E426: American Securities CEO on Warren Buffett, Private Equity & Playing the Long Game

26:01And when we started 30 years ago, if you were raising financing of more than, let's say,$150 million. So if you were buying a company for$250 million and you're putting up 50 million of equity and maybe 50 million of mezzanine or preferred stock and borrowing 150, that 150 was a syndicated, allowed a bank deal to be syndicated. And if it was, which meant that some intermediary bank like JP Morgan or Goldman Sachs or Citibank, B of A, pick your firm, would agree to underwrite that loan and sell it to their account holders, insurance companies, small banks, pension funds, large list of buyers. When that happened, you got lower interest rates.

26:47A couple points. than the alternative, which is a club deal, where you find one bank or two or three banks to take the whole loan, and they just commit it, and you're done. There's no syndication process. Kind of like private credit today, which is a whole market. So if you could do the syndicated market, then those companies tended to sell for one or two times more multiple. So instead of paying, let's say, six and a half, seven, you'd pay eight and a half, nine for the company. And we didn't care about how much money we were managing. We just cared that we made money for our investors. And I used to talk about Warren Buffett back then because I had come to know him a little bit.

27:25Buffett's legend is his returns. It's not how much money. It's more impressive because he managed so much money and he made returns that were generally beating the S &P. But the stock and trade of your investor is having good returns. And that's what we cared about. And so we didn't care about size. We cared about having good returns, risk adjusted. And that meant buying it for seven and a half was a complete winner versus paying nine and a half. So we wanted to be just below Mr. Mega. Now what happened, the big, what are now mega firms, but the bigger firms at the time, well, they kept raising more money.

27:57If they started off with, we had our little 71.4 million kitty and they started off with a massive 350 or$500 million fund. Well, when they went to a billion, it gave us the opportunity to operate below them. So the competitive set wasn't as stringent, but it allowed us to do the same thing, but just do it with bigger companies. And so that's basically how we grew from 71.4 to 350 to 650 to a billion to 2.3 to 3.6 to five and then so on. You didn't break my venture principle, which is don't compete directly against Sequoia. Correct. Correct. We, now, again, at some point they fractured and started to have small market funds.

28:40So you couldn't help it because they kept their massive funds, but then some people created second funds or smaller capital. But as a general statement in those early years, we just were able to do slightly bigger deals in every fund, doing the exact same thing, same investment principles, market leading businesses, back in the existing management, because they'd gone for bigger fish. and why avoid starting private credit or other expansions of your business let's not avoid and there are things we've tangentially put our toe in the water over time but we have always been uniquely focused on our core private equity funds and we still are it's the only thing we do now because it's what we like doing these are personal journeys i love the investment business i love the details of transactions.

29:31I love going to plants. Managing other people having that fun is not as much fun for me. I'd rather be having the fun. And so we're all kind of into that, what we do all the time. And that's fun for us. It's interesting. You have this keen awareness that a lot of founders think about their business, whether they're founders of technology companies or financial firms, almost as this thought experiment. Like what should be the Pareto optimal way to structure and how do we maximize AUM, but you're very aware that you're not only the founder, you're also the person executing the strategy and you're really creating your own work week as you build your business.

30:07There are lots of other people in American Security who are responsible for our success and they're doing the same thing. But just as a personal journey, and it may be a failing lack of ambition, I used to say, when people say, what's your ambition for the firm? I think put one foot in front of the other and not trip. If we just keep doing what we're doing, our kids will not grow hungry. They'll be able to go to school. We'll have a roof over our head. It'll be just fine. And if we like doing it, why change it? And so, as I say, it may be a failure of ambition, but I like the investment business.

30:35My partners like the investment business, and that's what we try to do more of and not being the managing of other people doing the investment business. And certainly$23 billion is not like the turtle. It's a massive amount of capital. But have you found that a lot of your peers, the ones that were successful, also slowly built or are there people that really sprinted and ended up being successful? The world's a big place. There's all... Different models work. Different models work and different models bring happiness to different people and some work for a little while and then come undone. As a general rule, private equity, really different than private credit and some other things, it can only grow so fast.

