Rafa Quinn - Building A Diversified Lower Middle Market Holding Company

[Music] Hello and welcome everyone, I'm Peter Lerman and this is Masters in Small Business M&A. This show is an ongoing exploration into the vast and undercovered world of Small Business M&A, where we interview both the proven and the emerging owners, operators, investors and advisors, whose strategies and methods for transaction success have been put to the test. The show aims to surface the nuanced intricacies, the key ingredients, and the important factors that can improve your decision-making in your own journey in the world of Small Business M&A. This podcast is produced by Axiel, an online platform that makes it easier for business owners and their M&A advisors to find, research, and privately connect with the diverse mix of professional buyers of Small Businesses. In addition to learning more about Axiel, you can find this podcast show notes, edited transcripts, and many other related resources all for free at Axiel.com. [Music] Peter Lerman is the CEO of Axiel. All opinions expressed by Peter and podcast guests do not reflect the views or opinions of Axiel. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Podcast guests may have ongoing client relationships with Axiel. Hey everybody, this is Peter Lerman. Welcome back. This is Masters in Small Business M&A. I am excited to have Rafa Quinn, who has, in all fairness, been a little bit on a podcast tour of late. I'm maybe at the tail end of this one, but excited to find some new material with Rafa today. So Rafa, thanks for coming and spending some time with me. I'm happy to be here, Peter. Thanks. There's been a couple of great conversations recorded recently. I think that I've taken people through you, your origin story, your first deal, your HQ in Panama as opposed to America, where most of the sort of whole coactivity tends to be talked about on Twitter, etc. So we're going to skip all of that. We're going to go, we're going to just dive straight into the transactions that you've been doing and take, sort of, apply some of your tweets to the transactions, so to speak. So, great. I thought it'd be really interesting to just hear about the water businesses. You have two water businesses that you've acquired one a couple of years ago and actually one just on the first quarter of this year, tell us about water, water businesses. How did you get excited about this category and the businesses themselves? Yeah. So, I mean, first off, just to give a little bit of background, we do have two holding companies. One is based out of Panama. One is based out of the United States. We began Panama in 2011. So when we've been building the longest and then we began in the US in 2021. So when we began in Panama, the first company we actually ever bought was an industrial sales distributor. So basically, we distribute in Panama lubricants and filters for engines. And today we've moved into Hoses, Timingbelts, other kind of products that fit in that same niche. So when we see the first opportunity in 2022 for plumbing and HVAC distribution, which was Proctor Sales, while it was a different product, the business itself was very similar to what we've actually had the longest amount of time doing, which is distribution. We are the local representative for manufacturers. We are their boots on the ground if you want to see it that way. The levers that you're trying to control there as far as technical expertise, getting to clients, purchasing correctly, holding the right amount of inventory, selling on credit. All of that is very similar to what we've been doing in Panama since 2011. So I would say that was the initial reason why that business was attractive to us is we understood it. Even if I don't understand exactly how the hot water heater or the boiler gets installed in the building, I understood the business economics of it. Right. And then after that, it was this similar analysis that we do for any other type of company. Number one, geographically did it work for us. Yeah, I was in the United States. Number two, was the size correct at that point. We were looking for companies that were doing over $2 million in earnings. So that box got checked from there. We're looking at how hard is it to kill this business? So how many manufacturers do they have? How many brands are they carrying? Do they have one manufacturer that's making up over 50% of their sales? And the answer was no, they're actually carrying multiple brands. No one company represented more than say 25% of their sales. We liked that diversity. They had what's called a full line card. So they were offering a complete suite of solutions in their area and they had lost one brand. They can very easily replace it because they have other brands that they're carrying. We did the same analysis on their customer side. There was no customer making up more than three or four percent of sales. They're attending hundreds of clients a year, longevity of the business company. Been around over 60 years. So a lot of those boxes that we look to check for every company that we look at, they started checking. And then that deal just gets more interesting and more interesting. I think that's really how it first kind of came about to be, to be on our radar and look like a prospective company for us to buy. Is there something about that end market or that category that you guys find interesting? In as much that one of our principles is we're looking for businesses that we believe will be around at least 10 years. And that might seem really short to some people. But I try not to say if I know what's going to happen in say 20 or 30 years, we don't know what's going to happen in 20 or 30 years. In our experience, most companies that make it 10 more years will probably last 20 or 30 more as well. But we just try and look out 10 years. So let's take this industry, for example, hot water. The areas that we address are Alaska, Washington State and Oregon. So I believe that over the next 10 years people in Alaska will continue to want hot water. Therefore, yes, that product need is going to be met. But it's like, I don't see a change happening there. Could the way their water get heated change? Yes. And it probably will. If you look on the West coast, they're going through a big change right now where they're moving from electrical or excuse me, from natural gas to being plugged in electric as they want to move to more renewable energy sources. So how do you address that? Well, you've got to look at your manufacturers. Are they people who have been investing in R&D? Are they people have been continuously coming out with new products, innovative products to attend the market? As long as you have that, then you should be betting on we're going to be able to address that need. And those changes in the market will actually benefit us because that drives new purchase of units. When you do a retrofit, you have to change all the water heating because that's now becoming mandated by certain local governments. But yeah, in essence, for that end market, it was simply is this something that will continue to be used going forward? And that was a very easy yes to us. The other one I measure is always, can I explain this at the dinner table to my wife and kids? And yes, well, what does the company do, Dad? The water heater we have in the garage? We sell those. In places that are really cool. As you mentioned, I live in