Invest Like the Best with Patrick O'Shaughnessy - Matt Perelman & Alex Sloane - The Art of Franchise Investing - [Invest Like the Best, EP.393]

Starting point is 00:00:02 Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at join colossus.com. Patrick O'Shaughnessy is the CEO of Positive Sum. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of positive sum. This podcast is for informational purposes only and should not be relied upon as a basis for

Starting point is 00:00:43 investment decisions. Clients of positive sum may maintain positions in the securities discussed in this podcast. To learn more, visit psum.vc. My guests today are Matt Perlman and Alex Sloan, co-founders and managing partners of Garnet station partners. GSP invests in the trillion-dollar franchise and consumer services industries. Matt and Alex started the firm in 2014 as MBA students when they bought 23 Burger King restaurants. Since then, they've invested in 26 other multi-unit businesses, from gyms to car washes to funeral homes. GSP is now a leader in its field. In our conversation earlier this year,

Starting point is 00:01:23 Mark Lazary dubbed Matt and Alex the next generation of great private equity investors. You'll soon hear why. This discussion is a master class on franchise. investing. We explore GSP's playbook for creating value, the power of Matt and Alex's partnership, and their approach to scaling businesses for successful exits. This conversation is special for another reason. For the last year, we've been working on a print publication that will share the very best of what we've encountered and learned every quarter. As the world goes bite-sized, short form, and full of platitudes, we are drawn to harder searching, more detailed exploration and understanding, and more emphasis on the very best people we can find, who are doing unique things in both business,

Starting point is 00:02:02 and investing. GSP is one such firm, and along with many others, they are profiled in our first issue of an upcoming print publication to be revealed next month. We're going to print a limited edition of them to start. So if you are interested in hearing first when pre-orders go on sale, go to join colossus.com slash print. I really couldn't be more excited to share with you what we've been working on, including an in-depth profile of one of the great investors of the last 20 years, who is a cult figure in investing circles but has never been profiled or interviewed like this. So now, please enjoy the excellent and incredibly fun discussion with Matt Perlman and Alex Sloan. I can't wait for you to learn even more about them and their strategy soon.

Starting point is 00:02:40 Stay tuned next month and for now, go to join colossus.com slash print. We have a chance to talk about a lot of history this time, which I don't normally do. And I'm especially curious to learn about your history because you started the firm so young and you went through this interesting phasing of how you grew your business, which I'm starting to notice amongst lots of the people that start their first. firms really young is they go through this early, what I'll call like SPV phase, where they're just doing whatever it takes to get deals together, get capital together, have great deals, not lose money, hit home runs early on, to earn the right to go into the fund structure and then into

Starting point is 00:03:16 the firm building side. We'll talk about all three today. But to begin, I really want to hear the detailed version of the story about the original Burger King deal. And maybe even before that, just how you guys met and thought about and talked about what you might do together. I just think these early days are so critical for what the thing ends up becoming. And I actually remember hearing about you guys. I didn't know your names, but I heard about these young guys that had partnered to buy Burger King. So it was going really well. And I was like, okay, filed that one away. So it's funny to be here with you today. Our story is Matt and I grew up together. So we've known each other all our lives. I was at Apollo and that was at Catterton. We went to business

Starting point is 00:03:55 school. The plan was to go back to Apollo and Catterton after we graduated. While we were there, we developed a thesis around franchise consolidation. And we found a deal to buy five KFC restaurants in Vermont. And we thought we could sell the real estate for more money than they were asking for the whole business. So we hired fancy lawyers and accountants that we had no business hiring for a deal that small. We didn't know any better. We spent all of our savings on diligence. And the day before we were set to close, we got a letter in the mail from KFC telling us we were rejected as KFC franchisees. The reasons they gave were, one, we had no money, so we didn't meet the million dollar financial requirement. Two is, we had no restaurant experience, so they told us we didn't meet the operating requirement.

Starting point is 00:04:41 And three is, they told us we were in college and therefore two young KFC franchisees. Yeah, other than that, they loved us. That was how we started. And look, obviously, we were really disappointed and we were upset, but we also thought we were onto something. There were 150,000 tier one fast food franchisees in the country at the time. And our hypothesis was how many millionaire restaurant operators are there? It just felt like a supply demand mismatch. Rather than looking for a deal and then seeking approval, we said, let's go to the brands

Starting point is 00:05:11 themselves. Let's tell them our stories. Let's see if any of them will approve us as franchisees, maybe even introduce us to a deal, to an operator. And all of the brands rejected us except for Burger King. The Burger King management team introduced us to a guy by the name of Ray Meeks, who was a 30-year franchisee had 23 Burkings based in the Garnett Street train station in Henderson, North Carolina. His business was not doing well. It was headed for restructuring. And Matt and I spent the summer

Starting point is 00:05:40 between our first and second year of business school living with Ray and his wife Cass and then Henderson diligence in the business. We bought that business in August of 14. We're going back for our second year. We added management talent. We added data, capital, a capital allocation plan, and grew that business from those 23 locations to what is today the largest burricking franchisees who are 1,100 stores, the public company. And so that's how we started. And we realized pretty early on while we were building value in that business that there was a much bigger opportunity where we could take the playbook that we were developing while building value there, of adding technology, of adding data, of adding management talent and growing these businesses with M&A and new unit development and remodels.

Starting point is 00:06:23 And we could apply it to what is a much broader set of businesses, which is the franchising, multi-unit consumer services businesses. And fast forward, it's been 10 years. And we built an investment firm to go after and capture that. What was it like living with them? That sounds like a very unique experience. We have so many stories, Patrick. Yeah, we used to say the meteorites are worth way more than the company, hopefully 10 years later. That's not still true. But they were terrific people. And it probably... They still are. Yeah, still are. It probably looked a lot like my cousin Vinnie. We were deligencing our partnership with them, diligently the business itself, and trying to figure out where the most highest returning places we could be spending our time in capital were

Starting point is 00:07:04 within that business. And to raise credit, he was in his middle eight 60s at the time and never had a financial partner. And he really embraced us and our ideas with open arms. It's funny about we give Ray so much credit and CASS because fast forward, we manage over $2 billion the capital, we've done 27 different platform companies that all look very similar to that Burger King deal, but we were from different worlds. Ray was from Monroe, Louisiana. Never met a Jewish person in his life for meeting me and that. We were in business school at the time. We were 26 years old. We had, again, we had no capital to speak of. It was just like he drew it up. And he and Cass embraced us. And the humility, what we've realized over the years, is that we

Starting point is 00:07:46 always need a ray in each of the platform businesses that we build, right? Ray, we'd go around the Southeast, buying burr-working franchises. Ray was the president of the Southeast Burr-Rurking franchisee association for 30 years. He knew every single one of these franchisees helped build the system. And Ray would introduce us to these people and he'd say, I'm Ray Meeks. These are my partners, Matt and Alex. They call us the two Jews and the general. And he would say, now, which one's the general? And he would give us credibility. And say, look, these guys are going to treat your people right. do what they said they were going to do. You should trust them. I was talking to Dan Schwartz, who was the CEO of Burger King for a long time and a key partner for you guys, obviously an

Starting point is 00:08:24 amazing guy. That itself is an incredible story worth reading a case study about when talking to him, it was clear that sometimes these businesses are quite misunderstood. The franchisee, franchisor model, sometimes at the corporate level, those things are intermingled in a way that makes it hard to figure out the business. What was it like for you guys to learn about just that one specific constellation of franchises of Burger Kings. What did you learn early on that was surprising? What do those businesses look like for those that don't understand them? Just let us into the room as you were figuring it out for yourselves that summer. I think it's important to give some of the background of what those businesses look like in terms of the partnership between franchisee and

Starting point is 00:09:01 franchisor. So if you look at Burger King, and this is broadly true of any of the big Tier 1 brands, At the store level, you're generating somewhere between a 15 and 20% margin before paying the brand their royalty. And that royalty is usually 4 to 5%. And so that means that after paying them their royalty, you're generating, call it mid-de-low teens in terms of struggle, EBITDA margin, take away a couple points for G&A, and you're down to high single-digit, low-double-digit, EBITal margin business. That means that at the end of the day, you as the franchisee are effectively getting,

Starting point is 00:09:35 call it two-thirds of the profit and the franchisee is getting a third. is a real partnership in that regard. And I think a lot of people, at least when we first started investing in the space, don't appreciate that. Importantly, there are different incentives, right? The franchisor cares a lot about growing the top line because they're taking a royalty, which is tied to the top line. The franchisee cares a lot about driving the bottom line. I think we, relatively early on, were able to figure out where the different incentives between franchisee and franchise or why, and how to utilize our skill set, which had been capital structure and team building and that sort of thing, to help grow the equity value of these franchisees while

Starting point is 00:10:14 keeping the franchisor super happy vis-a-vis investing in high-returning, remodel projects, new unit development, things that grew their top line. But for us, we're also really healthy RICs and very attractive capital projects. The truth is Matt saying that the incentives are not always align. That's actually not true through cycles and over time. It's very hard to kill these brands. And at any given time, perhaps the franchisor is trying to sell dollars for 98 cents, which is not good for the franchisees. But for the franchisee owners, they can't do that through cycles and still have a brand that's valued at multiples. And these businesses are very, very valuable. So through cycles and over time, that is a true partnership. But any given time, the incentives aren't

Starting point is 00:10:58 perfect. How would you explain from the perspective of someone out there that my want to buy a single one of these things and run a single Burger King or a single dominoes or a single something, how to think about the structure of one of those businesses. What are the components, talk about real estate, talk about ongoing maintenance needs, the things that seems simple run a domino's earn a X number of dollars of profit a year or something, but I'm sure they're just pain in the ass to run and complicated. So just maybe at the unit level, you can pick any franchise you want. What is it like for one of these people to own and run just one of these and then build up from there? There's three costs that matter in these businesses.

Starting point is 00:11:31 and those costs are people, the labor line, costs of goods and rent. Those costs are the vast majority of what's driving the overall profitability or not in the P&L, aside from obviously revenue. They're difficult businesses to run. There are people, intensive businesses with potentially a fickle consumer, depending on where you are in the cycle, that in large part relies on the brand's advertising strength and the overall brand strength. So I would not necessarily recommend somebody go and buy and operate one single unit

Starting point is 00:12:00 because I think one unit is relatively risky. You could have a traffic pattern change or bad weather for a quarter, and that can dramatically affect your results. And the equity value. The Walmart could move. Yeah, the Walmart moves a mile away to a different traded area, and now your volume's down 10%. And in these businesses, which are relatively well-margined businesses compared to the SaaS software

Starting point is 00:12:21 stuff of the world, if you have a 10 or 15% drop in revenue, that could be 100% of your earnings at a 35% or 45% flow-through or change in an EBITDA divided by, you know, you have a 10% drop in, change in sales. Alex and I have focused on scale as relates to both franchisee roll-ups and overall roll-ups, an R-view scale, more locations, different geographies, and an overall broader exposure to geography and markets that limits a lot of the Walmart moving or the weather or traffic pattern shifting. And historically, we've gotten paid for that scale and diversity because it does provide a less risky, more stable business. One of the things we realized pretty early on, and when we started this consolidating

Starting point is 00:13:03 Burger Kings, there really were only two institutional firms doing this. Not that we were in any way institutional, but there were sort of two private equity firms at the time that had done franchisee consolidations. And so there wasn't a lot of today family offices and middle market sponsors and even sovereign wealth funds. They love this business. Rewind 10, 11 years ago, that really wasn't the case. what we realized pretty early on was that the relationship between the franchisor and the franchisee

Starting point is 00:13:30 was extremely important. And at the time, people were tired. Baby boomer retiring, perhaps next generation didn't want to take over the business. These businesses needed to be remodeled. And I'm talking about franchising generally, not necessarily specifically burricking. When you'd go to a franchise convention, get to the bar and the conversation was, oh, they, this, and you believe they did, the idiot this, and just very critical of the franchisor. What we realized was if you're going to become a franchisee, these franchise agreements, they're very much franchisor favorable. If you're going to take that view and mean it, you should sell and get out.

