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Your Next Hire
I had a conversation recently with someone who is building a venture firm from the ground up and after telling me a bit about what she did and ultimately wanted to do she finally said, “Hey, can I ask you a question?”
“Of course,” I answered.
“You guys aren’t big, but manage more money than I do and have a bigger team, and that’s where I think I’m heading next, so my question is: How do I get there? And more specifically, who is my next hire?”
“Because right now,” she went on, “I lead everything. I’m sourcing, negotiating, diligence, operations, finance, compliance, investor relations, accounting, you get the point…”
And I did.
When it comes to building an organization and figuring out who should be in what role, I find it helpful to keep four lists. List one is what needs to get done, rank-ordered. List two is what different people are actually doing, in order of time spent doing it. List three is what the people in your organization are good at. And list four is what those people like to do.
You can see where I’m going with this. In an ideal world, the four lists are nearly identical. But if they’re not, it stands to reason that what you should be hiring for and who you should be hiring are driven by items that are on list one, but not lists two, three, and four. And while keeping these lists can be complicated at large organizations, in the case of the woman building the venture capital firm, making them and seeing where they differ should hopefully be a pretty fast and illuminating exercise since it’s such a small shop.
Of course, hiring is a luxury, particularly at small organizations, and so if you work at one you may have to wear more hats than you care to for longer than feels ideal. But that doesn’t mean not actively knowing which hats you ultimately want and should wear. Because if you don’t do that, you’ll never wear them.
Have a great weekend.
-Tim
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Stupid Expensive Goldfish
I heard a funny story recently from a mom who went into Petco to buy two goldfish for her kids after agreeing to do so. She found them (the goldfish, not the kids) in a tank near the back of the store selling for 29 cents each and asked a salesperson to bag them up.
But hold on, the salesperson said, do you have a tank for them at home?
No, the mom said. I was just going to grab a bowl on the way out and fill it up when I got there.
You can’t do that, the salesperson said. You have to get a tank and then set it up, treat the water, and let it run for three days. After that, if you bring us a water sample and it passes muster, then you can buy the goldfish.
$125 later the mom had a tank and a filter, a collection of chemicals, a fake plant, a small castle and some gravel. Then, three days after that, after her water had passed muster, her kids had 58 cents worth of “stupid expensive goldfish.”
What is going on here?
Observation one is about the power of commitment to influence our behavior (shoutout Cialdini). The mom agreed to get goldfish thinking the cost was de minimis, but still did so even after the cost of doing so rose exponentially. So be aware of what you commit to and under what circumstances, because most of us have a hard time walking those commitments back.
Observation two is that rules make things more expensive. If Petco didn’t care about the well-being of their fish, this was a 58-cent transaction, but since they apparently do, it was a $125.58 three day slog. Is this a brilliant upsell (Petco is private equity owned)? Or do they truly care?
This is relevant because I’ve been thinking about the cost of rules a lot of late. See, Permanent Equity plans to begin experimenting heading into next year with something we never thought we would: boards of directors. The goal here is to regularly convene people with both inside and outside views of a business to discuss long-term objectives, report on progress towards achieving those objectives, and, to the extent that that business is or is not making progress, identify strategies that it might implement to improve performance. This sounds like basic blocking and tackling, and it’s not to say that we weren’t doing this, but absent rules around how and when to do it, we were probably doing it too irregularly and without all of the right people in the room as we’ve grown.
But board meetings are also really expensive. Not only does it take time to implement structure and abide by it, but the constraints imposed by objectives in and of themselves limit open-endedness. So we also don’t want our boards to be like other boards. Our intention is to keep them small, highly accountable, and responsible for making sure each business has a clear plan, but for the cadence of collaborations underlying the process for achieving that not to be regularly, but rather when necessary.
Because if you do things because they have to be done and not when they should be done, you end up with too onerous of a regulatory regime…and stupid expensive goldfish.
-Tim
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Performance and PKs
Christmas came early for me this year when I got a hold of Professor Geir Jordet’s new book Pressure: Lessons from the psychology of the penalty shootout. Because if there was ever a book written uniquely for me (soccer, cognition, risk, reward), this was it! And I offer no apologies in advance to the inevitably irate parent on the opposing sideline this season whose daughter is about to take a penalty kick against the u13 girls soccer team when our goalie inexplicably needs to stop the proceeds to tie her shoe (“The overall trend is that the longer penalty takers have to wait for the referee – typically because of goalkeeper delays – the worse these players perform from the penalty spot.”)
Jordet, a psychology PhD, has analyzed every major penalty kick shootout of the past 50 years and offers some ideas about how (and how not) to conduct oneself in this high stakes situation. A number of these tactics are specific to soccer, but others are relevant not only to soccer players, but to practitioners of almost anything where anxiety can influence performance. As for what those are, it boiled down to three things:
Have a repeatable process.
Don’t be a forced actor.
Prepare for stress.
The idea behind having a repeatable process is that it ensures consistent inputs no matter the situation, turning a thinking exercise where doubt can creep in into a reflex. For the penalty taker this might mean always setting the ball down, taking three steps back and two to the side, and two deep breaths before kicking. But it doesn’t matter what the process is, as long as it can be consistently deployed. This won’t ensure optimal results every time because outputs will be outputs, but rigorous quality control of inputs should mean better outcomes more often than not.
In our businesses, one way we think about this is as easy earnings versus hard earnings (with the acknowledgment that all earnings are hard). Easy earnings are what you get from doing the same thing over and over, like putting up fences. The process is predictable, reliable, and each time one does it, one becomes less likely to screw it up. Hard earnings are what you get when you have to reinvent the wheel every month. For example, if you have no repeat customers or every project you take on is new and custom. You can have a good business with those characteristics, but your results are likely to be more volatile if your process is not repeatable.
