E430: Goldman Sachs’ Michael Bruun on AI, Private Equity & The War for Talent

0:00It needs to come from the top. The CEO needs to make it well understood by all employees that AI is an absolute must and it's something that will change the way we do our business and we embrace that change. There needs to be some experimentation. If humans are not allowed to experiment, it is unlikely that we will get to the most relevant and most creative solution. CEOs are also faced, and this might at times be uncomfortable, with the task of deciding whether the rest of their ex-com or leadership team is actually ready for this transformation. The war for talent is bigger than it's ever been.

0:41If you can get the right people in with the right change mindset, they can move so much faster because they are AI enabled. Michael, you're the global co-head of private equity at Goldman, where you've been for nearly 23 years. And when you were earlier on in your Goldman career, you were influenced by Lloyd Blankfein's saying about having skin in the game. Why was that so influential for you? Goldman Sachs services its clients in a multitude of ways. It provides advice. It facilitates financings. It's a very large market maker in multiple markets, stocks, bonds, commodities. And then it's a principal investor.

1:20And I think what Lloyd meant when he mentioned skin in the game was that we can be several things for clients and give an even more comprehensive service. So not only provide advice and provide financing, also at times put our money where our mouth is and invest alongside clients. And that gives a very unique and trusted relationship. And it's something that is unique to our firm. Very few firms can do it, and no other firm does it at the scale of Goldman Sachs. And for those of us who have read his most recent book, Streetwise, you'll see that he specifically refers to this element and some of the unique characteristics of Goldman Sachs.

2:02How do you build the right incentives within your team? Ultimately, we get judged on our investment performance. So it's incredibly important that our incentives are aligned with investment performance. Like most other private equity firms, you receive a combination of annual compensation, and then you have a lot of your ultimate wealth creation or hopeful wealth creation tied to carry in the fund so that we are really aligned. And then we're also asking our investors to invest alongside us in the funds such that, again, we put our money where our mouth is. This is back to where we started. this culture of being a principal, both with the balance sheet of Goldman Sachs, but also with our colleagues' capital, but certainly also our own capital.

2:55We think that carry is important to incentivize great investment outcomes, but we also think that you need to have a lot of skin in your game at the most personal level. You operate in the core middle market,$500 million to$2 billion deals, the most competitive part of the middle market and you have some very formidable competitors. How do you outcompete them when it comes to the best assets? You're right. We have formidable competitors. We have been able to do well ourselves by activating Goldman Sachs. Nobody else has Goldman Sachs as their wingman or wingwoman in their investment strategy. I think we do that in a multitude of ways.

3:35We do the network piece that we already talked about, which is fantastic for sourcing, and it's fantastic for value creation. In addition to that, we have one of the largest operating groups in our part of the market. We have more than 110 operational partners that drive value creation in our strategy. And then we have insights beyond what most firms see. We're 45 ,000 employees at Goldman Sachs. We are in most markets around the world and we get a lot of signals and those signals float back into our business such that we can navigate either the most complex operational environments, environments like the ones that we are seeing right now with very meaningful geopolitical uncertainty and also a much more blurry macroeconomic picture.

4:21We spoke about the network effect. We haven't spoken much about our value accelerator. This is something that we've built over the last 10 years. We felt that we needed to have very, very strong operators drive outcomes in our part of the market. It's something that you have seen in mega buyout, but we felt, why don't we take mega buyout operational resources and bring them in to the mid-market? How could you do that? Again, Goldman Sachs has a ton of relationships to senior executives who maybe normally would operate in a mega buyout context, but actually felt compelled to come to us, to our part of the market, because it was an opportunity to stay with Goldman Sachs, an institution they probably worked with in a different context.

5:02Maybe they advised them, maybe they'd financed them at other parts of their career. And now they finally had an opportunity to actually make a real impact from an operational perspective. And we chose, and each firm does this in their own way, but we chose to do this through what we call centers of excellence. What you call areas of excellence, it's such a trend that I see across all private equity firms, which they take somebody that a middle market company could never hire. They just don't have the gravitas, even if they could pay them enough. And sometimes these companies are in remote locations, like my hometown, Indianapolis, Indiana.

5:39And Goldman takes one of the key talent in that space and then fractionalizes that person across multiple companies. And now suddenly they might have a 10, 20 % access to this talent that they couldn't recruit at this phase of their company. That's a good way of expressing it. But I would say that talented person, that talented executive usually has a network or he or she has a network. And so they will bring in even more talent. They're a talent magnet. That's an even better way. I might incorporate that into our playbook. They are indeed talent magnets. First, they open the eyes of the existing management team.

