Private Equity in 2025: Market Shifts, Strategy, and the Rise of AI

23:02So there's a competitive aspect, and then there's a structural aspect of hitting those growth targets to just having EBITDA on a steady march upward in many industries over that period of time. And software growth is so important. You're over 40 % year over year, get a nice healthy valuation. If you're like 20 to 40, it starts dropping off pretty quick. It's incredible, isn't it? Is that across all industries or is it just unfortunate to be in the software space? It's across many industries. It's most prevalent in software. And as I said, tech is the largest sector in buyout by quite a wide margin.

23:31And about 90 % of the value in anything you could call tech in buyouts is software. We've seen the rise of a lot of large software specialists that are GPs. The interest level is definitely there. And of course, software permeates, as I mentioned earlier, all of these other different subsectors. So a lot of it is software enabled. And when people hit the growth number, they were rewarded because people thought that that's clearly success. But when I referenced earlier that out of all of the deals done, margin expansion was not a contributor to value accretion over the last decade. There's now the concern in the industry.

24:02And we have seen this blip crop up after interest rates came up with like, can these businesses really make money? They're growing very rapidly. There may be a certain level of profit in there. But if I can't believe that EBITDA or cash flow is going to grow along at some rate with revenues over time, then this business isn't as valuable potentially as the multiple that I put on it. So we're in this period right now where we're coming back to the future, if you will, of show me exactly how this business makes money and show me how it's going to make money over the next five years. Not just that you can grow fast.

24:31That's not enough anymore. The way deals are getting sourced, it started mostly proprietary, but now it's getting more competitive, which means a lot of money for bankers to make. A lot of money for bankers to make. Yes. It is not kind of noticed on Wall Street that this is a very lucrative and growing asset class. Is it the culture for private equity to rely on banks for deal sourcing versus a lot of strategics are building their own search to find proprietary deals very proactively because they're always like focused on that strategy that are supporting their corporate strategy. Is that the case?

25:05Is that what's fueling a lot of this? It's just here's a culture in private equity where they play friendly because you go to a lot of these conferences, a lot of matchmaking with the bankers. Is that what it is? Or are they still building their own pipeline as well? It's a really good question, Keeson, because it has changed over the last few years. It used to be exactly what you're describing, that I'm a GP and I get a thousand, what they call SIMS, confidential information memorandum in the door every year. And I pick out which ones I'm interested in and do triage. And then I get serious about a few and I bid on those and I win what I win.

25:35That was what much of the industry was like. But this need to have industry sector and subsector specialization means I'm actually narrowing the aperture of things that I know a lot about, which means I'm narrowing the aperture on things that I want to look at. So I don't want to look at a thousand things that may come in the door. If I'm interested in these eight subsectors of the software space, for example, I want to understand who are the players in this space and who might I want to acquire, even if they're not for sale right now. And I want to begin to build my own sourcing because at some point, a lot of those assets will come for sale.

26:06And when they do come for sale, I'm not expecting that I'm going to get a proprietary look and nobody else will because again, sellers have become a lot more sophisticated. They're going to want to go to an intermediary and say, please find me the highest price for this asset in many instances. But if I've known the asset for a few years, if I know more about it than anybody else, I'm going to get speed to certainty on value faster than my competition and therefore be able to put a number in that's fully financed and win that asset more often than not. That's really the state of play and where we're seeing the private equity industry evolve.

26:35That's leverage, having that relationship, be able to call and say, hey, Joe, why don't we go grab a cup of coffee and chat before. Absolutely. That's really good to see that it's sort of pendulum went one direction, LA bank, and then it's coming back the other way because partly being so competitive. Financing, that's changed. We kind of mentioned the whole, there's like private sector and that's a big part of it. Now that you're seeing a lot of these funds offering different types of debt products and things. Teach me, what have we seen happen? Financing for buyouts has changed a lot. In fact, it's changing even more still with the rise of private credit.

27:09So it used to be a bespoke negotiation. There were few enough deals that people talked to different types of banks, got different rates from different banks, got different leverage ratios from different banks, having the skill to put together. And I'm just talking about a vanilla standard buyout here, not something that's very complicated, but you needed to work at it to get the most efficient capital structure at the lowest possible cost so you can make the most money. Then, as I mentioned, staple financing became popular, which is every buyer gets the same financing package. Here it is. And there's really no ability to differentiate because we can all get the same turns of debt at the same rate.

27:40The ability to really get a lot less in terms of cost or a better structured package went away. Now, especially with the banks having pulled back a bit just in the post-COVID era, we're seeing the continued rise of private credit. So there are a lot of private direct lending funds in there that they understand. Heck, some of these firms actually have buyout businesses alongside of their private credit businesses. So they understand buyouts, they understand credit, and they're stepping up and filling the gap and saying, we will do the credit needs for this deal. And that is a different source of capital than the traditional bank.

28:10So there's a lot less syndication on the private side. So the risks are up. So in some cases, the prices can be higher as a result, not in every case, but in some cases, they're also in many of these groups, there's no workout groups if something goes wrong the way that a bank has it. The ability for a GP to maneuver and do things differently in some cases is different with private lenders providing most of the capital versus the banks. And it will be interesting to see as sources of capital on the debt side evolve over time, whether there's a blurring of the lines here, one could argue that we're seeing, whereas the private lenders start to look a little bit more like banks, the banks may come back in, start to look a little bit more like private lenders, but how is this actually going to evolve, particularly in a time where interest rates are going to be real again?

