Ep. 144: Alex Abell, RCP Advisors | Evaluating Lower Middle Market Managers and Operational Value Creation

0:00Alex Abell: Hey everybody, before we get started with today's episode, I want to take an opportunity to tell you about my new book, AI Marketing Blueprint. It just hit number one bestseller status across multiple categories on Amazon, and it walks you through a proven framework that we are taking our clients through here at How to SaaS and how to stay relevant and visible in a world with AI platforms. One of the biggest problems that we have seen across clients and companies is that the traditional channels that they relied on, like paid search or SEO, have declined significantly or are getting more expensive and competitive.

0:34Alex Abell: The reason for this is that a lot of buyers are starting to self-educate themselves and research on AI platforms. So a lot of that volume that was previously going to those channels is now moving to these new AI platforms. So to stay relevant, the book walks you through seven new rules that companies in all kinds of verticals and industries need to consider so that they can continue growing their pipeline and revenue and ultimately their enterprise value. So if this applies to your business or one of the companies that you've invested in, I definitely recommend that you pick up a copy. It's available on Amazon, on Apple Books, on Barnes and Noble, and even share it with your teams.

1:10Alex Abell: Grab a bunch of copies so that you can kind of consume the content together and start to apply it to your business. And with that said, let's move on to the episode. Welcome to the Private Equity Value Creation Podcast, where we interview leading investors, operators, bankers, and advisors to help you answer one question. How do we increase the enterprise value of our companies? My name is Shiv Narayanan, and each episode, I will dive deep with a guest to help you become a better value creator and capital allocator. So with that said, let's jump right in and let's get started with today's episode.

1:46Alex Abell: My guest today is Alex Abel, and he is a managing partner at RCP Advisors, which is a subsidiary of Rich Post Capital. And what is really interesting about RCP is that they are a fund of funds. And Alex and his team specifically have access to data across hundreds of different PE investors and their investments and have built a proprietary data platform to help them benchmark performance and make better investing decisions. And this is something that I think is missing in the private equity ecosystem, which is there just aren't enough benchmarks out there outside of what you can internally produce.

2:23Alex Abell: But internal benchmarks are wrong all the time because the windows are really shortened or you don't have access to enough data sets. But RCP does because they have access to so many different GPs and their funds and their investments. And so they're able to benchmark vintages from one fund versus the same vintage from a different fund and be able to kind of figure out which fund is performing better than others. And beyond this, they also get visibility on the operational side and value creation side, which is how different firms are actually looking at creating enterprise value inside their portfolio companies and which approaches are working and which ones aren't.

2:58Alex Abell: So between all of this, Alex and I had a great conversation about the best approach to running funds and how they look at investments and how they underwrite deals. And there's a lot of great takeaways in terms of how they're looking at this market from their unique vantage point. So I certainly learned a lot from it, and I'm sure you will as well. So with that said, I'll leave you to it. Enjoy the episode.

3:25Alex Abell: All right, Alex, welcome to the show. How's it going? It's going well. Thanks for having me. Yeah, excited to have you on. So why don't we start with your background in RCP and then let's go from there. Sure. So I'm Alex Amell, managing partner here at RCP Advisors. RCP is in its actually 25th year. This year we're celebrating our anniversary. We are a fund-to-funds platform on private equity focused very exclusively on what we call North America small bias. Another name for it sometimes is lower middle market. but basically focusing on managers that have fund sizes under a billion dollars. And so I've been here for about just under 12 years now.

4:05And we have a team that goes back in some cases to our founding stuff. So we've been doing the exact same strategy for all those 25 years. Yeah.

4:16Alex Abell: And you're connected to Rich Post Capital. So can you expand on that relationship and also kind of what your focus is in more detail? Yeah, absolutely. So Ridgepost Capital is essentially our parent company. We are a wholly owned subsidiary of Ridgepost. RCP was really the initiators of creating Ridgepost as a holding company so that we could acquire other strategies. So we have folks that do venture capital. We have folks that do credit that are all focused on what we would generally call nichier markets, where we think there's advantage to having focuses on smaller investments and smaller funds.

4:52And so the creation of Richpost was quite a long time over now. We're now public and traded on the NLSE. And RCP operates as, I think, still the largest platform.

5:03Alex Abell: Got it. Okay. And so help us understand, because we've had some other funds of funds on the podcast before. So talk about how you go about this. How do you determine which funds to back? And how does that connect to an overarching strategy for your firm? Yeah. So for us, you know, we track about 1 ,200 managers in the lower middle market. It is a niche, but it's a very large niche. And I think one of our biggest advantages, because we're specialists, because this is all we do, we are generally meeting with hundreds of managers every year. You know, and maybe we're only investing in 10 or 12. So it's a highly selective process.

5:38But because we're focused exclusively on this area and probably one of the largest allocators to the lower middle market in the United States and Canada, we have, you know, a great deal of market intelligence on the entire market. Right. And so we meet with managers on a regular basis, even years in many cases before the fundraiser. So once they start to come back to market, it's very important for us to sort of already have an opinion of at least what are the issues that we're going to be doing due diligence on. And part of the reason for that is that our part of the market is in some ways very similar to venture capital in that the best managers are heavily oversubscribed.

