Peter Lacaillade——押注私募市场最优秀的管理人——[Invest Like the Best，第437期]

My guest today is Peter Lacaillade. Peter is the chief investment officer for private investments at SCS Financial and has built one of the most respected private equity allocation platforms in wealth management, overseeing $50 billion for ultra-high-net-worth families and earning the same access as top-tier endowments to the world’s best managers. He shares how SCS’s pooled-vehicle structure enables them to compete with institutional giants for the best funds, avoiding the adverse selection that plagues most wealth platforms. Peter shares his investment philosophy across lower-middle-market buyouts, emerging independent sponsors, and early bets on category-defining managers like Thrive Capital and Shore Capital. We discuss what separates exceptional private equity managers, the evolution of the industry toward AI-powered strategies, and private markets going mainstream.

To start, I really enjoy the line, “Private equity is a force for good.” People are going to be surprised to hear that. Why do you think that’s true?

1. Private Equity Creates Value

I believe it to my core, both in investing and in the alpha that I believe we can generate for our clients, but I also see it firsthand, having seen multiple private equity owners as partners with the firm we invest in or that I’m a part of.

I think that, when done well—and actually, I have a family business that was transitioned in a very great way to a private equity platform, so I’ve seen it a bunch of different ways—private equity has major advantages over public markets because you’re getting long-duration capital. They’re not thinking 3 to 7-plus years; they’re thinking strategically when done well, and they have major advantages over people in the public markets who have to manage quarter to quarter and deal with that volatility, et cetera.

The returns, if you look over 25 years, show a consistent 3% to 5% alpha that you get from investing in the private market, and that is probably appropriate given the illiquidity. However, one thing I love about private markets relative to public markets is that there’s the ability to pick top managers who persist over time, or structural things that enable us to have conviction that we can deliver top-quartile performance consistently. If you do that, you can get another 5% plus on top of the 3% to 5% that you expect over public equities, which basically equates to high teens, low twenties.

What they’re doing is changing system settings in a way that would be impossible, probably, in public markets or without real total control over the business. Is that the reason that it’s possible?

To go back to private equity being a force for good, when I say that, I’m actually talking more about the companies themselves and the way it works. I’ll back up. SCS is a founder-led company, founded in 2002 by a guy named Pete Mattoon and a few other folks who had a vision that the private wealth space had a real gap. You had the investment banks like Goldman Sachs on one side, which had great brands and investment capabilities but were very conflicted in what they did, and then you had independent shops that were good at trust and estates advice, aligned, but not that savvy on the investment side. There was a gap in the market.

They grew it to $7 billion at the time I joined in 2011, and a few years later, we did a deal with a firm here in Greenwich, Stone Point Capital, because we had a few early founders who were no longer involved, as well as a family or two that put us into business. We needed a liquidity solution, so we sold 25% of the equity to Stone Point. Stone Point was an incredible partner.

I might be a little off on the dates, but in 2016 or 2017, we at SCS were transitioning from gen 1 to gen 2. We needed to do a more holistic solution. Stone Point bought a firm called Focus Financial. Then you fast-forward: they took it public. You fast-forward a little more—we’re talking about 2021 or 2022—and Focus, at that point in time, had grown to about 90 firms and $400 billion under management.

But you basically had 90 firms doing 90 different things. Clayton, Dubilier & Rice saw the opportunity to take it private and actually integrate the company a bit, really leverage the scale of Focus across investments, technology, and a bunch of different vectors, and not have 90 firms doing 90 different things, but organize it into various divisions or hubs that are best in class.

The core mission behind Focus is really putting the client at the center, but these changes really benefit the client first, then also the employees of the different firms, and ultimately the investors at the private equity firm. So we’re about 18 months into the take-private. It was the end of January 2023 when the take-private was announced, and then it was delisted around Labor Day of ’23, so about 18 months ago. Of the $400 billion of assets, they’ve now consolidated from a balance-sheet perspective and aligned over half of that, including myself.

I had independent shares in SCS, so we had a revenue share with Focus and traded those partner shares to be part of the One Focus situation, as have the majority of the assets within Focus. So we’re all rowing, aligned, rowing in the same boat.

I believe that we’ll be able to solve our clients’ issues in much better ways, and it’s been a shot of adrenaline, too. It’s locked people in, it’s inspired people, and it’s enabled us to bring in really great talent we couldn’t have otherwise brought in: Lane McDonald, our new CIO, who had previously run the family office for the Johnson family of Fidelity, Harvard Management Company before that, and then had a career in private equity at 3 different firms.

And actually, you’re in the Boston area. He’s a bit of a celebrity from his Harvard and USA Hockey days, but literally the best CIO partner I could possibly imagine. Prior to the Focus take-private by CD&R, there was no way we could get Lane. We also brought in a head of client service, Adrian Penta, who just started a few months ago, and 3 or 4 other really senior, awesome hires at SCS.

We wouldn’t have been able to do that otherwise because they’re definitely incentivized and inspired by the vision we’re pursuing, which is to really be the best firm in wealth management, period. This is the ultra-high-net-worth end that we serve, and the other firms at Focus serve the high-net-worth end. So now, if I run into a client who is below $25 million, I’ll refer them to my colleagues at Focus, and we’re going to enhance our capabilities just across the board.

So I think private equity, when done well, can really be incredible for businesses across all different vectors. That’s not to say there aren’t bad actors, but from firsthand experience—and, of course, there’s the investment thing—talking as an employee of a private equity firm, what has me so excited for the future is that private equity plays a big role in that.

One idea that I think is really interesting around this private equity thing and the scope of your business is to understand your specific platform, how it is so similar to all the other institutional allocator platforms in size and sophistication, and that that then can fuel a better wealth management experience for the families that trust SCS and now the broader ecosystem that you’re going to serve—the ultra-high-net-worth or whatever.

One of the reasons that wealth management sucks is that there’s a horrible adverse-selection problem, and so any alts that they get suck because they’re last.

You've built something different, which is, to me, one of the most interesting things about SCS. It's wealth management, but you're in the same breath as these important bellwether LPs that other people look to to see what's interesting and new. That's the opposite of what happens in wealth management. Something interesting must have happened, so what would be the headline stats that you would hold out?

2. SCS Reaches Institutional Scale

Now we have over $50 billion under management.

At SCS?

Yes, with approximately 500 clients, so an average client of about $100 million. Because of their wealth, they can have an allocation to private equity or to alternatives, and a lot of private equity that resembles what the top endowments, foundations, and single-family offices have. Our typical client at SCS might have a 30% target allocation to private equity, another 10% or so to opportunistic credit and real assets, et cetera.

So you've got $50 billion.

Yes.

That sounds like Harvard or Yale, or any of these very big, famous foundations that have been the allocators of choice for the marquee private-asset managers.

Yes.

What's interesting to me is that everyone talks about how wealth management as a channel for new capital is going to be so important as endowments and others are tapped out or fully allocated. I'm curious about the ingredients for this. It seems like there are going to be more people like you who try to build an institutional-grade, bellwether allocator that's in the same breath as Yale, but serves the wealth-management market and the private equity as a force for good concept.

First of all, as I mentioned, the families themselves are very wealthy. They have enough money to keep in fixed income and cash to fund their lifestyle and deal with things, so they can have a sizable amount of capital that they lock up. We have a flexible model, but as I mentioned, the average family is somewhere around 35% to 40% in privates. Some people, myself included, are personally 60% to 70% in privates. I'm comfortable with that, and I believe in the long-term return potential.

There's a huge opportunity in wealth management generally. If you look at smaller families, they might have a typical wealth-management client with $5 million to $15 million. They can't have that type of 30%, 40%, or 50% allocation to privates, but they can probably do 10% to 15%, and maybe it's 2% or 4% right now. Often, it's in multifamily real estate or something that has an income component, and it doesn't have the upside of the buyouts and the venture stuff we do.

3. Pooled Vehicles Win Access

The other really key component to our success—and we've seen other competitors, firms that look like us, start to copy the model or just adopt the model that we went with from the beginning—is that we use pooled vehicles that we set up every 2 years. We get the money from our clients, and then we allocate across a series of different funds and co-investments.

And they're committing to those funds?

We call them pooled vehicles. They're structured much like funds of funds, although our underlying clients, or wealth-management clients at SCS, just pay a single asset-management fee. We make the same fee whether we're putting them into Parametric, which does tax-efficient indexing, or into private investments. We're not biased toward putting them in privates first. We're just trying to do what's best from an asset-allocation perspective.

Yeah, yeah.

Our approach has been, where's the alpha? It's in private investments, specifically private equity.

Yeah.

