E336: The Private Equity Firm of 2030

0:00Last time we chatted, you said that there's a lot of innovation going on in private equity. What exactly is innovating? I would think about innovation in three buckets. The front office bucket, which is origination, product, distribution. The middle bucket, which is the portfolio company value creation component. And then the third, which is back office. And I think the most innovative people in the industry have probably been the biggest private equity firms today. the Apollos, the Blackstones, the people that grew the fastest were the ones that innovated the quickest. Which part is the chicken?

0:32Which part is the egg? Did they grow because they were innovative or were they innovative because they had the budget? That's a very good question. It's probably a bit of both. One feeds the other. But these are firms that have been innovating in the product area very quickly. And you look at an Apollo that built super innovative retirement services business in Athene that's now the largest writer of annuities products globally. That was hyper innovative. So I think it comes down to culture a lot of the time. Speaking of innovation, I had the former partner of David Rubenstein, Carlisle, and he told me the story about how David Rubenstein was the first partner to actually say, well, we could have two strategies in one firm.

1:11Back then it was, you have a real estate fund, or you have a private equity fund, or you have a credit fund, and no one had ever thought to have two different lines in a single firm. You have to think like that these days. But it's also important to stay true to what your North Star is and your vision. Very quickly, firms become asset gatherers. In an environment where fundraising becomes harder, performance is more important than ever. The industry often needs to remind itself what its core product is. Its product is performance. A customer, a client gives you a dollar and expects two and a half, three dollars back.

1:43Do you really think that's true? Yeah, I do. I think it's really, really important. And I think asset gathering has become more about management fees than it has about performance. And that can be a dangerous mindset. For the purest, returns are the product. I had the former CIO of Calipers, Russell Reed. We talked about this very thing. What part of the LP market is chasing alpha versus beta? And by his summation, from a capital standpoint, it was more than 95 % were actually going after beta. Now people call it smart data, which is just a nice way to say beta. And only really 5%, the single family offices, the high net worth, some very innovative endowments, some very innovative pension funds, but only 5 % of the capital is actually chasing alpha.

2:23I agree with that. And I actually think that we're saying the same thing, which is value creation and alpha creation to generate returns is something that is increasingly important. You're at Access Holdings that has$2.5 billion, and you are competing one way or another with the Apollos, the KKRs, the Blackstone. How do you compete with them? Well, I don't think we do compete with them. We're further down the market. Now, we might compete in some way or form for LP dollars, but we don't directly compete with them. And that's a good thing because those are some of the greatest, greatest firms in the world.

2:57But we operate at Access in the lower middle market. It is our laser focus. It's why I joined the firm. I wanted to focus the rest of my career on the lower middle market specifically. And I do believe that the ability to create alpha at the smaller end of the market is so much more prevalent. But it does require an incredibly hands-on, incredibly labor-intensive model. And it's not easy. It's easy to say it's easier to take a$5 million EBITDA to 50 than it is a$500 to$5 billion. But in practice, it's really hard. Building businesses is difficult. Expert calls have always been one of the most powerful ways to build conviction.

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5:29It's a great question. So at Access, everything for us begins with research and data. And we have a handful of capabilities that were built on those philosophies. Firstly, when it comes to origination, we have an in-house research division business called NOAA Research. and that business allows us to pick a thesis area and go really deep on it instantly. We generate a thesis report and what we call an EKG report, an engagement kickstarter guide. In a matter of minutes, it pulls from multiple different agents talking to each other at the same time, including ChatGPT and Claude, and it generates a report that we also turn into a podcast so that our deal team can get up to speed on an industry really, really quickly.

6:15That doesn't mean all the traditional work doesn't need to happen, but it does allow us to be prepared and to go deep on an industry. The engagement kickstarter guide then pulls a one-to-own list. So if we're looking at pest control as an example, there might be 10 ,000 pest control companies, but there's probably only 200 that fit our criteria of EBITDA, of number of employees, of location, etc. And so we score these companies. We have a digital sophistication score that goes on their website and tells us how they're thinking about lead gen and analytics. We have 31 different data points that create that score and then populate our want to own list.

6:54So we then know which 200 companies we want to speak to. And that comes back to Kevin McAllister, the founder of Access's philosophy. We invest in businesses we want to own, not businesses that are for sale necessarily. This allows us to be that much more prepared and well-read on the types of companies we want to own in the space rather than just being opportunistic. Is AI also telling you which industries to go after, or is it you decide to go in an industry, you decide an industry may be something worth pursuing, you do the EKG report, and then you go after the target list? Talk to me about your process.

7:27Whilst AI creates a lot of efficiencies for us, which we'll talk about today, the fundamental is that you still need to have the idea. AI doesn't do all the thinking for you. You know, I can help prompt ideas, and we absolutely use our tools for that. But it doesn't do everything for you. One area that I think is particularly useful where it does a lot of ideation and insight and analysis for us is with our portfolio analytics. So we built, and this should blow you away because it's pretty advanced. I don't think there are many organizations that are doing exactly this just yet. But we worked with an organization called Accordion, who do Office of the CFO activities for private equity firms.

