Elements of Value in Private Equity (Part 4): How PE Leaders Evaluate Businesses

[00:00:05] Sean Mooney: Welcome to the Karma School of Business, a podcast about the private equity industry, business best practices, and real-time trends. I'm Sean Mooney, BluWave's founder and CEO. In this episode, we continue our element of value series where we share insights from our private equity leader guests as they break down what they look for when evaluating businesses with the potential to become great.

[00:00:31] You'll hear how top private equity investors approach key areas like leadership, understanding market opportunities, and uncovering factors that drive long-term growth. Enjoy.

[00:00:43]

[00:00:49] Sean Mooney: To kick things off, Vinay Kashyap from Mainsail Partners shares how his firm identifies and invests in Bootstrap B2B software companies. He talks about their disciplined approach and the importance of relationships when partnering with entrepreneurs.

[00:01:05] Vinay Kashyap: What I really love is, as I mentioned, I joined Mainsail 11 years ago. That scorecard has been very consistent and we plan for it to remain consistent even as we grow the firm and the franchise. And so. We get some Sims, but very few, so most of what we're doing is going out there and proactively initiating conversations with early stage B2B software companies that are 1, 2, 3 million of ARR.

[00:01:30] And we sort of track them over time and the most important, we look at three big things. The first is just growth. Like, we have a saying at Mainsail, the best predictor of growth is growth. We start with just, is this company growing very quickly? And then our filter, because we focus on bootstrap companies that have raised very little outside capital is if the companies are compounding revenue very quickly, then the products tend to be quite strong and they mean that the products are getting pulled into the market, not pushed into the market.

[00:02:03] Usually there's very little go to market dollars, all the scarce resources that the bootstrap software entrepreneur has, they've put into product. And so then we go to product quality, depth of product, durability of the moats, customer value prop, and we really dig deep on the product. How much time did it take to create how much workflow is in there?

[00:02:25] And that leads to our last sort of criteria, which is the entrepreneur that we'll get in business with, because ultimately the software companies are just a Sort of manifestation of code of the entrepreneur's brain, right? And their experiences. And so we're mostly investing in vertical SAS companies where the software is created by an entrepreneur who's coming out of that industry.

[00:02:44] So they worked in the construction industry. They worked in the veterinary industry. They start feeling a problem. They try to buy third party software, nothing exists. So they build it themselves. And that's the sort of entrepreneur we want to get in business with because they're resourceful, they're creative, they're driven, they're competitive.

[00:03:02] And then we want the entrepreneur to also be open minded. And having a learning mindset. And so when we get those three boxes checked, growth, product, quality, depth of product, which leads to hopefully a durable customer value proposition and pricing power. Then we look to, is this an entrepreneur that we want to work with?

[00:03:20] That we want to be in a. Business partnership that oftentimes ends up being a decade. Our average hold period is four to five years, but we oftentimes recap and keep going with these companies. And so that's where the relationship building process is really important. And on average, it takes about, we have it sort of track our sales cycle and Mainsail from first outreach to when we make an investment.

[00:03:40] It's coming up on between three to five years. This year, our four new platforms were five years, and that's wonderful from both sides of the table. We get to know the entrepreneur, they get to know us. We enjoy it much better than getting a sim and having to make a decision two months later.

[00:03:55] Sean Mooney: I really like that approach.

[00:03:57] One, the consistency of principles. I'm sure some of the things you look at over time maybe change as the world changes, but the consistency of the principle and then the long term relationship building, where you're like, We're gonna go on some dates, we're gonna meet each other, know each other, and if there's that mutual alignment of common goals, respect, trust, vision, then that's when the magic happens.

[00:04:22] And I really like as well kind of your mindset on looking at these kind of bootstrappers. And those are the types of companies I was investing in, kind of information data analytics, kind of like scientist run businesses. And when I had this kind of crazy mindset with BluWave. Where people thought I was insane.

