The Exchanges

Q avenues or the IPO market hasn't been around for a long time in mass, strategics have tremendous uncertainty in the economic environment. You're left with the sponsor to sponsor activity. If you're a GP looking to buy a business, you're a GP looking to sell a business, there's this feeling of a gap in the bid ask spread. How is that playing out in the deals that are getting done?

A It's playing out in a lot of different ways. The sponsor-to-sponsor activity was up in twenty-twenty-four. I take that as a good sign. The bid-ask spread problems are getting a little better, meaning interest rates have come down a bit. We've had two years of non-recessionary GDP growth. That means EBITDA has gone up a little bit, and the more of those things kind of happen, the less the spread is an issue. We've also seen that deals that are faster growing companies where debt has been less of a Percentage of the capital structure. So a lot of fast growing businesses may only have 30% debt on the capital structure and 70% equity. So the bid ask spread issue is less of an issue. Some of those software businesses that are doing really well are able to trade at good amounts. Some things in healthcare that are growing really rapidly are able to trade. So if you have less debt in your capital structure, it's easier to get a deal done two years down the road from when interest rates really spiked up over those 18 months by 500 basis points. But it's in those kinds of industries where people have comfort That we're not going to see a recession that will impact it, or we're not going to see macro issues. It will be a problem. And we're seeing the kind of balance sheet EBITDA growth movement that will allow us to refinance a deal and make the numbers work for the seller and the buyer. …

AI assessment note: “The bid-ask spread problems are getting a little better, meaning interest rates have come down”

Q If you look at some of the types of deals that you would think would lend themselves to that operational improvement, more value buys than growth buys, carve outs, things like that. What's the history shown of the success of those types of deals over the last decade?

A Over the last decade, the data's not as good as it was in the decades before. Part of that is the competition for a lot of these deals has gone up. Over time. So carve outs is a good example. The average carve out prior to about 20 12 was a two X deal because the industry had figured out that unloved businesses that weren't part of somebody else's core, but were good businesses in and of themselves could be invested in and you could get revenue growth, margin expansion, and multiple expansion on the back end of the deal. The problem is when everybody figures that out and everybody starts looking for carve outs, then the prices go up and a lot of that you have to pay for before you even get the asset. Now in the last decade or so, the average carve out is earning more like one and a half times and trailing the rest of the industry. It used to be the best source of deals in terms of value. Now it's one of the more challenging sources simply because it's known as a source and you have to pay for some of that. I also think that this question of really generating operating leverage for growing assets is a big challenge as well. You can see that the asset's going to grow. You can see that you need to invest for that growth, but How to really create operating leverage while you're doing that is not something that a large part of the industry is familiar with as an investment thesis, a…

AI assessment note: “Over the last decade, the data's not as good as it was in the decades before.”

Q What else have you layered on to that initial outside view of an industry for private equity firms in that practice area?

A We've layered on a lot of different things because the world has changed and accelerated so much. Back in the day, when we started this business, the average transaction size was a hundred million dollars total enterprise value. And so we thought no company was ever going to be big enough to hire Bain once they were a portfolio company, because they were so small. Now the average transaction size is a billion dollars. So that's a whole new product line. We also learned after coming out of the GFC, That many, many GPs figured out because LPs became skeptical of performance. They were worried about what private assets were going to do and what private equity was going to do in particular, that they needed some strategies themselves. The strategy and the accumulated history of the private equity industry had generally been make your next deal a good one. And that actually was fine as a strategy with a cottage industry, where there was enough of everything for everyone to succeed. If you were doing well, that worked fine. In an era of constrained capital, the competition for deals increasing, competition for talent increasing, you need strategy. Just like in any other maturing industry, you better have a way that you're competing that's different and sustainable compared to your competitors, or you're going to find life difficult. So we do a lot of firm strategy, organizational and…

AI assessment note: “So we do a lot of firm strategy, organizational and operational consulting now”

Q and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. I'd love to dive into some of these topics, and the one, certainly in the institutional market, you hear the most about now is this liquidity bottleneck. What is the data telling you about where we are and where we might be going from here?

