Tlao Cover Art 2023 Vector

Jay Davis and Jason Pananos – Serial Acquisition Strategies and Holding Companies

Jay and Jason acquired Vector Disease Control, which provides vector borne disease prevention and lake management services, in 2011.

Episode Description

My guests on this episode are Jay Davis and Jason Pananos. Jay and Jason acquired Vector Disease Control, which provides vector borne disease prevention and lake management services, in 2011. About 4 years after acquisition, they realized serial acquisitions complementary companies could be a powerful growth lever. And 14 acquisitions later, they sold the company in 2017 for a very successful outcome. Following the sale, they founded the Nashton Company where they’ve been mainstay search investors and the last few years holding company investors.

They’re also co-founders of Compounding Labs, a partnership between Jay and Jason, Kent Weaver and Will Thorndike to invest in long-term holding companies. Our conversation covers their investing in holding companies, how they approached serial acquisition at Vector and how they advise other searchers in the strategy, sources of capital and deal pacing, and building deal teams and when to start that process within your serial acquisition or holding company cycle.

Clips From This Episode

What college class would you teach?

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(3:17) – If you look at Vector as a play for acquisitions, how did it fit into your strategy?

(6:41) – What actions did you take to prepare yourself for rolling up other businesses and acquisitions?

(10:56) – What key roles need to be in tip-top shape before you begin acquisitions?

(14:39) – What were some best practices you developed over the process of 12 acquisitions?

(16:14) – How have your roles evolved over time?

(20:53) – Have you noticed folks things being easier for serial entrepreneurs if they have a partner?

(22:29) – What other types of investments have high returns in the early days outside of team-building?

(25:24) – Are there any misallocations of time entrepreneurs have in the early innings of a serial acquisition strategy?

(29:49) – Does the presence of Private Equity in a certain industry make it more attractive to you?

(33:10) – What are some factors you weigh when looking at industries to potentially invest in?

(35:27) – What characteristics do you look for in entrepreneurs?

(37:46) – How does pace increase factor into your path as the team grows?

(39:38) – How does the source of capital shift over time?

(42:38) – What are your thoughts on Long-term holding companies and their increased popularity?

(47:27) – How do you sus out whether an entrepreneur knows they’re in this for the long haul?

(50:51) – How do these long-term hold companies shift over time?

(54:02) – How do holding companies shift your role when investing compared to a traditional search fund?

(56:59) – What strongly held belief have you changed your mind on?

(58:43) – What’s the best business you’ve ever seen?

Alex Bridgeman: I’d love to start by kind of talking about Vector in terms of its fit for serial acquisition strategies. Obviously, there were a lot of things within that business that worked really well for a serial acquisition strategy. But there’s probably some things also that were less than ideal. If you look at Vector as a kind of play for acquisitions, how did it fit and not fit in kind of that broader strategy?

Jason Pananos: Yeah, I mean, to be clear, we didn’t really set out to do a serial acquisition strategy when we first we got started in a traditional search fund. We bought a company that did municipal mosquito control programs for mostly cities and counties and fairly spread out based in Little Rock, Arkansas, but we were spread out across the country when we first bought the business in 2011. And I think follow on acquisition was maybe one bullet point in our 60-page memo to investors. So, we thought that could be an opportunity, but it’s not something we really set out to do. And we had initially thought that lake and pond management could eventually be a fit with mosquito control. And it really wasn’t until two years into running Vector, towards the end of 2012, that we had a live actionable add on opportunity in the lake and pond management business that we and the board at the time felt like would be a good fit with VDCI. And it was fairly opportunistic. At the time, we thought it was a fit, it got us over 2 million in EBITDA, and it was a great price, it was a business we got to follow for two or three years. And that went well. So then, a year later, we did another add on. And then we were probably four years in when we realized, wow, there might be a few more opportunities in this industry than we thought, and we could really make this an add on acquisition story and strategy. And I’d say that the downside to those industries was just the total addressable market size wasn’t massive, but there was enough players in there where we felt like we could certainly do this for 5 or 10 years and be the number one player in these markets. And we had really high-quality revenue. There was reasonable pricing in the market since there weren’t a lot of consolidators. We were providing a good exit for business owners that really hadn’t existed before we started to do that. So, those things all boded pretty well for that working for us for an add on acquisition strategy. But it’s not like it had a business where you could put two things together and take out a lot of cost. In many situations, we were actually adding. We were trying to grow the businesses. We were keeping all the teams and adding to that to continue to grow the businesses, and they were very- we were essentially adding new markets. So, we were expanding geographically through acquisition. So, it’s not like there was a lot of redundancy or synergy. But I think we were able to generate cash flow and build momentum in the business through cash flow and incremental debt without having to deploy really any new equity after the first deal. So, if you do that long enough, you don’t need a lot of synergies to build a great business. So that’s kind of how it worked for us.

Alex Bridgeman: Since you didn’t acquire the business with the intention of rolling up other businesses immediately, what actions, either intentionally or unintentionally, in the first four years kind of prepared you for other acquisitions down the road once you got into the business and understood it better?