[00:04:40] I worked my whole life to become a partner at a P firm. And then I'm going to do a startup to really just solve my problem. And I was like, well, if I'm going to do this kind of like you much more eloquently describe what was in my mind. It's like, I've got to do like the private equity version of venture capital, where we're going to take some friends and family money, but then we're going to be really clever with it and constrain the model, knowing that that drives innovation.

[00:05:02] Like so many of the peers I had who were doing other things, it was just so capital inefficient because they were just thrown. Everything against the wall and seeing what stick in the meantime, they're getting diluted down to during the most dilutionary period of business down to levels that I was like, ah, I just don't like that expected value calculation.

[00:05:22] And so what you're describing, it seems like you're probably getting quite a bit of like ingenuity out of these entrepreneurs as well. They just need now a little more fuel to get over that next hump.

[00:05:32] Vinay Kashyap: Yeah, absolutely. I mean, the culture in these companies is definitively frugal by necessity. And to your point, we find that.

[00:05:40] Bootstrap entrepreneurs have a very heightened sense of opportunity costs that is very useful over time. Cause I mean, as you put the primary capital on the balance sheet, as you build out infrastructure and then you start making longer duration offensive bets, that mindset and that culture persists and ultimately leads to profitable growth, which is what everyone has to achieve eventually.

[00:06:02] And I think our companies are able to sort of achieve sooner just because of that. Founding bootstrap philosophy in the business.

[00:06:09] Sean Mooney: I think that's great. And it's that cleverness that you're almost ingrained in. You have to be it. And you become a custodian of the balance sheet as well as the P and L.

[00:06:17] Vinay Kashyap: Yeah.

[00:06:18] Well said.

[00:06:19] Sean Mooney: Next we have Kristin Johnson from Altamont Capital Partners.

[00:06:22] Kristen offers her perspectives on evaluating investment opportunities where she touches on important considerations like market dynamics, team strength, and aligning with founders. Kristen also explains her firm's unique approach to ensuring rigor during the investment process.

[00:06:39] Kristin Johnson: I'd say we start with market dynamics, size of market growth, competitive set, not just now what the current state of play is, but what could it look like in the next 10 plus years? And I think you made this point on another show, which is an excellent one that it's important to assess, not just the company in today's environment, but really figure out when you go to exit, what is a potential buyer going to see?

[00:07:06] Secondly, we look at the company's position to win. Do they have the right products? Do they have the right service offering and innovation to maintain or gain market share? Where do they sit in the value chain? Super important to understand. Third is talent. And I think over the years, you and I have been in private equity, there is a much bigger appreciation to translating desktop PowerPoint to who's actually going to do the work, how is the team staffed, what are their strengths, what are their gaps, and how can we build a team for long term success, again, over a five, ten year period, that's hard to do.

[00:07:44] And lastly, I'd say we do look at ownership dynamics. Most of the investments we make are investing with founders and families where there's often a meaningful rollover component. We try to understand what have they done well, what are the gaps and where can we help accelerate that growth and accelerate that cashflow, making sure that there's good alignment there on the vision.

[00:08:07] So taking all this, we pressure test all of our analysis through a rigorous investment committee process. Every private equity firm has one. We've added a couple of things, which I think are interesting. One is a red team, which sort of plays a devil's advocate role in an investment process. So it's a team staffed outside of the deal team to ask the hard questions and make sure that the deal team is following up.

[00:08:33] As we've gotten bigger, having that accountability and rigor, I think has been an important function. Our teams are specialized by industry verticals. That's really important. We bring in a lot of outside. Executives to advise. We work very closely with Bain and other advisors to make sure that we're not in our own ecosystem, analyzing a situation, but we're getting the benefit of a lot of different experience spaces.

[00:08:58] Sean Mooney: I love so much of what you said there in one, like the elements of value for our listeners. Kristin kind of gave the kind of like save your money on the MBA class of like, what's really important, right? Are you playing in a good market? And you made a really good point. It's not just a good market today.

[00:09:13] It's will it be a good or even better market tomorrow, which is so key. We live in a three dimensional game. Nothing persists and then tying that to the team that can do it is so much of the art of the possible and private equity because you are transforming companies today when probably when both of us started it was more of an optimization game.