That's where we want to use our illiquidity budget. In the more efficient areas of the market, like public equities, we are largely doing a lot of passive investing, because our underlying clients are largely U.S. taxpayers.

And so the pooled-vehicle thing—which is an interesting structural innovation, maybe—what does that unlock? Is it just certainty, so you can then go to the GPs of the world and feel like Yale or something?

Yeah, exactly. There are a couple of things I would say. Yes, the pooled vehicle enables us to do that, and we've actually found that you don't want to do it every year. You want to do it every 2 years, but you don't want to do it every 3 to 4 years. With 2 years, you get the right mix of underlying buyout, growth, and venture funds and co-investments, because we want to have diversification across these different sniper, laser-focused people who might be doing subsectors in defense, like Eagle River, or healthcare software, et cetera.

The venture funds often raise in 2-year cycles, so it's nice. Thrive or Founders Fund are basically in each vintage vehicle we set up. You're going to have that fund. But it gives the optionality that if we have a client—say they're an entrepreneur, they start with $50 million with us, then they sell their business and go up to $250 million—they can flex up accordingly in their allocation.

And each time, they are choosing with you the amount of their marginal allocation to the new pooled vehicle?

We're doing cash-flow modeling.

Do they generally take your recommendation?

Yes.

So in some sense, they are committing, but they trust you.

What we're trying to do is—let me just run some simple math for you. Let's say you're a $100 million client of ours, and we want to have you be 35% private equity. The rough back-of-the-envelope math—this is a little SWAG—is that in order to get to that NAV target that you have, say you want to have $35 million of NAV in private equity, you need to commit a third of that allocation per year, somewhere between $10 million and $12 million annually.

We do it every 2 years, so you would commit, say, $20 million. Twenty is probably good. You're going to commit $20 million to the vehicle we're setting up right now, which is called Private Equity 10. Then you're going to commit—hopefully, your portfolio's growing a little bit—you might commit $21 million or $22 million to Private Equity 11, and $23 million or $24 million to Private Equity 12.

When you get to year 6, the modeling would suggest that your NAV—and hopefully your portfolio's grown a little bit—will roughly be at $40 million. You're going to be at that 35% target NAV. You're going to have an unfunded liability. You're trying to be 35% private equity, and you probably have to have about 15% unfunded, but we just manage against that.

If you get divorced—God forbid, I'm sure you won't—or if life changes, then you can toggle down. That's how we do it. It's really about thinking very long term. I think it's very important to get the vintage diversification.

Doing this now for 14 years at SCS, we're targeting our bar. If you think of the market generally, the private-equity market generates multiples somewhere between 1.8x and 2.2x, with IRRs between, say, 10% and 15%. That's roughly the average private-equity return over the past 25 years. Some vintages are better than others, and we're trying to generate—what we're striving to do in our program is generate—top-quartile returns, which is typically going to be an additional 5% or more of return above that.

We're targeting IRRs in the high teens to low 20s. We put in our book 16% to 18% net IRR, with a multiple roughly around 2.5x. Certain vintages, I think, will have the potential to be north of 3x. But then you get a bad vintage in the COVID era, where you had really inflated multiples out there, and you have to grow into these purchase prices that people paid. You might end up in the low twos, and your IRR might be mid-teens or low teens in the top quartile.

What's really important is to be consistently investing in the asset class. I worked at HarbourVest Partners in the secondary group between 2007 and 2009, but there was a lot of enthusiasm around large-cap buyouts leading up to that, including Blackstone. When I joined SCS in 2011, I looked at a bunch of our clients' portfolios and their legacy wealth managers, and they were just chock-full of large-cap buyout firms from 2005 to 2007. That's not a great vintage.

Because of the global financial crisis, a lot of people took a pause, and they missed 2009, 2010, 2011, and 2012. Then maybe they started getting excited again, and those were the best vintages. They get excited again when things start to heat up. I think it's really important to be consistent in your allocation so that you capture the really good vintages.

Through the unique way that you've structured it, and maybe the unique capital base that you've gotten to work with—these very high-net-worth families—you've created a situation where SCS is a privates-heavy allocation, but it is an allocator that feels like the great institutions out there. All those things you just described are the means to that end.

What are the biggest risks? The trend seems to be that everyone is saying wealth-management clients need to go from zero-ish private-equity exposure to much, much higher, and the reason is better returns or risk-adjusted returns, et cetera. You've been doing this a while now. What are the big risks that you see in allocating to private equity now, if we're about to get this big wave of a new source of capital doing so?

4. Private Equity Brings New Risks

I think you run the risk that a lot of people are going to have pretty mediocre experiences in private equity, because a lot of the products being put together to cater to the high-net-worth or even mass-affluent market are done by really large-cap shops in vehicles with a lower cost of capital. They might be targeting 10% to 12%.

And if they undershoot on that, you might end up—

T-bills plus—

You’re in private equity. Yeah, exactly. So I think that’s the risk. The cost of capital for some of these evergreen private equity vehicles is far lower than the standard players. I’m talking specifically about a very high-profile secondary sale that had been in the market a lot.

The bids from the sophisticated buyers for these assets came in at mid-80s pricing. Then a couple of the evergreen vehicles—interval funds that have been set up to raise capital and need to put it to work so they don’t have cash drag—bid in the mid-90s. So there’s a 10% spread between folks that, candidly, have big funds and want to put the money out. I don’t know exactly what they’re underwriting to, but they were blown out of the water by these new sources of capital that really need to put money to work.

We executed a trade. We sold some of our direct-lending private credit from the ’18, ’19, and ’20 vintages—stuff where the underlying companies maybe weren’t the best vintages of private equity. We got par and the tightest spreads. We got par from an interval fund buyer.

I think the risk is not that there’s a blowup or a catastrophe or something like that; it’s that it’s an underwhelming experience, because you also have the friction of the various fees involved that are going to drag things down. Then the other risk, and we saw this with Bre, is that people think they have quarterly liquidity. There are gates. Oftentimes, when things happen in markets, everyone rushes for liquidity at the same time, and they can’t get it.

I think people need to be really clear that, yes, in a normal situation, you’re very likely to be able to get quarterly liquidity after a 2-year lock, but you have to be prepared for a scenario where you’re actually locked up for 5 or 6 years.

So really, the risk is that you get results having given up liquidity that you probably could have gotten for very cheap, very liquid alternatives, be that public bonds, public stocks, whatever.

The beautiful thing about SPY or whatever is that you can buy this morning and sell this afternoon if you want. In the business that you’re focused on, and you’re getting in bed with a person or a couple of people leading the firms that you give this money to, what lessons have you learned that you would coach the next generation of people who want to build a great private allocation platform in wealth management or something about getting that piece of the equation right? What are the big lessons learned?

5. Character Drives Manager Selection

I would say this is very obvious: You’re getting into a partnership that usually is a 10-year term plus 3 years, and then there could be extensions beyond that. These things are often lasting 15-plus years, which I think is longer than the average marriage. You really need to know the character of the partner that you’re investing in and understand that they’re going to be good partners in good times and bad.

If you have people who are very focused on themselves and greedy, that can cause real disruption with teams, which can cause firm instability and make for real issues in the underlying stability of the team that you’re partnering with for this 10-year-plus horizon. Fortunately, we’ve had a really great set of partners generally. But where we’ve had issues, we often back real kind of alphas. I think that’s great, but some of the ones we’ve had issues with have had controversy around them, and when they’ve faltered, people are ready to kick them when they’re down and the team isn’t cohesive and things like that.

So I think that can be a risk. In the due diligence, what’s really important is not to get stuck in the echo chamber of doing the on-list calls and talking to the other LPs that are doing the fund, because you can get a lot of positivity if you’re just listening to the people who are fans.

One thing I’ve really done, and continue to do—I was talking about this with my colleague today—is really making sure that we are trying to find contrary views or people who are not doing the fund. I don’t even do many on-list reference calls. I’m generally just assuming they’re all good and focusing on going off-list. But it’s also really important that you know you have very trusted relationships with people on the other side of the phone.

There’s an example I can think of recently with a fund that we passed on where another LP had shown it to us. They had spoken to this group, looked great on paper, had great presenters, et cetera. They were very excited about it. My colleagues brought it to me. I thought it was interesting. I know one of my good friends works at that firm, and I called him. It was like, “Don’t walk away. Run.” He gave me a lot of detailed reasons why we should not do this fund and why we should not back this person.

We passed this along to this other LP, and he goes, “Oh my gosh, I just spoke to that person’s boss, and they said the most amazing things about them.” I’m like, “Yeah, well, that’s the company line.”

Just to summarize, you have to be investing with really great people, but also people who have great character and integrity and are going to be awesome long-term partners, because nothing’s a straight line. You really need to make sure we have both those things when we make investments.