31:20You just can't add lots of assets in private equity. Mark Rowan at Apollo is brilliant. He was one of the early folks to say this, basically. The private equity business can only grow so fast because you can only do deals of such a size, and there's only so many people who can do them, and it's just limited. Whereas in private credit or debt, there's infinite amounts of debt out there in the world. There's companies that are issuing tons of debt, and instead of being 1%, you can be 2 % or 5 % or 10 % if you have more money. It's still 1 % of your funds, but it's easy. The same people can invest a lot more money.

31:52Private equity is harder that way. It's almost like a TAM of the opportunity set. The TAM's gotten bigger because the industry's gotten so much bigger, but in each sector, whether it's industrials in the United States, consumer, or globally, there's only so many people. That person can only invest so much capital because he or she can't do more than, pick a number of deals a year, put out a number of capital. It just can't grow as fast as debt can, where I can, oh, I'm doing this financing for, pick your big public company for this data center. It could be 10. I can take 10 million of this billion-dollar facility, or I can take 100 million.

32:29It's the same work. And so you can expand if you're asset gathering. And in private equity, you can't. The companies just don't expand it. How's the business evolved from going from a few partners doing their own deals to now having 150 employees. With people who've been with us for, as you highlighted, David, for a very long time. So you'd know, I had one partner who used to say, it's not that someone says it's blue or it's green. It's that you know they're colorblind. So if they say blue, it means green. You've come to work with these people for a very long time. You know their biases, you know their strengths and their weaknesses.

33:01Well, not even strengths, which is what it means when they say something. You know what that means for them, because we all sound different and say things differently. And so when we first started, like we were just a bunch of deal people. And I think most private equity firms evolve the infrastructure in a step function way. So first we were just a bunch of investment people looking for companies, meeting with management teams, financing those businesses, sitting on the boards of those companies and trying to help the management teams create very successful investments for them and their families and for our investors at the same time.

33:37And then there are two other streams that come to pass. One is investors start saying, okay, you might be a great deal person, but why are you the best owner of this asset? What do you bring to the company after you've bought the asset? And people have developed very different strategies around that. Some, many have operating partners for a variety of reasons. Some would call those shadow CEOs. our approach was to have what we created what we call our resources group, the American Securities Resources Group, which is actually the largest sector of our firm for years now, bigger than our investment team.

34:14And it's some 50 people who are functional experts in something, hiring, procurement, Salesforce management, financial planning analysis, a whole bunch of other things, things that can help the management teams be better depending on what they want to be better in and we can help them with. IT. And that's been super successful. And we've tried to do things that we can do in a group basis that none of our companies can really be expected to be great at on their own. And what I mean by that is take IT. everyone has an IT leader in a company and he or she's probably great most of the folks we meet are great but a company only puts in a new ERP system every seven to ten years historically so most IT leaders have never put in a new ERP system and that can be really complicated because the system always works according to the manufacturer and they're not wrong but the company's application of it, their knowledge of how to use that system, how it fits into their business processes can require an enormous amount of rejiggering to make it all work for the customer and the manufacturing floor.

35:32Our IT people are terrific. They put in typically two ERP systems every year because our portfolio is big enough. So they're experts at that and helping the outside integrators and the systems and the management team make it all happen. And that's an example of something that we can do really successfully that no company can do really great on its own. And likewise, we talked about recruiting before on the professional investor side. All of our companies are recruiting for positions all the time. And many of our companies have plants in different locations and different functions. we are doing so much recruiting among our roughly 120 ,000 portfolio company colleague base that our HR folks know who the firms are and how to manage that recruiting process to cut down the time and have a better quality outcome as we were talking about.

36:24And we rate ourselves, we go back six months after, does the company think that they hired an A player with our help versus not to make sure we are getting great players, great people to join. On this value add on these resources that you give to the companies, is it more or less perfectly, perfect information on which firms are good at that and which firms are not? There's never perfect information. I hope we're super well known for having the highest, what I call CEO win rate in private equity. For our history, more than 80 % of the CEOs who were there when we invested in the company, were there when we exited, or were there with us today.

37:04So that's a CEO retention. I call it a CEO win rate because most of our companies do well in the interest of the CEOs. But I think that I've never heard of anyone with a higher CEO win rate, absent ordinary course retirements, which isn't like when we decided you need to retire. And we're really proud of that. So we are looking really hard when we meet a company. is this CEO someone that is super good at their job and wants to work with us and vice versa, much like our thing for recruiting ourselves. I want to work with people that I like. We want CEOs and we have some terrific CEOs and that 80 % CEO win rate, I've never heard one higher.