[00:09:37] But today it's like how do you turn this thing into something that's its most beautiful version of itself and that takes a lot of work and then the other thing that I thought was really interesting. That I hadn't heard a lot of before. Was this kind of red team concept when you're exploring it?

[00:09:53] Because I think many private equity firms having sat on an investment committee you want to ask the hard questions but you also Want to be supportive of the team And maybe a lot of those harder questions Maybe then time would come through like back channels and things like that It's not that they didn't happen, but I love how you've empowered a team to ask the tough questions and it's their job It's not personal.

[00:10:16] Kristin Johnson: That's exactly right There's a lot of emotion that can Get built in an investing process And so trying to take that away and make sure that we're building a culture of constructive conflict is really healthy. And so we do that by the culture that we're building at the firm and being open and transparent and all that around questions and, and issues.

[00:10:39] But I think having a formalized team in place in the form of the red team serves an important role as well.

[00:10:46] Sean Mooney: I love that. And I'm even thinking about it just through the lens of the seat I sit in right now as a CEO of a company. And you have the same kind of things where people want to be supportive, but you want to have a culture of accountability and a performance culture, but you also want to make sure the world is positive.

[00:11:04] But if you get assigned someone, this is your job is to ask the tough questions and almost like try to poke it, then it takes some of the, you said like the emotion and the angst out of the process. It just is what it is. I'm going to borrow some of that. Hi, this is Sean. Wanted to take a quick moment to tell you a little bit why BluWave exists.

[00:11:25] It's based on this whole notion that assessing opportunities and building business is really hard. We all know third party expert service providers can dramatically help, but at the same time, it's hard to know who's good. Usually leaving you like I would do and call friends and ask, do you know someone who does this?

[00:11:44] Just go the square peg round hole route. So, after nearly 20 years in PE, I decided to solve my own problem and created BluWave. Today, many hundreds of PE firms, thousands of portcos, leading public companies, private companies, all call BluWave to instantly get connected with the exact third party service provider they want that's pre credentialed by BluWave and perfectly calibrated for their need.

[00:12:08] Really good. You too can give us a call or visit our website at BluWave. net. We're free to use and you can benefit the same way other top PE firms do. Back to the show.

[00:12:19] Now we'll hear from Trent Hickman at VSS. Trent explains what his team looks for in founder-led businesses. Trent emphasizes the importance of management, integrity, vision, and hunger for growth, as well as looking for opportunities that allow for multiple paths to success.

[00:12:36] Trent Hickman: I think management is number one. If not number one, two, and three, just as a bit of background, we're a relatively small fund. Current funds, 530 million. So we're dealing overwhelmingly with founder led bootstrap businesses. They're profitable, they've built some substantial value, but they're not huge.

[00:13:01] So typically between five and 15 million of EBITDA. And so with management, we're looking for a few things. Number one is high integrity. If you don't have that, then pretty much nothing else matters. There's kind of a great cliché, but it's a cliché because it's true that integrity is, is really what you do when nobody else is looking.

[00:13:27] And as much as we like to say we're super active in these companies and we're on the boards of every company and we think we bring something to the table from an operational perspective, That's never going to be the same as working within the company 50 60 70 hours a week. That's kind of one a number two Do we buy into their vision?

[00:13:52] Is it truly a shared vision? sometimes I worry when management teams will say well gee, what's your vision for the company and They're trying to figure out. Hey, do we buy into that? It really needs to be shared, but at the end of the day, they're leading the company, so it's typically going to be hard for us to come in from the outside and say, Hey, you're doing it all wrong.

[00:14:21] You should really be focused on this area. Instead of that, we might help them shape that vision, refine it, add resources to it. But it's at the end of the day, their company and their vision. The last two points really fall into what I call fire in the belly. Are they really hungry? Are they selling or taking on an investor because they're done and they want somebody else to carry the load and they're staying on because their investment banker told them they have to, or are they taking on an investor because they see an opportunity?

[00:15:04] But they need some combination of capital, maybe a little bit of courage, taking some chips off the table. It's uncomfortable to bet the farm, if you will, if 110 percent of your net worth is in that farm, which we understand. Do they have a lot of hunger for that next step? And is there really a desire to improve and change?