Jay Davis: Yeah, I can take that one, Jason. I’m not sure how intentional they were, Alex, to be honest. As Jason mentioned, the first, quote unquote, tuck in we did was really opportunistic and ultimately was a way for us to expand our addressable market. That was the rationale. The mosquito market that we were in originally, it was a great business and a great industry for a lot of reasons, but it was very small. And so, the pond and lake acquisition was a way for us to expand our addressable market. That simple. And even at that point, we did not have a plan to then go on and do several more acquisitions. It happened organically even from there for the next few years, I would say, where that after that first one, its local competitor actually reached out to us and said something along the lines of, “Hey, I wanted to buy that business. It didn’t work out. But I think these businesses are better together. Do you want to have that discussion?” And we said, “Sure.” That then happened again. And I think it wasn’t until that point where we thought, well, maybe there’s an opportunity. We’re just slow, I guess, is probably the takeaway. But it was really after that third one where we thought, okay, well, maybe there’s an opportunity. And I would say what we did from that point of kind of really realizing that maybe we can buy a lot of these and putting ourselves in a position to execute on that more effectively, I would say a couple of things. One is we actually hit the pause button a little bit. We made one more acquisition. And it was a business that was a very well-run business and really an industry leader. And they had a very well-developed service delivery model and field operations model. And when we did that acquisition, we took that as the opportunity to hit the pause button. We did some rebranding work and really intense integration work from a process standpoint. And that then put us in a position to go faster. And that was roughly year three and a half or four. And then we had another two or three years to step on the gas pedal a little bit, quote unquote.

Jason Pananos: And I’ll just add too, Alex, I think, one thing we had throughout really our whole journey which is really critical to the consolidation strategy, we had a really strong CFO who was with us from the beginning. And being able to really integrate financials, accounting, back office immediately with almost every acquisition was really important. And we had that from the beginning. And we can get into advice we give to other consolidators. But having a really strong finance function early is really important. And we’re lucky to have that from the beginning. And then to Jay’s point, in terms of when we started to move fast, in the early days, we could do one or two deals a year with Jay and I being on the ground, helping to drive the acquisition and make those key decisions. But we couldn’t really do three, four, or five deals a year until our team was versed in that, and the team had multiple reps of acquisitions and making some mistakes and being on the ground to know the tone, things to say, not to say when you’re on site in the early days. And once our team, both the functional leads in both companies but even our operations managers and leaders in the field, until all those people had experience with the acquisition process, we really couldn’t move that fast. Because there’s only so much Jay and I could do, and really having a team where M&A was in the DNA, we can move a little bit faster. And we were lucky to have advisors and mentors to follow to help us get there. But that was a key tenant for us and I think sort of a key success factor we see now when we’re-

Alex Bridgeman: When you think of preparing the team for multiple acquisitions, both your internal team, your executive team, and then advisors, service providers, lenders perhaps, what are some of the key roles in each of those buckets that need to be in really top shape before you acquire other companies?

Jay Davis: I mean, the first one is the finance organization. And I see Jason smiling because we’re pretty focused on that. We were very lucky we had a great CFO. But the minute that you get financial reporting and the ability to close books and report on performance, the minute you lose that, I think these strategies can fall apart very quickly. And it’s important not only so that you understand how your own investment decisions are doing, but you have this whole sort of cash management capital structure question happening in the background, and you can’t get that right unless you can report correctly. And so, finance is the first one, I would say. There’s a lot of other things to it, but I would think next go to HR, and it’s maybe not even like a significant HR team necessarily, but it’s getting the HR component of integration right. And benefits is, I think, the biggest example. Benefits are really, really important to people, understandably. And we found that that was- that’s the first question you get – pay, sort of job role, boss, kind of the same kind of question of benefits. And so being able to communicate clearly our benefits program, how it’s different, where it’s better, where there might be shortfall. We actually, in a lot of cases, took steps to top people up very purposefully to sort of make them whole, if there were cases where our benefits weren’t as good. That was less common, but it certainly happened. And we think that was the right thing to do. And then the last thing, Alex, I’m really glad you mentioned service providers because I think it is absolutely critical. You can’t do a lot of M&A if you don’t have great partners doing it with you. And whether it’s a QV provider, obviously your attorney, lenders are very important, we treated those people and still do today as our business partners; they were part of our team. Yeah, we were their customer, but that’s not how we felt about it, honestly. They were our partner, and they might as well have been working in our company with us. And I think when they interacted with sellers or parties on the other side, that came across, and I just think made us, I’d like to think anyway, made us an attractive counterparty, just based on the people who we had representing us in those various ways.

Jason Pananos: Well said, Jay. I’ll add sellers to that, too. So, we didn’t always get everything right. But our goal was every seller should be a reference for another seller. And that meant there’d be things that maybe post close, based on your document, you could go back and take something out of escrow or have a negotiation, but generally our view was transact with good people, buy great companies with great people, and have those folks be references for other sellers. And we would literally give a potential business owner our list of deals and owners and phone numbers and say, “Hey, call them, ask them anything, ask them the good and the bad.” And we were always comfortable with that. And a lot of our best deals came from friends of other business owners who had had a good experience. And that was really important to us as well. And having that reputation to this day is important to us.

Alex Bridgeman: Yeah, that reputation piece is definitely huge. By like the last handful of acquisitions before selling Vector, what were some of the best practices you developed through a dozen or so acquisitions up to that point in terms of how you communicate with sellers? You mentioned already working with partners and treating them like partners with your service providers. But what are some other kind of practices you established by the end of your time with Vector?

Jason Pananos: Yeah, I think it’s kind of everything we talked about. First of all, never say nothing’s going to change when you’re there on the first day meeting the team and talking to folks. I think in the early days, you have the tendency to want to say that to make people feel comfortable. The reality is things are going to change. But it’s important to us to respect the culture and the processes that people had. And there’s certain things that you could leave alone and certain things that certainly as we got bigger and you had systems that were non negotiables that you had to adopt. So, we tried to be transparent and open about that. And I think that was really important in the early days that we learned to get comfortable with. But it was really about the team and the people around us. So, at some point, there was only so much we could do, and we were lucky to have a great team of people and a great team of advisers. And most of those people are still with the company today, and they’ve done really phenomenally since we sold the business.