A It's scary. In sounding the alarm on this, I'm very surprised that there's not more discussion going on about how serious a situation this is. Last year, the distribution to the private equity LPs as a percentage of their net asset value was 11%. Historically, this number is between 20 to 30%, which matches up with a four-year cash recycling cycle. Well, 11% is more like 10 years, and no LP has a model that says I'm getting my money back in 10 years. The last time that number was 11% was 2008. 2008, we're entering the worst recession for 75 years. We're not even in a recession, and we're hitting a number that is correlating to the worst recession in 75 years. To make matters more challenging, the number that I just threw out at you, 11% for twenty-twenty-four, in twenty-twenty-three, that number was 12%. It wasn't much better in terms of liquidity a year earlier. The number of the year before that in 2022 was 15%, which again is not much better. And everybody was thinking, oh boy, 2025 is finally going to be the year of lots of liquidity coming back. Investment banks were telling us their pipelines were full. GPs were optimistic. We were at incredible levels of activity in January. And then this word tariff started to come out in February. And that caused a tremendous amount of uncertainty. And the deal markets have slowed and gotten slower and slower. Since then, right now we'…

AI assessment note: “Last year, the distribution to the private equity LPs as a percentage of their net asset value was 11%.”

Q Retrospectively, you had this environment of low interest rates, increasing multiples, and good returns for all private equity. Without the likelihood of multiple expansion, you got higher cost of debt. How does the historical experience inform what might need to happen on operational improvements so that private equity can drive returns in the future?

A The data is really, really clear on this. If you look at the last 14 years of realized returns, Roughly speaking, 50% of the returns of buyouts have been due to revenue growth. 50% has been due to multiple expansion, largely owing to the low interest rate structure that we were talking about, and zero has been from margin improvement. For a dinosaur like me that's been kicking around this industry for over 30 years, having zero percent of the value creation on average come from margin expansion is unthinkable. This entire industry was founded on Buying unloved industrial businesses, fixing them up, getting them to run more effectively, and then selling a better business for a better price. That's the history and the DNA of the buyout industry. We had this anomalous ten-year span where I really didn't have to do that because I had this zero central bank interest rate, constant GDP growth environment that was creating multiple expansion, along with the fact that the industry fell in love with underwriting growthier assets, fast-growing software businesses, fast-growing healthcare businesses, And multiples went up and up and up over time. As you pointed out, I don't think we're in that environment anymore. There's certainly in some cases opportunities for multiples to go up with certain assets, but I don't think the industry can bet that the amount of value that was due to multipl…

AI assessment note: “that margin expansion on average cannot be zero going forward if we want to have”

Q I want to make sure I get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family?

A Boy, there are a lot of hobbies and activities that I have. I'll pick out one. I am a long time frustrated gardener. I relocated years ago from Massachusetts where it's very easy to be incredibly frustrated as a gardener to Florida. And so instead of just failing at tomatoes, cucumbers, and zucchini, I can now fail at mangoes and avocados and grapefruits and bananas as well. I do enjoy getting out and getting my hands dirty and doing something just completely different and digging in the dirt and trying to grow things. And sometimes it works and sometimes it doesn't. But as gardeners, we try to hide our mistakes and then celebrate our victories. So I try to cover up the mistakes as quickly as possible.

AI assessment note: “I am a long time frustrated gardener.”

Q What led to the focus on private equity in the early years?

A It's interesting. Back in those days, this goes back to. There were no practice areas in consulting firms at all. So if you went and hired Bain to do something, you could literally get anybody from Bain on the case and regardless of their background. So to give you an example, my first few cases of Bain, I worked in food consumer products. I worked in corporate charge cards. I worked for utility and I worked in the life insurance business. That would be absurd. And impossible today to actually do, but back then it was normal. There was no internet. There was no real requirement for industry expertise. And it was, let's just get a bunch of smart people and we'll solve your problem. Against that backdrop, a few of us began to notice that Bain & Company had also formed a private equity firm in the 19 eighties called Bain Capital that had been doing pretty well. And I'd love to take credit that we were geniuses and somehow figured out that there was a consulting opportunity in private equity, but it was actually One of our now clients that came to us and said, we actually do pretty well at this private equity game ourselves, but we noticed that Bain Capital seems to be doing really well, and the biggest difference we see between them and us is that they have a hundred percent of their employment staff come from Bain & Company. Could you do for us on an outsource basis what they see…

AI assessment note: “it was actually One of our now clients that came to us and said”

Q What is it that you do with the LPs?