What’s your most direct and honest assessment of the wealth management industry?

6. Wealth Management Has an Access Problem

It’s a huge industry. It’s close to $160 trillion globally. I think there’s a $90 trillion-plus pool of assets in the US, and generally, I think it’s pretty crappy. It’s not great.

You have the banks like Goldman Sachs, Morgan Stanley, and JPMorgan. They’re great firms. They can do nice things on the lending side, and they will do interesting deals from time to time that they’ll offer up to their clients. But in general, I think you get real adverse selection doing private investments through those platforms, because they have fee arrangements with these firms, and they will only put a firm on the platform if there’s some fee share.

The best funds are heavily oversubscribed and don’t take wealth management dollars. There are exceptions, but in general, you have an adverse selection of funds on wealth management platforms. My advice to my friends who ask me what to do is, maybe there are certain credit funds. If you go plain vanilla on something like that, you can be fine; you may not get hurt.

But I don’t think in the areas where there’s a lot of alpha in the market—small buyouts and venture capital—those are really nonexistent on the large private wealth platforms at the banks. You just don’t know. You’re like, “Why am I being shown this?” There are fees, incentives, and conflicts involved in most things that are being shown to the clients. They’re showing something because they got a deal.

If you think of the large-cap buyout world, there are some firms that are oversubscribed, one-and-dones, and are really great firms with great cultures and are very hard to access. They probably don’t have much, if any, dollars from the wealth management channels. That’s just a fact.

Then there are others. They don’t want to do that because they’d have to pay the bank. It’s like a placement-agent fee. It might be 50 basis points or 100 basis points of management fees, something like that. Whereas the folks that often do it need to raise that money. They’re not really oversubscribed.

Sometimes what you’ll see, too, is that you might have a really good firm. They don’t have their flagship product that’s oversubscribed on the platform; they have the new thing that they’re starting, whether it’s a new sector-focused fund or geography. It’s the upstart thing that they need to launch. So you might not even get the best of these large firms. That’s the issue on the banking side.

You also don’t have, on average, families over $100 million. A typical wealth advisor is really not as steeped in trust and estate stuff and the complexities of larger families—

Oh—

—like some of the boutiques are.

There are a bunch of boutiques out there that are really good at helping you with your estate, doing bill pay, or providing other family office services, but they might not have a very robust investment platform. The vision for SCS, when our founder, Pete Mattoon, started the company in 2002, was that he had had a liquidity event himself. He was looking for a solution, and he was like, “Wow, there’s a huge gap in the market to bring these 2 things together”: having a world-class investment platform that looks like the best single-family offices and the best endowments and foundations, while also being very client-aligned and sophisticated on the family office side.

There are a handful—probably fewer than 10—of firms out there in the country that have achieved really significant scale like we have and deal with these types of families, because it’s hard to get to, and scale is really important. If you’re a $1 billion or $2 billion firm, you don’t have the scale of assets to be as relevant on the investment side.

I was really fortunate to join SCS when we had $7 billion, and now we’re at $50 billion. But I feel like to have a really attractive program in the alternatives space, it’s difficult to do that with a sub-$5 billion portfolio.

I understand the banks and their problem, and then subscale is a problem. Then there’s this other middle channel, which is the roll-ups, other big collections of RIAs, or just big individual RIAs. But I don’t know of many of those—maybe Iconic's an exception, where Iconic has seemed to have been able to develop an alts investing program that’s respected and sought after or whatever.

I can't name 5 other ones. So why is that not the case? There are other places as big as you, but they're not a sought-after LP yet.

Yeah, and that's an opportunity for them. I think you need to have coherence across the platform.

It's one of these things where the best time to start that was in 2011, because it takes time to build the reputation—

It takes a lot of time. There's real luck involved.

Yeah, sure.

I stumbled into the job I'm in to begin with. I was going to go and be a lower-middle-market buyout and growth-equity investor, and it was just through networking that this guy was like, “I don't have a job for you, but the guys who manage my money…” I wasn't thinking about private wealth. I didn't know what a multifamily office was. GPs were really open to taking my call in 2011. At other points in the cycle, it becomes harder to get access.

Right now is a good time to be launching a program. I think it's been a tougher capital-raising environment because distributions have slowed down, and then you layer in the fact that the endowments and foundations are in a tough spot right now, and there's a lot of uncertainty around funding and taxes. I think there is room for a number of new players to go into the wealth-management area, but I think the scale is really tough.

If I weren't at SCS—and I'm in it to win it here and really love the vision of not only SCS but the Focus platform that we're a part of—if that weren't the case and I were going to start something, one of the key things is I would want to start with an asset base of around $5 billion going to $20 billion, because I think that scale piece, that first couple billion, is really hard because it's the chicken-and-egg issue.

One of the things that I think is so cool about where it's all going is that you, at SCS, now being one of the investment leaders of this much bigger platform, get to see everything that's emerging at the frontiers, how things are changing, and sort of who is best and what they're doing. You're a great person to ask to dispatch from the front, saying, “Here's what's happening, here's who's good, here's why.”

I thought it'd be fun to do a round robin, almost, of what is changing at the edge of different asset classes. Maybe we'll start with private equity, since I know that's one that you spend a lot of your time on, and we can take this in subcategories, too. We can talk about independent sponsors, we can talk about the big buyout firms, we can talk about platforms.

What do you think are the most interesting things that are changing about private equity as it's become a very mature industry over 50 years or so?

So, buyouts at the large end—this has been happening for a long time, but the bigger buyouts are definitely moving toward asset managers. One thing that a lot of those firms, like Blackstone, KKR, Carlyle, and Apollo, are focused on is having vehicles that cater to the mass market, interval funds or things like that, and really also having more customized solutions for their big sovereigns or whatever it is.

They're not private-equity investment firms; they're asset managers, and they're some of the most important asset managers in the world. That's not where we spend a lot of time and play.

Why not?

7. Small Buyouts Create Alpha

Because we think that by going in the smaller end of the markets, we're taking on maybe more risk, but you're able to buy into things at lower prices. You can do more operationally and improve these businesses, and then they can be sold up the food chain to these larger players, into these places that have lower cost of capital. And that has continued to evolve.

I think it's not happening overnight, but one thing that is interesting about those big places is that they have become maybe more like investment banks than private-equity firms.

What does that mean? Bring that point to life.

You go join Blackstone or whatever after your stint in banking, and you're really just cranking through models. You're not really on the front lines with entrepreneurs. It's more about financial engineering than it is business building. I'm making generalizations, but I think the size of what they do—

But that makes sense for them with their low cost of capital. They don't necessarily need to deliver the same return.

Yeah, I think they are targeting lower cost of capital. They're really focused on, “Okay, what kind of premium are we going to get over public equities? Is this suitable?” There's a real emphasis on credit from these shops because it's very scalable, and a lot of their end clients are not taxable. They're less sensitive to that sort of thing.

I would say that the cool thing at HBS maybe 10 years ago was to go back to your firm that you'd worked at or go back to Blackstone, Carlyle, or KKR. Now, I think a real trend that has been going on for many years, but is really accelerating, is actually to not go back to these big shops, but to become an independent sponsor, to do a search fund, to go do a roll-up in a certain industry, and maybe that leads you to building out your own private-equity firm.

Royce Yudkoff teaches a class at HBS, and there have been some real success stories. You had the Garnett Station guys on, who we both know and are good friends with. I think they have been inspirational for the next generation of leaders. That is an area that we're spending a ton of time on.

We've been backing lower-middle-market firms for a long time. Since I started in 2011, the majority of our buyout investments were in these smaller-cap businesses or firms that were going after smaller-cap businesses. When I say that, maybe just to back up for 1 second, what's the thesis around why lower middle market versus mid-market versus large cap?

Lower middle market varies depending on the business model and industry dynamics and growth, et cetera. But say a typical small business will trade for, say, 5 to 6 times EBITDA on the low end. Maybe if it's a really great business with high growth, maybe it's, say, 5 to 8 times EBITDA. Whereas when you scale that and take it from somewhere in the $2 million to $7 million of EBITDA and it grows to $20 million-plus, then that is valued by the market somewhere between 12 to 16, 18 times.

The multiple you can sell that business at is twice as big as what you paid, or significantly ahead. Now, why is that? You professionalize the business. You put in financial-reporting systems.

It's hard.

Yeah, it's really hard work. And why did it grow? You made different acquisitions. You expanded into different markets or built out your sales force, et cetera. You did a bunch of things that have made it a more stable business.

You don't have as much customer concentration, therefore banks will lend more money to it. And this is a tale as old as time, something that is very repeatable and something to go after.

