Invest Like the Best with Patrick O'Shaughnessy - Robert Smith - Investing in Enterprise Software - [Invest Like the Best, EP.291]

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Starting point is 00:01:04 software all in one place. Ready to accelerate your business, learn more at brex.com slash best. That's bR-e-X.com slash best. 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 O'Shaunacy Asset Management.

Starting point is 00:01:48 All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunacy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaunicee Asset Management. may maintain positions and the securities discussed in this podcast. My guest today is Robert Smith, the founder, CEO and chairman of Vista Equity Partners. An engineer by training, Robert started Vista at the turn of the millennium and built it

Starting point is 00:02:18 into one of the world's most successful software-focused private equity firms. We discussed the white space left in enterprise software investing, the importance of capital cycles, and what he's learned building an iconic investing franchise. Please enjoy my discussion with Robert Smith. So, Robert, I was towing with where to begin our discussion. And because we're in such an interesting market for software companies, let's say if you just looked at public equities where multiples have come way down, my first question is one of perspective. You've been investing in software, maybe more specifically enterprise software for a very long time. I think if you have to find the right pond to fish in, you found this pond earlier than most, maybe just lend some perspective to us on what this market looks and feels like to you versus your long history backing these sorts of businesses. The whole reason I even got into this space, I started my career as a chemical engineer, you know, was at a time when we were really doing some interesting things in that area.

Starting point is 00:03:14 And part of it was we were digitizing the operational elements of what we call unit operations, i.e. running plants and facilities, et cetera. And we're going from an analog model where you're what I call observing an event might be a reaction or state of reaction, and then making an adjustment, adjusting various inputs to modulate that reaction. Well, when you introduce computing technology into that environment, you go from an observation being episodic or periodic, depending upon who's the operator and what they happen to be thinking about at that moment in time or human foibles. Yeah, exactly, literally, to you're actually measuring the outputs of a system thousands of times a second, which gives you.

Starting point is 00:04:00 the ability to then make changes to the inputs at a similar rate. The nature of that is it actually eliminated a tremendous amount of waste in process industries. And then once Moore's law kicked in computing capacity became more readily available and the insights and the skill sets of people like myself and others expanded through our colleges and university systems, we were able to bring that productivity into the broader industrial environment and then, of course, the office environment, where we went from doing things quite manually in the office environment to automated things as simple as word processing and calculations and spreadsheets and ultimately utilizing things like artificial intelligence to aid and decision making created massive efficiency in productivity in our

Starting point is 00:04:48 economy. The insight around all of this was, well, at the end of all of this, but as enterprise software, business software that ultimately has now been identified as the most productive tool introduced in our business economy over the last 50 years and likely for the next 50, we as Vista were the first to really stand up a business to really invest just in that space, enterprise software, not consumer software, but enterprise software. These businesses, as you know, would come to rely on these systems that are governed by software to manage the day-to-day workflows and to bring additional efficiencies to their existing workflows. And in many cases, because of the way that this industry, I'll call it Artesian's data,

Starting point is 00:05:34 can bring new insights into either products or services or solutions or even different workflows that hadn't been conceived up before. The whole idea and conceived around it was, how do you bring, I call it an engineered approach to investing in this space called Enterprise Software, which actually is a ecosystem into itself. If you think about the percent of the time that a given person that's a professional working somewhere spends in some form of software, it's crazy high. I don't know what the percentage is, but it's really, really high.

Starting point is 00:06:05 And I think about it almost like an oil well or something. How much is there left to mine or extract of people's time and their workflow? And my question is, how mature it feels to you in the world of enterprise software? Like, in the one sense, we're all using software all the time. So it seems like it's a penetrated story, like lots of people use software and their daily work all the time when you got started. That probably was much less the case. As you think about the next 50 years, what drives that? Do you share that sense that there's some saturation in this market? We'll talk about the business model and a million other things in a minute, but just at a high level, how far into this does it feel to you? Not to be too much of a cliche, but we are in the early innings of this. You have to remember in the early days the access to computer. power was the rate limiting step. It was like, who could afford a computer, governments and large corporations and ultimately universities, et cetera. And then you went through the micros

Starting point is 00:07:00 and the minis. And now the next generation of this, the superscalers, the hosted computing systems, cloud computing is how people really think about it. What that has done in many cases, you look at some of these businesses that have multi-billion dollar valuations. All they really did, in some cases was to digitize a manual workflow. There's some that you can think about now for managing sales flows. Before you had a bunch of salespeople sitting around and they put together their information about, oh, yeah, all right, here's what I think I'm going to do, and here's my prospect list, and they'd send it to the regional manager, and that person kind of moved their Ouija board around

Starting point is 00:07:40 and say, here's what I think it is. They go up to the national manager, and then they report to the CEO and the head of finance, and, okay, here's what we think our sales are going to be for this month, this course, this year, whatever it might be. And a lot of big companies, actually all they do is they digitize that. But did they really bring any insights or start to create predictive analysis? That is just now starting. That's what I talk about, the data that now has been digitized across these systems is now accessible. And then you can start to implement algorithmic systems on those to now make it predictive and a little more accurate. And in some cases, now reach forward and saying,

