[00:00:04] Speaker A: Hello and welcome, everyone. I'm Peter Lerman, and this is Masters in small Business M and A. This show is an ongoing exploration into the vast and undercover world of small business M and A, where we interview both the proven and the emerging owners, operators, investors, and advisors whose strategies and methods for transaction success have been put to the test. The show aims to surface the nuanced intricacies, the key ingredients, and the important factors that can improve your decision making in your own journey in the world of small business M and A. This podcast is produced by Axial, an online platform that makes it easier for business owners and their M and A advisors to find, research, and privately connect with a diverse mix of professional buyers of small businesses. In addition to learning more about Axial, you can find this podcast show notes, edited transcripts, and many other related resources, all for free at axial.
[00:01:02] Speaker B: Peter Lehrman is the CEO of axial. All opinions expressed by Peter and podcast guests do not reflect the views or opinions of axial. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Podcast guests may have ongoing client relationships with axial.
[00:01:21] Speaker C: Hey, everybody, this is Peter Lehrman. Welcome back. This is masters in small business m and a. I am excited to have Rafa Quinn, who has, in all fairness, been a little bit on a podcast tour of late. I'm maybe at the tail end of this one, but excited to find some new material with Rafa today. So, Rafa, thanks for coming and spending some time with me.
[00:01:39] Speaker B: I'm happy to be here, Peter. Thanks.
[00:01:41] Speaker C: There's been a couple of great conversations recorded recently, I think, that have taken people through you. Your origin story, your first deal, your hq in Panama, as opposed to America, where most of the hold co activity tends to be talked about on Twitter, et cetera. So we're going to skip all of that. We're going to just dive straight into the transactions that you've been doing and apply some of your tweets to the transactions, so to speak.
[00:02:07] Speaker B: Great.
[00:02:07] Speaker C: I thought it'd be really interesting to just hear about the water businesses. You have two water businesses that you've acquired, won a couple of years ago, and actually won just in the first quarter of this year. Tell us about water. Water businesses. How did you get excited about this category and the businesses themselves?
[00:02:23] Speaker B: Yeah, so, I mean, first off, just to give a little bit of background, we do have two holding companies. One is based out of Panama, one is based out of the United States. We began Panama in 2011, so we've been building the longest, and then we began in the US in 2021. So when we began in Panama, the first company we actually ever bought was an industrial sales distributor. So basically, we distribute in Panama lubricants and filters for engines. And today we've moved into hoses, timing belts, other kind of products that fit in that same niche. So when we see the first opportunity in 2022 for plumbing and H Vac distribution, which was proctor sales, while it was a different product, the business itself was very similar to what we've actually have the longest amount of time doing, which is distribution. We are the local representative for manufacturers. We are their boots on the ground, if you want to see it that way. The levers that you're trying to control there, as far as technical expertise, getting to clients, purchasing correctly, holding the right amount of inventory, selling on credit, all of that is very similar to what we've been doing in Panama since 2011. So I would say that was the initial reason why that business was attractive to us, is we understood it. Even if I don't understand exactly how the hot water heater or the boiler gets installed in the building, I understood the business economics of it. Right. And then after that, it was this similar analysis that we do for any other type of company. Number one, geographically, did it work for us? Yeah, I was in the United States. Number two, was the size correct? At that point, we were looking for companies that were doing over $2 million in earnings. So that Box got checked from there. We're looking at how hard is it to kill this business? So how many manufacturers do they have? How many brands are they carrying? Do they have one manufacturer that's making up over 50% of their sales? And the answer was no. They're actually carrying multiple brands. No one company represented more than, say, 25% of their sales. We like that Diversity. They had what's called a full Line Card. So they were offering a complete suite of solutions in their area, and they had lost one brand. They can very easily replace it because they have other brands that they're carrying. We did the same Analysis on their customer side. There was no customer making up more than three or 4% of sales. They're attending hundreds of clients a year. Longevity of the business company had been around over 60 years. So a lot of those boxes that we look to check for, every company that we look at, they started checking, and then that deal just gets more interesting and more interesting. I think that's really how it first kind of came about to be, to be on our radar and. And look like a prospective company for us to buy.
[00:05:03] Speaker C: Is there something about that end market or that category that you guys find.
[00:05:07] Speaker B: Interesting in as much that one of our principles is we're looking for businesses that we believe will be around at least ten years. And that might seem really short to some people. But I try not to say if I know it's going to happen in, say, 20 or 30 years. We don't know what's going to happen in 20 or 30 years. In our experience, most companies that make it ten more years will probably last 20 or 30 more as well. But we just try and look out ten years. So let's take this industry, for example, hot water. The areas that we address are Alaska, Washington state and Oregon. So I believe that over the next ten years, people in Alaska will continue to want hot water. Therefore, yes, that product need is going to be met. It's like I don't see a change happening there. Could the way their water get heated change? Yes, and it probably will. If you look on the west coast, theyre going through a big change right now where theyre moving from electrical or, excuse me, from natural gas to being plugged in electric as they want to move to more renewable energy sources. So how do you address that? Well, youve got to look at your manufacturers. Are they people who have been investing in R and D? Are they people who have been continuously coming out with new products, innovative products to attend the market? As long as you have that, then you should be betting on we're going to be able to address that need. And those changes in the market will actually benefit us because that drives new, new purchase of units. When you do a retrofit, you have to change all the water heating because that's now becoming mandated by certain local governments. But, yeah, in essence, for that end market, it was simply, is this something that will continue to be used going forward? And that was a very easy yes to us. The other one I measure is always, can I explain this at the dinner table to my wife and kids? And, and, yes. Well, what does the company do, dad, with the water heater we have in the garage? We sell those in places that are really cold. As you mentioned, I live in Panama, so I always say selling hot water in Alaska or in the northern us is like selling air conditioning in Panama. That's the easiest way to explain it. Down here at least. I mean, no one can go more than a day without AC in their house down here because it's so hot, just like no one could go without hot water from worth and tay up there in the winter. That was how we looked at that industry in general, I would say, when we first bought Proctor, in terms of.
