Josh Koplewicz – Flexible Capital and Creative Structures at Thayer Street (EP.451)

0:04Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators.com. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

0:44Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast. My guest on today's sponsored insight is Josh Kopowitz, managing partner of Thayer Street Partners, a boutique private equity firm he founded in 2012 that provides flexible growth capital to lower middle market companies in financial and business services. Our conversation traces Josh's journey from his early fascination with business and real estate to building Thayer Street into an institutional platform. We discuss the lessons he learned at Goldman Sachs and his transition from scrappy dealmaker to fund manager.

1:25We cover Thayer Street's thematic sourcing, deal structuring, and portfolio construction, the evolving landscape for non-bank growth capital, challenges of scaling a boutique firm, and Josh's vision for Thayer Street's future. Before we get to the interview, a quick announcement. We've set new dates for our Capital Allocators University for investor relations and business development professionals. Those dates are December 3rd and 4th in New York City. Later in the year is just a better time of year for this gathering. It's post-AGM season, travel starts to wind down, it's right before the holiday crunch time, and it's a great time for capital raisers to reflect on their previous year and plan for the year ahead.

2:06December 3rd and 4th in New York City. CAU for IRBD is a closed door gathering for capital raisers to connect with peers, learn from allocators and other experts, and really share in best practices with each other. You can learn more at capitalallocators.com slash university. Thanks so much for spreading the word about Capital Allocators University for investor relations and business development professionals. Please enjoy my conversation with Josh Kopowitz. Josh, thanks so much for joining me. Great to be here. Why don't you take me back to your earliest interest in business or finance? Probably informally, I became interested in it, I'd say, in middle school and high school.

2:48No one in my family was in finance. I grew up in New York City, surrounded by lots of people in finance or real estate. A lot of those things didn't make sense to me at the time. But I was one of those kids that was always interested in following the stock market and then also interested in how neighborhoods were changing and developers were shaping them. And growing up in New York City in the 90s and part of the 80s, got to see development of neighborhoods evolving and people around me were involved in that and benefiting from that. And then when I got into college, I went to Brown, generally a pretty liberal arts education.

3:29I was a history major. And honestly, a lot of my time at school was spent working on a commercial radio station as a DJ. So a lot of my time was involved in the music business, which is definitely not analogous to the types of things I invest in today. But in the classroom, there are a few experiences I had with independent studies or classes with adjunct professors who were entrepreneurs or real estate developers or had experience doing lower mid-market private equity. It wasn't called that at the time. The process of learning about that evolution of a company or evolution of a development project really intrigued me.

4:11I didn't totally understand how to connect working on those things into a linear career path, but it was something definitely of interest. And I was fortunate enough to have someone that was leading recruiting at Goldman Sachs, former Brown alum, be in a group that was doing creative lower mid-market and mid-market on balance sheet investing on behalf of the firm. Managed to get a summer internship in that seat that was called the Special Situations Group, and then was able to turn that into a full-time position and it was off to the races from there. In your time at Goldman, when do you remember starting to connect the dots between the interest in real estate and small businesses and the financing around it?

5:00I don't know if there was one aha moment. When I joined, I was an analyst and our group was doing a little bit of everything. So anything that was too small for client-raised third-party funds got shuttled to our group where folks were trying to make money in interesting ways. Because there were smaller deals, in part, and because our group was an amalgam of some ancillary groups from other departments, when I joined, a lot of people were really young. You could get involved in a lot of different deal types. So it was trial by fire. I was not someone that had been in Warden doing Excel classes.

5:42Previous to work, I'd only used a Mac. I could barely use Excel. I was great at back-of-the-envelope math, but that was about it. So it was really trial by fire and trying to play catch-up. But in our group, because it was such a lean team and because the folks were young, you were thrown into the deep end and told to figure things out. I think my second or third week in the job, someone handed me a stack of papers and said, were buying four aircraft from American Airlines, figure out how to get the deal done and close it. Now, the deal was signed. They'd agreed on the price. But there were logistics to be dealt with with coordinating transfer of title with the FAA while the planes are on the ground in between flight, coordinating with tax counsel that were 30 years older than me and spoke some foreign language, yet still in English, and all the little considerations.