Starting point is 00:08:17 here's where you ought to spend your time. Or how do you now bring in two or three of those systems and platforms together so that it's not just one system of record, i.e. what your salesperson put in, but also starts to evaluate what your customers are actually doing every day. What are they're buying in spending patterns? And that confluence brings some insights into that. If you think about it, I call it the second order effect of enterprise software, which is data. The analytics of that data is in its infancy. And that is where the actual true expansion of productivity will now come. I do think there's a lot of opportunities set there. I think it is orders of magnitude, bigger than what we've seen in the productivity to date, but is going to continue to require

Starting point is 00:09:05 the adoption, I'll call it, of the platforms, and then, of course, the application of the analytics on top of those platforms. And frankly, there are constraints still around how we do that. One of the biggest constraints, of course, is finding capable people. And we always talk about this war for talent in our space. Seven and a half billion people on the planet, it's only 29 million of us who write code for a living. I mean, it's the most productive tool out there. It impacts every business during the time of COVID. We all, quote, unquote, went home or went to some place that wasn't working, and we're accessing our work through these systems. But there's only 29 million of us who actually write the code for those systems. Before we get into the specifics of today's market

Starting point is 00:09:44 environment, you mentioned something which was bringing the engineer mindset to the game of enterprise software investing early on. I'd like to understand that origin, maybe via the first few deals that you did at Vista. What was the nature of those first few deals? What did you felt like you saw? And then I'd love to understand how this engineer's mindset started to build into the culture of the investment practice. The most important thing to think about in our firm is we focus on building systemic solutions that can scale. Engineer mindset isn't what I call an episodic fix, but an engineered solution. An engineered solution can grow at scale. The way Vista is oriented is a group of investment professionals, call it 150 or so of them, who were really looking for companies,

Starting point is 00:10:33 mission critical, business critical, enterprise software companies, that when you bring specific sets of operational improvements, create massive amounts of value. in those businesses. The second leg of this is a group called Vista Consulting Group, BcG, our value creation group, which includes now our operating MDs and Vista Consulting Group. And what they are focused on is identifying best practices. And this is one of the key things when you think about deals that we do. What are the best practices that we've seen built, own, developed over now doing almost 600 transactions of the last 22 years, right? that improve the operations of the businesses that we then invest in and buy.

Starting point is 00:11:14 And the third leg of that stool, honestly, is in management teams and spending time with them. And I like to characterize it about 70% of the deals we do at Bista, believe it or not, our founder-managed businesses. And 90% of those founders are still with us someplace in our ecosystem, either at those companies or sitting on other boards, et cetera. But one of the things that we do is work with those managers to teach and train and inform and help them run their businesses more efficiently. Part of that whole dynamic is, here's what we've seen in the past, and you founder, A, this founder, the business she's running that day is the biggest

Starting point is 00:11:51 company she's ever run and is growing and is encountering issues that they've never felt before or never experienced before. And so we bring an ecosystem to say, here's how we've solved that problem in the past for 30 companies. Those are the dynamics that we employ in our underwriting When you think about, okay, early deals and things, what we did was identify what is it that we can change in this business? How can we change it? In some cases, it is changing a business process. In some cases, it's changing the organizational design of that company, who reports to whom, and in some cases you have to actually change certain members of management because someone who was great helping you grow your business from 50 million in ARR to 100 million may not be

Starting point is 00:12:33 the right person to go from 100 million or 400 million. Is there a single change that you made to a business after buying it that stands most out in memory as one that was hugely impactful? Single change, no. Like all things, it's many changes. We'll have some businesses that are enterprise businesses, but they've got some small to medium business segment. And then when you do the analysis, you figure out you're losing so much money on a small

Starting point is 00:13:00 and medium business segment and it actually takes away from your ability to grow your enterprise business. It might be as simple as change your field sales deployment model. Some people will have all their field salespeople in one location as opposed to distributing them. It's harder to do it that way, but if you do it that way, you get deeper relationships with the customers. These are simple things in some respects. Sometimes you really have to evaluate the way that you manage your cybersecurity practices in that company. These are companies that have massive amounts of data implementing,

Starting point is 00:13:33 robotic process automation solutions to cut down on the cost of delivery of that product to your customers. In some cases, it's implementing an AI solution to develop a new set of products to expand the market. So there is not one. We've got over a hundred of these best practices. And when we're underwriting a business, we'll end up with, okay, here are the eight to ten that we really have to do right now. Here are the next 20 that it'd be great to do in the next couple of years. Here are the next 30 if we have this company long enough that we need to do after that. There's like all things, you know, as an engineered mindset, there's just this thing you think about continuous improvement.

Starting point is 00:14:12 We all can continuously improve on what we do. But you have to have a system. That's why I keep talking about this engineered solution, the way we are organized, that has a systemic solution of feedback and feed forward mechanisms that are constantly activated as opposed to episodically used. So that's really how we think about it. If you think about the landscape, if I had every single eligible, let's say, enterprise software business in the world together, and I wanted to arrange them in a room from lowest quality to highest quality, they're not all created equal, right? Everyone seems to have come

Starting point is 00:14:47 to accept that software businesses can be the best businesses in the world based on just some economic features of them, but some are very bad. So if you think about that spectrum from bad degree. How is the spectrum itself defined? What's a Vista company? What are the qualities boiled down that are most critical to you when evaluating one of these businesses? Sure. And I'll give you some of the things that are critically important to have and some of the things we really do, I'll call it, in a differentiated way versus anyone else out there. So, look, everybody knows the nature of enterprise software lends itself to what we call these mission critical, business critical type of businesses. And if you run them well, you'll have high

