The Exchanges

Q I'm curious, being in this market for a long time, there are a lot of the interest in co-investing coming from, say, primarily fund investors. Looking to reduce their fees, increase their exposures. What have you learned that could help those people be better at what they do?

A First of all, be careful that you invest to lower your fees. You know, I know a lot of politicians and other people attack pension funds. Oh, look at all the fees they paid. Well, how about just looking at net returns? There is a correlation between getting good results and sometimes paying higher fees. That's one. Two, one of the things I think people do in co-investing sometimes is they get their sizes wrong. They get their portfolio screwed up. So let's say you're a private equity investor who puts twenty five million into a fund. That means typically you're putting two and a half million into a company. If you then go into the co-investment business and put five or seven and a half or ten million in a co-investment, you're getting your portfolio out of whack because you're only doing one deal and maybe that deal's bad. You shouldn't have all your positions from your funds as two and a half million dollar positions and a bunch of your co-investment positions as five, seven halves and tens. And why would that happen? Well, Because sometimes you need to be that big to get included. Sometimes you need to be that big to justify why you're bothering to do it. Sometimes you do that big because you really think you love it, even though, you know, we're, none of us are smart enough to know it's going to be perfect as it relates to just what could they do better. First is you've got …

AI assessment note: “one of the things I think people do in co-investing sometimes is they get their sizes wrong.”

Q So how did you go about getting into the business and learning it?

A You know, I guess I always had a desire to work, uh, more than to study and learn. I loved cars as a kid. I bought my first car at 14 years old. Started taking it apart. There was a Peugeot dealership in my hometown. I worked there after school. I worked there all summer. I worked almost every summer. And so I like to work and I like to do. I wasn't one of these kids who said, oh, I like the stock market or I read the Wall Street Journal or I understood finance. I just sort of thought I somehow liked business. As opposed to academia, maybe, you know, you go in the opposite direction. So I went to Tufts university and I studied political science, but I took economics, but then there was a corporate finance class. There was a decision-making class. There was an industrial psychology class. And I tried to make my sort of own business degree. Nobody came to Tufts to recruit at all, but I was, I was interested. I got a mail job, a job in the mailroom at Wertheim and company for two different summers and actually learned quite a lot being in the mailroom at Wertheim and company. It was a small investment bank, very well capitalized, Major bracket firm run by the Klingenstein family. And I would deliver the mail and I'd go into the corporate finance department and I'd go into the executive group and I'd go into the equity sales and trading group and I'd go into the fixed income group.…

AI assessment note: “I got a mail job, a job in the mailroom at Wertheim and company”

Q Another piece you mentioned was that you don't pay a carry. So again, there's two ways of looking at 49 sponsors and 57 deals. One is diversification. And another is the sponsors say, well, maybe you're not our favorite. We're not going to come back to you for another deal. So how does that play out?

A Yeah, you're asking sort of the second part of how the heck do you get deals with without being an LP, and are you getting negatively selected? And first of all, some people believe that co-investment in its own right is negatively selected. I don't, patently don't believe that because almost every single deal we do is because somebody needs more money. Never because like, oh, our normal equity check is a hundred, but we're only taking 70 here. 99% of the time, it's just too big an equity check for them. They need to reduce the risk. Depends on the firm, but Most firms probably these days try to keep a position, especially the bigger firms, to seven or eight percent, and some really smaller funds who want to be concentrated maybe get it up to 11 or 12%, and I'd say the norm is nine or 10%. So around those numbers, you can be pretty sure that they're going to need more capital, and then sometimes it's a little smaller if it's really a buy and build, and they know they're going to need more equity capital, but that's really as a percentage of the total. So I don't think there's negative selection in co-investment. Then as it relates to us, I think the simple answer is if you look at how we get deals and the situations, very, very rarely, Do I feel like we're the second choice? If you're Clayton Dubler and Rice, you have a fifteen billion dollar fund. You want to write billion dol…

AI assessment note: “very, very rarely, Do I feel like we're the second choice?”