Panama. So I always say selling hot water in Alaska or in the 200 US is like selling air conditioning in Panama. That's the easiest way to explain it down here at least. I mean, no one can go more than a day without AC and their house 10 here. Because it's so hot, just like no one could go without hot water from worth and take up there in the winter. That was how we looked at that industry in general. I would say when we first bought Proctor in terms of just the way that money moves through that business. Could you just talk a little bit about the way you sort of thought about that? So just how does the company actually earn, which is your question number one on your 13 or 15 15 point checklist? Yeah, I mean, the distribution business is to me, it's like it's commerce in general. Like if you go back a few hundred years, what was commerce? I buy from one person somewhere. I take it somewhere else and I sell it more expensive. That's in essence what we're doing. We're buying off manufacturers. We're selling to end users. There is a value add there because of our technical expertise. So a job that we did, for example, was or that the company did before we bought it was the Seattle Cracket, the hockey team. So they play where the supersonic used to play. Well, when you take a basketball stadium and you turn it into a hockey stadium, you need to be really careful with the way your water is being heated because obviously the temperature of that ice can't be affected by all that plumbing and the way that stuff. Well, that tech somebody needs that technical expertise to bring it in there and make sure that that works and that's the type of value that we add. We're buying products. We're selling them for a profit and we're collecting that cash. We have to maintain inventory, but other than that, you've got a pretty light capex structure besides the warehousing, some trucks. It's not like a bunch of our cash is having to be redeployed into the business simply to maintain how we are. As we grow, we do have to invest in higher inventory levels and we'll have a bit higher receivables. But again, we were used to that from our industrial sales down here in Panama. Other than distribution is a pretty good cash flowing business. I would say that the trickiest part is the purchasing of the inventory. So there you're looking at am I selling something that's perishable or it's going to be obsolete was the same decision down here 13 years ago. Lubricants as long as they stay in their barrel, airtight, they can last a decade. The only risk you're running is if technology changes in that product becomes obsolete, but you're not dealing with stuff like fashion, let's say, which becomes obsolete after six months. So that's how we looked at that as far as the cash production. Is there any version of that business where you consign the inventory with a markup as opposed to taking purchasing risk and do you do you explore? So it's not cons, it's not a typical consignment, but what it is is so we are a rep and distributor. So the way you would look at those two and and that really ship berries by manufacturer. Okay, so the distributor is actually buying the inventory, taking ownership, taking that risk and then selling it. The rep is simply doing the sales process. The purchase order actually goes from the end user direct to the manufacturer and we receive a commission. So we never actually touch that inventory. We don't take the credit risk from the client or the inventory risk from the manufacturer. It is a better cash flowing business, but the total dollars you can earn are less on the effort of the sale. Obviously, in our company, we're about 50/50 in Proctor between rep and distribution. So yeah, that's how that works. The second business that you bought this spring, like maybe we could just talk a little bit about that and just sort of how that came about and how you think about this. I know you operate these two businesses separately today. I know that you've talked about publicly, like you started out sort of creating a sort of a horizontal, whole co-conceptually with you and your co-founder, which favors the generalist investor mind. But now that you're more than a decade in, you have a bunch of different businesses, there are these opportunities to go deeper in different categories in your sort of horizontal disposition can become a bit of a hybrid and you can become sort of deeper and deeper and more and more vertical in certain categories. Do you see yourself spending more and more time? You bought a second business in this category, the spring, like how are you thinking about how the whole co-model could potentially go deeper in some of these areas now that you're more than a decade in? Yeah. I've written about this before that a horizontal hold co is more, it's the thesis in the sense that when we're starting, we're not simply going to be focused vertically or in a roll-up, let's say just focused on one industry. So that permits us as investors to go where the fish are, right? We get to pick where we find investment opportunity. We get to look at all the options out there and pick which is best for us. That being said, if you look back historically at horizontal hold cos, almost always one or two or three investments will become outsized over time. So in Panama, for example, it's restaurants. If you go back five years ago, we have three verticals here. They were about one third, one third, one third. You go to today and restaurants are now 75% of our Panama hold co. That was not by plan, right? And the same could be said today for plumbing HVAC distribution in the US as of now that come those two businesses make up 80% of our revenue. So they're outsized. That wasn't by design, but to get into kind of how that happens, you can have them for various reasons. In Panama, it came about because we had opportunity met management, right? Restaurants are you can push the pedal down in restaurants. You just go and open more restaurants. I mean, that's it. It's harder to push the pedal down, say on business process outsourcing. It's like, I have to win contracts. I can't just throw money at that and win more contracts. There isn't a funnel I can drive that way. Whereas in restaurants, I can just look at the map and say, well, I don't have one here, here and here and go and open them and all of a sudden I've grown revenue. If you couple that with a manager that wants to grow and can execute that vision, now all of a sudden you have that opportunity. In the United States, it came about differently. We had closed proctor, the acquisition that was in August of 22. A couple months later, my business partner actually was with the CEO at a trade event. They were at a trade event. It was a convention. During that convention, they meet a guy that the CEO knows from the industry. He starts telling his story that he has a business partner and the business partner is getting closer retiring. He's not sure. Their shareholder agreement says that he's the rest to buy the partner out or they both have to sell and he's kind of undecided what to do. Well, I'm behold, there's my partner. That's what we had just done with proctor. They start speaking at over a year of working with them because they didn't have a broker. They didn't have anyone holding their hand or helping them. They were very new in that decision of what they were going to do. It took us a year working with them to finally close the