Starting point is 00:14:04 Today, and even back then, we will only get into a system where we feel fully aligned with the franchisor and with the management team and with the ownership group. That's one of the reasons why our relationship with Dan is so important with the 3G folks, with the board and with the management team there, because you're going to have disagreements, and that's very normal, that's normal in any partnership or any relationship. but the spirit of those disagreements have to be in the best long-term interests of the brand. And so we took what at the time felt to be a little bit of a different approach, whereas we went in and said, we want to be your best partner.

Starting point is 00:14:33 And you have a remodel program, we want to remodel more restaurants than anyone. You want to build new locations because that grows your business. We built more burrachings than anyone else during the first four years that we built that business. And obviously, we didn't do this out of the goodness of our heart. We did it because we believed in the unit economics. we believed in the returns, but there were things that you could negotiate with the franchisor that perhaps they didn't value that really helped the downside protection. For Matt and I, rules one through nine or don't lose money. Safety principle is what really matters. You know,

Starting point is 00:15:03 rule 10 is to generate great returns and we care a lot about structural protections and downside protection that the brand can give you, that these franchise wars can help you with to help on the downside for us to be willing to take the risk of investing that capital and remodeling building new stores. And historically, there had been a real need for private equity and institutional capital, both a need at the franchise law level and a desire for private equity firms because of how high returning the capital was. For example, when we first invested in the Burk King business, 23 stores with an $8 million remodel slash cap-x obligation. It sounds like a huge number. But that $8 million was some of the highest returning capital we've ever deployed. And I think a lot of

Starting point is 00:15:44 franchisees then, and it's probably true now, just stared down the barrel of the absolute size of needed investment, potential investment, and it scares them off for when you actually double-click and even before getting into how you can finance it even more effectively, even on an unlevered basis, those returns are dramatic for the first few years that we were doing remodels and investing in the brand. Those were north of 30% unlevered returns. And then because of how big these brands are and how long they've been around for it, you can actually get really attractive financing. And then the point Alex raised about franchisors can give franchisees things that the franchisees really value that's no skin off the franchisors back. In almost every franchisee deal we've ever done, we've been able to negotiate for the brand's right of first refusal, meaning if you own a unit in a particular system in a particular state, it has to go through us before it can trade to a third party.

Starting point is 00:16:36 And that's hyper valuable to us for all the obvious reasons. But from the franchisors perspective, they aren't buying stores. They don't want to operate stores. And so that's a way to really incentivize us to deploy capital in the system without taking away any economics from them. Coming back to your initial question matter, the other nice thing about doing franchise consolidations is you have access effectively to the entire system's P&Ls over time. So Matt and I, we are very much believing in underwriting businesses through cycles, particularly if you're going to pay a franchise fee to operate someone else's brand. And in the world of franchising, you have so much data. So even we were buying a 23-unit burricking franchisee back in 14, but we were able to access effectively the 7,500 other burricking franchisees, and we could look at them historically.

Starting point is 00:17:21 And we could also see Matt talked about the remodel returns on that $8 million remodel liability. We could diligence how those remodel dollars were spent and what the returns were across the other thousand burrachings that had been remoded at the time. And you could do a cohort analysis to understand what was the trade area, where was the Walmart, what were the demographics, what were the demographics, what side of the street, where is the restaurant on? And you could make a much more educated underwrite about the impact of that remodel dollar versus if you're buying a roofing business and you just don't have access to that same level of data. The other interesting thing in the franchise ecosystem that's not true of a typical deal is it's a tri-party negotiation. You have buyer, seller, and franchisor. And franchisors can do things to effectuate that transaction that's in

Starting point is 00:18:09 everyone's mutual interests without reducing their economics dramatically. If we have 50 units of whatever brand and we're buying 10 units that perhaps need a lot of capital or they're underperforming for whatever reason, the franchisor can offer to reduce the royalty associated with those stores for let's say two years. And we're buying up 6% margin business because it needs some TLC and help. And they're going to reduce the royalty by half. So say they're paying 4% before that. So now, our cash flow has gone up by a third for two years, which really helps us finance it, and we can redeploy that capital into high returning projects related to that bolt on. And to the franchisor's perspective, they're probably thinking about that as an ad back

Starting point is 00:18:51 and the overall improvement in royalty, which trades at a far higher, multiple or lower cap rate than whatever we're buying the franchisee at, typically, that's value-enhancing for them over the long run. How much variance is there at the unit level across some of these systems? If I looked at today, the very best performing Burger Kings versus the very worst, or whatever, it doesn't need to be Burger King, can be anything. It seems like variance of the unit. Obviously, the franchisor wants that variance to be super low because then financing is easier and performance is better and more of people want to be a franchisee and on and on.

Starting point is 00:19:25 So I'm sure that franchisors are always incentivized to drive down variants at the unit level, but you guys have probably seen more data on this than anyone alive. What have you learned about unit variance, performance variance within a given system? From the top line, it varies a lot, and a lot of that is based on location and brand strength. So within different systems, you'll see dramatically different average unit volumes. And even within one system, you'll see dramatically different average unit volumes. Alex and I have taken the view that it's a lot easier through technology to change the variance in the middle of the P&L than it is the top line. Yeah, it's really hard to take a million and half sales per box unit and make it $2 million.

Starting point is 00:20:05 But if that million and a half dollar box is generating 11%, and we can see that the food cost variance and the labor matrix is off by 300 base points, we feel really good that through technology and the fact that we've done this with over 3,000 locations over the last decade, you can really, I don't want to say easily, but with high confidence narrow that gap over up three to six month period. You might be surprised about the variance. You might think it would be tighter bands than it is in the middle of the P&L, in part because franchising is a huge tamp, there's been so much capital.

Starting point is 00:20:35 that's flooded into the technology to help manage these businesses in a multi-unit way. And franchisors help make that tech and the standard operating procedures available to their franchisees. But depending on the system, the franchisees don't always listen. A lot of operators will base waiver just based on what their anticipated dollar sales is. And they said, so last Tuesday, I did 10,000 sales. This Tuesday, I think I'll do 10,000 of sales. And so I need X amount of people.

Starting point is 00:21:04 If you actually double-click on that and you can do this pretty easily with technology, we're less focused on the dollar of sales. We're more focused on the number of transactions because transactions is what drives labor, obviously not sales. If you take price by 10%, you don't need 10% more labor. And then also there's factors that go into a labor matrix that are impossible to do by hand, but with technology, you can do that pretty easily in terms of what's the weather? What are the traffic patterns?

Starting point is 00:21:29 Is the road construction? It's as localized as is the local high school football team playing to the local. night. If they are, I'm probably going to need more people. And it usually results in us adding labor at the peak hours to drive throughput. And so you get rid of the veto vote of people walking in saying, this is too busy. I don't want to stay here. And taking away labor at the shoulder hours, because the shoulder hours are smaller, both in time and dollar size than the peak hours, we're overall adding labor dollars, but the margin goes up because it does drive the top line. And there's meaningful operating leverage to that. That's a huge part of value creation for us. On that point,

Starting point is 00:22:03 It may sound niche you talking about franchising, but franchising is a massive part of the U.S. economy. It's over a trillion dollar part of the U.S. economy, but it's also a very small world. We've spent the last 10, 11 years at every franchise conference meeting every franchisee, every franchisee war out there. And we've traveled to meet all of the multi-unit franchisee operators over these years. And we've made a point. We asked the same questions.

Starting point is 00:22:27 We have detailed notes from all of them on how they manage their business. We try to take a nugget from every single one of them. The best one, sort of early on, was a Taco Bell franchisee who would literally do labor by 15-minute increments. And you'd think, based on the weather and all the factors that Matt mentioned, you'd think that means they're reducing labor. It actually typically means adding labor, which is actually a really important point. You can think about it. Labor is the most important part of these businesses. They're people businesses.

Starting point is 00:22:55 And getting labor right is the key not only to the middle of P&L, but it really is the key to top line. get satisfaction, net promoter score, and tend to return. And in any one of our markets, our consumer typically is our team member. And the customers are typically family members of the teams, cousins of the teams, teachers of the teams, nephews of the teams. So you have to factor that into how you treat your people. And just to put a finer point on that, it's a virtuous cycle, meaning the better labor you have, the better your customer experience, which means that they come back more often, which drives sales growth, which means you have more margin, which means you can hire better team members, which leads to customer satisfaction and thus your sales grow.

Starting point is 00:23:35 And so it is a virtuous cycle. The other thing that I think is important to touch on is we invest in simple businesses. We're investing in multi-unit businesses throughout the country. They're not particularly difficult to understand. The nice thing about that is if you show our team at Garnett Station the top line of a multi-unit business, the rent structure of the multi-unit business, and what the resultant margin is, we can tell pretty quickly, good, bad, or ugly, and how we would go about improving it. Sometimes we can't improve it. It's too good. But because these are simple businesses, and we've seen thousands and thousands of them over the last 11 years, with sales, rent, and the output, we have a pretty good sense of where the opportunity is. What, if you think back on those

Starting point is 00:24:15 thousands was the most surprising or confusing presentation you ever got, where you looked at something you're like, holy shit, we can't figure this one out as intuitively as you just described? We've looked at countless and countless Taco Bell deals over the last 11 years. Taco Bell is the darling of the franchisee investment universe. It only comes positively, meaning same for sales always seem to grow. It is higher level margins than the competitors. Typically, new units are created at really attractive cash and cash returns. The remodels always seem to work. It just seems to go up into the right. And we can certainly be too cheap for our own good. And we've just looked at those businesses for the last 11 years and said seven times, that's crazy, eight times, that's crazy.

Starting point is 00:24:57 Who's paying these prices? And we've missed every talk. about deal. And we probably would have made money on every single one of them had we invested. I think we're probably hopefully better at this today than we were 11 years ago when we started this at my dorm room kitchen table. But that's something that we've consistently missed and we'll probably miss again. What's your theory as to why? Why is that an outlier? Two things. They have better marketing than most. Think about the various Taco Bell iterations of commercial and marketing that you can think of all the way from the Chihuahua up to Pete Davidson recently, and they have a really compelling operating model.