[00:07:15] Speaker C: Just the way that money moves through that business, could you just talk a little bit about the way you sort of thought about that? So just how does the company actually earn? Which is your question number one on your 13 or 15 point checklist?
[00:07:29] Speaker B: Yeah. I mean, the distribution business is, to me, it's, it's like, it's commerce in general. Like, if you go back a few hundred years, what was commerce? I buy from one person somewhere, I take it somewhere else, and I sell it more expensive. That's, in essence what we're doing. We're buying off manufacturers. We're selling to end users. There is a value add there because of our technical expertise. So a job that we did, for example, was, or that the company did before we bought it was the Seattle Kraken, the hockey team. So they play where the supersonics used to play. Well, when you take a basketball stadium and you turn it into a hockey stadium, you need to be really careful with the way your water is being heated because obviously the temperature of that ice cant be affected by all that plumbing and the way thats done. Well, that techsomebody needs that technical expertise to bring it in there and make sure that that works. And thats the type of value that we add. Were buying products, were selling them for a profit, and were collecting that cash. We have to maintain inventory. But other than that, youve got a pretty light capex structure. Besides the warehousing, some trucks, its not like a bunch of our cash is having to be redeployed into the business simply to maintain how we are. As we grow, we do have to invest in higher inventory levels, and we'll have a bit higher receivables. But again, we were used to that from our industrial sales down here in Panama. Other than distribution is a pretty good cash flowing business. I would say that the trickiest part is the purchasing of the inventory. So there you're looking at, am I selling something that's perishable or it's going to be obsolete? Was the same decision down here 13 years ago. Lubricants, as long as they stay in their barrel airtight, they can last a decade. The only risk youre running is if technology changes in that product becomes obsolete. But youre not dealing with stuff like fashion, lets say, which becomes obsolete after six months. So thats how we looked at that. As far as the cash production, is.
[00:09:16] Speaker C: There any version of that business where you consign the inventory with a markup as opposed to taking purchasing risk.
Do you explore?
[00:09:25] Speaker B: So its not a typical consignment, but what it is is. So we are a rep and distributor. So the way you would look at those two, and that relationship varies by manufacturer. Okay, so the distributor is actually buying the inventory, taking ownership, taking that risk and then selling it. The rep is simply doing the sales process. The purchase order actually goes from the end user direct to the manufacturer and we receive a commission. So we never actually touch that inventory. We don't take the credit risk from the client or the inventory risk from the manufacturer. It is a better cash flowing business, but the total dollars you can earn are less on the effort of the sale. Obviously, in our company, we're about 50 50 in Proctor between rep and distribution. So yeah, that's that, that's how that works.
[00:10:15] Speaker C: Did the second business that you bought this this spring, like maybe we could just talk a little bit about that and just sort of how that came about and how you think about this. I know you operate these two businesses separately today, and I know that youve talked about publicly, you started out creating a horizontal hold company conceptually with you and your co founder, which kind of favors the generalist investor mind. But now that youre more than a decade in, you have a bunch of different businesses. There are these opportunities to go deeper in different categories and youre sort of horizontal disposition can become a bit of a hybrid and you can become sort of deeper and deeper and more and more vertical in certain categories. Do you see yourself spending more and more time, you bought a second business in this category this spring. Like, how are you thinking about how the holdco model could potentially go deeper in some of these areas now that you're more than a decade in?
[00:11:10] Speaker B: Yeah, I mean, and I've, I've written about this before, that a horizontal hold company is more, it's, it's the thesis in the sense that when we're starting, we're not simply going to be focused vertically or in a roll up, let's say just focused on one. So that permits us as investors to go where the fish are, right. We get to pick where we find investment opportunity. We get to look at all the options out there and pick which is best for us. That being said, if you look back historically at horizontal hold, cos almost always one or two or three investments will become outsized over time. So in Panama, for example, its restaurants, if you go back five years ago, we have three verticals here. They were about one third, one third, one third. You go to today. And restaurants are now 75% of our Panama hold code. That was not by plan. Right. And the same could be said today for plumbing H Vac distribution in the US. As of now, those two businesses make up 80% of our revenue. So they're outsized. That wasn't by design, but to get into kind of how that happens. It can happen for various reasons. In Panama, it came about because we had opportunity, met management. Right. Restaurants are. You can push the pedal down in restaurants. You just go out and open more restaurants. I mean, that's it. It's harder to push the pedal down, say, on business process outsourcing, it's like, I have to win contracts. I can't just throw money at that and win more contracts. There isn't a funnel I can drive that way. Whereas in restaurants, I can just look at the map and say, well, I don't have one here, here, and here, and go and open them. And all of a sudden, I've grown revenue. If you couple that with a manager that wants to grow and can execute that vision now, all of a sudden you have that opportunity. In the United States, it came about differently. We had closed Proctor, the acquisition. That was in August of 22. And a couple months later, my business partner actually was with the CEO at a trade event. So they were at a trade event. It was a convention. And during that convention, they meet a guy that the CEO knows from the industry, and he starts telling his story that he has a business partner, and the business partner is getting close to retiring, and he's not sure. Their shareholder agreement says that he's either asked to buy the partner out or they both have to sell, and he's kind of undecided what to do. And lo and behold, there's my partner. That's what we had just done with Proctor. They start speaking. And over a year of working with them, because they didn't have a broker, they didn't have anyone holding their hand or helping them. They were very new in that decision of kind of what they were going to do. So it took us a year working with them to finally close the transaction. And that's how now we have 80% of our revenues in water distribution. So I don't believe a horizontal hold code grows into these verticals by design. A lot of the time, I simply believe it's just different. You start getting inbound deal flow. You've got the CEO that really wants to grow. You see the opportunity, and that works out that way.