6:14They can pick and choose who their LPs are. Their fundraisers don't last particularly long in many cases. And so our ability to develop those relationships over long periods of time prior to them raising their next fund is really critical to both getting access and then being able to do a good job in our capabilities. And what we're looking for, for really any manager, is I guess the best way I could describe it is there's something about the team, something about their strategy, something about their process that we find unique, differentiated, something that they're, you know, sort of, sometimes I call it their superpower, right?

6:48So what is their manager superpower? Sometimes managers have more than one superpower, right? It could be how they source deals. It could be how they add value to the portfolios that they're managing. but every manager generally should have something about them that makes them unique and differentiated. And then what we're looking for is that that is attached to something about them, either their process or who they are and their expertise that makes it a repeatable strategy, right? So something that not only has produced returns in their past fund, which is obviously very important, but that we can look at it on a deal-by-deal basis and see how they implemented in that superpower in order to do well in deals on an ongoing basis as well, right?

7:27And that gives us a lot of comfort when you're investing in a blind pool. Yeah.

7:31Alex Abell: Are you looking at these unique capabilities using metrics or specific benchmarks? Like how are you trying to, or is it more of a qualitative exercise? Like how are you figuring out which managers are worth backing versus others? Yeah. I mean, it's both, right? So qualitative component is extremely important. So, you know, our specialization has allowed us to develop very good networking within the ecosystem that we operate. So the ability to do references on these managers, not just obviously the references that they give us, which is important, but also the references that we can get to of people they've worked with in the past, former employees, intermediaries within the, you know, could be the banking world or it could be within the placement agent world who've represented them or know them.

8:18So being able to sort of pinpoint a lot of off list references, not just on the team and the manager, but also on things like their value creation team, right? If they're having a, you know, a group of operators, that's really critically important. That gives us, let's say, the qualitative view. And then what we want to do is match that with quantitative analysis. And one of the things that's really difficult about private equity is the evaluation of track records can be very true, right? So, you know, in most cases when you're evaluating a manager, the most recent fund is probably the most, let's say, relevant fund to analyze, right?

8:52It usually has a similar strategy, maybe it's closest in size and types of target companies. The team that invested that is more than likely the team that you're evaluating today. And the funds that are further in the distance, which are more realized, right, they can sometimes be very different in terms of strategy of what that manager might be doing going forward. And so part of the difficulty that a lot of allocators have in evaluating private equity track records is that things like vintage year benchmarking, which has been sort of a standard in our industry for years, are very difficult to do on less mature funds.

9:26So even if you look at some of the biggest benchmarks that are out there, in their footnotes, they'll say things like that managers will jump around four tiles within the first six or seven years, right, of their existence. But that doesn't really help you when you're dealing with a fund that might be three or four years old and you're trying to evaluate, right? So for us, one of the unique things that we have that, you know, as a big differentiator is our data and analytics platform called GPScout. And what it really allows us to do is sort of forget about the funds. You know, we obviously look at fund viable benchmarking as part of our analysis, but we can actually dig deeper into the deals.

10:03And what we can do is look at every deal that manager has done and compare it to all the other deals we have on our database, over 50 ,000 deals that other managers have done in the same time period, same subsectors, right? And the same size ranges, right? So for us, size is really important. We're investing in smaller companies and other managers. And we can see whether or not that manager has outperformed on a deal-by-deal basis, not just at the fund, right? And the other big sort of important distinction that helps us evaluate whether a manager is actually creating, let's call it alpha, right, or performance in their portfolios, even portfolios that are younger, right, where they haven't had an exit maybe, is we also collect tons of information about the operational data of these upper earnings, right?

10:48So we know what the revenue CAGRs are, the EBITDA CAGRs, the margins at the time that they enter, the current margins of these companies, whether they've shown improvement or retraction. And what we can do in a similar way is that if a manager is, you know, let's say pitching me, right? And we're in a meeting, maybe we're outside in their offices and they say, yeah, we've grown this healthcare services company, you know, 20 % revenue cager over the whole period. It sounds good, but I don't know if that's good or not, right? Because if I look at our data and we have 30 deals that were done in a similar time period and the median of that 30 deals is 35 % revenue cager, then all of a sudden the manager's revenue cager doesn't look very good, right?

11:27So benchmarking is a way of sort of controlling for time, right? And comparing similar types of investments over that same time period. And so we can do that not just with outcome, right, like marks and like the ultimate realization and cash on cash returns, but we can actually see whether our managers in an operational sense improving those companies compared to their peers, right? And that's a really critical component, especially in the lower middle market where we focus because in the lower middle market, you're generally dealing with relatively small companies compared to most private, right?

11:59So in our world, we're generally focused on companies that are under 200 million enterprise value and the vast majority are under 100 million enterprise value. So these are like, you know, three to$5 million to$20 million EBITDA companies, right? And 75 or 80 % of them are family-owned businesses that have never had institutional capital. So these are companies that have areas that they can improve, right? And we're a manager's activist strategy of actually creating value in these companies and growing them creates a ton of value in returns because not only are you growing these companies that are small into companies that are bigger in scale, which makes them much more attractive to the people that have capital above us, right?