6:33And the guidance was figure it out. And so it was just spent a week pulling all-nighters, reading everything, asking a million questions. And on the other side of it, you feel a little more confident about the next deal. So pre-GFC, that was a really exciting way to learn. Debatable how great that was from a risk management perspective for a regulated bank, but exciting way to learn. Our group did great. We were super profitable for the firm, I think, in and out of the downturn. And so then what happened through the GFC in what you learned about what you hadn't known previously? I think the mantra of our group generally was don't lose money.

7:09So every deal was first underwritten like a debt deal. Our group was doing both public and private investing. I would spend all my time in private investments, but debt, equity, and a lot of things that were in between, JVs, minority deals, et cetera. And our capital was using the firm's balance sheet. So firm would allocate some amount of dollars, it would get levered eight to 15 times, and then we'd put it into companies. And so always the first set of questions around committee were, where's the risk exposure? How do you lock in some basic return? And then how do you create some really interesting risk-adjusted return?

7:48So deals that might only yield 10 % or deals that are the potential to yield 30 % were all weighed with consideration for the risk. Even when things were heady in 2007 and before things started to really fall apart in 2008, that was the mantra. And I remember us losing out on lots of opportunities because folks were so downside-oriented, it ended up being a blessing in disguise or as intended. It was formative to initially, but then when we saw things fall apart in terms of liquidity, just entirely leaving the market through the GFC, it really hit home. And focus on how you find multiple ways to de-risk, multiple ways to take your capital off the table, and then also hopefully multiple ways to win and win big if you can.

8:38That stayed with me into personal investing, into my time at my own firm. And then we were in an interesting seat because as certain funds had to dispose of assets in the face of 2008, 2009 liquidity issues and even banks disposed of assets. We got a look under the hood of a lot of these guys. And so we got to see what a lot of folks had done wrong. Really interesting position to learn from others' mistakes. What mistakes did you see at the time that you learned from in that period? We saw people doing minority deals without any real protections or some set of rights, but no clear form of enforcement of those rights and no game plan or instrument in place where if they needed to effectuate some sort of right they had underwritten and relying on, they could do it.

9:30There were debt deals that we saw that were underwritten assuming just the next guy would pay a higher price and the game of hot potato would play on, but there was no real focus on a liquidation or workout. So when the rubber met the road, there was little you could do. Today, we spend a lot of time in financial services. And I spent a lot of time looking at financial services businesses. One of the things that stuck with me was having a business that is entirely reliant on dirt cheap, consistent debt financing from a bank is really risky and particularly risky if you are sub$200 million market cap.

10:15So a small gust of wind, a small hiccup, and we saw this with SVB and FRB, et cetera, can just render your business completely insolvent. So my big thing today is really how does this business and how does this opportunity make a lot of sense on a completely unlevered basis? That makes sense to bring in leverage? great. It's icing on the cake. It can be an accelerant. But can we build the business in a way where debt market can fall away, lender may not renew the modest amount of debt that we've taken on, and we'll survive and do great. So you were part of a long line of people at Goldman in and around different parts of the capital structure that ultimately left to form their own funds.

10:59I'd love to hear what your thinking was at the time of how you progressed and when you felt like you were ready to launch? So my path is a little different than some of the other guys that left. They had been working there 10, 15, 20 years. They were partners. They left with backing of a major asset manager. Mine was a lot scrappier, more entrepreneurial than that. Mine was a few years after the GFC. It just became really tough to do small deals. Number of committees had grown. There was more pressure to write checks that were larger, that were worth the time and effort to justify the incremental bureaucracy and additional scrutiny we'd get around here three assets.