[00:14:10] Speaker C: Trey, do you see yourself? You have these two businesses you're running them independently. Do you anticipate exploring a change to the way that those two businesses are run over the next few years? I guess what I'm curious about is you start out horizontal. You're looking for interesting opportunities. At some point, get sufficiently deep enough by virtue of circumstance and happenstance in a subset of verticals, and you begin to see a capacity to compound earnings with higher and higher levels of conviction and confidence. Because just by virtue of the fact that you're now operating in those categories, and then because you now have that angle within that category, it seems like that can potentially be an easier path to outsized compounding than to continue to start anew as a horizontal holding company, kicking something off in a, in yet another new category. So, like, does your, does your lens change on how to spend time and how to spend capital as you start to get sharper and sharper on restaurants in Panama and water in America?
[00:15:16] Speaker B: Okay, that has a lot to unpack there. I would say. One of the things I heard you say that to me is super important is yes, the more time you operate in a certain industry that maybe was already within your circle of competence. That circle maybe doesn't get wider. It gets deeper, if that makes sense. So we understood distribution when we bought Proctor, but now we feel we understand distribution of h vac and plumbing and the relationships with those manufacturers and the different markets and which markets we'd like to enter and how to enter those markets. All of that is accumulated knowledge over time. So could that lead to us making more investments in this group? Yes. The answer is yes. We would also judge that with, and remember, our end goal is the health of the hold company. So it might not be wise to end up being 99% invested in water distribution. If I can find something parallel in a different industry that also offers the same type of return investments, there would be a benefit to that. If I go look, these two deals are identical. One of them is in plumbing distribution and the other is not. Well, the one that is not. At some point we'll get a little green check because it'll simply be diversification. Right? So I think that that's how I would look at that. As far as changing our day to day. I would say that I continue, my partner continue to look at deals the same way we always have. So we are always looking at opportunities. We spend a lot of our time looking at sims, looking at teasers and looking at deal flow. And I don't control a lot of that because 90% plus of what we look at is on market. So it's what our network is sending to us to look at. And I can't tell them only send me plumbing distributors. Right. I'm not going to do that. So I'm looking at everything. That being said, we do delegate a bit of this to the CEO's in the sense that if a CEO knows we're willing to invest and they have that attitude, they want to grow this company, they would be willing to do m and a. They will be looking at some of these opportunities and actually bringing them to us. And again, that was what I talked about with the restaurants of it has to be the opportunity has to meet the management, because invert that and imagine a manager that says, I'm happy exactly how this is. I do not want to grow. I don't want to integrate another operation. I mean, if we found something even that is a perfect fit, that means, okay, you got to fire the CEO. So that's a whole other decision you have to make. When you're doing that analysis on that.
[00:17:36] Speaker C: Deal, maybe it's a good time to, like, talk a little bit about how you work with managers. I mean, if you read the buffet letters, this sounds like maybe a little bit of hyperbole from Warren Buffet, but if you read the letters, he kind of makes it sound like he buys these businesses, and then he hangs out at Omaha headquarters and just kind of.
[00:17:54] Speaker B: Waits for the phone living that.
[00:17:55] Speaker C: Otherwise, he kind of leaves these. Right? And he leaves these and he leaves the managers alone. I have a sneaking suspicion that it's not quite like that. But generally speaking, the narrative around sort of the buffet approaches. Find great businesses, hire or back the existing managers that are outstanding, wonderful long term managers, and stay out of their way. Right. How do you compare to that? How do you think about that approach? What have you found yourself doing similarly and differently with alternative holding?
[00:18:28] Speaker B: When you mention Buffett's writing, I always like to think that Buffett was the original newsletter writer or, like, social media influencer, when everything you put out there is obviously, even myself included, is a lot cleaner than reality. So Buffett makes it seem like he just never has to get involved. But you go back to the eighties, and Buffett had to take over and be the CEO of Solomon. I mean, he actually had to step into the role because of what was going on at the company. So I think, yeah, the. The way he presented is probably not always 100% how it is for us. We definitely copied them. Our three is buy businesses we understand run by people that we want to work with and pay a fair price. We didn't invent that. We just pretty much copied Berkshire in those three core principles. The way we've done it is we buy businesses that management, which is generally the owner, is willing and able to stay on at least medium term. So we're not looking for. Yeah, I'll give you a one to two year transition. That doesn't work. We're looking for. I'll give you a minimum of five years, but I've probably got ten to 15. That's the type of conversation we're looking to have with the CEO when we're going to do an acquisition. And I would say that is our biggest filter. You don't find a ton of deals where that is the case. On the flip side of that, that scenario doesn't work for a lot of buyers. So the seller that wants that, there's a lot of people that aren't looking for that because either they're looking to come in or they're in the industry and they're looking to simply erase management and have their own team take over or they're in private equity. I mean, so when we find those deals, a lot of times they'll end up closing for us or working for us because it's a match. That makes sense. So we leave them running the company. Up till now, we have not had equity rules, so we're buying 100% of these businesses. The CEO is staying on with an attractive base salary. So that's going to be something market or market plus a bit. And then they are also getting a percent of distributions. So that's how we incentivize. So for every dollar you send to the hold company, you're getting a percentage of that. What percentage it is, is going to depend a lot on how much we. It's the whole comp package. I'm going to look at what your salary is, how much we think you're going to be able to distribute. Find a percentage that makes that entire comp package attractive, but obviously not, not absurdly attractive. It has to be. It has to make sense in the market. And we have found, at the end of the day, at the CEO level, an incentive plan is important. You want to keep them engaged and you want to keep them motivated and aligned. But a great incentive plan is not going to take a c level CEO and make them an a level CEO. At the end of the day, you still, you still got to find a good operator. I just think this. It's more like the cherry on the top. When you find the good operator. And then you can align in with those cash distributions. It just makes that wheel work even better because the conversations get a lot simpler. Okay, you want to invest in a new tech stack. Okay, I need a distribution. So which are we going to do? Great. We're going to do tech stack. Okay, perfect. Well, then you're not getting the bonus for that money and I'm not getting the distribution. It's just, it aligns that conversation a lot, a lot better.
