My guest on this episode is Alex Mears. Alex started his career in investment banking and consulting before leaving for the Navy and eventually returning to private equity at the Carlyle Group. Two years ago, Alex launched a non-profit called Search and Acquire to support veterans pursuing search. And he just recently announced a search investment firm he’s co-founded called the Brydon Group to invest in searchers from all backgrounds.
I’ve really enjoyed getting to know Alex over the last few years. I always appreciate his ability to take concepts from the military and large-cap private equity and apply them to our own lives and careers. He’s a wealth of knowledge, and I’ve been excited to record an episode with him for a while. Alex and I kick things off by talking about the causes of failure in search, why you should always invert due diligence, best practices from large-cap private equity, and how to run software and government services businesses.
Live Oak Bank — Live Oak Bank is a seasoned SMB lender providing SBA and conventional financing for search funds, independent sponsors, private equity firms, and individuals looking to acquire lower middle-market companies. Live Oak has closed billions of dollars in SBA financing and is actively looking to help more small company investors across the country. If you are in the process of acquiring a company or thinking about starting a search, contact Lisa Forrest or Heather Endresen directly to start a conversation or go to www.liveoakbank.com/think.
Hood & Strong, LLP — Hood & Strong is a CPA firm with a long history of working with search funds and private equity firms on diligence, assurance, tax services, and more. Hood & Strong is highly skilled in working with search funds, providing quality of earnings and due diligence services during the search, along with assurance and tax services post-acquisition. They offer a unique way to approach acquisition diligence and manage costs effectively. To learn more about how Hood & Strong can help your search, acquisition, and beyond, please email one of their partners Jerry Zhou at [email protected].
Oberle Risk Strategies– Oberle is the leading specialty insurance brokerage catering to search funds and the broader ETA community, providing complimentary due diligence assessments of the target company’s commercial insurance and employee benefits programs. Over the past decade, August Felker and his team have engaged with hundreds of searchers to provide due diligence and ultimately place the most competitive insurance program at closing. Given August’s experience as a searcher himself, he and his team understand all that goes into buying a business and pride themselves on making the insurance portion of closing seamless and hassle-free.
(4:32) – What are some major causes of failure in Search?
(10:17) – What are some interesting strategies you’ve seen used to maintain a healthy pipeline while in a live deal?
(11:52) – Phase 2 failures & the period of greatest risk in a search transaction
(15:56) – Alex’s background and career
(18:11) – Why did you join the military?
(20:12) – What were some of your learnings and best practices from working in Large Cap Private Equity?
(24:56) – Why are you investing in government services businesses?
(27:13) – How do you pair government services with your search model that emphasizes customer diversification?
(30:09) – What are some KPIs in government that Government Services Business CEOs need to pay attention to?
(31:58) – How do you find out if there are tailwinds and what the government will be spending more money on?
(32:56) – What is inverting in due diligence?
(34:50) – What are some of the best and worst traits in veterans as business leaders?
(36:19) – Are there certain business models veterans outperform in?
(37:23) – How can Brydon be a better supporter of Searchers?
(41:29) – What has been the investor appetite for Search over the past 5 years?
(43:15) – What were the values you spent a lot of time working on?
(45:03) – Brydon’s Entrepreneur & Residence Program
(53:23) – What college class would you teach if it could be about anything?
(55:22) – What’s a strongly held belief you’ve changed your mind on?
(56:55) – What’s the best business you’ve ever seen?
Alex Bridgeman: We were just talking about the causes of failure in search that you’ve done a lot of research and thinking on. I kind of want to start there versus going straight into the background because that sounds really interesting.
Alex Mears: Yeah, absolutely. So, when Steve and I really started getting involved in search several years ago, one of the first things that I started digging into, and again, just given the private equity background and the focus there, was really unpacking what causes failure in search. And I use that term loosely. I do not use that term pejoratively. I mean that just in the sense of if a searcher raises a fund, do they close on a transaction? So, we’ll call that kind of phase one failure. Or in phase two failure, if they do acquire a deal and it does not return capital or one times capital. And again, I do not mean that in any way pejoratively, but just to categorize it. So, we basically did a ton of research on using both case studies, we ended up talking to close to 200 searchers, both successful and unsuccessful, trying to unpack what were some of the common themes and features of searches that don’t work to better improve the model, to better improve the support that we provide to searchers. So, to start with the first bucket, if you want to call it the phase one failure and in the case where a searcher raises a pool of capital and doesn’t find a deal, these aren’t particularly surprising, but what was interesting was how consistent they were in coming up in the conversations with searchers. So, the first and most common theme that came up over and over again in that kind of phase one failure was the initial ramp up was too slow. And so, we heard this over and over again where a searcher or a partner in search, they launched their fund and they really didn’t feel like they kind of hit their stride from a sourcing perspective, from a diligence perspective until they were anywhere from 6 to 12 months into the search. And if you think about search, whether traditional or self-funded, you’re on a clock. And so, any kind of wasted time or any time where you’re not operating at full efficiency is just going to lead to suboptimal outcomes. You’re going to see fewer deals, you’re going to get fewer reps and you’re less likely to find the one deal that you end up closing on. And so, what we saw in that was in many cases, they would be the CRM system took too long, the data sources they were using, how they worked with interns, how they worked with Upwork, all those things. From day one, it just took too many weeks and months to really get that system up and running. And so we can talk about it later, but that was one of the key lessons that we wanted to apply with what we’re doing at the Byrdon Group and with the entrepreneur and residence program is to minimize that amount of time as much as possible so that searchers are really getting 24 months of active searching as opposed to 7 months of ramp up and then 15 months of real searching and then 2 months of kind of scrambling at the end. So that was by far the biggest. The next one was spending too much time on deals that fall through. And again, this is one of those that is much easier said than done. And there’s always such a- when you have a live deal in front of you, it’s just so easy to drop everything and focus on it. And really, as we talked to searchers, there were kind of two subcomponents of that. The first was there were deals where their investor base was I would say lukewarm going in, but they didn’t get a no. And so, they ended up spending a ton of time. Diligence, in many cases, wasn’t either net positive or net negative from the beginning, but then they came back to investors and