We Study Billionaires - The Investor’s Podcast Network - TIP179: Private Equity Investing w/ Doug McCormick (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we talk to a good friend and fellow West Pointe and Harvard grad, Doug McCormick. Doug is a partner in a private equity firm that has conducted countless deals across two decades buying and selling companies. And what I think you're really going to enjoy about today's show is the perspective on valuation and how to think about buying businesses with an enduring competitive advantage. Doug is one of the smartest people I know when it comes to investing in capital allocation, so I have no doubt you're going to capture a lot of value hearing his thoughts on the industry.

Starting point is 00:00:32 So without further delay, here's our discussion with the thoughtful Doug McCormick from HCI Equity Partners. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, so how's everyone doing out there? We've got our special guest here with us. It's Doug McCormick. And Doug, thanks so much for coming back on the show. We had such a great time the last time we talked with you. So we're excited to have you back. Glad to be back and had a lot of fun last time as well. Not as much fun as the Warren Buffett annual meeting, but still a lot of fun. Hey, since you bring that up, we've got a group. We're going out there again this year and we're really excited about the event. Tell the audience quickly about the event. Since you brought this up, what kind of stands out in your mind about why a person should go to this because there's a lot of people that listen to the show, they hear that it's fun. But like from your vantage point, Doug, what did you get there going out to the meeting? Yeah, well, first of all, I would say this is,

Starting point is 00:01:47 it, it's a very big, very well-attended event. And I think having a chance to go with you guys because you guys know the whole circuit, you know, where to go, where to stand in line, how to get good seats. So first of all, if you're going to go, you got to go with you because you you guys got it wired. So that would be the first thing. The second thing I'd say is, listen, I think it's a chance to see history. No other investor has been as successful as Warren Buffett and he's not going to be around forever. And just to be able to watch he and Charlie think and respond to questions was absolutely amazing. And then the social stuff is equally good. So it was a thumbs up event all around. Yeah. Let's go ahead and dive into our questions here. So we're talking about private

Starting point is 00:02:32 equity and you've been in this space for a little bit and you understand it quite well. And so I'm really excited to have you kind of teach our audience some of the things about private equity because people hear this terminology. And for a lot of young people, maybe just fresh out of their undergrad or something like that, they hear private equity, but they really have no idea what that means. So if you could just give us a simple definition, kind of what you think when you hear private equity. And then if you could share how you got into the space, that might be interesting for some people. Sure. Sometimes describing it's almost easier to talk about what it isn't. So, you know, very simply put, private equity refers to making investments in equity securities

Starting point is 00:03:11 in companies that are not listed on the exchange like the NASDAQ or the New York Stock Exchange. If you want to list on an exchange, like one of those, there are a number of criteria. You've got to meet regarding financial performance, liquidity, governance. And essentially, these requirements ensure that there's enough interest and information in the marketplace to have a liquid market. So private equity investors are essentially pursuing opportunities that don't meet these size, liquidity, or information or governance requirements. And as a result, you see some very different attributes in these kind of investments. So I think there are five worth noting.

Starting point is 00:03:52 The first is lack of information. So there's no equity reports, no published financial statements. you're really making decisions only on the diligence that you've done as buyer and the information that's been shared to you by the seller. And so that makes underwriting much more difficult, but it also makes for a much less efficient market. So that's kind of one key difference. The second is everything's negotiated.

Starting point is 00:04:17 So when you think about a public market, all the terms of an equity offering or a debt offering are set, and the investor determines the price. In a private equity situation, you're negotiating not only the price, but you're negotiating terms and conditions, things like governance, things like interest rates, if it's a contractual return, et cetera. The third would be governance. These type of securities are often take a while to get into. They take a lot of work. And so private equity investors generally buy a meaningful portion of the company. So a minority or a majority stake.