28:51Interest rates are not zero. So instead of paying 5 % of the coupon on the debt, I'm now paying 8%, 9%, 10 % coupon on the debt, in some cases, even a little bit more than that, the chances of things going wrong in that environment are higher simply because the interest rates are real. And if things go wrong and I have to pay that interest rate, there may need to be restructuring or a workout or some other type of issue. And that's going to be a different conversation now with the multiplicity of credit providers than it was 15 or 20 years ago. Private lenders are expensive. Is it me or it's just something from the software industry we get taxed for?

29:22They can be expensive. They also can be much more efficient than banks because in many respects, they're not syndicating a lot of the credit. They're taking it on themselves. They get their sense of certainty and they hit go and they can do things faster. And GPs appreciate that as well. They can be more expensive, absolutely. But again, the more competition there is, even on the private side, we're seeing with this explosion of private credit, the industry is probably four times the size it was even 15 or 17 years ago, that the competition level there has gone up a lot as well. On the private capital side, obviously that's a good thing if it gets more competitive, which gives better terms.

29:56What other things have you noticed in terms of structuring deals? Or now it's always been a common tool to use. What are other things like, what does that trend look like? One of the interesting segues, as we were talking a lot about credit, is that because the industry has shifted to underwriting a lot more growth, we're seeing in many cases less debt as part of the capital structure and deals. So a typical fast-growing software company might have 30 % of the capital structure and debt and 70 % in equity and literally effectively taking the L out of LBO. Where's leverage if I've got to put 70 % equity in to get a deal done?

30:31That just fundamentally looks quite different than the structure you might've seen at a slow growing 3 % industrial business in the 1990s. You might've seen the opposite capital structure, 70 % credit and 30 % equity. It's like you generate value the way you would in owning a house. You have a lot of bank loans in there, but your equity is worth an awful lot if the house price goes up over time. And that same kind of amplifying effect of credit was definitely used a lot by the industry when they had slow growing assets that they were fixing and most of the capital structure would belong to the bank and the equity belonged to the GP as provided to the LPs.

31:04In this world, where I've got 30 % potentially of my capital structure in debt, I've really got to no kidding, make sure that this asset grows and performs because I'm not going to get paid. That amplifying effect of the credit is much less in these fast growing assets now than it was with the slower growing assets. Why is that? That ratio is so different than it was before. It's different for a number of reasons. One is a lot of these businesses don't have the cash flow because they're growing so fast in order to pay off a lot of debt. So I'm still getting maybe seven times EBITDA leverage, but the EBITDA is not that high for this particular business.

31:37Therefore, there's only a certain amount of leverage you can get and you need to have the ability to invest in the business to grow. So playing with that capital structure to make sure you've got enough credit on, so you're juicing your returns a little bit, if you will, but not so much that you're actually hamstringing the business's ability to grow is an important thing to consider. So the high multipliers works against you when it comes to leveraging. High competition for good assets means less margin for error. Absolutely. Yeah, a lot less now. The operational efficiency against your purchase price, but now you got less debt you can put in the business.

32:07It makes believing in the business all the more important, really knowing what you're buying. Let's talk about creating value, the value levers. How's the playbook evolved? The playbooks evolved a lot. We talked a lot about the fact that margins and costs were very important and they still are obviously, but that was a lot of the playbook in the past. And now the playbook is much more about how do I grow profitably? What is the best way in a B2B situation? What does commercial excellence look like? What does my strategic view of the marketplace look like? What are my customer segments really? What do they want?

32:37Does someone want Rolls-Royce treatment and is prepared to pay for it? Does someone want the least cost imaginable and they're only willing to pay for a little bit? What's my value proposition to those different segments? Where do I focus? Is my sales force big enough? Is it fit for purpose? Am I selling the right messages? Is my pricing appropriate for what I'm doing? Do I change my pricing? How do I augment my pricing in certain ways? How do I make that more dynamic in a way that's going to be useful to my customer as well as to the actual target company that I'm buying? These are all highly complex issues that are now crucially important to the industry.

33:07I'm not saying that revenue growth wasn't important before, but if I'm underwriting things where the primary value lever is going to be on the revenue side, and let's call it B2B, all of these things are now must-dos and must do very well in a specific industry segment. Getting that right and knowing it's there and having the confidence to bet on the come that the revenue at a certain margin structure will occur over a five-year period if I do the following things, that's a different act than carving out a big industrial business and saying, I know I can cut costs here. I know I can cut costs there.

33:38I know I can actually save this by selling these non-core assets and I'll be able to make that happen. It's just a different equation. And we're seeing the kinds of value creation approaches and teams in the marketplace evolve along with that kind of dynamic. This isn't the only way that people are adding value, but it's probably each end of the spectrum, if you will. And many firms need to be good at both because they're buying fast-growing software assets over here and their industrial group is buying carve-outs over there. It sounds like it's gotten a lot more sophisticated. I feel So like the traditional model, the term buy and build, you buy and you go buy some more and just valuation triage.

34:14That was pretty much the way forward. That's not the playbook anymore. It's not. And we flirted with buy and build. Roll-ups. Doesn't roll-ups. Isn't that what they do? They just consolidate a sector. Roll-ups, build-ups. There are lots of different things that have been called over time and they've changed dramatically over time. There's a right way to do them and a wrong way to do them. What we've learned at Bain is that a few things need to be true in order to get this right. And this has changed even a little bit since interest rates went up a couple of years ago. But one is you have to be buying a stable platform, which sounds like a platitude or a tautology or something completely obvious.