transaction. That's how now we have 80% of our revenues in water distribution. I don't believe a horizontal hold code grows into these verticals by design. A lot of the time, I simply believe it's just different. You start getting inbound deal flow. You've got the CEO that really wants to grow. You see the opportunity and that works out that way. Can you see yourself? You have these two businesses. You're running them independently. Do you anticipate exploring a change to the way that those two businesses are run over the next few years? I guess what I'm curious about is you start out horizontal. You're looking for interesting opportunities. At some point, you get sufficiently deep enough by virtue of circumstance and happenstance in a subset of verticals. You begin to see a capacity to compound earnings with higher and higher levels of conviction and confidence because just by virtue of the fact that you're now operating in those categories. Then those, because you now have that angle within that category, it seems like that can potentially be an easier path to outsized compounding than to continue to start a new as a horizontal holding company, kicking something off and yet another new category. Does your lens change on how to spend time and how to spend capital? As you start to get sharper and sharper on restaurants and Panama and water in America? A lot. There's a lot to unpack there. I would say one of the things I heard you say that to me is supermores is yes, the more time you operate in a certain industry that maybe was already within your circle of competence, that circle of confidence just gets, it doesn't maybe doesn't get wider, it gets deeper if that makes sense. So we understood distribution when we bought Proctor, but now we feel we understand distribution of HVAC and plumbing and the relationships with those manufacturers and the different markets in which markets we'd like to enter and how to enter those markets. All of that is accumulated knowledge over time. So could that lead to us making more investments in this group? Yes. The answer is yes. We would also judge that with, and remember our end goal is the health of the whole co. So it might not be wise to end up being 99% invested in water distribution. If I can find something parallel in a different industry that also offers the same type of return investments, there would be a benefit to that. If I go look, these two deals are identical. One of them is in plumbing distribution and the other is not. Well, the one that is not at some point will get a little green check because it'll simply be diversification. Right? So I think that that's how I would look at that. As far as changing our day to day, I would say that I continue, my partner continued to look at deals the same way we always have. So we are always looking at opportunities. We spend a lot of our time looking at sams, looking at teasers and looking at deal flow. And I don't control a lot of that because 90% plus of what we look at is on market. So it's what our network is sending to us to look at. And I can't tell them, only send me plumbing distributors. Right? I'm not going to do that. So I'm looking at everything. That being said, we do delegate a bit of this to the CEOs in the sense that if a CEO knows we're willing to invest and they have that attitude, they want to grow this company, they would be willing to do M&A. They will be looking at some of these opportunities and actually bringing them to us. And again, that was what I talked about with the restaurants of it has to be the opportunity has to meet the management because invert that and imagine a man is says, I'm happy exactly how this is. I do not want to grow. I don't want to integrate another operation. I mean, if we found something even that is a perfect fit, that means, okay, you got to fire the CEO. So that's a whole other decision you have to make when you're doing that analysis on that deal. Maybe it's good time to like talk a little bit about how you work with managers. I mean, if you read the Buffett letters, this sounds like maybe a little bit of hyperbole from Warren Buffett. But if you read the letters, he kind of makes it sound like he buys these businesses and then he hangs out at oba headquarters and just kind of waits for the phone to live in that otherwise. He leaves me. He leaves the managers alone. I have a sneaking suspicion that it's not quite like that. But generally speaking, the narrative around sort of the Buffett approaches, find great businesses, hire or back the existing managers that are outstanding wonderful long-term managers and stay out of their way, right? How do you compare to that? How do you think about that approach? What have you found yourself doing similarly and differently with alternative holding? When you mentioned Buffett's writing, I always like to think that Buffett was the original newsletter writer or like social media influencer. When everything you put out there is obviously, even myself included, is a lot cleaner than reality. So Buffett makes it seem like he just never has to get involved. But you go back to the 80s and Buffett had to take over and be the CEO of Solomon. I mean, he actually had to step into the role because of what was going on at the company. So I think, yeah, the way he presented is probably not always 100% how it is. For us, we definitely copied that. R3 is by businesses we understand, run by people that we want to work with and pay a fair price. We didn't invent that. We just pretty much copied Berkshire in those three core principles. The way we've done it is we buy businesses that management, which is generally the owner, is willing and able to stay on at least medium terms. So we're not looking for, yeah, I'll give you a one to two year transition. That doesn't work. We're looking for, I'll give you a minimum of five years, but I've probably got 10 to 15. That's the type of conversation we're looking to have with the CEO when we're going to do an acquisition. And I would say that is our biggest filter. You don't find a ton of deals where that is the case. On the flip side of that, that scenario doesn't work for a lot of buyers. So the seller that wants that, there's a lot of people that aren't looking for that because either they're looking to come in or they're in the industry and they're looking to simply erase management and have their own team takeover or they're in private. I mean, so when we find those deals a lot of times they'll end up closing for us or working for us because it's a match that makes sense. So we leave them running the company up till now we have not had equity rules. So we're buying 100% of these businesses. The CEO is staying on with an attractive base salary. So that's going to be something market or market plus a bit. And then they are also getting a percent of distributions. So that's how we incentivize. So for every dollar you send to the hold co you're getting a percentage of that. What percentage it is is going to depend a lot on how much we it's the whole comp package. I'm going to look at what your salary is, how much we think you're going to be able to distribute, find a percentage that makes that entire comp package attractive, but obviously not not absurdly attractive. It has to be it has to make sense in the market. And we have found at the end of the day at the CEO level an incentive plan is important. You want to keep them engaged and you want to