Starting point is 00:04:52 And along with that significant portion comes. some level of governance or control or influence. The fourth would be duration. On average, I think private equity investors expect to be in their investment for five or six years. Compare that to, you know, average whole period on the New York Stock Exchange is well under a year. So I think those are those are the four biggies. So, Doug, we hear about private equity in the news all the time, and you also hear about venture capital. So could you please explain the differences and the similarities between the two? Yeah, so I actually think the way I would describe it is I think venture capital is a subset of private equity. So private equity are all things not listed on exchanges like we just talked

Starting point is 00:05:32 about. And then within private equity, you have growth equity, which is a business model that's been established, but looking to really scale. You've got venture capital, which is a lot of the early stage stuff that we think about in Silicon Valley. And then you've got things like leverage buyout, which are big mature businesses, and often because they're mature, they can afford to be financed with debt. And then you've got a bunch of other smaller kind of niches like turnarounds, like mezzanine financing, which is private debt capital. But all of those strategies kind of play in the overall private equity asset class. What would you say for this space, where do you think most private equity people dwell? Like, what kind of market cap? That's really interesting.

Starting point is 00:06:17 So first of all, it's a classic conversation around means and medians, right? So if you think about means, the averages are skewed to the very big, and there's some very big private equity firms out there, KKR, Carlisle, Blackstone, for example. And they would be dealing with very, very large companies, billions of dollars in enterprise value. Having said that, there's probably about 4,000 private equity firms out there. And if you look at medians, most of those private equity firms are focused on much small. businesses, like good American businesses that are not in urban areas, but are a critical part of today's economy. And those have, you know, kind of enterprise values well under 100 million. We talk about enterprise value a lot in the public markets when we talk with Toby Carlow and Stig and I use that as one of our main metrics for filtering results and trying to find the best undervalued picks is using the enterprise value to the EBIT. I'm curious, Is that how you typically look at things from the private equity side? Are you looking at enterprise value a lot versus just like the value of the common stock?

Starting point is 00:07:24 Absolutely. We look at enterprise value relative to metrics of cash flow. And depending on the business, there may be slightly different metrics to look at. But to your point, enterprise value to EBIT, I think is probably one of the most important. And essentially, enterprise value allows you to think about the value of the concern absent capital structure. Could you please elaborate on that, Doc, because it goes into the debt structure of the company and why it's such an important starting point to have? Yeah, well, I think, you know, as we talk about the big landscape of private equity,

Starting point is 00:07:56 and we talked about leverage buyout as one of those, and so those are more mature businesses, more stable businesses. One of the ways that that part of the asset class drives returns is they finance the transaction with a significant amount of debt. And, you know, I would argue it's often appropriate because those businesses are slower growth businesses, but more mature, less earnings volatility. And, you know, the analogy I would make is it's the same analogy as buying a house. You know, if you bought a house with no financing and the house appreciates 10%, your equity went up by 10%. If you, you know, bought a house with 90%

Starting point is 00:08:31 purchase price financed with debt, the house goes up by 10%. You've doubled your equity money. Same concept in financing leverage buyouts. And there are numerous benefits to that. The first we talked about is, you know, you leverage your equity investment. The second is you're providing a cheaper, lower source cost of capital. And then the third is there are tax deductibility issues with interest. And so when you add all those things together, it can really help drive attractive returns for that part of the asset class. So this is my impression of private equity is that it's grown a lot in the last couple decades. And that might be true or false. I'm kind of curious to hear your thoughts on that. But if it is true, why has that occurred and why has this become such an

Starting point is 00:09:16 attractive asset class for investors? No doubt about it. This asset class has experienced tremendous growth. So if you define the asset class by assets under management, AUM, in the 2000 time frame, the entire market was about 600 billion of assets under management. And today, that's approaching two and a half trillion. So, you know, kind of a 4x growth here. And as I mentioned, there are now 4,000 firms approximately in this market space. Very simplistically, I think the number one reason the asset class has grown is it's been an attractive returner. You know, there's lots of firms out there that estimate what the kind of market return looks like for the asset class. And most reports would say that the private equity asset class has returned, you know,

Starting point is 00:10:03 three to 400 basis points in excess of a broad equity indices. So if the Russell is doing 10% on a long-term basis, private equity is kind of done 13 or 14 percent. So I think that's the number one reason things have grown. And as you kind of think about why private equity is interesting or why it's performed well, a couple comments. First of all, it should, right? This is a very illiquid asset class. There are risks associated with being the asset class. So if it's not returning better than the public equity markets where you can turn around and sell tomorrow if you don't like the way things are going, then it's not going to be a smart investment. But I think at a very high level, there are some things that make this asset class sustainably attractive. One is the overall

