I was on a call with one of our investors the other day and he said, “Hey, if I wanted to be helpful and refer a business over to you that you’d invest in, what characteristics should I be looking for?” It was a much appreciated question because the only thing we can’t make more of is time, and it makes sense to waste neither his nor ours looking at a potential deal that we would ultimately have no interest in closing.

A few days later I was talking with Brent and he asked me to try to distill as much as I could what Permanent Equity looks for in an investment.

The thing is, I think we’ve done a pretty good job defining our investment criteria, but our investment criteria isn’t what either our investor or Brent were asking about. Rather, they wanted to know what traits make us most likely to want to close an investment.

What, in other words, after so much trial and error, is Permanent Equity’s investing heuristic?

Now, there are exceptions to every rule, but on the quantitative side, the two things I now ask about every business we see are:

1. Show me your margins.

2. Show me how fast you get paid.

The reason being that if you get paid a lot fast, your customers are telling you with their wallets (which is an indicator far more important than words) that your business is differentiated and special. In other words, that they need and want you. Businesses like this are rare and incredibly valuable because they can grow at above average rates for long periods of time.

But if, on the other hand, you get paid a below market rate slowly, it means your customers don’t value you, that they’re probably only going with you because of price, and that they don’t care if you get angry at them because they can easily take their business elsewhere. Businesses like this can provide a decent standard of living for their owners, but you have to watch them like a hawk (because there’s no upside or room for error) and don’t make for great long-term investments.

These metrics are also good shorthand to assess technical expertise. We’re cognizant, for example, that we can’t be experts in everything, so when a business tells that it’s the best-in-class at what it does, we’re aware that we may not be able to assess the validity of that claim ourselves. But we can let someone’s stakeholders do that work for us, by analyzing how willing they are to pay premium prices upfront.

There’s also nuance, though, because this is the real world and most businesses exist somewhere in between these poles and because, on the qualitative side, we need to assess how likely the people and market positioning will be able to sustain the numbers going forward. Moreover, you can (and should) measure these factors both on an absolute and relative basis because there’s no world where a construction business will get paid everything upfront for its work, but there absolutely are construction businesses that get paid way faster than others because their customers value them so highly.

Yet in a financial industry that is now awash in metrics that make it possible to make almost anything look like a good investment, these two factors are telling. So if you’d like Permanent Equity to consider an investment, show me your margins and show me how fast you get paid.

– By Tim Hanson

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