Trish Higgins, Chenmark Capital

I want to start by asking you what made you leave your hedge fund jobs and move into buying businesses in their entirety. What was that decision and what was the motivation? 

After I graduated business school my husband James and I moved to Connecticut. We bought a house, it was lovely and we started work at a hedge fund called AQR. About a year into doing that we both realized that wasn’t the life that we wanted and that we felt the desire to do something much more entrepreneurial and also that we felt like we spent a lot of time with screens just looking at Excel spreadsheets, PowerPoints, Bloomberg screens, and we want to do something that felt more like we’re having a tangible impact on something.

It took us a little while playing around with ideas alongside James’ brother Palmer, who’s living with us at the time, about what are we going to do that makes us feel like we’re actually spending our time doing something useful. The idea of buying small businesses and helping them operate and building a portfolio of those companies that generated cash flow was something we kept coming back to. We kept stress testing it and finally as we start talking through it more and more we started saying, okay well how are we actually going to do this?

We started evaluating that until finally we found a company that we were pretty sure was going to close and so at that point I quit my job and moved to do this full time. There was an investment component to it, but it wasn’t really driven by money. It was more driven by the fact that we want to do something we felt like more interesting with our days and our lives than just sort of live out this kind of Connecticut suburb finance life that just wasn’t the right fit for us.

In your hedge fund jobs, were there times where you remember looking at public companies and bringing those lessons you’ve learned into these now private businesses that you’re analyzing? What things did you find helpful in analyzing private businesses that you’ve learned through your public investing? 

There’s a couple answers to that. One, Palmer was actually an equity research analyst. His ability to build financial statements, he really understood how the different financial statements talk to one another on a very granular basis. I mean, even though he doesn’t like admitting that, he actually does know a lot about just basic transactional accounting and all that sort of stuff that was incredibly helpful when we were starting to build deal models and all of that. So I’d say that that was something he specifically brought to the space that usually isn’t a skill set that is super developed in small business.

I was more of an investment research analyst so I could do the basic finance stuff, but then I could also do just generals or market research on things. I’d say that the framework on how to do that, but then also the ability to say here is the thesis and here are the three things that matter and here is the actual decision that we have to make, was really helpful because it allowed me to not ever get too far into the weeds. I was able to focus on saying okay, this is a situation where there’s uncertainty, let’s make a decision and move on. That was something that I learned from like basically day one of being in terms of traditional investment rule that I think has been really helpful in the world of small business because I think if you are only doing research all the time, you just like don’t actually get much done.

When you went through these businesses to acquire it sounds like you just found a lot of pizzerias and other random businesses. How did you filter through businesses that you would be interested in buying and are their business models you have found over the years to be really attractive and you hunt for?

I think it’s an evolution, we’re still in the very early days of what we’re trying to do. So I’d say we’re still very much learning what exactly it is we’re looking for in a business. We first started by just looking at like what are businesses you can buy and it turns out that most of the businesses out there in terms of volume are retail, pizzerias, liquor stores, restaurants, that sort of thing. For some people those are great businesses, for us we felt like we wanted to focus on businesses with a certain size threshold. We are looking for companies that had cash flow over a million dollars and there’s aren’t that many pizzerias out there that hit that criteria so that disqualified them to start with. Then the second piece is that we wanted something with less consumer focus and a little more business focused with the theory that a B2B type business could build a bit more of a sort of competitive advantage in that area versus we felt like there’s a lot of disruption happening right now in terms of the consumer markets in general and that wasn’t really a place where we wanted to get started.

Speaking of competitive advantage, now that you’ve been doing this for a few years and you’ve acquired multiple businesses and proved that you can do it, is there an advantage that you get in terms of deal flow in that most companies now reach out to you instead of the other way around?

Yes. Definitely. I think that everything’s a scale. I think the fact that we’ve done multiple deals and we actually know what the deal process looks like and can talk somebody through that, instead of us having no track record talking to an owner for whom this is the most important financial decision they will probably ever do is really valuable for us.

But we still make efforts and spend resources in trying to get out there and meet business owners, so it’s not as if we just sit in our office all day and have the phone ringing off the hook with people dying to sell to us. We still have to do work to get out there and I think if we’re critical of our own efforts, we are not particularly good at marketing and branding of ourselves. I think we could do a better job of making sure that owners knew that we were an option and I think we’ve done that a little bit and we have focused on that. It has produced good results, but it’s not something that comes naturally or that we’ve spent a huge amount of time and energy figuring out. How do we make sure a business owner in Toronto or Ontario knows that when they want to sell they should call us? That’s the next stage in our evolution. We’ve been a little more internally focused just because there’s a lot of different processes for us to build up internally. And so now we’re at a stage where we’re having conversations about how we become a little more external and get our name out there a bit more.