Starting point is 00:10:49 supply and demand equation. There's a lot of capital out there. And there's certainly a lot of capital that's come into this market, but it's also a very big fragmented market in terms of where this money can go reside in terms of the deals. And so I think the supply demand equation has been favorable to private equity. I talked about the inefficiency of this market in terms of there's no information out there, and that makes it very challenging to get good deals done, but it also creates real opportunity where we think you can find real value because of just the inefficient nature of information.

Starting point is 00:11:22 Another aspect of why this is such an interesting asset class is it actually solves real problems. And what I mean by that is when you're trading stock in the market, It's buyer and seller directly as a secondary share, and the company is really not a participant in that transaction. When you think about private equity, you are solving a corporate finance need. A company needs capital to grow, and they're raising capital from you, or a founder or an owner needs capital to execute a succession plan or a consolidation strategy. And in all cases, I think those are win-win scenarios, not just buyer and seller where one wins and one loses. So I think that's a big contributor as well.

Starting point is 00:12:04 So if we have this one scenario where you as a private equity company would go in and just outright buy the other company and you will just get all that net income back to you, basically everything would be business as usual and you won't really interact with that company. And then the other scenario where it would be completely opposite that the private equity company would go in, send all the experts, perhaps even change the management. and basically not only look at the strategy, but also all the nitty gritty operations. What are we closest to are those two scenarios if you have to say what a typical case would be like?

Starting point is 00:12:44 As you think about, we just described how this market's experienced tremendous growth. And as it's experienced tremendous growth, it's matured a lot as well. And so, you know, I generally break it down into three stages. When people first started doing this in the 70s and the 80s, the real value of driver was price, price discrepancies, real discounts to the public markets. And then in the 80s and 90s, a lot of the value was driven by leverage, and you were able to get much higher leverage reads at that point, and so you could finance a much greater percentage of the deal with cheap capital. And in today's market, I think both of those two previous sources of value have been kind of commoditized, if you will.

Starting point is 00:13:23 And to be successful, you've got to be a really good underwriter, which means you need to specialize in certain industries where you have a competitive edge. And then you've got to figure out how to drive value or do something different with that asset over time. And so lots of firms have developed different strategies for that. But common strategies are bringing operational expertise to the party or bringing unique industry expertise to the party so you can really help grow the business. And so I think to a certain extent, organizations are evolving to be strategic buyers.

Starting point is 00:13:55 You know, they come at it from a financial perspective, but they've got to bring more than capital to be successful. Interesting. So I would imagine that you'd see a lot of private equity firms really specialize in certain niches. Is that true? Yeah, I think it's specializing in niches or specializing in a business model. So you can define your core competency as we know everything about aerospace and defense. You could define your core competency as we know certain types of business models, distribution, transportation, let's say, or you could define your core competency as, you know, we have operational capabilities to drive, you know, enhancements and operations. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in

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Starting point is 00:18:35 That's Shopify.com slash WSB. All right. Back to the show. Talk to us a little bit about the negatives because I think a lot of people that would hear this be like, wow, you're getting 3% more than the public markets. This sounds like a lot of fun and really interesting stuff. But like what are some of the negative sides of private equity that I think a lot of people maybe don't think about or miss? Lack of liquidity, right? So these are generally 10 year limited partnerships. And so, you know, the duration between the time you invest your capital and you get. it back is going to be a very long period of time. So you kind of got to be comfortable with parking this money for a long time and not expecting to get at it. And if you do need to get at it, in many cases, you're taking a significant discount to avoid that illiquidity. The second thing is,

Starting point is 00:19:27 we talked about this inefficiency in the market, lack of transparency. That also exists in terms of trying to find investments as a retail or an individual investor. And that's good news and bad news, but it's very hard to identify good deals. And candidly, it's very hard to identify good teams. So if you think it's challenging to underwrite a business where you can see the business, you can see the financial performance, and you can evaluate the businesses and performs today, imagine trying to underwrite a team that's going to invest in those kind of businesses, and you're trying to evaluate consistency of strategy, quality of team, teamwork, team's ability to source deals and add value. And so that's a challenging process as well. The last thing I would tell you

