Sweating Hay in the Shining Sun
The first six months of 2018 have proven to be the most jam-packed in Permanent Equity’s history. We recently added the seventh portfolio company with our second deal of the year, an opportunity that was four years in the making.
But there’s opportunity cost to everything, even the best of times. One downside to all the activity is a team stretched thin. Currently, we’re not built to do 4-6 deals/year. We completed two in the first six months and had a third get weeks from the finish line only to have, as Elon Musk likes to say, a “rapid unscheduled disassembly.”
We’ve recently brought on four new team members and opened up a new office in Columbia, SC, but we still have a key position to fill (CFO). More on that later and how you can help, if you’re so inclined.
The sun is shining, hay is being made, but we’re sweating it out.
DEAL TWO, DEAL SEVEN
Until recently, the capital base of Permanent Equity was internal and recycled from a decade of compounding. We had, and continue to have, five companies in that original portfolio. Then, in December of 2017, we took on $50 million of outside capital from like-minded families. If you’re curious, I wrote about it in the 2017 Annual Letter.
This makes the latest acquisition the seventh portfolio company for Permanent Equity and the second in the fund. We don’t distinguish between the original five and the next two. To us, they’re all part of the Permanent Equity family.
The deal has quite a backstory. I got a disappointing call about four years ago from an intermediary letting me know that while our offer was simple and attractive, the seller had chosen to go with a higher offer that put more debt on the company. He said he appreciated our approach and looked forward to sending us other opportunities.
A few months later the intermediary called back and said that he had another company that might be of interest. He sent over the deal book and we immediately liked it. Negotiations commenced and we eventually went under a letter of intent. Due diligence started off strong and the more we dug in, the more we liked what we saw.
The problem was the working capital calculation, or to borrow from Dante, the sixth circle of deal hell. We just couldn’t see eye-to-eye, and in all fairness, it was an unusually difficult analysis with plenty of room for (mis)interpretation on both sides. The business had periods of seasonality that caused working capital needs to spike. Both sides agreed that the seller didn’t get to bottom-tick and we didn’t get to top-tick, but we couldn’t come to middle ground and ultimately walked away.
We stayed in touch through the years and would check in every now and then. They continued to grow nicely and exceed expectations, but the timing wasn’t right.
Disappointment is the norm in our business, but this period was particularly rough. A string of legal and accounting fees on dead deals and years of salaries add up, especially when there’s little to show for it. While losing deals is vital feedback, you have to distinguish between a bad result and a bad swing. In this case, it was both. We knew we needed to get better and be patient. Jeff Bezos sums it up nicely:
“We’re willing to plant seeds, let them grow—and we’re very stubborn. We say we’re stubborn on vision and flexible on details. In some cases, things are inevitable. The hard part is that you don’t know how long it might take, but you know it will happen if you’re patient enough.”
Fast forward to the end of 2017. We got a call from the intermediary saying the business was performing, a leadership transition was taking place, and it was time to make one final push on the deal. Already familiar with the company, we got up to speed quickly, adjusted our previous offer in light of recent performance, and went under a letter of intent soon after.
We closed a few weeks ago and couldn’t be more excited to welcome Great American Merchandise and Events (GAME) to the Permanent Equity family. As a manufacturer of pool lighting, inflatables, maintenance products, decor, filter systems, and solar heaters, they’re our first foray into consumer products and an expansion of our self-admittedly odd expertise in the swimming pool space.
We have a simple thesis in each of our investments. For swimming pools, it is: “Until people stop dipping their bodies in water for pleasure, we’ll be fine.” When something has been going on for millennia, there’s a strong likelihood it will continue, which fits with our thousand-year plan. Take that Masayoshi Son.
The structure of the deal is down the middle for Permanent Equity. We used no senior debt, bought a fully loaded balance sheet, put in additional cash for growth initiatives, and kept the entire team. The plan is to grow aggressively, but responsibly. It’s beautifully boring, just how we like it.