Not being a forced actor is all about moving on your terms rather than someone else’s. For example, one of the more interesting observations in Jordet’s work is that the length of time that elapses between when the referee blows the whistle signaling that the penalty taker may take the kick and when the penalty taker takes the kick has gotten longer over time. In other words, it used to be that when the referee blew the whistle, the penalty taker immediately took the kick. Now, the penalty taker tends to take a few moments to breathe before proceeding. As long as this delay is on the kick taker’s terms (and not because the goalie inexplicably has to tie her shoe), success goes up. Indeed, I’ve talked a lot about not being a forced actor in this space, and our entire firm and fund structure at Permanent Equity is designed with that concept in mind. The reason is simple. If you do something when you think you have to, it may not be the case that you should.
Finally, Jordet calls out France coach (and World Cup winner) Didier Deschamps a number of times for not believing that one can practice penalties simply because you can’t replicate the stress of having to take a penalty on the biggest stage until one is actually taking a penalty on the biggest stage. Jordet disagrees and recommends practicing penalties a lot (just like you would practice any high stakes situation a lot even if you can’t replicate the stress) and in situations where you introduce mild levels of stress i.e., have the entire rest of the team stand and watch as their teammate practices a penalty. The reason is that if you learn to deal with a small amount of stress, it makes you a lot better at dealing with a lot of it.
While we famously don’t use deal debt at Permanent Equity, that’s not because we don’t expect our investments to be able to perform under pressure. Instead, we don’t want them to be forced actors, but we still think they need to operate ruthlessly and efficiently in order to generate acceptable returns. One way we do this is by distributing excess cash regularly out of our businesses, leaving them only with what they need and/or can profitably reinvest.
Of course. that practice can lead to some uncomfortable conversations with our operators who might sleep better at night knowing their business has a so-called “green blanket” in place, but it stands to reason, and Jordet cites myriad studies that say the same, that if you’re used to some pressure, you’ll better handle pressure. Not always, of course, but more often than not.
-Tim
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Small But Important
A funny thing that happens when you’re living two thousand and twenty-four years after the start of the common era, but haven’t yet read everything written up until now, is that you can have an epiphany that you believe is novel, but turns out that many, many others have had before. So it went as I was reading Capital Returns, which was graciously gifted to me by one Michael Newton after he recommended I should read it (happenstance?).
A theme that keeps arising in the book (which is a collection of investor communiques published by London-based Marathon Capital between 2002 and 2015) is that companies that earn high returns are often ones that do a small, but important thing for their customers. In other words, they are a low cost, but critical part of a project or value chain or supplier to a company. Some examples…
August 2011: Another class of business whose weight in our portfolios has expanded…has been companies with annuity-like revenue streams…The common theme here is a longer-term commitment made by the customer, together with an element of inertia when it comes to renewals. These factors…make for significant barriers to entry and high and sustainable returns. This is particularly true where the cost of the service is only a small proportion of the customer’s total spending.
February 2013: Pricing power is further aided [when a component]...plays a very important role…but represents a very small proportion of the cost of materials.
May 2014: Sometimes a product is so embedded in a customer’s workflow that the risk of changing outweighs any potential cost savings…The very best economics appear…in a situation in which the cost of the product or service is low relative to its importance.
February 2015: Our preferred growth stocks undertake apparently unglamorous activities that are essential to their customers – so essential, in fact, that customers pay little attention to what they’re being charged…Here, reliability weighs more highly than price.
Marathon Capital is not wrong! (Though they got their Baidu bet wrong, but who among us has not been wrong about China?)
Anyhow…
One of my biggest learnings over the past five-plus years at Permanent Equity is that the place to be in business with your customer is small, but important (see for example among others waterproofing and commercial fencing). Because small, but important, businesses, for all of the reasons Marathon cited, have the best of everything: pricing power, margins, cash conversion, growth opportunities, etc.
The reason is that small, but unimportant businesses are undifferentiated afterthoughts, large, but unimportant businesses are commodities, large, but important businesses are highly scrutinized, but small, but important businesses have carte blanche. And carte blanche is some place to be.
-Tim
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Be Ruthless
You may or may not know this, but we’ve taken the best (relatively speaking) of seasons one and two (and soon three) of these missives and turned them into short books, Unqualified Opinions, You Can’t Buy All the Biscuits, and the forthcoming Don’t Skimp on the Swag, respectively. This gives us something to hand out to people who stop by the office (alongside our sweet swag shops), so if you want one (or more), come visit!
But a consequence of keeping these books on hand at the office is that I read them over and over again looking for (and finding!) things I might have done better. So it went the fortieth or so time I read You Can’t Buy All the Biscuits when I was about two-thirds of the way through and realized that the book was just too long. And that the reason it was too long was because past me told SarahBethGDub that I thought we should include some chapters that I liked, but that in hindsight really didn’t need to be there.
So I jumped on Slack and wrote to the team “Biscuits is too long and that’s on me. If we do another one, it should be as tight as the first one. Let’s be ruthless.”
(And hopefully the forthcoming Don’t Skimp on the Swag reflects that.)
See, a danger of having your own ideas is that (at least initially) you like them. A further danger is that it feels good when the world acts on your ideas and so you tend to be a little biased (subconsciously or not) about pushing for them. But the world isn’t about you or your ideas, it’s about utility and value, so optimize for that.
I had a writing professor in college who could be pretty ruthless. He said after giving us an assignment that after we finished writing it to then cut it by at least 33% because the world doesn’t have time for or care about at least that amount of what we think or have to say. That’s kind of a cold view, but probably also not wrong.
Yet it’s also in recognition that if you meet the world on its terms and not yours, you’re likely to enjoy much better experiences and outcomes. So be ruthless. It’s not as bad as it sounds.
-Tim
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The Messier Marketplace?
I revealed last season that Brent was getting set to update his book The Messy Marketplace, and I’d like to think that putting that little bit of public pressure on him was helpful to him getting the project over the finish line. Because he did it! The second edition was published earlier this week, and you can get your copy here.