12:38And they send a much more interesting company for them to buy, but they're also improving the operations of those companies. They're making them. Management teams are being replaced and upgraded. And all of this creates the ability for it to become a very attractive asset to the majority of the capital that's raised in the private equity markets, which is in funds above. folks that we're selling into. And so for us, being able to sort of identify these components, not just the vintage-year fund-level returns, but really how these managers are doing in terms of operational performance is really critical in evaluating where they can generate returns going forward.

13:13And as an allocator, we're dealing with a blind pool and we're bringing fund investing. And this is one way to sort of validate through more data points that this manager is actually good at what to do.

13:24Alex Abell: Where are you guys finding this proprietary data for GPScout from? Because a lot of this is proprietary data. So just help us understand, how do you have this unique insight if you're not necessarily involved with those companies? Yeah. So the reason is because we are evaluating all of these managers that come to market with their funds that are in our area. So every year, we probably have 300 managers or so that are coming to market. We take me's, we're all of them. We collect information and data about their portfolios, we're all of them. We have regular updates with most of these managers in between fundraisers where we get a lot of information and data that we can use.

13:59And so because we are, as RCP, one of the largest allocators in the world and in the market in terms of dollars, right, that gives general partners all of a sudden to work with us and provide us information about what they're doing because they want us to invest, right? And that is very beneficial for us, right? And so we can write big checks into these funds. We're usually one of the top investors from a size perspective in most of the markets that we're investors with. That also attracts people that want us to be OPs, right, in their fund. And that allows us to collect a lot of information about these folks, which is very helpful for us.

14:33Alex Abell: Yeah. Yeah. And so I think that's a huge competitive advantage there. Talk about the benchmark. You mentioned like, hey, looking at different vintages across different funds or evaluating a particular business in a certain way. Walk us through that. Like how detailed are you getting into there? And like, can you pull up some examples or help us understand how you have done that in real time? Yeah, I mean, in terms of the operational benchmarks, for sure. I'll give you, yeah, I mean, I can give you an example of a manager that I worked on. We were doing the underwriting and, you know, and this is actually a good example of sort of marrying the qualitative evaluation with the quantitative, right?

15:08So we got a manager that was in the industrial space and they were doing a lot of deals where they were paying a pretty high multiple, right? And so again, one of the data points that we can collect is data on valuation, right? What are managers buying things at and what are selling things at? And one of the key components of returns in our part of the market, right, is value creation. But what that leads to is also what we call multiple expansion, right? The ability to buy something at eight times EBITDA and sell for 10 or 12 times, right? And part of the reason that, you know, people are able to get that is because for every dollar of cash flow, the people that are buying our company is not a bigger part of the market.

15:50We're using more leverage. They have a different positive capital. They're willing to pay more for a scale business. So we were doing evaluation of this manager. And what we were seeing was that they've been in operation for 25 years, very industrials, which of course has a lot of cyclicality risk in it. And they were paying pretty high multiples for their portfolio companies. And a lot of industrial strategies we see with managers tend to be more valuary, to be honest with you, right? So we tend to see folks that are buying kind of C companies in the manufacturing space and making them either B or A companies.

16:21And what these folks were doing, this is the strategy that they were articulating to us, was they were buying, you know, A companies in industrious, right? Companies that were higher quality in their mind, and they were willing to pay a higher valuation. So yeah, nothing wrong with that strategy. And their belief was that they were experts in the space and they have the ability to create value and returns, even with buying companies for maybe a full valuation for a company. And so as we were on slide, we were talking and we're like, well, give me some, you know, what does that mean, better companies, right?

16:51Because that can mean a lot of different. And some of it was very qualitative where it would be like, well, these are certain end markets that we'd like to either stay away from or that we'd like to lean into. But some of the qualitative metrics, one in particular was marginal or EBITDA margin to be specific. And for them, what they really were focused on was managers or companies that had high EBITDA margins because in cycles, they tend to be buffered from the downside of this, right? And so one of the things that we did then after we had that meeting, we went back and we looked at our data. And what we would expect to see, if what they're telling us in their narrative was accurate, was that the companies that they were buying at the time they were buying, the EBITDA margin of those companies was significantly higher than the EBITDA margin of other companies in the industrial space that were also being bought by private equity during that time.

17:42right so they we wanted to use our data to benchmark the EBITDA multiple yes so we were able to see that they were higher on EBITDA multiple but also the margin of the EBITDA that they were buying at the time of the entry of that deal and what we found was that they were buying companies that significantly higher EBITDA margins than what the rest of the market their peers basically were buying at so we were able to kind of validate this idea this narrative that they were selling to us in their marketing, that we are buying higher quality companies, yes, and paying more for them, right? And that's a strategy that we have decided that we want to embark on.

18:19Now, whether or not that strategy is a good strategy or not is another question, right? And we did some work on that idea as well through our data of like, what happens from a performance perspective on, let's say, value-oriented versions of that strategy versus let's say the more, let's say, fully priced version. And so that is an example of how we can use our data to validate the narrative we're hearing from a manager and to validate their strategy. Now, again, it doesn't necessarily lead us to a yes, no decision by itself, but it gives us a lot of context out of what we're seeing about that manager's information and data.