When you tell these business owners that your goal is not to buy their company add a bunch of leverage and then sell it in a few years and you tell them you’re going to hold it for a long period of time and you’re there to turn the keys over, how do they react to that? Are they pretty receptive? 

It depends, some owners care about that, some owners don’t. Some owners say, ‘I built this company up over the last however many years. I want to sell it for as much money as I possibly can.’ Maybe they care about some key people, are sentimental, care about the business carrying on for a long period of time, or maybe they don’t. Fort us, we’re trying to find the owners that do care about that and those are a good fit for us.

But they’re a lot of business out there some have zero interest in our value proposition, and we’re very comfortable with that. We tend not to be bidding against other people in that way we tend to say, ‘this is our offer, if you’re trying to get the very most cash in your bank account, we’re probably not the right fit.’ But if you want to work with a family-oriented firm, if you want to work with people who intend to own the company for a long time, who want to keep your management team on etc, etc., then we’re the right fit. But a good thing for our models, we don’t need to buy hundreds of companies to be successful. So there’s probably one of the hundreds of thousands of companies out there at any one time for whom that’s an interesting value proposition.

When you acquire business, it sounds like you do a lot of operational improvements to increase efficiency. What are some things that you do to add value and increase efficiency in these companies? It sounds like you have a Director of Technology at Chenmark whose sole job is to increase technology, or increase the efficiency of it, in your subsidiaries. How does that process work? 

Whether it has value over the long term is still theoretical since we haven’t yet experienced the long term, but one of the things we observe is companies that are the size that we’re targeting, they don’t have super developed executive suites because they don’t have the dollars to do so. There’s no tech help, HR help, and no finance help. It’s just that companies our target size tend to contract that out to part-time consultants. Sometimes they’re not highest skilled in whatever their area is.

Part of our theory has been as we grow we have the resources to attract really really talented individuals in these fields that can spend all of their days thinking about making our companies better in that way. And so we swap out the sort of dollars for consultants that are currently being spent and hopefully get a pickup and value add for full-time employees.

The first step for our team is to think about risk management so from a tech perspective, that would be making sure everybody has the right tech infrastructure to make sure that they have the right protections and they have the right set-up to be able to do the things that they need to be doing. That is step one that our CTO goes through and after that we start thinking about more offensive things in terms of how do you build custom applications that actually help improve our businesses.

Everybody goes through the “Chenmark Car-wash.” First is the downside protection and I believe that over time that de-risks the business and it also provides it with a stable base to grow over time. But we’re still very much in the process of doing those things so we’re doing it with the notion of it paying off 10 years from now.

What are some of the components or details of that “Chenmark Car-wash”? I’m sure it’s not standardized, like for every company you do these things, but maybe there’s a few consistent things you actually do with your businesses?

It is becoming more standardized in terms of we buy a company, this is what has to happen. The first thing is, from a finance perspective, the integrity and timeliness of our financial reporting is really important and if something isn’t being produced accurately, or in a timely way, it usually points to some breakdown in process at some point. So the first thing we do is create a forcing mechanism to create deliverables that then show us where there might be issues if there are issues.

At the end of every month we have a standard accounting principles, which is super boring sounding but it basically goes through what any accountant would find very very very basic. But this is how you close out a month and these are all the different steps that you have to go through to make sure that your month is closed out. Then there’s a process we’re building right now so we can visually see where people are in the closeout process.

We focus on training in-house staff if they don’t know how to do it already with our Director of Finance saying, ‘okay, this is all the stuff that needs to happen.’ Everybody creates a weekly cash management dashboard so we know the amount of cash we have in the bank, the amount of our AP, if we have a line of credit this is how much of that outstanding, and that is an ongoing insight into the cash side of the business, which is usually not produced before because the owners always just look at the bank account and get a sense of how things are going. Forcing the companies to do that every month means that you’re starting to create a culture of everybody looking at these things and being accountable to them.