Alex Bridgeman: The thing I’m also really curious about is how your individual roles evolved over time. So, from that kind of year four where you haven’t acquired another company yet and you’re still running the same one, versus now you have a dozen or so acquisitions under your belt, how did each of your individual roles on the team shift? Like your day-to-day responsibilities, type of appointments that were on your calendar, how did those things shift and evolve? And was it a pretty gradual shift? Or did you have to really move things in and out fairly quickly as things ramped up?

Jay Davis: Yeah, I’m not sure we’re the perfect examples of what’s right to do here, to be honest. The first business we bought was fairly small, had 34 employees. And so, the reality was that Jason and I were both very involved in basically every major decision for at least the first two years. And there was a lot of cross pollination, even in the various functions of the business. I think you could argue, and this probably was the case, that that was relatively inefficient. So, I would acknowledge that. I do think we got to better decisions, though, because of that. It set us up well for the next 5 years. As the business grew, that became more difficult, obviously. And so, there was, I think, a pretty organic evolution in how our roles took shape both functional, like function wise, but also business line wise. So, at the end, we had two service lines, mosquito control and pond and lake management. And so, we split responsibilities on that dimension, but then also on a functional dimension. Because we had finance, HR, sales and marketing were, for lack of a better way to describe it, essentially centralized, and then, worked across both business lines. And then the operations were very focused per service line. And so, again, as we grew, that became easier to do. And I can’t say, although wish maybe I could say, but I can’t say that we were very intentional about it. It was more of an organic evolution, but I think it worked out well. And at the end, I would say it’s like how our calendars changed, well, the first few acquisitions we were doing everything, negotiating the deal, that never really changed, but sourcing the capital for it, showing up on day one to talk to the team, and working on integration, talking to the benefits broker, like you’re doing it all. And at the end, it was very much different where we had a great management team by that point and had leaders who could lead that process for each acquisition. And so, it became much more of a deal sourcing and execution capital structure role in supporting our managers as we diligenced to close deals and then integrated them. And that was more fun, frankly. Yeah, it just was more fun and felt more scalable. And a lot of smart people are working hard around the table to make it happen. And that was really enjoyable.

Jason Pananos: Yeah, I’d say the pattern, and I see this among other first time CEOs, but from a personal perspective, I describe it as in the early stages, it’s a lot of individual contribution, it’s a small company, like we could go out and make a sale or do a bid directly and have that impact the business. And then over time, as we grew as leaders, we get better at delegating and giving more of that responsibility out where maybe we didn’t do our team the best of favors in the early days by just trying to do stuff on our own. But then eventually, the delegation only gets you so far. And then you have to be a leader and build culture, and you’re only as good as the team you have and the processes that you have in place. And I think I’d say we’ve seen others do that better than we did. I think we were really good in the capital allocation front. I think we got to a point where we had great teams and great process in place. And frankly, a lot of that was driven by some of the leaders in our business and owners who sold their companies to us and stayed on and drove a lot of that. So we were lucky to have really good people around us. And as Jay mentioned, as you get bigger, that’s the only way you can build value in the company. And we evolved through that over 7 years, and I’d say that’s a consistent pattern that we see in first time CEOs is making that transition from a contributor to a manager to a leader.

Alex Bridgeman: Yeah, that’s a big transition. When you’ve seen, as you’ve kind of studied other serial acquirers and entrepreneurs take similar paths, have you noticed that folks have an easier or more difficult time whether it’s a single entrepreneur versus two partners?

Jason Pananos: I don’t think so. I mean, I think when there’s two, in theory, there’s just more capacity. A lot of times the value you can create in these businesses, whether it’s a consolidation strategy or not, minutes, hours, and days spent working on the business are more compound to major value creation then time working in the business. So, when there’s two partners that are buying a company, there’s just more time to be spent on the business. So, I think to some extent, that’s true. But we’ve seen solo entrepreneurs be just as successful, and maybe they have to build the team around them a little bit faster than if there’s a pair entrepreneur, but I think you can be successful as a solo entrepreneur or a pair doing a consolidation strategy. But it’s all about the infrastructure that you can build, it’s not, at least what we’ve seen now that we’ve studied a lot of these, invested in a lot of these, like you’re going to build a consolidation over 10 or 15 years. Like the EBITDA you build in years one through five is less important than having the right team and people and machine in place to both do acquisitions and integrate and build the platform as you move. So, whether you’re solo or a pair, I think team building is probably the most important thing.

Alex Bridgeman: Yeah, outside of team building, when you talk about investments being made in those first couple of years, that pay off down the road, what other types of investments tend to be really effective and have high returns for entrepreneurs to focus on in those early years?

Jay Davis: I wouldn’t say just there’s a lot of process stuff. I’m not sure this is all that different than- some of it’s not specific to consolidation strategy, necessarily. But a lot of the businesses that we invest in, as you know, Alex, there’s a process of professionalization that happens, I think, mainly in the finance function, but certainly in the sales and marketing function. And so those are two that come to mind. But I think it is exacerbated, I guess, when you’re doing a serial acquisition strategy because you’re adding employees and significant amounts of revenue and EBITDA in one chunk. And on top of it, you’ve done that in a way that’s not, by definition, is not organic. And so you can’t just- it’s not joining automatically your own process. And so, having the team, as Jason mentioned, and the process pretty defined so that you can integrate into that I think is important. I want to pick on or maybe slightly disagree with Jason, which is very rare, and I think maybe he would rephrase what he said. But building EBITDA early is very important. It’s just that you have to do that in conjunction with having the right team in place to then put you in a position to scale. So, there’s definitely a balance.