But why a second edition?
The first edition was written in 2017 when Brent and our team had been at this for about 10 years. Since then the marketplace and valuations have evolved, we’ve all endured a pandemic, and Permanent Equity has made more than a dozen new investments. In other words, we know a little bit more than we did back then and wanted to publicly update our thinking on what it means to successfully do a deal.
As for all that’s changed, well, buy the book! But an example of something we’ve learned is that there are a lot of nuanced reasons why someone might be looking to sell a business and/or bring on a partner. Whereas the original version assumed sellers were ready to exit, or slow down, or were in over their heads, we know now there is more to it than that. So the new edition recognizes some additional profiles:
The Seller: You are ready to personally exit your business both as an operator and as an owner.
The Scaler: You have one or more significant growth initiatives on the horizon and want some combination of diluted risk, more resources, and strategic support to take them on.
The Stabilizer: You have no intention of leaving tomorrow, but want to begin separating your personal timeline from the needs and ambitions of the broader organization.
Every owner wrestles with when to sell, what to sell, and to whom. I can’t answer those questions directly, but I can help you understand the landscape of options available to you depending on your personal priorities and the needs and goals of your company.
The reason it’s important for a business owner to reflect on what kind of seller he or she might be is because if you don’t know who you are and what you are trying to achieve with a transaction, you won’t get what you want out of it. A Seller who misidentifies as a Scaler, for example, will likely end up leaving a lot of money on the table. And a Stabilizer masquerading as a Seller might get forced out of an organization long before he or she is ready.
The challenge with selling a family business is that you’re likely to only get one shot at it, so it’s worth doing research ahead of time to prepare. Our hope at Permanent Equity is that the second edition of The Messy Marketplace is an indispensable part of that process for anyone going through it. So, again, get your copy here and also give it as a gift.
Thanks in advance, and have a great weekend.
-Tim
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Brat Summer Sausage
Something Holly has taken it upon herself to do at our office is make sure that we all stay current on popular culture lest we embarrass ourselves when we are out in the real world. So it went during a recent check-in when she let me know that “brat summer” was officially over.
“Got it,” I said.
But she was skeptical. “Did you even know it was brat summer?”
And I did because I had absolutely heard the term before. That said, I will cop to thinking it had something to do with grilling and was unaware that it was “an aesthetic trend defined by party animal antics, cool-girl style, and lime green everything.”
I guess you learn something every day. But I mention this here not to lament my missing out on the true brat summer, but rather as an example of someone in an organization adopting – and thriving at – an informal role.
The way I think about it, if you work at an organization there is what you do at the office every day, which is your formal role, and then what you bring to the office every day, which is your informal role. And what’s interesting is that while most people are hired to fill a formal role, their longevity and trajectory inside of an organization is usually determined by their informal one.
To wit, I was once witness to a hiring process for a quantitative analyst that ended up landing a technical expert with multiple advanced degrees from a rival firm. With regards to the formal role that needed to be filled by the hire, this was a no-brainer home run. But it didn’t take long for things to turn sour when this person adopted an informal role of being an instigator, a lone wolf and a fault-finder. And while the person’s work as an individual contributor was good, the cost borne by the organization with regards to overall productivity was too great.
This isn’t to say that if you’re fun to hang out with you can loaf at your job (those people are eventually let go as well), but rather that the most successful professionals don’t just do what’s asked of them. Instead, they’re constantly looking for ways to share their talents, knowledge, and passions across an organization in order to make it stronger and more well-rounded. Further, it’s by making one’s talents, knowledge, and passions known and admired across an organization that one’s formal role will grow over time.
An analog to this is that if you see a void in an organization, fill it. Because it may be the case that no one else in the organization even sees it yet.
-Tim
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Unfair Value
If you’re in the business of investing, your product is returns, which is to say that if you’re in the business of investing, returns are what your customer expects. But unlike other products, to the chagrin of customers and proprietors alike in this space, returns can’t be manufactured at scale on an assembly line according to a production schedule. In fact, by trying to manufacture returns, investors often do worse (and/or commit fraud).
Yet if you don’t have a product that you can reliably manufacture at scale and on schedule, you arguably don’t have a business. And since I’m in the business of investing, I was some combination of outraged, amused, impressed, bewildered, skeptical, and cynical when I read about Hamilton Lane, a fund that reported that on one investment of pretty good size they made 39% in a day. And further that they had done stuff like that before.
The trick is that Hamilton Lane went into the secondary market for illiquid private investments and bought something for a price no one else would pay. Then they marked the value of that investment on their own balance sheet not at what they paid (or cost, as the nerds would say), but at a higher “fair value” (which is even nerdier) with “fair value” being what other people who owned shares in that investment thought it was worth.
Of course, people who own things have every interest in portraying them as worth more. An opposing force is that buyers have an interest in acquiring those things at a price that is less. What’s the truth? Who knows?
Because arguably Hamilton Lane shouldn’t have marked the investment at the value others were carrying it at, but rather that the others all should have marked their investments to the value that Hamilton Lane had just paid.
But Hamilton Lane isn’t the only one in this industry massaging returns by citing fair value. To wit, mammoth financial firm Blackstone’s $59B real estate trust is kicking ass only if you are willing to give it credit for the “appraised values” of its investments. What are appraised values? They’re numbers in spreadsheets, not numbers being offered by buyers.
Is this a problem? I think yes and no.
Returns are what you put in your pocket (hello, beer money!), but an important qualifier is that what you put in your pocket depends on when you decide to pocket it and why. In other words, if you buy or sell something, you may transact at fair value, but more likely you’re not. Because the reason you’re transacting is because the price is a lot more or a lot less. In Hamilton Lane’s case, for example, they may have gotten a great deal (unfair value?) because the seller was distressed and they were the only ones who could wire it money that day and so maybe they were right to then mark it up?