Starting point is 00:15:28 retention rates with your customers. You'll be able to have businesses that have visible recurring revenue components to the business. Those are things that we look at, not surprisingly, and understanding the quality of all of those elements and what are the quality of the relationships and the quality of the product. Where are they in the stages of what I call product superiority and then what are the elements of execution excellence that the company needs to emphasize or support. But on the other side, and this is when people get it wrong, they get it wrong here most of the time of the businesses, the enterprise software companies that have failed and gone bankrupt or had all sorts of financial challenges, it's because typically

Starting point is 00:16:11 they have too much technical debt. Most people don't really understand what that is. They think about debt in terms of financial debt, but technical debt is compounding. And as you write code over a year, five years or 10 years or 20 years, often if you don't take the right product development approach to it, you create a tremendous amount of code that has some flaws. It has some bugs. It has and architectural idiosyncrasies that might work for eight customers or 200, but not for the other 5,000, that every time you make an upgrade in the code, you have to go back and make those adjustments so that your customers, products continue to work, or their solutions, how they use, and continue to work. And that is often an oversight for almost every investor that I know of

Starting point is 00:17:01 outside of this stuff, that they don't really spend enough time on that. And if and when you do, this is when we take a pass on a company, it's often because they have too much technical debt relative to the pace of the market that they are in. We have a whole set of best practices around reducing and then ultimately eliminating technical debt. To me, that is one of the more liberating elements that one can do in managing these businesses. And it's not something that you just naturally know how to do as an investor. A lot of investors think, well, let me just buy a good company and hope the management team can figure it out. But you'd be surprised at how many management teams, I know that we spend time within due diligence, evaluating businesses that

Starting point is 00:17:42 actually don't really have a sense for the amount of technical debt that they currently have and never thought of that. Yet they provide increasing levels of resources against managing their existing code base and not really realizing that they're losing ground every day because they actually haven't taken the right approach to eliminating technical debt. They just figure it's just a cost of doing business. How has the profile most changed of the kind of company that you've bought from the first, let's say, five years to the last five years? In the early days, I chuckle a little bit. There was no such thing as a hosted or a cloud architecture type of an environment. There was, but we call it ASP. You had these big mainframes that you emulate into. And if you think about it's

Starting point is 00:18:30 kind of the same now, but now it's a public cloud or a private cloud. That advancement in and of its created massive opportunity for innovation to occur. That innovation manifests in a couple ways. One was the proliferation of cloud-native software companies that didn't exist 15 years ago, eight years ago in some cases. We look for a lot of those businesses because if you architect them properly and you do them well, and I think we own now the largest number of these cloud-native software companies based on our account, it gives you more freedom and flexibility to innovate faster, which means you can actually grow these companies faster and at scale, operate them with more flexibility in terms of when you turn on and off what I call the

Starting point is 00:19:16 profit spicket in those businesses. Whereas early days, it was all on-premise software. So a big part of the cost was the operating costs characterized by capital cost of buying equipment. And today it is truly operating costs because you just go to the super scalers out there, the AWS, the AWS of the world, and the GOs and India and other places and say, okay, I need to buy computing capacity, not servers, but computing capacity at a specific rate. And of course, with our size and scale, we have the capacity to do at different rates than others. What that enables our companies to do is, and what we look for, is now innovate their product set faster and use various architecture like microservices, et cetera, to actually

Starting point is 00:20:05 move the code base along at a much more rapid pace, which gives you the ability to deliver additional sets of product, services, and solutions to your existing customer base and for what we call newer customers that we want to capture. That's one of the big differences. But remember, that's all powered by a change in the underlying, I use the word substrate, but architecture of how computing power is accessed from on-premise to cloud. And in terms of just now software has become so proliferated. There's lots of subcategories. There's cyber software. There's vertical market operating system type software. Are there categories that you've gravitated to or away from that you feel most lend themselves to this sort of engineered approach that

Starting point is 00:20:49 you've outlined to managing them? There are some industries where the participants, the software providers have relinquished or given up a lot of their intellectual property to their customers. You think about pharmaceuticals. Those are sort of areas, for instance, where often the end-user environment is so concentrated, they actually have the market power in how that software and that code advances. We look for more broadly distributed customer bases where you don't have high concentration risk in your customers. And we look for where there's actually still a high ROI return on investment of the

Starting point is 00:21:26 products that you are selling to your customer base. I mean, this is an internal statistic, but we measure every year. what's the average return on investment for the products that we sell to our customers? Think about we have 80 plus software companies, 300 million users of our software over, I think it's not 2.2 million customers, I think 800,000 plus enterprise, 1.4 million small and medium businesses. But we look for what is the value of this software that we're selling? The average ROI of the products that we sell to our average customer is 640% ROI. Now, think about it.

Starting point is 00:22:03 There's very little business investment that you can make that gives you that level of ROI. So a small and a medium business actually typically higher, more like 900% enterprise, depending upon what it is in terms of the product. Again, the average is $640 maybe a little lower. But what that says is your next incremental dollar as almost any business in any industry is best spent on buying more software. How do you measure that? That seems like a hard thing to measure and capture it.

Starting point is 00:22:28 Not really. it's as simple as if I implement Pickett a solution for payroll. Okay, if I implement, pay this old school, how many payroll clerks do I no longer need if I implement a payroll software system? Pretty easy to calculate. Here's how much of cost, all right, or waste. How much waste do I eliminate by implementing this software solution to measure some energy usage or something?