Starting point is 00:25:31 Their food is reheated. And so whatever they don't sell that day, they're able to reheat and sell following day, which we can all debate how delicious that is or not, but it does drive. It's delicious. It tastes amazing. It seems to work.

Starting point is 00:25:46 And marketing drives a higher top line. Their food cost model drives a higher swirl of EBITDA margin. That allows for more money to be reinvest in the boxes. so they look better, and the top line drives more advertising dollars, which what forces more people to come in, human beings, at least in America, are very Pavlovian. If there are more Taco Bell commercials on TV this month than the same month the prior year, there's probably going to be more people who show up to Taco Bell. And with comps that have gone up every single year for 12 years, that's really driving that flywheel. As we think about our business, Patrick,

Starting point is 00:26:19 sort of we think about, you ask, why is that you're referring to Taco Bell, but why did we miss it, something that I come back to a lot? I think when we got started, we were certainly guilty of value traps and buying things because they were cheap and cheap for reason. And so we talked a little bit about our Burger King investment, which again, happy to spend more time on. But it's funny. Our second investment was not a good investment. We lost money on it. And in some ways, it was the best thing that ever happened to us.

Starting point is 00:26:44 We called tuition today. We did a consolidation of an auto services franchisee. Our view was it's very low cash-o multiples that we're buying and for let's go after it. and it ended up being a terrible deal, that was really eye-opening for us and said, huh, first of all, roll-ups are really hard. And if you look over time, roll-ups are not a great place to invest. The zero-rate world, notwithstanding, go back before that. It's a tough place to make money consistently. And we always joke, it's tough to make less than five times your money in Microsoft Excel in a roll-up. I don't think it's ever happened. But in reality, particularly through cycles,

Starting point is 00:27:18 again, we look at everything through cycles and think about that. It's really tough to make money in roll-ups over time. We plan to do this for the next. next 50 years. And for us, every single deal has to stand on its own. That's our underwriting. We're not going to justify one deal by saying we could buy the next one at a cheaper multiple and pro forma and run rate. We're creating this thing for X, Y, and Z. We've really, pretty much since 2015, 2016, evolved our investment philosophy, although we still very much believe purchase price matters and we're very value-oriented. We also really believe quality matters. And we have a saying, you don't get paid for a degree of difficulty. And we really believe that. So if we're

Starting point is 00:27:52 going to do a roll-up and do a consolidation, we're only going to do it in industries and in businesses that are high quality. And we have very clear definitions of that. But I would say we've missed Taco Belt. We always said, oh, it's so much more expensive on a relative basis from a valuation perspective, that we sort of missed the very important part, which is also higher quality. Can you take us back to the most stressful moment you can recall with the auto services business? Sounds like that taught you a ton of important lessons. So I want to hear the lessons, but I'm more curious about the actual felt experience of being stressed out that maybe you did a bad deal, you're trying to fix it. You're in your late 20s. It's not like your season

Starting point is 00:28:27 bets at this point. Yeah, Badger is very funny. We are, Matt and I, we're entrepreneurs, we're founders. We run an investment firm. We invest for a living. We run a business. And the initial auto service is franchise deal. I think that's when we first realized, and again, I said it was the best thing that happened to us because it was early on. And the one sense, the Burger King investment went really well, really quickly. And that, in retrospect, actually wasn't great because we thought, oh, this investing thing, we could do this. And it was very humbling to get beaten up and very quickly. And we moved too fast in that investment. We used too much leverage up front. Sail leasebacks on stores that shouldn't have been sale lease backs. And we can get into that.

Starting point is 00:29:06 But we couldn't have made more poor decisions if we tried, which was truly impressive. We hired young people, put them in positions of power, gave them tons of incentives. And it turns out, at least in our opinion, these operating businesses, that's very challenging to do. I think people can do it well, and that's a skill in its own right. But for us, we very much believe experience really matters. And today, we'll only hire people with decades of experience, building value, in exactly what we're trying to go and replicate. Also, no one had ever consolidated this franchise system before. We were the first ones to ever do it. It had historically been one unit, one owner. In our view, some businesses just aren't meant to be consolidated, perhaps. And we weren't able to

Starting point is 00:29:42 benefit from the technology that had been invented to manage these businesses in a Multina way. We couldn't draw from boards of directors or management teams to learn from their mistakes, to benefit from their successes, or ultimately to sell to one of these successful players. We call it tuition because this was the first time when we had a really big problem. It was severe. It was big. We were able to ultimately recover 30 cents in the dollar in terms of the invested capital. Forty. Thank you, 40. But look, we were able to engage a consultant who had gotten by the name Howard Norowitz, who has worked with us ever since. And at the time, he was consulting with us to help us navigate what was a restructuring, but for a very small business. We couldn't afford to hire as a firm

Starting point is 00:30:23 one of the big restructuring advisors or even, frankly, the smaller ones, and the business wasn't big enough to support that type of expense, but we really needed the help. And we found a guy who had 25-year background in distressed investing and in workouts gone to West Point, and he did it an hourly rate. And Howard's just terrific. We call him the left tackle of the firm. After he finished with that restructuring, we asked him to join us full time and take a big risk on us. because he was doing very well and was going to go to an established bank. But we convinced him to join us. He was our second or third employee at the time. He's our partner. And Howard's job technically runs capital markets. But his job is to make sure that nothing like that ever happens to us again.

Starting point is 00:31:06 And that's been the only deal we've ever lost money on, which I do think is a huge testament to Howard. He has helped us think through structure and plan around contingencies that, frankly, without him having joined the team. I doubt we could say that was the last time we ever lost money. What was the deal itself? How much money did you invest to buy? What was the structure? How much leverage it did you use? What was the setup of the deal? Fortunately, at the time, it was a relatively small equity check. So we invested three million of equity. We borrowed another five and a half, six million to buy or to have the opportunity to buy and convert 16 makos throughout California. Another key learning. We don't tend to invest in

Starting point is 00:31:46 that state much anymore, given what's happened vis-a-vis regulation and whatnot. And then we 100% debt financed the next six or seven million dollars to go buy another, call it 20 locations. And the issue was upfront, we thought we were buying them particularly well. We were acquiring them at three or four times what had been historical cash flow. And it's not a particularly cyclical business. And you could diligence that, given it's been around for 40 or 50 years. The problem was because we had no technology to operate these things in a multi-unit way. And as Alex mentioned, it's a core part of what we do today. As the owner of these individual locations left, we bought the business from them, there would be an unbelievable amount of theft. It was a mostly cash-based business that would occur when there

Starting point is 00:32:31 wasn't just that level of oversight on a unit-by-unit-level basis. And because we'd have the technology to manage that, we had to add more and more GNA to help counteract that theft and drive operations. and that led to what was a three-times deal pretty quickly becoming up six or seven-time's deal, times leverage, times we had sale lease backed a lot of the real estate to use the proceeds to buy the next one and the next one. And we were just wildly over-levered. It's a big reason why we don't lever things up front anymore. Do you talk about capital formation in the early days?

Starting point is 00:33:02 What was it like to raise equity capital for some of these deals? When you didn't have a track record, you were really young. Obviously, the Burger King deal went well, so I'm sure that helped to start. but then you had this deal that didn't go well and you had to keep raising capital. What was it like in those early days? Yeah, it's funny because today there are people who will call us an Apollo and Catterton spinout, which is hilarious because we were so young when we left those firms. And actually, those firms have been extraordinary to us and some of our greatest mentors and supporters. You could not have done it without their support. Without their support, to this day, by the way. But the

Starting point is 00:33:33 reality was we were 26 and we were associates at those firms. I don't think we knew where the bathrooms were, other than crying. That was the crying room. But look, we were. We were. We were, were really fortunate. We were put in business by a number of family offices, people who we had gone to school with, their families, or known through friends of friends. And we were bringing deals to these people to help them to raise the capital. It wasn't a blind pool of capital. We were saying, here's the transaction, here's the deal. Would you consider investing? And that was initially how we raised the capital for the burricking deal. And then once the burricking deal got going and went well quickly, that's what allowed us to then raise money for other deals. And then in 2019 was when we said,

Starting point is 00:34:17 okay, we had done seven deals. They had largely gone well with the exception of one. The track record was very good. We said, let's raise a fund structure. And initially, the idea was let's raise a three-year fund structure. See, do these investors want to invest in a fund structure? Do we want to invest out of a fund structure? They're plus and minuses to commingled funds, as you well know. And we could spend hours talking about those considerations. And then COVID hit. And we did two extra. We deals in that fund and the rest we did and we were buying distressed debt loans in other franchise and multi-unit businesses in industries that we either had analogous assets or we had previously where the data and the tech that we had put in place to help manage our businesses that

Starting point is 00:34:56 were giving us real-time information gave us real insights so that we could underwrite them and move fast. And that really worked and that worked quickly. And in 21, we transitioned from a family office, LP base to our first institutional fund. And then we invested that one over the next two years and then raised the most recent fund in 2023, which is majority. We still have the family offices put us in business, but today it's mostly the institutional piece. Seems like the right time to talk about COVID. It has to be the worst possible imaginable scenario for what you guys do and completely existential, I'm sure like in March and April, you're not having your best days. Talk through that entire experience. Some people say COVID wasn't a cycle. It was only a couple of months. If you aren't

Starting point is 00:35:39 owned our portfolio, it was a cycle. I think literally other than owning perhaps a cruise ship or a Hudson newsstand in LaGuardia, we had about the scariest portfolio in the history of private equity standing in our office on Sunday, March 13th. 2020, we had a portfolio that was 100% foot traffic dependent. We don't use a lot of leverage, but when your portfolio goes to revenue zero, any lever, a dollar of leverage is over levered, obviously. And yeah, we had that. And Alex and I obviously never left the office. The two of us would walk there every single day. And after we had our ritualistic morning cry, we went to work and battled. And we're really proud. I think the team is really proud. The LPs are really proud of what we did. We didn't lose a single company. We didn't have to put

Starting point is 00:36:25 in a dollar of rescue capital. We didn't breach a single covenant. And we give our partner Howard and our team a lot of credit for that. We put a lot of liquidity and thoughtful capital structure into these businesses up front, obviously not predicting COVID, but predicting cycles that enabled the portfolio companies to both play defense and then quickly play offense by acquiring competitors in June of 2020, acquiring competitive real estate, acquiring competitors debt, do things that at the time people thought we were crazy, maybe, that generated a ton of value for the firm for the portfolio companies and for the investors. And we were really proud of that. How did you solve the problems early on? Revenue went down so fast. It didn't come rocketing back. What were you literally doing?