[00:21:35] Speaker C: So are they deciding on what to distribute and how much to distribute up to the holding company?
[00:21:40] Speaker B: We're setting them our expectation and then that expectation can obviously change, be due to market forces, results at the company, planned investments, et cetera. But we're basically working through a budget process all through Q four of the previous year. Based on that budget and how much of their net income, we estimate they can turn into operating cash flow. We're then coming up with that, or what we call maintenance cash flow. So it's simply operating cash flow minus the capex. You need to maintain the business as is. And then of that we would say this is what we're expecting as a distribution, because any other capex would be for growth. If they want access to that capex for growth, they need to present us a business plan. And we're going to lay that out on the table with all the other opportunities we have, which could include bolt ons investment in a different business we own acquisition of a whole new vertical, just sitting on the money and having optionality of waiting for future opportunities. And we're going to analyze that and we'll make those decisions. And it's a balancing act. I wish I could say we're a robot and we just go for the best risk adjusted IRR every time. But the reality is I've also got to keep my CEO's motivated and engaged. So if they're coming with growth plans, even if it's not hitting exactly the highest return versus something else, we're probably going to say yes because we want to keep them motivated and we want to see how it plays out.
[00:22:56] Speaker C: The details that you mentioned around maybe we spent a little bit of time on just like budgeting, just keep going with budgeting year. I mean, I guess the CEO's, they're looking to optimize with this incentive plan. They're optimizing within the realm of the business that they operate. So they're trying to think about should I distribute to the holding company or should I invest in this project for this business and defer the distribution to the holding company in exchange for potentially more cash flow and a more significant distribution at some point down the road. Right. That's the lens that they're essentially being asked to look at investment opportunities. And you at the holding company level have the ability to look at that view of the ability to look at completely new capital deployment that's totally unrelated to that operating company.
[00:23:50] Speaker B: That's correct, yeah.
[00:23:51] Speaker C: Correct. And so has that ever gotten challenging just because they're in the tunnel focusing on operating that business and you're able to look at the full waterfront of opportunities? You have such different perspectives from one another in terms of how the capital should be getting reinvested.
[00:24:07] Speaker B: Okay. Yes, we do. And I think a lot of that plays out also with the types of businesses that we buy. So we're not buying a business. That's. This goes back to kind of our thesis. We're buying businesses that have been around at least ten years. We always say minimum of three. The reality is we've never bought anything with less than ten. And in the US, they've all been 30 to 60 years old. So you're not talking brand new companies in that initial growth phase where you could be reinvesting 100% of your cash flows plus debt and continue attacking market. You're looking at stable businesses. So that's. Let's start there. Number two, our investment thesis isn't built on them doubling earnings in the next three years. I don't need that to happen for our returns to work out because of the price we paid and our debt structure and how we have it set up. So now let's actually go to the CEO. In my experience, I have. I mean, except for the restaurant example, that was the only one that we had where a company could truly reinvest 100% of their cash flows. And it wasn't for a long term. I mean, we capped out Panama can maybe handle 20 restaurants, let's say, of the brand we were growing at that moment. We were taking it from, let's say, five to 20. So, yes, on that base, capital base or earnings base you had, that's a big growth. If you want to execute that quickly, you're going to have to consume a lot of that cash flow. But in general, we're rarely getting asks that are really putting in jeopardy the distributions that we're counting on. It's also up to us to negotiate our debt in a way where that shouldn't infringe on their operating ability. Does that make sense? Like, we're not putting in capital repayment structures that just completely eliminate their cash flow. So their hands are tight because that's not fair to the operating team as well. I think we've done a good job as far as aligning ourselves in that sense. As far as looking at the different opportunities, yes, we see a bigger playing field, I think is how you put us. We're seeing more opportunities where we can maybe say this doesn't make as much sense. On the flip side of that, they're seeing things more short term. So their opportunities are quarterly, whereas if we close one acquisition a year, that's like super aggressive. I mean, that, that's a lot for us. We've gone four years, we didn't buy anything. So that gives a lot of leeway to. Yeah, you want to keep saving cash for those future acquisitions, but youre also obviously going to be executing on plans this quarter or next quarter, opening a new location, bringing a new line in and buying inventory with it. I think lastly on this point is we dont buy businesses in general that are extremely capex heavy. That goes against our whole philosophy of trying to have heavy cash flow production. Therefore, even their growth usually doesnt require mass amounts of capex. Again, restaurants was the different one there.
[00:26:53] Speaker C: I think the other thing that I was hoping to just talk about because I think it's, I haven't seen it get a whole lot of airtime. The concept is well known, but like, just how it gets implemented is the zero cost budgeting exercise. So I wanted just to like, just have you maybe take us through what you hope to see when, when you, when a CEO is doing that or a CFO is doing that, or when you ask them to do that, just take us through that process. What are you trying to achieve? How do you define a good outcome there? How precise versus broad is the net being cast? And yeah, I'd love to just hear the practical application of zero cost budgeting for businesses that you're helping to own and operate.
