Episode #25: The Pre-Middle Market Advantage - Finding Value Others Miss w/ Mason Myers

Speaker A: The Lab takes the ethereal to the practical. Our, uh, podcast acts like a business school case study for private equity professionals, CEOs, operating partners and chief transformational officers. We all know transformation is the key to differentiated alpha. Uh, here's how you actually do it. Our audience tunes in to learn from those in the field getting their fingernails dirty and driving meaningful growth through, through better operations, technology and data. We learned from going to business school, teaching at business schools, and applying these lessons in the real world that case studies actually help the insight stick better. Come join us.

Speaker B: All right, well, welcome to the next episode in the Lab podcast. We're excited to have Mason on today from Great Ball for a number of reasons. One, I noticed that, uh, Mangy Moose was rated as top five operate situations and Mason's face to Jackson. So that's always positive. Maybe we get into that, maybe we don't. We probably spend more time getting into your version of the truth, Mason. Why, you know, why you, uh, started Gray Bull, the operational approach to it. Because certainly that's consistent and part and parcel to what we're doing collectively on this end is you need operational insight to drive value. So why don't we give a quick overview of how we got to where we are, how you, why you started this firm, and then we'll start peppering you with some thoughts around case studies so folks can benefit from what you've learned.

Speaker C: Yeah.

Speaker D: Excited?

Speaker C: Well, I'm excited to be here. Thanks for the time. We love what you guys are doing with the operating focus.

Speaker D: Right.

Speaker C: Obviously that's a big part of what we do. So we love hearing what you, you, your podcast and your interviewees say about all that. So thank you for doing what you're doing. You know, I'll start with Grable. Just real quick. Like, what's different about us is we focus on what we call the pre middle market. To the investment community, for us, that means less than 25 million enterprise value, less than 5 million EBITDA. So we're talking about smaller businesses. You know, we're really focused on business model first, like finding a really excellent business. Good bones to the business. Obviously we're going to make improvements to it, uh, that I'm sure we'll talk about it. And then we want to grow that business and to be a true mid market company and sort of, you know, we exit oftentimes to platforms backed by mid market PE firms or mid market PE firms. So that's what, that's what we do. And we'll talk more about that. I'm sure. But you mentioned Jackson Hole. You know, I grew up in Wyoming. I was born in a little town called Grable. So that's where our name comes from, Grable stewardship. Just because, you know, we are different. We're from like the state that has the smallest population in the union. And we like emphasizing that difference. Right. We're not from a major financial center. Most of our investments are not in a major financial center. Uh, you know, they're all over the country. And that's a part of our character and who we are. So I think I'll go now wherever it is most interesting to you guys in talking about our strategy.

Speaker B: Well, if we think about, you know, where you're playing, you know, some people may say, isn't that venture capital? Is it? You know, where are you on the life cycle of a, uh, company's growth? So, you know, I think the earlier you are in a, uh, company's sort of journey, you're taking more development risk and the larger it gets, you're taking more execution risk. So how do you think about where you guys are playing? Because people that are running a, uh, two, three, picking over 4 billion EBITDA business, the needs that they have and the experiences they have are different. So how does that work? Any examples of, say, hey, listen, here's one that was right down the middle of fairway because it had these qualities and actually maybe there was less, um, development risk than otherwise advertised. And how do we think about that? Fair point. The buyers of those firms that you're, that your companies you're buying, that you're owning and developing, you're going to want to know where they are on that journey.

Speaker C: Yeah, absolutely. Well, I think it's, I love the way you phrased it with development risk versus execution risk. And just to, you know, contrast it to venture for a second, we are not taking development risk. So we're not taking product market fit risk. We're not taking risk of whether technology is going to work or not. And one thing earlier in my career, you know, I started an Internet company in the dot in the 90s, you know, we merged with another company. We got venture from Greylock. We went public, and I was managing about half of that public company and we were buying lots of smaller businesses. And one thing I realized was that there was a huge universe of companies that didn't want to pursue a venture strategy or they weren't appropriate for a venture strategy and they were too small for bigger private equity. But a lot of the risk on the developmental side had been removed and so you almost could get good pricing and then venture like returns because you had a lot of upside but you weren't taking like the risk where most of them aren't going to work out. Right. We have a very low loss ratio and that's because we're focused on a uh, business model first sort of strategy and finding really good bones of business. But maybe they're not perfect on the execution yet because they're still small, they don't have a sales and marketing team or whatever it might be. So using your framework, we are purpose built to help them work on the execution. So most of our investment team are functional experts in various functions and so they're, we call them operating partners but they're basically think of them as our investment team and they're in the categories that you would expect for our small businesses, accounting and finance. Because almost everybody needs the upgraded theirs strategy which may sound sort of amorphous but you know, a lot of these smaller businesses are very entrepreneurial. They've got a lot of opportunities that they're pursuing and the art of getting them um, to the next level is often focusing them on the very best opportunities. And so strategy, we have a process that we can talk through, an eight step strategy where we really work through the strategy and what we're going to go do and help give them the conviction to focus. Right. Which I think is one of, one of the keys. So we're purpose built to help them work on the execution, to strengthen the company and then grow it to be a mid market, you know, star.