37:45So hopefully we're super well known for that. And one of the things that animates that is our resources group because, as I tell prospective CEOs, it's not that any of our people are necessarily better than your people. It's that your people have a day job, and our resource group day job is to help your people win. That's all we want to do. Our purchasing people, our HR people, our IT service people, FP &A, they don't want to do your people's job for them and replace them. They want to help your people be better. And we've got, because we don't have a day job, we can help them be better in things we agree that the company has an opportunity to be better at.

38:23Double clicking on the CEO win rate from the outside when you look at these private equity deals especially with these highly shopped processes you almost look at it as a deal and somebody won the deal but is there more to it in terms of making sure that there's culture fit similarly to how you would want to recruit somebody into the firm with culture fit? Oh for us there is absolutely. 30 years ago, we could get on a plane. A meeting would be set up for us with a CEO owner in a city. And we'd go have lunch. And it may be the case, it really happened that after that lunch, we would sign a letter of intent.

39:04The seller would sign a letter of intent with us at a price and give us six weeks to due diligence and make sure we wanted to invest in the company. and then we'd sign a contract. Now that seller is much more likely. That situation almost never exists the way it used to. And now that seller is much more likely to have interviewed three or four investment banks, picked one, spent a bunch of weeks or months writing a book, an offering memorandum, a selling memorandum, or a management pitch deck, and have been coached on things that questions people like us will ask, private equity people will ask, and what the best answer is.

39:44So simple example is add-on acquisitions. 20 or 30 years ago, you might say, have you ever done an acquisition? Management team may say no. Have you ever thought about it? They may say yes or no. Okay. We'd have our view whether you had competitors for sale, whether they were synergies that could make this a more attractive investment if you were able to buy a competitor. Now, I don't think in the, I actually think it's possible in the last 10 years, no one in our firm has ever gone to a management presentation and the manager has said, yes, we can do acquisitions and here's a long list, even if they've never done one before.

40:23They're just coached. That's something that you need to have an answer to and say, yeah. So some people to where you started, they are, it is only about price. The highest price gets the company and there may or may not be a cultural fit and the buyer may or may not care about cultural fit. We care a lot about it. And we regularly encounter management teams who are very attracted to that and they would love us to be our partner and someone pays more and we don't get that opportunity. But the good news is the funnel is pretty big and we see a lot of companies and we get that opportunity. And just to be brute, the seller doesn't care about culture fit sometimes because they're just looking to cash out.

41:02Who cares? They're like you and me and everyone else. They're all different flavors. Some really care about culture. I want my management team to have a say in who the purchaser is. They're a new partner. I want the best for them. And some people for fiduciary reasons or other just want the highest price, and they don't care about the continuation of the business and how it's operated and the principles. Just depends. You call it Mr. Mega, these large funds. Some of these funds are now over a trillion dollars, which is crazy. and now there's retail capital going into the market. How does that affect your business?

41:37The very small one or two that might be over a trillion, that trillion is not in private equity. There's private debt and credit. There's a whole bunch of other things. But as I said, private equity, the largest, these are not for the faint of heart, don't get me wrong, I don't think there's a private equity fund that's over$30 billion. Now,$30 billion is a ton of money, but it's a long way from a trillion is kind of my point. So there are certainly those Mr. Mega private equity firms, and all of those are global at that size. And they're some great firms. They've been successful for a long time, and they do a lot of things, and they have multiple offices.

42:20And there, if we were 150, they would have 10 or many multiples of that times the number of people. So they're applying the same principles in many cases in very sophisticated ways, but they're not real competitors for us. But companies are a pyramid, so the number of companies that they can invest in is a much smaller subset than us. We have for 15 years been investing an average of$400 million per deal, maybe$350 million. And so in that$200 to$400,$500 million segment of equity per investment, there's a lot of companies and more growing all the time and big companies selling divisions or private companies selling divisions as they've gotten bigger that are no longer core to them.

