#132 - Steven Klinsky: Private Markets as Operational Edge

0:00Welcome to the Insightful Investor podcast, a weekly series that seeks to share industry, investment and market insights. Learn more about our show at insightfulinvestor.org. I'm thrilled to have Steve Klinsky join the podcast today. Steve is the founder and CEO of New Mountain Capital, an alternative asset manager with about$60 billion in assets as of year end 2025. Today's conversation explores the evolution of private markets, the current state of private credit, and how disciplined business building can create durable value. Welcome, Steve. Thanks for joining us.

0:37Steven Klinsky:Thanks, Alex. Thanks for having me on your podcast. Let's go back a few years. You began your career in 1981 at the birth of leverage buyouts. What did you see then that others didn't, and how did that early perspective shape how you still think today? I had fortunate timing. The first leverage bout of a public company happened in 1979 when KKR bought Houdai Industries off the stock market. And I was a law and business student in graduate school. I was the youngest guy at the school. I had no work experience. My biggest paycheck had been$3 an hour. And I read about it and said, wow, this could be a real interesting new idea.

1:14Steven Klinsky:So I actually wrote my graduate law and business thesis on buyouts and all the implications of them. went to Goldman Sachs in 81. And I said, I want to be your buyout guy. They said, we've never done a buyout. So you can be the buyout guy. So it's like being the wheat farmer on the moon. There was no competition. And we can talk more about the times and the conditions, but it was a very good time to enter. And what did you see early on that stood out to you? What I saw was, you know, the ability to actually own a company, which is a great thing. I come from a family business background. We had sold the family business when I was in graduate school.

1:49Steven Klinsky:So one of the thoughts in my head is maybe we'll use the tool to go buy another family business one day. You know, to be on the ownership side of something and actually building the company is, you know, obviously a uniquely good position. So that was what most attracted me, the idea. In contrast to buying, let's say, a public company where you're just the passive shareholder. You know, as a public shareholder, you have no control. I said to someone, I remember I was talking to someone who was thinking about leaving the firm to join a hedge fund. I said, do you want to be the player on the field or the bookie in the stands?

2:17Steven Klinsky:And he said, well, I'd rather be the bookie in the stands because you don't get hit as much. But I find the public markets very difficult, very frustrating. You could give me the earnings of every company by every year, and I still couldn't predict what the market expected versus. So I like actually owning a company, keeping it safe, building it. If you can build a safe company, you can consistently add value. That's what we try to do as a full team here. So when you zoom out across four plus decades, what are the few core beliefs about investing that you feel have survived every cycle? You know, 1981 was kind of a unique time to enter.

2:50Steven Klinsky:The highest I started at Goldman on October 181, the highest interest rates in U.S. history were the day before I started work. So the 10-year treasury was 15.84 % the day I walked into the office. There had been stagflation starting in Vietnam that had not yet ended. So the stock market was lower in 81 than it had been in 1968. The 70s were a totally lost decade. And the initial idea of leveraged buyouts was really, you know, have the nerve to borrow a lot of money in an inflationary environment. And it kind of paid off at risk-created return, debt-created return. The major principles, though, that I've kind of have come to believe over the last 45 years are that it's not about risk creates return.

3:35Steven Klinsky:It's about control risk and business building creates return. And that can make it, you know, a great consistent field. So what's involved in that, and we talk about defensive growth industries, choosing the spaces where the wind is at your back, where the industry is not going to melt underneath you is the first key step. Keep the company safe. Don't over lever with debt. So if there is a problem, you have time to fix it. But then take that safe base in a good industry and really build it. Add technology, improve the management. There's 20 ways we build companies. And that's kind of the fun and the glory of the business.