Starting point is 00:20:10 about the market is, I think averages are deceiving. And what you see in the market, I think it's one of those markets where persistency of performance is very high. And what I mean by that is if you look at the public markets and you look at top quartile performers in a period, let's say a year or five years, and you compare that to top quartile the next period, the pull through between high performers in both periods is often relatively low. But in the private equity space, you see persistence where if you are top performer this period, you are likely a top performer in the next period. And I think that's indicative of an inefficient market. But what I also think that means is it's very hard to identify good managers and it takes a long time and a unique skill set to do that.

Starting point is 00:20:55 Is that because they just get a bit of deal flow? think it's they get better deal flow success perpetuates success and I also think they continue to develop their skill sets and their capabilities and you know this is an area where you're not just competing on capital you're competing on human capital right so I think a lot of times at least in the market that I'm in which is the lower end of the middle market entrepreneurs are not only picking capital solution they're picking a partner and as they evaluate a partnership they want to work with people they like, people that they're aligned with, and also people that they believe can help them build a better business.

Starting point is 00:21:34 So I know if I was young and I was listening to this, and let's say I had $50,000 in my pocket, I'd be wondering, how can I invest in something like this? Like how is that possible? And is it possible? I'm kind of curious how you see that. Yeah, it's absolutely possible. And I think it's a mixed bag, candidly, but there are a number of very large private equity firms that over the course of the last decade have gone public. So KKR, Carlisle, Blackstone, Apollo,

Starting point is 00:22:02 I think all those four are public now. And so you can participate by buying and equity interest in a business that's investing in private equity. There are also ETFs out there that are investing in those kind of businesses. So that's an option. We started off the conversation by talking about what a great time we had at the Berkshire Hathaway annual meeting. I would argue in many ways, you know, Berkshire is a private equity holding company, you know, so you think about some of the big assets that they own and have bought, Burlington, Northern, Heinz, Geico, I mean, those essentially are private equity plays, and so that's an interesting way to play private equity. And then, you know, I think there are some ways that individuals can play directly, not through a private equity

Starting point is 00:22:45 investment professional, but lots of angel investing networks out there. I think investing in real estate in some ways is a private equity play. And then many of us are involved in families that have family businesses. And to some degree, that family business is private equity interest. So you've been in this business for a long time, Doug, and you both seen the successes and also the less successful ventures. So what would you say if you could come up with the common denominator of what separates the good deals from the bad ones? Yeah, so I guess the first thing I'd say is if anybody's been in the business a long time and they're not talking about both their good and bad deals, they're not being genuine with you because everybody sees kind

Starting point is 00:23:27 of both sides of that equation. And I think the first thing is it starts with good underwriting. You know, it's often in this business when you're a long-term investor, it's hard to win on the buy because you buy so well that you've immediately created value, but you sure can lose. You know, Warren Buffett has one of my favorite sayings which says, when a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. So very simply put, you know, good managers, it's hard to overcome a bad industry, even if you have a good management team. And that good industry, good business model starts with good underwriting. I will say the second

Starting point is 00:24:06 thing, though, is because you're a long-term investor, you've got to have a good team to go execute and take advantage of the opportunities. In every deal that I've been involved with, even if they're good deals, there are always periods of struggle. And so you've got to acknowledge that. And put the team in place that can execute against those struggles. And I think competitive advantage is ephemeral. So, you know, if you're not continually moving, continually improving, your competitive advantage is often, you know, kind of quickly eroded. The other thing that I see is when we underwrite something, there are a number of unknowns. But I take a lot of comfort when I see situations where there are multiple levers for improvement. And I essentially look at that as if I'm