Starting point is 00:37:08 We shut the businesses. We furloughed the companies. We mothballed the businesses. We furloughed everyone. We talked to our CEOs. We loved that analogy of we felt like airline pilots. Matt and I would be in the office every day. We talked to all the CEOs first thing in the morning. They're on the battlefield. Those are the guys and girls that are actually running the businesses day today. Matt, I would sit there. We'd talk to the LPs. We'd give them updates on what we're seeing in real time. We'd watch a movie, but literally just to past the time, and then a CEO would call. You get on the phone, you'd throw out, deal with an issue. Suppliers, Chapter 7, liquidating, if we can keep the stores open. We don't have any Pembera patties to sell out. Our Burkings CEO at the time, Dan Akardino, literally stood up at distribution and refrigeration business outside our stores with frozen food trucks in the span of three days because our distributor went chapter 7. It was insane. Getting more capital into

Starting point is 00:37:59 some of the businesses or helping our franchisees, we own a number of franchisors, blending our franchisees liquidity or capital to stay open. That was a good point. Had the franchisor has not had that liquidity, the franchisees would have died because we were the bank. And we're also helping our franchisees understand what all the government programs were and whether they were eligible, how to go after it. Obviously, speed really mattered. Think back to all these government programs, getting in the queue early, figuring out which banks were facilitating some of these government programs and which weren't. And we've great management teams. So they were really nimble. The CEO of Kona

Starting point is 00:38:32 Ana Ice, our largest food truck business in the U.S., an incredible founder and CEO, that business is an events-based business. So they park out of churches, little league schools, and obviously there were no more events. So Tony stood up in the course of two weeks software to allow Kona customers to get franchisees trucks at their homes and their driveways. The franchisees of Kona were all levered, and a few of the lenders were not providing for interest in MWRT holidays. So we had to find another bank to go buy one of the loan portfolios.

Starting point is 00:39:03 We had to back to back it off the Kona franchise or balance. It was while we were negotiating a Main Street loan. And it was wild. It was wackamol. It's funny. One of my mentors at Apollo would talk to pretty often. And he said to me, he said, you'll look back and this will be the most fun you ever had. And I thought he was nuts.

Starting point is 00:39:20 In some sense, it really did make our firm. How long did the most acute part of that last? How long was there that degree of coordination and whackamol? I think by May we were seeing green shoots in the portfolio and for our businesses that were located not in northeast west coast major metro, which is the vast majority of our businesses, there was real opportunity to reopen and start recapturing all that share. We knew by May that we were going to make it, I think. There's that milking quote we have hanging. Liquidity is an illusion. It's always there when you don't need it and never there when you do. We

Starting point is 00:39:54 looked at that every single day and we're prudent about going on offense. Certainly, By May or June, we knew at least that the investments we had made in March, April, and early May were working. Alex mentioned, but we had a lot of insights as to what was going on in the economy because we own and operate several thousand locations. We get daily sales on them. One of our better investments during that period was we bought 60-something million dollars, I think $65 million of the first lien debt of the largest Pizut and Wendy's franchisee,

Starting point is 00:40:24 which entered bankruptcy immediately as COVID began. And it's a business we knew well. We had diligence that we looked at buying it previously. But when we really started what was going on in our burking the drive-through part of the business where people were destocking their pantries and they were heavily utilizing drive-through. And because the dining rooms were closed, we had pretty minimal labor costs and profitability was going through the roof. We really tripled down on that pizza and Wendy's investment. And that ended up being, I think, probably our best debt investment ever. One of the things that stands out when looking through the businesses that you've invested in, one of the thoughts I had this morning looking through it was just, holy cow, there's so many of these multi-unit concepts that I've never even freaking heard of. I was looking through the timeline of ones that you've bought, some of you're the franchise. Or like you said, sometimes your collection of franchises, talk through the taxonomy of these things. Burger King, obviously, everyone's heard of, Taka Bells, everyone's heard of.

Starting point is 00:41:17 But some of these other things you bought, I had never heard of until looking through your deck. There's food, there's pet care, there's automotive services. How do you think and chunk the world up? Okay, this is in this category. This is in that category. What are the major categories that I want to start there, but I really want to get into what are the different features, I'm sure there's tradeoffs and all these different things, of the kinds of businesses that they are for those that like this category for investment? Yeah. To your point, we've invested across a number of different multi-unit categories. You mentioned food and beverage. Auto Services is our second biggest one with carwash and

Starting point is 00:41:52 collision repair, health and wellness, particularly gyms and fitness, is a category we've played in a bunch and then pet services. You mentioned as well. Look, obviously, the end market or the end consumer of a burr-working business versus one of our more successful deals was a funeral home roll-up, for example. Those are obviously very different end markets. The ways that we go about driving value in those businesses in terms of professionalizing them and thinking about building versus buying the next location, that's identical. And we overlay our quality bar onto these various multi-unit businesses, which we can do because they're simple businesses. And so when we think about what quality is to us, there's a couple heuristics we use before we double-click and dig in.

Starting point is 00:42:38 But everything we've invested in, every multi-unit business we've invested in over the last few years has been the number one highest average unit volume, sales per box in its category. Every concept has at least 20% scroll of margins. This is true of the last five or six years, which is top decile for multi-unit. Everything we invest in has sub three-year paybacks on new builds, which is important for us because it provides both downside protection in terms of capital deployment at high returns, but also meaningful equity value, growth potential. And on the consumer side, they all have the number one net promoter score in their category. The category could be Las Vegas car washes, or our wow business is one best car wash in Vegas the last five years in row,

Starting point is 00:43:18 and they have to have the number one consumer intent to return in their category or microcategory. And all multi-unit businesses, different verticals, but wildly similar in terms of how you can think about investing in them, how you can think about underwriting, building versus buying the next unit, and how you can think about quality as relates to the competitive set. The majority of FAR investments is thematic. And in order to qualify for an industry, the industries have to be highly fragmented by number of units, not percentage. That's very important. to have to be organically growing for not just our hold period, but for the next buyer's hold period. There has to be real industrial logic to the consolidation. So it can't just be more as more. It has to be more as better. It has to be done successfully before by other private equity or

Starting point is 00:44:00 strategics. We very much believe, as I've said, experience matters, experience boards of directors is a huge part of our GSP playbook. And finally, why us? One of our mentors and very successful investor said whenever he looks at a private investment, he always says, why am I so lucky to have this opportunity. Am I the 50, the schmuck who's seen this deal and every one of our investment memo is the third page is always the YOS page. Our franchisee deals have led to company-operated models. It takes us on average three years from when we first start looking at a theme to when we get a deal done. We have a whole process for how we source deals and every single transaction we look at. We have to have an edge. There has to be some reason why we're a strategic buyer.

Starting point is 00:44:39 Why do we have a right to own this? What's one or more examples of that? Is there a common Whyos answer? Taking a step back, when you just think about multi-unit and consumer services, franchising more broadly, we live in the greatest country in the world. People take it for granted. People take for granted how massive the U.S. economy is, common rule of law, financing. And we estimate for the size companies we target, again, we don't really invest on the coast, it's over a trillion dollar tan. It's a massive market. And in some sense, we're building a firm to serve as real partner capital to baby boomers and small business owners. So there's 10 trillion of business value that is expected to transition over the next two decades from baby boomers.

Starting point is 00:45:26 There's six trillion, whatever the number is, of private equity going after that market. One of our mentors and LPs calls us a build-to-suit firm for the Leonard Green's, odd-axis, sentinels of the world. And we love that framing. We're building a firm. We want to be the partners of choice to these founders, business owners, entrepreneurs throughout the country, and bridge that bridge to Wall Street and position their businesses to maximize value. And just to provide some color there, so we've done 27 different deals or 27 different businesses. We've been the first institutional capital into 25 of them. So the vast majority of the time, we're partnering with a founder or with a family or with an

Starting point is 00:46:08 entrepreneurial management team, and we're buying anywhere from 50 to 90% of the business, and then we are helping them not only turbocharged the growth of that business, perhaps the family over the last 30 years, built up 50-unit business, and we're saying over the next five years, we're going to build it to 200 units. It's obviously a different trajectory that requires meaningful investment in terms of GNA, but we're also professionalizing the business and diversifying the sources of those cash flow streams across markets and geography, to Alex's point, to sell it to a private equity firm, typically one or two notches above us on the size food chain of private equity. The first seven or eight years of doing this felt like we were in the wilderness

Starting point is 00:46:49 of the wrong side of what LPs were looking for in institutional firms. We cared a lot about purchase price. We talked about that. We used very moderate amounts of leverage, tons of liquidity, and we sell things. We sell companies. All of our funds have been top 5 percent in each of the fund vintages in terms of DPI. And DPI is returning capital. That's a big part of our model. And the first thing we do whenever we invest in a business at the first board meeting is what we call writing the sim exercise. So we actually write the sale memo, the sale document, that we want the investment banks to take out to private equity firms and strategics five years later. And every single decision that gets made over the next five years, or in our case three years, refers back to that document.

Starting point is 00:47:32 And we are constantly thinking about the exit and the sale. And our sourcing process is very clear with our prospective partners. That is the goal. Investors give us a dollar. Our goal is to give them $3 back. Every decision we're going to make is so that when that private equity partner sits around their investment committee table, they're talking about this platform that they have to own.

Starting point is 00:47:51 We want each of our companies to be at the very top of our private equity firms hit list. As I think about the features of these different unit level businesses, I'd love to take everything you've learned and apply it to somebody that wants to start a new concept, something that doesn't exist yet. And I'm curious what variables pot to mine. Two for me are obviously brand. I'm sure is really important. But I'm curious what you've learned about, what a good brand is in this kind of space. Something like frequency of use could be interesting. Auto repair, I'm not doing that very often. Burger King, maybe I'm doing it three times a week or something. So here's how something like frequency plays into this. But if you were just to teach a class at Harvard or something,

Starting point is 00:48:28 like, okay, everyone in this class wants to launch a new concept that hopefully can get to thousands of units or something. What advice would you give them about the variables to focus on or think the most about? I think the things that drive success in a lot of these multi-unit businesses is both obvious statement, the unit level economics. I mentioned earlier that we're only investing in concepts that are north of 20% at the store level in terms of store-level cash flow. And so building a business that has a cost profile that enables that, I think, critical. I think being on the right side of tailwinds, whatever those tailwinds are for a particular industry is critical. Everyone knows the Buffett quote of the management team with a great reputation

Starting point is 00:49:08 meets an industry known for difficulty and the industry survives with its reputation intact. Yeah, I think that's critical. Don't bet against tailwinds. I think figuring out who the ultimate end market in pay or is critical. The collision repair business we invested in, we love businesses where the customer, the decision maker is not the ultimate payer. So in that scenario, insurance companies were the payers. And so you would win based on service, reputation, and brand, not price. If you get, God forbid, into a serious collision wreck, your insurance company is paying for it, whether the Dow's at 40,000, 30,000 or 10,000. And I think that's critical in terms of driving a cyclicality. I will say, though, Patrick, I think it's really hard to build a brand, build new companies.

