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Here For It
I admitted this last season so most people who read Unqualified Opinions may know it already, but I send all of these out internally at Permanent Equity before they go public for both a sanity check and quality control. So it went that before Season 2 launched our Chief Excitement Officer James said upon receiving the first email that while I love what is happening here, why is the Dot at the top saying “Season 2!” and not “Here for it!”?
This deserves some explanation…
One thing we’ve noticed about all of us around our office is that we all have catchphrases. You’ve really impressed Taylor, for example, if something is “terrific” and you’ve entertained Nikki if you get the laugh and really entertained her if you get the snort. Me? Apparently I picked up “Here for it,” which is what I say when I’m excited to participate in something. And now Taylor rings a bell on his desk whenever he hears me speak those words.
It’s funny, really. “Here for it.” DING.
But is it a bad thing to be excited to participate in things?
Apparently I’m very excitable, though, because even my daughter made me a “Here for it” charm bracelet.
Where is this going? It’s a fair question.
The other day Brent called me a “good sports parent.” One thing about Brent and me is that we are of similar ages (though I’ll admit Brent is younger), but his kids are a standard deviation younger than my own. So I’ve got a daughter who soccers and a son that swims and they travel far and wide around the Midwest, which is crazy, but that’s how it is. Brent’s aspiration for his kids is that they are good enough to enjoy a sport, but not good enough to travel far and wide.
Then one of Brent’s daughters placed great in swimming at the city finals and showed some interest in doing more. Despite all that goes along with driving to Topeka when one makes regionals to sit through an 8 hour meet for 30 seconds of swimming, he seemed “Here for it.”
At the end of the day, Brent and I both know it’s extremely unlikely that our kids become professional athletes. What, then, is the point of driving all across Missouri and its environs to facilitate participation? Why be a “good sports parent”?
The fact is, I think we should all be “good sports parents” when it comes to something that shows promise. Edges are rare in this world, and if you have one – or even sense one – you should press it as far as you can because the rewards from being successful are a power law and you never know when an idea, a person, or a business will show accelerating aptitude or ability. So if you have a kid that’s good at anything or interested in anything, encourage and enable him or her!
But the thing about being a “good sports parent” is that while you’re keeping power laws in play, you’re also having shared experiences and making memories. If all I get out of driving my daughter to St. Louis for years to play soccer is the ongoing debate around whether The Clash is better than Taylor Swift because we heard so many songs on the radio, it will still be worth it.
That’s what “Here for it” means. It’s recognition that things can not go according to plan, but still be worth it. The reason that’s so is that because as long as it’s not game over, give it a shot and that shared memories and experiences matter. You learn, you get stronger, you have fun…as long as you’re here for it.
– By Tim Hanson
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Bluey’s Not Bad
If you’re like us, then your meetings start with a few minutes of casual banter or, if Taylor’s attending, more than a few. So it went at a recent investing team check-in where I looked down at my watch and 17 minutes in, we had yet to conduct a minute of business.
The reason was Bluey, an Australian cartoon for little ones that you can watch on Disney+.
See, both Taylor and Emily have younger children, and they all love the show. The 17-minute preamble to our meeting was full of quotes from the show, plot recaps, and Taylor doing an Australian accent. It was as entertaining as it was inefficient.
My kids have been out of that stage for a few years and are on to being sullen and cool, so I wasn’t familiar with Bluey. That’s how I ended up with homework. I was supposed to go home that evening and watch “Takeaway” from season one, “Granddad” and “Daddy Dropoff” from season two, and “Whale Watching” and “Granny Mobile” from season three. (If you get nothing else from this Opinion, there you have Permanent Equity’s curated list of Bluey episodes for your enjoyment or if you want to run this experiment yourself.)
When I got home, my daughter had soccer practice, but I said that after soccer practice, we would watch Bluey.
“What’s Bluey?” everyone asked.
“It’s this cartoon from Australia that everyone from my office says is great,” I said.
So expectations were elevated.
We got home, fired up the Roku, and put on Bluey. The episode “Takeaway” was amusing. “Granddad” had a sweet ending. Then we watched an episode called “The Magic Xylophone” because of autoplay, and that one was a little didactic.
Anyhow, the point is that Bluey’s not bad. And while it’s a good kids’ show, none of us Hansons feel compelled to watch all of the episodes. I also probably did the show a disservice by raising expectations. We were expecting our minds to be blown, but it was dogs with Australian accents being nice and clever and frustrated. Again, a good kids’ show!
I messaged Emily the next day and said that she may have overhyped Bluey, but that I could relate because I did the same thing with Pocoyo (an originally Spanish kids’ cartoon with an English version narrated by Stephen Fry) back when my kids were in it. Awash in terrible kids’ shows, I latched onto the best of the bunch as high art, but when I’d tell my not-yet-parent friends that they should watch it, they’d come back and ask me if I was on drugs.
A few takeaways:
High expectations, if not met, result in disproportionate downside. This can be a stock market bubble that pops, a construction project that is bid with no room for error, or a TV show or restaurant recommendation that doesn’t live up to the hype.
Context matters. A good kids’ show isn’t necessarily a good show, but that’s ok if you go into watching it knowing what you’re up for. An investment analogy is that a good low margin business isn’t necessarily a good business or investment unless you go into it knowing what you’re up for and do something like buy it cheap.
Spending time with your kids (or grandkids, so I’ve heard) when they’re little can warp your perception of reality. But that’s ok…and you should do a lot of it anyway.