18:53And so I think that's a good example of something like how marries the qualitative assessment, right? Because part of our assessment also is talking, obviously, to CEOs of these companies or the entrepreneur owners and being able to validate that they are operating companies that they think are, you know, higher quality along these different things.

19:10Alex Abell: Yeah. I think one of the biggest advantages here is that you have access to so much data that you can kind of contextualize a lot more discussions. Like one of the challenges is that every year companies are different. The valuations are different. The returns that these GPs and LPs are seeing are different. So it's very easy to kind of get caught up in one fund that's maybe overperforming or seemingly overperforming. But in reality, it's just the market, you know, baseline for that particular vintage. And I think that's a that's a huge advantage that you guys have here, especially as you're investing in in multiple funds.

19:49Yeah, I mean, there's certain like sectors and sub sectors, right, that can outperform during periods of time. And that's I mean, this is what benchmarks are really for is to control for the time period. So, for example, I remember looking at a manager who, you know, the marketing deck, and they did an IT services deal back in, let's say, I think it was 2015 to 2016, and they did like a 3X. And, of course, like, you know, if you get a triple, you know, your money deal, that generally is a good deal, right? And, you know, this is a good deal. But we want to remember, we're not just trying to see whether they've done well, but, like, how are they doing against their peers, right, during the same time period?

20:24So what we're able to do is look at, of course, all the different IT services deals done in that same time period. And it happened to be a very good time period to be doing IT services deals. The median was 3.6 or 3.7. So while a 3X looks really good, if all you're working off is the marketing, right? And maybe the data room that you're being given that information, it's hard to put it, as you mentioned, in context, right? And so by being able to have a much broader set of information about what deals have been done over time, the outcome of those deals, and they're on different metrics, either just performance outcome, a mark, or operational metrics, we were able to see that, yes, this manager did really well on that deal, but more than 50 % of the deals done at the same time period were actually better.

21:10right and so that puts that in perspective the way i think about track record evaluation as a limited partner and i've been doing this for 25 years now is that you know we're always dealing with like a like an incomplete picture right like a puzzle right and so you maybe we have certain pieces of that puzzle that we can put in to try to see and the picture is whether they're good right at what they do and more importantly whether they can do it over in a repeatable fashion and i think that our data and our data advantage has given us the ability to put more of those pieces into the puzzle to have a clearer view.

21:44Not perfect, right? Because again, we're dealing with a lot of unrealized noise in historical track records, right? That you never know how that's going to outcome. And again, as we all know, past performance isn't necessarily a predictor of future performance. But what we know is that we feel like we have a higher conviction in being able to identify the managers that at least the way I would put it is have a higher probability of being in that top portal or decile, right? We don't always have every manager in the top portal or decile, but what we're looking at is have our worst managers being good and our best managers being exceptional, right?

22:20And if we do that in a portfolio over and over again, as we have for 25 years, you'd lead to really consistent outcomes.

22:26Alex Abell: How are you doing this on the operational side? I get the, you know, looking at the fund or thinking about getting the right return for the fund based on the companies you're investing in, what valuations you're investing in. What about operationally getting these companies to perform at a level that actually creates organic value inside these businesses so that the funds can exit it at a multiple that actually returns the fund at a healthy level or above, let's say, market benchmarks? So as a fund of funds, right, we're looking at managers. And what we're really looking at is their capabilities and resources related to what we'll call value creation, right, operational value creation.

23:02And, you know, over the years, that has meant very different things, right? So I've been doing this a long time. And it used to be that, like, way back in the day, managers would have, like, an advisory board of operators, right? Like, a bunch of ex-CEOs. And they would sort of maybe sometimes put those CEOs on the boards of their companies or at least talk about that as being a resource they can run. And we still see that, too, today. And that kind of like operational relationships that a manager is kind of bringing to bear their portfolio, I would say is table six. What that means is if we don't see somebody that has some sort of form of operational resources, it's very rare now, right?

23:43Especially in the lower middle market where that value creation is so important as part of the returns because we don't use leverage, to say. And so what we've seen is like a mix of other types of structures, right? That have been very successful, right? So some structures are where you have an operator, an ex-operator that's actually part of the, let's say, the general partner. And maybe that means that they are part of the investment team or maybe they are equal status. So one of the things that historically we've seen a lot of private equity is that operators have always been very much second-class citizens compared to the deal professionals.

24:18But we have a bunch of models where they elevated those people to be essentially equalism with your professionals in terms of status, but also, of course, economics and carry and things like that, decision-making. And we've seen those models work really well, right? Where you have operators that are part of the process from the very beginning, they're part of the deal teams. And the other model that we've seen, you know, that's really kind of gotten a lot of traction of a lot of managers for the last five or 10 years is what I'll call sort of this in-house functional to them. And so what I mean by that is, again, historically, a lot of the way that private equity firms were using operators, which were these ex-CEOs that were retired, and maybe they'd done a deal, now they were sort of looking for a new deal.