Speaker D: That strategy piece is super interesting to me. So you have like an eight point framework. Are you looking in diligence to see if you can marry that up to what's already existing? Is that something that you're doing in the hold period? What's that look like? And share in a bit of a

Speaker C: first just high level, you know, start sort of the basics of defining an industry, you know, and then the five forces, Michael Porter's five forces, what are the strengths and weaknesses of that industry, et cetera. Then a real focus on customer needs. Right. And really understanding, you know, let's list all the customer needs, let's rank order them as in priority by the customer, what. And let's rank order how good we are as a company at serving those, et cetera, et cetera. We go through it, we, we come up with a strategy statement which is different than a vision and mission. It's a little bit more specific. It's what are the objectives in five or six years, you know, what's the scope? Which is sometimes the key, like what are we going to do and not do? And then the last section is like competitive advantage, differentiation and so forth and we love. And um, and then it leads to like the annual planning and budgeting process which a lot of times these companies don't have a very robust system for doing that. So it leads to that and we actually do the first few steps of that in diligence just because it is a way to sort of get rid of the checklists and all that sort of thing and really get to the heart of uh, this business. Like what makes this business good, what makes it differentiated, how much developmental risk is there and if there's too much, obviously we're not going to do it, that sort of thing. And it also helps uh, us get, you know, once we've closed the transaction, really get on the same page with the management team so that you know, six months goes by and an add on acquisition comes up or something. We have a framework and a like common understanding of what we're trying to do and whether that initiative that pops up fits into that strategy.

Speaker B: Well, listen, I think one of the reasons we are so excited to connect on um, this on um, the podcast with you is if you can get this right, right. Which you guys, your returns would suggest you have. As we've seen, it's meaningfully differentiated. Right. So I'm curious about where the deal flow comes from because there's lots of great organizations like the ACGs of the world. There's lots of organizations that the Maguire woods, like there's lots of things out there to help you find assets. But the other part of this is the end or the opportunity set of assets that fit your box, at least initially is huge.

Speaker C: Yes.

Speaker B: There's many more companies which is part of your upside. So how do you find these assets? And then what are some of the quick looks where you're like ah, uh, not for me because I imagine like anyone in private equity and M and A, you say no at least 20 times as many times as you say yes.

Speaker C: Oh yeah, for sure. Probably more than that because it's just where in the funnel you say no, but yeah, like thinking about where these opportunities come from. I think one framework that's helpful to think about is by our estimate there's somewhere between 4,000 and 5,000 intermediaries that could represent a business that we'd be interested in at some point in time. We've never done two transactions with the same intermediary even if it's a uh, small investment bank or something like that, that just shows you that the way you need to think in this marketplace is, is getting uh, very broad exposure to a lot of intermediaries, which one of our main advantages on the sourcing side is we've been doing this now for 15 years and then obviously I was doing it for a long time before that. So just the time in the marketplace means that more referral sources, CPAs, lawyers, all that stuff know that what we do, right. They have a really good company, but it's small. They know to call us for these intermediates, know to call us. You know, our competition for deals is usually a search fund or an independent sponsor or somebody who's in the market temporarily, maybe a strategic is coming down trying to buy add ons. And we have a huge advantage over all them because they can't build that exposure in a year or two years or whatever. And so that's, we get, you know, 50% of our closed deals come through intermediaries, 50% come through referrals of all sources by just being in the marketplace for a long time now at the top of the funnel, you know, it's probably 70, 80% from intermediaries. And I forgot the second part of your question.

Speaker B: Well, I mean the question is how do you get to them and how do you decide which is the second part? M. Hey, you know what, like the number of opportunities is big, so getting the funnel the right way is very helpful. But then like there's a big number. I'd argue that, you know, you're going to look at 4, 5, 6x. Uh, could look at 4 or 5, 6x things that the average middle market private equity shop has because there's just more companies that are smaller. So how do you quickly determine, you know, thumbs, thumbs down.