Starting point is 00:24:49 buying a decent business with embedded options. And what I mean by that is there's options to grow through acquisition. There's options to grow geographically through opening new entities. There's options through pricing or through supply chain management. And so when I'm underwriting that, I don't know for sure which of those options will present themselves to me, but I take a lot of comfort in. There's numerous ways to kind of drive value in this business and we'll figure out, you know, of the five we've identified two, three or four that can really help get us home. And then listen, I think in every good deal, there's some element of luck. Talk to us more about you brought up competitive advantage. And this is another big buzzword that Buffett and Munger always talk about is an enduring

Starting point is 00:25:31 competitive advantage. I know from my own personal investing experience, this is something that I think has matured where I didn't realize how important this was when I'm a lot of it. I know, I know, whenever I first started investing, but now when I look back, I think that that's one of the most important things that I can look at next to price and all the others. But this competitive advantage piece is so important. Can you explain why you also think that that's so important to the audience? I'm working process and my experiences cause me to think about things differently. But I have a lot more confidence in my ability to underwrite the quality of a business

Starting point is 00:26:09 model, then my ability to underwrite growth in a market. So, for example, you know, you think about trying to project GDP growth or the growth of an end market like oil and gas or commercial aerospace. I think that's really challenging. And in many ways, it's a little bit like a coin toss. But if you ask me to underwrite what makes a good business model and you think about the attributes of that, once you've identified that, I think those attributes are likely to be persistent. So, for example, we look at things that have very low customer concentration. We look at businesses that have barriers to entry. We look at businesses that have relatively high variable costs because that allows you to navigate changes in the marketplace. We talk about value in terms of multiples of cash flow, but we talk about quality of businesses as a product of return on tangible capital. How much cash flow to the tangible assets of this business generate. And so I think that's a much more durable way to underwrite and get comfortable with the investments that you're making. And you're obviously looking at the trends of those and how they're progressing over time,

Starting point is 00:27:14 I'm assuming as well. Absolutely. Yep. And, you know, it's kind of interesting. All the analytics are quantitative and they focus on the metrics, but it's easy to forget that those metrics are driven by people. And so, you know, it really is a combination of financial capital and human capital that create a successful situation.

Starting point is 00:27:35 You know, I'm curious when you think about a discount rate for the business that you'd be looking at. One of the frustrations with a lot of people that are Warren Buffett-style investors that are doing these calculations for intrinsic value and things like that, they go to a business school and they're doing these CAP-M models and they're using the prices of other businesses and the volatility of other businesses to determine what they think the risk or the discount rate should be. You know, my personal opinion is that that approach is so backwards. I'm kind of curious how, because in private equity, I would think you're not doing no cap M model. You're doing what you think your risk is, and then you're assigning that as your discount rate. Let's talk about DCF and discount rates and cap M in general. So it's tremendously theoretical. And so it's interesting, but I think it's interesting not because of the answer it gives you,

Starting point is 00:28:28 but because of the process that forces you to explicitly make assumptions. So when you're doing that analysis, you've got to make assumptions about growth rates, and you've got to make assumptions around exit. And so those are all valuable processes to kind of work through, but I think the answer doesn't really drive how we think about what we're going to pay. So first of all, the great thing in the private equity market is you pay a combination of what you think it's worth, but also what you think you have to pay, right? Because, again, it's a negotiated transaction.

Starting point is 00:28:58 So we think about the analysis we do as what can we afford to pay, what's the time? top end. And then if we can, we obviously try to do better than that. But as we think about the actual modeling, you know, we think about it in the context of a five-year-hold period. What can we pay assuming a certain capital structure? We've been out in the market. We've talked to lenders. We know how much leverage they would provide at roughly what rates. And then we do a forecast over a five-year period. And we generally assume we're going to exit the same multiple that we bought in at. And the combination. of those things drives a certain return profile. And we would expect on, you know, deals that are

Starting point is 00:29:39 in our kind of wheelhouse that those pencil out somewhere in the 20 to 30 percent IRA over a five-year period kind of time frame. So, you know, that is a planning process, not necessarily, you know, the gospel, but that's how we think about the process. And do you have an internal rate of return model for this? In other words, a threshold of how much return you're expected to get if you invest in this opportunity? Absolutely. Yeah, no, for us, it's not so much in theoretical what is the cost of capital. It's what's the IRA to the investor. So, Doug, now that we heard about some of the good deals that you made, I don't want to put you on the spot, and I guess yet I'm doing it anyway, could you tell us about some of the mistakes that you made in some of those deals and perhaps