Jason Pananos: Yeah, no offense taken there. Yeah, and obviously, we’ve mentioned it, but investment in third party advisors, and obviously you’re spending money, but you’re putting time into those relationships. So, people you can depend on and can help you move faster, I think that’s really important. And in terms of things that aren’t people, but having some process, having metrics. One of our board members, a gentleman named John O’Connell, who’s been a mentor to us and ran a fairly large consolidation himself, he defines this thing called enterprise control, but you basically have kind of agreed upon metrics with your team and your investors and board. And it helps kind of govern your pace of acquisition because if you’re meeting enterprise control, meaning you’re getting your financials, monthly financials done on a regular basis, you’re hitting your operational metrics, you essentially have enterprise control, and it’s okay to move faster. But when those things start slipping, that’s a sign to slow down the acquisition engine and make sure you can regain that enterprise control. That kind of helps- that can help things get out of control. So, I think having that type of a process and understanding and metrics can all complement the team and the processes that Jay was mentioning.

Alex Bridgeman: Are there a handful of common, mistakes is a strong word, but maybe just mis-investment or misallocations that early entrepreneurs have when in the beginning of a serial acquisition strategy where maybe they’re spending too much time here and less time there, where you commonly come in to explain or walk through different ways that they should be investing their time? Like what are some common maybe misallocations of time that you see early on?

Jay Davis: When consolidation strategies start out bigger, and we have less experience with that. We generally start in the lower end of the lower middle market, I would say. But I see what happens in middle market private equity investing when they’re doing serial consolidations. And I think a lot of people have a tendency to want to build a corporate team fast and early. And Jason and I just made the point about, yeah, you have to have the right team and build it, but I think what we’re saying is different than that. In our heads, we’re thinking you’ve got to- you can’t get too far behind the curve on making sure you have the right leaders in your business. But just as intensely, we would say it’s very dangerous to get way ahead of the curve. Because I think what happens is you drive EBITDA so much that you then put yourself in a position where you have to do more acquisitions, you have to go at a faster pace. And I think that is just riskier. And I’m not saying that doesn’t work sometimes. I mean, it works a lot. But that’s not how we think about serial acquisition strategies. It’s a more balanced approach, I think, to pacing and team building that just has a balance. So anyway, that’s what came to mind, I guess, is CEOs were wanting to build out this really big and expensive corporate overhead that I think just then creates some bad incentives, potentially. Do you agree with that, Jason?

Jason Pananos: I agree with that. And it’s not maybe a time allocation misstep. But I think one pattern I see, it can be more in the mindset. So, it’s easy to look at private equity consolidations in certain industries and look at what multiples private equity firms are paying and what they’re selling to the next private equity firm for. And I think that can be a dangerous game because you might want to get into an industry and have this idea of, hey, I’m just going to buy a bunch of stuff at this multiple, and we’ll be able to sell it for a higher multiple because that’s what’s going on in the market. Or you’re watching what other private equity firms are doing, and they’re paying 9 and 10 times in my industry, like we’re not going to be able to buy anything of scale, so we need to either stop doing this or maybe raise even more equity to try to compete. And our experience has been, and the same was true even in our industry, although, it was a small addressable market compared to some others, but there’s always more opportunities out there. So, as you’re spending more time and building more relationships in the industry, our view is you’re going to find exciting deals at reasonable multiples if you’re patient over time. So that’s probably one mistake we see folks make. And I think in terms of thinking about how much equity is needed for consolidation strategy. So, as Jay mentioned, our experience is more working starting at the smaller end of the lower middle market and trying to be a little more equity efficient. So, we’ve seen this now done in multiple industries where you can get to, we call it flywheel, but essentially the point where you can do additional acquisitions with cash flow and debt or all debt, and you’re levered at a reasonable level. And our view is you don’t need more than 10, maybe 20 million max to build a massive company over a long period of time through acquisition. And I think that’s just we think about things in that way in a 10 or 15 year timeframe. And if you’re focused on just buying a lot of stuff at a low multiple and trying to flip it, I think you can get caught up in short term incentives, or the market could change on you and then you’re in trouble. So, we like the idea of thinking about things very patiently, and you can, as we’ve been saying, build that team, build it prudently and along the right timeline and not worry about having to sell in the next two years.

Alex Bridgeman: I think competition in terms of buyers is an interesting topic. When you work with entrepreneurs to determine good industries for this strategy, is the presence or absence of other private equity activity in that industry a good or bad thing? Like how do you think through the amount of competition in a certain industry and whether that makes it more or less attractive to you?

Jay Davis: Yeah, I mean, I think all else equal, it would be nice to not have other buyers. And that is the situation that we found ourselves in at Vector and the pond and lake management industry. There really weren’t other acquirers, and that was a very good dynamic. Having said that, I think there are plenty industries where there are private equity buyers and strategic buyers, but they’re so big and so fragmented that our feeling is that you still have tons of runway. And I’ll just mention two examples. But I think HVAC. I mean, everybody knows that there are dozens of private equity backed HVAC consolidations. But we are aware of a few where you’re still able to find good businesses for reasonable prices. Have the prices inched up versus where they were? Probably, but still very reasonable. I think dental is another example. I mention those two because I think they’re so well known to have had consolidations ongoing. But dental is just massive. And there’s still a lot, I think, of runway at the lower end, in particular, where you can buy great practices for reasonable prices. So, for us, to sum that up, like it is not a disqualifier if there’s private equity activity in an industry. I do it makes it extra important that the industry is large enough and fragmented enough. So that’s, I think, the question that that leads to, but it’s certainly not a disqualifier.