Starting point is 00:49:52 We're not smart enough to do it. Plenty of your guests who are, and that's amazing. say, we're not that smart. We love what we do is we think it's very simple. And the U.S. consumer, what a consumer likes in Texas may not be what they like in Ohio, may not be what they like in Arizona or in California or in other parts. And we have a few of our friends in public markets investing. And it cracks us up. We call it hedge fund math when they're looking at out. Chipotle has X number of stores per head in this market and pro forma run rate, looking at other sort of public restaurant or other multi-unit concepts and trying to apply those growth rates. And it was like, it is really hard to scale these businesses. And for us, when we look at a concept and think about

Starting point is 00:50:29 underwriting growth, the quartile analysis is one of the most important parts of our diligence process. So we try to see how dispersed are the unit economics? Is it quartile one is driving all the returns and is there inconsistency, I should say, in the quartile analysis? And that's because if we're underwriting growth and we're growth investors, is the next unit going to look more like a quartile four unit or a quartile one unit? And we won't invest in concepts that don't have consistent quartile analyses because we just, our view is, again, it's really hard to predict the future. We're not going to take that risk. Yeah, we have a consolidation, a roll-up. We call them regional fortress restaurant brands. It's called Authentic Restaurant Brands. We go around the

Starting point is 00:51:08 country buying these regional businesses that are beloved by their customers and their core geography. We always say if a brand has customers who have tattoos of that brand on their arm, that's an ARB, authentic restaurant brands type of brand. But importantly, we do not take those brands to new markets. That's really hard. Daleks' point just because everyone in Pittsburgh loves Permanati Brothers, which is one of the brands we own in that consolidation, that doesn't mean that people in South Carolina are going to just because perhaps the demos in certain submarkets may look similar. It's also why we tend to focus a lot on purchase price. Our view is if you buy something at a really high in-place free cash flow yield or relative high in-place free cash flow yield to generate a

Starting point is 00:51:48 really attractive return, you don't need to believe that you're taking it to new markets and convincing consumers to try it, meaning if you buy something at 12, 13, 14, 15 times cash flow and you're underwriting making 3x, particularly in an environment where perhaps you can't get as much leverage as you used to, you need to really grow that business to make that return. Whereas if you're buying something for, let's say, six and a half or seven times cash flow, there's just obvious mathematical, obvious reasons. You need to grow it far less to make a similar MOIC at the end of that rainbow. And we're not smart enough to buy things that 20 times EBITDA generate 3X MOYC. off of that. That's really hard. I love how in your deck it says roll-ups are really, really, really, really hard.

Starting point is 00:52:28 Fun to put stuff like that in a deck. So maybe one reason for each really. You've done a lot of these. When people fail trying to do a roll-up, what would you say are the three or four, one for each really, reasons that they fail? One is leverage. Two is integration, not integrating these businesses. Three is a lack of appreciation of culture. And we haven't really talked a lot about this, Patrick. I mean, we've talked a bit about culture at our firm, which we take extremely seriously, talk about our core values, but this is a big part of what we do. We also have enormous respect for the culture at our partner companies. And while we have an entire GSP playbook for how we institutionalize, professionalize,

Starting point is 00:53:04 at data, technology to these businesses, we work very hard to do it in such a way that honors and respects the culture at each of the businesses. And what we've found is in consolidations, too often people just view them as numbers on a page. They just view it as Excel math. But again, these are people businesses and they're real customer relationships that matter. And if you agitate the wrong person, fire the wrong person. We call press the red button, you can blow yourself up. And the other problem is people we found is they fool themselves with this sort of adjusted

Starting point is 00:53:32 EBITDA, run rate EBITDA, pro forma EBITDA nonsense. And in a world of zero rate and with leverage, perhaps you could sell these things like the hot potato to the next buyer. But people forget, in part, the Trump tax cuts, they capped interest. deductibility at 30% of EBIT. So you look at some of these consolidations and you say, how much of that adjusted EBITDA actually turns to cash flow? Okay, how much leverage did you put on this business? Now, rates went up by 500 basis points. Did you buy caps and swaps on the debt? If you did or you didn't, what is your tax rate? How much actual cash flow is there in these businesses? And that's what sort of

Starting point is 00:54:07 scares us about some of these consolidations is how much of the EBITDA that you're underwriting actually turns into cash flow. And we're very focused on that in part because of our makes experience, but also again, we're students of history when you look back at some of the failed roll-ups. I think a lot of it was believing the pro forma's in the run rates. And when you're acquiring things and when you're in super acquisition mode, you can always have those adjustments. The problem is when you say, wait a second, what do I actually own? How much of that is real? And can I maintain the culture at each of these local businesses in order for those cash flows to persist and grow? I don't think I've heard someone say that they write the sales sim as they're doing

Starting point is 00:54:45 deal. And in your deck it says, ring the bell. And there's the opportunity to sell in our target range. We sell. We create liquidity for our investors. That demands the question, what returns are great in this category? And I'm curious, levered, unlevered, any way you can slice and dice it. What defines great in a world where the S&P kind of delivers, I don't know, 8, 9% long term return, something like that, sometimes more, sometimes less, justify illiquidity and fees and all this stuff that comes with this kind of model? What kind of returns are you targeting? And what distinguishes great from good. Look, we always say our mission at GSP is to generate excess return per unit of risk and to do it with consistency. So whenever we're looking at a deal, we price it to

Starting point is 00:55:28 generate a 3x. That's our underwrite, a 3X M. M.YC in five years. We've had 10 exits. The weighted average of those exits has been meaningfully above three. That's happened in a short time period than five years. So historically, we've beat that. We've also had the benefit of investing behind the U.S. consumer for the last decade, which is a terrific place to be for all the obvious reasons. Our view is if you're investing in any of these brands and you can create the new unit for sub three times or you can buy the next incremental bolt on and attractively high free cash flow yield, you should be generating 3x plus. We certainly don't feel like that's heroics. I think it's far more heroic the people who generate 3, 4, 5x outcomes, investing in businesses at two or three

Starting point is 00:56:15 times the going in valuation that we do just because you have free cash flow yield if you're buying something at 15x is going to be pretty low. Super simplicity of one divide by 15, knock off some taxes and working capital and that sort of thing. You need to really grow the hell out of that business to generate a 3x. In our world, perhaps oftentimes because we're starting smaller and a smaller, less diversified business is just fundamentally more risky and worth not 15 times. Our view is we've been doing this for 10 years. We're pretty good in terms of professionalizing and scaling these businesses. We should be able to beat that three X under right. What about leverage? You mentioned several times that you're conservative and how much you use. It sounds like you

Starting point is 00:56:54 backload it. You don't use as much up front. You put maybe put more on later once you've gotten your arms around the business. But what is a normal range of leverage to put on this sort of strategy or this? If you think about at the deal level or platform level, how much leverage do you feel like is appropriate? So for most of our consolidations, we're actually starting with 100% equity. Is that really unusual? I think it's unusual. Yeah, I think it's probably unusual. It's also just because we've done 27 of them and more and more and more from the one that didn't go well, certainly than the other 26, but in large part, that did not go well from leverage up front.

Starting point is 00:57:26 And by the way, had we used more leverage over the last 10 years, at least in Microsoft Excel, our returns would be a lot higher. But we probably wouldn't have the sub 1% loss ratio that we have today. I think that certainly would have tripped us up in COVID. And so oftentimes we're starting these consolidations with zero leverage, but we're entering a start small-scale-fast consolidation at a nearly 20% in place for cash-field. So you don't need a ton of leverage to make the math work. Once we get these consolidations scaled and professionalized to call it north of 10 million of cash flow, then we're back covering the business and swapping our equity cost of capital for debt cost of capital and whatever that is today, 8, 9% or so. And that undrawn development line of credit, revolver, whatever it is, that's enabling us to continue the consolidation and to do it in a really capital-efficient way and to de-risk it because, A,

Starting point is 00:58:19 we've replaced our equity with someone else's capital. And B, the business is bigger, more scaled, more professionalized, and more able to absorb the things that come along with leverage. You guys work together in a fairly uniquely intimate way. You've known each other your whole lives, like you said. So it's like a really cool partnership and set up. When are you two today having the most fun. If you audited the last year, let's say, you mentioned the four things that you do, building the firm, sourcing, fundraising, problems. What would you both say is the most fun part of what you do together as partners? We're really lucky, Patrick, for a lot of reasons, but we have each other. I don't know that it comes across in the podcast, but our partnership is

Starting point is 00:58:59 really special. We value it as much as anything in the world. We believe it's a big part of, certainly a big part of our culture, and we believe it's a big part of our success. And we have a working style that's perhaps not the most efficient in the world. We sit next to each other, or we share an office, we sit next to each other in our office, we take every meeting together, we call together, we trip together. I've sometimes felt bad texting one of you. This just feels like I'm cheating or something. Yeah, exactly. You just know that when you text one of us, screenshot and sent to the other if we're not sitting next to each other. We do everything together, and that makes it really fun. And we really believe in that expression that the low

Starting point is 00:59:37 Those are so much lower than the highs are high, but because we have each other, we do always have fun. Even at the hard days, we're going through it together. Our process is we disagree all the time. So don't get me wrong. We fight all day long. And it's funny for the new members of the team we join this. Sometimes it's like get nervous because it's like mom and dad are fighting. And now everyone has to explain that this is just how it works around here.

Starting point is 00:59:59 And that's very much part of our process. Matt's a crumajun. He's always agitated. He always thinks everything's a disaster. My wife is so fortunate. But we can't figure out whether this started with sort of me being too excited and Matt, therefore, getting agitated because when Matt's really excited about something, I'm agitated, so it's our process is we take the other side of things.

Starting point is 01:00:20 We work with an incredible executive coach, a guy named Jim Kachalk, I don't know if you know Jim, but Jim's amazing. And we've worked together for, I don't know, seven, eight years with Jim. And we work on our partnership. We work on management and the team and our ambitions and culture. And Jim is also part of our process. We don't make any decision unless it's unanimous, right? The investment committee at our firm is me and Matt.

Starting point is 01:00:42 We would never do a deal unless we both agree to it. If one of us doesn't want to do something, we want to hire somebody who doesn't want to go on a trip, we don't go. Matt's very funny. I hate to admit that, but he has the same jokes. They're all the same. You get to know him better about you. They're largely the same. And yet for some people are still.

Starting point is 01:00:57 They are. Scares the team sometimes because he's extremely serious. The guy has a photographic memory. He's like mental math in his head, whatever. But he can go from just totally joking around and very, very, very funny and making fun. There's a mistake. Page 7.

Starting point is 01:01:10 Screaming it. It's wild to watch. Probably hard to work for the two of us because you don't have one person. You're working for two, but you don't say. We're very lucky to be doing it together. I would say the most fun part

Starting point is 01:01:20 is that we get to do it together, doing this shoulder to shoulder side by side, which is awesome. I would say the other most fun part, I think you agree with this, Alex, is getting to know the entrepreneurs, getting to their families, and then figuring out with them

Starting point is 01:01:35 what the path of success is. And we've been fortunate that we've had some unbelievably impressive partners over the last decade and just getting to know them and seeing whatever the creases in terms of what the opportunity to grow and scale their business. And for whatever reason why they need someone else's help or counsel or capital or whatever it is, that's super fun. And then ringing the bell with them at the end of that rainbow. It's a great point.