[00:15:31] Are they somebody that has a growth mindset and Is open to suggestions that doesn't mean just by rote, do everything we say, but to on board suggestions or ideas, think deeply about them and then talk through it and figure out what makes sense and what may be an interesting idea, but really doesn't make sense.

[00:16:00] We'll make suggestions to fall into both categories. I think number two is really looking at market factors. The way I like to think of this is for this particular business and its prospects of the next five or 10 years is the wind at our back and that's going to push us forward and we have a chance at above average growth even with average execution or is the wind in our face and we have to do an outstanding job just for a so so growth result.

[00:16:38] And the third area we look for is what I call multiple ways to win. So if I've got a strong management team, I've got the wind at my back, I should be able to get above average growth, not really doing anything too special beyond that. But are there obvious product line extensions? Are there obvious geographic extensions, add on acquisitions, growth opportunities that While we may not hit all six or seven or eight of them, if we get one or two or three and we do those really well, that should give us the opportunity for an outsized return.

[00:17:22] If we hit on more, then we do even better. Those would be kind of the big three for us.

[00:17:29] Sean Mooney: I love that. So for our listeners who are coming up in the industry of private equity or our business builders that want to embrace the private equity way, do what Trent said, he just, he just summed up thousands and thousands of hours of lessons learned really succinctly, I think, in a way like this is how you build companies with speed and certainty and efficacy.

[00:17:52] And so I really love what you said. It was a bit of a masterclass there. And. The management team part that you said, I think was so well said in terms of what you're looking for. It starts with integrity. You don't have that. You might win for a little bit, but ultimately karma catches

[00:18:06] Trent Hickman: up. If they don't have integrity, you better hope they don't have skill.

[00:18:11] Sean Mooney: I think it's exactly right. It's so well said, but you have to have integrity before you can do anything else. But then you also have to have a vision about where you want to take the business. I think so many people think they're going to sell the PE because they can just like. Defer or delegate that that's not what investors are looking for.

[00:18:35] We want to make sure there's alignment of vision, but you better still have that. Otherwise it's probably not for you if you want to stay a leader and then coupling that with hunger and a desire to win and change and improve as ahead of probably where changes in the world are happening. Those are so important.

[00:18:52] As you said, it's the most important part of building a company is the people. And so I think you summed that up so well. And I really liked also. That with the market factors, so many people will try to push a rock uphill or divert a stream to go up the mountain. Whereas like, no, go where water is flowing easily.

[00:19:12] Cause if you don't have product market fit, if you're having to forage your customers to take your product, if the markets aren't growing with you, it's going to be a slog and so design your businesses in a way that go downhill.

[00:19:25] Trent Hickman: Exactly.

[00:19:25] Sean Mooney: You want to be skiing with the mountain, not up it.

[00:19:28] Trent Hickman: Exactly.

[00:19:29] Sean Mooney: And then don't only have one way to win, because if that doesn't work, game's over.

[00:19:33] And so I love that. That was really, really well said. I think it's great advice for anyone who wants to be in the business of business building.

[00:19:43] Hi, Commerce School of Business listeners. Sean here. Wanted to shine another quick spotlight on one of the most important ways PE firms preserve and create value.

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[00:20:10] To this day, many don't know that BluWave has turned the interim exec offering on its head and completely made it the way that my friends and I in PE always wished it was. BluWave has a dedicated team that does nothing but interview, pre vet, credentialize, and reference private equity grade groups and people so that we know who you need before you call us.

[00:20:32] In the case of interims, we have more than a thousand top interim private equity grade CEOs and CFOs that are ready to be matched for your exact need when you need it. Give us a call or visit our website at BluWave net. And we can give you excellence and alpha with ease back to the show.

[00:20:50] Finally. Last, but certainly not least, we're gonna hear from Misha Logvinov of MGX. Misha brings a unique perspective on what makes businesses scalable and resilient. He explores the roles of leadership, adaptability, and technology infrastructure in helping companies improve and grow.