11:44And I like small deals. I thought small deals were more intellectually interesting. I like things that didn't fit, weren't cleanly defined, that fell through the crack somehow. And love the fact that you could find a business at the right moment, even as someone that was young, but someone who had studied that industry, small but pithy insights could actually make a difference in the business's evolution versus a billion-dollar market cap company where there was a little I could add value to in terms of the CFO or the go-to-market strategy or a connection that I could make. And intrinsically, that was more interesting to me.

12:23And those deals were less efficient. Just you could get way better pricing. So I wanted to put my money on that. I left really because I wanted to experiment to see if I could get small deals done. They couldn't happen at Goldman. My plan was really, there are a few families that had said that if I found deals, they would fund them. Scroll forward, ended up working with an entirely different group of families to fund. I had enough money saved up and earned that I felt comfortable taking a risk. and I was excited about a lot of relationships with potential portfolio companies I'd built up during my time with Goldman.

13:01At Goldman, we're doing very industry-specific vertical approach to sourcing. So build a point of view on a subsector, build relationships within that subsector, get entrenched in the ecosystem, and then wait a few years till someone wants your help and capital. And maybe overly confident, I thought I could translate that into a few deals. and I left. And my thought was, if it doesn't work out, I'll go to business school. My first office was the print center at Staples, two blocks from my house that I would skateboard to in the morning because I had to get out of my apartment. My next office was sublease space in Nine West, so figured out office space.

13:44But it was really scrappy early beginnings driven by my interest and desire to get involved with these small businesses. So what happened when you launched? You had a few families you thought were going to back you that didn't. You were looking for deals. What did those initial years look like? At the start, the goal was find a great deal, build relationships with initially family offices that love to fund one-off deals, and see if I could pair the two together. And the overarching theme in finding deals was, how do I find something that is truly proprietary, where I can justify my place in the capital structure versus another firm.

14:26The way I did that was similar to how we approach investments today. So develop sector expertise where board and management don't feel like they're educating you, where I'm not necessarily telling them how to do their job, but I may bring insights or connections or network to the table. I think the second is be really solutions-oriented. So today at Thayer Street, we're focused on businesses in the lower mid-market that are somewhere between a conventional debt investment and a levered private equity investment. So we're investing in the fat middle part of the capital structure. Sometimes it's an unlevered investment.

15:06Sometimes it's a super bespoke preferred security and took that same approach when we were doing one-off deals. So it was cases where someone didn't want to sell the company, they wanted to minimize dilution, they would give up some equity, they didn't want current paying debt, there was an opportunity to structure something interesting and differentiated. The idea was leverage the relationships that I invested time and effort into and effectively structure something interesting. Because of some of the goodwill I had built up, management teams and sometimes existing owners were willing to give me a little bit of time to put together the capital because I was pretty upfront with them.

15:46Very quickly, there were a few families that more materially aligned with our business and began to fund all of our transactions, even though they were still case by case, slowly and kind of organically built a team. So when you are starting out, you said you're young, you're getting going, you're trying to be scrappy. How do you go about building the right relationships so that you can get your way into deals? I'd say when we were doing it then, it was, again, pick a theme within those focus sectors. Usually that theme is going to be the result of being on the right side of ongoing increasing regulation, consolidation in an industry, or adoption of technology, and just map the market and be dogged about meeting everyone and be comfortable getting lots of doors slammed in your face.

16:42So finding warm connections for introductions, cold emails never worked for me, meeting people at conferences, meetups, referrals from larger funds where they thought they saw an interesting deal, but it was too small for them to invest in. So they referred it to us. But when we were starting, a lot of it was attempt to meet with and build relationships with hundreds of people and get rejected by most of them. So it was just getting really organized and really intentional around the companies that we met where there was connectivity and where I believed we could truly add value beyond just writing a generic check.