keep them motivated and aligned, but a great incentive plan is not going to take a C level CEO and make them an A level CEO at the end of the day. You still got to find a good operator. I just think this is more like the cherry on the top when you find the good operator and then you can align them with those cash distributions. It just makes that wheel work even better because the conversations get a lot simpler. Okay, you want to invest in a new tech stack? Okay, I need a distribution. So what are we going to do? Great, we're going to do tech stack. Okay, perfect. Well, then you're not getting the bonus for that money and I'm not getting the distribution. It's just it aligns that conversation a lot, a lot better. So are they deciding on what to distribute and how much to distribute up to the all the company? We're setting them our expectation and then that expectation can obviously change due to market forces, results at the company, planned investments, et cetera. But we're basically working through a budget process all through Q4 of the previous year based on that budget and how much of their net income we estimate they can turn into operating cash flow. We're then coming up with that are what we call maintenance cash flow. So it's simply operating cash flow minus the cap X. You need to maintain the business as is. And then of that, we would say this is what we're expecting as a distribution because any other cap X would be for growth. If they want access to that cap X for growth, they need to present us a business plan and we're going to lay that out on the table with all the other opportunities we have, which could include both on's investment in a different business we own acquisition of a whole new vertical, just sitting on the money and having optionality of waiting for future opportunities. And we're going to analyze that and we'll make those decisions. And it's a balancing act. I wish I could say we're a robot and we just go for the best risk adjusted IRR ever every time. But the reality is I've also got to keep my CEOs motivated and engaged. So if they're coming with growth plans, even if it's not hitting exactly the highest return versus something else, we're probably going to say yes because we want to keep them motivated and we want to see how it plays out. The details that you mentioned around maybe we'll spend a little bit of time on just like budgeting, just keep going with budgeting here. I mean, I guess the CEOs, they're looking to optimize with this incentive plan. They're optimizing within the realm of the business that they operate. So they're trying to think about should I distribute to the holding company or should I invest in this project for this business and defer the distribution to the holding company in exchange for potentially more cash flow and a more significant distribution at some point down the road. That's the lens that they're essentially being asked to look at investment opportunities. And you at the holding company level have the ability to look at that view, the ability to look at completely new capital deployment that's totally unrelated to that operating company. That's correct. That's correct. And so has that ever gotten challenging just because they're in the tunnel focusing on operating that business and you're able to look at the full waterfront of opportunities. You have such different perspectives from one another in terms of how the capital should be getting reinvested. Okay. Yes. And I think a lot of that plays out with the types of businesses that we buy. So we're not buying a business that's this goes back to kind of our thesis. We're buying businesses that have been around at least 10 years. We always say minimum of three. The reality is we've never bought anything with less than 10 and in the US they've all been 30 to 60 years old. So you're not talking brand new companies and that initial growth phase where you could be reinvesting 100% of your cash flows plus debt and continue attacking market. You're looking at stable businesses. So let's start there. Number two, our investment thesis isn't built on them doubling earnings in the next three years. I don't need that to happen for our returns to work out because of the price we paid and our debt structure and how we have it set up. So now let's actually go to the CEO. In my experience, I have, I mean, except for the restaurant example, that was the only one that we had where a company could truly reinvest 100% of their cash flows. And it wasn't for a long term. I mean, we capped out, Panama can maybe handle 20 restaurants, let's say of the brand we were growing at that moment. We were taking it from let's say five to 20. So yes, on that in space, capital base or earnings base you had, that's a big growth. If you want to execute that quickly, you're going to have to consume a lot of that cash flow. But in general, we're rarely getting asks that are really putting in jeopardy the distributions that we're counting on. It's also up to us to negotiate our debt in a way where that shouldn't infringe on their operating ability. Does that make sense? Like we're not putting in capital repayment structures that just completely eliminate their cash flow. So their hands are tied because that's not fair to the operating team as well. I think we've done a good job as far as aligning ourselves in that sense. As far as looking at the different opportunities, yes, we see a bigger playing field. I think is how you put us. We're seeing more opportunities where we can maybe say this doesn't make as much sense. On the flip side of that, they're seeing things more short term. So their opportunities are quarterly. Whereas if we close one acquisition a year, that's like super aggressive. I mean, that's a lot for us. We've gone four years. We didn't buy anything. So that gives a lot of leeway to, yeah, you want to keep saving cash for those future acquisitions. But you're also obviously going to be executing on plans this quarter and next quarter, opening a new location, bringing a new line in and buying inventory with it. I think lastly on this point is we don't buy businesses in general that are extremely cat-ex-heavy. That goes against our whole philosophy of trying to have heavy cash flow production. Therefore, even their growth usually doesn't require mass amounts of cat-ex. Again, restaurants was the different one there. I think the other thing that I was hoping to just talk about because I haven't seen it get a whole lot of airtime. The concept is well known, but just how it gets implemented is the zero cost budding exercise. So I want it just to like, just have you maybe take us through what you hope to see when you, when a CEO is doing that or a CFO is doing that or when you ask them to do that, just take us through that process. What are you trying to achieve? How precise versus broad is the net being cast? I'd just love to just sort of hear the practical application of zero cost budging for businesses that you're helping to own and operate. Yeah. I would start with, we definitely are not doing zero cost budging every year. So maybe a famous example of that was like a 3G capital. So 3G capital is very well known for doing zero cost budging. I think every single year, I don't know how they did. But we're not doing that again. And this goes back to our thesis. We're buying things that are functioning. We're not buying turn arounds and our goal is to let them continue