Speaker C: And I mentioned a little bit earlier, business model first, right? And so in that huge universe of companies, you know, we're not, we don't do roll ups. Like we're focused on quality, like a super high quality business like the Berkshire Hathaway like thought process. You have limited time, limited capital. You shouldn't necessarily do cigar butts or like things that are not that awesome of a business. You should focus on business model first. So what that means first of all is we're looking at totally different companies than a lot of other people who might be doing lower middle market strategies because they're doing roll ups, right? They're looking at roofing companies, H vac companies, vet clinics or whatever they may they be looking at. And so for us what business model first is, you know we're looking for like it's all going to sound very obvious and like the ideal business recurring revenue, good margin profile, very efficient with capital and then on the non financial side you know, competitive advantage, differentiation, all the things that other people would look at. But we're, we're going to buy a roofing company right? Nothing against them, nothing against those roll ups but they have trucks and people and not recurring revenue and all those sort of things. So we, you, when you look at our portfolio, uh, we have software businesses, we have franchisors, we have these membership subscription businesses that are really amazing businesses. We have business services or specialty manufacturing that will have those characteristics. So in the top of the funnel we're really focused on that you know, eliminating things that we're never going to do and they're probably being looked at by lower middle market roll up strategies. So that's at the top of uh, the funnel. And then later as we're getting more deeper into the businesses it really comes down to validating and verifying that there's not that development risk that we talked about earlier and that it has these underlying like characteristics that make it an amazing business. And they just need help with education, execution. So that's, that's what we're there to do is help them execute.

Speaker D: Yeah, I mean that's filling a huge void. I think when we talk pre middle market one of the things that comes to mind is potentially a longer hold period. I would love to for one kind of hear a story about how you've been impactful because you don't have to sprint for that first a hundred day plan. You don't have to be on that tight three to five year timeline, you know, sell it to the next one. And caveat with that. If you could kind of feather in. Is there a common trend that you see that founders or leaders need after that first year of your guys partnership that they're, that they're really enjoying and liking and saying I need more of that.

Speaker C: M. Yeah. So I mean we can give a um, sort an example of a 10 year hold period for us and I think you know before that like why a longer. So you referred to some of it. It just takes time to do the value creation projects with these smaller businesses you can't, they don't have the management team to absorb 10 projects at one time. You have to be very savvy about which projects you do and the sequence in which you do them. The other thing, why a longer term? There's two other reasons why longer term hold period really makes sense. One is if you get, when you do the math of it, you get better returns if you can let the business get a little bigger. So you're getting more absolute return that way. But also you get more multiple expansion when you get it to be a bigger company. And both of those, when you sort of run the math, you've done all the work, right? Holding one year longer, the math usually works that you're going to get a better return. And the other thing is it's better for the business, right? Like these are smaller businesses and so it's quite disruptive to go through transactions. So if you can sort of take that off the table and give them Runway to execute four, five, six, seven years, that really helps them just focus and do what they need to do. And then when they're a bigger company, they're better able to do the transactions, so forth. But uh, I'll give an example and mention subscription and membership businesses. You know, the company that we took public in the 90s was a membership subscription business for college students. And I learned that business model. And so that's one that we found a number of times, you know, out there that may not be necessarily a theme or something that other people are looking for. And so this one happens to be in license driven continuing education in healthcare. So specifically this company served physical therapists and occupational therapists who needed to do continuing education to maintain their license or certification. And we started with a really great business. It was uh, doing in person workshops across the United States. 2000 workshops. It had really high instructors as independent contractors and they were very early in doing online. And when we bought the company, you know, we paid five times EBITDA for it. It was a 1.4 million EBITDA business. And we knew that we had a good starting business. And we also knew that there were some business model improvements and strategy work that we could do. We first really helped them, um, go online and really do that well. And then we were able to turn the business into a recurring revenue subscription based business. So the EBITDA grew from 1.4 to. The recurring revenue went from 0% to over 90%. The EBITDA margins went from 14% to 40%. So it became just an amazingly better business and a bigger business. And honestly there was lots of mid market private equity firms that would be interested in that. We exited last year. Very good situation for us. Some of the execution things I talked about the strategy Court. But also, you know, this was one where there was an agreement to put in a new leadership, new CEO, new CFO. And so about 50% of the time, we're putting in a new CEO. And oftentimes the people who are rolling equity, the founders or the management team, you know, we've worked on that together, and everyone's decided, hey, that's the right way to maximize value from this business. So 50% of the time we'll hire a new CEO. 50% of the time, we'll work with the founder. He was there, and the CEO has been hired by the founder.

Speaker D: Yeah.

Speaker B: What's interesting, that one of the characteristics of a founder is a, uh, borderline delusional sense of optimism.

Speaker C: Yes.

Speaker B: Because you need to make sure that you're, you know, there's lots of roadblocks. So that's where I was going to go. And you sort of touched on it. But the, the proverbial playbook. No one likes a chapter. One says acts. Chapter two says, go back to chapter one and read chapter one again. M. Right. So it has to be flexible.

Speaker C: But there's.