[00:27:36] Speaker B: Yeah, I would start with we definitely are not doing zero cost budgeting every year. So maybe a famous example of that was like a 3g capital. So 3G capital is very well known for like doing zero cost budgeting, I think every single year. I don't know how they did that, but we're not doing that again. And this goes back to our thesis. We're buying things that are functioning, we're not buying turnarounds, and our goal is to let them continue functioning with the same management team. Therefore, as long as everything goes according to plan, we shouldn't need to go in and do a zero cost budget. So what would trigger one would be something is not going according to plan. We're seeing opex versus revenue creep up. We're seeing inefficiencies. We're measuring versus other players in industry and saying that we're just, we're inefficient. So we need to look at that. So that's what would trigger us actually even having the conversation of doing it. Then how it's applied is when we buy a company, one of the things that we, that we implement, it's not highly sophisticated is, is a unit analysis. So it's simply breaking down the business into the smallest profit centers possible. So we want to get as granular as possible as where our actual profits are coming from, not just revenues. Right. So we're assigning operating expenses to each line of business or sales, channel or restaurant or how or contract, depending on the industry. We're assigning their cost of goods sold or assigning their revenue. And then we obviously are, you're going to end up with some unassignable amount which is going to be admin that you'll keep separate. So that is generally our roadmap of where we're going to apply it. So again, starting off with that first trick of the results are not what we were expecting. Okay, now lets drill down and see who was the culprit. Where did this come from? Okay, now lets apply this strategy to that budget. Because if you, at least at our size, I believe if we tried to do zero cost budgeting for the entire company, were going to end up with a lot of stuff just getting put in there because thats what was there the year before, which isnt, it's, it's literally the opposite of why you're doing. That's just a typical budget. Usually it's just, let's just do, we did last year plus 3%. This is supposed to be, let's actually sit down and work through our processes and really understand how are we doing this function. Is it the right way to do it? Could we do it better? And now let's assign expenses to it and rebuild out that team. So one I would use is, is wait staff in a restaurant. Are you get used to having a certain amount of wait staff in a restaurant? Well, does that make sense based on our traffic numbers currently? Because it made sense ten years ago. But what about the type of traffic we have now? The amount of tables we have now? How fast are those tables turning? How many plates are we bringing out? Are they ordering appetizers, entree, and dessert. So is it three servings per sit down or just one? Yes. Our sales have grown, but a big chunk of that is now third party delivery apps or takeout. So how has that affected the volume in the stores, the size of our restaurants? That's a very specific niche that you can go in and work at. At the end of the day, those salaries are a large percentage of our overall opex. So it's somewhere you could get a lot of bang for your buck for the effort, but it's. It's narrow enough where I feel you. You really could sit down and work through those processes.
[00:30:42] Speaker C: Do the managers know how to do this, Rafa? Or do you? Who's helping do this?
[00:30:50] Speaker B: Yeah, I mean, so we. Okay, so we do have a corporate team here. It's very small, and our goal is to always keep it small. But our corporate team is my partner and myself, where we are mainly focused on investment analysis and then acting as what's called a managing director. So the CEO's report to one of us, we also have in house COO, CFO, lawyer, and internal auditor. So for this type of project, it could pull in resources from our CFO, our COO, and our internal auditor. Because the internal auditor is not a controller. They're much more on the operations side of things. They're actually going in and auditing the processes in the companies. So that would be an invaluable resource for doing this, this type of.
[00:31:34] Speaker C: Got it. And so they're typically the ones who are then working with the management team of a given business.
[00:31:40] Speaker B: The management team. Correct. Which would include the CEO or the head of maybe that area of the company, and then obviously their accounting department. So each of our OPCOs, we like to say, is fully self sustaining. I hope we add value, but we are not necessary. In that sense, we should add value, but we're not needed to maintain the day to day. So they have their accounting departments, they have their HR departments, they have operations, they've got their CEO. So they would pull from resources, depending on which area of the company we're actually looking at to implement that.
[00:32:11] Speaker C: Is there anything else you wanted to touch on in terms of just how you're working with the businesses that you've bought that you think is worth covering and that may have gotten less airtime in some of the prior conversations that you've had?
[00:32:23] Speaker B: I think, one, it goes back to what you mentioned about the Warren Buffett way of kind of presenting things. Most people, if they know me at all, it's because of what I write on Twitter. Right. And obviously, in Twitter, you're presenting something as best you can. And I try and present a best case scenario or an idealized scenario of how it should be or what I strive for. Uh. Cause it's difficult to get into the intricacies of everything on a written Twitter feed. And the reality is, it's not that clean. I'll give you an example. We run a delegated management system. We have a CEO, and we say that we 100% empower them and we don't get involved. And we don't. Yeah, the reality is, it's a little messier than that. I mean, yes, I'm not clocking in at the distributor business or at the restaurant business today to go give orders, but I'm obviously very attuned to how that company is doing. And I have thoughts, and I try to keep them to myself as best I can, because what I've found is, as an owner, sometimes our thoughts carry more weight than they should. Right. Our thoughts carry weight due to our position in the equity stack rather than in our position of the knowledge stack. So I could have this great idea of a new plate I want to see at our restaurants. But I have no idea the headache that just caused to our production team, the kitchen, the production center, the. The purchasing department. So while I try not to do this, sometimes it's stronger than me. I suffer from Mild OCD. So the.
And I'm a workaholic. So you put those things together. And it's hard for me to not get my hands into the companies, but I strive for it, and I'm open with the CEO's when it happens. If I make a mistake, I always say, be very careful on your debt. And the reality is, I also say that our first deal, we totally over leveraged that deal could have gone super bad. So. So, yeah, it's. It's that if you have already bought a company or you're looking to buy a company, have realistic expectations. These things. There's a reason we're buying them at four to five x, and it's because they're messy. You're not just getting hand at a 20% to 25% return. There is. There's constant disasters. That's the reality when you see the back. That's why sometimes it's good just to go in as a customer and be like, well, I came in, I got attended to, I got given my lubricant, my filter, I went to my car. I don't know that it's an absolute shit show in the back, but they all are like that. You're always finding issues in your accounting department and fixing things and cleaning things and buying wrong inventory. It's just. It's always happening. And at the end of the day, as long as you continue improving, they still provide really great returns. And that's just. That is part of the game. But I guess that that's what I would add is it's not as easy or clean as it looks like. Oh, this is so simple. No, it's not. It's. It's. It's a lot of work, and they're not perfect. They never are. But you strive for it.