– By Tim Hanson
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There Are Few New Problems
One of the paradoxes of owning and operating a small business is that it can feel really lonely. Even if you have lots of employees and customers, no one else knows what it’s like to sit in the owner’s seat, often get paid last, keep everything from going off the rails, and have no thought partner when it comes to thinking about risk and opportunity.
This is a challenge we hear about from business owners time and time again. In fact, we were in Cincinnati recently for a potential deal and asked the owner what he was looking for in a partner. His answer? “Someone to help me think through growth and scaling and who has done it before in this and other industries. Because I don’t have that context or experience.”
It was a good, self-aware answer because our experience is that when it comes to business, and small business in particular, there are few, if any, truly new problems. Rather, it’s the same challenges arising over and over again in new contexts, sure, but where the same solution can still apply. This is where having a trusted network helps. Trust, of course, matters because in order to accept help you need to be able to let it be known that you don’t know how to do something – and that’s hard. But if you have someone to ask about a problem and that person knows the answer and you take that answer and run with it, you’ll get better faster.
NPR did a story recently on “boomerang CEOs.” These are people such as Bob Iger (Disney), Howard Schultz (Starbucks), and Michael Dell (Dell) who were CEOs of a big business, then stopped being the CEO of that business only to return as CEO of that business. Leadership guru Cindy Solomon said during that story that the reason this is so is because big companies (like many small ones) are underinvesting in leadership development at the highest levels because “The perception is that by the time you reach that C-suite level, you really should have all of the skills you need, and by golly if you don’t, don’t let on.”
The problem, of course, is not not having the skills, but rather not letting on!
One of the most successful things we did this year was host all of our portfolio CEOs in Columbia, MO, to talk and share best practices. Our only guidance to them was to be honest about the states of their businesses. Not only did the conversations go well then, but they’ve continued into the present and the benefits of being an SMB operator that’s able to bounce ideas off of another SMB operator are real.
When something goes well, we immediately think about how we might scale it. Where that landed with this is something we’re calling Main Street Summit that we’re hosting here in Columbia in November. The goal is to bring together as many SMB owners, operators, and investors as we can to learn, get better, and create connections so that everyone can go back to work and no longer feel lonely, but instead have a trusted network in tow.
If that’s you or someone you know, we’d love to have you join us. I promise that someone there will know how to solve your problem if you’re willing and able to ask.
– By Tim Hanson
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There Is No Plan
Here’s a dialogue that happened at a team meeting the other day…
EMILY: So what’s the plan?
ME: We have optionality at this point to develop one.
DAVID: I think he just said there is no plan, but it sounded smart.
EMILY (unamused): I’m glad you enjoyed that.
David later added, “It was also your delivery. It made me confident in the non-plan that you just laid out. Me in my head: ‘Well it’s always good to have optional…wait a minute!’”
Gun to my head, did I have a plan? No. But was this Mad Max nihilistic-post-apocalyptic-the-plan-is-there-is-no-plan stuff? Also no. (Though imagine if Pig Killer in that scene there said “We have optionality at this point to develop one.”)
Worse, though, than disappointing Emily is that when I tweeted (X’d? posted?) about this amusing episode on whatever Elon Musk is now calling the platform he purchased, I got called out by Bill for “Next level corporate speak.”
It was not that!
It was that I (and Sarah (and maybe you’re guessing by now that this has something to do with Unqualified Opinions (and did I just use a parens inside a parens?))) had started working on something that could go in many different directions. And in the course of working on it, intentionally did not do anything that cut any one of those directions off. Instead, because we didn’t have a plan and didn’t know what a good one might look like since we didn’t know what the end product might look like, preserved open-endedness.
In other words, if you don’t know where you want to go, it’s fine not to know where you’re going. Instead, keep making choices that create more choices, and if you do that, you might just end up someplace valuable, plan or no plan.
Remember that, and have a great weekend.
– By Tim Hanson
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Department Stores and Metallica Shirts
It’s a known-known that what’s old will eventually be new again (just don’t ask that teenager in the Metallica shirt if she can name any of their songs). So I thought this was an interesting article about a growing trend across startup consumer brands that raised capital to sell directly to consumers instead about-facing and wholesaling to department stores. You know, like in the olden days.
One reason for this is that money isn’t free any longer, so the idea of an approach that’s profitable from day one is a lot more appealing than it used to be compared to the prospect of raising a bunch of money and spending it to build a business that might be profitable in the future. There are other benefits as well, particularly in an uncertain economy. While selling wholesale means means you won’t capture 100% of the economics of your business (a feature, not a bug, if your economics are terrible, but I digress), shared margin also means shared customer acquisition costs, shared risk-taking on things like inventory obsolescence and markdowns, and access to broader data sets that might inform better choices about what to sell when.
So why did that whole direct-to-consumer wave pioneered by companies such as Warby Parker take off in the first place? The answer is that if your economics are good, then capturing 100% of them is better than a smaller number. But it’s a riskier bet, and the world cycles through phases of risk on/risk off even if it never seems to time it right.
Two of my rules when it comes to risk are (1) Don’t time it, so be consistent; and (2) There is no medium risk, so either take it or don’t. Through timing and “risk mitigation” you ultimately create the conditions for lower upside but the same downside (since everything can go to zero), and that’s a bad bet, risk-adjusted or not.