Speaker B: There's sort of similar things that happen. So I would imagine that because maybe, uh, maybe the CEO and founder doesn't want to stay. Okay, fine. That's a pretty straightforward plan. You know, we do that all the time in our business. The other one is the person who wants to stay. They're the founder, the CEO, they're the chief development officer. They're the, you know, chief revenue officer. And so I imagine taking them off some of those and showing them, like, you know, the chief sales or the chief revenue officer, like, do you have an inside sales team? Do you have an outside sales team? Like, what are best practices? You were calling your buddies and get. That's how you got to 1, 2, 3, 4 of you. But to get to 5, 10, 15, you need to do things differently. So is that the operator mindset that you're bringing to bear, saying, hey, our money is more green. You're. We're going to help you. You'll make more money at the second bite of the apple. Yeah. You'll sell me, at the moment, 60% of the business. Pick a number. But I'm not 40. You'll make a lot more down the road.

Speaker C: Absolutely. And we talked about the strategy process before, and I think that's key to getting alignment and getting on the same page on this topic that you're talking about, because you're really, really spending all this time talking about what's best for the Business and you know, you're talking about, you know, what you need here to serve this customer need or uh, what's the best way to go to market. And usually the founders are, you know, they know what they're good at, they know what their strengths are and they know where they may want help or support or something different. And so I think getting on the same page through that strategy process is key.

Speaker B: Cool.

Speaker D: When we get to about the 20 minute mark, we always like to kind of shift from where we're at today to where we're going. So in the next five years at Grable, what do you, what are you optimizing for? Is it more deals, is it more depth? Is it something else entirely?

Speaker C: I would say, you know, what's really worked for us is having these specialists focus on various elements of the business. So if we think of it like a really good race car, right. It's fast, it's stable and so forth. But we want to bring specialists who can work on the engine or work on the steering or work on the tires or whatever it might be and really make that car even better and faster. And so as I look ahead, you know, we're getting to the scale where we can bring even more specialists to bear on making these companies better. So maybe it's a pricing expert or maybe it's an HR expert or something like that. Where other people who are working on small businesses could never bring those resources and that execution to bear on these smaller businesses and really helping them, you know, and make them strong.

Speaker B: How do you feel about one of the. I always think about on um, that take because maybe that specialist can be an independent board director. I always find that sponsors that's the m most underutilized arrow in their quiver. Right. By saying let's say we need be thoughtful about the the topic du jour of AI or we have to be thoughtful about pricing. We have to thought about marketing. Sometimes you can get that by. You can rent talent okay I guess better than you ever could These days there's, there's good people doing being precise. But does the independent board director lever get pulled a bunch like hey, you know, maybe we eventually want to bring in a chief marketing officer, but we can't get a really awesome chief marketing officer in a business that's 4 of EBITDA. Pick a number. So maybe you bring up talent in on the board and then you help mentor the team, uh, accordingly. How do you use that lever? The independent board director a Grable?

Speaker C: Yeah, I mean I think it can be a Great tool. You know, it's one that we actually prefer to have those people full time on our team participating in the carry. And I think one of the reasons for that is, you know, we've built these systems on, you know, how to build out the strategy and manage the projects, the value creation projects that need to be done at the companies and having people constantly collaborate deal, you know, opportunity after opportunity building the internal frameworks, we find that you get a lot more. There's nothing wrong. Independent board members, all that stuff obviously can add huge value but we like it to be a little tighter with a lot more alignment in the culture about what we're we're doing now. It doesn't mean that something that we don't have a full time person, you know, we need to bring to bear with an independent consultant or board member or something like that. But we find with a, uh, smaller businesses focusing on those core functions, those core specialties that really helped them execute has had the most banning for the buck for us.

Speaker B: Listen, I think it's, you found a really neat niche, you've done it for a while, you've had success and you know, the minute you're happy with your reality, the minute you're in trouble because things change as to for it. But uh, well listen, uh, appreciate you letting us bend your ear a bit. I think what you've built is great success would suggest that, you know, your point about, you know, there's a difference between cash on cash and irr and you can't eat irr so you know, cash on cash is sometimes a better judge of value and that often requires a longer hold. So uh, I imagine a lot of the folks that are running a business of 1, 2, 3, 4, 5 of the EBITDA would find working with you compelling. We've seen that. Imagine the people looking to buy our businesses will say maybe we do or execute a roll up strategy eventually but we need the platform company to be super stable and thoughtful and that's sort of what you're providing for them.

Speaker C: Absolutely. You know, and we want our companies to be really solid with all their foundational and fundamental elements so that when they, you know, go to a bigger private equity firm, you know, they're ready to be that platform and the firm can be confident that you know, they got a good foundation.

Speaker B: Again, we appreciate you with us and look forward to keeping in touch because it's a fun journey for us to watch you and participate along with. And as we said for all of us when we're in Jackson, we'll chase it and take some turns.

Speaker C: We love it. Open invitation.

Speaker B: Yes.

Speaker C: Great to be on. Thank you guys for your time. Love following you guys as well.