6:15Sometimes we'll have to do changes to the existing management team, but for certain, those management team will see what good looks like in specific areas of the value creation playbook. That's probably the most powerful thing that you can give a company. I mean, giving them a new customer, that's very powerful or giving them a great introduction, giving them a new supplier relationship, that's pretty powerful, but giving them talent is what really moves the needle. We call this at our firm, putting a body at a problem. Everybody's extremely busy. So if you come to me and you say, hey, I got this AI stack that could really improve your business.

6:53I may intellectually agree with you and you might be incredibly credible and make a really good pitch. But an hour later, I'm going to be distracted by my next task. And now I go on to other priorities. But if you recruit a top person in that space to me, now it's somebody's entire job to deal with that all week long. And that actually compounds. Ideas, though sometimes sexy, though really interesting and maybe even empirical, don't compound as well as talent. I agree with you. And one thing is, theorizing of all the things that we could be doing, but putting a great person behind it. Somebody who's maybe let companies or let big functions in companies, so you can actually get the throughput and you can get the followership from the portfolio company is incredibly important.

7:44I see that not only on the frontline stuff, the fancy stuff in sort of like the tech stack or some of the supplier relationships, these things are equally important. Some of the things that we may as customers of some of these companies don't see day to day. This is where some of the magic really happens. Just imagine the difference between having access to the greatest LLM vendors in the world right now versus not having access or during COVID having access to the most important supplies that you needed to produce your product or produce your service. Getting the right talent, getting the right network effects around some of this can really change the trajectory of a company at this moment in time.

8:26And so we have actually noticed that our playbook works the best in volatile times. And it's been pretty volatile for the last several years. And so having senior leaders who have seen a lot, who's used to volatility, is used to making decisions around your portfolio company is incredibly important. Double click on that. Why does it work better during volatile times? Because you need to make decisions faster. And those decisions need to be made on a sound set of observations and based on a lot of experience. And so either you've gone through a crisis or you haven't gone through a crisis. If you've gone through one crisis, you are better prepared to go through the next crisis.

9:04And the world has gone through multiple iterations of very high volatility in the last few years. And this is where I really see the leaders step up. We learn more as humans when we're in volatile times. And those humans who have gone through the volatility can really step out. Best example right now, we're faced with maybe the most consequential moment in private equity driven by AI. Either you face up to that challenge and that opportunity or you don't. And having leaders around your business who may not have experienced AI because no human has really experienced AI until it's all like all of a sudden arrived.

9:40But they have seen big seismic changes in tech roadmaps. They've seen big changes to their business models. And so having these people around our companies. And here's the beauty by focusing on the upper mid market, there is this talent arbitrage because many of the leaders that we have involved in our portfolio have seen it even greater scale. So now they can take that toolbox and apply it in the upper mid market. And I think that they think it's more fun because you can actually move things faster in the upper mid market. So it's all like highly synergistic. I'll tell you, one of the greatest things in my career is you saw like you venture a few, in my case, several decades now of your career.

10:20And all of a sudden I get to work with the most senior executives from a ton of different companies, a ton of different backgrounds, and we're all on the same team. And I think what normally happens in people's careers is you saw like every year become slightly closer to being the oldest person in your team. In my career, I've had this wonderful experience that I saw like went somewhere between 12 and 15 years into my career. And then all of a sudden we started building this. And now I have this group of people who have seen even more than I have. And I get their advice every day and I get to work with them every day.

10:52And so that has been personally a very rewarding journey. It used to be a very common diligence question in the venture space, which is, have you seen the last downturn? In other words, were you around in 2008? I started my career literally in 2008, so I could check that box. But for 13, 14 years, there was a bull market. And the premise of that question is, sure, you could ride a bull market. But what happens when there's a bear market? How do you react to that? In many ways, it's an unknowable question. You must experience it before even you yourself know how that could affect you. I saw like hit the great financial crisis, I guess, four years into my career.

11:30And that saw like reset a lot of expectations. And then we went on. And since I was spending the vast majority of my time in Europe, we in 2011 went into saw like the sovereign debt crisis. So once again, we were sort of like experiencing this setback. And then we actually had, as you mentioned, like this decade-long bull run up until sometime 21, 22, inflation rates, a lot of other factors. And all of a sudden you had to reset. And one of the things that you couldn't rely on was multiple expansion and rely on very low funding costs in the debt market. I think that's been healthy for the industry.