[00:35:05] Speaker C: I mean, it's maybe, like a really good time to cover just the return side of what you're hoping for. I talked to you before. We pushed for cord about, like, just this idea that any one of us can very easily go and just buy an S and P 500 ets. And that is a cap weighted, dynamic summary of effectively the best run, most significant publicly traded american businesses. You can get it with very, very low expense costs to buy those ETF's. And over the course of time, that set of businesses has returned. I think. What is it? I think 11% or something like that.
[00:35:47] Speaker B: They call it 10% historically.
[00:35:48] Speaker C: Yeah, 10% historically. And so when you buy a business for four to five times earnings, as you said, they're not just handing out a free and clean 20% unlevered return. When you think about all the work that you guys have to do, what type of return are you guys trying to achieve over the long term? Where do you sort of, in your mind, sort of set the number? What justifies all of this hard work? What justifies all of this messy management and zero cost budgeting exercises and.
[00:36:21] Speaker B: Right, yeah.
[00:36:22] Speaker C: Just, again, I know you love the investment business, and I know, obviously, Rafa, that's part of why you're here, is because you love this work. And it's intellectually very interesting for you. But if you were to just look at it purely as a raw economic animal and say, okay, I can earn 10% without lifting a finger, by just putting parking my savings in the s and p and holding it over the long arc of time, how are you trying to outperform that? And what do you feel is the return threshold that makes it worth undertaking all of this work over such a long period of time?
[00:36:59] Speaker B: Right. So if we look at that from two different sides, asking me and starting with maybe the quick one, which is, why do I do this? Is because as a job, let's say, I mean, I do this also as a career. It's not like I'm independently wealthy and just chose to invest passively in this as an lp, right. I'm actually on the active side. So as you mentioned, I love investing. I've always loved investing. And I think the most important thing about being a good investor is finding. It's knowing yourself. It's finding what works for you. There's guys out there who can day trade stocks and make a ton of money. They do exist. The majority don't, but they do exist. I've sat next to them in New York and seen these guys do it. They're absolute animals doing this. I was horrible at it. I just don't have the disposition to do that. I don't like real estate investing. There's guys out there that are absolutely great at that. Taking on that much debt on those terms, to do those types of structures makes no sense to me. It doesn't work for me. This was the niche that played to my strengths as far as being an investor. So that's why I chose this path. Now, looking at it, maybe from that LP perspective, what types of returns am I expecting here?
Why should I do this instead of just going with S and P 500? So we're targeting 20% plus compounded returns over a very long time. All right, that's what we're looking for. How do we get to that number is, again, we're buying businesses. Let's just say on average, at five x. And we understand that as we move up in size, this will adjust a bit, but we'll just call it an average. So, yes, those are unlevered 20% returns. We do have debt, therefore, and it's, I mentioned this before, it's well negotiated debt that, that whole structure that we put together. So it's, it's, we're 30% equity, 70% debt. But that 70% debt isn't your traditional bank debt, where they're getting their interest payments every single month and capital repayments every single month. Therefore, when you sprinkle in that debt now, our leverage returns are even higher. And I'm still just aiming for, let's say, 2020, 5%. Why do I think we can do that? And what's our edge? And I go back to why did we choose a horizontal hold company? My business partner and I do not attack this or come at this believing we are better operators than the guy that's been running his business for 30 years from a thousand square foot furniture retailer into a hundred thousand square foot furniture retailer and has gone through multiple economic cycles and done that business. There is nowhere that I think I can operate his business better than he can. Therefore, for me to come in and do a roll up strategy and say I'm going to do this better, I know more than you that to me there is no edge for us. However, we do believe that through our experience and not just the last 13 years buying SMBs, but previously, because we came from investing backgrounds of analyzing companies and actually looking at which ones will last that ten years plus and which management teams will last those ten years plus. We have shown ourselves adept at doing that well. As long as we can do that well, the returns will take care of themselves simply based off of the multiples that we're paying and our capital structure. So when I look at that, I go that to me it's a low bar to have to clear. I'm not setting myself up with this ten foot hurdle. I'm extremely patient. We sit here waiting for the right deal. We have no gun to our head that we have to buy anything ever. We simply keep accumulating cash at a very good pace. Right now its in treasuries, which is nice because its making 5% at least. And we wait for that right pitch to come down. In our strike zone, youre north of.
[00:40:34] Speaker C: 100 million in total consolidated sales at the holding company level to grow, lets say youre at 100 million in total and you were to grow 20 youd go from 100 to 120 and then you would go from 120 to grow 20% again. Now you're at 144, right? And then you're at, I think, 165. I mean, to hold the compound, to compound at 20% over the long term is it's a high, that's a higher, that's a higher hurdle. The math works the way that you've laid it out. But as the numbers get bigger, the businesses will presumably become bigger that you both own as well as the businesses that you want to keep buying. You've mentioned online that you have basically bought a bigger business every single time that you've bought the next one. How do you think things will change? Like, what are you trying to anticipate between 100 million and 500 million? What changes are you anticipating? What do you think will stay the same? What are you hoping to avoid that you've seen go wrong as others have kind of started to reach these initial levels of scale?