17:21What are the particular skill sets that you need on your team to be able to build relationships and then have the creative, structured finance piece that brings that together? I think there's two components. So right now, our senior team comes from similar backgrounds to myself. So they come from other institutions. Some folks have been at Coleman, but other institutional firms where they're investing in the same business, financial and real estate services, combination of debt and equity, but they did it at a larger scale. So they're a part of roll-ups or creative financings. They have the real institutional pedigree to understand what good looks like, but they've joined our team for that same reason.

18:12They find it more fun and rewarding to work in this part of the market. So having that debt equity lens is an important part of the team. Not everyone has it, but we have a mix of perspectives. And I think that's something that we're gonna continue to focus on maintaining. And the other one is just being tenacious and dogged and thoughtful about research. So part of it is having the right idea. The other one is getting out there and listening and meeting companies and figure out ways to be collaborative and solution oriented. And not everyone on our team does everything. But I think the combo today is what ends up being our secret sauce.

18:52So at what point in time, as you started having some success deal by deal, did it turn into being able to build a team and raising capital in a more traditional institutional structure? Our first committed fund had a final close in 2019. So it was a good five, six years of really doing a deal by deal. Now on the back part, we had a process, we had a team of five people, we had a lot of repeat family offices, high net worths, and even institutional investors. But it took a while. And frankly, we did it slowly because SPVs worked really well as a business for us. In order for us to level up our impact, retain really good talent, and also make it a little easier on our LPs, it made more sense to convert into funds.

19:46Having said that, still today, we have a pretty active co-invest component to everything we do. As you crystallized the ideas you had into a strategy, how do you describe what you're doing at DagerStreet? I think two sides of the coin. So what are we doing from a structure and approach perspective? And then what are the themes we're investing behind? So from a structure and approach perspective, we are doing proprietary relationship-driven partner deals where we are investing either on a totally unlevered basis or in the upper half to upper two-thirds of the capital structure in a manner where we feel we're relatively downside protected and collateralized by some underlying recurring revenue stream.

20:38That could be subscriptions, royalties, leases, or other financial assets, or a hard asset. We're primarily providing capital to these companies for growth. So it's mainly primary capital, sometimes a bit of secondary. We're really not doing any buyouts. We've never been in an auction. We are investing in businesses where we hope have really low correlation with the capital markets. So these are businesses that their in-place revenue is super consistent. So north of 90 % annual gross retention, north of 100 % year-over-year net retention, where these are businesses in financial services, real estate services, and business services that are going to keep operating like clockwork.

21:28and they have through the recent tariff spikes, COVID, last several downturns, the key way to make money is can they either consolidate in a fragmented industry or can they grow organically in a way where usually they are selling some sort of product or services, again, in a fragmented industry, but they're selling that service to consolidators. So they're growing as a result of their client's growth. Most of the securities that we're investing in are some form of preferred equity. So structured equity, senior preferred, convertible preferred, participating preferreds. Occasionally it can hit the form of other stuff too.

22:08What do you find particularly interesting about the opportunities that you see in the strategy in the current market environment? Our mandate is flexible capital and structured equity. What's interesting is it feels more and more like we're filling a void. I don't know if it's a full black hole, but it's definitely a growing void. So you have this massive growth and at the same time consolidation of non-bank private credit, trillions of dollars being managed by a small number of firms. And in many ways, the growth of those firms is phenomenal, but it's leaving companies behind that need 20, 30, 40 million dollars of debt.

22:54and it may not just be senior debt, it's mezz, it's second lean, it's something that's a little more flexible. In checks that size, your guys just can't afford to spend time on. The same time you see a continued pullback in what the smaller banks are doing. What's left is often really expensive or really rigid growth capital for these lower mid-market businesses, and it's not for everyone. Oftentimes, while our capital is a little more structured and a little more tailored, we don't invest with back leverage. We don't require current coupons or current amortization. We're focused on the long-term cap gains event alongside management.