Q Which two people have had the biggest impact on your professional life?

A Well, the one I would say from a personal level is clearly Mike Carpenter, who I call my business dad. You know, Mike was the CEO of Kidder P when I got there. I was 27. He was 43. By chance, you know, we both left Kidder, and he ended up at Traveler slash Citigroup as well, and he just taught me so much. He's very, very smart, very strategic, but more importantly, just how to be better in a business setting. He's always just given me really, really good Advice. Maybe from a slightly different perspective, I guess I'd sort of say Mike Milken. We talked about Drexel Burnham earlier. Mike really changed the world. There are plenty of people who make a lot of money in finance. Then there are people who changed the world. Mike Milken changed the world. Little, small to medium-sized companies, the American dream were not easily financeable. Those all little banks went out of business or got merged into all our big banks. So if we didn't have the high yield market and the, and the private debt markets and all the things that came out of Michael's revolution, And understanding to finance small to medium sized businesses. Uh, I don't think America would be where it is today. So very interesting and an openness to understand that getting rid of bureaucracy, being nimble, being quick, having people own their own companies, equity ownership, all those things, things that really have led t…

AI assessment note: “is clearly Mike Carpenter... I guess I'd sort of say Mike Milken.”

Q There's a bunch of things you said that would be head scratchers for other people doing co-investments. So first, you're doing co-investments, but you're not investing in the funds. How does that work?

A You know, when I first started, there were some people who thought I was somewhere between crazy and stupid. I don't get it. Co-investments come as an LP. What I had learned at Citi was we weren't big LP investors there. You know, while Citi was a big place, we'd put 10,000,020 1,000,030 million in a fund for the most part. We did a lot of stuff with people we weren't LPs with, and we weren't getting it because we were Citi either. You know, I mean, yes, we lent to companies, but lending was a competitive business. I believed that, again, if you put a high-quality, good-sized team, treated them like clients, were transparent, were proactive, were responsive, were good partners, had knowledge, At certain points, you know, we don't ever advertise that we add any value. I think that would be arrogant, but I do believe at times we do add value. We don't get favors. People need our money. They are doing a deal that's too big for them, and they need more money. And so I knew from Citi that people always are doing deals that are too big, whether the firm is a hundred and fifty million in size or fifteen billion in size. We just did a deal with Platinum Equity. It's a ten billion dollar private equity firm, and we got into a deal, Ingram Micro. So people needed more money, and very frankly, it's much better today, but Back then, certainly, co-investors weren't as good as not, and frank…

AI assessment note: “People need our money. They are doing a deal that's too big for them”

Q management firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, 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. Well, I'd love to hear a little more about the filtering that you'll do when these deals come in. So you mentioned stage, size, sector. What's your sweet spot?

A Well, first of all, overall sort of investment philosophy. Be curious. Really focus on risk-reward. I mean, that sounds sort of like motherhood and apple pie. Realize that there are great companies that aren't great investments, and sometimes there are not great companies that are great investments. You can't buy crappy companies. I don't think that works, but there are some companies that are fine, but at the right price, and with the right professionalization, and the right changes, and the right this, and some M&A, can be really, really good investments. And one of the things I think that's good about going across a lot of sectors is we focus on a lot of sort of Porter's Five Forces type stuff. You know, does the company have a moat? Does the company have a lot of free cash flow? Is the company's margins defensible? What is the competitive dynamic? Where are they standing in that competitive dynamic? What are the changes that are coming that could disrupt or not disrupt? And we try to apply those to every company we look at in certain ways. I would also say, you know, again, we like things sometimes that are a little more boring. I have a joke with the team, which is my favorite companies are there's a guy who lives next door to you and he has a really nice house and he has really nice cars and he goes on really nice vacations. And he belongs to a lot of really good golf clu…

AI assessment note: “we like things sometimes that are a little more boring. I have a joke”

Q Across those range of different companies and sectors that you won't do again, you mentioned a roll up versus a, you know, just buy and grow the original business. What are your preferences and what do you think works best?