[00:41:42] Speaker B: Generally when you're looking at that type of growth of 100 to 500 million, the first thing that comes to somebody's mind is the operational complexity of that change. If I'm selling $100 million of pizzas today, and now I want to sell $500 million worth of pizzas, that it's going to include multiple new countries, multiple new distribution centers, there's a lot going on there. One of the benefits of the Holocaust structure is I can get there simply by doing a few more acquisitions, let's say, over the next ten years. Right. Because right now we're doing about 10 million in EBITDA a year. Okay, so that's. That's our number right now. So if you look at that and you go, well, imagine you just did an acquisition every three years, and you're. You're picking up pretty decent sized companies, and that's how that compounding starts to take place. So since we run that delegated management system, a lot will come down to do we do the right investments. I mean, if we buy a lemon or a horrible management team, I mean, that's going to set us back on that pace. That is truly where I see that risk much more than in the sense of, well, how are you going to scale up to that size? I don't see a ton of things changing on the operational side. For us to do that scale, yes, we will have to keep adding people at the corporate level, but I think that that will be a much slower pace than the overall growth of our companies is. That's how it's played out up till now. I would say where we would look to add people is to continue building out the relationship between COO operations and the CFO here. And those hold codes, the. The more we can get that off of our plate, that would probably be that next step. Right? We're still managing directors, we're still doing daily or weekly calls, meetings, zooms with CEO's of our companies that will eventually become unsustainable. And you will be able to hire people who are actually better at it than we are. Again, we never came here saying we were great operators, but I would hope that my partner Lucas and I are able to continue reviewing every single deal that we invest in, which is how we've done it up till now. We review every single sim and it's what we like to do. That's where the joy comes. I think if you ask me. What's the one thing you could see yourself push, like stopping doing this? It's if the operational headaches start to come too much to me, I'm going to at some point just say, this isn't worth making the extra points. I'm just going to go buy the S and P 500. But if it's just getting to sit here and analyze companies and negotiate investments and look at new businesses and speak to owners and speak to brokers, I love that. It's a lot of fun. Some people don't, they hate the search. I absolutely, I've been doing search for 13 straight years. I absolutely love it. It's just, I don't know, we talked about this earlier. I'm a business nerd. I could look at new businesses all day long. It's just super entertaining to me and trying to figure out their economics and what makes them different and what's the same as other ones I've seen and what sets them apart. I just find it really, like you said, it's intellectually stimulating to me, so I enjoy doing it.
[00:44:36] Speaker C: You mentioned before we got on, we were just talking about your last deal and how it wasn't a broker deal and that was why it took so long to actually get it across the finish line. And you sort of concluded that little vignette by saying brokers deserve way more respect than they get. Can you just talk about how you've built, how you, how you work with brokers, your point of view on brokers, why you take issue with like the sort of cliched kind of like negativity that brokers are on the receiving end of. Like just share your point of view on how you've approached those relationships and how you see their, their value in the system.
[00:45:11] Speaker B: Yeah, I mean we've done six, what I call major transactions. Right. We've done other bolt ons since we started. We've done six major transactions. Of those, three of them were broker sourced and three were not. None of them were cold, so none of them was a knock on the door and we were able to do it. They just simply came, came inbound from somebody else who wasn't a broker. I believe there's two aspects of that, that broker relationship that's so important. The first is on a selfish side. As a searcher, as a buyer, you need practice.
You're like a basketball player. You need to be taking 1000 free throw shots a day to get better. It's the same if you want to be buying businesses, you need to be looking at opportunities every day, all day long and reading about them because that's getting the reps in. That's what's going to help you be attuned to when you see the right one, you're going to know it's the right one. To try and do that via cold outreach to me, just seems insane. I mean, the brokers have the deal flow, therefore take advantage of it and just be selfish. Even if you never want to buy one off a broker, you can still look at all of their deal flow and actually just get those reps in. So that's just from a selfish side as a buyer, that's one the other end. As far as brokers not getting enough respect, I think a lot of of buyers only look at the service the broker gives once they've been introduced to the transaction. So a broker brings them a deal, they think it's interesting. They sign an Loi, they're doing their due diligence, and during that process, they're not seeing the broker do all that much. Or maybe some of the information they were giving initially doesn't match up with what they found in the due diligence. Therefore, those are the two general complaints I hear. What I think is undervalued is all the work that happened before that deal ever came to your inbox. And we went through it with RM Cotton. I mean, we met them via happenstance, and they had just entered into that mentality of, I'm looking to sell this business, and there was a lot of handholding. What's their tax implication going to be? What's the legal structure going to look like emotionally? Getting around, wanting to sell. Most people who are selling a business built that business. This is not just a financial. The financial component of that decision comes at the very end. Once they've emotionally gotten ready to sell. And the people that hand hold them through that whole emotional process are the brokers. So we don't see all the work that happened and all the deals they did that for, that never even made it to come to your inbox because the person got cold feet or decided not to sell, said to continue with their business. Therefore, the value add there, it's just, it's huge. It's huge. I mean, again, I think if we had another deal come to us the way this last one did, we would either get them a broker, literally say, like, hey, this guy will come and be your broker for a reduced rate because the deal is already on the table, but just he has knowledge, or at least get them, a banker, somebody with deal experience, to walk them through these steps. Because when you first come to the table with a seller, there is no trust there. You're, look, you're negotiating. The trust has to be built over time, and they need that. Seller needs somebody in their corner and that person is the broker. So. So I'll continue beating that drum. I just believe anyone looking to buy their first business, build a hold company, do a vertical roll up, anything that's m and a focused should be using all the resources as far as brokers are concerned for them, which is, again, that's what attracted us to Axel in the beginning because it just brought a ton of big funnel of brokers that actually started sending me deals. So as of today, that's the resource where I get most of my deal flow from coming into my every day in my inbox. I probably get ten different deals.