23:38So what we see is an opportunity to offer them best of both worlds. A little more upside preservation for them, but total alignment in that if they're winning, we're winning. And that makes us supportive of the right CapEx investments, people investments, M &A. And it's actually folks who used to compete in that market and provide phenomenal solutions in that market are kind of outgrowing it. What are some of the themes that you're excited about today? There's kind of micro themes within each of the sectors that we're hitting on. Big picture right now, I think structured equity or flexible capital is really interesting in our part of the market for a few different reasons.

24:26The setup is intriguing because on one hand, in terms of credit, you see this tale of two cities. You see small and local banks providing debt to an increasingly de minimis portion of the population of companies out there in the mid-market and small businesses. It happened materially starting the GFC, and it's accelerated more dramatically, typified after SVB and FRB, et cetera. And then everyone talks about how direct lending is approaching$5 trillion. And folks assume that that's serving the market that's less served by the banks. But the reality is 80 % of private credit is dominated by 20 % of the players.

25:09They are investing out of very large funds. That market continues to consolidate. and the focus of most folks in direct lending and private credit is on opportunities that are larger than$50 million checks. It's$100 plus million allocations. So you have this piece of the market, somewhere between$5 and$50 million that is not efficiently served in terms of flexible debt. So that's one. I think the second is you have this array of fragmented, high recurring businesses. And examples of some of these business models that we've invested in are Sleepy licensed maintenance software companies that provide some sort of essential solution.

25:51Vertical payments companies that are very specified for a specific industry, and they have a ton of tailwinds because of regulation. Elevator maintenance, super regulated business. You have to maintain your elevator. Elevator regulation only increases every year, regardless of who's in office. Elements of property management. Property management is 90 % fragmented and owned by individual owners. So these are companies that are small, mid-size, and you have a dramatic number of these companies that are changing hands in the U.S. today. So 70 plus million baby boomers own shy of 50 % of the small businesses, and a lot of them are retiring and don't have a succession plan.

26:35So we're trying to find businesses that we can back or consolidate alongside management teams that have crazy high recurring revenues that are super resilient. And they can grow by buying customers from folks that are retiring or they can be the recipient. Sellers can contribute their businesses into a consolidating business. And that company can get the benefit of all the contemporary tools that everyone in private equity is talking about, software, AI, machine learning, but small little gains on those companies on that scale can drive really material outcomes. So that's the overall setup, provide very flexible capital that's not buyout, that's not super levered, and partner with folks to get exposure to those areas.

27:29Once you've identified one of those, what's your diligence process look like? Our diligence process starts a lot earlier than the identification of a deal. Usually when we've struck a deal with someone or found a company that's ready to go, 80 % of our diligence is done. We may not have a view on that specific company. Usually that company is one of many. And we want to have a view on that exact business model, its subsector and the broader ecosystem well in advance. So as a team, quarterly, we're doing deep dives on themes we want to invest in. And that research turns into a multi-year research project where we're tracking those companies, following them up, scoring them in our CRM, really dialing in a thesis.

28:20Once we've identified the companies we like, and in some cases, it may be identifying the teams that we want to back running a consolidation play in an industry we like. If there isn't a specific company, we're going to spend a lot of time getting to know folks. So there's a lot of dating before there's a proposal. And it's outside of a process. In some cases, it could be years of dinners, lunches, golfs. I don't golf. Other people on my team might be golfing. referring clients, comparing notes, helping them iterate on a comp plan, and observing how the teams act through thick and thin, getting them to know us and our style.

29:04And so at the time when we're arriving at a transaction, it's really a conversation about structure and price. After that, it's all about confirmatory diligence. So doing the QAV, background checks, reference checks, even though we've probably already referenced the business, really getting into legal tax and regulatory diligence. But it's very micro at that point. And as a result, even though sometimes these companies are not totally prepared, they don't have a banker, they haven't done that prep work, we may be able to make the closing process pretty efficient because we're just focused on the confirmatory side.