An interesting thing about rules, though, is that in order for one to be one, there need to be exceptions, and the optimal strategy for balancing wholesale and retail sales for consumer brands is an exception here. In other words, a great consumer brand, if it’s doing it right, will have both less-risky/upside/downside wholesale as well as more-risky/upside/downside direct-to-consumer (in the form of both e-commerce and company-owned stores). The reason for that is that these approaches can be complementary and lead to higher highs.
That’s not a free lunch, though, because it takes discipline to balance the channels.
For me, one of the vanguards in this space is Brunello Cucinelli, the ultra luxe Italian fashion brand, whose most recent results showed a roughly 60/40 split between retail and wholesale revenue. The company has long believed in a balance because the wholesale channel could serve as a physical advertisement in new markets, serve as a gateway to more specialized pieces in a collection, and be a source of vested, but independent, feedback, particularly if you are able to show that people who become customers at a department store eventually find their way to your destination store or website. Yet it also takes humility to not expand too quickly, to value that external feedback, and to build a culture where people who aren’t you might win alongside you too.
But it’s also not altruism. If you boil it down, a consumer brand selling through wholesale channels, if it's doing it right, is making a profit while advertising at a high conversion rate for its most profitable stuff to what will become its most loyal customers. And that’s a pretty good bet, risk-adjusted or not.
– By Tim Hanson
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The Two Signs You’re Special
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:
Show me your margins.
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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When Great Doesn’t Feel Great
One of the benefits of writing daily about things that interest you is that other people read about the things that interest you and then curate the internet on your behalf by sending you things they think might interest you. And that, thanks to Michael Newton, is how I got my hands on 15 Ideas, Frameworks, and Lessons from 15 Years by Corey Hoffstein.
When he sent it over, Michael noted that “While Corey is focused on public financial securities and derivatives, many sections are universal to all forms of investing,” pointing explicitly to Idea 6: “It’s usually the unintended bets that blow you up.” And they’re right…Michael about the piece being worth a read and Corey about unintended bets, observing that the problem with unintended bets is that you don’t know you’re making them and therefore don’t take steps to stop them from going poorly.
My favorite idea, however, was number 5: The philosophical limits of diversification. Here Corey says that if you take away all risk, you shouldn’t expect any reward. And that’s correct. The more insurance you buy, the less money you make.
More importantly, he says that if you’re building a portfolio, you need to take risk, and further that when that risk plays out and your strategy stops performing, it’s a feature, not a bug! “Because if a strategy worked all the time, everyone would do it and it would stop working.”
It was serendipitous that Michael sent this when he did because I read it as one of our companies was struggling and facing very difficult decisions. I was, in other words, wrestling with an obvious example of our strategy not working and that was leading to self-doubt about the strategy.
Last season I wrote about a potential investor who decided not to invest in us because nothing really bad had happened to us yet. That view confused me at the time, but made sense as I thought about it. But now that something really bad was happening, it still didn’t feel great.
That anguish, though, is why there’s opportunity. If every lower middle market private equity deal went well, everyone would invest in lower middle market private equity deals and there would be no return to be had. Similarly, if something goes well every time you do it, it’s either (1) luck or (2) means you are leaving a lot on the table because you’re not doing enough. But if something goes well seven or eight times out of 10, or even just two or three depending on the magnitude of the potential reward, well, that’s actually impressive.
Corey sums up the idea by saying that in order for a strategy to work, it needs to be hard so it doesn’t get arbitraged away. So I guess this all means that our strategy is hard, which is great, except when all of those times when it’s hard because that never feels great.
– By Tim Hanson
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Why We Gave Away Our Diligence Checklist
You may have noticed earlier this week that we open-sourced our entire diligence process. We told you how to start, what to do, what to ask, and how to structure the team to see it through. Now anyone can go out and be Permanent Equity.
Not so fast…
The open-source concept has its heritage in software development, where engineers could access code written by others in order to debug, optimize, and improve it. Paradoxically, the point of sharing software is selfish. By doing so, your software gets better faster and exponentially increases in utility – and therefore value – to the world. That exponential increase in value is why sharing something also makes sense economically. Usually having a small interest in a big thing is better than having a big interest in a small thing.
One of the reasons we do what we do at Permanent Equity is to help more American small businesses stay independent and thrive. Therefore, if there is a bigger, more reliable market in which small business owners may sell their businesses, it benefits us. We want small business owners to know that if they go to market to sell their business they are more likely than not to receive a fair valuation and also to go through a reliable process. That’s because an expectation of fairness and reliability will make more small business owners more likely to sell their businesses to outsiders.
That’s very much not the case today. In talking to sellers and intermediaries, we hear horror stories all of the time about prospective buyers who lied about sources of funds, violated confidentiality agreements, and so on. This can lead to owners hanging on too long or selling out to a competitor or just closing up shop.
Again, that’s not in our interest.
Further, we’re self-interested because we know our diligence process isn’t perfect. Like software developers, by open sourcing it, we’re looking for feedback. What might we add? How might we ask certain questions better?
Permanent Equity is in the business of confidently investing other people’s money, and the aim of diligence, as we say in the document, is not uncover gotchas that enable us to renegotiate, but rather to gain an accurate understanding of how a business works and what its opportunity set is so we can do that. Because the more we can confidently invest, the better, so we’re excited to show our work so we can get better too.