Starting point is 00:22:51 It's math at the end of the day, and you've got to have some analytics around the math, but that's what we do. We do it for everyone in the companies. And so that gives you a sense for, okay, here's how valuable that software is to that industry. Media industry, am I, okay, if we give you this system to manage how your media spins or buys are done, how much more efficiently can you promote and or sell it, how fewer resources do you need to develop or to devote to that activity? Robotic process automation, so you asked me an earlier question about, okay, where are we in the inning?

Starting point is 00:23:23 okay, if you've got a bunch of people going around and doing some clerical work, let's say, and moving one set of data from one system to another day to day, I call it a swivel chair kind of an enterprise, pull out of one system, put it another, versus put a robotic process automation system in, guess what? R.R.I is massive. Could be simple as transaction reconciliation. How do you reconcile a purchase order versus what was shipped? And if that's done manually versus put an RPA system in it, guess what? You get massive. massive implications of ROI. So the 640 or whatever the number is, that napkin math is an absolute no-brainer for the customer. If we take that napkin math, I'll call it IRR napkin math now to the

Starting point is 00:24:06 investing side, as you think about what you're willing to pay in terms of a multiple, let's say, for one of these businesses, how has that evolved over time? Like public multiples and enterprise software got so crazy a year ago and now that come basically back down to their long-term norm. But what are the key things in the napkin math that you've evolved over time as you think about the price you're willing to pay for a single one of these businesses? We kind of look at it in two buckets. There are the companies that are growing faster. And then there's what I call the companies that have met their addressable market and

Starting point is 00:24:36 they're operating on a profitability metric. Take out the last six months. But the prior two years has been the most frothy from a valuation perspective that we've seen in the history of enterprise software, in the history of software, period. We had VISTA took advantage of that and took six companies public and sold into that market. Valuations are rough. Guess what? Let's sell into that market. And we actually were one of the few, and actually one of our investors pointed that out, that actually decelerated in the investing in that marketplace, in terms of public market, not in the rate of investing, but public market, which were really

Starting point is 00:25:13 experiencing those lofty valuations. Interesting enough, we actually maintain the same market multiple, it actually biases down over those two years that we did the prior five. We used a thing called a growth-adjusted multiple. The first, call it half of the decade, the growth-adjusted multiple on average in the overall market was like 0.43. The market in the last couple of years maxed out at twice that amount, 0.93. And what does that number mean? What does the growth adjustment? How do you think about a price revenue growth multiple? What's the price that you're paying something relative to the growth multiple of that business? So you've heard of peg ratios, price earnings ratio? Yeah, of course, sure. Rather than earnings for a fast-growing software company,

Starting point is 00:26:01 use revenue. So you do that and you divide it basically by that growth rate of that business. So it's kind of doubled over those two years. Our average was still over the last two years below that point four three, whereas the market went as high as point nine three, the market average went to point six, one, six, two. These are people buying into these enterprise software businesses. We've always maintained a very disciplined approach to how we buy those businesses in last couple of years. We've been buying them at half the price last two years of the overall market. The vast majority of those businesses we bought last couple of years were private. We only did two take privates in that period of time, whereas any time's a downturn, we took six

Starting point is 00:26:41 before that and two before that, two before that in terms of public to private, that type of models, because those public markets were experiencing those lofty valuations. That's one way that we really think about it, really evaluate and understanding that when the markets are being lofty, that's a good time to sell into it. Not surprisingly. Makes sense. And when the markets have come down where they are today and if you look at our overall market, these growth-adjusted revenue multiples back down towards 0.41 type of the level, which is just slightly above where we've been buying our companies over the last couple of years. What have you learned about the role of churn, like customer churn inside these businesses that seems to be a variable that's coming

Starting point is 00:27:24 at me from every direction, that this is the ultimate arbiter of revenue quality for a software business, not net dollar attention, but just actual customers leaving and why. What have you learned about that over the 22 years? We have a couple metrics. One is recurring revenues and one is retention rate. And we look at net dollar retention rate as an important statistic or KPI that we measure. In many cases, I mean, our overall portfolio, which is whatever call it, fifth largest enterprise software company, if you just added all of it up together, over this last two years, it's a 104% net retention rate. Think about that. That's pretty staggering. in terms of, okay, showing that what we provide to our customers is of value.

Starting point is 00:28:11 The thing you have to think about in an environment like this and a recessionary environment is, okay, where do you get that churn? We just walk through the mission critical nature of these businesses, the actual ROI of the products that we sell to our customer base and how important it is. So if you've got churn, you've got to look at it. Is it because the customers picked another solution or they went out of business? business. If they've gone out of business, is there some fundamental underlying element of that industry that you're serving that gives you some suggestion that this is not one that you want

Starting point is 00:28:45 necessarily invest in? Our teams, and I've just got a marvelous investment team, frankly, really think about that and unpack that and get very granular by geography, by segment, by customer, by customer size. And we really spend a lot of time on it to understand. are there some inherent issues with the industry or the products position in that marketplace that should give us some pause or confidence on how mission critical, business critical, not only the solution is, but that specific solution is with the company that we're evaluating or the company that we own. And then that informs us as to how we bring forward our value creation motion.

Starting point is 00:29:28 And what are the things we want to focus on? Because that may inform you, guess what? Here's a segment in the marketplace that we need to spend more time on or invest in or build a different set of solutions for or enhance, call it the go-to-market opportunity with that segment. If you think about all of market history, especially when it was dominated by industrial companies, the capital cycle is this really important thing that drove outcomes for investors and for businesses.