4:10Steven Klinsky:So to be able to build company after company after company is, I think, a very high form of business. And that's what we try to do here. It's interesting. You mentioned 1981. So obviously, you didn't know this at the time, but that was the peak interest rate. And you basically had four decades of either falling or low interest rates and relatively stable inflation since the, you know, stackflationary environment of the 70s and 80s. So how do you feel like that contributed to the industry's growth and are we now entering a structurally different regime? It contributed to the industry's growth. First of all, I compliment my parents were having perfect timing on when to give birth to me so that I entered right on the turn.

4:51Steven Klinsky:If you look at me and some of my, you know, compatriots joining in 81 and seeing the stock market go from 1000 to, you know, wherever it is today has been a pretty good run. I think what has changed again is it's gone from a form of finance into a form of business. So, you know, if you are good at building businesses and you really understand industries, that is what you need to go forward from here. And, you know, interest rates at 4 % or something are not wildly high. They're not wildly low. They're kind of I think we're in pretty good economic conditions overall. And the key is to, you know, not just be someone leveraging an index, but actually knowing businesses, building businesses.

5:32Steven Klinsky:And I think any firm that if you haven't evolved, if you're still in the 1981 model of waiting for debt to save you, that's not a smart model at all. But I think if you're the, you know, very, very strong business builders, that is a permanent, I think, smart model. If you go through an environment where you don't have falling rates and that tailwind that's created by that, it's very possible that you don't have maybe the same winners in that environment as you did in the previous. The winners in 1981 and 82 and things like that were, you know, you had 95 parts debt, five parts equity, 10 % inflation, and you could triple your money with no growth at all.

6:08Steven Klinsky:It had nothing to do with really building businesses. It had to do with, I used to say it was four investment bankers in a room, borrowed as much as we humanly could. And I was one of the four and I was happy to be one of the four. You know, now it's totally evolved, I think, into a difference to be successful. It's a totally different proposition. But I think that's been true. We've been talking about that for the entire 25-year history of my firm, and I think that's been true for decades now. And I think it's just more and more obviously true as time goes on. So when you think about building New Mountain, what did you deliberately choose to do differently from the dominant private equity playbook at the time?

6:42Steven Klinsky:In 84, I was poached away from Goldman Sachs. I had started Goldman's private equity group with another guy. When I got poached away, there were only 20 private equity firms in the world. There are now 5 ,000. And the biggest private equity firm was KKR with 400 million of assets. And I joined Forceman with 200 million of assets. And that was the second biggest in the world. And, you know, Forceman, the culture was very glamorous and totally dysfunctional. Ted was dating Lady Di. We own Gulfstream Jet. We had more people flying our jets than our helicopters than working at the firm. So it was totally dysfunctional.

7:15Steven Klinsky:The returns, though, in the 80s and 90s were terrific. We were the second biggest firm, but I think the highest returning firm. And what Forrest Littell was very good at, even with our small team, was focusing less on using high levels of junk debt. We kind of were against wampum and junk debt and more into building businesses. So and my last big deal with Forrest Littell was something called General Instrument, which was one of the tech deals in the 90s, went from a billion of value to 20 billion. All the technology behind high definition television and broadband communications. So Forrestman was a great place to develop those ideas.

7:50Steven Klinsky:But what I did differently, the culture is very different. The culture is much more of a family business culture or the Goldman Sachs culture of 1981. When I left Forrestman, we had eight people at the firm. My firm has over 300. It's less of about, you know, Ted had a very much of a personality of what he was doing. And I'm much more stressed the team and try to not put myself on press releases and all that. But the ideas were great at Forrestman. the culture is a different culture. You talked about building a business that builds businesses. How does that mindset change decision making versus viewing investing as just a capital allocation?

8:27Steven Klinsky:Yeah, I think it changes it in every way. I mean, I think it's the key message. First of all, it changes who is attracted to join your firm. So we go for the best talent we can find in the world, but people who actually want to build things, work together, share ideas. So it leads to that sort of a culture. It leads entrepreneurs and founders to want to team up with you. 85 % of the time, the sellers are keeping some stock with us. And we haven't bought one thing in a sealed bid auction. We get, you know, we get a relationship where the seller says, look, if you can match the price I can get in the market, I'd rather do it with you.