[00:48:44] Speaker C: Just maybe one last thing here, just to sort of hear how you think about brokers. Thats great context on how you think about it. And it definitely differs with what you hear about at least what I hear. I hear just a lot of frustration and skepticism and negativity and stuff like that. So I think its good to just hear someone as accomplished as you whos as active in the category as you take an opposing point of view on that. If you were to find a business like the one that you just bought and you wanted to refer a broker to take them through the transaction, what kind of, how would you select the broker that, what would make you choose a given broker to refer to them? It's kind of a backhanded way of.
[00:49:26] Speaker B: Asking, what do I look for in a broker?
[00:49:29] Speaker C: What do you look for in a broker?
[00:49:30] Speaker B: Right. Yeah. So, I mean, we've had experience, again, dealing with different brokers through deals that have closed and also, obviously through deals that, that have not closed. So we've had a lot of interactions. What I would say is a good broker obviously is knowledgeable. It's just somebody who has done this multiple times. And you can tell through the initial conversations if somebody is knowledge or knowledgeable or not, they're going to understand tax implications. They're going to understand different types of deal structures, whether that be an asset purchase, a stock purchase, an f reorg, different ways of buying a company. And also there's somebody who looks to find the middle ground. I think that's the number one quality in my experience. A deal dies at least three times before it closes. It's, it's crazy. I mean, there's three times that you literally were set. I'm sitting here with my partner. We're like, well, onto the next one. This one's not going to close. And then, but just, it comes back and it's actually during those moments of the process, especially for us, who's going to keep that seller on as management where the trust is, is built.
I look forward to those moments now because it's where I'm going to see their true colors. A tax implication came out of nowhere and they realize they're going to get less money than they thought and now they want to change the price and they're not going to move from that. Okay, well that's a moment to actually find middle ground. And if you're going to have a working relationship with this person going forward, you're going to have to find middle ground for years. So this is a great test of is this somebody who's reasonable or are they just stuck on their point of view and they will not bend. It will show you their true character. Well, a good broker, a great broker helps find that middle ground. They're not just out for the seller, they're not just out for the buyer at the end. They should be out for the deal. They want this deal to get to the finish line. Therefore, hey, you're going to have to give a bit. You're going to have to give a bit. They're kind of working the back rooms, feeling out the different sides and they'll help guide you to where that middle ground is. And that's something very intangible. You just have to live it with them.
[00:51:25] Speaker C: To know you've been doing this for 1314 years. You seem to love it. You seem to have an insatiable appetite for reading sims and studying business, which is effectively like the private company equivalent to a ten Morningstar.
[00:51:43] Speaker B: Right?
[00:51:44] Speaker C: Exactly. It's Morningstar. What do you do to maintain the motivation? What do you think has gone into just your durability in terms of doing this work over 13 years? What do you attribute to some of the consistency to or the sustained motivation in it? Do you go through ebbs and flows in terms of motivation and energy? And if so, just what do you find is the way that you kind of renew yourself and stay high energy? Im sure theres ups and downs. What do you find works well for you to maintain a pretty high level of energy and consistency over all these years?
[00:52:21] Speaker B: Yeah, I mean I would start with I really believe this is what I was born to do. As a kid I loved baseball cards and the Beckett price guide and that to me was my first stock market. And then I loved seeing the little arrows up and down on my cards each month. And then I loved the stock market. And now I love tracking my businesses and their KPI's and their results and learning about new ones and how that could grow. So in the sense of, I go back to that nine year old kid who could sit in his room for hours on end just comparing his cards to the Beckett. Well, that's me today. So in that sense, it truly is what I love. I love doing this. So that. That helps a lot. I wrote somebody about that today. They were saying, boy, it's. I had posted some tweet about not taking on too much debt. Yeah, it sounds like a really reasonable way to build the old code, but, boy, it's going to take forever. And I was going, well, yeah, I mean, if you don't love the process, then there's a lot of other ways to make money. Just I wouldn't even do. I wouldn't recommend doing this if you really don't love it. I would also add to that my partner. Having a business partner has been one of the greatest gifts of this entire process. And that. That just came about by luck. At the end of the day, I mean, we met. There was no hold company. We literally met on a different investment. And then we bought that first company together, and over those initial months, kind of put together this idea to do a hold company. But having a business partner, we have lunch every week. He's the godfather to one of my kids. We spend weekends together. It's. We have a. We have a good, very close relationship. And that helps because. Yeah, man, there's frustrations. Of course there is. There's times where you are just, this is really hard, and it's really nice to talk to somebody and they can empathize with it and they know what you're going through, and they have that long term vision that you have, and they can remind you of why you're doing it, and it. It helps get you through those hard times. I would say the ebb and flow of this business is much more. Rather than motivation or energy related, it's work flow related. When you're in the closing 30 days of a deal and you're dealing with investors also, and you're dealing with your current operations, and maybe it's happening right around tax time, and it's just like, you're just saying, like, this is, this is too much. And then all of a sudden, the deal closes, the taxes got presented, the investors are happy, and then you're sitting here like, well, I got nothing to do today. I'm just going to read some more sims. But that's the ebb of it. But again, over time, I would say, I mean, I started this. I was 31. My partner was 28 when we began. So just maturity and amount of time doing it and getting used to it. Now I kind of cherish those low ebb ones. I'll spend a little extra hour at the house with the kids, come home early. I'll go play some tennis. It's like, okay, because I know it's not going to last forever. Like, I know the next crushing moment is coming. Therefore, I might as well take advantage of this right now and enjoy it.
[00:55:06] Speaker C: This has been great, Rafa. I mean, it's been, it's been a ton of fun. I've learned a bunch. I really enjoyed being able to go deep on some of the businesses instead of just sort of staying up at the higher levels. So thanks for being so forthcoming on how you buy and what you do after you buy and how you think about your work. It's been, it's been a lot of fun. I've learned a lot and I think it's a it's a great recording.
[00:55:27] Speaker B: This has been great, Peter. Thank you so much.
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