34:48But there are many instances where some of these businesses that GPs are buying are themselves amalgamations of investments. They're somebody else's buy and build. Someone bought something, they bought four other things, and now they're selling it to you. And understanding whether or not that's one company or four companies that you're buying is the first critical question. Because if they have four different ERP systems, four different sales forces, that could be a company that's very challenging to then build upon and use as a platform because it hasn't been integrated. It hasn't actually been made into one company yet.

35:18Do you look at that as an opportunity to integrate that company and then unlock some value? It is an opportunity. Now, why a lot of folks don't do it is that it's hard to do and it's expensive. You have to believe that the synergies are there and that they're measurable. but you absolutely need to do it in order to get the full value out of an asset today. I'm going to come back to that because that's the thing that's changed. But one thing is it's got to be a stable platform. The second thing is it actually has to have enough fragmentation, not just for your ownership period in the industry, but for the next donor as well.

35:49Because when you go to sell, the next donor has to look out and see lots and lots of targets that they can buy, continue this buy and build it. If they don't see that same level of opportunity or greater for themselves, they're not going to pay you the multiple you want for that asset. So there has to be real fragmentation of lots and lots of owners of businesses who will be willing to sell over a long enough period. We're talking 10 plus years, 15 plus years, not just the next five years in order to give you confidence that's the right kind of industry. Another critical one has to do with the industry structure itself.

36:18This is number three. And that is, is that it doesn't have to be an exciting or sexy industry, but it has to have stable EBITDA growth. Cyclical businesses do not make good buildup targets because when EBITDA goes down, my ability to effectively do the buy and build goes away. And that's why we see a lot of these things in veterinary centers. Everybody always takes Fido to the vet, no matter what happens, no matter what the economy is. It's not the sexiest business in the world, one could argue, but it's going to grow at a certain rate that you can predict. So that steady growth is crucial. And now to your point, Eason, the other thing that was always on our list is nice to have, but now it's must have, are these synergies have to be real.

36:57It's not just buying things that look like one another, but there's no real operating synergy in there. It's putting businesses together where one plus one equals three or one plus one equals two and a half and actually having that work because the cost of debt is real. I've got to be able to put these things together. I may actually lose my arbitrage and my multiples if too many people are trying to buy these smaller businesses and do their own buildups. My only bug spray against that is to have real operating synergies that I then go and get when I integrate these businesses at the end of the day.

37:26You have to. You don't have a choice. You're paying more. You got to do more to make a return. We agree. All those things have to be true in today's buy and build. And buy and build is still, I would argue, the most popular way that many GPs add value. Over 60 % of all deals in the marketplace are still add-ons. And the majority of deals have been add-ons for years. I've noticed that the strategics will do a lot of things in-house when it comes to executing a value creation plan. Unless it's like a really big deal, a billion plus. We'll call Bain and go after that. Then private equity seems to outsource everything.

38:01Everything goes to some consulting firm, shape or form. Is that the same thing you've seen? Have you seen that change at all? Yes, it does have a flow. The GP landscape is very different than the strategic landscape. Strategics are generally speaking, if you're in the business and you're buying a business that's very similar in the same category of subsectors that you're in, you tend to believe that you can integrate it because you're in the business. Most GPs are not in the business. They may own it for a few years, but they're not in that business. They haven't been operators for 30 years. They don't want to be operators.

38:30Some GPs have a lot of in-house folks that actually make that work. And I would call the term, if you're specific enough about what you do and you repeat it often enough, you kind of have a playbook. Whether that's buying only software businesses and growing them incredibly rapidly and improving their profitability, whether it's doing carve outs and taking lots of costs out. if you're doing similar things again and again, it can be worth it to have a large team of folks that's on the cutting edge of how to make that happen because that repeatability factor makes you more efficient, makes you more knowledgeable, makes you better than others at what you do.

39:01So you'll get more value out of the same asset than someone else who's not doing that. For folks that are buying across many different sectors, different types of investment theses, some buy and build, some organic growth, some fix that dented can, the business is a little broken, we can make it better. Those are a lot of different things. And most buyout firms, they don't have thousands of people running around. They may have 100 people. They may have 50 people. They may have 200 people. But they don't want an army of people on staff for something they may do once in five years. So it doesn't make a lot of sense to have every possible value lever covered with someone on your team that you're paying for.

39:35What makes more sense is that you agree that you want to have a certain rigor in your value creation plan process. You'd like to try and do the same thing in partnership with management every different time. There may be some people on your payroll as a GP that you want involved the majority of the time, the air traffic controllers, I call them. But you're going to have an ecosystem of partners, experts, CEOs, other advisors, consultants, people that are going to be useful that can do a lot of different types of things so that you can use them on a bespoke basis for when you do that deal. You're going to do it once in five years.

40:07I'm not going to have that on my payroll, but I know how to put together the people that can actually help me get that value. That sounds great. Why don't we start a private equity firm? Well, it sounds great. It's easy for me to say, Kies, and it's actually very challenging to execute on. And while I have thought about starting a private equity firm at times in the past - I think we'd be a great team. Well, we would be a good team. We've got a good thing going here in this dialogue right now. The unfortunate reality in the world is that when I started in this business, the scarce commodity was capital.