This is why this stuff is confusing.
A better way to think about it is that there are two types of value: Spreadsheet Value, which is an academic estimate, and Real World Value, which is what a willing buyer would give you in cash today. And both numbers are worth acknowledging and knowing because rarely are they the same.
As for which one is “fair,” that depends. And that’s why returns are so hard to manufacture (absent, of course, fraud).
-Tim
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Serendipity Now
“How did you get here?” is an interesting question to ask and be asked. So it went on a recent call when a college student I’d been introduced to wanted to know – because I think he was interested in doing the same – how I had become the chief investment officer of a private equity firm.
“I,” I said, “have a fairly non-traditional background, so take from this what you will…”
Coming from Long Island, N.Y., where I did landscaping as a summer job, I went to Georgetown University in Washington, D.C., because I thought at the time I made that decision that I was interested and had a future in government. But I got an internship in the House of Representatives early on there and realized I had very little interest and definitely no future in government. I also found that I liked my political theory (shoutout Plato) classes far more than my practical politics classes because of the writing and thinking and so eventually wound my way to being an English major with a concentration in playwriting (which is why after I became CFO of Permanent Equity with no classical training in numbers, our CEO Brent would refer to me as the most under-qualified CFO in America).
I graduated from Georgetown in 2003, which wasn’t a great time to be looking for a job what with the economy still recovering from the double shocks of the dot-com bubble burst and 9/11 (both formative events in my life that had occurred before the college student I was telling this tale to had even been born…ahem). Without a lot of prospects, I was expecting to head back to Long Island to landscape and then maybe go on to graduate school. In fact, I hadn’t even received a response from any of the more professional jobs I had applied to, including one as a writer at The White House, which I had applied to at the recommendation of one of my English professors even though I didn’t think I was qualified.
And I wasn’t!
See, the job required a master’s degree, and I didn’t have one. Because of that, I later learned, my resume was put at the very bottom of the pile.
But never underestimate serendipity.
Because they interviewed everyone on top of me in that pile and none of them got the job. So the choice came down to interviewing unqualified me or reopening the process, which meant it might take six to nine months to fill the role. And so I ended up on the right side of the fact that something is better than nothing.
Now, an important thing to know here is that this happened a long time ago and I didn’t yet have a cellphone. So the number on my resume was attached to the landline at the house I shared with a bunch of others on Potomac Street near campus. But by the time this all happened, we had graduated and were moving out. I kid you not that my roommate Doug was about to pull the jack out of the wall when the phone rang with The White House calling on the other side.
An interlude…
Getting a job writing at The White House might sound impressive. You’re probably thinking about memorable lines spoken during grandiose speeches on impressive stages. And there were people who did that.
But what also happens is that the President meets, greets, and receives gifts from a lot of people that then need thanking. And someone needs to write those thank you notes because the President doesn’t have the time for that, but also wants to promptly send detailed thank yous because votes and also because not thanking a world leader for his or her gift might cause an international incident. Again, something is better than nothing.
And that’s how I got hired for that job. Because I was better than nothing. But I’m still not close to telling you how I became the chief investment officer of a private equity firm…
That wheel started turning because I’m a cheapskate. Not as cheap as Morgan Housel (shoutout Morgan…we good?) and not as cheap as I used to be (shoutout past me), but always and still stingy. What’s relevant is that back when I worked as a thank you note writer, I saved everything I could in order to be relentless about investing.
One reason I learned to be relentless about investing is because my Dad was relentless about investing. In fact, he started as a professor at SUNY Stony Brook (now Stony Brook University) around the same time as Jim Simons, the founder of the wildly successful quantitative investing firm Renaissance Technologies who recently passed away. Jim and my Dad shared a relentless interest in investing and allegedly talked shop, but Jim I think pursued that interest somewhat more relentlessly (if measured by financial outcomes and so it goes). That said, my Dad was still relatively relentless about the topic, and I took that in.
So as a young, relentless investor with a small amount of savings near Washington, DC, I inevitably happened upon The Motley Fool (based in Alexandria, VA). Then as I read The Motley Fool, I discovered that they were looking for a writer (and then ended up working there and doing other things).
I’m going to fast forward because this is getting long and attributing things to serendipity seems lazy, but I will say that another question I get asked is: “Should I work at a big company or a small one?” My answer is that big companies might pay you well and give you lots of training and small companies might pay you less and provide minimal training (and the government might…well, I won’t comment on government jobs). You can do well anywhere, of course, but I think something about working at small companies is that you get the opportunity to do whatever you want. That creates variance and variance is upside (unless you screw it up). So if you value the future over the present, the opportunity to do more and earn less until later is always worth more (shoutout lifetime value) than the opportunity to do less and earn more in the present. Even a lot more (unless you screw it up).
Back to serendipity (and whoa is this too long a tale), I got hired at the Fool just as they were recovering from the dot-com bust, so I was a very junior employee at a very small company given the opportunity to do whatever I thought I should to add value while sitting at the same pod everyday as Bill Mann (you’ve met him before) and Fool co-founders David and Tom Gardner.
Serendipity.
I listened first-hand as smart people debated not only what investments to make, but also how to run a business that was at times under stress and at other times very much not. I guarantee you that the people being hired into Amazon or Apple or Goldman weren’t and aren’t being afforded the same opportunity.
After more than a decade of doing that (and a short stint managing Morgan), I got introduced to Brent Beshore (because of Morgan…it all comes full circle), saw what Brent and team were building here in mid-Missouri and thought it was pretty smart, and was paying attention when he told the world he needed someone “with a breadth of financial, accounting, and tax experience to help lead our team.” Even though I had little of any of that, I sent him an email saying that I thought I could be helpful, we met, and here I am. So the answer to how I got to be the chief investment officer of a private equity firm is: I was curious. I learned from great people. I worked hard. I took risk. And I got lucky (because I don’t think I ever applied for and then was offered a job I was qualified for).