Finally, if you go ahead and read about our diligence process, one thing you’ll undoubtedly notice is that it’s both time and labor intensive. It’s work! At Permanent Equity, we’re willing to do the work and that’s something that’s also been a differentiator and competitive advantage for us in the lower middle market. In other words, it’s one thing to know what we do at Permanent Equity and another to go out and repeatedly do it.
– By Tim Hanson
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The Cost of Certainty
Philosopher GK Chesterton famously wondered whether a man can be certain of anything at all. And that’s a fair question in a world that keeps throwing us curveballs. But assuming certainty is possible, another more interesting question is: What is certainty worth?
This came up in deal negotiations with a company that had history going back decades and lots of products out in the market. We had agreed on major terms and were now focused on details, including future liability. While the company had a very good safety record, one of their requests was that we assume all future liability for anything in the market, new or old (successor liability).
This is not a standard deal term!
Yet we always seek to understand where people are coming from so asked why that was a request. The answer was that the seller wanted peace of mind. In other words, out of the business, he didn’t want the business to ever come back to bite him.
I get that. But when we priced out what it would cost to carry forward that potential liability on insurance, the answer was about $100,000 per year. Assuming 3% annual escalators (and insurance rates have broadly been way higher than that), a 10% discount rate, and a 30-year hold, that’s a $1.2M ask. In other words, it surpasses our materiality threshold. Further, when you take into account that a claim could make our new company uninsurable for reasons that were entirely outside of our control, it’s an open-ended risk that we simply can’t be in the business of taking.
When we pointed this out, we were told that the likelihood of a claim was microscopic because of the company’s safety record. We asked that if that was the case, then why couldn’t they retain the risk? Again, the answer was peace of mind. And we get it, zero is a very different number from a number greater than zero. How different? Well, that depends on how likely it is you can be certain of something.
So can we be certain of anything? When it comes to offloading risk, the answer is yes, but there has to be a buyer and what’s more, it’ll cost you. Have a great weekend.
– By Tim Hanson
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The Least Helpful, Most Disrespectful Thing
Permanent Equity’s fund structure is, ahem, unique. We keep investors’ money for 27 years and are allowed a lot of flexibility. This means that there need to be mutual, high levels of trust between us and our partners for the model to work.
Yet if there is something that is in short supply in the financial industry, it’s trust.
You might think that this would make fundraising a challenge for us. In fact, the opposite was true when we last raised in 2019. Being unique turned out to be an incredible time saver. The reason this was so is because we got a lot of quick nos. And by quick I mean within five minutes of getting on the phone with someone.
“What’s the fund duration?”was usually one of the first questions.
“27 years,” I’d respond.
“Uh, we can’t do that,” they’d say.
“Ok, great to meet you. Let us know if we can ever be helpful.”
I can’t tell you the number of times I had that exact conversation. And I loved it. It meant I spent five minutes instead of untold hours on a lead that probably would never convert anyway, avoided traveling to an in person meeting, and didn’t end up with a partner who ultimately wasn’t fully on board.
Now contrast that experience with its opposite. That’s the long no. And that’s the least helpful, most disrespectful thing.
We had a prospective partner once who told us that they would be in for $10M, but that they wanted to do more legwork so that they might get comfortable increasing their allocation up to maybe $25M or $50M. Great, we thought, let’s put in the work.
They came to visit us several times in Missouri and talked to our entire team. We went to visit them and spent hours walking through our historical investments and plans for the future. We answered a lengthy questionnaire, shared financial models, and tried to make ourselves available to answer any and all questions.
This entire process took almost a year and with a month to go before we closed our fundraise, they still hadn’t committed. More concerning, they started becoming slow to return our calls. Perhaps out of naivete we’d hived off a portion of the fund for their capital, so if a commitment wasn’t forthcoming, we’d be left in a lurch. Finally, they let us know via email that they wouldn’t be committing. What’s worse, they didn’t really even provide any specific reasons why.
You can understand why this is not helpful and disrespectful. Leaving aside the time, money, and opportunity costs, their sandbagging their way to a no made our entire business model vulnerable. We kind of took that personally.
I mentioned this story to another GP recently and he said that his bet was that they were having liquidity problems and were either hoping to solve them in time to commit or were too embarrassed to admit it. Maybe that’s so; I’d like to give them the benefit of the doubt. Yet if they were ever to come back and ask for feedback from us, we would tell them that we would have preferred to hear that there was a chance they wouldn’t be committing as soon as they knew there was a chance they wouldn’t be committing. And if that was on the first day we met, even better! Because there’s nothing that’s less helpful or more disrespectful than the long no.
As an aside, I was on a panel discussion recently and someone asked what all of our LPs had in common to make them commit to such a weird fund structure. It was a good question, and I didn’t immediately have an answer. We have LPs of lots of different sizes, from different backgrounds and geographies, and with different investment objectives. But as I thought out loud, I think I hit on it. What binds them together is that they are all genuinely curious about why things work and don’t work and also, like us, try to always do what they said they were going to do when they said they were going to do it.
Which is to say, if you’re curious and have follow-thru, that is both helpful and respectful.
– By Tim Hanson
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Stay Inside the Box
One of the points I made previously in this space is that neither people nor businesses should regularly exceed expectations. The reason is that if one makes a habit of outperforming, it means, just as if you make a habit of underperforming, that you’re lousy at making predictions about your abilities and capacities.