40:35People actually needed the money, the equity to get a deal done. That is now not at all the case. If anything, we have a surplus of capital. There's more money chasing fewer assets than in the past. What the world doesn't need is another dollar of private equity capital chasing those assets. What the world does need and what is rewarded is that differentiated angle, that view of an asset, a subsector, a thesis that plays across subsectors that's going to make a repeatable play happen. That's what LPs are looking for. And that's what's new and exciting in the private equity world. So it's not that we're not going to see new firms pop up.

41:12We are always been an entrepreneurial asset class and it always will be. But if you don't have the idea on what's going to generate alpha, that excess return, it's going to be much, much harder to get in business and to raise capital. All right. So we're not going to start a PE firm, but we can build an investment thesis. This is actually interesting. What have you generally seen of those interesting investment theses in the past decades? What we're seeing now is people in search of interesting, repeatable, long-term trends. One of the ones that we've done a bunch of work on is the changing demography of different countries over time.

41:47In general, there's an aging population trend that's going on in a lot of places. If you look at the US, with the baby boomer generation, we're going to have more people, I can't remember the numbers, but more people over the age of 65 than ever have existed in history. And they need and want to do certain things, their entertainment, their exercise, their sporting, that all of the things they're going to spend money on We're now going to have more people in that age cohort, more healthier people in the age cohort than ever before. And they're going to spend money on a whole bunch of different products and services.

42:13So if I can understand that, predict it, and then figure out how I want to play it, there's a lot of value in that, particularly if I understand that better than other players that don't. At the same token, there's another even larger cohort of folks in the United States that are in their household formation years. So these are people that are about to, if they can afford it, buy houses, have families, have, again, when you start to have kids, when you start to buy a house, there's a predictable set of things that you're spending money on in terms of products and services. And we are going to have more people in the largest cohort of those folks in that age range in history in the United States.

42:46And if you understand that and understand what we call the spend corridor better than others, then you're going to be able to get there first on a lot of these businesses that may be doing fine now, but they're going to take off in the future because of the way that the demographics of the country are playing out. So that's just one example, but it's those kinds of longer term I'm thinking about how is the world going to change? How are the macro and microeconomics of things going to change? And if I can get certainty around what some of those things are going to be, then I'll get ideas and investment theses around where attractive places to play might be and recognize those opportunities perhaps faster than my competitors.

43:21You know, with AI in play, it's like every industry is going to be evolving, shaping quickly. But I get what you mean of like, where's that big trend you see that's going to indicate where the puck's going? Absolutely right. What is it? What are we betting on? What are we betting on? I had a very wise partner once tell me, this was probably two decades ago, maybe even a little bit longer than that, never ever bet against technology. And he meant it in the case back then of retailing. This was the beginning of e-commerce. And he was very wise because that remains to be very good advice today. Never ever bet against technology.

43:52Now, timing is important and understanding what technology is going to do is even more important than that. And as you mentioned, AI is the zeitgeist for technology, everything. and that everything is not generative AI, but some things are. And I think the rate of change and the amount of impact that AI is going to have in any given industry is very different from one another. It also may take a little bit longer in many industries to have the kind of transformative impact that a lot of people read about or talking about in the newspapers or on TV these days. Transformation is very difficult. There are some things where it's easy to see how a bot might be able to answer student questions at an online university faster and more efficiently than a person can.

44:31And you get that accuracy rate up and you say, gee, that's a great use of AI, having that bot answer student questions. That is a tremendous productivity enhancement idea. That is not a transformative idea that changes an entire industry. What I'm seeing, at least from my vantage point, is lots of ideas about where this might go in time, but how fast we get there and how transformative these things really are in different industries by when, they're very much up in the air. I don't want to throw cold water over any of our ideas to start a private equity fund, but I'm just trying to be a little bit realistic here.

45:02I changed it. I wrote AI M &A services. I have a feeling somebody on your team is working on that. I have a feeling. We have a lot of people working on that. Absolutely. All right. More than one. Yeah. The entire investment process is changing. So AI enabled M &A services is something we are definitely experimenting with a lot. Okay. We can use that or we can make up another example. Can you teach me how to pitch a private equity firm? It's the whole dynamic shift. It's not about creating a fund and go soliciting LPs to invest in the fund. And here's like more of a capital allocation thesis. Now we're coming up with something that's more of real, it is capital allocation, but operationally into something that we're going to either build or acquire a specific business around.

45:44I'm trying to flip your view from your experience of working with private equity and knowing what their appetite is and how that's evolved to somebody that's on the other end when you're trying to be attractive to private equity firms. What would that look like to appeal to them? And maybe it's shifted. Maybe it is the other way around. We get a lot of inbound from private equity. Maybe it's the pitch has shifted. Maybe it has shifted. I don't know. To make yourself attractive as a company, to private equity firms. Yeah. I feel like you have a thesis, but it's a little more than that. Here's an idea.

46:12There's certain things that you really prepare that makes it attractive? My view would be, if you were a seller, you have to have things that have legs. They have to have something that is going to last beyond the investment horizon and be attractive to the next buyer. Because at the end of the day, private equity firms take money from institutions, individuals, insurance companies, an increasingly complex set of sources, wherever the money comes from, that money needs to go back. There needs to be an investment horizon that's attractive and an exit multiple that's attractive, particularly in a world where the entry multiples are going higher and higher.