9:01Steven Klinsky:And, you know, we go off to the side and make the deal. And, and I also think the most predictable way to make returns, you know, someone said, taught me, if you don't lose money, the only question is how much money you can make. So we're very downside focused. But once the downside is covered, rather than hope you get lucky on something or the market goes your way, if you have people who can actually improve things, you know, you raise the growth rate, you raise the margins, you raise the earnings, you also deserve a higher multiple on the way out. And that's the best way to, you know, go for high returns, but it's not because of risk.

9:34You talked a little bit earlier about defensive growth as a core concept. Would you talk about how you think about that and why it's potentially more important now than ever.

9:43Steven Klinsky:Yeah. So it's a phrase that I think we cooked up and now other people use. And I know I gave a speech in Japan and they tried to translate it and the translator said in English, defensive growth. So I don't know if it's kind of a made up term. What we mean by it, it's pretty common sense. It's, you know, one of the great luxuries of private equity is you don't have to inherit your grandfather's iron foundry and turn it around. You're empowered that at this point in time, there are 8 billion people getting up in the world. If one of them has a good idea, we can get behind that idea and say that's where we want to be investing for the next five or ten years.

10:16Steven Klinsky:So you can pick your sector. And the sectors we're looking for are ones that can grow whatever happens to the macro economy for the next five or ten years with high free cash flow, high barrier to entry. And we have a whole formal process, a top-down process we've been using for 25 years now to shape the list. We have 12 sectors staffed up with 25 subsectors. And we can repeat over the years and get stronger and stronger. So like some of our best sectors now are infrastructure services, you know, all the engineering to build out the electric grid, there's a long-term need for that. Water service grid, there's a long-term need for that.

10:52Steven Klinsky:We have the biggest force of technicians working in the data centers. We think there's, you know, even if they stop building data centers, you need the best technicians to maintain them. So those type of things, we're not picking a restaurant concept or hoping housing goes up or down. And we're also on things like accounting firms, we believe is a great space. If you have thousands of clients and you can keep improving the operations, insurance services must have databases, those type of companies. So it's a lot of it is must have B2B services. So when you go back and you look at your track record and your hit rate on picking those sectors, do you feel like it's been relatively high?

11:30Steven Klinsky:We've had very good luck on choosing sectors. And the main thing is to avoid the sector You're melting underneath you. I mean, if you're the toy store in the mall and Amazon comes in, you can't put enough good management in to save your business. So you have to be in a good spot. And we do evolve the list over time. So like the first company we bought 26 years ago was post-secondary education for working adults called Strayer. It went from 400 to a billion six as the market was crashing. The first Internet was crashing and we did great in it. But we got out in 05. We've never gone back into another in that industry because tuition goes up, up, up.

12:05Steven Klinsky:We think it's getting unfair. I actually run the biggest free college for credit charity in the country now. So we do evolve the list. But the point is the characteristics are the same. You know, what is defensive, growthful, positive for society, you know, that we can get behind? And so when you're picking those sectors, are there any signals that you really focus on that maybe are often overlooked or underappreciated? The process we use to pick those sectors, and again, we've been doing this for years, is we have everyone in the firm, at the beginning of the year, we have everyone in the firm from the first day associate to the former Fortune 100 CEO write a memo about what sector they think we should add or how we should be evolving the list.

12:46Steven Klinsky:And we take all of those memos and we take the names of the writers off the memos because we think good ideas are age independent, politically independent. it. We distribute the memos to everyone in the firm. And if you were with us, there might, you know, some are duplicates. So you might have 50 or 60 different nominations. And we would say, you know, Alex, you have a hundred new mountain points. How would you allocate New Mountains time across these sectors? You might say, well, 15 on internet of things and 20 on food safety. So we total up those scores and that doesn't determine, but it shows the wisdom of the crowd is more interested in these sectors than those sectors.