When I started this in 2011, most of these emerging firms were people who were spinning out of other shops. There were a number of them, but it would usually be a mid-market firm that got big, and 3 junior partners decided to go off and—

Leave to do the same thing.

And that still happens. But now, with the rise of these independent sponsors and search-fund people, the lines kind of blur together in what you call these things. I think part of what can be different there is that these things are usually focused on very fragmented, aggressive roll-ups.

HVAC is one that everyone talks about.

Love the HVAC roll-ups.

We're seeing things in youth sports. Accounting is something that's gotten some heat. We have a landscaping company we're looking at. It goes on and on and on.

If you see the 10 people who want to do this, what separates the wheat from the chaff? What does the best of those 10 typically look like? What are the attributes of somebody doing this? Especially if they're very young, it's hard to know. They typically don't have huge track records. They haven't run their own thing before. How do you know which of the independent sponsors to back?

Usually they have some experience at a real firm where they've worked for a couple of years and learned how to financially model and learned how transactions work and whatnot. There's something in them. They have that bug where they want to be an entrepreneur. They don't want to go work for some big firm.

This isn't a fallback, like they couldn't get the job at their private-equity firm, so they decided, “Oh, okay, this is the cool thing to do.” They're very passionate about the strategies that they're pursuing and are really going to run through walls to make it happen.

I think the velocity of acquisitions, the constant getting on planes, going to God knows where to find the next garage-door roll-up—there's this guy we're backing right now, Jordan Dubin, who literally hasn't graduated from HBS yet. But over the 2 years he's been there, he and 2 of his former partners at L Catterton have built a garage-door platform, Guild Garage Doors. It is well north of $30 million, maybe north of $40 million, in EBITDA.

The platform.

Yeah. He has a new platform he's starting in an adjacent area, so it's very related. And then a third idea that's also in the same area. You could see how these things all come together.

Yeah, what are his attributes? What's he like? This is what I'm trying to get at.

He just runs through walls, just going to work harder than anyone. He was an athlete. He doesn't have a chip on his shoulder. I think he has a boulder on his shoulder. He interned for Matt and Alex at Garnett Station Partners and was mentored by those sorts of folks.

I think we'll talk about Jake Sloan later, but Jake Sloan doesn't throw around compliments that much, if you know him, and he thinks that Jordan has the potential to be even better, potentially. Now, how do we source these things? There is an ecosystem of people who are mentoring and inspiring others, and we know and are close with some of them. Jordan Dubin, for example, was referred through Ross Goff, first of all, because he was a student of his. He said, “I can't invest—”

Yeah, “I'm your teacher.”

“...but this guy is really exceptional, on the level of Matt and Alex, Jake and Frank from ZBS, and Alex and Ross from Heritage Holdings.” When I saw that statement, that introduction, it was like, “Hey, we get on immediately.”

I want to press on what makes you good, because on my screen here I've got the list of funds that you've invested in and some of the deals that you've done, and it is, in some ways, the who's who of the category leaders in the different spaces. In most cases where I know the details, you've been a partner with them for a long time. Now, it's the who's who, but you were a Fund 1, 2, 3, or 4 investor in those funds.

So what does it take to win in the same way that you would hope a GP would win finding the best assets? Is it just the same exact stuff? Is it just hustle and taste and intelligence?

Yeah, it's hustle. By the way, I absolutely love what I do.

Yeah.

I get so much energy from it, and I work really hard—

You're overscheduled.

—and run around. I'm overscheduled, and by the way, I'm very critical of myself, and I'm definitely stretched too thin, et cetera. But I'm getting so much positive energy meeting new and emerging groups or spending time talking about direct co-investment deals with established people, et cetera, that I love my job, and I think the passion comes through.

I think there's a taste and a gut instinct that's intuitive, and I had it when I started this in 2011, but you also grow and learn and refine what you're looking for. I'm just very authentic. I'm very open and transparent and real, and what that leads to is very deep, trusted partnerships, which then refer other people to us. When you're known as being a leading backer of different firms, then you're sought after. If Notre Dame is doing something, they might refer it to us. There's a really good feedback loop that happens by being a good partner.

But I think it's finding people. I say this frequently, but track record is important, but we're investing in the next fund. We're trying to go where the puck is going, and I think really trying to be intellectually honest and strategic with partners about that, and not be overwhelmed by, “Okay, well, who did this and who did that?” There's a lot of box-checking that goes on in the LP world, and I think, relative to the GP world, it's less competitive. I could get into those dynamics, but I will say what we're doing is not off the radar anymore. There are a number of folks that are moving into the space.

In the public equity world, when you study the factors that drive returns, almost all of the studies come back to 3 things: value, momentum, and quality. Do you think those 3 ideas apply to the style of investing that you do, effectively investing in people and teams in private markets?

I don't really think of it that way, but I would say certainly value, and it's relative value. You could pay 15 times for a software business that's growing a lot. It could be a great relative value, and I think that you want to be in the market leaders. That is a key thing.

I've been disappointed—I don't know, not disappointed, because I'm a glass-half-full type of person—but there hasn't been more of a correction in venture land. I think there's a lot of businesses out there that were overvalued and aren't the No. 1 or No. 2 leader in their category. They might be number 5 or 10, and there's probably not a lot of value there. But they're somewhat zombies, and these things take a long time to play out in private markets and in the way things are marked.

I think that's one theme you'll get if you get to know me: I'm not really concerned about marks. At the end of the day, I'm trying to have great partnerships that will deliver distribution in due time. If something goes wrong, I'm like, “Okay, well, maybe that's a learning experience,” and that creates a situation that can be advantageous to us because the fund's smaller, there's more co-investment, whatever. It's not necessarily a bad thing.

In the venture world, the reckoning was definitely put off, majorly, and I don't know how it's going to play out because so much capital is coming to AI. These bigger funds had issues with the later-stage stuff, and so then they're doing the seed things, and seed hasn't really corrected, even though public multiples are way down.

That would be another reason why I really love lower-middle-market buyouts, because I think the ability to generate alpha by professionalizing businesses, or it could be carve-outs, too. Some of our greatest deals have been very operationally focused, like teams that carve out a division. They take on a ton of difficulty through complexity. But what's really hard to do is to generate alpha doing consensus trades.

By the way, they can make money. There are various friends of yours, probably in Greenwich here, who are going to be very successful financially by buying businesses that lower-middle-market firms professionalize, and then they generate somewhere between a 2 to 2.5x gross and maybe high teens that gets down to net. That's okay. That's okay for a certain pool of capital, and that's fine.

I don't want that to go away because I want to have those people be willing to pay 12 or 15 times EBITDA for a business that our managers create at 7 times. So I'm rooting for it. And by the way, for that pension money, if we go all the way up to Apollo, KKR, and Blackstone, their major clients are the U.S. pensions that have to deliver alpha to these various plans. And that could be doing double digits, so there's an opportunity across the spectrum.

One thing that frustrated me a lot—I haven't had the vindication as much as I would've hoped—was, from 2018 to late 2021, just how silly the numbers were across everything and how everyone looked good. I have confidence that, with the right set of partners, in time, things will play out. Being with the people that are actually truly adding value will deliver differentiated returns.

I think the idea of size and flexibility without bureaucracy is a very interesting combination. I'm literally thinking of your top 4 things, and I'm throwing back in there the fact that you serve as a signal for other LPs. Whether you lean into it or not, it's attractive to GPs for sure.

It actually sounds very similar if you go up a level from GP to LP to Thrive. It's the same-size team. It can write a tiny seed check or a billion-dollar check. You can cover the universe with a team of 10-ish people, and they serve as this signal that other people want to follow. It's an interesting comparison.

I mean, that's a wonderful compliment. Thank you. Wow, that's just being compared to Thrive. But I do think there are parallels to one thing I was saying to Nabil at Thrive—I think it was yesterday—because they came in last week to demo some of the AI tools they're using internally, as well as what they're doing with their accounting platform, and it was so impressive.

I think that's a firm that has had continuous evolution, and they started off with friends and family. It was like $7 or $8 million. Then it was $40 million; we came in a year later, when he raised $150 million. They were known for doing seed and Series A. There's a lot of consumer in there.

But from the beginning, Thrive was very clear, saying, “We're stage agnostic, industry agnostic.” They didn't want to be put in a box, and I think that's good. I think some people probably say too much in their fundraising in the early days. They may box themselves in too much. Josh did the opposite. He was very open about that.

But they've continued to evolve, and I think they've emerged as one of the most important growth investors in the world. What they're doing right now with their holding company is doing buyouts, utilizing AI to really enhance some of these fragmented industries.