And look, we’re all lousy at making predictions about our abilities and capacities. For example, I hosted a morning discussion at the last Capital Camp where 40 people RSVP’d to attend. At 8am, when the discussion began, 20 people were there. I get that people may have had too much fun the night before or decided to do something in the moment like hit the omelet station across the street, but the fact is that half of the group couldn’t accurately predict what they were going to do 12 hours into the future! And if we can’t do that, what’s the point of planning anything at all?
Yet there is absolutely value in planning and structure, so the question becomes how might one plan while acknowledging that it's difficult to forecast what might happen next?
My answer to that is “The Box.”
The Box is something I ask our team to build with our portfolio companies before the beginning of each year and is also something I work with the team at Permanent Equity to build for ourselves. The Box is different for each business, but broadly speaking is a range of assumptions and outcomes that are all achievable and acceptable relative to our goals, capabilities, capacities, and level of investment.
You can think of it almost like a reverse budget that’s meant to manage expectations. If we have a Box and we’re inside the Box, all good. We can talk about ways we might optimize performance, but it’s likely that no drastic actions need to be taken or hard conversations need to be had.
If, on the other hand, we’re outside of The Box, all bets are off. Our portfolio companies know that they are going to hear from us and that we will need to do something different, regardless of whether it’s on the upside or downside.
On the downside, it’s how do we get back in The Box? We might need to cut costs, for example, or spend more to drive revenue.
On the upside, it’s why was The Box wrong and what opportunities are we clearly missing that we didn’t plan for and could we take further advantage of them? Because the fact is that if you just celebrate outperformance (and you should do that, too), you may be missing the opportunity to generate further outperformance!
A common question I get when I talk about this topic is how big can The Box be? I don’t think it matters because broad ranges can be as useful as narrow ranges provided your range is clearly defined and you are prepared to handle anything that happens inside of it. So do just that, and stay inside the box.
– By Tim Hanson
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Pizza Place Beer Garden
Think about all of the things you might do if you were sure you could just break even.
Me? I run a lot and am fortunate to live alongside the Katy Trail, a 240 mile long gravel path that happens to be both a state park in Missouri and the longest running trail in the country. Along that trail, in Rocheport, Missouri, there happens to be a small piece of land for sale with a pizza oven on it. You can’t imagine how often I’ve run by that and thought to myself, “I should buy that and start a pizza place-cum-beer garden.”
I would do it, too, if I knew that all I had to lose was my initial investment. But of course running a business is hard and a restaurant particularly so, and I could lose a lot more if I didn’t operate it well.
Somewhat related there was an interesting article in The Wall Street Journal over the summer about how the people who want to build things in rural America (i.e., doers) can’t agree about the value of those things with the people who have the means to finance them (i.e., bankers). Here’s the link. We’ve experienced this phenomenon both with the piece of real estate our picture frame business operates out of in the middle of Michigan as well as with the piles of airplane parts we have out in southern California. Both are worth way more in our eyes than in the eyes of lenders and that probably also makes sense because, more so than the lenders, we know what to do with them (I hope).
So I was glad to read that we are not alone:
Lambke wants to construct a new building on the empty lot next door but has run into a problem impeding economic development in rural communities across the U.S.: The new building would cost $7.4 million to erect. When completed, it would be worth $2.4 million, according to an appraiser brought in from Boston by a local bank.
First of all, that’s an impressive feat to devise a plan that would result in an immediate 70% loss. Second, how can something be worth less than its cost anyway?
The answer is that things trade at a discount to their book value all of the time. The reason is that anything, absent momentum, is worth less than its cost because unwinding stuff is expensive. Take my pizza place-cum-beer garden. Even after I bought the property I’d probably have to pay to upgrade the oven, buy furniture and fixtures, hire staff, acquire inventory, do marketing, and so on and so forth. Then if it failed, I’d still be on the hook for taxes, have to severance the staff, pay the local hauling company (shoutout D.J.) to dispose of all the stuff, and so on and so forth.
At the end of the day there wouldn’t be much left against my initial investment, and this is why banks will never lend 1:1 against any asset and usually will only do so at really steep discounts. It turns out creating value is hard!
So hats off to the people who start things. And even more so those who do so and create value. Most small businesses are stupid risk/reward profiles, but America wouldn’t be the country it is without them. So sometimes I’m glad more people don’t think like me.
That said, does anyone want to invest in a pizza place-cum-beer garden in Rocheport, Missouri?
– By Tim Hanson
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How We Can Help
We had a meeting with some prospective partners recently who wanted to know how we could help them. They were having trouble implementing Netsuite. Could we do that? They wanted to source from more factories in China. Who did we know? And they wanted to be more effective with their marketing spend. What was our track record?
At the end of the day we do want to be helpful and it makes sense that anyone taking on a partner doesn’t want a freeloader, but honestly the way that we can be most helpful, and the thing that makes us stand apart from competing investment firms, is that we can give people and companies time to become whatever it is they are supposed to be.
There’s an old saying that if you give a man a fish, you’ll feed him for a while, but that if you teach him to fish, you’ll help feed him for a lifetime. And that makes sense, but it’s frustrating too because of delayed gratification and an indirect connection to outcomes.
A resolution I made in 2023 was to show more gratitude to others. One way I did that this year was by sending a long overdue thank you note to my college playwriting professor. I never did become a playwright, I told him, but I think about and/or reference his class, standards, and teachings everyday.
Warren Buffett says that he’s a better investor because he’s a businessman and a better businessman because he’s an investor. Well, I’m a better investor because I took playwriting with John Glavin, and a better businessman, too.