Starting point is 00:29:55 And a lot of that was just the sheer amount of literal capital that it required to invest run these businesses, lag times, gluts that would come after. big changes. How true do you think that is in the software world? Do you think that cycles and capital cycles are as important? How do you think about cycles now that we're deeper into this story? There's a capital cycle in and around the investing environment that informs us on multiples. You and I just chatted a little bit about that. We had a massive amount of capital that flooded the global economic environment, frankly, since great financial crisis, accelerated during COVID, every central government on the planet said, I am not going to let my people suffer, even though they

Starting point is 00:30:37 may not be able to go to work. And so they flooded more capital. And of course, you saw a massive increase in various equity markets and credit markets and liquidity and cash was available everywhere. So you have to be thoughtful about that as an investor. So for us, of course, like I said, when the markets were booming, guess what? That's the time. We hadn't taken any company public in our, at that point in time, 18-year history. So we took six companies public during that run. selling into those robust markets and not surprisingly when you see now a retrenching of those, now is a good time to really expand our buying dynamic of our business. Now, all that said, the last two years, we invested $18 billion and returned $18 billion. Invested, I think it was

Starting point is 00:31:21 $18.8, almost $19 billion and returned $18.2 in the last couple of years, right? So we continue to be very active in the buying and the selling, but in the buying, we like to maintain discipline in buying evaluations that from our perspective make a tremendous amount of sense irrespective of where the cycle might suggest that you are. And that's because we'd like to truly create value and alpha in our businesses through changing some of the fundamental ways in which they approach their market and expand their opportunity set. We were chatting a bit before our recording about the ways to build endurance into investing franchises. It's like a pet passion of mine is building investing businesses themselves. Everything you just said makes me think, look,

Starting point is 00:32:06 the capital base has to match the opportunity set. Otherwise, you're not going to be able to do those things you just said, pig, sell in defraught buy from despondency. As you've thought about Vista the business, we've talked a lot about the investing strategy, but Vista the business itself, what elements of company building have most appealed to you personally? What is it about building Vista that continues to light your fire, so to speak, 22 years in? Yeah, it is like all businesses. It's the people. I look at my investment team and VCG and our operating team and the longevity and what they've done and their capacity to learn. And we do a lot of what I call building from the draft and not the trade. We bring in people from various backgrounds and teach and train and develop them as opposed to, oh, let's go find some high flyer from another firm to now come be a part of what it is that we do. We think that that builds a culture of accountability. We think it builds a culture of excellence and high performance.

Starting point is 00:33:08 And one that ultimately in my mind leads to kind of long-term economic benefit for the entire ecosystem of Vista. That's an important cultural element. And then from that, you can start to develop the things that we think are important in who we are, develop our leadership and our talent so that we're focused on and building infrastructure around compensation related to ESG initiatives and our diversity, equity, and inclusion initiatives. And people don't just say the words and fill out a form. The action hits the entire ecosystems from our boards to our C-suite to our executive committee at Vista and Private Equity Management

Starting point is 00:33:47 Committee to the way that people actually vest into their ownership of the firm. There's D-E-N-I initiatives and ESG initiatives tied specifically to that. When you talk about endurance, you've got to have what I call stability, you've got to have courage, you've got to have tenacity, and you've got to have a team that is willing to invest in the development of others, not just people who report to them, but others in their peer set to inform them. So having that sort of a collegial environment and shared responsibilities and shared, in many cases, economic outcomes by funds is one of the ways organization I like to design the way that we compensate our team to get that sort of a behavioral pattern. When you think about innovation inside of a firm, every firm needs innovation

Starting point is 00:34:35 to adapt. I remember distinctly a conversation actually I had with Martin Taylor on your team last time I was in Austin. And he said something like, when you have software that has 500 or 1,000 installs, the innovation equation is just harder. It's just really hard to change and do fresh new things while also servicing a huge customer base. How do you think about that phenomenon in an investing business. Obviously, you've done well investing in software, world changes, software changes. How do you make sure you change the investing strategy, the team, whatever, with it? So again, it is, yeah, with 50,000 customers or 100,000 customers, which some of our companies have, you have to build an infrastructure where that is not only emphasize, but it's

Starting point is 00:35:20 rewarded in a priority. Let me give you an example. Our BCG, Vista Consulting Group, part of what they do is they bring together groups of our senior executives to part of what we call a BPSS Best Practice Sharing Summit. I think this year we have 26 of them planned. And in those cases, we will bring together functional heads to not only teach train, but also to build out, I'll call it, innovative engagements with them. For instance, last one that I personally attended was one with our product and technology group. In that group, there was 421 senior private.