And curiosity, mentorship, work, risk, and luck is a helluva equation. But I’ll tell you, I often think what might have been different if Doug had unplugged that phone.
-Tim
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Get Activated
It seems like tradition now to start off each season with a learning from the u12 (now u13!...where does the time go?) girls soccer team, so here we go…
We had a subset of the team play recently in a 3v3 tournament. What you need to know about 3v3 soccer is that it is a fun and fast-paced game, but played on a small field with small goals and no goalies and in very short duration. So whereas the girls were used to playing on a big field with big goals with goalies for 60 minutes, now it was the opposite compressed into 24.
Which sets the stage for variance…
We won our pool games going away and so therefore all of the other teams had their sights set on us. Come the semifinals, we came out complacent against a team that didn’t. They got an early lead and our girls didn’t help themselves either by being errant on some shots on a small goal that might have gone in on a bigger goal. And starting with about 10 minutes left in the game, the other side started clearly trying to run out the clock.
It worked. Our girls lost 3-4.
Facing a dejected group ahead of our consolation match, I said, “Hey, is this field bigger or smaller than normal?”
“Smaller,” they replied.
“And is the game longer or shorter?”
“Shorter,” they replied.
“So if the field is smaller and the game shorter, does each touch and moment matter more or less?”
They kind of looked at me funny.
“Guys,” I said, “on a small field with short time, every touch and moment matters more. So get activated. If we come out flat, luck and chance are going to decide the game. But if you’re activated and play the way I know you can, you control the outcome.”
And I think that resonated because the girls won the consolation game in lopsided fashion.
I’ve said previously in this space that sometimes it feels like the world conspires against us. And while it can certainly feel like that is the case, I think what’s more true is that the world is full of competing interests and also that there are a finite number of outcomes, which means that we all don’t always get what we want. Further, it may be the case that the field is always smaller and time shorter than we would like. So if you’re complacent and come out flat, you might get an unpleasant surprise.
This isn’t to imply that everything is zero sum like the outcome of a 3v3 soccer match, but rather that if you’re not activated, you should be and particularly so when (because?) fields are small and time is short.
-Tim
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The Dots are Off the Beach
If you’re new to Unqualified Opinions, or maybe even if you’ve been reading since the beginning, you may be wondering what the heck the deal is with the Dots. The answer is: It escalated quickly. It really got out of hand fast. It jumped up a notch.
Looking back at my notes, it started when SarahBethGDub and I were talking about what to call this thing that didn’t yet exist way back in January 2023, and (after we nixed “From the Trenches”) I suggested Unqualified Opinions (an audit and accounting joke). She said she liked that and so I asked her to come up with some branding to put at the top of the email that “was a little irreverent and maybe incorporates your dot people somehow.” Next thing we knew she was putting hats on Dots and making punk rock Dots and investing icon Dots (sometimes both at the same time) and now, for better or for worse, we have legions of them (see the beach party scene below that evokes Seurat’s 1884 pointillist masterpiece A Sunday Afternoon on the Island of La Grande Jatte).
Between you and me, I thought about not bringing Unqualified Opinions back for a fourth season. It seemed like it had had a good run and done its job, and I have some trepidation about becoming boring and/or didactic and/or repeating myself (and Danny-didn’t-get-a-glass has accused me of at least one of those things). But then SarahBethGDub made the new Season 4 nameplate with Swaggy Dot above, and now I’m all in (and hope to live up to expectations without being boring, didactic, and/or repeating myself).
So the deal with the Dots is that they’re fun. And if you’re going to do anything for an extended period of time, you need to have fun. Dots are fun. I hope you’re having fun. I’m having fun. Let’s have some fun.
See you Monday for Season 4.
-Tim
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¡Adios Amigos!
The Ramones released ¡Adios Amigos!, their last album, in 1995, nearly 20 years after they released their debut, Ramones. Johnny Ramone, the band’s guitar player, rated it a B+ saying, “Some of our albums would have three or four really strong songs, and then the rest would be pretty weak. But on this one, even the lesser stuff is decent.”
(And I hope that you would at least say the same about this third season of Unqualified Opinions.)
The reason this is relevant is that one fascinating video you can find on the internet is a 16-plus minute compilation of The Ramones playing their hit “Blitzkrieg Bop” over the years at faster and faster tempos. What started as a 175 beats per minute jam in 1975 accelerated to a 252 beats per minute screamer by 1996. That’s fast! And it’s relevant because it’s a simple-but-elegant illustration of a point I’ve been meaning to write about for a while, but haven’t been able to find a way to do so without it seeming didactic.
Namely, that there is no substitute for reps.
How do you play “Blitzkrieg Bop” at 252 beats per minute? By playing it for 20 years straight at less than 252 beats per minute, but pushing the envelope a little bit more each time you do.
How do you find more than a few mushrooms? By spending years looking for and not finding them.
How do you build a portfolio of good investments? By analyzing thousands and thousands of bad ones.
This, of course, isn’t a new idea. Even since before author Malcolm Gladwell coined the “10,000-hour rule” in his book Outliers, everybody knew that (deliberate) practice (informed by feedback) made perfect. Yet I’m always surprised by the frequency I turn to Brent or someone else in the office and we say almost simultaneously, “Huh. It turns out reps matter.”
Because most things are not rocket science. If you show up, put in the effort, and learn from failure and feedback, I all but guarantee you will develop an enormous competitive advantage in your chosen field. You, in other words, will be playing “Blitzkrieg Bop” at 252 beats per minute when everyone else struggles to get over 200.