functioning with the same management team. Therefore, as long as everything goes according to plan, we should need to go in and do a zero cost budget. So what would trigger one would be something is not going according to plan. We're seeing OPEX first revenue creep up. We're seeing inefficiencies. We're measuring versus other players in industry and saying that we're just inefficient. So we need to look at that. So that's what would trigger us actually even having the conversation of doing it. Then how it's applied is when we buy a company, one of the things that we implement, it's not highly sophisticated, is a unit analysis. So it's simply breaking down the business into the smallest profit centers possible. So we want to get as granular as possible as where our actual profits are coming from. Not just revenues, right? So we're assigning operating expenses to each line of business or sales channel or restaurant or however contract depending on the industry. We're assigning their cost of goods sold, we're assigning their revenue. And then we obviously are going to end up with some unassignable amount which is going to be admin that you'll keep separate. So that is generally our roadmap of where we're going to apply it. So again, starting off with that first trigger of the results are not what we were expecting. Okay. Now let's drill down and see who was the culprit. Where did this come from? Okay. Now let's apply this strategy to that budget because if you at least at our size, I believe, if we tried to do zero cost budgeting for the entire company, we're going to end up with a lot of stuff just getting put in there because that's what was there the year before, which isn't. It's literally the opposite of what you're doing. That's just a typical budget. Shush, if it's just let's just do it last year plus 3%. This is supposed to be let's actually sit down and work through our processes and really understand how are we doing this function? Is it the right way to do it? Could we do it better? And now let's assign expenses to it and rebuild out that team. So one I would use is wait staff in a restaurant. Are you get you stabbing a certain amount of? wait staff in a restaurant. Well, does that make sense based on our traffic numbers currently? Because it made sense 10 years ago. But what about the type of traffic we have now, the amount of tables we have now, how fast are those tables turning? How many plates are we bringing out? Are they ordering appetizers, entree, and dessert? So is it three servings per sit down or just one? Yes, our sales have grown, but a big chunk of that is now third-party delivery apps or take out. So how is that affected the volume in the stores, the size of our restaurant? That's a very specific niche that you can go in and work at. At the end of the day, those salaries are a large percentage of our overall off-back. So it's somewhere you could get a lot of bang for your buck for the effort, but it's narrow enough where you really could sit down and work through those processes. Do the managers know how to do this, Rafa, or do you-- who's helping do this? And-- Yeah, I mean, so we do have a corporate team here. It's very small, and our goal is to always keep it small. But our corporate team is my partner and myself, where we are mainly focused on investment analysis, and then acting as what's called a managing director. So the CEO's report to one of us. We also have in-house COO, CFO, lawyer, and internal auditor. So for this type of project, it could pull in resources from our CFO, our COO, and our internal auditor. Because the internal auditor is not a controller. They're much more on the operations side of things. They're actually going in and auditing the processes in the companies. So that would be an invaluable resource for doing this type of-- Got it. And so they're typically the ones who are then working with the management team of the given business. The management team correct, which would include the CEO or the head of maybe that area of the company, and then obviously their accounting department. So each of our op-codes, we like to say, is fully self-sustaining. I hope we add value, but we are not necessary in that sense. We should add value, but we're not needed to maintain the day to day. So they have their accounting departments. They have their HR departments. They have operations. They've got their CEO. So they would pull from resources, depending on which area of the company we're actually looking at to implement that. Is there anything else you wanted to touch on in terms of just how you're working with the businesses that you've bought that you think is worth covering? And that may have gotten less airtime in some of the prior conversations that you've had? I think when it goes back to what you mentioned about the Warren Buffett way of kind of presenting things. I, most people, if they know me at all, it's because of what I write on Twitter, right? And obviously in Twitter, you're presenting something as best you can. And I try and present a best-case scenario or an idealized scenario of how it should be or what I strive for. 'Cause it's difficult to get into the intricacies of everything on a written Twitter feed. And the reality is, it's not that clean. I'll give you an example. We run a delegated management system. We have a CEO and we say that we 100% empower them and we don't get involved and we don't, yeah, the reality is it's a little messier than that. I mean, yes, I'm not clocking in at the distributor business or at the restaurant business today to go give orders. But I'm obviously very attuned to how that company is doing. And I have thoughts and I try to keep them to myself as best I can because what I've found is as an owner, sometimes our thoughts carry more weight than they should, right? Thoughts carry weight due to our position in the equity stack rather than in our position of the knowledge stack. So I can have this great idea of a new plate. I wanna see it at our restaurants. But I have no idea the headache that just caused to our production team, the kitchen, the production center, the purchasing department. So while I try not to do this, sometimes it's stronger than me. I suffer from mild OCD. So the animal workaholics, you put those things together and it's hard for you to not get my hands into the companies. But I strive for it. And I'm open with the CEOs when it happens. If I make a mistake, I always say be very careful on your debt. And the reality is I also say that our first deal, we totally over leverage. That deal could have gone super bad. So yeah, it's that if you have already bought a company, or you're looking to buy a company, have realistic expectations. These things, there's a reason we're buying them at four to five X. And it's because they're messy. They're not just getting handed to 20 to 25% return. There is, there's constant disasters. That's the reality when you see the back. That's why sometimes it's good just to go in as a customer and be like, well, I came in, I got attended to, I got given my lubricant, my filter, I went to my car. I don't know that it's an absolute shit show in the back. But they all are like that. They're, you're always finding issues in your accounting department and fixing things and cleaning things and buying wrong inventory. It's just, it's always happening. And at the end of the day, as long as you continue improving, they still provide really