25:02Alex Abell: And again, what sometimes can happen is that that person may have a lot of expertise in healthcare, right? When they wrap healthcare up. But not all healthcare companies are the same, right? And so depending on how close to match their experience is, what we saw with some private equity firms is they bring in this operator to be on the board and they were trying to sort of apply what they knew to a company that was, yes, a healthcare company, but a totally different type of company. And it wasn't really valuable, right? And so what we've started to see now is private equity firms really focused on bringing in functional experts.

25:36And what I mean by that is one big area, of course, is like HR and hiring. So instead of using outsourced providers, that might be headhunters or things like that. Most of these small companies, you are adding to the management team. You are replacing folks that are not ready to make the jump from a$7 million EBITDA company to a$30 million EBITDA company. And there's a lot of hiring that goes on. Well, a lot of teams have brought that function in house because not only are they generally hiring for the book path ones, but oftentimes there's acquisitions that are being made and things like that within those platform companies.

26:10So, you know, so you're bringing in sort of functional expertise in-house. Another example would be like for software, for example, or technology-navored services type stuff. What we've seen is a lot of managers bringing in experts in digital market, right? Bringing experts in pricing instructions, right? So they're not bringing in a COO or CEO. What they're doing is they're developing a team in-house that can, almost like a SWAT team, right? That they can deploy sometimes even before they do the deal, right? Where the deal's closed, I should say. So they'll bring these folks in. One is a way of selling themselves to the seller, to be a preferred buyer, that we have these resources.

26:49In our market, most of the sellers, again, are sort of entrepreneur owners or family-owned businesses. And I would say most of the deals we see, there's some form of role of equity. So that seller is going to be a partner with this private equity firm for the next three or five years. And they're going to get a tremendous amount of return above and beyond sometimes what they originally got out of their first event. So for them, like being able to have confidence that this manager has resources and people available that they like and trust that have a plan for how to make their company that much better, that's really important, right?

27:20So we've seen managers start to bring a lot of these functional things in-house instead of relying on sort of a more amorphous advisory vote.

27:28Alex Abell: That definitely resonates with our experience. Like when I first started this business in 2019, there were way more advisors and board members involved. and then as time has gone on and the PE sponsors that we work with, they'll have an operating partner that has either deep expertise or is kind of like a quarterback on making sure that the right resources are coming into the organization. And then we get tapped every time marketing is an area that needs to be addressed and diligence or post-closed, and we're able to be that functional expert inside these organizations. And I'd say historically, it was a harder sell because people in these operating roles felt like they had a handle on it because they had industry experience or relationships, and that was kind of what the business was relying on, and we've seen that shift completely to more functional expertise.

28:20Look, I think it's valuable, and from an LP's perspective, one of the things we like about that as well, and again, every structure is a little different, right? So one of the things that's a big question mark that LP should be asking whenever they're evaluating the operating resources that, you know, a GP is using is who's paying for it.

28:37Alex Abell: Yeah. So, you know, many of the outside resources generally are paid by the company. Yes. Themselves. But that means the LP is paying, right? Because those are, at least the majority of it is being paid by capital, right? That we own those companies. Sure. So you take ash out of the company that is the owners of the LPs. And the other models, you know, the GP is paying for it as a management. right okay and what we've started to see a lot of gps create almost like separate mini companies they're you can just pass through vehicles but they're llc sometimes where that's how the operators that are part of your team get paid so from the companies usually through that llc and then paying you know these operators and the llc is generally not made to create a profit right so that's, that's something that's pretty important.

29:28Um, but it's made to facilitate the ability to have like all these multiple people that, you know, they can actually utilize across, let's say that could be 10 or 15 or more companies within these managers portfolios. Right. And usually build that sort of some sort of arm's length way. Right. And that's, and that, and that again, understanding how the GP is actually doing that as an LP through your due diligence process is a really important part of getting the trust that what they're doing, you feel like is not just effective, but also effective from a cost perspective for the LPs.

30:01Alex Abell: I think that model works a little bit better than having almost like a captive team in most cases, because for the GP, the economics break after a certain point. Like you can have a few operating partners, depending on the number of portfolio companies you have. But if you try to build out a full out team, the economics stop working for the firm in terms of the firm's own margins and operating capital. Yeah, that's more extreme in our part of the market, right? Because we're dealing with funds that are generally pretty small, right? So the median underlying fund size in our primary fund portfolios is right around$500 million.

30:37So most of the managers at a$500 million fund are not getting wealthy on the manager. No. They're hoping to get wealthy on the carry interest.

30:47Alex Abell: Yeah, exactly. Yeah. And as an LP, that's one of the reasons we like these managers of the size, because we're very aligned, right? So they generally are only making money when we're paying them their carry, and that means we're making money as well. And so what we tend to see is that the structure of these operational teams and how they use them can often evolve as the manager gets bigger. So as the manager gets bigger and bigger, we go from seeing a lot of outsourcing, right? And even like just outsourcing the sense that like you said, it could be an established group of people, but their paychecks are being paid by the companies to a point where you might be bringing certain people in-house sometimes just to manage that group.