Jason Pananos: I totally agree with that. And I think in the context of search funds or other entrepreneurship through acquisition models, it’s okay having private equity there because you’re essentially selling against that, and you are a differentiated option for a seller. And that doesn’t always matter in every scenario, but there’s plenty of sellers where the entrepreneurship through acquisition story resonates more than a private equity firm. So, I think for an entrepreneur that’s looking to do a consolidation, there’s plenty of owners that that will really resonate with. So, I think it’s okay for there to be private equity in those markets. Because that’s an opportunity for an entrepreneur.

Alex Bridgeman: Yeah, there’s a media entrepreneur I’ve chatted with a bunch and one thing he said was the presence of, at least in terms of media, the presence of competition in your topic or theme or industry, whatever, is almost a good thing because it primes those advertisers in that space to get used to paying for sponsorships to media businesses. So, I thought that was kind of an interesting way to look at competition. And I was thinking in terms of this strategy where perhaps, kind of like you said, where private equity is already there, you’re selling into it, but also, it’s kind of an external validator that there’s something here in this industry that might be attractive. So, kind of almost backtracking a little bit, when you look at industries to take a serial approach to with entrepreneurs, we’ve mentioned a few factors that make it interesting – the fragmentation of that industry, competition being kind of case by case in terms of if it’s a deal breaker or not. What are some other factors that you weigh when looking at interesting industries?

Jason Pananos: Yeah, and I’d say some of these apply to consolidations and non-consolidations. But revenue quality is obviously very important. And we think about that as percentage of total recurring revenue, and for the revenue that is recurring, how does that behave year to year, how sticky is it, how high is your retention, so the higher quality revenue, the better. Obviously, you want to be in a non-cyclical, low capital intensive industries. Specifically in consolidation, having low capex just helps you redeploy that cash flow into new acquisitions, as opposed to having it tied up in capital. Having reasonable multiples in an industry, again, most of the time, there is opportunity at the smaller size companies with multiples, but there are industries where there’s large strategic or financial buyers that will pay high multiples at the very small end. So being in industries where there is opportunity at the lower end obviously matters as well. But I do think it’s easy to dismiss industries, to Jay’s point, and he brought up HVAC and dental as two, but there’s others out there where it’s easy to say, oh, that industry, it’s already over, there’s too many consolidators, or there’s one 800 pound gorilla. Our experience is there’s always more opportunities than you think. And you really have to study the targets and the dynamics of the industry before writing it off because it’s easy to be anecdotal about that.

Jay Davis: And I would just add one more thing, Alex. As we look at both industries and also entrepreneurs to partner with, we are trying to solve for long time horizons. And so, that requires a pretty large industry, making sure there’s enough one way over a long period of time, but also a CEO who shares that view and appreciates the power of compounding over long periods of time.

Alex Bridgeman: Building on that further, what kind of characteristics do you look for in entrepreneurs that would be fit for this?

Jay Davis: So, I mean, a lot of it’s just speaking the language honestly, like what have they read and studied and someone who can really voice the benefits of a 20 year hold versus a 5 year hold. And if you do the math around having capital, the sort of buy-sell versus hold, and you’ve got all sorts of friction in the buy-sell example, that just leads to really unbelievable difference in 20 years about total capital. People who can speak to that and understand it and really value that. And it’s really, I think Jason will agree, it’s very crystal clear, honestly, when someone understands that and when they don’t. You can just tell. And so, in addition to all the other things that you might look for in the ETA context, Alex, obviously, smarts, but most of the people pursuing this are smart enough. It’s smarts plus like the EQ component that I think is really important. Because you’re working with small businesses particularly early and it’s just so critical to be able to relate to all sorts of people, all sorts of employees and suppliers and various constituents that you might deal with. So, we really focus a lot on that. And then people who’ve, quote, unquote, drank the Kool Aid on these long term hold benefits.

Jason Pananos: Yeah, and they have to want to be operational. So, you can certainly be more of a- you can be a CEO and be the culture driver and the capital allocator if you go down the road of wanting to build a consolidation or Holdco, but you can’t do it without being super operational along the way in the early days and working with the teams in the small businesses and getting involved in the issues with the owners. So, if somebody just wants to go out and do deals, this is probably not the path. Because I think you have to want to be part of that operational experience. It doesn’t mean you have to be sucked into the operations every single day. But certainly, in the early days, it’s a really important component, is to get operational, to be there with the teams, to build out those processes early on is really important.

Alex Bridgeman: One other interesting point, or let’s see, one other aspect to these long term acquisition strategies is pacing. And you kind of alluded to it earlier with Vector where acquisitions were initially slow. But as the team developed and scale started to reap its benefits, you could increase pacing over time. Is that a pretty common theme across other entrepreneurs that you’ve worked with, invested in, or studied? And that pacing is a growth curve over the years? How does pacing kind of factor into all these?