Starting point is 00:30:26 even some of the things you completely neglected in whenever you did your due diligence of the company. Yeah, so first of all, I think let me go back to one thing I said when we were talking about good deals. All these deals have challenges, so you got to expect them. We kind of joke. There's no such thing as a 20% T bill. We're pricing these assets with an expected high return and implicitly that means I've got significant risk here. And so I think a lot of the game in my mind is setting yourself up to avoid long-term impairment. And what I mean by that is, you know, these things will go through cycles and there'll be tough times, but if you can avoid long-term impairment, you generally can find a way to work your way home to a decent outcome, or at least an outcome

Starting point is 00:31:11 where you haven't lost significant capital. Where I find you run into real impairment risk that's hard to navigate through, I think businesses with real customer concentration can lead to real drivers of impairment. And then, you know, we talked about capital structure, and that drives a better return because I'm using leverage. The reverse of that is if you're too aggressive with capital structure and you hit a bump in the road, it's very difficult to kind of course correct. And so, you know, we think about leverage as a double-edged sword. We want to use it to leverage returns, but we try not to take the last dollar to give ourselves kind of a zone of error or a margin of error in a way that we can navigate, you know, kind of Murphy's law, if you will.

Starting point is 00:31:57 And listen, we talked about teams on the positive side. Teams, bad teams can be an opportunity or a liability. If you find a situation where you have a bad team, if you're willing to make changes, that actually can be an opportunity. But I think you've got to go into the deal knowing that you think you're going to change out the management team and be committed to doing that. But I find generally, you know, on the deals we've struggled with, we thought we had a management problem and we probably didn't act soon enough.

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Starting point is 00:35:27 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. Talk to the audience about the term impairment so they understand the terminology there. Yeah, essentially think about the stock market. You know, the stock market goes up, the stock market goes down, and I still have value. The good news is the concern has not been impaired and over time I can still kind of grow my money back, if you will. And impairment essentially means you've permanently diminished value in the asset. So a good example is a bankruptcy, right?

Starting point is 00:36:13 At that point in the cycle, you were forced to turn over the keys to another owner, essentially. And so there's no way you can kind of overcome that impairment. Okay. So, Doug, you have written a book. And Stig and I have both gone through your book, Family Inc. is the name of the book. And writing a book is really time. consuming. I mean, it takes a lot of effort to put a book out there. And when you look at the revenues that a book generates, it's often not worth the effort to write a book. And so the reason

Starting point is 00:36:46 I ask this is because you've dedicated so much of your time and energy to writing a book. And I'm curious, what motivated you to do this? Like, why did you put this out there for people? Yeah. Well, so first of all, let me let me make, just reaffirm something. You said, I'm, I'm pretty sure that I'm violating minimum wage laws. If you look at it. how much I've made on the book versus ours invested. So I can promise you there's not a money-making adventure. And listen, I did it because I'm passionate about the topic and I think there's a big opportunity to have an impact on people and really change the way people are thinking about financial literacy. I argue it's one of the biggest challenges that we face in America today.

Starting point is 00:37:26 There are so many trends out there that are making it harder for people to navigate their life in a way that's financially secure. You know, it's job mobility, it's wage stagnation, it's increasing cost of education, it's diminishing social safety nets, and it's increased life expectancy. You throw all those things together, and the skills required to create a life where you're financially secure are dramatically different than they were 20 years ago. The problem is we're teaching this topic the same way we did 20 years ago. And so my book is really an attempt to give people an actionable frame.

Starting point is 00:38:03 where they can make good decisions for themselves and help identify the big decisions that really impact your financial security over a lifetime. You really have these awesome tools on the website and we'll definitely link to them in the show notes where it's very clear that you look at yourself and even your family as a business and it's all lined up with financial statements that you can directly apply. I don't know if it's because I know you and I know your background, but I couldn't help but think, is this not just seeing yourself as running your own company, perhaps even a private equity company? Is that the right interpretation of that?