great returns. And that's just, that is part of the game. But I guess that's what I would add. Is it's not as easy or clean as it looks? Like, oh, this is so simple. No, it's not. It's, it's a lot of work. And, and they're not perfect. They never are, but you strive for it. I mean, it's maybe like a really good time to cover just the return side of what you're hoping for. I talked to you before we pushed record about like, just this idea that any one of us can very easily go and just buy an S and P 500 ETS. And that is a cat weighted dynamic summary of effectively the best run, most significant sort of publicly traded American businesses. You can get it with very, very low extents costs to buy those ETFs. And over the course of time, that set of businesses is returned, I think, you know, what is it? Like, I think 11% or something like that. If you let it tap 10% history. Yeah, 10% historically. And so when you buy a business for four to five times earnings, as you said, they're not just handing out like a free and clean 20% on levered return. When you think about all the work that you guys have to do, what type of return are you guys trying to achieve over the long term? Do you, where do you sort of, in your mind, sort of set the number? What, what justifies all of this hard work? What justifies all of this messy management and zero cost nudging exercises? And yeah, just what, what, what, again, I know you love the investment business. And I know obviously Rafa, that's part of why you're here is because you love this work, right? And it's intellectually very interesting for you. But if you were to just look at it purely as a raw economic animal and say, okay, I can earn 10% without lifting a finger by just putting, parking my savings in the S&P and holding it over the, over the, the long arc of time, how are you trying to, to sort of outperform that? And what, what do you feel is the return threshold that makes it worth undertaking all of this work over such a long period of time? - Right. So if we look at that from two different sides, I mean, and starting with maybe the quick one, which is why do I do this is because as a job, let's say, I mean, I do this also as a career. It's not like I'm independently wealthy and just chose to invest passively and this is an LP, right? I'm actually on the active side. So as you mentioned, I love investing. I've always loved investing. And I think the most important thing about being a good investor is finding, it's knowing yourself. It's finding what works for you. There's guys out there who can day trade stocks and make a ton of money. They do exist. The majority don't. But they do exist. I've sat next to them in New York and seen these guys do it. They're absolute animals doing this. I was horrible at it. I just don't have the disposition to do that. I don't like real estate investing. There's guys out there that are absolutely great at that. Taking on that much debt on those terms to do those types of structures makes no sense to me. It doesn't work for me. This was the niche that played to my strengths as far as being an investor. So that's why I chose this path. Now looking at it, maybe from that LP perspective, what types of returns am I expecting here? And why should I do this instead of just going with a SES and P500? So we're targeting 20% plus compound returns over a very long time. All right, that's what we're looking for. How do we get to that number? He is again, we're buying businesses. Let's just say on average at 5X. And we understand that as we move up in size, this will adjust a bit. The world just caught an average fire. So yes, those are unlevered 20% returns. We do have debt. Therefore, and I mentioned this before, it's well negotiated debt that whole structure that we put together. So it's more 30% equity, 70% debt, but that 70% debt isn't your traditional bank debt, where they are getting their interest payments every single month and capital repayments every single month. Therefore, when you sprinkle in that debt, now our leverage returns are even higher. And I'm still just aiming for, let's say, 20%, 25%. Why do I think we can do that? And what's our edge? And I go back to why did we choose a horizontal hold co? My business partner and I do not attack this or come at this believing we are better operators than the guy that's been running his business for 30 years, from a thousand square foot furniture retailer into a hundred thousand square foot furniture retailer and has gone through multiple economic cycles and done that business. There is nowhere that I think I can operate his business better than he can. Therefore, for me to come in and do a roll up strategy and say, I'm gonna do this better. I know more than you. That to me, there is no edge for us. However, we do believe that through our experience and not just the last 13 years buying SMBs, but previously, 'cause we came from investing backgrounds of analyzing companies and actually looking at which ones will last that 10 years plus and which management teams will last those 10 years plus, we have shown ourselves adept at doing that well. As long as we can do that, well, the returns will take care of themselves, simply based off of the multiples that we're paying and our capital structure. So when I look at that, I go, that to me, it's a low bar to have to clear. I'm not setting myself up with this 10 foot hurdle. I'm extremely patient. We sit here waiting for the right deal. We have no gun to our head that we have to buy anything. Ever, we simply keep accumulating cash at a very good pace. Right now it's in treasuries, which is nice, 'cause making 5% at least. And we wait for that right pitch to come down in our strike zone. You're north of 100 million and total consolidated sales at the holding company level. To grow, let's say you're at 100 million in total and you were to grow 20, you know, you'd go from 100 to 120 and then you'd go from 120 to grow 20% again, now you're at 144, right? And then you're at I think 165. I mean, to hold the compound, to compound at 20% over the long term is, that's a high hurdle. You, the math works the way that you've laid it out. But as the numbers get bigger, the businesses will presumably become bigger that you both own as well as the businesses that you wanna keep buying. You've mentioned online that you have basically bought a bigger business every single time that you've bought the next one. How do you think things will change? Like what are you trying to anticipate between 100 million and 500 million? What changes are you anticipating? What do you think will stay the same? What are you hoping to avoid that you seem go wrong as others have kind of started to reach these initial levels of scale? Generally when you're looking at that type of growth of 100 to 500 million, the first thing that comes to somebody's mind is the operational complexity of that change. If I'm selling $100 million of pizzas today and now I want to sell $500 million worth of pizzas, that is gonna include multiple new countries, multiple new distribution centers, there's a lot going on there. One of the benefits of the whole cost structure is, I can get there simply by doing a few more acquisitions, let's say over the next 10 years, right? Because right now we're doing about 10 million in EBITDA a year, okay? So that's our number right now. So if you look at that and you go, well, imagine you're a student acquisition