investors were basically like, no, we don’t think this is a good fit for us or for you. And so, making sure that a searcher is more aligned upfront with their investor base on opportunities is incredibly important. The second one, the second feature of that that we saw a lot of was, and again, this is coming from a private equity background, when you are on a live deal, it is so time-consuming, but basically searchers would end up focusing a hundred percent on the live deal in front of them and they would stop building pipeline. And that is you hear this over and over again. Again, it’s so much easier said than done. But what that means is roughly one third of LOIs, deals that are under letter of intent, actually convert to closed transactions. So in two thirds of the cases, it’s going to fall through, and searchers who don’t have that kind of sourcing engine down and that pipeline is still humming even while they’re focused on doing diligence on a live deal, it just means that you end up starting back from point 0. And that’s just really, really hard, again, with a two year timeframe. If you lose that deal to get that engine back humming again just takes time. And so, that’s another thing that we’ve tried to focus on heavily in the searchers that we work with is making sure you’ve really systematized the early, especially the early outreach, the proprietary outreach, and even the brokered outreach to make sure that even when you’re working on due diligence on a deal, there is a pipeline of new opportunities that are coming up. I mean, candidly, on this one, this is something that I see all the time in private equity too. There’s also just a psychological benefit of having new deals appear in your inbox or at least the prospect of new deals because there’s such a tendency – and this is true in private equity, this is true in search – there’s such a tendency to fall in love with a deal. If it’s in front of you, it’s just so easy to focus a hundred percent on that. And we just found that even like having new opportunities in that pipeline, it helps searchers as it helps us as investors just be probably a little bit more realistic about how much hair there is on that deal or how many warts there are on that deal. And I think that just leads to better outcomes.
Alex Bridgeman: One question on the sourcing piece. So, I’ve heard a number of searchers who use interns or some are even using virtual assistants or services like Athena or something like that to keep a pipeline going. And what are some interesting strategies you’ve seen searchers combat that getting sucked into one deal and letting their pipeline dry up a little bit? Do you have- have you seen folks who try to maintain some sort of team or separation between the actual grunt work of reaching out to people and building that pipeline, or what are some ways you’ve seen folks combat that?
Alex Mears: Yeah, it’s a great question. A few. So, one on partnered search, I think it’s one of the values of partnered search. Generally, what we’ve seen is one partner will focus a hundred percent on that live opportunity. And then the second partner may spend 30% of their time still focused on new sourcing efforts. And so that’s one way that works well. For solo searchers, it’s just what you said. So, we’ve seen searchers who- and whether they use interns or a combination of kind of interns and outsourced work, making sure there’s someone else who is focused on that as their primary area that they’re really focused on and spending their time and effort is just really, really valuable because it’s so easy to say mentally, hey, I’m going to allocate 20% of my time to new deal sourcing even when I have a deal under LOI. The reality is just much, much more difficult. And so actually having someone else who is responsible for that new deal sourcing, again, whether it’s a partner or an intern or a group of interns or something like that, we found to be incredibly valuable.
Alex Bridgeman: Yeah, absolutely. And then you were going to mention phase two errors. So once the searcher has acquired a business that doesn’t reach that 1X return threshold, what are some failures there that you’ve seen?
Alex Mears: Yeah. And again, with this sort of phase two failure, and this gets a lot to private equity, because this is really- just these are essentially micro private equity transactions. So, kind of two areas I would say. The first being issues that are identifiable in diligence. And then the second are just issues that there’s just no way you could’ve known beforehand and just happened. So, when you actually look at the data, the number one issue that we consider highly diligence involved that leads to failure is customer concentration. So, I know we’ve had lots of conversations about this in the past. I don’t mean to get on a high horse on customer concentration. But until you have run a business that has one customer who accounts for 25% of your revenue, it is hard to describe the amount of pain that causes to you as a CEO and an owner. And it just gets even worse in a private equity or in a search or private equity transaction where you’re acquiring a business because inevitably the seller always knows more about their business. They always know more about that largest customer, and they always know most about that customer relationship. And so we’ve seen that customer concentration bite searchers pretty badly or in research, both in terms of immediately after the transition where literally the largest customer just walks away, and that happens at a much higher percentage of the time than you would imagine, even when a searcher tried to do due diligence on that customer relationship and may have even spoken to the customer. But then the secondary is just over a 4 or 5, 6 year hold period, having one customer who disproportionately impacts your business, it just gives that one customer so much more control. You control your fate much less than in a business with a lot of diversified customers. And so, inevitably, you end up spending your R&D dollars on that one customer’s needs, your support dollars. The amount of time and mental energy is focused on not losing that customer instead of really focused on the overall business and growing the overall business. We see that customer concentration issue be fatal, candidly, for both those reasons. Really the period of greatest risk in a search transaction is call it the 6 months post close, when you have the existing owner, who is almost always the CEO, transitioning out and a new searcher stepping in as the CEO. And it’s risky for all the obvious reasons. I mean, it’s a period where there are always skeletons in the closet that you learn about no matter how good your diligence is. So there’s always just kind of those skeletons you’re dealing with. There’s also just a question of how does the organization accept a new CEO. And so, that is one area that we see lots of transition issue or not- in the data, that first six months really can determine and set the course for how the investment turns out. And so, pieces of that, it’s something that Steve and I harp on quite a bit. And I think people are sometimes surprised given that we’re kind of- I have that kind of harder finance background, is just seller integrity, is really understanding deeply how has that seller treated employees? How have they treated former partners? How do they treat customers? And generally, if a seller has in the past treated those constituents poorly, it’s unlikely to be different in a transaction. In fact, it’s even more extreme in a transaction when they’re selling a business. And so, really getting a grasp around that and a true assessment of management integrity is incredibly important because I think that just buying a business from someone who is upfront, candid, you can believe their word just de-risks a lot of those skeletons generally in the closet that always pop up. It’s just a question of how extreme they are.