Starting point is 01:02:00 I was listening to the Brad Jacobs podcast with you. And he made a point that he doesn't buy businesses from people he doesn't like. that's so rang true to us. We won't hire an asshole. We won't do business with jerks. Life's too short. So much of our process is building that relationship with these founders. Because when you think about it, we're partnering with people for whom their business is their identity. They're part of the social fabric of their communities, their families work in the business. Sometimes they are second or third generation part of the business. And it's a extremely big deal for them to take on institutional capital and partners. For us, so much of our

Starting point is 01:02:35 Our process is building that relationship so that when we do invest, we're very close to our partners and very close to their families. They're close with ours, and we have a whole program for spending time together. And again, I said it takes three years when we start working in an industry until we get a deal done. Sometimes it takes three years and up from when we first meet a partner until we get a deal done. So much of our diligence playbook is building that relationship to make sure that after closing, we don't destroy that culture with our playbook. We haven't talked that much about the playbook, but on average, we're enhancing same store sales, organic growth by four to 500 basis points

Starting point is 01:03:14 from pre-closing to post-closing. We're enhancing margins by 250 basis points at the store level. We're redeploying cash flows at a 20 to 40 percent return on capital. And these are businesses that typically when we first invest, the founder thinks about success based on how much cash they have in their bank account at the end of the year. And we totally flip that mindset. We say, success is how many 25% plus IRA projects can we possibly find? It's a huge part of our playbook, new technology, new ways of doing things. And how do you do that without destroying the culture? So much of that work is done up front. The other best part, I guess there's a lot of best parts. It's like Howard Marx is the most important thing. There's like 40 things.

Starting point is 01:03:53 Over and over. Yeah. Is seeing the incentive structures that we put in place alongside the family or the CEO payout. We do all the obvious stuff in terms of management option pool and that sort of stuff. But over the last 10 years, we've come up with, I think, additional creative ways to incentivize people. And for example, for any team member, CEO down to regional manager, every new dollar, not roll over, but every fresh dollar that they write into a deal, which is obviously same security as us side by side with our security, we give them one-to-one additional options on that So put aside your base management option grant. If you write a check, not roll over, if you write a check for another 100 grand, we will

Starting point is 01:04:35 give you on top of that another 100 grand in terms of option allocation. And seeing people do that and then three, four, five years later when it pays out and holy shit, it worked. That never gets old. It's another added benefit of selling businesses. Quite refreshing. So many people are, we want to hold this franchise forever and power law this and we're not power law people.

Starting point is 01:04:58 Sounds great. We're more driven by consistency, and I think it's part of why we've never had a zero. We certainly don't plan to. But if you look at our returns, it's the opposite power law. Our view is not every business is meant to be grown to the sky. Not right, exactly. Not every business is a hundred bagger. Dan, it's who we talked about.

Starting point is 01:05:17 Dan, Dan has his line that you don't actually know until after you've owned the business, whether this is a business you want to own for a long time. I don't know that you guys have had that conversation. It's one that he said to me years ago that really stuck with me. There are certainly businesses in the portfolio that we want to own for a lot longer than the three and a half years that is historical, but we're operators. We ran our burglicking business. We know how hard it is. These are people businesses. We know how hard is to run these businesses. We're very tuned to cyclicality and the challenges. And we also, we want to have a reputation as good sellers of businesses. One of our mentors who built a big investment firm taught us that early on. This is a repeat game for us. And obviously, there's a limit. We don't want to be the schmucks that we're the next buy. buyer makes a hundred times their money every time. We typically roll over a turn of MOIC to benefit from the continued compounding. But we really do want to be known as someone when you buy a business from us, you're going to do well with it. And it's set up for success and to win because we plan

Starting point is 01:06:10 to do this for the next 50 years. What this feels like to me is that you are general contractors that unlike most GCs have also had experience at each line of the subcontractor jobs. Maybe it's because you did it together. You started young. You had to figure it out. But you weren't doing this at some big firm with plenty of resources and then just recreated that setup at a new firm. You had to build it brick by brick. And that gives you this ground level experience. I'm guessing it makes it very hard to bullshit you in diligence and things like that. And it makes me wonder about innovation. You mentioned that each of these businesses is really driven by real estate or rent, cost of goods, and labor. And so maybe that's an excuse to talk three times about innovation.

Starting point is 01:06:50 What do you think is the trajectory of innovation in these three areas? You heard a lot about Domino's Pizza or something being amazing at technology that makes the things run better, and that's innovative. But at the end of the day, I'm still doing something and a pizza shows up and eat the pizza. The product innovation seems less. Maybe I'm wrong about that. But talk about the vectors of innovation as you see it, having been so close to the ground truth in each of these categories.

Starting point is 01:07:13 It's funny as you mention Domino's because Dennis Maloney, who ran digital and technology Domino's for 15 years and it was responsible for so much of that is one of our operating partners, is on number of our boards and is incredible. tech adoption is a huge part of that GSP playbook. It's a huge part of that same source sales growth and margin enhancement that we talked about. For us, though, it's not inventing new technology. It's asking the folks like Dennis to join our boards and to help us think through for this business. What is the best in the world tech stack that's out there and let's go adopted and implement it at the businesses. Marketing is another example. We have a guy by the name of Fernando Machado,

Starting point is 01:07:53 who's an operating partner for us. Fernando, To ask anyone in the marketing world, Fernando is widely considered one of the great marketing executives globally. We first met him when he was working for Daniel Schwartz at Burger King, winning every award around the world, building tons of value for RBI and for franchisees. And having Fernando on boards and helping us think about diligence, questions as simple as we were talking the other day about our wow car wash business in Las Vegas and whether they should sponsor the local hockey team and how to think about that, how to price it, and what the sort of strategy is. for typical small businesses with eight figures of Eibita, they don't have access to people like Fernando to help. It also talked about rent, and that's another area we do love to talk about, because most people look at rent and they see a fixed expense. But the reality is it's just a contract. It's like anything else. It can be renegotiated. It's an area where you can create tons of value. These businesses, particularly where we do business, which is not major metro, whether it's a funeral home or a Burger King or a car wash, if our brand doesn't work,

Starting point is 01:08:53 there, unlikely that another brand is going to work there. So you actually have a fair amount of negotiating power with the landlord. And then these are just contracts. They're typically from the beginning, 20-year contracts, but things happen and they change and perhaps the Walmart moved away, but maybe they've moved closer. Maybe Chick-fil-A has come in and taken some market share or another car wash brand has built on you. And most people we find look at rent and they said to fix expense. That's a contract you can renegotiate. And that doesn't just mean you can lower the rent. maybe you actually can increase the rent. But in return, the landlord will pay to remodel your location or there are other terms of these leases that sort of coming back to the earlier franchise

Starting point is 01:09:29 negotiation point that we know really matter to landlords, things like where is the guarantor, what is the term of the lease and how much financial reporting requirements are there. And then there are 1031 buyers, sort of moms and pops, doctors, and lawyers, and then there's the re-market. People sort of look and rent and they say it's fixed, but in fact, that's actually a huge area, value creation. And it's also funny. Investors, LPs we've found, don't love to hear people, at least in our experience, GPs talk about financial engineering. That's fine. But one of the things we love about the areas we invest and in the financial engineering opportunities. We talk about purchase price matters and structure and rollover and liquidity and leverage. So at least back is a

Starting point is 01:10:10 great area to create value when you're not growing earnings. We typically use the real estate proceeds to de-risk part of the DPI and returning capital to investors and shareholders. Part of the reason why we do love this part of the market is in addition to all of the tech and data and management, things you can do to grow the businesses, there's a fair amount of financial engineering you can do it to de-risk and help with safety principles. Often do you own real estate or does the thing you're buying on real estate that you then sell or you want to buy the real estate or you don't? Does it differ by a category type or theme type? Say a little bit more about the actual ownership of the asset, the real estate asset itself.

Starting point is 01:10:42 So we're rarely holding real estate for long periods of time. Alex alluded to it, but there's a pretty different cost of capital between our operating companies and the landlord. Every business we own has a lease. And at the end of the day, that's just effectively off balance sheet financing vis-a-vis the landlord. And perhaps cap rates in our world used to be five to six, and now they're seven to nine. But the inverse multiple of five or six cap or a seven-to-nine cap is still meaningfully above where of our operating companies are created at. If it's a seven cap, that's about 14x. We're not buying any of our businesses at least today for 14 times. And so there tends to be a pretty big gap in terms of financing costs and potential value creation to be had if you can shift

Starting point is 01:11:28 some of your operating company cash flow into what looks like a property company cash flow. And so we rarely buy businesses that have real estate upfront because it's a perfect market, sophisticated sellers or pricing that appropriately, what we do oftentimes is either we're figuring out through diligence how many of the leases are perhaps below market in terms of what their rent level is. Maybe the Walmart moved closer to you five years ago and now your sales are two million instead of a million and so the rent looks lower than it could or should be. That means you can buy back that property, reset the rent to a higher amount and capture the spread between selling that cash flow at a six cap and having created the portfolio company for six times, the difference between

Starting point is 01:12:13 18x and 6x there. Or oftentimes, a lot of what we do is building new locations. And in that scenario, there's a multi-trillion dollar development industry that exists to capture the spread between development costs and exit costs. And our view has been, why shouldn't we capture that? And so a lot of times we'll buy a piece of land for X million dollars. We'll develop the site on it. And then we'll turn around and sell that piece of land in a sale lease back to a 1031 or a reed buyer. And that not only reduces your all in build costs, perhaps from up four or five times creation multiple, down to a two or three times creation multiple, but it provides for more liquidity because you're getting that capital back.

Starting point is 01:12:53 You can decide to reinvest it in the next unit, either buying or building, or you can de-risk your equity by paying out a dividend and increasing DPI. We're able to do this and take advantage of it across the portfolio, in part because that arbitrage works because we're creating the Opco cash flows inside of that for 14 times in the example that Matt gave before so that there is arbitrage. It's not always the case in multi-unit investing in part because if you're buying the platform at 15 times EBITDA, that arbitrage doesn't exist. But about the labor side, I remember doing research for an investment one time and some stats about labor turnover. And first I thought it was annual turnover. And then it turned out the day was

Starting point is 01:13:31 actually weekly that we were looking at. Insane falloffs. And someone that shows up for one shift that then doesn't show up for a shift the next week or something. So management of the labor force seems like, one, incredibly hard and two, therefore a critical part of margins and whether or not this thing works and a risk factor and all these kinds of things. Is there innovation in this part of the world and just maybe what's your general commentary on the labor force that makes these things go and how difficult that is to manage? So if you look at the average location we own, every time we have to retrain somebody or train somebody a new employee, because of turnover, it costs us about $3,000 to $5,000 to train them because they're not

Starting point is 01:14:10 productive for the first amount of time. And you do that across 20 to 40 people per location times 12 months in the year, times a couple thousand locations. And you pretty quickly realize that the more capital you can deploy to lowering turnover and recapturing that three or five. It's like the highest ROI you can have, exactly. And so in addition to incentives and paying people more to retain them to drive guest satisfaction, which drives sales, which drives more money through the door to pay people more to retain them. There are a number of tech solutions that we utilize where you can have more frontline employee engagement and ensure that we're doing everything we can to lower turnover. And if you look at the fast food business, for example, industry average is north of 100% turnover.