And there are a lot of folks out there. There's hype around, “Oh, okay, use AI to do roll-ups.” You see deals getting done where a couple of engineers from a top company might get $8 million on a $40 million valuation to go do a roll-up. They don't have a broad set of skills or any private equity experience. They also don't have enough capital. They can do one deal.

In order to do this right, I think you need to have a significant amount of capital and a substantial team that has skill sets from both the finance industry and the AI engineering side. I think nothing embodies this more than what Long Lake's doing.

Long Lake, for reference, is a holding company that was founded a couple of years ago by a guy named Alex Taubman, who had been at Oaktree, and another guy named Zach Frankel, who was co-founder of Ramp and co-founder of Cognition. He's one of the smartest human beings either of us have probably come across. I think you would agree with that.

General Catalyst initially seeded Long Lake. Kudos to Hemant for really believing in them and pushing this. They've gotten capital from Thrive and others at different stages, and we're looking at an investment right now.

But you look at what they're doing: They have a team of, call it, 8 private equity folks who come from great places—top vice president or director-level people at really great firms who have great experience working under Alex on the private equity side. Then you have engineers who've had senior positions at Scale AI, Palantir, et cetera, who are top of their class at the best schools. They're building tools that aren't about the shiny UI or about something you want to sell. They're going into the workflows.

Their first major area of focus has been homeowners associations, which is a very large and fragmented area that trades at a pretty high multiple. They demoed a tool for us. They sit down with the manager, who has to put together this monthly report, has to do this every month, and probably has a few different associations he or she has to do this for.

What they do is open up a clean Excel document, get sources from 5 different areas, populate it, and put it all together. It takes 10 hours. By building various AI-powered tools to pull in data in certain ways and put it all together, what was taking 10 hours now takes less than an hour, even with checking it in a much better, more thorough, customized, standardized way. So you just saved 90% plus and made a better experience for everyone involved.

Do that times every part of the business.

Totally. That is also going to be very compelling on the acquisition side. You have a regular-way private equity firm that's going in and trying to do an HOA roll-up, and then you have Long Lake, who's going to be like, "This is what we can do," and you can roll and however it might be. That's going to be very powerful.

And not to give away trade secrets, but on the accounting side, what Thrive and ZBS are doing with Cree is some of that same stuff. They're going in, looking at the workflows, and taking accounting's time—the way they're coding the different transactions—and reducing these things by over 90%. It's not sexy. It's really about going 5 layers deep, and that's creating real moats. I think there's going to be a lot of noise out there—

People claiming the same narrative.

Claiming they're doing this. I remember seeing a bunch of companies back when I was first starting at SCS, in 2011, 2012, 2013, and 2014. They would have websites, and they would say that they did real estate online. All it was was a shiny website. There was no substance. It was just all maybe trying to make your user experience look cool.

It's a very good narrative to say you're using AI to reduce costs and time by 90%, and therefore you can pay a little bit more, and therefore you can have much higher margins and all that. It's a very simple idea. The devil's in the details.

Yeah, and it's like having A-plus teams go extremely deep and build something. You're specifically trying to solve a problem versus sell a product.

It's a really interesting trend. I'm curious about the structure, though. From your perspective, for your clients, 2 of these examples are permanent-capital holding-company structures versus drawdown funds. What are the trade-offs there? I think the trend has been toward more people trying to raise permanent-capital vehicles, which obviously confers certain benefits. But from the LP's perspective, from your clients' perspective, what are the trade-offs that you care most about between a drawdown fund and a holding fund?

Sure. We're flexible in our mindset. We have ourselves a lot of our capital invested out of a 12-year vehicle that has 3-year extensions. We need to have some sort of understanding around exit rights when you get out toward the end life of the fund and have those things built in.

In reality, I think probably if Long Lake is successful at doing what they want to do, they will take it public. They're like a private equity firm in some ways, but there's a very substantive technology story here. I'm sure there will continue to be lots of BS stuff out there, but they will have real substance. Maybe instead of trading at a teens multiple, it will trade north of that because of the AI story and the different areas it can go into, and we might have the opportunity to get liquidity—

Whenever you want it.

Yeah. Well, they might IPO in year 6, 7, or 8, whereas if you're in the typical fund structure, we're actually—

You're 20. You might still be holding some of this stuff.

Yeah. So I think we'll have more flexibility. I think for Long Lake and for Thrive, what's really important is that these are really durable, lasting businesses that you want to own for a long time, because that's the beauty of the compounding.

Long Lake is very focused on having real moats, because there are going to be quick wins that can happen that don't have the long-term moats. Being very discerning around those things is important.

And another holding company—you're on a roll, Patrick, with some of my favorite people. Darren Farber, we helped anchor his holding company, Albion River. That's another one where it makes a lot of sense in terms of there being real rationale behind why you would do it in that structure.

First of all, there's a lot of cash flow that comes off these businesses that can be recycled to drive more acquisitions, so there's an efficiency from the holding-company structure that Darren gets. But there's also just synergies across cross-selling or customers. A lot of these businesses are selling into the Department of Defense and government. There's definitely overlap in these companies, and if you look at whether it's TransDigm or L3Harris, there is a market for a publicly traded conglomerate of businesses that have certain characteristics.

So I think that is what Darren is trying to do. I'm sure there will be other people that do holding companies where it doesn't make a lot of sense. But I think we're trying to be intellectually honest around the things that do make the most sense.

The best version of anything is probably pretty good.

Yeah.

So try to find the best ones—

Yeah—

—with very talented people behind them.

In real time, there's another manager we think extremely highly of who's considering doing a holding-company structure. The question that we're going to have to work on with this manager, because we definitely want to back them—I love the fact that he's thinking this way, because he doesn't want to be like regular-way private equity—

Mm-hmm.

—but is this helping him and his partner get to the optimal structure for their strategy? Their strategy historically has been to aggregate, roll up a bunch of businesses, loosely integrate them to a certain extent, but then punch out and move on or sell a larger stake to a larger private equity firm or someone who will take things to the next level, while they find the next area to consolidate.

That strategy might not be as conducive to a holding-company structure. What we try to do—this gets back to what I was saying earlier—is really just be open-minded, supportive partners. In our business, we're really focused on what's best for the client. If you have that as your North Star with managers, it's maybe, "How can we all win together?"

Having the ability to put agendas at the door and just have a supportive, intellectually honest conversation is helpful.

So we've got 2 really interesting things: the emergence of independent sponsors in the lower market, and the evolution of buyout firms to be the buyers—the people who are buying the businesses from you that earn your return—which is really interesting. There's also this evolution toward holding companies, even from some traditional venture-type players or something.

What about old-school venture land? What are you seeing? Who is emerging as the most interesting, best managers that do the original style of very early-stage bets into companies? How is their strategy changing? What interests you most in that category?

8. Venture Finds New Leaders

I'll back up for a second. When I started at SCS in 2011—really great timing—the financial crisis had really shaken things out a bit. We had a firm that had a sticky, growing capital base and were able to start relationships with a number of emerging, up-and-coming firms like Thrive, Founders Fund, Andreessen Horowitz, and a few others.

At that point in time, you had Sequoia, Kleiner Perkins, Greylock, and Accel. The benchmark would be the top 5, and then the emergence of Union Square Ventures and a handful of other more boutique firms. We made the decision to back some of the emerging leaders.

So we were early checks into Founders Fund, early checks into Thrive, early checks into Green Oaks a couple of years later, and Andreessen Horowitz. Those were really helpful. Having the good partners in venture has been a really good run, and I think as Josh has scaled up Thrive and Neil has scaled up Green Oaks, at each step of the way, just asking, "Does this make sense from a bottoms-up perspective, given the flow, given what you're trying to do?" That's great.

What we noticed, though, was our dollars were going more and more toward growth as those firms grew. I think they made a lot of sense in why they were doing what they were doing, but what that led to was us thinking we wanted more early-stage exposure. Then there was this emergence of these solo capitalists and these early-stage investors.

We basically carved out about a third of our venture budget to invest in these emerging solo capitalists. You had some very credible people deciding not to join firms, but to be their own kind of firm and get access to the best companies.

Elad Gil, Oren Zev, and Ray Tonsing are some who are well known, but also people like Jack Altman, Nico Winneborne, and Ramtin Ray at Abstract. There’s been a whole host of next-generation VCs, a lot of them operators, though not all of them, that have emerged. We’ve backed a lot of them and anchored a lot of them, often introduced through Thrive.

Thrive has been the most prolific introduction for us, but Andreessen Horowitz, Founders Fund, and the connectivity around our network have also been sources. In Jack Altman’s case, we were introduced to Jack Altman through Thrive. Then Jack connects us to Zachary Gray and the team at Mischief. Sometimes there’s a thing that goes that way.