every three years and you're picking up pretty decent size companies and that's how that compounding starts to take place. So since we run that delegated management system, a lot will come down to, do we do the right investments? I mean, if we buy a lemon or a horrible management team, I mean, that's gonna set us back on that pace. That is truly where I see that risk much more than in the sense of, well, how are you gonna scale up to that size? I don't see a ton of things changing on the operational side for us to do that scale. Yes, we will have to keep adding people at the corporate level, but I think that that will be a much slower pace than the overall growth of our companies is. That's how it's played out up till now. I would say where we would look to add people is to continue building out the relationship between COO operations and the CFO here and those hold codes. The more we can get that off of our plate, I would probably be that next step, right? We're still managing directors. We're still doing daily or weekly calls, meeting zooms with CEOs of our companies. That will eventually become unsustainable. And you will be able to hire people who are actually better at it than we are. Again, we never came here saying we were great operators, but I would hope that my partner, Lucas and I are able to continue reviewing every single deal that we invest in, which is how we've done it up till now. We review every single SIM and it's what we like to do. That's where the joy comes. I think if you ask me, what's the one thing you could see yourself push like stopping doing this? It's if the operational headaches start to come too much to me. I'm going to at some point just say, this isn't worth making the extra points. I'm just going to go by the S&P 500. But if it's just getting to sit here and analyze companies and negotiate investments and look at new businesses and speak to owners and speak to brokers, I love that. It's a lot of fun. Some people don't. They hate the search. I absolutely love it. I've been doing search for 13 straight years. It's just, I don't know. We talked about this earlier. I'm a business nerd. I could look at new businesses all day long. It's just super entertaining to me and trying to figure out their economics and what makes them different and what's the same as other ones I've seen and what sets them apart. I just find it really like you said. It's intellectually stimulating to me. So I enjoyed doing it. - You mentioned before we got on, we were just talking about your last deal and how it wasn't a broker deal. And that was why it took so long to actually get it across the finish line. And you sort of concluded that little vignette by saying brokers deserve way more respect than they get. Can you just talk about how you've built, how you work with brokers, your point of view on brokers, why you take issue with this sort of cliched kind of like negativity that brokers are on the receiving end of. Like just share your point of view on how you've approached those relationships and how you see their value in the system. - Yeah. I mean, we've done six, what I call major transactions. We've done other bolt-ons since we started. We've done six major transactions. Of those three of them were broker sourced and three were not. None of them were cold. So none of them was a knock on the door and we were able to do it. They simply came inbound from somebody else who wasn't a broker. I believe there's two aspects of that, that broker relationship that's so important. The first is on a selfish side as a surcher, as a buyer, you need practice. You're like a basketball player. You need to be taken 1,000 free throw shots a day to get better. It's the same if you want to be buying businesses. You need to be looking at opportunities every day, all day long and reading about them 'cause that's getting the reps in. That's what's gonna help you be attuned to when you see the right one. You're gonna know it's the right one. To try and do that via cold outreach to me just seems insane. I mean, the brokers have the deal flow. Therefore, take advantage of it and just be selfish. Even if you never wanna buy one off a broker, you can still look at all their deal flow and actually just get those reps in. So that's just from a selfish side as a buyer. That's one. The other end as far as brokers not getting enough respect, I think a lot of buyers only look at the service the broker gives once they've been introduced to the transaction. So a broker brings them a deal. They think it's interesting. They sign an LLI. They're doing their due diligence and during that process, they're not seeing the broker do all that much. Or maybe some of the information they were giving initially doesn't match up with what they found in the due diligence. Therefore, those are the two general complaints I hear. What I think is undervalued is all the work that happened before that deal ever came to your inbox. And we went through it with RM Cotton. I mean, we met them via happenstance and they had just entered into that mentality of I'm looking to sell this business and there was a lot of handholding. What's their tax implication gonna be? What's the legal structure gonna look like? Emotionally getting around wanting to sell. Most people who are selling a business built that business. This is not just a financial decision. The financial component of that decision comes at the very end once they've emotionally gotten ready to sell. And the people that hand hold them through that whole emotional process are the brokers. So we don't see all the work that happened and all the deals they did that for that never even made it to come to your inbox because the person got cold feet or decided not to sell, decided to continue with their business. Therefore, the value add there is just, it's huge. It's huge. I mean, again, I think if we had another deal come to us the way this last one did, we would either get them a broker, literally say like, hey, this guy will come and be your broker for a reduced rate because the deal's already on the table, but just he has knowledge or at least get them a banker. Somebody with deal experience to walk them through these steps because when you first come to the table with a seller, there is no trust there. You're looking, you're negotiating. The trust has to be built over time and they need that seller need somebody in their corner and that person is the broker. So I'll continue beating that drop. I just believe anyone looking to buy their first business, build a hold code, do a vertical roll up, anything that's eminent focused should be using all the resources as far as brokers are concerned for them. Which is again, that's what attracts us to act still on the beginning because it just brought a ton of big funnel of brokers that actually started sending me deals. So as of today, that's the resource where I get most of my deal flow from coming into my, every day in my inbox, I probably get 10 different deals. Just maybe one last thing here, I just just sort of hear how you think about brokers. That's great context on how you think about it and it definitely differs with what you hear about, at least what I hear. I hear just a lot of frustration and skepticism and negativity and stuff like that. So I think it's good to just hear someone as accomplished as you, who is as active in the category, is you taking a opposing point of view on that. If you were to