46:44So whether you fit into some long-term macro trend, whether your business has a repeatable model and you're in the first inning of the game and the whole nine innings is going to take 25 or 30 years to play out, it's better if there's some tail along those lines that's provable with analysis and the diligence process than it is, here's a high quality asset. A lot of people are going to look at it. It's going to sell for a very high price. Nobody, including the management team, understands how we're going to get the year five projected EBITDA and revenue numbers because they're just so high because they need to be high to support the price that the seller wants.

47:19That's what you run into when you run into it's time to sell the asset, but I can't really link it to anything that's repeatable, extensible, or in some long run trend. So much better to be able to say, and that's why buy and builds have become popular, right? And that's what most of it is. I haven't met a single PE firm, and maybe I haven't met that many, that doesn't include M &A or add-ons as part of the strategy. It is and has been a very attractive way to build value. And of course, it solves the problem of where do I find a scale asset? I can have bigger and bigger funds and still buy medium-sized businesses and then add on to them and make them big companies over time that consume a lot of equity.

47:55It's much easier to do that than it is to find a$1,$2,$3,$4 billion TEV platform. And finding the next platform that's really scale, that's tough. And by the way, the more scale it is, the more visible it is to the large funds. And therefore, the more competed it's going to be in that process. So have an investment thesis. Find a space that's got a good investment horizon that there's more than one deal to do. But the synergies, that's the other piece. It's got to be something. There's a thesis built around how you're going to actually generate value more than just buying the businesses. and also looking at a long-term future, the real strategy for how it's going to improve outcomes down the road.

48:36You got it right. I'm going to work on it. I'll come back with some ideas to pitch you. I'll be listening. All right. We got the first question done with this interview. Is that one? I thought we did them all. What are the key challenges private equity firms face when scaling investments to the billion dollar range? It's what we talked about. Everything just gets more competitive and more visible. The bigger things are, and by the way, It's obviously fixing and turning the super tanker is harder than the fleet of little ships. The bigger something is, the more unwieldy it is, the harder it is to add value, the longer it takes to add value.

49:05It's not a bad thing to do, but you need to be aware that the larger, more complex businesses that you buy are simply going to take longer to transform. And that's why when you look at the very largest checks that are written in the industry, you don't see the absolute highest returns. Highest returns are still in the middle market. but when you're talking about these larger organizations, there's a narrow range of outcomes. If you look at the normal distribution of outcomes, you don't see a lot of companies going bust either because you get to be a big company because you have a right to exist.

49:36There's a reason you got to be a big company because people found value in your product and service and your group. The chances that it's going to be a really horrible outcome are lower. The chances that you're going to take some giant super tanker and go to the moon in it are probably a little bit lower as well but you could make a very good return in just a slightly narrower range with a bigger asset and being geared up with the right resources to make sure that you understand that's the game. And that's going to take a while. And it's going to take investment to get there is important to ensure success.

50:01How has competitive environment for private equity evolved? Was it a take to succeed in today's market? We talked about being more competitor, but like, what do you really break through? I think you covered it like in terms of unique thesis. Yeah. And just differentiate a point of view and real sector expertise. It used to be when I started doing a lot of work for LPs about 20 years ago, that I could go and say, go into a sovereign wealth fund that had a big portfolio and they would have lots and lots of books from GPs that wanted to raise money. And every single book looked pretty much the same.

50:31It was, we have a really good investment track record. We have the same team that created this track record today and we have aligned economics. So we've done well. We're smart guys and gals and we're going to have aligned economics. The problem was if that's what all the books say, how do you tell where it's really true and where it's not true. Again, that was the standard and that was adequate to raise money. Today, you couldn't raise any money with that kind of a statement because people want to understand, well, there's a lot of money out there chasing deals. What do you know and what do you do differently that allow you to do deals in a way that creates alpha that other people that are larger than you, maybe better capitalized than you, cannot?

51:07What is your secret sauce? What is your repeatable model? What is it about how you find deals? What value levers you underwrite in which subsectors, how you go about creating the value, how you go about partnering with management. What is it that you do that's got a moat around it that's unique, that allows me to believe as an investor? And by the way, that means you're going to have to show me examples of where you've actually done it. So I really believe you. That is going to allow us to walk in partnership together as an LP and a GP in the future. What's going to give me that confidence that you've got that special sauce that I can trust for the next decade?

51:37There's no magic formula on that. It's about what your story is, about having your differentiator, your moat, but then also validating and improving it. Absolutely. There's more validating, improving required now, certainly, than there was before the GFC. Now it's okay. You've told me this is your model when you're at your best. Show me the examples. Let's talk about your investments all through your history and you tell me exactly how you applied these levers, these advantages, how these moats actually work when you're at your best. And we're going to go through these examples in a lot of detail.

52:05What strategies have been most effective in helping GPs and LPs align on operational and organizational goals? We go through cycles, communication cycles, and they follow capital velocity cycles. And let me tell you a little bit what I mean. In 2007, early 2008, 2006 as well, capital velocity cycle was going way up. People were raising funds every couple of years, deploying them. The check sizes were getting ever bigger. And 06 and 07 were the two largest buyout years at the time by value that the market had ever seen. Then came the crash of 08, 09, what we call the GFC. GFC, aka Great Financial Crisis.

52:43Some people call it the Great Recession, but I said GFC. And when you're raising money that quickly and recycling it that fast, the alignment between GPs and LPs is that everything's going really well. I'm writing lots of checks. I'm getting lots of checks back that say they have profits on them. That's great. When the music stops is when you get a crisis that forces a different type of communication style. And what we saw after the GFC was that LPs were a bit nervous, obviously, because we just had a massive recession, the biggest in 75 years. They weren't sure if any of the portfolio companies that they'd invested in with any GP were solvent, whether they were going to get their money back.