31:27Right. Or it might be someone who's like, as you think you mentioned, the quarterback. Your job is to figure out what we have in-house, what other types of resources like you guys, right, that they could bring in as a way of like adding value to their companies. And almost every case, they're still bringing in outside parties for various, you know, certain very specific tasks. Because it's very hard to get a team that has everything covered, right, as part of that process. And that's really important. But I think that what we're seeing is that from an LP's perspective, those resources and finding a way to create a very systematic process of how you deploy those resources is one of the things that can differentiate a Mac.

32:08right and as we look at like are we going to invest in one of 300 managers over the year like it gives us you know that that being able to see that process and really a well thought out process that sometimes begins even again you know during the due diligence process you know gives us a lot of conviction that they they have the ability to do this in a reputable

32:27Alex Abell: way right we'll get back to the show in just a moment but before we do one of the most common and important value creation levers that we hear about on the show from private equity investors and our own PE partners is go to market. Yet when these same PE partners bring us into their portfolio companies or new target investments that they're exploring, we find that the marketing function is quite immature, underutilized and under optimized. And so that's a huge opportunity that we see inside these companies. And if you have a portfolio company that you feel like it's scale a lot faster to drive more pipeline and revenue, or you're looking at a new investment where you feel like that could be core to your investment thesis.

33:08Alex Abell: Well, we'd love to explore that with you and figure out how we can partner with you to drive more enterprise value creation on the marketing side, similar to the way that we've done with major PE firms like TA, Updata, HG, SDG, and many more. At this point, we've done hundreds of engagements across hundreds of industries and verticals, and we have a ton of benchmarks and frameworks that we bring to these engagements to help you drive as much enterprise value as quickly as possible. So if that sounds like something that you might be interested in, you can just email me directly at shiv at howtosass.com or go to our website and schedule a demo and we'd love to speak with you about it further.

33:45Alex Abell: And now with that said, let's get back to the show. One of the trends, especially with valuation multiples and operational excellence is more important now than ever before, right? Like these companies need to create enterprise value organically than ever before, because previously you could just layer on M &A and kind of scale the thing, find efficiencies and flip it. I'm hearing that a lot of GPs like having a unique angle to value creation and building that in-house is is critical to winning deals and, you know, passing those hurdle rates and generating the kind of return that you would want as a fund.

34:25Alex Abell: And so how do you marry those two ideas where at the same time, like some of these funds are too small, they can't really afford an extensive team. They have to rely on external partners and then also still having a unique perspective that allows you to actually generate alpha for the fund. Yeah. So, again, I think when managers are small, their funds are small, right? You're really leveraging as an LP as we're evaluating them. We are seeing how they're leveraging their own networks, right? Because they may not be able to bring those team members in-house, but do they have the relationships with, let's say, former people that have done all these things that they can have the companies hired?

35:04So, again, they don't have a big team themselves necessarily when they're$300 million fund size. But as they grow, they start to bring the resources both in-house. But what's critical is that those GPs, the senior people, have worked with those people in the past and have ideally proof books. So one of the things that we see often, which is also very common sometimes in the venture world, is we're seeing repeat CEOs, right? Where a manager has worked with a CEO, they've been successful in another company, and then they go out and there's actually some GPs that have a very specific strategy where they bring on a CEO that they've worked with in the past to go find the next deal, right?

35:44And they are going out there and sourcing alongside of the general partners in the investment profession. is. When they find interesting companies, they are helping do the due diligence on those companies with the idea of implanting that CEO as the CEO of that company once the acquisition occurs. And usually as part of that, it often requires that CEO to put a bunch of their own money into the deal to make sure they're aligned with the private equity firm. And so what I would say is that for smaller firms, finding unique ways to leverage the relationships they have to add value, And then as they grow, they can expand that network in a more robust way because they just have more resources to throw around, right?

36:23Both internally as well as externally. So what I think is like, you know, critically important, you know, that we've seen is that most of the GPs that have been very successful, you mentioned sort of like having a playbook or, you know, like, and I think that like that's really important, right? So we've seen some GPs that have had very rigid playbooks, right? Where they come in, they say, okay, here's what we're going to do to your company.

36:48Alex Abell: and either you're on board or not and you can pick us or don't, but that's what we're going to do, right? And that sometimes is very successful. There's a couple of really big firms that have grown over time because they've done that very well. But I would say that most of the managers we meet are trying to find a partnership really with the existing owners, right? Because again, those owners tend to have a big share of the equity. So what they want to do is make sure that owner is okay with a plan that they talk about ahead of time of how they're going to and what they're going to do. And I would say the most successful GPs that we've seen generally have a very specific way they attack the same types of problems in their companies, right?

37:25So we have one manager that I like to say has a great saying about they don't buy the A assets all the time. But A buy is, he describes it as companies with crooked teeth. And what he means by that is that there's something about that company that they can identify they're not doing very well, right? It could be like, you know, like retention rates for a software strategy. It could be, you know, manufacturing efficiencies, but that they have the expertise as the GP because they've seen it before, right? In previous deals. And the crooked teeth metaphor is we can put braces on. It's something that can be fixed, right?

