, then you can have returns that mirror Google’s, who everyone thinks of is the biggest rent seeking monopoly out there. So yeah, that was pretty cool.

Yeah, I also have a personal note with Domino’s. I was a co-president of my accounting group in college and a big part of my job was making sure there was pizza or some food available for our Monday meetings. And I can’t tell you how much Domino’s I ordered, but I know that my car frequently smelled of Domino’s for a week at a time and it was not super fun. So I’m not a huge fan of Domino’s as a food, but the business is very impressive so I completely agree with that one.

Thank you so much, Ross, for sharing your time today. This has been really awesome. I love the discussion. And hearing more about your long term hold vehicle and some of your thoughts for entrepreneurs buying companies in the future is really interesting. So thank you for sharing today.

Yeah, of course. Thanks for having me. It’s been great.



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