There. That’s my observation that reps matter. It still seems didactic, but since this is where I am going to end Season 3, unsubscribing will do you no good. Yes, I know we published through Memorial Day last year, but we’re hosting our first ever Partner Summit in Columbia, Missouri, next week on Monday and Tuesday and then a few hundred more people for the fifth annual Capital Camp on Wednesday and Thursday. In other words, next week is pretty chock full and then the lazy days are here. But if you’re looking for a more dramatic finale than this one, go back and read Day 2. A bunch of people told me it made them cry.
Have a great summer and thank you for reading and writing back.
-Tim
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The Long-Awaited White Paper
Thank you for bearing with me as I spilled my thoughts about portfolio construction out onto the page. It turns out that writing a cohesive white paper is difficult, particularly when it’s on an abstract topic with the goal of being both in-depth and in plain English.
But here we are, and I am proud to release Portfolio Construction and the Lower Middle Market to the world. (Click that link or this one to get your copy.)
If you read the working on the white paper series in this space, there may not be much that’s new, but I think each section benefits from being together in the same setting as the others. For qualified investors, we are working on an expanded version that includes data around Permanent Equity’s portfolio and its returns over time, but we can’t put that out into the wider world because the SEC would frown upon it (spoilsports!).
Hopefully, you find our weird way of thinking about the world helpful.
-Tim
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Explore, Exploit, and XNPV
I’m not fishing for compliments, but it’s hard work to write everyday (except on weekends and when I arbitrarily decide to take two weeks off for spring break). And it’s not so much the writing that’s the hard part, but rather the generating of ideas to write about. Of course, that was the whole point when I started doing this: I challenged myself to find something interesting to say everyday.
And again, not fishing for compliments, but based on the responses I’ve received from you all to the things I’ve said everyday (except on weekends and when I arbitrarily decide to take two weeks off for spring break), I think that’s mostly been the case. But I can’t take all of the credit for that because along the way I discovered a hack for being able to say something interesting everyday, and that’s to respond to something interesting said to me. That’s why so many of these start with prompts from you.
With that as background, here’s what I heard back from Daniel after I wrote about hunting for mushrooms(!) in a business-like manner: “This reminds me of the explore-exploit paradigm in computer science. Great post.”
Now, did I include “Great post” in the quote there because I am fishing for compliments? Maybe, but more importantly, explore-exploit! I vaguely recognized that terminology, but it had been a long time since I had heard it and I have zero computer science background, so I looked it up. Here’s what I found on Wikipedia:
The exploration-exploitation dilemma, also known as the explore-exploit tradeoff, is a fundamental concept in decision-making that arises in many domains. It is depicted as the balancing act between two opposing strategies. Exploitation involves choosing the best option based on current knowledge of the system (which may be incomplete or misleading), while exploration involves trying out new options that may lead to better outcomes in the future at the expense of an exploitation opportunity. Finding the optimal balance between these two strategies is a crucial challenge in many decision-making problems whose goal is to maximize long-term benefits.
I feel seen.
If you want to be crass, I think you can reduce a lot of business, and perhaps the world, to the explore-exploit paradigm. Or as I say, because I live in the world of spreadsheets and not computer science, everything is a present value-future value problem (shoutout XNPV). But a crucial nuance that explore-exploit calls out, that present value-future value doesn’t, is that when making a decision, your current knowledge of the system may be incomplete or misleading. But “may be” may be being generous there. That’s because it may be the case that when making a decision, your current knowledge of the system is incomplete or misleading.
I say that because after I wrote about your colleagues having an outdated perception of you, Brent wrote me back and said simply “Perception is a lagging indicator for all things.”
And I said, “If that’s true, then perceptions are always wrong, which is humbling.”
To which he said, “Yessir.”
And while I am tempted to end it right there, the point is, and this is a recurring theme this season, that you or the world is always moving on, so you will never have or have processed the information you need to ever make a bullet-proof decision about what to do next in business or anything else. So explore as you exploit, but also exploit as you explore, and thank you to Daniel for bringing that to my attention.
-Tim
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Don’t Skimp on the Swag
We were meeting with the owner of a blue collar business recently and he was curious if he did a deal with us, what types of things might change. For example, he’d heard that a lot of private equity firms like to identify and cut unnecessary costs post-close in order to increase profits and pay down debts. He said he probably had some of those, but if that was us and we did a deal together one thing we most assuredly couldn’t get rid of were his boots.
Curious, we asked what he meant by that.
Well, he said, every year the company buys each employee a nice new pair of boots and outfits them with new branded shirts and jackets to wear in the field. Further, the employees had some say over the brands and styles purchased for them provided what they wanted was up to safety specifications. The program, he went on, cost about $10K per year.
Before we could interject, he held up his hand and said hold on. Sure, he could make his employees buy their own gear (in fact, his competitors mostly did) and sure, boots and swag could last more than a year, but he thought the investment more than paid for itself.
He held up his hand again…
Because of all this great stuff, he went on, his employees happily complied with his uniform policy. This meant they had uncompromised steel-toed boots, had reflective material where they needed it, and were always dressed appropriately for the weather. This, he thought, meant they were always able to take their time and do a good job regardless of conditions, which also contributed to his company’s pristine safety record.
Second, it was great for morale and culture. These were not items these employees might splurge on for themselves so that meant they were not only happy to receive them, but also that they proudly wore them outside of work. This, he knew, helped with customer acquisition and retention as well as with hiring.
So, he concluded, no matter what happens, we are keeping the boots.
Finally given the chance to speak, we wholeheartedly agreed. In fact, we told him, we do the same thing at Permanent Equity. See, our founder and CEO Brent had an insight a couple of years ago that while we had purchased a lot of swag, people didn’t seem to be wearing it. So we brainstormed about what we might do about that (throwing away ideas like forcing people to wear it or making them get PE tattoos) since what good is swag if it just sits in a drawer? What we finally hit on is that we’d give each person a generous budget to buy whatever swag he or she wanted to wear and then have a PE logo put on it.