[00:21:10] Misha Logvinov: I would highlight three key things. There's of course a much longer list, but I always default to these three to begin with.

[00:21:17] First. It's people. It's always people, right. And I would say specifically leadership team and the quality of that team. Starting with the CO and one level down, in my experience, no matter how good is your business strategy or idea behind that, it's ultimately the people who make them real. That would be the first thing I would look at.

[00:21:36] Second thing is historical track records of delivering results and also being able to adapt and be agile, especially during times of significant change adversity, whether it's. Market downturn or even acquisition by a strategic bio or a private equity firm. Like what, how does the company react to it?

[00:22:01] And are they able to pivot, expand, and just adapt to the situation while continuing to deliver and grow? So that would be another factor that I would typically look at. And of course, me being a technologist, right? In this day and age, I believe that technical acumen and robust technology infrastructure, absolutely critical for being able to scale the business.

[00:22:21] Of course also right now, it is really critical for having it in order to take full advantage of artificial intelligence and other emerging technologists, and also being able to protect your business from disruption. Of course, that said, you know, I'm not looking for a perfect technical setup, especially in PE and my experience, such a thing doesn't exist right in.

[00:22:49] Company is taking technology seriously and also taking some concrete steps towards enablement when it comes to technology data. And nowadays,

[00:22:58] Sean Mooney: ai, I love so much of what you said and for all of you kind of thinking about business school, you save your mind. Just listen to what Misha just said. So, and, and there's some really good stuff there and, and one, it's business and people that are intertwined.

[00:23:12] And without really good people you're not going very far. And it's interesting. So. It's been fascinating in this second part of my business life going from a PE investor to an operator. Now in our business, as you know, Misha, we're this kind of super connective kind of market network for pe and as much as we're getting reams of calls for AI and tech today, we still as two to three to one for people.

[00:23:36] It just shows you like you're not going anywhere without the right people to drive the ship. And then the second thing that I thought you brought up that was really insightful was this idea that a lot of people measure their candidates and the acumen of the company when the tide is rising and all boats are just kind of smooth sailing the winds at their back.

[00:23:56] And kind of what you just mentioned there about like how do they do both the people and the company when times are tough, do they have that tenacity, that grit, that resilience because nothing is up into the right forever. A lot of companies, what goes up goes down. It's the ones that continue to go up when everyone else is going down that are the real, real amazing ones.

[00:24:16] The third thing that I think you really brought up that is a lot of people kind of sleep on is not just the technology itself, but you, what I love how you mentioned the infrastructure, it's the foundation and we'll get all these calls and from my CEOs of the Port cos and like we wanna talk about neural networks.

[00:24:35] How about first we get you snowflake and like sigma and like give you some areas that like make, let's get your data structured, let's get a process in place so you keep it in high quality ways and then let's visualize and analyze it and then we'll talk neural networks. But let's get this stack in place.

[00:24:52] Make sure you're maintaining it like you would like a highly honed piece of equipment. And that's where I think a lot of people lose it 'cause. It's garbage in, garbage out if you don't have the real foundation for success to do the really cool stuff afterwards.

[00:25:04] Misha Logvinov: Yeah. Can't agree more.

[00:25:07] Sean Mooney: That's all we have for today. Thank you very much to Vinay, Kristen, Trent, and Misha for joining. If you like what you hear, please follow five star rate, review and share.

[00:25:18] It's a free way to support the show and it really helps us when you do this. So thank you in advance. In the meantime. If you're looking to connect with the world's best in class private equity grade professional service providers, independent consultants, or interim executives that are trusted by many hundreds of the world's top PE firms and thousands of business builders at portfolio companies,

[00:25:38] as well as leading independent companies, visit our website at bluwave.net That's B-L-U-W-A-V-E, and we'll support your success onward. The views and opinions expressed in this program are those of the individuals presenting and do not necessarily reflect the views or positions of any other persons or entities, including those referenced herein. No representations, warranties, financial, legal, tax, or other advice made herein. Consult your advisors regarding any topics discussed during this episode.

Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company.

BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.