The point is that you don’t help someone or some business or some youth soccer team or some wannabe playwright by telling them what to do. Rather, the best way to be helpful is to foment conditions under which a person or business or team or wannabe playwright might have an epiphany that leads to sustainable success. And to ask good questions and give honest feedback.
At Permanent Equity the way we try to foment those conditions is by operating within a fund structure that gives us and our portfolio companies three decades to figure it out. That was intentional by design because we know that growth is not linear, that arbitrary timelines beget arbitrary results, and that it’s only through learning from mistakes that one figures out what works. And since we don’t need to gussy anything up to sell it in a short time frame, we’re also free to ask good questions and give honest feedback. While I’m loathe to ever say anything nice about or to Mark, those are two things he and his team do well.
The other thing is don’t beat yourself up about a bad result. John Glavin gave me an F on my first dialogue exercise, but he also asked a lot of questions in the marginalia. I’d never seen an F on a paper prior to then and it was disappointing at the moment, but then exciting. The reason is that I thought my F dialogue was pretty good; it was only then that I realized how much better it could get provided I had time and feedback and intention.
Because if you have time, feedback, and intention, you have everything you need to succeed.
– By Tim Hanson
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The World’s Greatest Asset
We talked last season about the Dallas Cowboys, Manchester United, and irreplaceable assets. In doing so, I compared Jerry Jones to Warren Buffet because Jerry’s returns from owning a football team have been competitive with Warren’s at Berkshire Hathaway. Moreover, the Dallas Cowboys over the last few decades have been a fun and competitive team to watch as much as that pains me to admit and by any measure, owning that has to be way more fun than owning reinsurance.
Now we have the example of Daniel Snyder, who ran the Washington Commanders nee Redskins into the ground over his 24 years of football ownership with the team being neither fun nor competitive over that span (that one RG3 playoff year being the exception).
And yet!
Snyder bought the Commanders nee Redskins for $800M in 1999. He sold the team for a little more than $6B in 2023. That’s good for an 8.8% annualized return, which while not quite as good as what Jerry and Warren are putting up, compares favorably to the 4.8% the S&P 500 returned over the same period.
This raises so many interesting questions!
Since Snyder nearly doubled the market return, did he do a good job?
If he didn’t do a good job (which he didn’t), why did he earn such a good return?
I think the answer is that even if you pay up for a high quality asset and run it poorly, you can still do quite well because to some extent return streams are embedded in the very essence of an asset. And if that’s true, then be well aware that even if you pay very little for a low quality asset and run it well, it might still go to zero.
In other words, operating a great asset poorly is better than operating no asset at all (which is also why being fully invested beats market timing), while operating a crappy asset well still leaves you exposed to a lot of exogenous risk.
So I think the way to view Snyder is not by how much excess value he seemingly created, but rather by how much excess value he failed to create relative to what any reasonable individual might have done. If you’re into baseball statistics, this metric is called value over replacement player, or VORP, and Snyder has negative VORP.
Investor Peter Lynch reasoned that he liked buying a company that could succeed despite being run by a “monkey” (his word to describe someone with negative VORP) because inevitably it would be. So I think the conclusion is that if you ever get the chance to buy into an NFL team, do it. They may just be the world’s greatest assets as evidenced by the fact that I struggle to think of a business leader with more negative VORP than Snyder who still generated such strong returns.
Have a great weekend.
– By Tim Hanson
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Small Business and the Real World
I have a reputation around the office for being a bit of a skeptic, so I felt a little challenged the other day when Emily asked me to name some things I am bullish on. I think she thought she had me at a loss, but as I rolled the question over in my head, two trends came top of mind: Small Business and The Real World.
By Small Business I mean independent proprietors and regional firms that are well-known and supported in their communities. The reason this is the case is because I think consumers want to patronize these types of businesses, and I think the tide is turning on the technology side to help them stand shoulder to shoulder against bigger firms. For example, something like Square was able to let small businesses easily accept credit cards, making them as convenient to buy from as larger retailers. And technologies like Shopify’s enable small businesses to look as professional and be as efficient to buy from online as big ones. (Yes, I also see the irony of big businesses being what enables small ones.)
Yet whereas in the past, consolidation and the Wal-Martization of the world seemed inevitable, I think it’s going the other direction now despite who is enabling what. There are risks, of course. Many of the most innovative technologies, such as AI, are being developed by large corporations for use by other large corporations, which if not proliferated out could give them permanent advantages over small businesses and lead back to consolidation.
But ultimately pluralization and specialization have merit. A world where that’s the case is more competitive, provides more choice, and makes everything less fragile. So I’m bullish on that, and we have our money where our mouth is on this one by focusing on small- and medium-sized businesses in our investment approach. After all, one of the reasons we do what we do is to help more American small businesses stay independent and thrive.
By The Real World I mean actual experiences that people can touch and feel. It is, for lack of a better description, the antithesis of the Metaverse, which as an entire concept is something I find both bewildering and depressing.
We have our money where our mouth is on this one too, with investments in our portfolio in swimming pools, airplanes, amusement park rides, and relationships. Fun and love, I hope and think, aren’t going anywhere.
And this is good for the world, too. I try to not get too serious in this space, but I don’t think it’s a coincidence that rising levels of teenage suicide and depression have coincided with the digitization of society.
I’ve said it before and I will say it again, it turns out we’re social creatures.
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What’s Next?