Patrick O’Shaughnessy

Deals beget deals.

Deals beget deals. I’d be remiss—there’s also Locky Groom and Josh Buckley. There’s a whole host of very credible players. There was a blooming of that, and now I feel like that’s slowed down a little bit, but there’s definitely a next generation of people that are very competitive. David Tishapock’s group has really emerged as a real player.

Moving forward, that has been true for the past 6 or 7 years. What has started to happen more recently has been the rise of Andreessen Horowitz, Sequoia, Lightspeed, and General Catalyst. They’ve just grown massively in size and are, at least from a size perspective and a team perspective, really looking more like asset managers than traditional venture firms.

We’re not invested with General Catalyst. I have a lot of respect for Hemant Taneja. I think there are certain deals, like the Long Lake deal. Hemant’s the CEO of that firm. That was the type of deal—that’s a CEO deal, and that’s an awesome deal. But I don’t know how involved he is in all the different things that are going on, and they’ve got a lot of money to deploy.

Now, the capital needs are huge. But I will just say, you think of the army of people, of GPs, at some of these firms. A lot of them were invested in firms. There are so many new faces there. I don’t know them, and I think the entrepreneurs feel that way too, or I think some of them do.

Actually, the approach that Green Oaks takes, for example, where Neil Mehta has gone the opposite way, is interesting. The typical way that people go is to hire more people, delegate more down, and cover more of the waterfront. That’s a strategy. Green Oaks has shifted to having Neil at the tip of the spear for almost all first meetings.

He said that, short of himself, his wife, or a kid being in surgery, he’ll be there for the first meeting. Be a prepared mind, truly try to add value to the entrepreneurs, and be available to negotiate a deal on the spot if it needs to. That’s a much different client experience than when you talk to the principal, who then kicks you to the junior partner, who then elevates it to the senior partner.

If I’m an entrepreneur as well, I worry, “Okay, wait. Maybe there’s a bait and switch.” It’s dynamic. Maybe the best entrepreneurs don’t feel like they need the help from the venture capitalist anyway, and that is what it is.

A few things that worry me are that the game the big players we’re talking about—Andreessen, Lightspeed, and General Catalyst—are playing, doing $10 million on $50 million to put a chip down, might make sense for them. Maybe the company wanted to raise or needed to raise $3 million or $4 million. They could have done that, done $4 million on $20 million, whatever it might be, and instead they’re doing $10 million on $50 million.

Could be bad for companies.

That could be bad for the company, probably bad for the seed-stage firms that don’t have enough money to play. Not everyone’s aligned; they’re playing different games. This is happening in real time. I think it makes sense in a lot of circumstances. It’ll probably be problematic in others. How people navigate it is going to be interesting.

I think there’s an opportunity for a seed fund. Though, you can probably sell into some of these rounds. If you’re a big fund that’s a lead, it’s bad signaling. But if you’re a small person that we back and they say, “My LPs are pushing us for liquidity,” maybe—

Sell into a big Series B or something.

You can sell into the big Series B that’s oversubscribed, and it’s a dynamic thing. My high-level feeling is that we still really believe in venture. It’s so important to be with the best people, and it’s changing in real time.

Any other categories that you think are especially interesting, with the same question behind it of what is newly interesting or changing?

9. Private Markets Seek Liquidity

Bringing private equity to the masses is something that I think is great. I like it more because it feels to me like it’s an avenue where we can exit things to. It’s a lower-cost-of-capital avenue.

In the private markets, we’ve seen the evolution of continuation vehicles and the secondary market, all of that. I think it’s really positive because they’re creating liquidity options in an illiquid asset class. People talk about, “Oh, put things on the blockchain,” or, “I don’t know.” We’ll see where things go over time.

The core thing that I think is really interesting right now is the stuff going on at the lower-middle-market buyout end of the market, and where it intersects with some of these circumstances with AI. Maybe it doesn’t. But that professionalization of the small businesses, I think that continues and continues.

What worries me is that the secret has been out for many years, but there appears to be, similar to maybe some of the hype in what we see in the AI world, arguably too much hype in the independent-sponsor lower-middle-market space. We’re seeing teams that we view as B’s, B-pluses, maybe A-minuses, that would’ve struggled to raise capital 7 years ago, even in a hotter market, now raise because of a few different actors who have a lot of money and have identified this as a great area to invest.

I don’t know if they’re loosening their standards, but they’re doing things that we wouldn’t do. Then you worry, similar to the venture valuations. We think that this firm should raise $150 million. Maybe we do a budget-based management fee they can offset. We can be creative to make sure they can cover their budget, and we’ll say, “Okay, you can get over a 3x return, 25% carry. Over a 5x net return, you can get a 30% carry.”

That might be what we would feel would be appropriate, and instead you have a group come in that caps them at $400 million. We see this sometimes, where you have LPs that have lots of capital and are trying to push it on GPs. That’s tricky because, for a GP—

Turtles all the way down.

Yeah. For a GP, if you make a lower return on a bigger amount of capital—

You make more money.

That can be more money on the carry, and then you definitely have a bigger management fee that’s contractual. So it’s dynamic, but I think if you kiss enough frogs and meet enough people, we really feel like we have way more great opportunities than we do capital at the moment. I think that’s going to persist for a long time.

You mentioned the onslaught of new liquidity solutions for some of this bigger illiquid asset class—continuation funds, secondaries, et cetera. What do you think about everything that’s going on with the endowments, which were, for a long time, the pioneers of this style of investing? They were the first ones to do it in size and put a lot of these firms in business. Now it seems like we’ve reached the other end of that cycle, where they have huge allocations to privates and, in some cases, have sold big chunks of that to create some liquidity. What is the changing role of endowments? What do you make of all that recent news?

It’s happening in real time, and it’s a big deal. You have the pullback in funding that will have a lot of impacts on these budgets, but the tax thing seems like a bigger pull. These budgets are tight to begin with.

I was speaking to a really great manager. They’re going to raise $60 million from new LPs. They probably have $1 billion in interest. One of the prominent endowments had worked for 2 years to get that spot and then just told them, “We love you. We have to be on pause. We might want to do it. I would invest personally. We’re so sorry.”

That is just a real story that happened 10 days ago or whatever, and I think that’s probably happening a lot. So I think it just underlies a point that I’ve made for many years that’s a little self-serving, which is that you want to have diversity of LPs.

I think having a mix of single- and multifamily-office LPs can be great, but there are limitations. In the single-family-office world, entrepreneurs who make that type of money can be a little crazy. They can die. Single-family offices aren’t necessarily the most stable base of capital either. No one’s perfect.

The endowments and foundations have been very steady, but sometimes when teams change, you can have a real rethinking of the program. This liquidity shock—I did not fully see this coming. I think it’s a surprise, and it’s a dynamic situation that’ll be worked through, but it’s definitely going to put pressure on people.

It’s going to be interesting to see how all the sovereign dollars approach these markets because they have huge amounts of capital to play. I think they should barbell it, and they probably need partners to help them barbell it.

But there’s a bias, from what I understand, for a lot of them to try to do it themselves and do it with teams that are often based in the Middle East or elsewhere. I think that’s going to be harder to get on the ground, like some of the smaller stuff we do. But I think they’re getting more and more sophisticated. There are some really good people at those places.

I think there are a number of fund-of-funds doing very good work. If you think of the evolution of certain kinds of fund-of-funds, they were providing access to people who had built out their own teams in the US and then moved abroad to do that same thing. Really, everyone needs to continue to evolve their strategy and pursue continuous improvement.

So I give this advice to people: The best managers can have their cake and eat it too. You want to have a group with a stable and growing capital base and a team that is smart, that you enjoy interacting with, that can be strategic and add value where they need to, but also that is not overburdensome or full of box checkers, because we certainly see that a lot.

There are a lot of LPs that can really detract value or be a pain in the butt because of the requirements they have in terms of check-ins and all these different things. They're not actually asking the right questions; they're just doing their checklist stuff. So you want to have the personality of those people and also an understanding of whether these people are going to be there, what the economic situation is, or, if it's an endowment or a foundation, what personal ties this team has to their alumni.

The Notre Dame guys in South Bend are a great example. They're very passionate about Notre Dame, and they've had a lot of consistency on their team. When you have either changes in capital or changes in the team, that's where you get the instability that can be distracting for GPs.

And then on fund-of-funds, my hot take has been that fund-of-funds actually get a bad rap. However, they often have agendas, whether it's looking good with a seeded portfolio and special co-investment rights or whatever. They can be more transactional, so just understanding those things is important.