Jason Pananos: I don’t think- and see if you agree with this, Jay, I think the pattern I see emerging is certainly if an entrepreneur is starting smaller, it may be that they might do a few early, but then there’s a pause. And it’s like a few because you’re getting enough, to Jay’s point, yes, you do have to build EBITDA because you can’t build a team unless you have cashflow to do that. So, a trend that I kind of see is, and you may even use all equity for those first few deals, maybe you don’t have enough EBITDA to bring in debt early on. But then there’s a pause. And it’s absorb, bring together what you’ve built, start building that team, start thinking about debt and lenders for the next few acquisitions as part of the capital. But there is that 24 month, maybe sometimes 30 month period, where you’re absorbing, digesting the first few deals, getting the house in order to then move again. I do think our pace was very spread out and nonlinear. I think we’re seeing entrepreneurs build through consolidation now faster than we did. And I think that’s okay with all the components that we’ve mentioned in place. So, we probably could’ve move faster in hindsight. But I think having that pause and getting the house in order early is really, really important. And having those pieces there, having that definition of enterprise control that we talked about before.

Alex Bridgeman: And you also mentioned it too with equity being perhaps a stronger source of capital early on. How does source of capital shift over time? You mentioned kind of a flywheel point that’s hit where internal cash flow and debt can largely finance deals from a certain point onward. Can you kind of walk through how that source shifts over time?

Jay Davis: I’m going to take that. I see you smiling. Yeah, I mean, I would say that the way that we think about this is we try to get the flywheel as quickly and responsibly as possible. And that doesn’t mean that you over-lever or take risks with the business. But at the same time, some of these businesses, even though they’re small, they’re highly recurring, relatively low churn, there’s not a lot of capital intensity so that they can support leverage in a responsible way. And so, we try to get to that point very, very quickly. And so, what I would say is it generally starts out where you might do a deal, if it’s on the smaller end, as Jason said, you might do all equity. If it’s maybe a little bit above that, you might bring in some third-party lender. The end goal, Alex, I think is a capital structure where you have some combination of senior and mez. So you might have some senior that’s traditional term loan amortizing. And you have in conjunction with that mez, which is a little more expensive, but also friendlier and lower amort. An alternative to that end goal would be a unit tranche type product, where it basically synthesizes what I just described. And that’s all unit tranche is doing. So, if that’s the end goal, then you have to kind of work from the early days to that. And what we’ve done a lot in our own investing in conjunction with entrepreneurs is bringing in one of those lenders early, having them grow with you, and then at some point, you then bring in the other. We started with mez sometimes, and we started with senior. I think both can work. I’m not sure there’s a perfect answer; it’s probably situational. But as a sidebar, I don’t know that there has to be a perfect answer. So, I see sometimes CEOs will model the leverage out, and they’re worried about the last sort of 10 basis points on the interest rate. And our advice to them is you’re thinking about the wrong stuff. Like you need a good partner. And don’t worry about 100 basis points here or there on an interest rate. Think about the covenants. Think about whether they’re going to behave in tough times, whether they’re good partners, easy to work with, and they’re there to support you. And that’s what really matters. And so, again, I don’t think it’s critical whether you start with mez or senior. Every situation is going to be a little bit different, but that’s usually the path. It is one or the other, then you bring in the other one. And over time, you kind of ramp from sort of two and a half to three turns of leverage up to four, four and a half over time. And, of course, if you get really much bigger, then you can go above that. But that’s the path that we see. And of course, you’re using cash flow from operations as well to support acquisition activity.

Alex Bridgeman: You mentioned time horizon. We’ve kind of mentioned time horizon throughout this episode so far. I would love to hear your thoughts around long term holding companies and perhaps why you think that they’ve become so much more popular in recent years and there’s so many more kind of variations of a long term holding company being created today. Perhaps it’s my own perception, but it just seems like it’s becoming much, much more popular over the last handful of years.

Jason Pananos: Yes, it’s definitely been a buzzword in the last 36 months, or maybe even more than that. The idea of Holdco and long term hold, holding company, building through consolidation, again, in the context of entrepreneurship through acquisition and in search funds. And I think what we’ve seen is, one, there’s no standard model. So, there’s everything from entrepreneurs saying, hey, I want to build a private equity firm, and I just want to start small. And there’s others saying, I want to do a search fund, but I want to build through acquisition. And there’s a lot that’s in between. And I think what we see most common these days is a structure with a set amount of equity. Investor groups can be varied, but we’ve been pretty active in some of these through a partnership called Compounding Labs in partnership with Will Thorndyke and Kent Weaver, who many folks who listen to your podcast would know. And it’s really about you have essentially a committed pool of capital that is really set to get the platform to flywheel. And that equity can be drawn at various stages of the consolidation strategy over the first four years, let’s say, as you’re layering in debt use over time, and then eventually, you don’t need any, you don’t need any new equity. But generally, there is an investor group, there’s a board in place, there’s governance around how that capital can be used. So, it’s not a blind pool like a private equity firm would be, but it’s a very collaborative group of investors working with entrepreneurs to build something over a long period of time. And there’s usually not a time limit on that. It’s usually set up as a company, and with the idea that it could be a 30 year project. The reality is this is all really new. So, there’s only a couple years of these things happening. And probably not all of them will make it 25 years. Some will sell over time for the right reasons. But I think the idea, we see entrepreneurs doing this and investors coming around it, is really about, hey, let’s think about structure. Let’s build this like we’re going to have it for 20 years. And it’s okay, because of that, you can start small, you can think about building team differently. So, they are unique structures, I would say, and something that we hadn’t really seen before, but it’s becoming much more common. But that’s what we’re seeing. But I do think there’s lots of different ideas and instructors going on as all forms of entrepreneurship through acquisition are growing and continue to grow.