Filmmaker Quentin Tarantino’s retirement plan has been in the news lately because he’s long said that his tenth movie would be his last, he’s up to nine, and he’s shooting a new one this year. His reasoning for this is that “Directors don’t get better as they get older. Usually the worst films in their filmography are those last four at the end. I am all about my filmography, and one bad film [effs] up three good ones.”
In other words, the man wants his professional legacy to be one high quality, completed, coherent thought, and I respect that. I mention that here because Tarantino’s plan is relevant to a question we get a lot at Permanent Equity, which is what happens at the end of 27 years (i.e., our fund life)?
Candidly, it’s a good question that we don’t know the answer to, and the reason we don’t know the answer yet is because there is a lot of time between now and then and therefore a wide range of potential answers. The endpoints of that endgame interval are (1) Permanent Equity ceases to exist to (2) Permanent Equity goes on forever.
The interesting thing about endgames is that to be thoughtful about one, you have to start preparing for it long in advance, but you can also prepare for more than one at once. Here at Permanent Equity we are trying to get and stay prepared for a lot of possibilities. After all, if you’re in the business of creating variance (which is what I think we are), you have to be able to take advantage of it when it’s created.
The challenge is that preparing to take the Tarantino approach (i.e., end it) looks very different from preparing Permanent for permanence in terms of what we do and how we spend our time. To do the former, we should be heads down on our core business, with tight quality controls, while syncing everything up to pay off around the same time. The latter, on the other hand, would have us spending more time on talent recruitment and development and risking mistakes in the name of learning so that the practice can evolve and outlive the practitioners.
Tarantino has chosen the former, and in doing so, has assured himself of an incredible legacy. But what he’ll never know is if his 11th or 12th or 13th film might have been best and enhanced his legacy, or if he started a studio and let someone else make Pulp Fiction 2, if that would have been fantastic.
After all, that’s the value of open-endedness.
The risk, though, is that you or someone else tarnishes a legacy that should have been left alone to stand on its merits. For example, what would Goldman Sachs look like today if it hadn’t gone public? And is Giorgio Armani still a high-end brand?
So what in your life and work are you preparing for? You don’t have to know the answer now (again, we don’t either). The key, though, if you don’t, is to make sure you’re not doing or not doing things (like ignoring talent recruitment and development) that would make it impossible to accomplish one of your possibilities in the future.
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Permanent Equity’s Super Bowl Ad
What if Permanent Equity bought a Super Bowl ad? Would it be a good use of capital? How might we pay for it? What would we advertise?
I thought about this the other day after I read and agreed with my own opinion that problems that can be solved with money aren’t really problems if you can get the money. If we had unlimited capital, in other words, we would absolutely buy a Super Bowl ad, which would garner far more exposure than this humble daily, and that would help us become the world’s greatest private equity firm.
The catch-22 is if you have access to unlimited capital and spend it profligately then you will lose your access to unlimited capital and therefore not be the world’s greatest private equity firm (our LPs are nodding…and I assure them that this humble daily costs far less to produce than a Super Bowl ad). In other words, your greatest competitive advantage, if pressed, becomes your greatest weakness (hat tip, Sun Tzu).
Around the same time I was thinking about this, Johnny forwarded me something he read in Money Stuff (yes, I have gotten everyone around the office to read Money Stuff). It was a quote about Adam Neumann and WeWork and how he/it had incinerated many billions of other people’s – but mostly Softbank’s – money.
Johnny’s point was that no capital had been “incinerated.” Rather, it had been “redistributed” to WeWork employees, Neumann, startups that benefited from subsidized rents, and, of course, the guys that flew Neumann around the world on a really fast private jet to go surfing.
I’m not jealous, but more importantly, Johnny’s not wrong (nor a communist)!
Johnny’s question, though, was interesting. If you agree with the premise that this capital was merely “redistributed,” then why do people say that it was “incinerated”?
I think this goes back to the idea that having capital is a privilege and that funding something is one of the most meaningful things you can do for someone else. And if you agree with that, then the reciprocal is true. Receiving capital is a privilege and earning a return for someone else is one of the most important things you can do.
Was Adam Neumann trying to build something interesting? Maybe. But he incinerated capital in the sense that he prevented it from being provided to someone who might have done a better job investing it in something meaningful. Does that mean the capital is gone forever? Of course not.
But hopefully the next steward will do better. Better for others, that is. It’s hard to do better for yourself than by flying around the world on a really fast private jet to go surfing.
– By Tim Hanson
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Why We Eat Well
I’ve made the joke before (and I will absolutely make it again) that one of the biggest risks facing Permanent Equity is our cholesterol. This is in recognition of the fact that if you come to visit us or we come to visit you, no one will go home hungry.
What’s no joke, however, is how much actual credence we put in the practice of sharing a great meal with past, present, and future partners. But why?
Providing a substantive answer to this simple question is more difficult than it might seem on its face. What does one get out of a meal that one can’t get out of a phone call, Zoom, meeting, or coffee?
First, it’s inclusive. Everybody eats.
Second, there’s no agenda. You’re there to have a meal. Other topics might come up and if they are germane, great, but if they’re not, that’s great too. We’re there first and foremost for the food, and we can get to business later.
Third, it’s a shared experience. That’s important because those are all we have to fall back on when circumstances inevitably get difficult. If you’ve shared a great meal with someone, you will always have that in common.