Starting point is 00:35:56 product and technology, people from 78 portfolio companies in one city for three days going through five tracks. Part of those tracks is innovating on, in this case, robotic process automation, in some cases it was cybersecurity analysis and determination or artificial intelligence, but you have to build systemic infrastructure where innovation can occur. Oh, and by the way, we will in that environment do a set of hackathons with very senior people on product innovations, and we'll do that in India and we'll do it in some place in Europe. We'll do it also in the U.S. couple of times a year. Those are the sorts of activities you have to be intentional about that create that innovative

Starting point is 00:36:36 dynamic. Now, if you have that and you're managing that externally, i.e. portfolio companies, internally, you have to do the same sort of thing. So we have to think about how do we innovate in our capital structure? How do we innovate in our approach to delivering value creation, i.e. or BCG, into the portfolio companies, and what are the methodologies to make sure that constantly happens? If you're an organization that focuses on creating change for other organizations, i.e. portfolio companies, you darn well better have the DNA internally that you are accustomed

Starting point is 00:37:12 to change as well. The innovation that we're doing in ESG, I think we're one of the first firms to sign up to things like the principal for responsible investing in net zero asset managers, but we are one of the few firms that actually now has the ability to measure and do measure all of our greenhouse gases across all of our portfolio companies, setting greenhouse gas reduction targets, reducing those emissions, offsetting it. We now have the ability that 100% of our majority on companies that are not in the process of being exit, of course, have signed our Vista Climate Pledge, which enables us to now create offsets, greenhouse gas offsets across all of our portfolio companies. Those are the things that if you're not attuned to moving where the market is moving, you'll never get this done across a broad portfolio like ours. But this is one of the things that is important to us. If I were to somehow be able to zoom in everyone on your senior team right now to join us

Starting point is 00:38:10 and ask everyone what they think the biggest controversy is in terms of a decision to be made inside of Vista today, where there's argument about which way should we go. What would those topics be or the singular topic be? I think it is the whole idea of the war for talent. We have a whole set of tools and systems that enable us to bring what I call a unique way of developing talent and capabilities. We have these centers of excellence. The debate's going to be, well, where do you stand up the next one? Do you stand the next one up in Mexico, in Canada, in Australia, in the Middle East? those are some of the areas that we would be talking about because they have real impact.

Starting point is 00:38:53 If you talk about portfolio managers, they're saying, okay, I've got to hire 250 people in this portfolio company in next 18 months. Where am I going to hire? We've got some challenges in the U.S., as you know, just from a war for talent perspective because we haven't enabled enough people in the U.S. to participate in this market, yet we don't have an immigration set of policies that should effectively fuel the growth. You want to talk about things to debate? That's one thing to debate. Where do you invest in your Centers of Excellence capacity to expand the market opportunity for our businesses? Because we're seeing an accelerated demand for the products that our company sell. So we have to have people to support that growth. The good news is we're seeing some alleviation

Starting point is 00:39:37 because some of the consumer businesses, I think, you know, that they're getting hit disproportionately harder in this current environment of higher inflation and the Fed really looking to dampen the those inflation dynamics. And so you're seeing a slow in growth in the consumer space. So that's liberating more people in the U.S. That said, it's still not enough for the growth appetite of our enterprise businesses. So that's one area that I think would be of high debate. If you think about the entire firm's history, and I'm curious both on the company building side, but also the investing strategy side, what are the biggest mistakes that Vista has made that stand out in memory and how are lessons from those mistakes kind of reincorporated back into the DNA of the business?

Starting point is 00:40:15 I benefit from being ADHD, so I don't remember mistakes for long. Our market continues to evolve. I think we did a really good job in a couple of areas early on and building out the organizational design and really being on top of things like cybersecurity, although you can never win in that, you just end up in ties all the time. I think we need to continue to invest in the building of our platform geographically.

Starting point is 00:40:42 You know this, and some of the breeders and audience, there's now been a more rapid distribution of computing power through these super scalers. And while we've been effective, you know, we have a couple non-U.S. offices open. But I would look at that and say, should we have been more aggressive in that dynamic? You can't have too many regrets about what you did or didn't do in that regard. You've got to lean forward and take the best decisions based on the information that you have at the time. That's kind of how I think about it. I was talking to a friend who's a partner at Sequoia, the venture firm recently,

Starting point is 00:41:13 and talking about their culture. And one of the words that stood out in our conversation was paranoia, that the partnership there has been perpetually paranoid at not seeing the next thing, resting on their laurels and so on. If you were to apply that same word or maybe insecurity would be another word to the way that Vista looks today, what has you most insecure or paranoid about the platform that you've built? Vista, we are highly capable people with insecure overachievers.

Starting point is 00:41:39 We constantly think about how do we tune our system? So it isn't like one thing. Every day, it is something we need to tune and make better. I love our bug fixing culture. As effective as we are on certain things, every time we are getting together and having to sink, we're talking about that's great, but here's what we can do to fix it.

Starting point is 00:42:00 We've built the right culture around that. So the paranoia, if you want to think about it, is about a little bit of everything in every area. It's like, okay, but it's not just a paranoia. It is a, well, what do we need to do to tune it to fix it? Is it a small fix or is it an organizational change? I think we revisit it early and often and frequently, which gives us the ability to react and gives us the ability to make changes.