Starting point is 01:14:57 So we're not being unrealistic and saying we're not trying to bring that down to 25. but if the industry average is 130 and we're at 110, that 20 percentage point gap is worth an unbelievable amount of money to us. It is one of the benefits of investing in businesses that perhaps are 15 or 20 percent EBITDA margin businesses and not 45 percent margin businesses. Obviously, 45 is better than 15. But the difference being if you take a 45 percent margin business and you make it 48 percent, you certainly have grown equity value and that's great. But if you take up 15% margin business and you grow up to 18%, that has a far more outsized impact on the underlying equity value just because the swing as a percentage in terms of EBITDA growth

Starting point is 01:15:38 and overall free cash flow conversion is much more meaningful. And that's where we play. Now, the truth is also on the reverse. So operating leverage works both ways, obvious statement. We've found over the years the best predictor of success in a multi-unit business is the tenure of the general manager. And that is in part why firing people and hiring new people, or having a culture like that, that's really not the answer in our experience. And so much of

Starting point is 01:16:04 what we believe good management is focusing on our people, focusing on training, focus on we talk a lot about incentives, bonus plans. Turnover is something we spend enormous amount of time on our best CEOs, have industry leading turnover statistics. And part of their KPIs and bonus is related to their underlying business is turnover. I'd also do a lightning round of some themes. and in each theme, what I'm really curious about is why you think it's interesting, and also the things that matter as you're looking at them. So in each of these cases, I think you believe in the beta of the thing, but then there's lots of choices within that category that you might invest in. So what are the attributes that you would pick one and not pick the other? So maybe we'll start with auto services, because we talked about that quite a bit.

Starting point is 01:16:44 So, yeah, why auto services and what within auto services are the attributes that you think drive success? We love auto services businesses that take advantage of the fact that the U.S. as an 11-a-half-year average age of car on the road. This is a car economy. There's almost as many cars in the country as there are people, and they tend to be very old. And so we like auto services, businesses that take advantage of both the age of the automobile, the car park in the U.S.

Starting point is 01:17:13 and the fact that for the majority of the U.S., a car, particularly in 2024, is their largest asset. And they're going to be inclined to need to fix it to get to work and that sort of thing. and we focus on mission-critical auto services businesses. And the one business we lost money on that we referenced earlier, that was focused on what we call cosmolition, cosmetic collision, or changing the paint color of a car,

Starting point is 01:17:36 things that are discretionary and cosmetic. Today, in auto services, everything we own and invest in is mission-critical, and it tends to be paid for by the insurance company. We also look for how will technology impact these businesses. And so you look at EV is an EV adoption. We don't want to have to take a view about EVs. adoption curve. That's, again, we're not smart enough for that. We'll leave that to somebody else. And so when you look at, for example, collision repair centers, you feel pretty good regardless of

Starting point is 01:18:01 EV adoption. Just when you look at the cost to repair these cars, the trends are very much in your favor. You look at tire retail, which is where we have a consolidation today. In fact, EVs, the torque is actually harder on your tires than non-EVs. And so that's a business we believe will persist or some sense benefit from EV adoption. Same thing with car wash. Irrelevant. So we are very much afraid of Amazon risk or technology risk. We're trying to take a bet one way or the other. What about health and wellness? It's a tough place to invest, actually. So we love health and wellness. It's real tailwind. It's very much on trend. Jims are a challenging place to invest. We've made a number investments there, mostly in Planet Fitness, which is a gym franchise or the largest one.

Starting point is 01:18:40 But when you think about we're very much afraid of fad risk. So we talk a lot about how do businesses perform through cycles. We're afraid with gyms, even though the unit economics can look really good when they're working because you just don't need a lot of people working at a gym. How do these businesses perform over time and how do new entrants impact these gyms? We're very afraid to invest in the next curves, which had X amount of thousands of units and 10, 15, 20 years ago, and today obviously does not. One of the reasons why we like Planet Fitness, it's so big. The ad budget is so much bigger than the next five guys combined that there's a real moat in terms of the fact that they have 20 plus million customers across the U.S. and the brand really,

Starting point is 01:19:19 does mean something. What about early education? That's one that popped out of me. Quite a lot. It's multi-unit business. Weary of regulatory stuff and where the government reimbursement is. We're always looking at how do these businesses perform through cycles. So, and importantly, we have zero government pay or exposure across portfolio. We're afraid of fad, similar sort of fad risk there. We're afraid of how these businesses perform in recessions and through cycles and over time. And that's a business where your people, similar story, but maybe even more extreme. The customer experience and the people part is extremely important there whenever you're dealing with kids. So we love the category, but there are a number of things to watch out for. What makes you like it, setting aside the risks?

Starting point is 01:20:02 The secular growth is unparalleled. There is just more people spending more money every month to put their kids into extracurricular programming than there was the same month last year. And that's been consistent, obviously take away a few months from COVID over the last 10 years. And the vast majority of the growth in that category has been driven by traffic, not priced. You can't ignore that. You have to spend time on it. You talk a lot about selling. Talk about the buyers off another private equity firms. What do they want? What are they then going to do? There's got to be return left on the table for them, obviously. Talk about this interesting chain of this capitalism chain, so to speak, where you're doing one specific part of the value chain, but then you have key

Starting point is 01:20:41 relationships with upstream buyers. We haven't really talked much about that. So you don't have to name them. But if you just think of the concept of a buyer that you've sold to before, who are they? How big are they? How much money do they manage? What are they looking for? That sim that you imagine when you buy the business? What's the perfect sim to them? Help us get in the mind of the person that's buying these things from you. So we have, call it, 2.3, 2.4 billion of AUM. On average, we are selling these businesses to people who have two to four times that amount. So they're five to $10 billion private equity firms. We are typically scaling these consolidations up. to call it 15 to 40 million of free cash flow. That's where we found is a real sweet spot where you have

Starting point is 01:21:22 just very large addressable market of potential buyers. You have all of the U.S. middle market that spends time in these businesses looking at them, and you even have some of the larger guys who are coming down market to start a consolidation and then grow it dramatically. So we build these businesses up to 15 to 40 million of EBITDA, and then we sell them to larger private equity firms, I think in large part what they're looking for is consistency, professionalization, and scale across multiple markets. And at least in our roll-ups, we've gotten paid historically to show that it works not just in one micro-market or DMA, but that we have a consistent track record of doing it across market. So we'll start a roll-up that's in two DMAs and four

Starting point is 01:22:04 years later. It's in seven. And importantly, the band of outcomes within those seven DMAs is very narrow so they can underwrite. Yes, I'm going to pay a higher price on a free cash yield basis or a lower free cash yield basis than perhaps these guys created it at, but they've built the professional engine for me to take this business from 50 to 200. And we've gotten paid from taking it from 15 units to 50 and we're more than willing to roll over a turn of MOC and be as helpful as we can possibly be. We've stayed on the board several times of businesses as we've exited to larger private equity firms, all of which have gone so far. And I think that their view is these guys have de-risked this platform in terms of it's professionalized. There's a

Starting point is 01:22:49 really healthy tech stack. It's diversified across several different markets. They can lever it in a way from day one that we didn't feel comfortable doing when it was a fifth the size. So there's just a natural return that comes from the cost of capital arbitrage there, obviously. And then they're betting on the fact that we took it from 15 to 50 locations and they can take it from 50 to 200. We've learned so much from staying on the boards of businesses that we've sold and rolling over and watching some of these firms and how they create value. And our goal, anytime we travel, we make a point to go see every one of our competitors, even if we're not traveling for that business and discipline we learned early on from incredible operator in franchise world was very easy

Starting point is 01:23:29 to hate on your competitors. The goal in every single competitive site visit is to take three nuggets, three positives. You can't walk out of a competitor without seeing three positive things from that site visit. We do the same with sponsors. Sometimes we'll joke that you don't want to meet your heroes because we feel good about proud of our own firm, but we always try to take what are the positives away from it. And every one of the boards that we've been involved with and the businesses we've been involved with after we've sold the business, we've learned a lot that we can then take to our businesses. What do you think of the major risks to your franchise? So you've achieve one level of escape velocity, right? You've got big teams, sophistication, history,

Starting point is 01:24:06 data, you've got all this stuff that would make you better suited to be a buyer than the next 26-year-olds at HPS or whatever. So you've gotten to a certain level, which is awesome, but very often from to that level start thinking about, we don't want to lose this position. So we think about risks. What would be the things that would have to happen in order for historical returns, which have been in excess of your targets, to somehow be way below your targets, even if you're working your passes off and your team's great and you do sourcing well, do all this stuff. What do you think would have to happen for forward returns to be materially worse than past returns have been? We believe our culture is a huge part of what has driven the returns and what allows us to win

Starting point is 01:24:44 deals and build value for our partner businesses. And Matt and I are very focused that as the team has grown, we have 25 best professionals, 20 operating partners and operating executives, got a team of 11 in the back office. How do we maintain that culture and make sure that we maintain the ownership culture, the values that we believe have made us successful. And we send every year our two favorite books as a holiday gift to all of our partners. And one of them a few years ago was the Michael Dell autobiography, Play Nice But Win. It's a book we loved. And one of the takeaways from that book was as he was growing his business. He felt that the challenger culture was what allowed him to win against the sort of coastal larger players. And he wrote down his core values and he sent it out to

Starting point is 01:25:27 whole team. That really inspired us. We did the same thing and our core values document hangs in the bullpen in our office. We send it out every quarter along with our quarterly letter. We talk about it all the time. Maintaining that culture for us is the thing we worry most about it as we grow and we're extremely focused on it. That's right. The only other thing I would add is I think to the extent we've been successful over the last 10, 11 years, we've been able to price quality and sometimes that means X free cash yield and sometimes that means a lower free cashier yield for higher quality. And I think to the extent that we can continue to price things well and not overpay, I think that's driven a lot of the results so far. What do you think is the most unique thing about

Starting point is 01:26:07 how you source relative to others? I think a lot of our best deals come from the virality of relationships within the portfolio itself. We've had a number of really successful deals and ultimate outcomes that were sourced by relationships driven by CEOs and founders that we had previously done business with. That's gotten a lot easier today where we have 27 of those people times X amount of network and Y amount of phone calls versus seven, eight years ago, there were five of them. Our goal is to be the capital partners of choice for founders and business owners around the country. And that is how we built our firm. And that's how we approach every relationship. It's a repeat game for us. Part of why we tell founders, we're going to disagree and