A LP work is actually very similar to GP work. They need an overall strategy. Where do you want to be in five years? What's your ambition? Typically, there's obviously a level of financial return that's involved in that. There's an asset mix, a desire that's involved in that. There are organizational issues that are involved in that. Some of these organizations are quite different. LPs are quite different from one another. The question would be typically asked, they can see many and oftentimes their cash flows out into the Future in terms of the cash that will be coming in the checks that they need to write if they need to write checks. And they'll say, well, we're a. Two hundred billion AUM organization today in seven years will be five hundred billion. How do we organize for that? What does that mean? What do our departments look like? What does our decision-making structure look like? What do we need to do to manage risk better? There are organizational pieces of work that we do. There are operational pieces of work that we do. How do we think about one asset class versus another or within an asset class? What does investing excellence look like from the LP side of the coin? So how should I think about positions in different GPs, and how should I think about co-investment, and how should I think about strategic partnerships with GPs if I want to be doing that? What's the unive…

AI assessment note: “There are organizational pieces of work that we do. There are operational pieces of work”

Q To the extent that the thread through that is businesses that are doing well are the ones that get sold or have a partial sale. What does that leave behind in the portfolios of both the GPs and ultimately the LPs?

A That's the big question everybody's asking. What we know is that the average GP has twice as many businesses in their portfolio than they had 10 years ago. That's a lot of companies to look after. GPs are not house flippers. Companies are organic things that need to actually be tended and they need to be pivoted, reprogrammed, or some other ways improved in order to get on an exit path. That can take 12 months to 24 months if you need to really re-pivot something. Or rapidly accelerate performance. That takes planning. That can take investment. That can take time. There are lots and lots of companies out there that are doing buildups. Buildups are, I started with a platform and I added one or two companies to it, or I added 22 companies to it. I added some number of companies to it over time, and then I'm going to sell it. Imagine you were a GP that was halfway done with your buildup when twenty-twenty-two and twenty-twenty-three happened and interest rates went up 500 basis points over 18 months. Well, I'll bet there's a lot of stalled buildups out there with those kind of doubling of the interest rates. Now I don't have a five percent debt. I have 10% debt that I'm trying to put on it. My buildup doesn't work at 10% debt. That wasn't the model. So what does one do with a halfway done leverage buildup in order to create value if I can't do the rest of the buildup part of it? T…

AI assessment note: “I'll bet there's a lot of stalled buildups out there with those kind of doubling”

Q So much of what we're talking about are real challenges going forward. And then there's this fundraising trend of all this money of wealth that's going to come in. How is that balanced between the institutions that are not Piling money back into private authority there, and then you have this interest in wealth. How do you see that playing out?

A I think the answer, Ted, is yes, we do see that money coming at speed because individuals would like to have access to private markets, and why is that? We've learned over the last 15 or 17 years, taking the United States as an example, that the number of public issuances is less than half of what it was in the early 2000, and A few tech stocks tend to dominate how the market performs. That can be a wonderful thing because those tech stocks have done great, but at some point individuals say, well, I have enough of that exposure to Nvidia. What else have you got? And their advisors are telling them you need to diversify. You need to diversify away from these few stocks in these few areas that are actually providing a lot of fuel for your portfolio growth, but you need other things in there to be more diversified and safe in case something happens. That's private assets. So advisors are recommending it. Individuals want it. It is the great white board of capital that's out there. So GPs want it because others are liquidity constrained right now. Traditional asset managers want it. If you're a Vanguard or a Fidelity or a BlackRock and you're selling ETFs at 10 basis points, that's what you're charging for them. How'd you like to sell some private product at a hundred basis points or 200 basis points or 300 basis points or pick your price? They're pretty interested in that as well.…

AI assessment note: “we do see that money coming at speed because individuals would like to have access”

Q There are only a few firms today that are large enough to be the likely scale players. What are the elements of strategy that you tell someone who may not clearly know exactly where they fit in and are worried that they might not be one of the winners?