Starting point is 00:42:24 We now have some very stable committee infrastructures and effective committee infrastructures, which give us that ability to evaluate these things so it isn't just sitting on one person's desk and say, okay, here's something we need to think about and we'll create a subcommittee of, in your words, not mine, paranoid people to come up with the solution. And then they come back and present if it might be to the private equity management committee or might be to co-heads, it might be to the risk committees or the talent management committee or the executive committee and say, here's the change that we now need to make. And here's a recommendation that's been fully vetted and informed by stakeholders in the

Starting point is 00:43:02 organization, sometimes outside the organization, that we think are going to make us better and more effective at what we do. I love that about us. What have you learned on the other side of this business equation, the providers of capital are so key. They're the fuel to doing what you do. What have you learned about the great relationships? I'm sure you've had good, bad, a whole spectrum of relationships with LP investors. We think about the ones that worked really well, and I guess I'm curious about the ones that went poorly too. What characterizes those for budding, investing firm builders? What advice would you give there on LP relationships? So LP. have their own dynamic. In some cases, it's their organization. In some cases, it's the amount of

Starting point is 00:43:42 capital they have available, about a capital they have available that period of time and what they've invested in the past, which limits or expands or opportunity to invest in the future. So what that really says is you have to remain informed and in communication with them to understand what their dynamics and needs are. While their dynamics and needs may have been one thing three years ago, based on what they invested in then, they may have changed today. One of the things that we we've done is work with a number of clients who realized over time that they were underinvested in enterprise software. So we've come up with some unique solutions to keep them constantly invested in enterprise software through the various funds that we manage. The world of private equity,

Starting point is 00:44:23 there's episodic fundraising. That's a cycle that you live in in the world of private equity, and it's a different cycle than what the LPs are in. And so in some cases, how do you meld the two and come up with creative solutions, which I think some of the things that we've done do that. You've got to be in tune with them. And you're not going to get it right every time because, you know, they have turnover and they want to change your allocations in different ways. But you've got to be in tune with and listen, listen to your clients and listen to those LPs and see if you can deliver back to them unique solution sets that solve their problems. That's what they most appreciate. You're an engineer. So my guess is that the word calculated will figure into

Starting point is 00:45:00 this answer, but what is the largest risk that you or Vista has ever meaningfully or intentionally taken? Can we build by be a part of what is the ultimate winner in that space? Sometimes you don't have full access to it at that time, but that doesn't mean you shouldn't try to get some access to it in some point in time. Those to me are the biggest risks that we take. You see an emerging space. And, you know, the world of enterprise software, there's always these emerging spaces that are curve that evolve and that blossom. And, you know, I always think about our space, you know, these markets enterprise software still those kind of winner take most type of markets. Sometimes they're very attractive, very interesting, and you're not quite sure who's going to be the

Starting point is 00:45:46 winner just yet. Sometimes it's a capital play that makes them a winner. Sometimes it can be the management team that makes them a winner. And sometimes it's a regulatory environment that might determine winners or losers. But we think about really focusing on underwriting to critical factors for success being under our control, under our control being things that we know that we've done in the past, done before with an enterprise software company. But every now and then there's something that pops up that gets you out of blue and you're like, okay, now I've got to deal with it.

Starting point is 00:46:15 One of the great features of what you do is that it's a double opt-in process. You can't just hit buy. Someone has to also hit sell. So negotiation and sales become far more important in this world than they would in public equities. What have you learned about those two things? Maybe starting with negotiation, you've done 600 plus transactions. I'm sure the lessons are many. They are. I will tell you, there's a couple interesting statistics around us that I find fascinating. If you count deals, 71% of our deals, I'll call it just recently the last few years, frankly, have been founder influence.

Starting point is 00:46:47 And again, I told you this, 90% of those founders are still involved in the companies. But another interesting statistic, over half of the deals that we did were non-processed deals, meaning we had access. when no one in the market did. People came to us because they went to one of the other founders that we did deals with and said, okay, here's where I am. Who should I talk to? Founders kind of know each other in different clumps. It's like the old Berkshire thing, like it's a good home.

Starting point is 00:47:13 Yeah, and they're like, yeah, let me tell you how Vista accelerated my corporate maturity. Let me tell you how Vista accelerated the maturity of my management team. Let me tell you how Vista accelerated our growth rate or our operational profit or our entry into this market or our entry into this different geography. Let me tell you how they did that. When you cut through all that, I am still amazed at this, but of the deals where there are other people involved, almost 60% of them, we got at a lower price than when someone else offered. We talk about lessons learned. When we have the time to talk about our value creation dynamic, based on those statistics, more often than not, they come with us relative to what everyone else

Starting point is 00:47:53 would pay for it. So that's something we have learned. have to just make sure we take the time and the process and give them the opportunity to talk to the founders and the people that we work with and say, here, here's a list of call any of them, call 50 founders, see what they think, what it's like working for Vista. And guess what? Of the deals that were contested, almost 60% of them came our way, even though there were people who had higher bids. Think about that in this world where capital in some respects is fungible. And you attribute that mostly to how you run the business is after the fact versus something you say, obviously not the price you pay, you're paying a lower price, or in some other term or deal structure,

Starting point is 00:48:29 it's just mostly about, look, this is the place that relative to your other options, the most good things are going to happen to the actual business itself. Yeah, we're in enterprise software. I'm not investing in oil and gas one day and insurance accounting. We do one thing. So we're actually pretty good at it. And so the executive CSS software people who are part of a private equity platform or credit platform. I think that's what makes the difference as to why they like to work with us. And

Starting point is 00:48:59 our people are good people and they're thoughtful and they're experienced. And as a result of that, I think that carries the day with you're running a business and it's like, man, this is your baby, you raise this, eight, 10, 12, 20 years old. Some people just want to sell to the highest price. But others want to see that all the stakeholders in that business ultimately are thought about as they convey the stewardship of that business to the next buyer being us. If you had to give all your capital to another investor who doesn't work at Vista and never worked at Vista, who would you give it to and why? I would look for someone, again, who takes a systemic approach to investing.