Alex Bridgeman: Yeah, certainly. I want to walk through your background, but I want to walk through it in almost like different phases because there’s one topic we’ve talked about a lot just together is different best practices from large cap private equity that you feel are applicable to search or you’ve seen applicable through your 70 plus deals investing in search. So, I’d love to hear your background story. And then at each stage, or at each part of your career, what are some learnings or best practices that you think are going to apply pretty cleanly to the work you’re going to start doing at Brydon now?
Alex Mears: Yeah, absolutely. So, I’ll give you the quick background. I started in finance 20 years ago, did banking at Goldman, corporate finance at McKinsey, and then was at Blackstone in their large buyout fund. This was all pre-crisis. And then basically had an offer to go to business school and go back to Blackstone. Really, really loved the firm, but this was back in kind of 2007 timeframe. And I’d always been very interested in the military and foreign service. And if you recall, this was kind of the height of the Iraq surge and things were going on in Afghanistan. And I decided instead of business school to go join the military and foreign service. So, I ended up spending five years as an intel officer with Naval Special Warfare. So, I spent a lot of quality time in Iraq, Afghanistan, Indonesia, all those places, and then decided to come back after 5 years to private equity. And I’d always been very interested in government services, software, business services, and ended up at Carlyle doing that until just recently and absolutely loved it. We can talk about specific lessons I’ve learned through throughout the career I think that are directly applicable to search, but that gives you a little bit of the background in terms of the career.
Alex Bridgeman: Certainly. I haven’t heard of someone who went through a finance career and then went to military and then back to finance. It’s usually like military then finance and then the rest of their career. So that’s an odd twist that I haven’t seen someone do before. So that’s pretty interesting.
Alex Mears: I had a very funny conversation with Steve Schwarzman; he called me into his office when I told him that I was turning down the offer to go join the military. I think I was the first time he had run into that issue.
Alex Bridgeman: Was there some goal that you had going into the military where you wanted to learn like these three things or prepare yourself for a career and these were the skills or this was the experience that you wanted to get to that next step?
Alex Mears: Yeah. I mean, I think for me, the decision to join the military and foreign service, it was less about these are the hard skills that I want to acquire by doing this. It was I’d always been very interested in service. Way back when, back in 1999, I worked on Capitol Hill and got very interested in the rise of Al-Qaeda, and it was clear they were paying a great deal of attention to us. And no one in the US was paying attention to them. And at the time, I mean, the US government had only a handful of Arabic speakers. So, I actually ended up taking a year off from undergrad and went and studied Arabic in the Middle East and actually got back September 11th, 2000, so exactly one year before 9/11. So, I’d always been very interested in that part of the world and that problem set. And so, I think that probably drove the decision more than the desire for any kind of tangible skillsets. Now, that said, it is not a cliche to say that the leadership training that you learn in the military is I think second to none, being able to lead a platoon and getting to work with people from wildly different backgrounds in a way that, candidly, you don’t in private equity or banking or consulting was invaluable to me, absolutely invaluable to me. And our third partner at the Brydon Group, George Dutile, who just left JP Morgan to launch Brydon with us, he and I actually met in the military and served in Afghanistan together. So, there’s kind of no better way to understand someone’s character and see how they act and react under stress and everything else then serving in combat. So absolutely incredibly grateful for the time I spent in the military. And it’s part of the reason why we try to support veterans pursuing entrepreneurship through acquisition in all its various forms, self-funded, traditional, and otherwise.
Alex Bridgeman: Yeah. So, walk us through your notes of learnings, best practices from your career post-military at Carlyle. So, what’s the, when you combine the leadership experience you had from the military with your finance background and you combine them now at Carlyle, and you worked there for many years, what are some lessons that you took away from that experience?
Alex Mears: I think from spending as much time in large cap private equity, and we always laugh, like the years in large cap private equity, they’re kind of like dog years because you’re truly working 80-hour weeks much of that time. And so, you get to squeeze a lot more content into shorter periods of time. The first is just really understanding how to quickly come to a view of a business, business quality and valuation. And that’s something that just takes hundreds and hundreds of reps. We always say- I had a mentor who always used to say doing deals is easy but doing good deals is incredibly hard. And if someone finds due diligence and valuation easy, they’re doing it wrong. This is a skill set that is incredibly difficult to do well. And candidly, if you’re really good at it, the market will pay you multiple seven figures a couple years out of business school, if you’re good at it. So, it’s one of those things where it was just tremendous learning of getting to see literally hundreds and hundreds of deals and businesses and meeting with management teams and seeing what ticks. And then really over time to seeing, okay, that was what we saw in the SIM or the SIP[RD1] , the information memorandum upfront. What actually happened in the business over time? This is what we thought the value drivers of the business were up front. What did that actually look like under our ownership? Or if we passed on a deal, what subsequently happened? So, I think that, just getting those reps. And we try to apply that with our searchers. And search is such a funny thing because you get to wear so many different hats for a short period of time. We always try to be very, very helpful on, especially on that like quality of the business and valuation. What are the key issues? What are the key analyses I need to do? What’s a nice to have? What’s a need to have? And then how does that inform valuation? And so, we, because that private equity background in very practical terms in search, I am perfectly comfortable supporting a searcher stretching a little bit more on valuation for a higher quality business, just because I feel like we have had the reps and digging into a business, we can see when that makes sense and when not, as opposed to we have a bright line on- there’s some multiple you’re not allowed to pay more for. I think that’s- which happens. But I think that has been probably the single most valuable thing that we’ve been able to carry across to our work with the searchers that we work with.
Alex Bridgeman: Can you walk through a few examples or stories that illustrate some of those lessons?