13:21Steven Klinsky:And then we, we discuss and debate and boat and we then formally staff up the sectors. And people can still be looking at things off the list, but everything we bought has really come out of the sectors that we've identified as a firm or this is an area worth hunting. And again, it's the non-cyclicality, the fundamental need for the service, the consistency of the exit multiples, the free cashflow characteristics, the barrier to entry, how many deals there might be to look at. I mean, there's five or six obvious things we're looking for. Well, when I think about your career, you know, 40 plus years in private equity, you've obviously been through some pretty bad environments.

13:58So I can understand why resiliency becomes a high priority.

14:02Steven Klinsky:Yeah. Well, there's all, well, and what I also tell people is even when times are good, you're going to own a company for five or 10 years. So when times are good, you know, there's something bad coming somewhere. I mean, I was through 87 Black Monday and the 88 crash and the 90 fall of junk bonds and on and on and on. So you always have to be ready for some bad news to come because we don't own things for a day. We own things for many years. And then the next buyer is thinking about, you know, the next five or 10 years. So you need a long, you know, what's so interesting about private equity, what is I love it, is the intellectual interest of where is the world going?

14:38Steven Klinsky:You know, we can be in anything in any way we want. And where should we be? How should we position ourselves? And is that another reason you generally tend to have lower leverage than many of your peers? Yeah, we tend to have a lower leverage for a few reasons. One, it does obviously help the safety record where if you're in a solid industry and you're not over levered, if you do have a problem, which does happen, you know, occasionally, you have the time to go in with your operators and with your people and hopefully fix the problem. So we've had, I'm not sure I'm allowed to give numbers, but we've had a very, very controlled safety has been one of our major benefits.

15:16Steven Klinsky:So that's one benefit. The other benefit or the other benefits are two, if you're low enough levered, you actually have the capital to grow the business. We want to increase the R &D. We want to add to the sales force. We want to grow internationally. So you don't want to be pinned down using all your money to service debt and unable to grow. And the third benefit is that, like I say, we want the seller to choose us without an auction. And the normal owner of a business or decision maker says, hey, four times debt makes sense. Eight times debt is over levered. I'd rather, I don't want to be part of this over levered structure that could kill my company.

15:52Steven Klinsky:So it also helps you avoid auctions, get better prices at the end of the day. So it's all a unified virtuous cycle. And it also requires you to be more operationally value-add if you're trying to generate returns through that process. Yeah, well, we in no way compromise on saying lower returns because it's less debt. We have very high return targets, but our plan to make it is by the improvements we can see in the business and just the growth and the attractiveness of the business. And I think that's a more predictable way than saying, well, I'm going to use a lot of leverage. And I hope when I get out, I can, the next guy can get a lot of leverage in the same multiple I paid.

16:38Steven Klinsky:You know, one is, it's not that complicated. If you had a team of great, great carpenters and you buy a house that's not on quicksand and you have a team of great carpenters who can like fix the house, you can consistently make money on houses. And yes, there are some better environments to sell, some better environments to buy, but that is a repeatable business. And so what I try to do is, you know, I don't take credit for an individual deal. I'm proud of the way the firm has grown. You know, we employ 133 ,000 people. We would be 52 in the Fortune 500. We pull from the greatest strength we can find and focus on the next mid-market company and build it.

17:14Steven Klinsky:So that's the idea of it, not risk creates return. It makes sense. If you're confident and you have a lot of skill, you want that to be the determinant of your success or failure and your return, as opposed to hoping for the best from what the markets provide. Well, that's all you can count on because conditions are always changing and unpredictable. The other thing I've said to people, it's a little bit like the Hunger Games. Every year you come out and this year you're going to face COVID. No, this year you're going to face Liberation Day. This year you're going to face Iran. So all you know is if you have the right people on your team around you and the right basic principles, you will, you know, it's kind of, well, show us what you got next.