38:03It's something that can be, that we can identify that can be fixed. And once you fix it, you have a very shiny, nice asset that you can itself, right? And those are the strategies I think that have done really well, where they're very good at identifying those things ahead of time because of the expertise of the investment professionals and also because the outside and internal resources that have been.

38:23Alex Abell: Yeah. Yeah. I think that's a really, really great insight, which is that a lot of these firms, especially on the lower end, can benefit from having that unique approach outside of what, let's say a traditionally larger firm like Vista or Insight might be deploying with larger teams. How do you as an investor in these types of funds, how much of the operational side is factoring in your decisions versus the data side that we talked about earlier on the call when you're benchmarking against other funds and things like that? What's the determining factor? Yeah, I mean, again, I think it's going to sound like a weak answer, but it depends, right?

39:04So again, all of that's important. I would say that today, there's very rarely a case where we go and find a manager, we find a manager attractive that doesn't have a strategy that is heavily emphasized in operational value creation and conversation. It is so critical of the types of companies that our managers are focusing on in the smaller part of the market because we're not generating a lot of leverage. I'm sorry, we're not doing a lot of returns from leverage. The leverage used in our part of the market is significantly lower than what we see in bigger deals. So it's not financial engineering.

39:38It's really growth, right? And generating growth through improving something or multiple things about what those companies are doing. And I would say the way that the data works is that it's a way of validating our thesis when it comes to things like their operational value creation, right? So the data helps give us more conviction that we see proof points that that's worked. So when we do an evaluation of a manager, our focus is very much at the deal. So we are going through case studies of every deal. We're looking at investment community memos. We're looking at how they identify risks as sort of the upsides of these companies.

40:14And then we're looking at what happened. And what we want to try to do ideally is sort of like pull a thread through every deal that sort of shows a common denominator of how they got to a good outcome. if there's a situation that's very kind of like one-off, right? I've had GPs that like pitched me and said, oh, well, you know, we were able to, we did really great on this deal because, you know, one of our partners, roommates in business school, you know, had somebody who was an expert in this particular area. We were able to bring them in to this deal we did because we couldn't find anybody else.

40:50And then the deal did great. Well, that's a horrible story for an LP, right? Because how many roommates from business school have specific expertise in a deal you've done? That's not a process. That's not something that's repeatable. So for us, the data helps us validate that they are doing what they're saying they're doing in these portfolios and gives us a more clear picture of it.

41:11Alex Abell: Yeah, totally. Yeah, I think leveraging both of those areas and combining it into some sort of a unique perspective is the key. So that's definitely helpful. What about on the people side? Like, are you evaluating the leadership teams? Are you underwriting the assets inside these funds as well? Like, how involved are you getting in the micro level of these funds? Yeah, all of the above. So we're looking at every underlying asset. So, you know, one of the things that RCP does, we've been talking most about primary fund investing, but we also have a secondary funds. And we also have co-investments, right?

41:45So we have a lot of people in-house that have expertise in direct deals and understanding and evaluating underlying companies and all these portfolios. So we utilize that as a way of sort of, let's say, looking at their past funds, most of which maybe have a lot of unrealized information in it, and doing really a bottoms-up evaluation of what that fund is likely to do. We call it as mark-to-exit. So we talk to the manager. They give us their predictions. We look at the underlying companies. We put in our own models as well, and we get a sense for what that fund's outcome is going to be maybe five years from now.

42:20Now, we're not always right. The GP is not always right. But what we're trying to do is get a sense for, let's say, the potential of those underlying portfolios. So looking at their assets historically on the primary side, when you're investing in what is generally going to be a blind pool or maybe there might be a deal or two in there, is really important to understand. And then the people is quicker, right? Because at the end of the day, you are investing in a blind pool as a primary client LP. And what you're really doing is taking a bet on individuals, right? Not just the individuals, but obviously their strategy and how they work together.

42:52But at the end of the day, who those people are, whether we think they're great investors or not is really correct. And the way we figure that out is through a variety of ways. One is our interactions with them over many, many years. So most managers that we back, even if we haven't backed a previous fund, because we're a specialist and focused only on this market, we've been talking to them in some cases for 10 years. We've gotten to know them pretty well. The other thing that gives us a big advantage is because we are a co-investor and we'll look at deals from managers that are not in our portfolio, we get to see a lot of how the sausage is met behind the scenes, right?

43:29So what we're looking at from a co-investment point of view, right, even before we might be looking at from a crime and a fund investment point of view, we can see what kind of risks they're willing to take. We can see what kind of due diligence they take, right? And so it gives us a really interesting insight into the quality of that manager, those individuals as investors. And of course, like we're doing references, right? So we're doing references on people that have worked at the firm previously, maybe not working there. Now we're trying to do as many off lists, what I'll call off list references as possible on these individuals.

43:59And that gives us also, again, like being a specialist and like, you know, focusing only on this market gives us an advantage there as well, because we have lots of relationships in this ecosystem, right? With other GPs, with people that have worked for those GPs, as CEOs, with intermediaries. And so that helps us sort of coordinate on, let's say, the quality of that individual's abilities. One of the things about our part of the market is that most of the, because we're capturing a lot of these groups when they're in their first couple of funds, right? We actually have an emerging manager fund that does only first and second documents.