8:11And we worked with Snowflake to build a data warehouse. And we connect all of our common infrastructure in our portfolio companies, the ERP systems, HRIS systems. And using Fivetran, an engagement layer, we put all the data out and we put it into the data warehouse that Snowflake built for us. that then allows us to query huge sums of data all the way down to say a store level so that we can know real-time data on cash management and how the call center might be operating we know that maybe at our pet care business we're not answering the phones regularly enough so we're losing out on leads or we're paying invoices too early and taking working capital out of the business or as one example that we actually just were talking about yesterday our car wash business.

9:04We can look at, of the 250 car washes we have, which performed worse last month. We can then look at that specific store and say it's one in Philadelphia. And we can see that the rainfall last month was really high. And so that's why we misbudget. But we can also look at last year's rain data that tells us that actually it was the same as last year, and we just misbudgeted. And we can also then fast forward and use it predictively. So we can see if there'll be heavy rainfall next month. And then that allows us to do a handful of things. One, we could think through how do we lower costs on resourcing because it's going to rain more.

9:43Two, how can we think through supply chain and procurement adjustments? And three, how do we think through dynamic pricing? We could, as an example, focus more on interior car washes the next area and do offers around that to try and mitigate the weather. And then finally on pricing, another tool we have at the moment is a scraping pricing data tool. So we look at every single car wash in the United States every month. We refresh the data and we can then price match based on all of the car washes in the United States. That's on the third layer. So that's after you invest, that's the value add.

10:22We talked about the first layer, which is figuring out whether the industry is sexy enough to pursue, although it's pest control and car washes. Sexiness is a relative term. And then which targets to go after. So you have your target list, your 200 out of the 10 ,000 pest control businesses. And then the next step is winning, winning that business and going into the company with the right entry point. How do you use AI to win? The private equity industry has historically, in some situations, been painted with a brush of corporate raiders and sharks. Going back to the barbarians at the gate. Exactly.

11:00People you don't want to sell your business to. So we use our insights to not be smarter than the management team, but to use it to be prepared and to engage and develop relationships. And that's a cultural philosophy that we have. As an example, we have a large sports asset in the sports infrastructure space called Playfly. We pulled just yesterday a report through our research business on Hot Topics, and it used social listening tools to pull information about the name-image likeness discussions that are happening online between all the athletic directors so that we could engage in conversations knowledgeably about their perspectives.

11:41not necessarily the facts and figures but just understanding what their perspectives are going into conversations that stuff helps you win because it allows you to have empathy and this is an industry where sometimes empathy has been a little bit lacking the other thing i want to talk about in terms of winning deals is an area the industry has also had a very low bar in which is media. Now, understandably, the first word in the descriptor for the industry is private. So it hasn't been a marketing forward industry, although I do enjoy some of the Christmas videos that the bigger firms put out each year.

12:19But I don't know if I call that marketing per se. One area that is a really big part of the industry and growing as we see more consolidation is the independent sponsor market. It's formalizing. Thousands and thousands. Thousands of them. The last McGuire Woods conference had 2 ,000 independent sponsors. It's extraordinary. It's been growing at a 52 % CAGR over the last five years. 25 % of deals in the lower middle market will be done by independent sponsors this year. And so as the industry grows and becomes more institutional, they're no longer called the derogatory fundless. They are independent sponsors.

12:56That's an area we think we'll see a lot of good deal flow. and Kevin and I were talking before Christmas about how we can participate in that deal flow not just more proactively but how can we be a leading firm that participates in that deal flow and Kevin was a three times independent sponsor before raising funds at Access Holdings that he did a fantastic job but he's had that lived experience and he unpacked for me all the things that he wished he'd had as an independent sponsor and one of the big areas despite quoting facts that there are not uh there's not a lot of quantitative data in this space so the data isn't there um and there isn't a single source of media entity so an aggregation of news and what's happening in the industry um and and then the final part is services all these independent sponsors um they aren't in a position like access where they can build infrastructure and build a they don't have the management fees to support Correct.

13:55Yeah, they don't have the ability to build a 25-person value creation team or a five-person talent team. And so an independent sponsor needs that stuff if they want to continue growing and being ahead of the field, as well as equity and credit and all sorts of other things. And so our answer to that was building, which launched recently, independent sponsor news, ISN. You can think of that like Prequin or With Intelligence meets CNBC with a marketplace of services from providers who want to serve the independent sponsor community. That allows us to participate in the flow of information to and from the industry.

14:32And I didn't think as a private equity firm, when I first got into the industry, I would ever be launching a media platform. but that's what we've done. And the idea here is it helps us serve the industry, both as access holdings and our strategic partners to serve the industry. But it also helps us be better at what we do, which is find great deals. When we started the media franchise three years ago, it was a very contrarian move. Having institutional investors jump on a podcast was probably for 80 % of institutional investors, probably the biggest nightmare. And the way that I liken it is kind of like mental math before we had the calculator or the calculator before we had AI.