Jay Davis: I would just add one more thing to that. And I think one of the reasons people are interested in these holding company structures is I think it better strikes a balance between sort of investor capital allocator and operator than maybe a traditional private equity role would or simply being a search fund CEO would. It’s kind of a way to strike that balance. And I think that’s appealing to a lot of people. And the other thing I would say is do think people, more and more, are appreciating the benefits of long holding periods. And you can see that in the private equity world, I think scores poorly on that dimension, but there’s continuation funds and things like that that are taking advantage of longer holding periods, which I think is great. I think entrepreneurs are realizing that the challenge is that in the traditional ETA model, there are often points along the curve where the incentives just don’t align with that. And it’s perfectly natural and okay. We, in fact, live some of those incentives. And part of what we’re doing at Compounding Labs is trying to address some of those. So, we kind of build it into a structure where it really does align everyone and we think addresses some of those incentives that cause businesses to be sold too early.

Alex Bridgeman: I think one thing that’s interesting about long term holds that I’d love to hear your thoughts on is how do you, as an entrepreneur, know that this is going to be what you’re excited to work on in 10 and 20 years? Because the idea is that these could be run indefinitely, perhaps for the rest of the entrepreneur’s career. But I mean, in high school, I wanted to be an ROTC Air Force pilot, and today I work for a media business and have a small one on the side. So, it’s really hard, it seems really hard to predict what you’re going to be interested in, what’s going to motivate you, what’s going to be exciting to you a decade or two down the road, where that seems to be where the traditional search model is a nice fit for most folks because it provides kind of an embedded career transition at some point. So, you know that if it’s something you don’t like doing or maybe you’d rather do something else, there’s an embedded transition point for you to kind of make that fork in the road. So, when you’re talking with entrepreneurs or coaching them, how do you kind of suss out whether they know this is what they truly want to work on for several decades, perhaps?

Jay Davis: I think that is a great question, Alex. And I think there’s some distinctions that I would make because it’s one thing to say, I’m interested in the HVAC industry right now, but I don’t know if I’m going to have the same passion around that 12 years from now. I think that’s a different question than I think I want to go run a business, but I’m not sure I want to do that forever. And so, in the holding companies that were involved with, for the most part, I think the entrepreneurs are pretty convinced that, for lack of a better phrase, capital allocation is something they want to do. And they’re like sold on that. Maybe that changes, okay, but I don’t think so. Like, they’re convinced that that’s what they want to do. How they employ that desire can change. So maybe they start off in dental or HVAC or whatever. That doesn’t mean that’s where they have to end up. And I think that’s why it’s important for them, I think, to have good partners because it does heighten the bar when you’re talking about a multi decade partnership. You better be sure you have the right people in the boat with you. And I don’t think, at least how we think about it, we think it’s natural to have those transitions in your own career desires. And just industry in general things change; you have to be able to pivot. But most of the people we partner with are convinced that they want to do some form of capital allocation for their career, and therefore, they’re comfortable with this kind of structure that’s really driven to the multi decade time horizon.

Jason Pananos: I agree with that. And I’d just add it’s not for everybody. So, I think there’s some people that want to do different things, don’t see themselves building a business for 20 or 30 years, and that’s okay. And others that are really drawn to that and want to want to do that. And I think these Holdcos are a great way to do it. But again, I’ll just say, I think the reality is not every- if you take every form of Holdco that’s been put together in the last 5 years or so, not all of them will be in the same form for 25 years. They may be sold. Somebody may decide they want to move on and they built a great team, and there’s a great succession in place. So, it’s not as though you’re committing the rest of your life. Although I think, to Jay’s point, the entrepreneurs we see doing this really do have that passion to allocate and build something and build something big. And when you’re open to doing something for a really long period of time, the assumptions you have to make to get to something really big, it’s not crazy. So, it’s really just a function of time and making good decisions year after year. And I think you can get there. And I think there’s a lot of people that are really driven to that, like Jay said.

Alex Bridgeman: Do you have a strong sense for where these long term Holdcos become or how they shift over time based on some of the results or outcomes that we’ve seen so far with some of Holdcos, some of which have been extraordinarily successful? I’d be curious if you think certain results or outcomes are going to influence the direction for Holdcos going forward?

Jay Davis: Well, a little counter intuitively, Alex, I actually think the success of the traditional ETA model is in and of itself support for some of the Holdco structures, and that may sound odd. And Will himself has done some work on this in the search fund industry. If you just look at businesses in the ETA world that have sold and what happens to them over the next decade, the story is pretty compelling. It’s really good things. The next owner makes money, the next owner after that makes money. And so, then you start asking yourself, well, what if we had ran the business for 15 years instead of 5 years? And so, I think that’s part of what has driven the investor community to be more open to these Holdco structures is because they see what happens. These search fund entrepreneurs build these wonderful businesses in 5 years and then sell them. Why are we doing that? Let’s own them for longer. And the Holdco allows for that. And so, it’s not- so my opinion is, I’m sort of being picky about your question, it’s not just the success of the Holdcos that are driving it, but it’s the success of all forms of ETA, I think, that suggest, hey, wouldn’t we all be better off if we owned these great businesses for longer periods of time?