Starting point is 00:38:47 That's absolutely correct. And a little bit of history on how some of the key concepts of the book evolved for me. My inspiration for the book is a product of my experiences as a young private equity investor. And so I'm working on a number of portfolio companies looking at making investments. And what I realized is many of the tools and analytics that we were using to assist the portfolio company could actually be applied to my personal finance situation. So, you know, essentially, we're all in the business of selling our labor into the market. So you're in the business of you. I'm in the business of me.

Starting point is 00:39:21 You can make that leap. Then the same kind of tools and logic apply that, you know, we teach folks in business school. we should be thinking about that in our own personal financial decisions. Now, I'm not saying that means you need to make every choice that is the financially optimal choice, but I think at least it forces you to understand the financial implications of the choices you make. You know, so for me personally, whenever I started my own business and I had to do my own income statement and my own balance sheet and cash flow statement. And I was literally, you know, doing the double entry accounting on my company, that's whenever I personally felt like my

Starting point is 00:40:01 understanding of how to assess the value of another business just kind of went exponential. And it was very helpful for me to be doing those calculations and figuring it out because when I looked at another company's books, I was like, oh, well, that's, that right there is not good because in my own personal accounting when I would do that, that would be a really, that'd be a red flag. And so what I love about these tools that you've developed is that you've basically allowed any person off the street who doesn't own their own business to basically be doing these financial statements on their own on themselves. And I think this is my personal opinion for people listening to this. If you go in there and you play with some of these sheets that Doug's developed, you're really going to improve your understanding of how financial statements work.

Starting point is 00:40:47 It's going to help you when the next time you look at a public stock or, you know, maybe you get interested in private equity, someday. All this stuff is going to really help you understand the value of a business and to understand the plumbing of how the money moves through a business, how it moves through your personal finances. I just, I love it. So I'm just, you know, if I could give it a plug for people, I highly recommend that you check out these tools that Doug developed. Well, thanks, Preston. And for what it's worth, I agree with you, you know, if I could encourage folks in school to take one course, I think it'd be an accounting course, and not because you want to be an accountant, but it is the tool, it's the communication, the language of business, and I think it just gives you so many,

Starting point is 00:41:29 such perspective as you apply it in other fields. And so I think, you know, causing, forcing yourself to sit down and kind of think through what a person's balance sheet looks like and include non-traditional assets like lifetime value of labor, lifetime value of social security, and think through what the implications of those things are on your investment choices. I think that's a really valuable exercise. You know, I encourage people to do it periodically so you can see progress in the balance sheet or essentially accumulation of net worth. Having said that, just, you know, if that's not your thing, if you do it once and force

Starting point is 00:42:02 yourself to kind of look at it, I think that's still very eye-opening. So going back to the background, I'm very curious to hear how you would equate that to a busword like entrepreneurship, which is something that you always share these days. So if you have entrepreneurship on one hand, then private equity and another, how are they similar? And do you see them marry up in the end? Yeah, I think it's, there are very similar activities on different ends of the spectrum. But so first of all, I consider myself, and I'm a private equity investor, I consider myself a financial entrepreneur. And essentially what that means is my skill set is not technology or software.

Starting point is 00:42:43 My skill set is capital. and I'm trying to apply that in an entrepreneurial environment. And so, you know, I would argue if you're an entrepreneur and you're trying to create a business, you still are taking your intellectual property and your human capital and you're combining it with financial capital to create a business. And in that case, your primary tool is your intellectual property, your human capital. I'm kind of coming at it from the other side of the equation saying I'm trying to find businesses that have a capital need.

Starting point is 00:43:12 my primary tool is the capital, but I'm also using, you know, my intellectual capital and human capital. And so I think it's almost a matter of mix, you know, so an entrepreneur is kind of nine parts, human capital, one part capital, and a private equity investor's, you know, probably nine parts capital, one part human capital. But it's really, they're both very similar activities when you think about taking an idea, a strategy, and operationalizing it through labor. and a combination of capital. All right.