15:12You could either go out and spread your message one-to-one, which is also, there's obviously room for that. It's important. Or you could do a one to 10 ,000 or one to a thousand. I was just talking to a manager about jumping on the podcast and he's like, I'm busy building my fund. And I took a step back and I thought, well, what does a fund manager do? He raises capital and he sources deals. And there's some kind of obviously decision layer on top of that. What does a podcast do? So raise capital. We've had over$5 trillion AUM on this podcast, for example. And two is find deals because people want to hear.

15:45We've talked about this decommoditization of every private market. So before, I had Professor Steve Kaplan from University of Chicago. He's one of our advisors. And awesome guy. And in the 90s, he said people would come into University of Chicago, and they would talk about their private equity fund. And he would ask them, what's your differentiation? And most of the speakers would actually kind of look at him weird and like, we don't do that. Like it was almost a dumb question. In the 2010s, everybody had differentiated by focus. We're a private equity fund, lower middle market, focusing on$10 million to$20 million EBITDA businesses with a 20 % to 40 % growth rate.

16:17Of course, when you peel that back, that's not really differentiation. That's just essentially giving a banker a mandate on which auctions you want to be part of. So now we're in this third evolution, which is how do we actually differentiate by providing value and focus to the companies? That's why you see these niches in the private market. Some of these niches are$100 billion, like continuation vehicles. As an industry becomes more competitive, you naturally have this evolution from we're one of 10 firms. We don't really do that differentiation thing. That's weird. To now we focus on 5 to 10 million.

16:44We focus on this space. And here are the five different services we have for our portfolio companies. And by the way, we also have a really good reputation top to these 20 previous investments. So it's really kind of downstream of a hyper-competitive market. Touching on your first point around the evolution of media, if you'd ask that manager, would you like to be on the front page of the Wall Street Journal? They would have jumped at the opportunity. And it's an evolution of mindset. Now individuals are their media channel. And some managers are better than others at this. But that doesn't just mean that the managing partner needs to be the person out front.

17:21It's a responsibility for all senior employees. In fact, all employees in general. We have a dedicated social media manager at Access. Not many small firms have that. I hired someone who's an expert on LinkedIn, specifically on LinkedIn. The algorithms change every week and she's plugged into how the algorithms change so we can maximize our exposure. And our team, they are our greatest champions. They should be. And so they should be posting and championing our portfolio companies and our platform and our culture. Now, you have to be appropriate and everything is reviewed by compliance and there's processes wrapped around it.

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21:11I'll give you another example of something I thought was unique. Kevin has had this vision for a long time of us using technology across every part of our investment process. So we're looking at doing a deal in the towing. We've identified a platform and they were out meeting with a number of potential add-ons so that we can out the gates, do two or three deals and double the EBITDA in very short order. And as we were thinking through what type of add-ons and where should we do it, how do we create that market densification? One of our senior team members, using Claude, ingested four different types of information.

21:51One, where are the towing stores today? Two, where are the M &A targets on our one-to-own list towing stores? Three, what are the routes that they run today? And four, what is the, using all sorts of publicly available sources, what are the other towing company routes? And where are the biggest volumes driven through? And using that data, we could then identify how do we densify our market? Where do we want to do deals? So we then created this market map that I was reviewing this morning. It's fascinating telling us where would be most logical from a growth perspective to invest and in what sequence.

22:29Access holding is very tech forward. It's literally in your DNA. A lot of private equity firms or venture capital firms for that matter, they feel overwhelmed. and they ask themselves the question, where do I start? Where can I start integrating AI into my process? What's the lowest hanging fruit and what's a way to start integrating AI today? Yeah, it's such a good question. And it's really hard. I think it's particularly hard for the big firms. Firstly, it comes down to culture. We have a very innovative culture and that really is, it begins with Kevin as the managing partner. He pushes all of us incredibly hard to be curious and to be innovative and to think through how to leverage technology to do things more efficiently.

23:09And so we had one of the earliest instances of enterprise-grade ChatGPT. We rolled it out across the full company and all senior employees in our portfolio companies. Every month, and I don't know if Kevin would thank me for saying this, but every month we score our whole firm, 50 employees, and we score them based on how many prompts are they doing. Now, that allows us to see how much time on a kind of best-guess basis we've saved using ChatGPT, which is statistically the stuff that I quite like. But it also shows us by prompts who the person who's using ChatGPT the most is all the way down to the least.

23:43Now, it's unsurprisingly relatively correlated to age. Youngest people using it more, oldest people using it least. And we share it with the organization. Is it shaming to some extent? Yeah, sure, maybe. But it encourages people to use it, encourages me to use it. I was at the bottom of that list when I joined and now I'm somewhere in the middle. I don't know how these guys are using, doing tens of thousands of prompts a month. Maybe they've got an agent doing it for them. But it's, yeah, you have to change the culture. And don't just teach someone, say to someone, you've got to use AI. You've got to teach a person how to phish.

24:17So we do AI training courses with external providers. We did one two months ago, and we all learned how to build digital twins. So we now all have digital twins doing stuff for us in the background. Access Holdings is an interesting use case because you guys started using AI very early in the private equity space. Was it some combination of bottoms up, top down processes, meaning you started 24 year olds started using it for sourcing and then they figure out this process and then they took up to senior management and senior management created this protocol? Or was it kind of top down? How do you create these firm wide competencies?