12:08In some ways, we're, despite the tech roadmap changing dramatically, we're kind of going back to basics, going back to you drive value by compounding EBTA and cash flows. And you need to get used to driving value in a rate environment that I would characterize as all like normalized. If I add the base rate that we're experiencing in most places in the world, plus the credit spreads, it looks much closer to the average that you have seen for several decades. than anything that we obviously experienced in that bull market, especially in that kind of 19 to 20, 21 period where things really accelerated.

12:46It's interesting because for a decade or so, people were pricing in the lowering of interest rates into their model. And when I look at interest rates, all things being equal, the opposite should be true. You should be ready for the interest rates to go up and make your business anti-fragile to that. You should never price in the interest rates going down. That seems like a crazy strategy, But yet that was the modus operandi for so many private equity firms for probably a decade or so. I don't know how many actually priced like a lowering rates, but I would certainly say that. Or maybe they just thought they were that good.

13:16Yeah, exactly. But maybe they thought we got complacent by assuming that rates could stay low for a very long time. You had a quantitative easing for a very, very long time, et cetera. If you look at it the other way around now, you're pricing your model in a way where, let's call it, you're in a normal environment. And so rates, it might be sort of like a kind of normal distribution. They might go up. They might go down. It's very hard to tell. Right now, we on our side are hedging a lot, right? So we are hedging base rates for many years out in the future because we want to remove as many externalities from the return equation as possible.

13:58We want to take out as much regulatory risk as we can. We want to take out as much kind of market base rate credit spread risk as we possibly can, knowing that nothing can be hedged forever. So what are we talking? We can maybe hedge ourselves three to five years. We're not making the presumption that we can hedge a lot further. We want to take out FX risk and we want to take out as many risks related to the supply chain as possible. One of the things we saw through during COVID was obviously that supply chains had to be rewired significantly. So we're thinking a lot about these things. So what we're left with and what investors in our strategies are paying for is kind of our raw value creation capability and our raw strategy capability.

14:43and probably our ability to then ultimately exit this company to a strategic buyer. So there is a lot of focus on are you picking assets of strategic relevance, of high intrinsic value, and then what are you doing with them for the, say, three to seven-year time period that you are expected to own these assets? The best conferences do two things well. The content challenges how you think, and the people in the seats are the ones whose opinions actually move markets. Alpha Summit is AlphaSense's annual user conference, and it's built around both. Join me at the Glass House in New York City, October 5th through 7th, for sessions going deep on where AI, data, and human expertise converge.

15:23The room will bring together over 1 ,000 institutional investors, corporate decision makers, and capital markets professionals from firms like Goldman Sachs, JP Morgan, and the top PE and hedge funds. If you listen to the show, you're already asking the right questions. Alpha Summit is where you go to stress test your thinking with the people working through the same problems at the highest level. Register at alphasummit.ai to secure your seat. And as a How to Invest listener, you will get 50 % off. Check the show notes for your exclusive discount code. I look forward to seeing you there. And you mentioned this also before that your assets are more attractive to strategic investors because there's this value creation.

16:04How do you explain that? Is it just profits are higher, so therefore they're more attractive? Or is there something fundamentally not in the spreadsheet? I think there's a lot that's not in the spreadsheet. Like, one of the most important things that you can't actually see in financial ledgers right now is, does this company have a good tech stack? Does this company have a homogeneous set of data? Is it a clean data set? These are some of the things that will be very consequential for the way companies adopt AI. And so when we do our due diligence and we budget, like, what do we need to change?

16:39Where do we need to have more costs in order to maybe solve certain issues that we have observed during due diligence? We bake that into our returns and then that's what we're changing. And so when a strategic buyer then arrives and say, it might have been a very dispersed data set, they might have had 25 ERP systems. They may not have had a data lake, a lake house, whatever. Like they may not have all this in check at the time we acquired it. But after our ownership period, we fixed all of this and we high-graded the company. What I usually refer to as we future-proofed the company. And that's when we think that the company is of more strategic importance.