A I think we've decided that very commodity oriented cyclical businesses don't work in a private equity setting very well. It doesn't help that everybody also just hates oil and gas and you're better off in more nimble vehicles where you can get in at the right time, get out at the right time and have more flexibility. Especially as a co-investor. As it relates to styles, I think we're pretty open to styles. One of the things I'd say is like, I have this saying, strategy is nice and execution is king. If you look at where we've done poorly, it's because the management team slash the sponsor have executed poorly. You know, it's not too often that we just totally got the thesis wrong. It never happened to us, but you know, you could buy a yellow pages company and the yellow pages go away, but that doesn't happen very often. Mostly it's been execution errors. And, you know, sometimes also I'm a golfer, so it's much easier to hit an eight iron than it is to hit a five iron, right? So if the wind's behind your back and you're hitting eight iron, the chance you put it on the green is higher than if the wind's blowing in your face. So obviously if you have tailwinds, you know, execution's easier. If you have headwinds, execution's harder, but execution, having that management team, making sure they're doing the right things is absolutely important. So we look at how hard the execution l…

AI assessment note: “As it relates to styles, I think we're pretty open to styles.”

Q I'm curious to get your perspective on the environment going forward. What are you excited about? What concerns you?

A You know, it's a tricky world, and we've been doing this since 2011, and I think to be a good investor, you need to be a cynical optimist. We've clearly been in a pretty incredible time. The economy's done well. Interest rates have been low. Credit is everywhere. The cost of the credit is low, and the amount of the credit is high. You know, a lot of people say, oh, what happens if rates go up? You run an LBO model. And you take rates from six percent to eight percent. It does not matter. If you all of a sudden can only borrow four times versus five times, that changes the math. And by the way, the answer is simple. You just bid less, right? Because we're all solving for one number. That's 20 to 25% IRR. And so we'll look what we think the company can do. The second part is just enthusiasm, right? We've had endless enthusiasm. And you know, I do think there's been a bit too much enthusiasm, a bit too much willing to go too quickly, accept pro forma adjustments, 10 years ago, nobody even knew what ARR stood for, right? Annual recurring revenue. So now we're not only buying companies, certain companies, you know, software companies off of revenues, we're buying them off of annual recurring revenues at the time you did it, et cetera. And especially in the growthy venture world, it's been accentuated. I don't think it's been as bad in the LBO world, but I do think there's been some …

AI assessment note: “now what seems like pretty scary inflation in many ways”

Q Drexel had an interesting history from there through the late eighties, early nineties. You know, you went from there to a couple other banks before, you know, a while back starting cohesive. What was different in the cultures of the various places you sat?

A I was at Drexel. As I said, it was sort of like landing on Mars. When I got there, it was good and the people were pretty good, but then a four, 8586, 87, obviously it was just an amazing place to work when you look at all the people. Who ended up working at Drexel? Some who were there. Have they gone into private equity? Have they gone into credit? Just unbelievably. And I don't really know how it happened, but it shows that culture and workplace and what's going to be done attracts people. It was attracting two kinds of people. Some people who were younger, who had already worked at a Payne Weber or a Prue or a Shearson or this or that very rarely from a Solomon or from a Goldman or from a Morgan. And then it was attracting people out of business school and at Goodman. As an example, I remember him as a first year associate and he was special when he was a first year associate. There were people there like Josh Friedman from Canyon, who's a legend. And obviously Mark Rowan came and Josh Harris came and Leon was already there. And Alison mass Bomarito, who's been a legendary banker at Goldman Sachs covering the sponsor world. There was just tons and tons of amazing people there to get to know and to learn from. Now, to be honest with you, I was a little second class citizen. You know, if you remember Michael Lewis's book, Liar's poker. You know, what was the worst thing? Equit…

AI assessment note: “I was at Drexel. As I said, it was sort of like landing on Mars.”