44:35But even our core fund, we may have like fund threes and fund fours, right? That person usually came from another private equity firm that's on, right? Either one that's gotten big, you know, they left and they started their own firm. And in most cases, we have connections to people at those private equity firms, right, that they used to work for. And again, that gives us a huge amount of insight. Now, sometimes they were more junior, right? They might have been a vice president at that time or pre-partner. But you know what? We get a lot of definitive opinions about them too. They might say, well, that was the best VP we've ever had at our firm.

45:07He's amazing, right? Or we might hear the opposite, which is we counseled them out. He had this problem or this problem. So from a people evaluation standpoint, when you're dealing with, as an investor, as a partner, that is always a critical component because you are trusting them to invest capital in assets that don't exist yet. And the assets exist, but they're not in their fund. It's very different than things like seconders. We have a co-investment where we have a very specific thing we can invent.

45:36Alex Abell: Have there been situations where like the qualitative side has outweighed the quantitative side because you do have these benchmarks? Because something can look like a great investment on paper or with data, but the qualitative side kind of overrules that or outweighs that? Yeah, absolutely. So we see all the time, you know, groups that have the track records and they've done well compared with managers, but there could be something that we identify that's, let's say, not related to their track record that gives us pause, right? So there's, I mean, there's a million things that it could be. It could be everything from this person has an anger management problem, right?

46:12We've gotten references that we've had references of people kicking in the walls of their office and berating employees. So that's one qualitative thing that's kind of extreme. But less extreme versions, I would say, are things like hoarding of economics. So again, sometimes founders will take a disproportionate share of carry compared to the amount of value that they're creating at that moment. And what that ultimately can do is create destabilization in the teams. Right. So even though they've done really well up to that point, let's say all the more junior partners are getting much less carry than they would in most other places, let's say, as an example.

46:50Well, that creates a big alignment problem that would be worried to me because those are the folks that could leave. And if we believe they are important to backing in that strategy, then that's a qualitative issue that can override the fact that they've done really well historically because that team stability might be. this. The other thing that we often look for that's, again, very qualitative and hard to sort of quantify is the interactions among the team and the dynamics of decision-making. And that comes a little bit from having experience of seeing dysfunctional interactions. A very simple example would be a situation where sometimes we'll take meetings where one partner will dominate the conversation.

47:33And even when another partner is trying to add a point, you get sort of like overrun by this one partner. Well, that signals to us a lot about what that dynamic might be in their investment communities as well. Right. And so, again, it's not definitive, but like it will add to the picture that we're trying to paint of what this group is looking like from a healthy decision making and partnership.

47:56Alex Abell: Totally. Yeah. I mean, I think on the people side, especially like having GPs that understand how to grow companies, that aren't just doing financial engineering. I think that is a huge lever inside PE firms. And then having operational expertise that can actually create enterprise value, that is more of a rare find than I myself expected. But as I work with more funds, it's clear that there are gaps in a lot of firms, especially in that seat. Yeah, I mean, one of the things that we have seen, again, like you said, it's not the most common, but what we have seen a little bit more and we tend to like is when those operational people with really significant operational experience are really part of the investment deal teams, right?

48:38Where they are not like off in the corner being the ops team. They are part of the general partnership, right? And we've been very successful with a number of managers that have had that kind of expertise as part of the leadership of the firm,

48:53Alex Abell: not just a resource that they go higher for a specific company, right? But it's rare still. We don't see that as the norm, right? You know, the norm is still mostly investment build partners, right? And that's our experience. Totally. We're coming up on time here. But as we close off, Alex, if people want to get in touch with you or learn more about RCP, what's the best way to do that? Sure. They could email me directly at aab as in boy, E-L-L at rcpadvisors.com. our website is rsbadvisors.com and there's a couple links in there that you can certainly click on to reach folks here but yeah we're happy to chat with folks and we always say as well as if you're a limited partner out there listening to this we're always very happy to share information about managers and things like that so feel free to tempt us Awesome and we'll be sure to include all that in the show notes Alex and with that said I appreciate you coming on and sharing your wisdom we haven't had many funds of funds on the call and I think especially with the way you guys are approaching things with the data side and how involved you are with these firms.

49:56Alex Abell: I think there's a lot of unique insights that you brought here that the investors and operating partners and even CEOs can learn a lot from. So I appreciate you doing this. Well, I appreciate the opportunity and it's been a great conversation. And thank you very much. Thanks for listening to today's episode. Before you take off, just a few requests from our side. Number one, if you haven't done so already, please subscribe to the podcast on iTunes or Spotify or YouTube or wherever you go to listen to your podcasts. Number two, if you are in the market for due diligence services, strategy consulting or fractional CMO services, please get in touch with us at www.howtosass.com.

50:35Alex Abell: and third please buy a copy of my new book exit ready marketing it covers a ton of concepts that we take our customers through private equity investors b2b companies ceos operating partners and marketers and there's a ton of great value in there that expands on my previous book post acquisition marketing as well so with that said i hope you enjoyed today's content and we'll see you on the next episode