53:19They wanted to have a different type of conversation with their GP partners, which was, come in, let's sit down, and let's talk about your entire portfolio. And let's talk about where your assets stand, what your approach is to go through the entire portfolio, where you're going to invest time and money, what you expect to get back from that, by what period of time, and just show me a picture of what my cashflow models are going to look like from you as my GP partner over the next several years. And give me comfort that you're coming at this in a structured, rigorous way. And it's not deal by deal, everything, which tends to happen when capital velocity goes up, but that you're thinking about this strategically.

53:55And I can have confidence and faith that we're going to get to a certain set of results in a certain period of time. We're at a very similar spot right now in that dealmaking came to a little bit of, I won't say halt because it didn't come to a halt, but it went down dramatically after the capital velocity cycle went up dramatically in 2020 and 2021. 2021 was the largest by-value dealmaking year in the history of the buyout industry. And then in mid-2022, the Fed and the ECB started hiking up interest rates at an unprecedented pace over 18 months, almost 500 basis points. And that put the industry in shocked.

54:29Not only were people worried about doing deals with the cost of debt being so high, but for all of the deals that I did with 5 % coupon debt, the next buyer has 10 % coupon debt. I can't make the multiples work and sell those deals back. So the exit activity has dropped dramatically since 2022. That once again has made LPs nervous as the years go by and some of these assets are aging in portfolios. What are they really worth? What am I going to get at the end of the day? it's time for that structured conversation again, where GPs come back in and say, let's array the portfolio. Let's talk about where we are.

55:03Let's talk about each asset and let me help you, Mr. LP or Ms. LP, understand what your cash planning scenario should look like and what you can expect by when. And let's have that structured conversation the way we did 15 years ago, just post GFC to make you comfortable. Whether you're talking about cash flows, which are critically important, whether you're talking about ESG, that's another whole topic, that having a more open, transparent, and wholesome conversation about the full suite of topics and levers that you're going to deal with in the portfolio is most helpful and builds the most trust between the LP and the GP.

55:39That explains a lot. That's why we hit a record hold time on these portfolio companies because nobody wants to sell at a loss. Nobody likes to sell at a loss because it makes it real hard to raise your next fund if you're selling at a loss. I make friends that way. Where have you seen the heist returns? You got to like study all these PE firms. You got to know. I don't want names. Study firms, study segments. I'll get the list of names afterwards. Is there certain like size or industry focuses that you've seen pay off the best? And obviously this isn't a future indicator. Here's the funny thing.

56:07For the history of the industry, and this definition has changed over time, in terms of size, middle market deals have tended to do the best. Now, the notion of middle market is probably five times larger now than it was 20 years ago. So then what middle market is goes up as the industry goes up and the average deal size goes up. But middle market deals, companies you can get your arms around more easily, inflect the value, if you really understand what you're underwriting, that tends to be in the sweet spot of the industry size-wise. And again, that's an amorphous thing to say. A lot of people think about sectors when it comes to return.

56:38They say, with all these fast-growing software businesses, that's just gotta be the highest return sector. Or healthcare really is not impacted by economic cycles the way the industrial and other businesses are. So maybe that's gotta be the highest return or maybe it's high-flying consumer products or what have you. The reality is when you look at sectors over the long term, over decades, there is more standard deviation of return, higher delta in return within a sector than across sector. There are great deals that have been done in every single sector, but the variability of return within that sector from the best deal to the worst is always higher.

57:12So it's not so much about the sector, not good sector, bad sector, but what do you know about a sector and what are you able to underwrite and then execute on confidently again and again that gives me the belief that you'll be able to do it for your next fund? That's the right question to ask, not am I in the right sector? Middle market, stay focused. Middle market, stay focused. I should have said that. That would have been a lot shorter. That's my job. I just take what you say and put it in the most layman terms possible. biggest innovations when it comes to the deal execution, due diligence, big trends happening with AI, advanced data analytics.

57:46What do you see in reshaping private equity? We see a lot of innovations in due diligence. When I started doing due diligence, there was, embarrassed to say this, but people didn't use the internet too much. So it was very analog with lots of slides and lots of smiling and dialing people trying to find out information. Then the internet came and we took a big step function. we could do in a week and in a few days, what used to take several weeks with a high degree of confidence. Then we got to a space where lots of specialized tools, analytics, and data sets became available. Think about things like credit card spending for different customers in different countries across all different types of formats.

58:22So I could go into a, get some credit card data for a fast food restaurant and tell you exactly what your customers were buying, what they liked, what they didn't like. If they actually left your fast food establishment and spent money in another one. I could tell you where they go, what they're buying there. I don't even need to do a survey. I can just follow the credit card data and query it and figure out exactly what's going on. We saw an explosion of specialized tools and specialized data sets that allowed us to answer questions faster. I could do scrapes of LinkedIn and Glassdoor and I could tell you whether or not your sales force looked competitive with the competitors in the industry.