Those are things on the finance side of the car-wash and there’s a lot of training involved with those things on the other side, like everybody does an employee handbook review. Everyone makes sure job descriptions are all reviewed and done properly, that recruiting practices and payroll and overtime practices are done properly, all these different things that are really important operations of a business that usually companies are trying their best but frankly, a lot of these rules are really complicated and so it could be difficult to really even know what to do. For example, there are different job types that require different overtime eligibility, so if you’re in a straight financial analyst job and your job description is written in one way, you’re not entitled to overtime if you work over 40 hours a week. If you want to get super into-the-weeds about it, if you just have a straight analyst investment analyst job which has a job description written in a certain way, somebody could make the argument that I worked over 40 hours a week and you didn’t pay time and a half. So it’s those sorts of things that we try to bring our expertise to and make sure all companies are really buttoned up.

Those are the sorts of things in the car-wash which is why it started off as very investment focused. Now it is very operational focused as we try to build out a lot of these things. If you went to probably any company that Warren Buffett owns, these would all be very very very basic things, but for companies of the size that we’re targeting they have some of them but definitely don’t have all of them. So we buy a company, we score it on all these different criteria for internal report cards we have, and then that creates our action plan.

For any prospective business owners who might be listening or wanting to sell their business down the road, what sorts of these things could they do either now or over time and that would make it easier to sell their business and make that process a little bit smoother? 

There’s a couple different things. One is I think that they could talk to a local business broker of some type who could work with them to help them understand what an owner might look for. They could help them think about what their business might be worth and different things they could do to add value and that sort of thing. Some business brokers are really really good, some are not that good. So there’s a little bit of nuance to picking that sort of person.

I think if you Googled around you’d probably find a fair amount we would be looking for but one, don’t break the law in your business practices, which generally means don’t run a lot of your personal expenses through the books, keep financial statements, in general pay your people legally, and try to make more money than you spend. I think the big things are if you don’t have any processes in place and you can’t produce clean reports about what’s going on in your company, it makes it harder to sell.

In your interview with Patrick (O’Shaughnessy), you describe the market for this micro private equity space as being relatively friendly: you could reach out to other firms doing what Chenmark does, ask questions, and get advice. Is it still like that or is the environment slowly changing with new search funds or searchers out of MBA programs? Do you find that the environment is slowly changing? 

I think it might be, they’re definitely a couple of searchers that come out saying, ‘I don’t want to do this deal, but I’ll refer it to you for some sort of fee or something like that,’ and we’re just not really into that. We refer deals to people all the time with nothing in return. I think there might be a little bit of that.

My hypothesis is that the people who think like that aren’t going to get a deal done because that’s not the way I believe the small business space works. I feel pretty strongly that like we will continue to be friendly, open, and collaborative, even if maybe at the margin some people are not that way, just because I’d prefer to conduct business that way. I think that this space is still so big, it’s so big, that there is a lot more room for us all to add value by sharing information then there is by competing frankly. That’s just the reality, maybe if it’s many many many years down the road and this has become a highly efficient market, which I think there are probably reasons why that wouldn’t happen, but if it did then maybe it could be more competitive. But I still think that there’s a room to share best practices and to share deals with other people because what I’m looking for and what fits both my investment criteria, but also like our personality is a firm and what we’re looking for is different from you. If you start a search fund what, you might be looking at it because it was interesting to you. And so what is a good deal to me is a bad deal to you and sometimes in vice versa.

So that’s why I think there’s a fair amount of sharing to be had because we see deals all the time that, on the surface it might be interesting for us, and then we decide it’s not an area we want to be in for whatever reason. Then we remember there was that guy who was looking for a deal in Texas in this size range, maybe he’d be interested? It’s still a really fragmented, inefficient market and it’s not something I worry too much about.

Do you see other searchers and these search funds starting to not only compete, but are also bidding on these companies that you’re looking at? Are you finding more of those or bigger private equity firms too? 

It’s not so much that there are other actively people bidding on companies right now and you’re in some sort of direct bidding war with. I actually feel like it’s more that overall valuations have gone up everywhere so I just we see it more as a small business owner who’s like well I read Uber is worth one hundred billion dollars so my company’s got to be worth twenty.

It’s more just like the general sentiment I think of where we are in the market cycle as opposed to the reality and there are definitely people who are paying up for acquisitions right now particularly in businesses that are growing and in industries that are growing faster. We tend to not focus as much on more tech focused industries, but we have definitely noticed people coming to market. It’s almost like owners are being told that it’s a good time to sell by the world and so they’ll come and say, ‘well, I don’t really want my sell my business. But if I could sell it for $30 million I would’ and so we’ve definitely seen a pickup in the last year of people coming to market.