Jason Pananos: Yeah, and I’ll just- it’s fun to think about ETA, and you could take every form of ETA, whether it’s a search fund, a self funded search, a Holdco, accelerator, ETA within a PE firm, like take it all, and add it all together. And I’m not even going to speculate what that is because you could define- but you’re talking 500 million to a billion dollars of equity a year maybe getting put into that across, certainly across the US, maybe it’s more if you’re looking globally. But that feels like a lot of dollars when you think about search funds in the 90s and early 2000s. But in the whole scheme of privately held companies, that is nothing. ETA and search, like we are in the first and second innings, like what it will all become, I think there’s going to be continued innovation and evolution of the models, but we’re still early and it’s a very small piece of the private equity market. So, I often get questions from people considering search or doing something in entrepreneurship through acquisition and it feels like a bubble. It’s grown so much. But I think we just have so much more to go and we’re still in the early days of seeing where all this goes, I think.

Alex Bridgeman: How do holding companies from an investor and board member perspective shift your role compared to investing in a traditional search fund?

Jay Davis: Yeah, I would say two things, Alex. One is you certainly have to be comfortable with the time horizon. And we’ve beat that horse I know now throughout our conversation. But not all investors have the same time horizon. And so, I think as you enter these, it’s just important to really buy into that. It’s funny, we’re good friends with Trish Higgins at Chenmark, and we’ve laughed with her about this. But you talk to investors, and you kind of talk about how you’re long term focused, and this is like in the context of raising money for people who try to do that, and you say you’re long term. And the investor says, we’re long term too, we have pretty permanent capital. And then you eventually get to the point where they say, okay, well, but when will we get liquidity? And that’s a sign that that’s someone that probably doesn’t buy into it. But you have to be prepared, I think, to have your capital tied up in it for a long time. And not everyone has that viewpoint. So that’s one thing I would say. The second thing is I think all boards are a commitment, obviously, and a big lift particularly early with an inexperienced CEO when you’re mentoring them and bringing them up the learning curve. But I think in serial acquisition strategies, you very viably might get to a point where you’re doing 6, 8, 10 deals a year. And I do think for the board, that is a bigger lift then maybe an average business that’s growing organically or isn’t doing that amount of M&A. Because that’s a lot of material process and board calls, etc., a lot of financing is happening. So that sort of thing I would say is it does seem- it seems like it’s a pretty big board commitment for these serial acquisition strategies.

Jason Pananos: I was just going to say, regardless of form of ETA, if an entrepreneur is going down a consolidation path, an investor is looking at investing in a consolidation strategy, it’s just so important to have people around the table, both investors and board members, who have consolidation experience and have multiple reps and pattern recognition around it. Because it is different than a purely organic strategy. So, I just double click on that. That’s probably an obvious statement, but certainly something we look for. And luckily now, I think consolidation is more common. I think when we did our consolidation even a decade ago, there was less of this happening in the ETA world. I think it’s more common now. So there’s more people around that have experience doing this, which I think bodes well for others that are looking to do- entrepreneurs looking to do this.

Alex Bridgeman: Yeah, certainly. Shifting to closing questions. What strongly held belief have you changed your mind on?

Jason Pananos: Yes, maybe more personal for me, but my wife and I are in the same boat. We’re always like nurture versus nature people. And now after having had four kids and feeling like we kind of did the same thing with each of them, and they grew up in the same house, but they’re all very different, I think we’ve fallen on the nature – of course, nurture is extremely important – but I think nature rules when it comes to nature versus nurture.

Jay Davis: That’s such an interesting one. I have three kids myself, and it is amazing how different all three of them are. And it’s just like same parents, same home, it’s crazy. I’m going to sort of cheat a little bit, but there are things that I’ve certainly gotten more passionate about over time. It’s kind of the reverse of your question. But one is just that I think our world has gotten so transactional over the last couple of decades, just over time in general. And now more than ever, I believe that just working with people you want to work with has so much value to it. And we try to do that in the entrepreneurs we work with. And back to that service provider conversation, I mean, we’ve been really loyal to the folks that we have worked with since the beginning of our careers, and they’ve deserved that, but we just wouldn’t trade it for anything. And it’s a little bit romantic maybe, but I think you can still be successful in business and have that view of the world. And that’s certainly how we try to approach things.

Jason Pananos: And you get to work with me every day, Jay.

Jay Davis: That’s right. Exactly. Exactly.

Alex Bridgeman: Yeah, best perk. What’s the best business you’ve ever seen?

Jason Pananos: Yeah, I’ll say more of- we’ve seen a lot. We’ve been lucky. And we haven’t got to invest in all of them, but we’ve been able to see some really impressive businesses that have been built by some peers of ours and others we’ve invested in. But I think the sector that I’ve seen that’s the most interesting is vertical market software. So, if it was the railroads in the 1800s and cable television in the 80s. We’ve been lucky enough to invest in some really interesting vertical market niche-y software businesses, and we’re super- having revenue quality is just really important to us and the companies we invest in, and those companies are just phenomenal. And there’s so many of them out there. And it’s just an exciting- Everyone’s using technology as a mission critical resource to their business. And in my view, that industry is one of the better types of businesses that we’re going to see for the next generation.

Jay Davis: Yeah, I can’t argue that obviously, Alex. One I would add just like sort of pre that, records management was hard to beat. And it happened to work really well in a serial acquisition strategy for a lot of reasons.

Alex Bridgeman: There’s a great archives one, Harvard case study that’s out there that we can link to that’s phenomenal. AJ is a pretty savvy CEO and investor as well. Well, I would love to chat more, but we need we need to close. Thank you both so much for coming on the podcast and sharing about long-term investing and roll ups and a thousand things in between. It’s been a lot of fun. So, thank you for sharing some time.

Jay Davis: Thanks for having us. It’s been fun.

Jason Pananos: Thank you, Alex. Thanks for having us.

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