58:53Or we could go to Glassdoor and talk about what the employees were saying versus other competitors in the industry and do that in a very rapid way. So these types of tools started to become more and more ubiquitous and then we created a lot of them. And now we're moved into yet another realm of AI. What can AI tell us? We do more expert interviews than any firm in the world because of the size of our due diligence business and the size of our consulting business. What if we had transcripts of every single one of those interviews that we were able to query using AI and understand dynamically at any point in time what was happening in a subsector of an industry and what an expert said and get that summarized in three bullet points, three pages or 30 pages, depending on how deep you actually want it to go.

59:33The kinds of things that are possible now in due diligence simply didn't exist even two years ago. And the kinds of other things that I was talking about didn't exist seven years ago. And you can go back and back. The industry is constantly pushing the boundaries of how much can we know to reduce risk rapidly? And how much can we know to get us to certainty that this is an asset that we want rapidly? because the faster I know those things, the more confidence I have and I'm either out and I'm onto the next thing and using my time productively or I'm bidding and I'm bidding a full price with certainty because I know that I'm the right owner for that particular asset.

1:00:07That's what these tools are designed to do. Speed to insight, we call it. Speed to insight in every given situation. The clock is only moving forward on that and we're going to see more tools and we're part of the creation process for these tools so we're going to continue to do it and push the envelope at how fast we can really understand what we need to know to recommend to a client whether or not their investment thesis is a good thing or not a good thing. Learn faster, minimize risk, build better value creation plans. There you go again, shortening what I said and then making it very accessible.

1:00:35We can go on about the tech, right? There's just so many examples and you can like apply to every piece. How about the broader private equity as a whole? What do you see in the future? I see private equity and if I could make it a broader note piece and private assets in general is on an inexorable march to be a larger and larger piece of the investable pie for individuals as well as for institutions. Now, why do I say that? Let's again look at something like the US stock market as an indicative example. US stock market has what? 4 ,000, 4 ,500 issuances right now down from over 10 ,000, 20 or 25 years ago.

1:01:10A lot of that happened because of Sarbanes-Oxley. Sarbanes-Oxley made it extremely expensive to be a public company. If you don't have five or$10 billion more value, you don't want to pay all the costs and deal with all the compliance. What that did was effectively take the entire middle market or a lot of it in this public markets and chase it to places like private equity. They all went private and got bought out. It also means that the ways to play the public market are now far fewer than they were in the past with these much larger entities. And whether you believe that there are seven stocks or just one, how much NVIDIA do you want to own before you say, I've got enough exposure to tech through the US stock market, I need something else.

1:01:46A friend of mine, I put it really well, where he said, the problem we have, or the challenge, or the good thing, depending upon your view, is that you've got 10 % of the investment opportunities being chased by 90 % of the dollars, and you've got 90 % of the investment opportunities being chased by 10 % of the dollars. It just can't be that way going forward. And in other non-US stock markets, they're even more thinly traded than the US. So this problem compounds itself. So it's not that public assets and public debt are inherently unattractive places to put your money, they've been very attractive, especially in the US for the last 15 years.

1:02:15But it's just that particularly with tech being so pervasive, you're playing the same theme with every dollar that you put in. And at some point, investors say, I've got enough of that exposure, where else can I get exposure? And that's where we've seen an explosion of different types of private equity funds. That's where long hold funds have come from. That's where sector specific funds have come from, only healthcare, only tech, only other things. That's where large scale firms have come from smaller scale firms, growth-oriented firms, and other asset classes as well. Infrastructure firms. There's infrastructure starting to blur a little bit now with buyout.

1:02:48When it's a toll road, I can tell that it's infrastructure where it's a hospital and some people say that's healthcare infrastructure. Another person says, no, no, no, that's in my buyout fund. There's a little bit of a blurring of the line. So where does infrastructure start and stop, especially when it comes to things like digital infrastructure and the internet? Hard to say. More and more money though is interested in those kinds of activities. We've heard a lot about how AI is going to require a tremendous amount of infrastructure, energy infrastructure too. And people are interested in that.

1:03:14There are a lot of different opportunities in the private sector. We talked about private credit earlier. Real estate's another one where the number in different ways to play in private assets is simply more than in the public space. And individuals are actually going to fuel an awful lot of this growth. We did a study at Bain where we tried to forecast out what are the sources of capital going to be for private markets over the course of the next decade. And about a quarter of all the money going into the private asset classes we forecast are going to come from people like you and me, going to come from individuals because of the kinds of factors I described that people, they want to invest in the stock markets and it's all great.

1:03:51But once you've had enough, where else do you go? And their investment advisors are increasingly telling them, you should get into the private asset classes just for some diversification. This is coming. It's coming not just from the traditional alts. It's coming from traditional asset managers themselves. We've seen BlackRock buying companies. We've seen Franklin Templeton buying private asset managers as well. They're clearly intending to create products that you and I can buy at the retail level. More and more of that is going to be available for more and more channels. And that's going to fuel tremendous amount of growth in the private asset industry.

1:04:21So a little bit of it is the consolidation and the nature of the public opportunity. And a lot of it is just easier to play in the private markets in many different ways for individuals. We see growth ahead, which means more capital, means more niche funds, and then access to retailer. I heard the term perpetual funds, I think is one of the terms. Or long hold. Yeah. Long hold. That's going to drive evaluations? It's TBD. The amount of investable assets out there is still large. The amount of money chasing those assets is going to go up. So one would naturally believe that, yeah, if you're waiting for multiples to go back to five times EBITDA, you're going to be in for an awful long wait in the business.