Alex Mears: Stories on valuation are always pretty boring. I think let’s take a very simple example. So, software businesses. So, software businesses, 20 years ago in private equity, they were- the sort of innate value of software businesses were just under-recognized by most, I should say. Over time, what you’ve seen is not only have the values of those businesses gone up, but you also have very specialized private equity firms like Vista and Thoma Bravo and others that have arisen that do nothing but software and really focus on those businesses, both in the acquisition phase and then kind of their operating playbooks. So that’s one of those areas where we see that in search where searchers do software deals, I think about 40% of deals we’ve done are in software, but search in some ways is kind of where private equity was 20 years ago. Like people kind of like I like software, but there’s not a ton of expertise around how to optimize the businesses, how to value the businesses. And in our experience, a software business is the most quantifiable business in the world. We can sit down with a searcher or with a business and these are the eight key analyses you need to do. These are the key metrics. And based on that, yeah, you should stretch and pay more for that business, or no, this is a key risk. So, on the diligence side, there’s a ton that we apply directly for a software business like that. And then in the post-acquisition phase, there are just- It’s a solved problem I would say. In large cap private equity, like how do you optimize these businesses? And so, scaling that down and applying that to a searcher in terms of, hey, how do you optimize the salesforce? How do you optimize sales and marketing spend? How do you optimize your product roadmap and R&D spend? What are the key metrics to track? Being able to apply those and kind of simplify them for search businesses we found is just tremendously valuable. Because there’s so much value that you can create in those businesses, but you need to know the playbook and you need to know I’ve seen it a hundred times to kind of avoid a lot of the common pitfalls.
Alex Bridgeman: You’ve also spent a lot of time investing in government services which is an area I have not seen many searchers cover or talk about. So, I’d love to hear a little bit about what about government services is attractive to you, and what are some key types of businesses within that group that you find really interesting?
Alex Mears: So, government services, I would say, very broadly you can think of as say three buckets. One is selling directly to the federal government through contracts. The second would be selling to state and local governments, and that would include police forces, public safety, things like that. And then the third is just more B2B services, but they’re geared towards government contractors in that ecosystem. I’ve spent a fair amount of time in that space. I think it can be interesting for searchers. One of the key issues is the way the federal government procures, and not to go down a whole rabbit hole, but basically the federal government sets aside very significant sums, and it varies by agency, think anywhere from 5 to 20% of that agency’s spending, to be spent on small business. And there are all sorts of restrictions, legal restrictions around ownership percentages and things like that with those small businesses that can make it very difficult for a searcher to acquire one of those businesses. So, I would say it is something that we absolutely support, but it’s also one where you have to know very quickly, hey, these are the three red flags to look out for. If any of those three red flags are hit, move on. Like you just can’t- there’s nothing you can do to solve that problem. And so, I think that may be why historically government services has been an area where searchers spend less time. But absolutely, there’s some really, really nice businesses. Some have 5-year contracts, 8-year contracts. So, as you think about recurring revenue and being able to project a model and valuation, they can be wonderful businesses. It’s just a question of really making sure you have the expertise around contract vehicles. And there are more acronyms in government contracting, I think, then any other sector of the economy. So that’s what we’d say. Absolutely, we would encourage searchers and we have worked with searchers looking at that space, but there are some of these key landmines or red flags that you have to watch out for.
Alex Bridgeman: Yeah. Talking about the ultimate customer concentration with maybe even just one federal government customer, how do you kind of pair that with the search model which emphasizes customer diversification and the almost redundancy within your customer base? It has the recurring revenue, but that customer concentration, I imagine, would scare a lot of people. So how do you kind of fit the two together?
Alex Mears: Yeah, it’s a great question. So, I think one of the most important things with government services is, if we’re talking about kind of federal contracts, customer concentration matters less. Contract concentration is what should scare you as a prospective buyer. The nature of government contracting is – and this obviously varies, I’m speaking in generalities – but as a general rule, a company that has nine different contracts with different, with a large agency, Department of Defense, for example, or Department of the Army. If those are different contracting officers, they’re different periods of performance, they’re even different sort of ultimate end users within that customer, that’s fine. To me, that’s not customer concentration. As long as they’re well-diversified across those, that’s totally fine, if they are disproportionately serving Department of Army. It is the hey, we have one contract and it’s 30% of revenue and it’s up for recompete next year, that’s where it gets scary. And that’s where you have to be very, very careful because, guess what, all the same issues we talked about with customer concentration when it comes to a commercial business apply just as equally when it comes to a federal business where the seller knows a lot more, has a lot more information about the performance on the contract, the odds of winning that recompete, and things like that. So, it’s a great question, but for government services in particular, it’s really that contract concentration as opposed to customer concentration.
Alex Bridgeman: Does that make them also hard to grow if there’s one primary customer for your service and you just have to rely on your ability to win new contracts? I would imagine like that stable 5-, 8-year contract kind of works both ways. Like it keeps you stable, but I imagine it could make it more difficult to grow.
Alex Mears: Yeah, absolutely. And so, I would split that into two features. One would be what are the business development capabilities, i.e., the kind of sales and marketing capabilities of the company you’re looking at. And two, how much are the existing contracts and what they’re doing, how differentiated are those services and how likely are they to take those capabilities and kind of, I’m making it up, but if they’re providing some high-end it service for the Department of the Army, what does that look like? Can they go take that to the Navy? And can they take that to the Air Force? Can they take the broader Department of Defense? So I think, in our experience, that just gets to like, that’s just basic commercial diligence. It’s understanding how differentiated are their capabilities, how good are those customer relationships? How good is that sales and marketing engine? Such that they can take what they have in sort of existing backlog and actually grow it. Because you’re right, it often can be difficult if you don’t have those features.
Alex Bridgeman: And so, for a CEO of a government services business, what are some of the KPIs in government that they’re going to be looking for to just get a sense for on a macro scale how well is their business or the industry likely going to do? Is it like new bills being passed or orders for certain equipment, like more tanks, vehicles, aircraft? What are some of the KPIs that a government services CEO needs to pay attention to that are happening on the government level?