People that say, “Okay, well, we don't come into first closes. We're going to wait till the final close”—it's like, “Well, I thought we were in a long-term partnership. It'd be helpful for you to come in.” It's feeling out the softer side of those different partnerships: the people involved, their consistency, and the likelihood that they're going to be there for a while.

Because even though there are a lot of different firms and entities out there, it is still a pretty small community of both managers and LPs. It's really important for GPs not to just raise the money the fastest, particularly when they're starting off or at an inflection point of a firm.

If you set the table with the right folks, you set yourself up not only for this fund but for the next 2, 3, or 4 funds, as well as co-investments and, if you want to launch different strategies or whatever it might be. Similarly, if you don't do that, then you might have explaining to do, and it's just distracting.

Can you—let's use Jake as the example, since his name has come up a few times—sort of soup to nuts describe why he and ZBS are so special relative to the field, just as a case study in everything we've talked about?

I've been itching to talk about Jake and Frank because I just think they're truly exceptional. What's actually a little bit different with ZBS versus Shore is that Justin Ishbia, who is also an N of 1, has built a true machine. Whereas I think ZBS is really the partnership of Jake and Frank, and there's a real key-man risk with both of them and how much it scales.

But that is really a yin-yang situation. Jake is the most aggressive, high-energy guy, but he's also super neurotic. He's talking a mile a minute, and he's going to have a very high volume of acquisitions. He's extremely personable, et cetera, but he's also definitely got that kind of risk orientation.

Jake and Frank are both co-CEOs. Jake is going to be on the acquisition side, on the front end of things. Frank is going to be more on the finance and operations side. Jake will take 95% of the air in a meeting, but Frank is very, very crucial to their success. He's probably more risk-oriented. He's like the quiet guy at the poker table who's going to be more risk-on than Jake, who—I joke with the guys at Radcliffe—is like a neurotic tornado of energy.

Frank is really an exceptional partner to Jake. It's that yin-yang complement of them. They're going after businesses that started with veterinary, then HVAC on the commercial side and residential side. Now they've done accounting, which we helped anchor them in, and our good friends Josh and Karim at Thrive have partnered with the best folks in their accounting platform. They've also gone into youth sports.

I'm just so confident in the trajectory of what Jake and Frank will do together. Do you know the story of Frank?

Tell us.

Frank wasn't a princeling or anything in China, I think, but he was middle class or reasonably well-off and clearly a little bit of a renegade. His mom and dad dropped him off in Orange County in eighth grade—Irvine, California. Irvine is the Valley. They bought a house, left Frank in California, and flew back to China.

This was in the mid-2000s. There wasn't Zoom. This was not legal. He basically raised himself from eighth grade, I think, through high school. He went on to a great educational career and met Jake Sloane doing investment banking at Blackstone. They both have had great careers together.

But it's so funny: When he was at Blackstone, his parents—clearly renegades—I'm not sure if this was violating the one-child policy. I think it was. He had a younger brother, and they're like, “Oh, we had so much success with Frank.” They sent his brother to New York, and he was living—his brother was going to high school in New York.

So Frank was 21 or 22 years old, working 100 hours a week, and not only doing that but also having to be a father. He not only had to raise himself; he had to help raise his brother in his teenage years. That is very unique.

He's a very unique person, and so is his partner Jake. I think finding those outliers has been the key for me: identifying those outliers, embracing them, and trying to make them the best people they can be.

What should GPs that are listening try to do more of as they try to court the best LPs out there? What do the best GPs do that increase the odds of partnership with you?

I give this advice to a number of buyout GPs. In the venture world, you basically have a network thing, and you want to have various people who are very highly respected make introductions on your behalf to the core LPs in that ecosystem, and you don't hire a placement agent.

But if you're a buyout firm, you might want to consider hiring a fundraiser. I prefer boutiques generally that are very targeted. My view is to really focus on a smaller number of higher-quality meetings—not doing a scattershot across 100 different LPs globally, but being deliberate about picking the 10 to 25 you want to talk to and getting to a 30% to 60% hit rate. That is the way to do it.

You have to understand, okay, what is this LP's capital situation? What are they looking for right now? If you get an introduction either through a third-party placement agent, a fundraiser, or just your network—people say, “Oh yeah, you should talk to Liberty Mutual; they're looking to do this,” or, “You should talk to Notre Dame,” or whoever it might be—and then you get the introduction from those people, that's super powerful.

That's my advice to GPs. What I really hate, too, is when people are on the road. If we're talking about some of the GPs I'm upset with right now, they raised $550 million from their existing investors, but they're trying to push it to their $700 million hard cap and do that for 6 to 9 months and a ton of meetings. What is the point of this? They're distracting themselves from investing.

How many LPs of roughly similar setup to what you have—a pool of capital that's invested in a variety of managers and some co-investment, whatever—would you personally give your own money to?

That's a great question. Well, I'd definitely give it to Kevin Kelly at Sequoia, which maybe this is a catalyst. Definitely, you're not going to meet their minimum, but maybe as a favor. It's probably fewer than 5.

I'm interested in that.

There are a number of people who are really credible, and so I'm pretty outspoken about this. There are a lot of folks who are trying to do things internally. I've been on a whole host of reference calls recently with various institutions, and in many cases, they're trying to go directly, but they don't really know what they're doing.

My advice to them—they don't ask me, and I proactively say this—is, “You should probably, at least if you're committing, let's just for round numbers say $300 million a year or whatever it might be, put a third of that into a fund-of-funds, or split that across a small buyout fund-of-funds and a venture fund-of-funds, and then build on top of that, but not try to do it all internally working with a consultant.”

I think a number of the fund-of-funds are doing thoughtful work. I think people need to be intellectually honest about what they're doing, why they have a reason to source the best, get access to the best, and do the best diligence.

I'd also say the single-family-office world—I mean, these people are very wealthy, and they have their own prerogative—but I think a lot of the stuff they're doing has adverse selection and not the right portfolio construction. Those families will generally be fine, but maybe a hot take is that I think fund-of-funds are probably underrated.

You've mentioned a few times that a natural progression for very successful investors is to become asset managers. We started talking about Blackstone—an incredible business. But your interest, in terms of your clients' dollars, tends to be to recycle them back into people who are building new, innovative strategies, earn higher returns that way, and so on.

This is a natural tendency at firms like this: with success comes the opportunity to expand into new products, new business lines, new teams, et cetera. You've given lots of examples of both sides of that choice. I'm curious if there's an example of it being a good thing, in your mind, to expand into adjacent spaces and still be able to earn really high returns, because in general, it seems like your take would be that the transition to becoming an asset manager is the point at which maybe your interest goes down, and you might want to recycle that dollar back into something fresher and newer. Is there a good counterexample to that?

Yeah. Well said. I would agree. Normally, you see these things, and there's no logical strategic sense other than—

You're doing it because you can.

You're doing it because you can, and you want more assets.

Good for you.

God bless capitalism, but it's really for the sake of more money. The strategic rationale, if there is one, doesn't hold as much water as it could.

10. Shore Expands With Discipline

Shore Capital is the exception to that, I would say. Justin Ishbia and team—we've been investors with Shore since the first investment in Fund I—and it's been incredible to watch the evolution. They started off doing microcap healthcare buyouts and have been incredibly successful at doing that.

But over the years, they have been very disciplined in keeping the microcap healthcare side small. They went from, I might be a little off on the numbers, but say, $100 million or $110 million in Fund I to $220 million in Fund II. For that $220 million, I think they might have had $2 billion in demand, so a lot of demand. Then they've raised maybe in the $300 million or $400 million range for their microcap healthcare funds on a go-forward basis, which is enabling them to stay in the, say, $1 million to $5 million EBITDA startup platform.

They've continued to build out their organization with all sorts of areas that can help businesses professionalize and grow, and you can apply that across microcap investing in other sectors. They built out teams in the food and beverage space, in industrials, in business services, and also in real estate. The real estate team has a tie-in to their veterinary practices.

There are strategic synergies in the Shore organization, where all the different strategy funds are benefiting from the organization of Shore, which is, I think, 180, maybe 200 people. It's bringing a gun to a knife fight. The returns for Shore are exceptional, but what they've also done is delivered really high-quality businesses to their sellers, which is not something you can say for every single—

Healthcare roll-up.

So I think there's a durability to that. As they've evolved, there have been a few businesses that they've loved and wanted to stay in longer. The first was Southern Veterinary Partners. That's one where they established a continuation vehicle, or an SPV, gave their LPs the opportunity to roll into it, and then recently actually merged that with another veterinary platform, Mission.