1:05:01I think the multiples are going to stay high. The markets are going to get even more competitive and more specialized going forward. But when we talk about the whole world and the way things are changing, whether it's energy transition or new ways of creating more generation capacity to make all of these AI chips or whatever it happens to be, there's always new and dynamic areas to think about to put money to work in. So it's not all about the same set of companies are out there and now it's just purely more dollars chasing them. Yes, it's a lot more dollars chasing them, But there are new trends and new places to invest that didn't exist five or 10 years ago.

1:05:33And that's going to continue. What are common mistakes private equity firms make during acquisitions? What kind of mistakes do private equity firms make? And they're consultants, I should add, before I say I heap all the mistakes on the private equity world because we're a part of that world. Well, when I interviewed them, they always played the consultant. I'm used to it, I guess. When you identify what your sweet spot is as an investor, we've talked a lot about your repeatable model, your moats. There are a lot of different ways you can characterize it. but what it is that your firm with its DNA and its talent does uniquely well and can do on a repeatable basis.

1:06:05You want to stick with that. Everybody wants to stick with that because that generates the highest return. But when you get a lot of really smart investors and they see something else that's interesting over here that might not be exactly what we do today, but it sure looks like we can make a lot of money doing that. And they get away from that repeatable model, those moats, those types of results have tended to end not as well for most investors as that you're getting outside of your sweet spot, you're doing things that are not core to the business. Sometimes they do well and they become another extensible leg of the business.

1:06:35But often, if you're doing things where you're not the expert because it's not your repeatable model and you're competing with people that are the expert in that space, if you win, that may imply that you paid too much and or it may be difficult to win. Or if you do win and have the asset, you may not have the same kinds of abilities to add value to that particular asset that you do the things that are in your sweet spot or in your core. So I would say the single biggest challenge in the industry has been having folks focus on their repeatable model and say, with 80 % of my resources, I am going to do that and execute upon it.

1:07:08And if some of the interesting things come by, that's fine. But I need to keep that in the right proportion in order to make sure that I'm generating the returns of my LPs expect. Really staying focused. Staying focused. I know we're getting close to time here. I got to ask, what's the craziest thing you've seen in M &A? The craziest thing I've seen in M &A, or at least one of the most surprising things, was during one of these hyper capital velocity cycles that we were talking about. It was 2006 or 2007, I can't remember when. And this was when the advent of the club deal came about, which were two or three or four, in some cases, many as six.

1:07:42GPs would come together because none of them had a big enough fund by themselves to write a check. But if they pooled their money, they could actually go buy a big public company, take it private. And I remember I was doing a phone call and three GPs had gotten on the call. They wanted to talk about taking a big asset private. I said, okay, that's great. What's the investment thesis? And I would say for the next 40 seconds, there was complete silence on the other end of the phone. And I began to realize that these GPs had not even discussed amongst themselves what the investment thesis was. It was much more, we have a lot of money and we can do a deal in my mind versus we know what we're going to do with this company.

1:08:17And this was a multi-billion dollar take private. That was one of the wildest things I ever heard was to realize that people got all excited that they had enough money to do a deal. Very smart people. but then we had him on the phone and it's, what are you going to do with this asset? And I got silence for about a good 40 seconds there. At the end of that 40 seconds of silence, the comment I got back from one of them was, that's our next discussion. That's pretty crazy. Sometimes when the capital velocity cycle really gets going there, the deal fever can take root in certain quarters. That's the deal fever.

1:08:46Because the theme of the podcast is, you got to build a good investment thesis and stay focused on it. It is. And it's actually hard to do. We talk about it like it's the simplest thing in the world to do. But this was, this is, the private equity business has been for most of its existence, a pretty undefined industry. Like it's not like, this is where you play, this is where you don't play, this is so-and-so's pool over here, this is your pool over there. It's not set up that way. There are no rules set up. Very challenging. And it's only really been in the last few years where that specialized knowledge and that angle has just become so important for generating alpha that you've got to have it.

1:09:19And by definition, if you're becoming more specialized, you're closing down the aperture of things that you're looking at because you know these spaces over here and how they behave. But that means there's a whole bunch of other spaces that you don't know. And someone else does know because they're investing in those subsectors the same way you're investing in your subsectors. I think it's been a healthy thing overall that this specialization in the industry makes it more possible to earn differentiated returns while continuing to pay competitive prices. It's also forced the discipline of sticking to your knitting by defining what the heck your knitting is and what it isn't in a more specific way.

1:09:49It's still so easy to get deal happy. It is. We see these capital acceleration cycles. We just saw it prior to 2022. Dude, this has been a great conversation. I appreciate you taking the time, helping me become a better M &A scientist. It's been a real pleasure chatting with you and I appreciate you having me on the show. Fellow M &A scientists, we got this far. You're my family. Like, I love to hear from you. I appreciate feedback, topic ideas, criticism. That's how I learned to get better at this. Reach out to me. Probably on LinkedIn is the best way to get ahold of me. So next time, here's to the deal.

1:10:35Thank you for taking the time to explore the world of M &A with our podcast. We love hearing feedback. Tag us on a LinkedIn post, add a review on Apple Podcasts. We'd love to hear from you. If you need help standing up an M &A function or optimizing one that you already have, we're here to help. And if we can't help you, we probably know someone that can. You can reach out to me by email, Kisan, K-I-S-O-N, at mascience.com. Or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter.

1:11:20Again, that's mascience.com. Here's to the deal.

1:11:34views and opinions expressed on M &A science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual this podcast is