17:52Steven Klinsky:I mean, who knows what the next battle is. But if you have the right team around you, you should be able to keep finding good companies and building them. And that's kind of the fun of it. There's this longstanding teaching in finance that risk and return are linked. Well, why do you believe that relationship may break down in private markets? This is one of my pet peeves. You've asked me my pet peeve question. Everyone says risk and return go together. Risk and return go together. If I was in the UFC octagon against the toughest guy in UFC, I would have all the risk and he would have all the return because, you know, cage fighting is a game of skill.

18:29Steven Klinsky:So when they say risk and return go together in the mathematical finance models, and we all heard the mathematics, that assumes an efficient market kind of, you know, they assume you can have no impact on the business. Everything is efficiently priced. And then like if you're playing roulette, you have to bet more to make more. But what you want to do is be able to pick up the ball and put it in the slot. That's called business building where you can actually grab the ball and move it. And that's that's done from, you know, being a passive investor where risk needs more return in a passive casino versus, you know, actually owning and building things.

19:05Steven Klinsky:So they don't inherently go together. You want to control risk and use skill to make return. They assume all the skill out of it when they say risk creates return. Yeah, in an environment where more of the return is generated by skill as opposed to luck or just market forces, then you can see why there would be some asymmetry there. Absolutely. It's all how much skill you can add or how much business building you can add while controlling the risk so you don't get knocked off the game. While you have skill, you don't want to get knocked off by having taken too much risk before you can show the skill.

19:39Steven Klinsky:So it's controlling risk and having skill to create the return. That's how most things work in the world. Yeah, one of my observations, just talking to a lot of managers and just being an asset allocator, is those who have great skill really emphasize that in the way they manage money, whether it's public or private markets, more so in private markets. And they try to reduce the impact of the markets that they don't have much control over. And those with less skill tend to rely on markets. And during good periods, it's oftentimes difficult to differentiate between the two. but that's really what an underwriter needs to do.

20:20Steven Klinsky:Well, that's exactly what I'm trying to say as well. And, you know, you can have luck on your side and, you know, you can own oil when oil is going up and you look brilliant, but then when oil goes down, you don't look all that good. If you're actually, you know, had the skill to find oil in a rare space, you found oil. You know, you know how to find oil. So it's a different, they're totally different games. And why do you think that private markets offer more room for that asymmetry compared to public markets? I am not a public market investor. You and anyone who's good at public markets, I marvel at.

20:51Steven Klinsky:I've never been good at it. I don't understand it. And the reason is, in public markets, you're comparing yourself to the expectations of other people, which is considered by definition correct. So if a stock goes up because animal spirits drive it up and you were more conservative, it doesn't matter whether you're right or wrong. You're you're behind the market, you know. So I find it totally random and unpredictable where if you own a company and it's cash in and cash out, you know, you just clearly have raised the earnings of the business, raise the growth rate, choose your exit moment, pick a company where you know who the likely buyers could be on the way out.

21:30Steven Klinsky:you're not in that random animal spirits fight. And I saw like, again, you could give me the earnings, year end earnings of every company for the next five years on the S and P 500. And I would probably underperform as a public equity investor because I thought we're beating the estimate. No, the whisper estimate was higher than you thought. I, you know, I, I find it mystifying. I don't go long or short, you know, like I, I look at SpaceX. I'm not long. I'm not sure. I just go, that's not my game. That's a different, that is someone's making a lot of money in both directions, but it's not me on SpaceX.

22:02And within the world of private markets, how do you contrast the opportunity set in the middle market versus large cap?

22:08Steven Klinsky:We try to bring mega fund strength and focus chiefly on mid-market companies. I like the mid-market. Our average company is around$500 or$600 million. It's a lot easier to go from$500 million to$2 billion of value than it is to go from$10 billion to$40 billion. And yet at$500, you're a real company, you're important at something. So I don't really like the super small ones either because they're so perishable and hard to get good management. But 500, you have enough strength to be a meaningful business in a meaningful space. But there's probably lots of things they haven't thought to do yet is the first thing.