Alex Mears: Yeah, absolutely. So, I mean, some of the KPIs, they’re very similar to commercial businesses, so understanding backlog, understanding pipeline. What’s interesting about government services is because, in a sense, think of them as just there are a whole series of miniature discounted cash flows. If a government contractor has 20 contracts, literally the way we model that is you would model line by line the duration of that contract, and then, you assume some probability of a win on a recompete if it’s going to be recompeted and then you look at their pipeline and you apply some it’s called a P win, a probability of winning those new contracts. And so, it literally is a waterfall. Like you can like add up all those numbers and that’s what the revenue in the model will look like. So, those are some of the common metrics. I think in terms of your broader question on kind of macro trends and government spending levels, look, I mean, I think you have to be very careful that you are backing trends that are kind of where there are clear secondary tailwinds. Anything around cybersecurity, around cloud deployments, things like that, there’s just going to be a lot of tailwinds. Whereas if you’re backing kind of old legacy hardware systems, the orders are lumpier, they can get whacked year to year based on budgets and various partisan priorities, things like that. And so, the answer is to just avoid those and focus on the ones where there are clear secondary tailwinds.
Alex Bridgeman: How do you find out if there’s tailwinds? Is there datasets or just people you know or talk to you to find out what the government is likely to be spending more money on versus less?
Alex Mears: Yeah. The answer is all of the above. A lot of it is subjective diligence you’re talking, in the same way that it’s identical to commercial diligence in many cases. You’re trying to talk to customers, you’re talking to experts who are familiar with the industry, really digging into what are the actual capabilities that the company has. The face of a contract can say one thing, but just like in a general commercial services business, no kidding, what is the service that is performed? How difficult is it to do? How sticky is it? How mission critical? All those factors that you do, that we do all day long when we’re diligencing a non-government services business apply here as well. So, there’s no kind of one source. I mean, there’s great data on government spending, but in terms of kind of tailwinds and where things are going, there’s a lot more art and subjectivity to that.
Alex Bridgeman: Yeah. One other topic we’ve discussed is this concept of always inverting in due diligence. Can you walk through kind of what you mean by that and just walk through that concept?
Alex Mears: Yeah. I think it goes back a little bit to the start of our conversation, which is when we’re trying to optimize outcomes for searchers, I care a lot more about making sure they don’t fail then I do looking for a 100X return. And as we look at our entrepreneur and residents cohorts, if we’re taking five EIRs a year, I am much, much happier that each of them make $10 million from their deal then we have one that makes 200 million and a couple that turn into zeros in terms of the equity payout. I think that for me, that’s just how I think, it’s much more of a kind of a private equity mindset than it is a venture capital mindset. And there’s no right or wrong. It’s just kind of what- and even within search, and that’s what’s great about search, is that there are searchers- search investors who are much more, hey, we’re looking for that next big 20X deal, and we want to make sure that this thing can explode in a positive way. And that’s great. And so just making sure that a searcher is aligned with their investors on that. Whereas for me, I tend to always be- years and years ago, playing baseball, we always had a coach and he always used to hammer into us that like a home run is just a line drive that keeps going. And it sounds silly and trite, but I think it’s really true when it comes to businesses as well, which is not trying to swing for the fences and just worrying more about your downside ends up resulting in a lot better outcomes for us as investors and for our searchers who are backing. So, I think that’s just one example of inverting. We do quite a bit throughout the diligence process and everything else, but that’s just one kind of at a high level how we think about it.
Alex Bridgeman: We had Ryan Turk on the podcast here pretty recently. He was a veteran in his search or a veteran prior to his search, and he talked a lot about the different lessons from the military that came over and some that didn’t come over as well. I’d be curious about your experience with investing in dozens of veterans who’ve come out of the military into search. What’s been your experience in terms of what lessons are most applicable from the military versus maybe not as helpful?
Alex Mears: So, stepping back at a very high level, we’ve found generally kind of top tier veterans do make outstanding owners and operators of small businesses. A lot of the leadership features, the leadership training, working with people from very, very different diverse backgrounds, all that is, I think in many cases, a huge strength of veterans stepping in. I think some of the shortcomings are not surprising. Generally, just the level of kind of commercial awareness, the ability to do due diligence, things like that. Now, obviously, veterans certainly can spend time in banking or spend time in private equity or consulting or something like that as well. But just speaking in generalities, that’s an area where we’ve seen kind of additional support can be very, very helpful to veterans just given that they didn’t have that kind of business and commercial background. Whereas someone of the same tenure who did not serve in the military would have spent four years or six years, whatever it is, before business school actually working in business or finance.
Alex Bridgeman: Are there certain business models that you’ve found veterans do really well in, or is it kind of all over the map and there’s not any one sector or group that veterans outperform in?
Alex Mears: Yeah, I think in our experience, it’s been all over the map. We tend to be much more focused, veteran or otherwise, on kind of searcher business fit. And so, the great thing about search and ETA more broadly is no matter what your background is and your interest, there’s probably a business out there for you. So, we’ve backed people from cyber command who go buy software businesses, kind of very high-end software businesses. And we have supported people coming out of the military who want to go do more kind of the traditional dirty job, kind of HVAC services or plumbing services businesses or things like that. And the beauty of the model is that they can do all those, those are all open to them, and I’ll see kind of the importance of leadership and how to motivate people, how to incentivize people, all those are- those kind of transcend specific industries or specific business models.
Alex Bridgeman: Yeah, that makes a lot of sense. We’ve talked a lot about support as well of not just veterans but just searchers generally and trying to build a firm that supports searchers in the greatest possible way. What are some ways that you think Brydon can be a better supporter for searchers? For the searchers you invest in, what are some ways that you think might be interesting to provide an extra level of support?