CUSTOMER CENTRICITY
All business is solving someone else’s problem at scale. Fundamentally, Permanent Equity sells money and peace of mind to owners, and advice and stability to leadership teams. Those are our customers and all our resources are focused on these two groups. At great cost, we try to understand them and optimize our organization for their benefit. Here are some examples:
We frequently communicate our perspective because it’s a way to get to know us. We’re far from perfect, and a much better match for some companies than others. Sellers and leadership teams are in a superior position to evaluate their fit with Permanent Equity. By sharing our philosophies, values, and strategy, we hope to attract the right customers and repel the wrong ones. We believe this saves everyone a tremendous amount of time and attention.
We don’t try to slam every deal into a rigid structure. We’ve recently figured out that we cannot perform well at auctions, even if we believe it’s worth our time, for the most unexpected reason — we’re too collaborative. Some auction-oriented intermediaries expect a complete set of proposed terms with little-to-no feedback. Said differently, they expect us to dictate terms, along with other bidders, and then they’ll pick the one that suits them best. But without collaboration the situation is set up poorly from the start. Because of our long-dated capital structure and indefinite holding period, we can get creative on how to share risk and reward. Like our approach to partnering long-term, creating win-win deals is a collaboration we embrace.
We conduct the vast majority of our due diligence in-house. The norm in private equity is to outsource due diligence because it’s costly to carry specialized staff and it’s helpful to CYA, an industry acronym for “cover your ass.” Look it up; it’s a real thing. The opportunity cost of this strategy is fraught with principal-agent problems. Outside accounting and legal resources are paid to find problems and look at risk in a vacuum, which makes an already difficult process brutal. The other downside is all that knowledge and intuition built up while studying the company instantly evaporates upon closing. At Permanent Equity, we work to make due diligence as painless as possible and become knowledgeable about the company in the process.
We serve our family. Most private equity firms treat their portfolio companies as expendable assets. Which ultimately isn’t surprising. When your ideal hold period is a few short years - during which you need to radically change the business and explode earnings - people necessarily become an afterthought. Get on board with the agenda or get kicked off the bus. We take the opposite tack. Getting to know our leadership teams, understanding their quirks, adjusting to them, traveling to them, and offering support where we can be helpful. Otherwise, we try not to be a bother.
THE BEST CFO JOB IN PRIVATE EQUITY
With this in mind, we’re insufficiently resourced to solve our customers’ future needs and we could use your help. Yes, this is a blatant self-serving pitch. Strap in, or skip this section altogether.
There are two ways to handle weakness — hide it and remain weak, or explore it and get better. I believe we’re just scratching the surface of the opportunity to help business owners transition and, in absolute terms, not very good at it yet. That’s not false humility; it’s the truth. In the chart below, we’re in the late stages of hazard and the early stages of becoming an expert, which means self-awareness of our collective ignorance has exploded. We’re likely still overconfident, but at least it’s trending in the right direction.
While there’s room for improvement in every area of our business, our financial sophistication is an acute weakness, and that starts with me. To all the industry experts on conference calls when I’ve said, “Humm, let me think about that for a minute,” I’ll let you in on a secret — I was Googling the heck out of whatever terminology you just used. 99 percent of the time, the concept is easy to grasp. But, there’s a time for brute force and we’re beyond it.
To put things in perspective, our collective companies are approaching $150 million of yearly revenue and we’ll likely add between $25 million and $75 million of revenue each year, not counting organic growth. We’re still a gnat in the grand scheme of things, but expanding rapidly.
Each company has an independent financial team that handles accounting, financial reporting, and working capital needs, and collaborates with their local banks and auditors. And those are big jobs. But when you roll up responsibility for the portfolio, assisting with due diligence, fund requirements, future fundraises, as well as global compliance, taxation, and cash flow management, the job at Permanent Equity is for someone who has “been there” and “done that.”
I think we’re trying to find a CFO, at least that’s the title “people in the know” tell us to look for. Frankly I could care less what we call this person, or what they have been called previously. In fact, as we’ve been searching on-and-off for this person for the last 18 months and have interviewed dozens of candidates, we’re more open than ever to someone without previous CFO experience.