43:06So we have a very active set of potential investments every year. We probably see 400 to 500 investments a year. How many of those do you? One to four. Guess what I was trying to allude to is my thesis is that if there's a lot of retail going into the mega funds, one very obvious, but perhaps not as obvious second order effects is that capital has to be deployed somewhere. Firms like American Series are going to be net beneficiaries of that because of this new bid. What you're alluding to, David, is historically the investors in private equity funds, so-called the limited partners, were banks, insurance companies, pension funds, and other institutional investors, and some very high net worth family offices.

43:54Now, there is regulation which is permitting ERISA and other individual investors to invest without high minimums or sophisticated investors' legal term tests. And this retail money is enormous to give your listeners orders of magnitude. So if you're a big institutional pension fund, you might have 12 % of your capital allocated to private equity. That wouldn't be unusual, 8 to 15. If your average retail investor has 0 to 1%. So the tsunami you're referring to is the retail investor because most of the institutional investors are basically where they want to be allocated in private equity plus or minus.

44:42They've picked their managers. Some are growing, some are shrinking, but they're plus or minus. They're already at 10 or 12%. And so it doesn't matter how many GPs, private equity firms, come saying, please come invest in my next fund. They only got so much money. This whole new set, which is at zero, and it's bigger than the entire institutional market, the individual investor market. So yes, it's a tsunami. The thing about that market is it's a retail investor, right? So it's very brand sensitive. And there's a lot of regulatory work that you have to have in place to take retail investors. And it's just a slightly different, what they care about and the level of, support that they want from their managers is different.

45:30And you have to be happy with that. And it's for sure the case that the biggest firms are very focused on this dramatically, and they are focused on it directly through investment banks and other high net worth fund platforms. And they will, I'm sure, raise enormous sums of money from that channel. But there is, in our size range, there's always a place for people who are generating good returns, and there are people who want middle market. And so banks and investment banks do things like private label to their retail channel, firms like ours and other people like us. So there are some of that will come in.

46:08Speaking of capital, you've not only had people at the firm for over three decades, you've also had capital partners for over three decades. What are some timeless lessons from how to best deal with your capital partners and build these relationships over such a long period of time? Doing what you say you're going to do matters. and doing it well. Returns matter. So if you're lucky enough to have an investment strategy, which is durable over, in our case, decades, and to have had returns, which people find attractive, you're lucky enough to keep getting up every day and having fun doing it again and again, as long as we can.

46:45And has your capital base evolved greatly over those 30 years? Oh, sure. I mean, our first fund was almost entirely U.S. investors. And in our last bunch of funds were 50 % international. And as you've grown, are you able to bring in IR help or are you still managing all those relationships? We have tons of people doing everything. I mean, don't look at me like I'm doing anything. Because a lot of private equity founders will come in and say, I talk to every single person I meet with. I kind of find that hard to believe. to say that I'm going to tell you that most of our investors have met many people at our firm, and often I'm one of those people.

47:28But we have lots of touch points and are increasingly focused on having more and more touch points and trying to be not just a return provider in exchange for capital, but a thought partner and help some of our partners achieve investment objectives they may have outside of just great returns from our being a limited partner in our funds. What's an example of that? There are some international investors who are looking at deals directly, or they have investments in industries in their countries where we have experience. And so they're curious about a particular industry, particular manager, a particular lender relationship.

48:04We used to look for partners who wanted great returns and could be in a country because we never wanted to invest in a company headquartered outside of the United States. But many of our U.S.-based companies have international operations. So having an investor who's in country or was in a country that one of our companies were looking at an acquisition is super valuable. Now we have a friend who can help us find the right lawyer. Make us be U.S.-based but be local. Okay, who's the right lawyer? Who's the right accountant? what are the cultural norms in this company, in this industry, in that country?

48:39Super, super helpful. One of your life lessons you've described as make the call. What does that mean? Well, especially being an introvert, like it's so easy to play with numbers, think this might happen, this should happen. I was like, call the person, call the person. And I think the world is organizing more and more that way. It's not you have a great idea all the time, especially when you work through people as we do in private equity. It's a relationship with you or with someone else or with an investment bank or a lender, a management partner, a special consulting firm. Make the call. Anything else you need about our bid, we want to buy the company.