Alex Mears: Let’s bucket kind of the search, the acquisition, and then the operating phase. And so, in the search phase, I think there’s just a lot of best practices around sourcing where we think we can help add a lot of value in terms of how do you list build? How do you build an industry thesis? How do you reach out to river guides? How do you build the relationships with the small business owners? So, George Dutile, our third partner, is coming from JP Morgan on the private bank and so has kind of the best training in the world of how do you reach out to small business owners and how do you communicate with them? How do you relate to them? Because at the end of the day, it’s a personal relationship really that drives the decision for a small business owner to sell to a searcher. So, I think there’s a lot that can be done on the sourcing front. And we’ve tried to build just basically a better mouse trap when it comes to that. I mean, the other thing is, candidly, the three of us come from that background. So, we will be sourcing in the trenches with our searchers. We have a lot of great relationships with kind of like lower middle market investment banks and brokers, especially around software, B2B services, government services, GovTech, things like that, where we see a fair amount of proprietary deal flow today. And so being able to kind of feed that into our searchers’ pipelines I think is something that hopefully just makes that phase easier and more productive for our searchers. On the acquisition side, I mean, that’s kind of where I really roll up my sleeves and I think there’s a ton that can be done to improve that process for searchers. Just understanding, hey, these are the five pieces of data given this type of business that you need to go request day one. And then, okay, how does that, based on those analyses, how does that inform the valuation, iterating on that quickly and not spending a ton of time either requesting information or doing diligence that kind of doesn’t move the needle but a searcher may feel like they have to do because they’ve seen it in an old deck that was passed down to them or something like that. I think there’s a lot of value in that. Even to the point, I mean, oftentimes, I’ll literally jump in excel and help a searcher. Hey, they’re looking at a software business. Okay, how do you do a cohort analysis, like a meaningful cohort analysis? What are the outputs of that? And most importantly, what does that mean? What does that mean in terms of the quality of the business, in terms of the valuation that you’re willing to offer, and in terms of value creation post acquisition? Because you can often identify a lot of those levers in diligence. So, there’s I think a ton where it is like just taking what we do every day in large cap private equity and kind of distilling it down and providing those tools and frameworks and just support on modeling, on valuation, on due diligence that can really drive a lot of value, make a searcher’s deal process much more efficient and allow them to come to better answers. And then on the operating side, and again, this was Steve’s background, I mean, he is a multi-time founder, CEO, sold three businesses to private equity, et cetera, et cetera. And so really just distilling some of the key operating playbooks down for search. And so, we think there’s just a ton of value that you can create, especially in these recurring revenue businesses, whether software or business services or government services, where the appropriate way, what does that dashboard- what does your KPI dashboard look like from day one? Like this is a solved problem in private equity. Like don’t try to go create that. This is the answer, like use this one. And this is what it means, and this is why you should care about it. And this is how you impact those levers. And these are the pros and cons of this. So there’s just a ton of value also on the operating side. We think that rolling out kind of a slimmed down version of a private equity value creation playbook that we can provide and work hand in hand with our searchers on to drive value.
Alex Bridgeman: One other kind of macro question around search investing that I was curious about is you’ve obviously been a search investor for a long time and know others who are investing in search. What has been the investor appetite for search over the last call it five years? Is it- from what I’ve seen, it’s just only increased, but I would love to hear perhaps a more detailed look at what that interest has looked like over the last few years.
Alex Mears: I think in our experience, the interest has increased in commensurate with how much interest in search more broadly has increased. As you look at the number of searchers that’s growing kind of- actually growning exponentially in the last few years. And I think the level of investor interest has maybe not kept up entirely with that but has grown significantly. And so, you see it in many ways. You have a lot of searchers who exit, have successful exits, and then look to raise small funds to kind of invest back in the community, which is wonderful. And then you have some kind of people who are new, who kind of are intrigued by the model. They read the Stanford study and see the returns that are involved. So, I think the good news is there are, given the growth in search, we’ve really enjoyed getting to know almost all the investors in the space, and everyone has a slightly different approach and a slightly different preference. And how much do they get involved? What other types of industries do they like? And so, we always try to be very candid and upfront with the searchers that we look back. And this is who we are, this is what we like, this is how we try to add value, and these are our values. And if those align then great. And if not, there’s a wonderful ecosystem to really- for searchers to select from in terms of picking their investor base.
Alex Bridgeman: What were the values that you spend a lot- I know you spent a lot of time putting your values together. I would love to hear kind of what was the result of that work and thought process.
Alex Mears: Yeah. So, I mean, a couple things. One is – and this maybe goes back to kind of the time George and I spent with the Seals – that the culture of providing candid feedback and being upfront about challenges while not being a jerk, it’s actually harder to do than it sounds. Typically, what you see in cultures is either the culture encourages colleagues and employees to bury bad news and not surface issues, or it can be a little too kind of cutthroat or sharp elbowed. And to us both those values are very important. I really like to like the people I work with. I care a lot about them as people. I want to go grab dinner and drinks and hang out with their families and stuff like that. That to me, that’s just very, very important. But at the same time, I want to be told if I’m doing something wrong. I want to know my side. I want to know, hey, if there’s a problem with the business, it never gets better with age. Just highlight it. Hey, this is the problem. This is what I’m thinking about for I have these three options to address the problem. Like, what do you think? Like that is a key part of just that kind of culture of feedback, but also kind of transparency and honesty. And so, building that both within Brydon and the way we as partners interact, but then also the way we work with our searchers. Like we want our searches to always know where we stand and, hey, we think we like this, or we don’t like this, and these are the issues, but always in a very respectful and nice, well-intentioned way. And striking that balance is, in my experience, surprisingly difficult in a lot of institutions and cultures.
Alex Bridgeman: One thing you’re doing with Brydon Group that I’m kind of excited about, too, is this entrepreneur in residence program. Can you walk through kind of the structure of that and what your plans are for that program?
Alex Mears: Yeah. So what we wanted to do with the entrepreneur and residence program is at Brydon is really to combine the best of private equity and the best of search for a very small number of entrepreneurs that we back each year. So, you know, those three partners, Steve wrestler, George Newtown, and I know we’ve had many conversations over the years with prospective searchers, especially those with more work experience. So things kind of like a McKinsey engagement manager. Three or four years out of business school who would love to pursue search, but they look at the two existing options. And, and for some of you that just may not make sense, you know, for traditional search, there’s just no way they’re going to take a pay cut and go earn, you know, $110k to $125k a year.