We’re an awesomely odd situation — a team of eleven people who accidentally built a private equity business in the middle of Missouri. None of us have an Ivy League education, or have worked at another private equity firm. We rarely use Excel and only make investments that are obvious on the back of a napkin. I, quite literally, don’t own the standard issue PE uniform, a navy-blue blazer.
We’re built more like a hybrid between a family-owned manufacturing business and a marketing firm, which upends the traditional partner-led PE model. We’re obsessive about building repeatable systems that serve our customers (sellers and leadership teams), try to communicate with them frankly and regularly, rarely use senior debt, and buy with no intention of ever selling an investment. To traditional PE folk, that’s straight-up weird.
But for the right person, becoming CFO of Permanent Equity is a once-in-a-lifetime opportunity, and I’ll contend, the best job opening in private equity. It’s a chance to get in on the second floor of what we intend to be a skyscraper, with a group that cares deeply about each other and those we serve. Plus, we have a blast, consider time with our families crucial, and support each other in our out-of-office endeavors. There’s far more to life than ringing the cash register.
Beyond the obvious requirements of integrity, intelligence, low ego, curiosity, and hard work, here’s who the right candidate needs to be:
Experienced in how smaller companies “tick” financially, including accounting, taxation, benefits, and banking
Experienced in leading a team, recruiting, hiring, and setting compensation
Able to “play up, or down” — ride around on a four wheeler on a ranch in Montana, or throw on big city clothes and meet with (self-) “important” people
Excited about getting hands dirty and rarely getting the credit deserved
Ready to speak up, defend opinions, and be challenged without taking it personally
Up for parachuting in to help companies and a moderate amount of regularly scheduled travel
And here’s what the right candidate needs to want:
To live in Columbia, MO (which is awesome)
To alternate work styles between sprinting and power walking
To be with the organization indefinitely if it’s a good fit
We know the right person is out there, but we haven’t met them yet. That’s where you come in.
Let me pose a hypothetical. If you were in my shoes, who would you hire? Who’s that person who has a great financial mind, a kind heart, and just “gets it”? That’s the person we want to chat with.
Please introduce us by whatever means is easiest for you/them, although the simplest way is to contact us through the website. This immediately goes to Emily, Susanne, and me, and unless there’s some snafu, you should hear back within 24 hours.
*Note: If we hire the person you send our way, expect a very nice thank you gift.
PLAN A, THEN PLAN B
“We're in the part of the cycle where people start nervously asking what part of the cycle you think we're in.” - Morgan Housel
Guilty as charged. I ask because I have zero clue. Small business optimism is at all-time highs. The vast majority of company financials we see are strong and getting stronger. The labor markets are stretched drum-tight. Covenant-lite debt is readily available.
For buyers, especially those of cyclical businesses, this is particularly dangerous. Paying an elevated multiple on peak earnings is a clear path to suboptimal returns, if not disaster. But I would have said the same thing a couple years ago and earnings have risen since. Remember, Australia hasn’t had a recession in 27 years and counting.
The Permanent Equity posture is long-term optimistic, but short-term cautious. We’re buying, but price disciplined, despite seeing some nutty stuff. We’re financing our portfolio companies as a family would — little-to-no operating debt, few long-term obligations, and plenty of working capital. We’re building redundancy and asking our portfolio companies to be tempered in how they pursue opportunity.
Plan A is to support the companies through a continued period of economic expansion and prosperity. If the good times roll, we’ll do well, but not nearly as well as if we had levered up financially and operationally.
And if that doesn’t work out, we plan to follow Sheryl Sandberg’s advice and kick the shit out of Plan B. Plan B is to be a well-capitalized, aggressive, hassle-free buyer during the next downturn, a time when cash offers will be scarce and seller expectations dramatically lower. And because our portfolio companies are well-led, in durable industries, and under-levered, they’ll experience temporary pain, but come out the other side stronger. Cyclicality provides opportunity to those who survive. The trick is putting yourself in a position to take advantage of it.
On that note, please help us find a CFO.
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