I don’t know how often you go on Zillow.com, but you’re pretty young so you probably don’t go on as much as like somebody in their 30s does, but on Zillow.com they have a make me sell function where you could go on and list your house and it’s not for sale, but it would be at this price. I feel like there’s a lot of that in the small business space at the moment where it’s like I don’t really want to sell, but if you were going to pay me this much I would and we’re not going to do that. There are still deals to be had at attractive valuations for people who have a similar value proposition. I care about the value proposition and I think that we’re probably at a time of the cycle where it doesn’t make a lot of sense to chase deals. So we’ll just wait and we’re not really in a rush.

At this point in the market cycle, what do you see as the prospective returns going forward? It sounds like from what you’ve been seeing that valuations are going up, the “I will sell at this price type” of owners. What does a return look like for you going forward at Chenmark? 

We still believe that we can buy companies for between 3-5 times (EBITDA) that have cash flows of $1-3 million so our return expectations haven’t really changed. We have had to make sure we’re not chasing deals because the more and more we pay, the lower the return.

We’re not really looking for things that are going to grow a lot because we think growth represents a lot of risk in our model because usually growth means you have to invest a lot into the company and in a short period of time and that can cause problems in a business model. We are much bigger fans of steady growth over time. Not like we’ll double a company’s earnings next year, which might work in a tech based business, but for the businesses we own that’s really hard to pull off well and probably causes more stress in the business model than want. It’s difficult because the higher multiple you pay, the faster you need a company to grow to get the same return. For us it’s more important to stay more disciplined on the valuation side so that we don’t get a situation where we have to have growth to make the numbers work.

Do you find that it’s harder to have that discipline with your buy price as the market cycle continues and changes? 

No, we’ve got our partner Palmer and he’s the most value conscious person in the world. We have a good balance internally and again, we’re not in a rush. If we don’t do any deals in the next five years, I don’t really care. We don’t have any external equity investors, so it doesn’t really matter. It’s not as if I have to call up somebody and say, ‘hey, you thought we were going to grow this much this year because I told you but we’re not actually going to.’ If we end up just holding companies we have and let them plug away and build cash and pay down debt or have cash to buy a company when it comes available then that’s great.

For all I know this afternoon Palmer will call and say like, ‘three amazing companies fell out of the sky and they all want to sell next week and can we make it happen?’ That would be an okay path to follow or could be a little too much growth.

It sounds like landscaping companies have been a pretty consistent business model that you’ve found? 

Definitely models like business home services and blue collar industry fit that mold. We like businesses that have high amounts of contract revenue scaling up the number of people to do work. It’s hard which is why it’s hard to scale. It’s hard to take a landscape maintenance firm that’s doing $10 million of revenue to $25 million revenue in a year. It means so many more people to do that job. So there’s a huge HR element in recruiting those people and training them, making sure they’re doing a good job overseeing all that stuff. That is really really really hard to do.

But what’s easier is to go from $10 million to $12 million because it’s much more manageable and allows you to build up those systems over time in a way that you probably couldn’t build if you did it really quickly. Trades businesses definitely fit that criteria and it’s something that we look at as an attractive industry.

How has the Chenmark Capital team itself grown over the years? Obviously it was just the three of you to start out with, but what kinds of roles have you added? How have you managed Chenmark’s growth? 

We prefer to keep everything in the companies to the extent that we can. I would prefer us to never have a huge team. It is was helpful from day one for us to have all three of us because of just pure bandwidth. I think we have a pretty lean team. We have a Director of Technology, he is looking to hire more of a junior person to help him right now. He has very high standards so we’re not sure we’ll ever actually hire anybody but we’ve got a Director of Finance who’s a CPA and he does all the transactional accounting review type stuff. Then we have a VP of Reporting and he generates all of our internal reports and dashboards and does special projects that involve Excel and Tableau with the goal being to push that stuff in a usable manner to the teams of the portfolio companies.

We would prefer to allocate resources to our companies as opposed to the oversight of our companies. We’re trying to make sure that we are creating oversight that minimizes liability and provides a little bit of support for growth, but beyond that there’s no point to devoting large amounts of dollars to people to oversee a company as opposed to people, as we call, who do the actual work and who are actually out there generating value for us. If I had an incremental hundred thousand dollars, I’d probably prefer it to go towards helping our companies as opposed to hiring somebody to be a be an overseer.

And so when you have extra cash and you want to invest it in a one of your businesses, how do you decide which projects in which businesses are funded? Do you have an IRR hurdle rate that you need to hit and what’s your criteria for making those decisions? 

So that is also an evolution and I think to date it has been a little bit more internal company focused and we are moving towards across portfolio focused. We ask ‘if you want to just continue the company as is without growth, how much do you need to spend?’