And then even more so on the self-funded side, which can be a wonderful model as well. But for, you know, along with those people in those positions, you know, kind of be better at all on black with a personal currency, you know deal just doesn’t really make sense given where they are in their lives. And so what we, what we want to do was to design a program that gave a, you know, an opportunity for those both more experienced perspective, searchers but then also, you know, we certainly will we’ll consider intake searchers directly out of business school as well, but basically by, by offering.
You know, additional salary. So rather than that 110 to 125 page, we’re offering searchers salaries between 150 and 200 K per year while they’re searching. We as Brydon, basically take 90% of the equity in their search, both at the time, you know, in the upfront search vehicle.
And then at the time of the transaction. And what that does is it allows our searchers to do a much broader range of deal sizes. So because, you know, we’re taking 90%, a searcher and entrepreneur residents that we’re backing could do a deal as small as 5 million in enterprise value all the way up to 50 million.
And they have kind of the benefits of committed capital behind them. To, to do that. And we’re happy to support, you know, that, that whole range. So we just think it drastically increases the likelihood that our entrepreneurs and residents will we’ll find the deal. You know, in very practical terms, you know, we’re going to be offering kind of, you know, 10 days of initial training down at a resort in the Caribbean as a kickoff meeting, five, five entrepreneur in residence.
Per year unit cohort now. And we’ve just seen there’s, there’s tremendous value in, in searchers going through this as a cohort. So we’ll have that, that initial training that we fully fund. And then we, we are, you know, as we’ve seen it, you know, I think we we’ve talked about this a bit before as traditional surfers, they do have to commit to being You know, national in their scope in terms of where their searches, but at the same time, you know, the vast majority of searches end up finding a business to buy within a hundred miles of where they based their search.
And so I think we just wanted to come in with a little bit of a reality around that and say, okay you know, rather than having you search where we’re based, which is Washington DC or New York city, you know, we’ll provide all the training and the some more. Remotely so that, that someone, if they want to base their search in Texas or Florida or wherever it is that they want to, that they can do.
So and we can provide the full, full support. So after that initial in-person training, we’ll do quarterly in-person gatherings which will be foundation about training and support on an ongoing basis for the two years. So, you know, we also just try to address a lot of the challenges we talked about.
Initially, I think worse. What a lot of searchers run into is actually the majority of sellers and the majority of brokers or, or lower middle market investment bankers. Kennerly, won’t even starstruck take a searchers call because they worry about the lack of committed capital, right. They worry that a surgeon has to go back, whether it’s traditional or self-funded and kind of put together the equity after the fact.
And so what, what we’re, what we’re doing with Brian is basically trying to combine the best of both worlds, you know, a searcher. You know, go out to an owner and say, you know, basically they do have committed capital in the form of, you know, Bryden backing them. But they’re not private equity, right?
Like they can also describe what a search is and how they’re going to step into the CEO role. So really we think it provides kind of the best of both worlds for our searchers or for our entrepreneurs and residents, as, as they’re going out, interacting with small business owners. And then sellers. And I think most importantly, and this goes back to the start of our conversation was as, as we’ve looked at kind of the key challenges that searchers face, you know what I mean?
The reality is it is becoming much more competitive, especially to find high quality deals master in both traditional and self-funded. And that competition is coming from, from private equity. And so what we want to do is take kind of the absolute best practices from. You know, two decades of marsh got private equity and for Steve and operating businesses and for George, you know, especially on sourcing and reaching out to small businesses.
And distill that down to kind of, we jokingly call it our arming, the rebels for our, for our searchers, so that they can much more effectively compete. So as an example of what that looks like in real time, that, that sort of, you know, 5, 6, 7 month ramp up period that we talked about previously.
Getting your CRM system down. And, you know, just understanding how to work with interns or outsource work. Instead, what they do is day one, they step in and we have that all set up, you know, like a private equity firm so they can tap into, they don’t have to go individually buy a whole bunch of source scrubs and zoom info’s and things like that.
They have all of that. We have an outsourcing team already. That’s doing a lot of the data cleanup and things like that. That can just take quite a bit of time. For searchers as they’re, as they’re scaling up. And then lastly, you know, just bringing back best practices around sources. So not only on the trending side but also, you know, we will actually be [00:06:00] outsourcing with our searchers you know, according to the kind of industry niches that they’re looking at.
And just given our backgrounds, you know, we already see quite a bit of deal flow in, you know, in software, in business services and government services. And so being able to. Plug our entrepreneurs and residents into that deal flung hopefully helps them get more in better reps quicker and end up with better deals.
So, yeah. And then the last piece I think is, is, you know, on, on the sourcing is, as we talked about that, that, you know, one of the causes of failure is, is if that deal falls through, we’re spending too much time on deals that don’t go through. You know, again, the good news is, you know, working hand in hand with our entrepreneurs.
You know, we, we and our searchers will know living on a day-by-day basis, how attractive and opportunity is how hard to run at it. And when a searcher or one of our entrepreneurs and residents is working, on an all-live opportunity, you know, if they have a deal under LOI, well, there’s a whole team that’s in the back.
That’s still kind of really running that, that proprietary outreach edge. You know, reaching out to brokers, reaching out to small business owners so that they, you know, if the deal falls through the searcher can come back to basically a full pipeline that, that, you know, we have helped maintain while, while they were focused almost full-time on, on an opportunity under LOI.
So, we’re very excited about it. You know, we really are, are trying to combine the best of private equity and the best of search. And it is a bit of a hybrid, but we think, you know, for. You know, searcher’s a year. It could be pretty compelling as they’re thinking about, you know, buying a small business and doing so with a level of support that that we think is really attractive.
So if we’re opening our application process now for the, for the 2022 cohort. And you know, the deadline is June 15th for applications that Nicole covert with kickoff in kind of late August, early September. With that training down in the Caribbean not mentioned. So we are, we’re, we’re very, very excited about the program and you know, a lot of thought went into to really structuring it.
So it was a truly better offering for our searchers and will end up in better results for our entrepreneurs in business.