Within months no one was not wearing PE-branded apparel, and we’ve continued upping our swag game (shoutout James) from there, spreading the love to spouses, investors, portfolio companies, friends of the firm, etc. Now if you come to our office today, not only will you see almost everyone in PE-branded something or others, but you are likely to go home with a PE-branded something or other yourself for all of the reasons the owner of that blue collar business cited. Or as the great Deion Sanders says, “Look good, feel good. Feel good, play good. Play good, the pay good.”
-Tim
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Are You Being Chased by a Bear?
Something I do now is walk over to Stankowski Field in the middle of Mizzou’s campus early in the morning before the students are out and take the old man VO2 max test that I read about in The Wall Street Journal on the track there (which they say is one-third of mile in circumference, but is definitely shorter than that). That test consists of running as fast as you can for 12 minutes and then seeing how far you got.
I like it because I like benchmarking, the test is not too long, but not too short, and it’s been fun to see progress. And sometimes, to stay motivated, I imagine that I’m being chased by a bear.
Wait, what?
Well, after I wrote about creating a sense of urgency at work in order to drive accomplishment, I received a note back from Joe R. He said that one of his first bosses believed “that you never run faster than when you are being chased by a bear.” I thought that was a funny mental image, so I adopted it during my next old man VO2 max test.
As a practical aside, if you are being attacked by a bear, don’t run away. If it’s a black bear, fight back, but if a grizzly, play dead – and hopefully you have enough wits about you right as you’re about to be attacked by a large predator to know the difference. I digress…
While imagining a bear chasing me has helped me run faster and farther, it wasn’t a good management strategy for Joe R.’s first boss. Because in actualizing it he “motivated people with fear...in an environment of low communication…[and] remains the worst boss I’ve ever had.” Because, in Joe’s words, while “you run fast when being chased by a bear…you can’t run a marathon that way” (leaving aside the fact that it might go viral if somebody tried).
Of course, Joe is no longer in his first job and has moved up the organizational chain of command to lead others, so I wanted to know what he does differently as a result of that terrible experience. Here’s what he said:
I’ve found that you should recognize that everyone has an extra gear to up their productivity, innovation, etc. As a leader, I try to engage that gear regularly, but not frequently, and to do it by giving goals to people and teams that are hard but not impossible. I deliver these goals with the message that “I am confident you will figure out how to reach it, and I will help you to do so. I believe in you.”
And I liked that advice. After all, you can accomplish a lot during sprints, but if and only if you recognize that you need to rest in between them.
-Tim
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Return of CIMple Truths
If you’re a more recent Unqualified Opinions reader (and most of you are), CIMple Truths was a gag I pulled out on Fridays back during season one to highlight ridiculous things seen in deal teasers called Confidential Information Memorandums (abbreviated CIMs sounds like “sims”). I stopped doing it because as interest rates rose and deal flow slowed, people stopped making so many ridiculous claims (just not the Trump SPAC). But sufficient ridiculousness has accumulated since then that I thought I would run CIMple Truths out for a curtain call ahead of the weekend.
So without further ado, here are some things that recently made us scratch our heads.
Tech-forward organizations…
That is some cutting edge stuff.
Very humble brags…
Wait, is that a good thing?
Creative addbacks…
There’s probably a story there.
Non-core business…
Well, that was unexpected, but aren’t they all? Have a great weekend.
-Tim
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Becoming Predictable
I was talking to someone the other day about measuring investment performance and we got on the topic of volatility. I mentioned, with some frustration, how volatile and unpredictable the performance at some of our businesses can be and my interlocutor said, “I didn’t think you would have cared about that.”
“What do you mean?” I asked.
“In my view,” he went on, “measuring and worrying about volatility only matters when it captures the risk of being a forced seller at a bad time. At a firm like yours, with your horizon and mandate, it doesn’t seem like that would be a problem.”
And he’s absolutely right. The fact that unpredictable volatility exists together with our ability to tolerate it is what creates one of our biggest competitive advantages as an investment enterprise. After all, you can’t leverage and flip unpredictable volatility (or you can try, but you shouldn’t, unless you want to risk blowing up spectacularly), so we’re able to make investments others simply can’t.
Yet despite it being what puts food on my table, unpredictable volatility is still frustrating because staying prepared to weather it is an impediment to performance. Every dollar we reserve for liquidity, for example, is one that’s not generating return, and everything that happens for a reason we can’t explain is something we can’t reliably repeat in the future.
And it’s that last bit that’s so frustrating and that also raises important existential questions such as “What are we doing here?” Because if you, as a business, lack agency, do you really have a business at all?
It’s in recognition of the fact that an answer to that question is “No, that’s more of a hustle than a business” that one of our strategic priorities with our businesses is to help them become more predictable. This can mean taking on lower margin, higher volume business or signing longer-term agreements. But you also have to be careful here because becoming more predictable is a slippery slope. Certainty is expensive and if you fill up all of your capacity with guaranteed low-margin work, you’re not going to do very well either.
Where does that leave us?
One widely used investing metric to analyze risk and volatility is the Sharpe ratio, which basically says that something is good if it has positive returns with low volatility with volatility here measured using standard deviation. In other words, something is considered volatile in the Sharpe ratio if it goes down or up a lot and going up or down a lot is bad. But then Sortino came along and said “Wait a second.” Because if something goes up a lot in investing, that’s good! So Sortino put forth his own ratio that only cares about how volatile something is when it’s going down with the goal of finding investments that go up a lot when they go up and only do down a little when they go down.
I didn’t bring up Sharpe and Sortino here to wonk out on risk management metrics, but rather to draw a parallel to what it ideally means for a business to become more predictable. This is to take steps and do things that gradually make bad months less bad without also limiting what makes good months good. Because while bad months frustrate me like they would anyone else, if not for them, there might not be any good ones.