Starting point is 00:43:45 So I'm really curious to hear your response to this one here. Oh. If you could go back to being 22 years old, you could meet your 22-year-old self. That's how I need to phrase this. If you could go back and meet your 22-year-old self, you just graduated from West Point. You just threw your hat. And you could give yourself just one, two pieces of advice about investing. What would you have told yourself, knowing what you knew?

Starting point is 00:44:12 back then. What would you tell yourself? Oh, man. So advice about investing. So this is my advice to young investors. I think you're asking, right? Yeah. Well, and so, and after you're done with the investing advice, what would have been your life advice? So I want to get that next. Okay. All right. So, you know, I think young investors make a couple common mistakes. The first is return over dollars. And that concept is everybody focuses on IRR. People want to talk about my return on an investment and a percentage terms. I think dollars gained is a much more relevant metric. And so I don't want a 20% return for six months. That's 10% big deal. I want to invest in businesses where I can compound for long periods of time, which result in multiples of capital returned. So, you know,

Starting point is 00:45:03 20% for five years returning multiples of capital. That's the name of the game. And I didn't, you know, early on, I think I thought about return and be damned what the duration was. And I think duration is another concept that is hard for young people to deal with. But the name of the game here, you know, Warren Buffett talks about all the time is patience and conviction. And so when you believe you've got, you know, you're well-founded in your conclusions, you've got to have patience to let the market do. thing for a young person, that's often very difficult. All right. And then if you need a moment to think about this one, feel free.

Starting point is 00:45:41 So what is the life advice? I want to hear this one. Yeah. I honestly, it's a little bit of the same applied to your personal situation, not your investing situation, but it has to do with duration. And I think being able to think long term, being able to make choices that have long term payouts is a real competitive advantage, strategic advantage. And I wish when I was 20, I had thought more about what these decisions would, what the ramifications of these decisions would be when I was 50.

Starting point is 00:46:12 And I think when we're 20, we think about what it's going to be like when we're 20 and a half. And so forcing people to think longer term. You know, Bill Gates has a really interesting quote. I don't know if you've ever heard this. He said people way overestimate what they can do in one year and way underestimate what they can do in 10. Yep. Yep. I think it's right.

Starting point is 00:46:33 And I think that's a real competitive advantage. It's a real competitive advantage as an investor if you're able to look past the noise of a year and think about 10-year time horizons. And it's a real competitive advantage as an entrepreneur, you know, just a life choice as well. Thank you for your response, Doc. And I can definitely say for me, I'd wish that I had applied both of those two pieces of advice when I was 22 when just starting out. So my last question is a question that we're always very excited. to ask of authors. What is your favorite book and why? You know, I don't know if I'd say favorite, but the one that I'm most interested in right now and have really enjoyed, it's called

Starting point is 00:47:14 Lead Yourself First. It's inspiring leadership through solitude. And this is written by a guy Mike Irwin, who happens to be a buddy of mine, but essentially Mike studies leaders throughout history that have used solitude as an important tool for creative thought, using your moral compass, emotional balance and confronting tough problems. And so he studies people like Eisenhower, Martin Luther King. So I love the historical aspect of it, but I also love the tilingess of it. You know, I think technology has a lot of unintended consequences. And in today's environment, if you don't purposely carve out an environment where you're going to not be disturbed and you can have good quality solitude, I think it's very hard to have any kind of deep creative thought

Starting point is 00:48:00 these days. And so it's a book that I enjoyed, but has been impactful in the way I'm trying to spend my time today. Doug, we can't thank you enough. Brilliant answers here. And if people want to learn more about you, they want to check out some of these tools, where can they find that? So the name of the book is Family Inc. using business principles to maximize your family's wealth. And I have a website. So that's family inc.com, f-am, I-L-Y-I-N-C.com. And as you were so nice to describe. There's a bunch of tools there that help an individual create financial statements as if they were a business. So that's a balance sheet and an income statement. And I think just going through that exercise will force you to think a little bit differently about, you know,

Starting point is 00:48:45 things like your labor assets. So it was worth the time. Thank you so much, Doug. Really enjoyed the interview. All right, guys. That was all the Preston and I had for this week's episode of the investors podcast. We see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted. before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP179: Private Equity Investing w/ Doug McCormick (Business Podcast)

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