Let’s say that’s $250 to maintain equipment and capex and then it’s saying, ‘well now you want to grow from $10 million to $12 million in revenue, how much do you spend actually do that? You need to hire more people, do you need to do marketing? Do you need to buy new equipment and all that stuff?’

It becomes incremental growth investment and in the company you say, ‘to maintain, this is what we need to do and that happens first to grow. But there’s no point in spending $500,000 building out a sales team if your growth projections are 0% right?’ We’ve had that conversation a surprising number of times. Another example, there’s no point in buying five-year ad space at a giant billboard if your growth target is 1%. There is return associated with it and you go through that line by line and sometimes say no, sometimes you say yes, and sometimes you say let’s see, which really means no. What we’re moving towards is as the portfolio gets bigger is starting to look a bit more strategically at investment, maybe more investment in one company and less in another if the return is higher.

All of that sounds like super easy and clean if you’re a finance person because if you just look at the numbers then it’s just easy because that number is bigger than that number. But the reality is that you’re talking about people and we have operators who manage all of our businesses. They’re all wonderful people and telling someone, ‘no, you’re not spending money on that’ is a conversation that you have to have and you have to maintain the balance between giving somebody enough resources that they feel supported to grow their business, they like their job, and that they are being given the ability to succeed, and investing in a different business. It is a very rare operator who believes, ‘yeah, no problem. You’re going to give all the money that I generated to some other company.’ It’s fine if they believe that that company has a higher growth rate and they’re participating in some way in that growth rate. The real tricky part in the real world is when they think that, ‘well, I have a 50% return opportunity and the other person has a 50% return opportunity,’ but we actually think that they’re wrong and then that’s where the real life of management and leadership comes into play.

This is where it goes from, ‘hey this company has a potential return that is higher than company B’s’ to where you have to look at how that is cascaded down into how is this going to impact the culture of the company or the motivation of leadership team or like

It sounds like it’s much more of a people decision or process than it is a financial one. Am I correct? 

It’s not that it’s it’s not one or the other. It’s both and I think that coming from the finance world you tend to think about things as though there’s not a human implication and we’re just cognizant that there is a human implication for all of the decisions we make. There’s lot of people in small business world are not purely motivated by money. They tend to be motivated by lots and lots of different things so we have to be making decisions about capital allocation while taking all of those things into account and making sure that everybody understands how those decisions are made and that they’re being made in a fair and consistent way. That means even if you missed out this time, maybe next time you’ll be the one to get the capital and understanding all of that. It’s not the same thing as if you’re just talking with people all of whom have a sophisticated financial background.

It’s a learning process and the fact is it’s a lot more nuanced and execution based than it is if you just had a bunch of investors who are like, ‘oh why did you give money for them to do that?’ Well turns out that is a huge part of like the cultural component business and if we don’t do that then we’re going to have real morale problems. It’s a lot Messier in real life.

Tell me about a fortunate event that happened to you that was completely by chance. 

My whole career is pretty much entirely by chance. I just happened to take a course my senior year with a guy who was a hedge fund manager on sabbatical and that’s how I got into the investment world. I just went to his class and the most by chance moment is when he said ‘if anybody wants to review resumes or career interests or whatever, I’m free for coffee and chat hours’ and I think I was only person who like took him up on it. That started a relationship where he eventually offered me a job and I moved to New York and I got to do like finance thing which is crazy, at least for me, and for my background and my family.

That was entirely chance and going to that coffee in New Haven was probably where I had a big turn in my career trajectory. I don’t know what I would have done if I hadn’t gone.

That’s a great story! Final question for you, what is the best business you’ve ever seen? 

I don’t know if this is the best business, but just the one that comes to mind is an online provider of supplements for weightlifters and bodybuilders and stuff, but they happen to be located very close to a lot of suppliers of these products. They could buy them as they were getting to the end of their shelf and the end of when the actual suppliers wanted them. They could sell them on their website and get paid by the customer before they got the inventory from the supplier and ship it out for like next day service.

They were so geographically close to all these suppliers and so it allowed them to basically have no accounts receivable and have amazing working capital position and a competitive advantage because they could sell these things for much cheaper than other competitors because of where they were in the relationships with these different suppliers, all of whom happen to like randomly be in the same geographic region. I don’t know if that’s the best business we’ve ever seen but that just came out as something that had a structural advantage.

Thank you very much Trish. I’ve loved having you on the show. This is a very enjoyable conversation and I’m looking forward to having more in the future. 

Sounds great. Awesome.