-Tim
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The White Paper is Almost Done
If you remember our joke about being in the business of shaving hair, then you probably remember the business we reached out to that had botched an acquisition and gone through some rough years as a result. The reason we did that was because what was oddly impressive about this situation was that despite years of losing money trying to integrate a botched acquisition, the core business had been able to fund those losses for so long. Ergo, the core business might actually be a good one.
So we reached out and floated a valuation and structure to suss out interest and receptivity. The valuation, we thought, was competitive and down the middle, but the structure was admittedly conservative since the valuation baked in righting the botched acquisition and then also refocusing on the core business to grow it.
As for what made the structure conservative, our offer was to pay half of the consideration at close and the other half a few years later contingent on those things (righting the botched acquisition and growing the core business) coming true. Our rationale was that the business was worth one amount if the obvious problems were fixable and a different, lesser amount if they weren’t.
Of course, 50% is a pretty big haircut and the upfront consideration probably undervalued the core business on a standalone basis. But the reason we weren’t comfortable offering a consideration equal to the standalone fair value of the core business upfront is because the core business wasn’t standing alone. Its management was distracted, its cash flow wasn’t 100% distributable, there was the potential for conflict in deciding what to do next, and taking steps to help the core business stand alone would be expensive (severance and lawyers and liquidation processes add up).
All of these things are risks and if you are going to take them, our view is that you need to be compensated for doing so. How do you do that?
In our line of work we see a lot of what academics would call “idiosyncratic risk.” These are risks that are unique to a situation and so therefore aren’t captured in the risk premia assigned to more widespread factors such as illiquidity, small-size, or equity risk. Examples include:
Inaccurate information risk: We’ve seen businesses that track their inventory in a spiral notebook and also lost track of inventory “back in the 90s.”
Slow feedback loop risk: We’ve seen businesses that don’t close their books until six to eight weeks after the end of the month and others that only do reconciliations quarterly.
Whim risk: We once saw a business whose sole supplier was wholly-owned by a hostile foreign government and another whose sole customer was a big box retailer. In either case, the reversal of course by the counterparty would cause the business to disappear overnight.
Rural risk: It’s really hard to relocate talent to small towns.
Relationship risk: Are customer relationships with the business or with an individual?
The list goes on…
Now, some of these, like whim risk, could metastasize overnight, while others, like rural risk, manifest themselves as more incremental long-term headwinds. But you can take any of them (and we have taken some, but not all of these) provided you are compensated for taking them. Now, if you asked a firm to do an independent valuation, they might look at these idiosyncratic risks and bucket them into an “Additional Risk Premium” that they add to the discount rate when valuing a projected stream of cash flows. And that’s one way to do it, and we do increase our required rate of return as we identify more and more idiosyncratic risks.
But structure is another useful tool in making sure investors are compensated for taking odd risks because thoughtful structures can more effectively account for the potential timing and magnitude of the impact of a specific risk materializing.
For example, in the case of whim risk, the business might disappear overnight. To be compensated for that might mean negotiating a deal structure with a shorter payback period and perhaps attaching a put option as well.
For something longer-term like rural risk, you might ask for some kind of hurdle or preferred return that bakes in the expected growth rate in the event it doesn’t materialize.
To return to our offer of 50% guaranteed at close and 50% contingent and deferred to invest in a turnaround project, we felt that our offer was fair because it compensated the seller appropriately for what had been achieved to date, but also recognized that they were offloading significant risk to us. But offers aren’t made in a vacuum, and in this case we got blown out of the water by someone who offered more than us all guaranteed at close.
Now, that’s a great offer if you want to get a deal done, and in terms of immediate feedback loops, mission accomplished. But is that buyer being compensated for the longer-term risks they are taking or is it the case that we wrongly perceived more risk than was real? Only time can tell on that.
-Tim
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You’re Different
I usually take everything that’s written in the Harvard Business Review with a grain of salt, but this piece about “When Your Colleagues Have an Outdated Perception of You” resonated. That’s not only because I think people have had an outdated perception of me in the past, but also because I’ve been guilty more than once of having an outdated perception of someone else and seen people I respect and admire have their career paths impeded due to others having an outdated perception of them.
For example, I recorded a podcast recently with some guys who work with some guys I used to work with. In order to make that happen, we exchanged emails with the customary pleasantries. One of those jokingly closed with “We’re looking forward to having you on. A lot of folks think very highly of you…[but Person A] warned me to avoid you on the basketball court.” As Shakespeare wrote, there is truth in every jest.
Because was I once a competitive monster on the basketball court? I will cop to that.
Am I still? Not as much!
But the perception persists.
As for how this works in the working world, that HBR article relates the story of an entry level employee at a company who grew to manage a team responsible for $22M of revenue, but was still considered unqualified for the role of chief sales officer when it opened up. I had a similar experience in a previous job when I was trying to hire for a role whose primary responsibility would be measuring, reporting, and providing feedback on the performance of others – which therefore required a lot of collaboration and conversation. I identified someone I thought would be perfect for the job, but was warned by his manager that he was too stubborn and single-minded to do well in such a role, citing, when I pressed for information, an experience he’d had 24 months prior (the guy ended up doing great).
A recurring theme this season has been that either you or the world is always moving on. My hope for you is that you’re always moving on and in more interesting and productive directions. A funny thing about that, however, is that even if you are, others may not see or understand the change. To combat that, the article makes two recommendations:
Have a “conversation strategy” with your coworkers that enables you to receive immediate feedback.
Delegate tasks that may make you feel productive, but that you have outgrown.
Now, even if you do that, perceptions of you may linger, but if you’re getting transparent feedback and always seeking out your highest and best use, my experience is that you’ll achieve tremendous personal growth and that the world will catch up to reality eventually. That’s because, as I wrote when I was talking about high-performers, the world is more merit-based, and more people want it to be so, despite injustices, than it appears.
-Tim