The second time, they've grown this into a really, really big business. But they haven't done that with the majority of their assets. When they've gone really deep in something like that, they've done that in Southern Veterinary—now Mission—bringing it together, as well as BrightView. But the rest of them, they've sold to other private equity sponsors or things like that.

We do see the continuation-vehicle space get, I would say, arguably abused by some managers, where you're like, "Wow, you're selling everything to yourself. What's going on here?" Shore, I think, has a lot of third-party validation around their stuff.

But then, if you think of the evolution of the team, they've grown a lot of great investment professionals, and these different strategies are places for someone who might be an associate or VP on the healthcare fund to then go into a different vertical and become principal or partner.

The last thing: I'm very excited about the Shore Advantage Fund, which is essentially going to be picking some of their best companies from their healthcare fund, led by Mike Cooper and John Hennigan, who were 2 of the original investment partners alongside Justin Ishbia and Ryan Kelley. Justin Ishbia is just beyond driven. He's that maniac on a mission that we talk about. His engagement and his drive are next level, and he's going to be—

He just had his 4th child. He has promised his LPAC that he is fully engaged for at least the next 18 or 19 years, until the baby goes to college. I was waiting for the last one. He said this about 4 years ago. He's like, "When we have our 4th kid, add onto that."

But people like Mike Cooper and John Hennigan, they've been very successful. I wondered, are they going to have that same drive when they make real money? I think for them, the ability to invest in the mid-market in their best businesses and then maybe some non-Shore companies where they have real expertise—we think it will be a really attractive fund. So that's one that's really evolved, and I think it's very high quality in every single area.

If I play that back to you, it's something like, "Don't expand because you can. Expand where you can press an advantage and where the new thing actually benefits the old things or the other things."

That's exactly right. It's helpful both ways—organizationally, company-wise, et cetera. I think that's a great example, but there's only one Shore Capital. Be very cautious about most of—

The exceptions that define the rule.

Beyond the exception to the rule.

Is there anything else that you feel is most interesting to your prospective returns or the job that you're going to do that we haven't talked about?

An area that we've talked about, but that I think is super attractive, is the bootstrapped growth-equity area. We've backed a number of firms where people have been trained at the Summits, TAs, Accels, and Sequoias, and then decided to—

As those firms now generally are trying to write $50 million to $100 million-plus checks, some really talented professionals have launched their own smaller firms that are addressing that kind of $5 million to $25 million equity area. This is not venture capital; this is generally bootstrapped software companies.

Jeremiah Daly at Elephant Partners and his partner, Andy Hunt—Jeremiah was previously at Summit Partners, Accel, and then Highland. Andy Hunt was the co-founder of Warby Parker and then was at Highland, and they founded Elephant. That's been an incredibly successful investment for us that we came into in Fund I. They had a company, KnowBe4, which was a very big—was a public company, now taken private—but it had outstanding returns.

Then Jordan Bettman and Weston Gaddy have this firm called Radian. They were both at Bain Capital Ventures. We're very bullish on them.

Mickey Arora was at Summit with Jeremiah Daly and then was recruited to go to Sequoia. When he was at Sequoia, he did some good deals, but he was like, "Sequoia is not trying to get 3Xs. They're trying to get really—"

Nvidia.

Yeah, they're trying to get—so it was not the right fit for him at Sequoia.

The lowly 3X.

Yeah. There's the story he tells when one of his deals made, like, a 3X, and no one congratulated him. I guess that's typical. That's not unusual.

He founded Telescope. He's done really well. These funds—I mean, Mickey's Telescope I was $70 million or $80 million. Then we came into the $150 million fund. You're staying way below the radar.

Then there's a firm where we've had really great returns. This is an under-the-radar firm, but I would argue maybe some of our best risk-adjusted returns come from it. It's called Growth Street Partners. It's Steve Wolf and Nate Grossman, who were at Mainsail Partners together. They founded it together. It was a $70 million first-time fund. We anchored it.

They're finding that founder in Kansas City. They're looking for minority capital, but a little bit of money on the balance sheet and expertise to help them go from, say, $5 million in ARR to $15 million or $20 million. They're able to buy in at a reasonable price, accelerate and professionalize the business, and then those larger firms—whether it's Summit, Spectrum, Insight, Accel, I mean, it goes on—are really interested in these assets.

So there's a large group of buyers that will pay, that would love to invest in these businesses once they've scaled up more. Directionally, they've had a number of businesses where they sell half their stake, get a multiple of their money, and then roll half their stake with a great sponsor into the next transaction.

If you just do the math, you might make 2.5 times your money back in 2 years and then roll. If that 2.5X that you rolled does a 3X, then you're talking about returns that can be in the range of 6 to 10 times your money.

On the downside, you're in a business that's basically break-even. These are bootstrapped businesses that can be profitable. They want to be your minority preferred security. So you have really good downside protection, the ability to get interim liquidity, and get really differentiated returns on the upside. It's a really good profile.

A number of people try to do this, I think, who are not that good. So we're always on the lookout. If you think of new things we do, it's often either something that we do not have that we strategically want to add, or it's something that we absolutely love and we want more of.

What animates me is people who are totally and completely obsessed, via some curiosity, with the thing that they do. Probably the nicest thing I could say about you is that you're one of those people I would call if I had a question about who's got the juice in the investing world. It's obvious from our interactions how much you love the core thing here, the core craft, and it's so fun to have an excuse to talk to you about it on the record.

You know my closing question for everybody: What is the kindest thing that anyone's ever done for you?

I'll start by saying that my wife being married to me and my kids being so kind and lovely goes without saying. But when you think about who are the truly kindest, it's my son and my daughter.

Investment-wise, to answer your question, I would say there's been a lot of people who have mentored me and been very kind over the years. When I started at SCS, I was 30 years old. I hadn't really done this, and we were building out the program from scratch.

Steve Rattigan, who was our CIO; Pete Mattoon, who was our CEO and founder; and Tony Abiotti and Doug Adderley, who were co-founders with Pete leading client service, were extremely supportive of going to do Shore Capital, Thrive Capital, Founders Fund, and the edgier stuff. From the beginning, I got as much pushback doing Bain as I did Shore.

It was really supportive and very kind. Pete specifically, who's an amazing guy, was like a therapist. I would have a monthly sit-down and mentoring session, and he was great. Steve Rattigan is an incredible, incredible guy—truly like a father figure.

But there's one story I'll tell that stands out to me: our mutual friend Josh Kushner and Thrive, when I think of support and kindness. You remember certain phone calls and when they happen. It was the summer of 2012, and I'd been basically 1 year on the job.

I'd gotten to know Josh Kushner that winter. He had just invested in Fund Two, and rather than exercise his accordion on Fund Two to go from, like, 40 to 100, he decided to just raise Fund Three at 150. He was bringing in SCS and, I believe, Rothschild as the 2 LPs coming on top of Prince, Duke, Welcome Trust, and a few others. It was a very targeted raise.

We were in for an amount, and then one of our families had an idiosyncratic issue. They backed out really last minute, and it was very surprising. It was upsetting. I remember talking with Jared Weinstein, who was COO at Thrive at the time, and he was like, “This is pretty baked.”

I remember I was in Palo Alto on the phone with my colleagues, basically asking, “How can we solve this? How can we figure this out?” We actually put in $10 million from our public equity sleeve and then $5 million from our very small—this was early-days SCS—small private equity thing, to do $15 million with this 27-year-old unproven person.

Everyone had total conviction in the decision that Steve-O and I were making in Thrive. There was never, “Oh, wait, why are we backing this Josh Kushner guy?” It was just, “How can we solve this issue?” You look back on that support and think, wow, they were really forward-leaning and really supportive.

I'm just so lucky to be a part of such a supportive, kind group of partners who really gave me a lot of leash in the early days. If you fast-forward, we've invested $400 million or $500 million with Thrive across a lot of funds and had incredible returns. That investment was a huge returner for us. It was things like that that were the foundation of what's continuing to drive us forward today.

Actually, you've seen that bubble chart where I show the different co-investments that we do—the core firms and the managers and the co-investments, and how they intersect in the venture and growth world. Thrive has been a very prolific co-investment partner for us, but the most important thing for Thrive has been the fact that I think we've backed 7 or 8 groups that were introductions through Thrive.

Whether it's Jack Altman or Kirsten Green, they have been one of our top co-investment partners, but definitely our top source of introductions. That doesn't happen if I don't have the support of Steve-O, Pete, et cetera. What was so kind about it was that there was never any questioning. It really was just, from day 1, super supportive.

So I'm just very fortunate to be a part of this firm and really excited for the future.

What a cool story. I've never heard it before. I love hearing it in closing. Thanks so much for your time.

Thank you.