A It really starts with your DNA. How have you been so successful over time? What is it when you're at your best that you do that is uniquely driven your success? Coming out of a world where we had these very attractive structural economics for the industry where everybody could earn a lot of money as long as you were doing smart deals over time and getting into a much more intensely competitive world, you need to sharply distinguish and specifically articulate what it is that you do well. There needs to be a there there, which for most firms that have been around for a while, there's a there there. That's why they've been for a while, but what is it? Can you write it down on a piece of paper? Because You're going to need to explain it with a much higher degree of specificity than you have in the past, and you're probably going to have to invest your resources even more in making sure you continue to do that well at a very, very high level, and that you don't do certain other things that you may not be as good at, that you may have sort of diverged into over time. It's not that a lot of these firms that are good, that they can't reach areas like private wealth unless they have hundreds of people out there. Yes, it does cost more money, but if I have relationships with Private wealth managers, with traditional asset managers, with investment advisors. There are ways to go to marke…

AI assessment note: “It really starts with your DNA. How have you been so successful over time?”

Q And how about the other side? How do you work with clients on their value creation strategies once they have bought a business?

A The first thing we try to do on the value creation side is make sure that the beginning of that is at the diligence stage. As you're underwriting something, I've always believed that you need to know the three or four things that you really want to have happen to create the value at the outset of the deal. 30 years ago, you didn't really need to do that. When you're paying Five or six times EBTA for an asset. You could put some leverage on it, and as long as the asset did pretty well, you could cash out and make a lot of money. Now that the average multiple is 12, not five or six, that margin for error is gone. We're kind of starting from scratch and saying, we need to figure out how to make these numbers, because we're probably going to have to make a competitive multiple bid off those numbers to win the asset, and if nobody understands how we're going to get there, we need to, in the diligence, begin to flesh out what are the opportunities for this Business that are really grounded in data. And what are the three or four big things we think we need to do in order to win over time? So one of them might be for a consumer product. I need to figure out how to sell at a profit online because I'm not online right now. That involves a whole number of large things to do. But if I don't do that and online is growing as a share of the business, I'm not going to be able to make my reven…

AI assessment note: “make sure that the beginning of that is at the diligence stage”

Q On the other side, if you're an institutional LP that is down the middle, meaning they have a relatively mature portfolio, they have some of the similar liquidity issues than others, how do you advise LPs to think about their strategy going forward?

A LPs are on the other side of the coin, obviously, and they need to think about having more structured conversations with their GP partners. It's a relationship. Many of these relationships between GPs and LPs have been around for decades. It's a different type of conversation. The conversation begins with, talk to me about your portfolio. Talk to me about your liquidity plan for the next three years. Typically many GPs, they sell something when the MD that led the deal said, we're ready to sell. Let's go. I don't want to have that conversation. I want to have the conversation around, show me your whole portfolio. Let's talk about the next three years. When do you expect things to go? Why? And at what sort of level of return? So I can help with my cashflow planning. Let's have a structured conversation about the entire plan for that. That's something that happened in 2008, 2009 when too many people were thinking that the private equity portfolios were all going to go bust. I don't think anybody's worried about that, but people are worried about when am I going to get my money back? So let's talk about a three year window and you take me through the whole portfolio is discussion one. Discussion two is how prepared are you For the future. On the LP side, the world is changing. We've talked about a lot of those elements that are going to change in the future. So you, Mr. GP, I want…

AI assessment note: “they need to think about having more structured conversations with their GP partners.”

Q How's your life turned out differently from how you expected it to?

A My life in many ways has been way better than I would have expected it to. I was a daydreamer in college, so I kind of hoped it was going to be a good life, but the advice that I give a lot of young people as I reflect on my own life is that pretty much 90% of the specific things that have happened in my life, I could never have planned for. I kind of had a macro journey in place. I wanted to go to college, get a job, thought I wanted to go to business school, get married, have kids, That's a very generic description of my life. I did all of those things, but all the specifics around those, I had absolutely no idea. So I had no idea I was going to go to the schools I went to. I had no idea I was going to work at a place like Bain. I had no idea I was going to be at the same company for 30 years. I had no idea I was going to meet my wife. I had no idea. I tell people, be open to opportunity, because there's more opportunity in your life that's going to come your way for specific decisions than you could possibly plan. No matter how stressed out you are and you think you're a planner, there is no way you're going to be able to predict the specifics of what's going to happen and where, and you might miss some of the best opportunities if you try to organize your life that way. So I try to be open to possibility because I've learned that whether I'm open to it or not, things are go…

AI assessment note: “My life in many ways has been way better than I would have expected”