49:13Don't think they'll call you, but always make the call because you're building a relationship. As long as you're exhibiting good comportment and making a friend all along the way, always make the call. Did this come from some loss in terms of a deal? It wasn't only that. It was my time as an advisor to companies in the M &A process, just coming first on all of you. Make the call. Don't presume anyone's thinking about your deal. Just make the call to just, hey, please work on my deal. You've got other deals you could be working on. Other people are presenting things. Someone's got to do the work at that bank to, say, lend you money.

49:45Or that investment banker, we're looking for things in this. Always make the call. How do you get somebody to work on your deal? Call them up. Make the call. Is it just, hey, I was thinking about you? 30 years ago it's like hey john we sent you information on xyz deal what do you think have you had a chance to look at it yet i'm sure you're really busy just making their priority making them focus on the deal you always want people to try to prioritize the things that are really important to making your investors money and make the call i remember in the first startup that i started and i was fundraising with angel investors and my friend who was in sales i was telling him, I didn't know why this person wasn't investing.

50:28He said, just go and have coffee with him. And I was thinking, what else could I tell him? I've told him everything about the business. Why would I go and get coffee with him? And I went and got coffee. He asked me a couple of questions that were probably subconsciously in the back of the mind. I answered them and he invested and it just blew my mind that just having an incremental meeting. It's the make the call concept, have that personal touch, a call, a meeting, a meal. I think that stuff is super important. And I'll extrapolate and say in the AI world, the analysis, the pyramid used to be like a rainmaker at the top and a whole partner and a whole bunch of vice president, a whole bunch of associates.

51:02And this pyramid is collapsing. That rainmaker is still super important because that's the person making the call with the relationships. But the analytical work is AI is collapsing the number of bodies needed to do great analytical work, but it's never going to replace the person just making the call. It's even more important than it was. Make the call. Also, I had a former colleague from Goldman. He was there for seven years, a little bit younger, Max, my friend Max, and he taught me this principle of even if it's for one meeting, you go to LA and you have that one meeting. The value of having this in-person meeting is always undervalued in finance.

51:40Do you agree with that? Absolutely. Absolutely. What's the furthest you've ever flown for a single meeting? halfway around the world New Zealand? China China I've been to New Zealand too Australia, China I went to China for a 45 minute meeting Did that pan out well? Yep If you could go back 32 years ago when you just started American Securities and you could give yourself one timeless piece of advice what would that be? He's a very famous investor not really private equity on wall street and uh more in the hedge fund business and he had people work for him and he was super successful and they would often spin out and when they would leave they would ask him what do you have any advice for me and he'd say yes be lucky early because if you're not lucky early you're out of business and that's cute i'm not sure it's helpful but there's lots of things i mean love what you do love the people you do it with there these are timelessly.

52:42Because a lot of the failure mode comes in the first couple of years. Well, we have success bias. If you fail in the first couple of years, you don't often get a chance. You're going to be doing something new with new people because that first thing is not going to work. Most people do not reinvest with people who've not done well for them. I've noticed that as well. And maybe on the operation side of the business of the fund, I think about it. How do you make yourself inevitably successful? And part of that is how you structure, make sure you stay in the game. The asymmetry of staying in the game is greatly undervalued.

53:13Some people get these huge offices or invest in all these things, and then they end up two years without a business. And they don't realize that asymmetry if that just stayed in the game. If something has made you successful and you keep doing it, you're more likely to be successful than not doing it, getting distracted by another business or another activity. And so if that's staying in the game, I certainly agree with that. And that's part of this. We just want to put in American Securities one foot in front of the other and not trip and just keep doing that, hopefully for another 30 plus years.

53:44I notice a lot of people have had the level of success that you've had always say, I don't have any regrets. But if I forced you into a regret over your career, what would that be? I regret a few people we didn't hire that I thought would be good hires, but we didn't have a consensus around them. So we didn't. I regret a few people we did hire that weren't working out and not working them, loving them out of the firm sooner. I got lots of regrets. We make many mistakes and we do this in a team-based way. Try to recognize our mistakes and correct them as best we can when we realize something is not going right, be it an investment, be it a colleague, be it a relationship, anything.

54:29Michael, this has been an absolute masterclass. Thanks so much for jumping on. Thanks for having me, David. I appreciate the time. It was fun to chat with you.