Fourth, it’s revealing. What and where people eat and drink tell you a lot about what they value and where they’re coming from. And if the meal doesn’t go well, it’s a red flag. If you can’t engage in conversation or treat people well while dining on delicious food, what’s going to happen when the stakes are higher than steaks?
None of this is to cast any aspersions at any type of eating or drinking. A meal doesn’t have to be fancy or expensive or long to be great. We get called heroes, for example, when we show up with donuts for everyone in the warehouse. And we don’t go to California and not get a Double-Double animal style. But, yes, there are some fancy meals that we’ve enjoyed too.
The point is that it’s through food that we have been able to build our most meaningful relationships both personally and professionally. Which is why being well-fed is a competitive advantage (and why meals should go back to being 100% deductible).
Have a great weekend.
– By Tim Hanson
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About the Benjamins
We hear it all of the time in our line of work. That something – a deal, a contract, a decision – is “not about the money.” Sometimes that’s ironic because in the context of it not being “about the money,” someone is asking us to solve a problem with money (ours, not theirs). In the past, I’ve called money an interesting way of keeping score. And it is. But money can also be a tool or a weapon because with enough money, anything can be about the money.
The latest outfit to learn this lesson was the PGA Tour, which found itself forced into a merger with Saudi-backed LIV Golf despite shouting on high that it would never do so. The reason, commissioner Jay Monahan finally conceded, was that the PGA could not compete with “unlimited money.”
The plain truth is that you can have every other advantage on your side, but if the other side has unlimited money, there is no way to win. It’s like that old up up down down left right left right b a start Konami cheat code that would give you unlimited video game lives. If you have that, you’re going to beat the game no matter how many mistakes you make along the way because your ability to keep playing the game can never be exhausted.
There’s a saying in investing that the stock market can stay irrational longer than one can stay solvent. This is a nod to the reality that unless you have unlimited resources, betting against momentum is a dangerous game. And it is, which is among the reasons why I’d buy put options before I’d ever short a stock. The latter strategy puts you in a position of open-ended liability, whereas in the former you can only lose what you staked.
Facing LIV, the PGA found itself in a position of open-ended liability against an adversary with a balance sheet that was orders of magnitude bigger. That’s an unwinnable game. And if you agree with that, then it leads to a very interesting conclusion. Namely, that the greatest competitive advantage of them all, is the ability to raise money. Here’s what I mean…
Tesla went public on June 29, 2010, at a split-adjusted price of a little more than $1 per share and finished that year with about $170 million on its balance sheet. Over the next 10 years the company burned through almost $7 billion of cash and should have been long since bankrupt when 2020 rolled around.
Instead, the stock had increased over 70 times in value. The reason? People couldn’t stop giving the company money. In fact, over that decade, the company put more than $25 billion into its coffers
As someone who at one point owned Tesla puts on the belief that the company would run out of money, I under-appreciated Elon Musk’s showmanship. This ability to get people to stroke him a check meant that Tesla could never go out of business. And for a long time it was a better capital raising vehicle than it was a carmaker (and might still be).
So if the ability to raise capital is the ultimate competitive advantage, why don’t more people press it? The US government, for example, is resisting calls to mint “the coin.” Institutional investors shudder when GPs raise too much. And companies that are constantly selling stock are viewed as dilutive and shareholder unfriendly.
I’m not sure of the answer here, but I think it has to do with a general feeling that money is a crass advantage to play. That it’s somehow not fair to be better resourced than your competitor. Or that having money might make you reckless in other aspects of your life and business. And perhaps that’s all true. But it’s worth remembering that if you ever have a problem money can solve, you don’t really have a problem, unless you can’t or won’t get the money.
– By Tim Hanson
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The Four Important Roles
At the end of Season One, when I was running out of ideas, I shamelessly asked you to send me some. And you did!
So thanks for that. Now I’ve got fodder to keep this train on the rails.
One interesting request was from @loadlinefinance and @fortworthchris who sent me this piece and asked me to react to the idea that a CFO’s role should be redefined to distinguish between strategic and administrative functions. The reason being that it takes a very different person to be strategic versus administrative, so if you ask the same person to do both you will end up being subpar in one area.
As you may know, I used to be a CFO and if you asked me where I was good and where I wasn’t, I was probably better at being strategic than I was at being administrative. Thankfully, we have others (shoutout Lori) on staff who are great at making sure that we survive things like our 401(k) audit and that no one goes to jail!
But now we also have a qualified CFO and I’ve shed many of those responsibilities, and I think that’s been better for both me and the organization.
That said, I think there’s an opportunity here to be even less specific about roles, but more helpful about achievement. For me, every endeavor, whether it be a project, team, or organization, needs four important roles:
A person who generates opportunities to create variance;
A person who decides which opportunities to pursue (i.e., how much risk to take);
A person who oversees the execution of those opportunities;
A person who measures the results and confirms that the opportunity is as risky (or not) as anticipated.
If you wanted to put organizational titles against these roles, (1) is roughly a Chief Executive Officer, (2) is a Chief Investment Officer or could be a Chief Financial Officer, but could also be a Head of Strategy, (3) is a Chief Operating Officer or maybe a Chief Technology Officer, and (4) is a Chief Financial Officer or Controller.
But I’ve never really liked or understood titles, and also appreciate that many organizations can’t have four or more senior executives, so my advice is if you’re doing anything make sure you’re covering all those bases. And if you’re doing all four yourself, make sure you compartmentalize and don’t let one area dominate another.
– By Tim Hanson