Alex Bridgeman: I always enjoy out chats and they always go quite long and I wish that they could go longer, but I want to make sure we get closing questions out of the way. What college class would you teach if it could be about any subject you wanted?
Alex Mears: So, I’ll give two answers. The one is kind of an easy cheating answer which is advanced topics in due diligence and valuation for search because it’s a program we are actually pulling together and then have taught parts of. So that’s an easy one. It’s taking kind of the best practices for private equity and helping kind of give that next level. Once the searcher reads the books and hears that they should do [inaudible [RD2] 49:16], like no kidding, what does it actually look like from a due diligence perspective I think is really valuable. The second one is probably unusual, it would be just like a course on happiness and like what actually- looking empirically, looking historically at like humans’ approach to how do you live a good life. And I think there’s been a lot of interesting research. I studied economics as an undergrad, and there’s been a lot of really, really interesting research that’s come out over the last 20 years on, hey, these are things like, there’s just kind of a genetic set point, but then, there are certain activities you can pursue, there are certain values and things like that that just seem to correlate very well with kind of human flourishing. And I think it’s probably the single most important thing we as humans have to decide, like what is the career we want to pursue, who are the people we want to surround ourselves with friends, family, colleagues. And I feel like it doesn’t get addressed ever in any way, kind of in a scientific or kind of a thoughtful way. And so just pulling from like the research and showing kind of what works and what doesn’t. There’s, as you know probably from studying behavioral economics, there’s massive differences in terms of what people think will make them happy versus what actually makes them happy. And just being aware of those biases, it’s not like it cures you, but just being aware of those going in not only makes you a better investor and operator of a business, but just makes someone’s life richer and more meaningful.
Alex Bridgeman: Yeah, I completely agree. What’s a strongly held belief you’ve changed your mind on?
Alex Mears: Yeah, and this is one I would say that’s evolved over 20 years, and again, maybe it goes back to having studied economics as an undergrad where the numbers all line up neatly and the charts are all- the [inaudible [RD3] 51:05] lines cross perfectly. It’s how much kind of human emotion and subjective reactions matter in terms of outcomes. Like the deals at the end of the day, I think everyone who ends up committing to a life of doing private equity or transactions or something like that, at the end of the day, a lot of it comes down to do you trust the person across the table? Do you like them? Is this something that you want, both in terms of prior to an exhibition and then the operating phase. And so, I think I have come to appreciate much more how important- build the relation with an owner before you start grilling him for what his net retention rate was two years ago. Like it’s much more important that you kind of establish that common rapport and common values in a very positive way, not a manipulative way, then you get the exact right answer. And it always happens, like we always laugh in private equity. Like the analysts and associates, they always want to get to the number. They need the number, they need the answer and that’s important, and of course, you need to get that ultimately. But oftentimes, the way you approach it and being thoughtful about the relationship you’re building with the other person is even more important than kind of just that one number.
Alex Bridgeman: Yeah, I completely agree. That’s a great one. What’s the best business you’ve ever seen?
Alex Mears: I will not use specific names, if that is okay, just given NDAs and everything else. I would say, and not to give an unsatisfactory answer, but two business models in particular, and when they intersect, they’re just absolutely amazing businesses. And it is software, like vertical market software, and information services, kind of media or however you want to define that. And if you can combine those two, it just is an incredibly powerful business model. And the reason is, I mean, in very simple terms, if you think about it, the marginal cost, if you are operating software business, or if you’re generally operating information services business, your marginal cost is zero or pretty close to zero. And so, that is just such a tremendously powerful fact. A lot of people don’t- I think when we work with a lot of searchers and doing more think like a traditional techs and trucks or something like that, there are actually three limiters on revenue growth. Only one of them is customer demand. Everyone always like only focuses on customer demand or market demand or however you want to characterize it. But in reality, especially if the business is labor intensive, it’s often actually hiring the right labor to support that customer demand is really the limiter on growth. And then the third being kind of capital that you would need, like in a tech and trucks business, for example, can you actually get the trucks to support those additional customers and the additional labor, that skilled labor that you’re supporting. And so, if you look at information services and software, because the marginal cost is zero, that just makes your life so, so much easier to grow the business, to expand, to scale. And that’s how you end up with incredibly positive outcomes. I would say the last feature of that is if you can combine those two, and then there is actually some network effect, where think, and just to use an example, think about software that you would sell and put on a jet engine. And that software collects data on the jet engine’s operations. And based on that data is able to make maintenance recommendations or repair recommendations or things like that. So, not only do you have- there’s a piece of it that’s information services because each engine is totally different and has different parameters, et cetera. There’s a software piece of it because you are actually installing a piece of software on an aircraft’s computer system. But there’s also a bit of a network effect because the more engines you’re on, the more problems you’ll see, the more data you’ll have to help either extend maintenance or all the things you can do to sort of create value for the end customer. And so, finding those businesses, it’s incredibly hard. I know venture capitalists always love to talk about network effects. They’re actually much rarer in the wild than they are in PowerPoint, but when you can find those, those are just incredibly valuable businesses.
Alex Bridgeman: Yeah, that’s a fascinating one. I’ll have to ask you about that one later. But thank you so much for sharing a little bit of your time. I always enjoy our chats, and I want to congratulate you on the Brydon Group and putting your business together and leaving Carlyle and having your own search venture. It’s very exciting. So I’m excited for you and I can’t wait to track the next few years that Brydon’s going to have.
Alex Mears: Thanks so much, Alex. One thing we didn’t talk about which I am very grateful for is that you actually came up with the name several years ago for Search and Acquire, for our nonprofit. So, I always want to give creative credit where it’s due. So, very much appreciate that. And also, just appreciate what you’ve done for the search community. I mean, I know we’ve been talking for years, but just being able to show searchers all the different flavors of search and types of investors, types of businesses. I think you’re doing an amazing service for the community. And so, I really do appreciate it.
Alex Bridgeman: Well, thank you. That’s very kind of you. And I’m very proud of that name, so I’m glad you’re sticking with it.
Alex Mears: Absolutely. Thanks so much, Alex.
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