17:20It's by no means guaranteed, but we know that all of these steps will also make the company perform better. Obviously, one of the things you have to accept is it's going to cost you some money normally. So you need to bake that into your model. For example, one of the things that we like doing is doing a carve-out. Usually a carve-out is happening when a company wants to focus on its core capabilities, its core businesses. That could mean that the company that is being carved out has been to somewhat at least strategically neglected for some time. So there is an expectation that there's a lot of things that are not at the level that we would hope for to have an exceptionally well-performing company.

17:57So when we do the carve-out work, we're literally budgeting and we need to change a ton of things. The good news about doing carve-out is however painful some people might think they are, it's also kind of a line in the sand. It's an opportunity to put the best tools into the company instead of so like changing a lot of legacy stuff. A forcing mechanism. Absolutely. It's a forcing mechanism. And so we will put those tools in. We'll go through the hard work, but there could be a bit of a J curve because as you're doing all of this, it will cost you real money. But hopefully it will allow the company to grow much faster on the other side and certainly be good for profitability or margins.

18:33Sam Zell's former partner, Mark Soder, who now also continues to run his family office. And one of the things he talked about is the absurdity of the private equity model, which is you take an asset, you grow for three to four years. then last year you're dressing it up to sale and then you sell it to one of your competitors today we have this rise of continuation vehicles it just hit 110 billion dollars are you guys looking at continuation vehicles and are there some assets that you want to continue to own for many years i think it's quite normal for a private equity investor especially at the deal team level and i've been there myself several times that you fall in love with your asset you've been building this asset and you think it's a wonderful asset and you wish that you could own it forever because it's a well-performing asset and then you don't have to go through the burden and go and buy another asset.

19:21That's very relatable. The thing is that your investors is entering into a time-bound relationship with you. You need to generate DPI along the way and it shouldn't be one of those where you wait for 10 years and then you're trying to deliver everything in year 10. And you should do that continuously along the way. By the way, when you have your colleagues' money and your balance sheet, there's a lot of people reminding you about that at any moment in time. So we feel that dynamic, which is something I appreciate and probably has meant that we have generated DPI maybe at moments in time where you could say, oh, things are, it's really sunny.

19:57Let's continue for a little while longer. We have large businesses at the firm where we engage in continuation vehicles, and we can certainly see the value of continuation vehicles, especially when you are buying into the continuation vehicles and you have a lot of choice, which my colleagues who run those businesses have. They've been doing it for a very long time and they've been very, very successful. As I think about it in our direct private equity strategies, we have not been big users of continuation vehicles. It's not actually because we have anything against continuation vehicles. It's just that we have mostly sold our assets to strategic buyers who acquired those assets with synergies and therefore were able to pay the highest price for the asset.

20:45We do have assets that we would like to own. And so I could see ourselves using continuation vehicles as one of many, many sources to continue to stay invested in a company, but at the same time also return capital to our LPs. I'll say that there are other versions of CVs that are almost even simpler, like selling a minority stake to a close partner or somebody where you think that you can continue in a sort of like a strategic or synergistic ownership structure. We also very much like that trade where you on one end are taking some money off the table, but also very much so like invest into the future, potentially with a partner that could help you say do M &A or other things that could accelerate the journey.

21:28So nothing against CVs. I just think with most things in life, you should diversify your sources of liquidity. Yeah, it's such a good point that the CV itself, if you want to sell the CV essentially to yourself, and obviously there's different conflicts around that and how to navigate those, but your competitor implicitly is a strategic investor, and it's really hard to compete against a strategic investor that's going to value the asset above and beyond its intrinsic value. That's almost the definition of a strategic investor. Absolutely. the strategic investor with synergies should at most moments in time prevail.

22:03And that's certainly what we've seen in our strategy, that the well-performing asset where we have built that intrinsic value usually gets sold to a strategic buyer. That has been the history of our strategy. That's not to say that we won't use CVs going forward, but I don't see like a significant share of our exits happening through CVs based on what I'm observing and the pipelines that I'm seeing. I was having dinner with one of the largest VC firms in the world that are doing accounting roll-ups of all the industries. And it really started making me think about the integration of AI into everything.

22:41You guys are in a very interesting part of the market because you're not lower middle market. So these companies have some scale, but there's also a lot of meat on the bone because these companies are not yet very large companies. Today, what are you seeing in terms of AI being integrated? What's actually being done within the companies that's moving the needle? Support for today's episode comes from Square, the all-in-one way for business owners to take payments, book appointments, man's staff, and keep everything running in one place. Whether you're selling lattes, cutting hair, running a boutique, or managing a service business, Square helps you run your business without running yourself into the ground.

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