Starting point is 00:49:38 There's one young man who I really, really like, I would know if I put all my capital today. But I just had him on a call with my Morehouse team, got my name of William Hurd. He's just very thoughtful, very deliberate, and I like his demeanor, his approach. But again, he's a public market investor. So would I put it all in public markets? Probably not. Just if you force me to give a name of someone, that's someone who I really like. As you think about another chapter and another part of your life, I think it seems from

Starting point is 00:50:10 the outside looking at, like you've had a second founding moment around the types of people that you want to focus on giving back to, specifically. We were talking about some of the crazy stats around the false. system in the U.S. I'd love to revisit some of those on the air. They're sort of staggering. Do you think about the world of giving back in the same way that you want to have a clear focus? And if so, how did you arrive at the themes that matter most to you? It's all informed by being an African-American male, plain and simple. I mean, I grew up in this country and I witnessed all sorts of things from racial injustice to ways that we as a society

Starting point is 00:50:49 need to empower and enable more people to participate in this capitalistic society. And to me, those things are racial equity and digital inclusion and educational opportunity. And that's what I think about. You and I chat a little bit about this war for talent. And one of the things I learned, 82% of the historically black colleges and universities are actually in a broadband desert. How are you going to get people to participate in the digital economy if the schools and colleges they're in don't actually have broadband access. So that's one of things that I say, okay, we got to go fix this. So that's one thing. And then you start thinking about how do you create opportunities for people? Again, I really believe in creating equal opportunity. That in my mind is

Starting point is 00:51:34 opportunity to capture educational opportunities and health equity and wealth creation and all those things to me require on-ramps. And one of the most important on-ramps is this digital divide on-ramp. How do we now ensure, which is one of the Southern Communities Initiative that I'm leading with the folks at Dan Schumann over PayPal and Rich was a chair of BCG. And, okay, we can solve these problems. Let's bring corporate resources to solve those problems. I think, you know, I've been very focused, of course, also on the student debt crisis and providing through the Student Freedom initiative, a fund where students from HBCUs and MSIs can borrow money from this fund and they don't pay it back to the government. They actually pay it back to this fund that gets paid for it to the

Starting point is 00:52:19 next generation of students. And those are some of the things that I really think about enabling. And part of that, we also are doing this kind of 4G, 5G cyber improvements with HPCUs. And part of what we've been able to do with that is to now upgrade all of the HBCUs, which serve over 300,000 students per year at no cost to them. Well, what does that enable? That enables 300,000 students now participate in the economy per year in a time when we have workforce challenges. I think about how do you then create these holistic solutions, the systemic solutions to these problems that we have in America that ultimately, I think if we solve, we're just going to be a far better country and, frankly, a far more productive country that we can now compete more effectively

Starting point is 00:53:04 internationally with our digital capacity. Can you say a little bit about the work in the foster world? You mentioned a stunning 3% stat that I'd love you to repeat here. That's sort of insane that I certainly didn't appreciate and is really interesting. We just had a celebration of a program my wife and I initiated and started supported by the Funtute Foundation, of course. But it's called the Family Fellowship we do through Together We Rise. And, you know, 65% of foster care students want to go to college, only 35% apply and only

Starting point is 00:53:34 3% graduate. And our program to date, we've got 49 out of 50 graduated. And many have gone on to graduate schools from London School of Economics to various top five law schools, et cetera, and providing support and infrastructure. Some of that support is as simple as making sure that when they show up to college their freshman year, someone's there. You and I talked about it to help them move in, hang up their clothes and put the contact paper in there and just make sure they have someone there to make them feel part of the community, the new college. community. And then during the holidays, one of the things that still challenges me is that they'll shut down all the dorms and aged out foster care students. They no longer are part of a

Starting point is 00:54:14 group home. And so those homes don't get that 218 bucks a month or whatever it might be to keep their bed. And so these kids often go to homeless shelters. And we do a program here where we built a facility a nice, beautiful place where members in our program can come during the holidays and celebrate the holidays with us and have a place to come and stay and be a part of a family the environment that is supportive while you're entering college. So those are some of the things that speak to what my wife and I like to support for communities that we know are frankly deserving of equal opportunity to live great lives. The pay-it-forward concept is a wonderful excuse to ask my traditional closing question, which is to wonder, what is the kindest thing

Starting point is 00:54:55 that anyone's ever done for you? I had a really humbling mistake in the deal I did 20 plus years ago that I resolved with the government two years ago. And the good news is behind us and behind Vista. And I'm just grateful for really the global beloved community of friends and family and colleagues who know me, believe in me, and continue to support our mission and what we're doing. So the kindest thing they've done is, in some cases, forgiven. And in some cases, really encourage me to keep going forward and know that that power of forgiveness is so powerful. And that power of love is so powerful in the world we live in. And we just need to continue to to pay that forward. Well, you built what is certainly one of the iconic investing franchises of the

Starting point is 00:55:37 last couple of decades behind some of the themes that have driven so much of what's happened in the world. Really have enjoyed getting to know you here today and hearing about the birth and growth of Vista. Thank you so much for your time. Patrick, thank you. Thanks for inviting me and excited to see you continue to grow this platform. I think it's quite informative and helpful and frankly bring some unique insights to our wonderful world of investing. If you enjoyed this episode, check out Join colossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources 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

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Invest Like the Best with Patrick O'Shaughnessy - Robert Smith - Investing in Enterprise Software - [Invest Like the Best, EP.291]

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