Starting point is 01:26:57 they're going to be ups and downs. But if we screw you somehow, it's not just about this one deal. It's about how you talk about us in the market. And we give a list to every prospective partner of everyone we've ever done a deal with. And we say, call them all. And we encourage them mostly to call founders and partners of companies we've sold so they can see it all to work with us. There's no longer any sort of incentive for them not to tell the truth. And what they'll say is we do we say we're going to do and we work really hard. We are difficult. We're rigorous. We're analytical. There are bumps in the road, but our incentives are aligned and we have fun along the way. The other thing which relates to that in terms of sourcing deals is we're relatively young. We're both

Starting point is 01:27:39 in our 830s. And a lot of people who graduated college at a similar time period that we did, we graduated during the GFC, the world's been pretty up into the right since then. There's been a lot of investors who have incredible track records since then and how much of that is beta versus alpha. A lot of it tends to be levered beta. And I think we're smart enough to know that we have massively benefited from that. And because of that, we are students of history. You've seen some the books in our office and we've sent you them. We have pretty much every finance book written from 1979 to 2023. We read them religiously. We reread Predator's Ball, which is the story that started them all every January, and we have a very healthy appreciation of cycles. And having an

Starting point is 01:28:23 appreciation of that and how it informs capital structure and valuation and liquidity, I think we have a better appreciation of that than most people our age, and certainly not nearly as good of appreciation of it of people who have lived it. But fortunately, we have mentors around us who have. Why do you read Predators Ball every January? I think that people our age don't have a full enough appreciation for what Michael Milken both built and set into effect in terms of his creation, in terms of high-yield securities, spawned the ability for private equity to exist at the speed, size, and scale that it is today. And we always get disappointed when we interview younger people, and we ask about that time period, and they look at us like blankly. And I think a lot of the

Starting point is 01:29:09 thoughtfulness of that era, and obviously there were accesses too, but a lot of the thoughtfulness is lost amongst people in their 30s and 40s today. And I think it's important to reread that and appreciate it. And it's inspiring. You had people in that book who were our age who built some of the most incredible, successful companies on earth when they were even less experienced than we were at the time with far less of a roadmap. We stand on the shoulders of those giants and benefit from that. They didn't have that. You mentioned how pioneering they were. What is your philosophy of cap structure? Because so much of what Milken did was, I guess, create the opportunity to have a philosophy of cap structure in the first place. You just had to go all the way

Starting point is 01:29:47 to the 30,000 foot view on capital structure. How would you sum it up? I think I would sum it up in terms of liquidity in downside scenarios is always worth more to you over a longer period of time than max leverage is in an upside scenario. And what does that mean for us? That means entering with low leverage. That means never maxing out firstly in debt capacity. On the downside case, first lien debt is by far are the easiest thing to raise, particularly if you have baskets and caps and availability for it. And when Microsoft Excel maximum leverage works wonders in real life, it can lead to poor decision making and zeros, both of which we actively try to avoid. You've said cycles so many times, maybe it's just an opportunity to ask what that means to you.

Starting point is 01:30:31 Is that just variance in demand for lots of different reasons? If you had to think about what is a cycle, why do you care so much about cycles? How would you describe it? Yeah, I think a couple of thoughts on cyclicality. One is private equity, at least in the U.S., has a tendency towards recency bias, both in terms of what they think the underlying cash flows of a business is. The distribution of outcomes tends to skew towards what's focused a lot on the last 12 months and less so on three years ago in terms of underlying earnings, as well as what is the right

Starting point is 01:31:02 multiple for this business. It's the last 12 deals of traded at X, so it's probably close to X. I think both those things ignore that, at least in our world, where everything we touch is the U.S. consumer, there's cyclical elements to both those things, both in terms of the underlying cash flow and what the appropriate market multiple for these businesses is. And so we like to diligence not only the earning streams over cyclists, but also the valuation across cycles. The other reason why we're so focused on cyclicality and probably because our portfolio was so in the eye of the storm of COVID is never waste a good crisis. Some of our best deals were

Starting point is 01:31:37 done in April of 2020 in the depths of the COVID crisis. And God, less undrawn debt financing and committed equity capital, but we have the luxury of being able to go on offense at those times. And that's where, at least in our experience, you can really generate the excess return per unit of risk you're taking. And we certainly wouldn't be able to do that in 2015 as much as we can in 2024 because we didn't have a fund back then. We didn't have committed capital. We probably weren't able to get the size of undrawn committed debt facilities as well as obviously equity as we can today. But today, with 2.3 billion of AUM, tons of undrawn capital, both in the fund and the portfolio level through Delox, development lines of credit and that sort of thing.

Starting point is 01:32:22 Shame on us if we can't take advantage of crisis. What's the closest you guys have ever gotten to like a terrible argument or a terrible disagreement between the two of you and all these years? We disagree every single day about everything. That's the process that hopefully drives, at least the outcomes we've had so far. But I would say it's never personal, but it's always personal because we know each other so well. But in a loving way, like here is your bias that you're bringing into this,

Starting point is 01:32:48 you effing idiot. And because we've known each other for over 30 years, you can say those things and go out to dinner that night, and that's Tuesday. You have to remember, we have three meals together, four days a week. Every Monday through Thursday,

Starting point is 01:33:01 breakfast, lunch, and dinner every single day for 11 years. There's things that I could say to him that if I said to my wife, I'd be living on the street. And what are we doing Fridays? We have breakfast and lunch on Fridays, but not every Friday dinner. It is very special, and we're very sensitive to it. Very sensitive to Matt, and Matt's very sensitive to me. But that doesn't mean we don't scream at each other.

Starting point is 01:33:20 And I do think I give Jim a lot of credit for that because we work at it. We work very hard at our partnership. We've been through a lot together. Our partnership is extremely solid, and we have the confidence to know how important that partnership is for what we do. I think we also both recognize that there's a zero percent chance we could do this by ourselves. Some people can find that incredible to be able to withstand the woes by yourself and still fight back to the highs. I couldn't do it. I think Alex would agree that he couldn't do it. And having the other

Starting point is 01:33:51 person to balance, yes, this is awful, but here's the light at the end of the tunnel and we got to fight. And by the way, you have to fight. There's no alternative. If we were ever very low at the same time, that'd be really bad, but that hasn't happened yet. I've been in scenarios with you guys and your LP investors a few times. And I've been in lots of those scenarios with lots of other combinations in my last 15 years. It stands out that you have a notably good relationship with your LPs, both professionally and personally. Maybe just say a word about that. What drives out how intentional that is, how you think about that side of the business? It's one of your two customers, right? We work for LPs. And one of our core values is accountability. We say,

Starting point is 01:34:32 all the time in our business, LPs, LPs, LPs, we work for LPs. Everyone in our team knows that. We talk about it all the time. What isn't the best interest for LPs? That's why we're so focused on alignment and not taking fees or anything else that's in any way not aligned with our LPs making money. And so we view that relationship is extremely important. We're also, again, we mentioned the word cycles a lot, but we want LPs who really understand

Starting point is 01:34:57 what we're doing and what we're building and appreciate it. and who will understand that in cycles when things inevitably, recession comes, sales decline, who are going to be excited to invest additional capital behind our platforms when we call additional capital or say the opportunity is there. And so that's part of why we spend so much time on our quarterly letters, not just the sort of intro few pages, but also company by company. It's why we spend a lot of time with our LPs and our partners. And we really want them to understand our investment philosophy,

Starting point is 01:35:30 how we approach the businesses, the management teams, so that we can do this for the next 50 years. We've benefited massively from our LPs over the last 11 years, and we were originally put in business by a number of family offices of people who had built asset management firms, and those people have, I'm sure,

Starting point is 01:35:50 forgotten more about investing than we'll ever learn. And we did and continue to lean on them and rely on them for everything in terms of guidance and mentorship and being as thoughtful. possible about building the team and whatever the problem children in the portfolio are. And Royce Yudkopf, who is our HBS professor, or professor of business school, rather, who founded Abrey, he was the RY in Abrey. He took us under his wing 12, 13 years ago and forever

Starting point is 01:36:17 changed our life by his guidance and introducing us to Abri LPs and just being there for the darkest days of COVID on the phone. And we wouldn't be here without people like that. managing other people's money is an enormous responsibility. We take that responsibility extremely seriously. We don't just view it as, oh, we're providing a service and they have to invest it somewhere. And not a supplier. They're a customer. And we are extremely customer focused. And we're also, all of our money is invested in our funds every dollar we've made. And we're terrified of our wives, whom we love. And we take the responsibility of managing other people's money extremely seriously. So spending time with them getting to know them making sure they understand what we're doing

Starting point is 01:37:00 and how we're doing it and our approach to it, I think it's just a part of that. Was the comment about it being terrified of our wives, them thinking that we're over-allocated to our funds? Because mine does. Good excuse to ask my traditional closing question. I get two answers. What's the kindest thing that anyone's ever done for you, each of you? For me, and I know Matt will agree, the kindest thing anyone's ever, done for me is my parents and how they raised me and my siblings. Matt was raised similarly, but I was given every advantage growing up education otherwise. My parents still are extremely involved and dad was on the board of our school and went to every game and parents helped us

Starting point is 01:37:39 with homework. They were home for dinner every single night, very loving, supportive family role models. They were also extremely tough in their bar for success, ambition, hard work. was always extremely high and is extremely high. And we're forever thankful to them for our siblings. And we talk to our parents, our siblings, our family, each other every single day. And we're forever grateful. Yeah, I would certainly agree with that. My parents are as important, impactful, meaningful, and motivating as Alex is, who I know very well and loved dearly. My wife and Alex's wife have also picked us both up off the floor many times over the last 11 years of doing this together. and we'd be broken destitute certainly without them.

Starting point is 01:38:24 I do have to add one of the best learnings from my parents was picking the right partner. And certainly my wife, I'm not sure I could say I picked her, she more picked me. I'm forever grateful to my incredible wife, but also partners in life. And Matt is much more than just a business partner. This is family, and I want to make sure I add that to the list. I also should mention my wife has known Alex longer than I have. They went from preschool through college together. And true story.

Starting point is 01:38:47 GSP is her brainchild. She was the one who really suggested we start working together 12 or 13 years ago. And then look, the guys at RBI Restaurant Brands International who owns Burger King, they gave us a shot to enter their system and become franchisees when every single other Tier 1 franchisee or shut the door on us when we were 26 years old. And I don't think they did it out of the goodness their heart. I think they thought that we were on to something and we could help them consolidate their system and grow their royalty stream.

Starting point is 01:39:15 but we are forever grateful. Dan Schwartz, Paul Freiburg, Alex Macedo. We simply wouldn't be sitting here today had they not seen something in us back then. It's so true. Paul Freiburg, who's been my mentor for 20 years and was on the board, Daniel, Josh, Cobza as well, Mesaedo. And Brian Feinstein, by the way, I know you know and have interviewed who was extremely helpful in that as well. If you enjoy this episode, check out joincolossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources

Starting point is 01:39:45 to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.

Invest Like the Best with Patrick O'Shaughnessy - Matt Perelman & Alex Sloane - The Art of Franchise Investing - [Invest Like the Best, EP.393]

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