find a business like the one that you just bought and you wanted to refer a broker to take them through the transaction, what kind of, how would you select the broker that what would make you choose a given broker to refer to them? It's kind of a backhanded way of asking, what do I look for in a broker? What do you look for in a broker? Yeah, so I mean, we've had experience again, dealing with different brokers through deals that have closed and also obviously through deals that have not closed. So we've had a lot of interactions. What I would say is a good broker obviously is knowledgeable. It's just somebody who has done this multiple times and you can tell through the initial conversations that somebody is knowledgeable or not. They're gonna understand tax implications, they're gonna understand different types of deal structures, whether that be an asset purchase, a stock purchase, an F-reorg different ways of buying a company. me, and also there's somebody who looks to find the middle ground. I think that's the number one quality. In my experience, a deal dies at least three times before it closes. It's crazy. I mean, there's three times that you literally are sitting around my partner and we're like, well, onto the next one, this one's not going to close and then, but just it comes back. And it's actually during those moments of the process, especially for us who's going to keep that seller on as management where the trust is built. It's, I look forward to those moments now because it's where I'm going to see their true colors. Tax implication came out of nowhere and they realized they're going to get less money than they thought and now they want to change the price and they're not going to move from that. Okay. Well, that's a moment to actually find middle ground. And if you're going to have a working relationship with this person going forward, you're going to find middle ground for years. So this is a great test of, is this somebody who's reasonable or they just stuck on their point of view and they will not bend, it will show you their true character. Well, a good broker, a great broker helps find that middle ground. They're not just out for the seller. They're not just out for the buyer. At the end, they should be out for the deal. They want this deal to get to the finish line. Therefore, pay. You're going to have to give a bit. They're working, they're kind of working the back rooms, feeling out the different sides and they'll help guide you to where that middle ground is. And that's something very intangible. You just have to live it with them to know. You've been doing this for 13, 14 years. You seem to love it. You seem to have an insatiable appetite for reading sims and studying business, which is effectively like the private company equivalent to a 10-cap. Morningstar, right? Exactly. It's Morningstar. What do you do to maintain the motivation? What do you think has gone into just your durability in terms of doing this work over 13 years? What do you attribute to some of the consistency to or the sustained motivation in it? Do you go through ebbs and flows in terms of motivation and energy? And if so, just what do you find is the way that you kind of renew yourself and stay high energy? I'm sure there's ups and downs. What do you find works well for you to maintain a pretty high level of energy and consistency over all these years? I would start with, I really believe this is what I was born to do. As a kid, I loved baseball cards and the Beckett price guide. That to me was my first stock market. Then I loved seeing the little arrows up and down on my cards each month. Then I loved the stock market. Now I love tracking my businesses and their KPIs and their results and learning about new ones and how that could grow. In the sense of, I go back to that nine-year-old kid who could sit in his room for hours on end just comparing his cards to the Beckett. That's me today. In that sense, it truly is what I love doing. That helps a lot. I wrote to somebody about that today. They were saying, "Boy, I posted some tweet about not taking on too much debt." Yeah, it sounds like a really reasonable way to build a whole cup of boy. It's going to take forever. I was going, "Well, yeah, if you don't love the process, then there's a lot of other ways to make money. I wouldn't recommend doing this if you really don't love it. I would also add to that my partner. Having a business partner has been one of the greatest gifts of this entire process. That just came about by luck at the end of the day. There was no hold co. We literally met on a different investment and then we bought that first company together and over those initial months kind of put together this idea to do a hold co. But having a business partner, we have lunch every week. He's the Godfather to one of my kids. We spend weekends together. We have a good, very close relationship and that helps because, yeah, man, there's frustrations. Of course there is. There's times where you are just, "This is really hard." It's really nice to talk to somebody and they can empathize with it and they know what you're going through and they have that long-term vision that you have and they can remind you of why you're doing it and it helps get you through those hard times. I would say the ebb and flow of this business is much more rather than motivation or energy related, it's workflow-related. When you're in the closing 30 days of a deal and you're dealing with investors also and you're dealing with your current operations and maybe it's happening right around tax time and it's just like, "You're just saying like, this is too much." Then all of a sudden the deal closes, the taxes got presented, the investors are happy and then you're sitting there like, "Well, I got nothing to do today. I'm just going to read some more sims." That's the ebb of it. But again, over time, I would say, I mean, I started this, I was 31, my partner was 28 when we began. So just maturity and amount of time doing it and getting used to it. Now I kind of cherish those low-ebb ones. I'll spend a little extra hour at the house with the kids, come home early, I'll go play some tennis. It's like, "Okay, because I know it's not going to last forever." I know the next crushing moment is coming. Therefore, I might as well take advantage of this right now and enjoy it. This has been great. I've learned a bunch. I really enjoyed being able to go deep on some of the businesses instead of just sort of staying up at the higher levels. Thanks for being so forthcoming on how you buy and what you do after you buy and how you think about your work. It's been a lot of fun. I've learned a lot and I think it's a great recording. This has been great, Peter. Thank you so much. If you enjoyed this episode, check out Axeal.com. There you'll find every episode of this podcast as well as our recorded Axeal member roundtables. Some downloadable tools for deal makers. Axeal's quarterly league table rankings of top small business acquires and investment banks and lots of other useful content that we've created over the course of time. If you're interested in joining Axeal as either an acquirer, an owner, considering an exit or as a cell site M&A advisor, you can get started for free at Axeal.com as well. Lastly, if you have ideas for podcast show guests, feel free to reach out to me directly at [email protected]. I promise I will respond. Thanks for listening.