Last June, as I sat alone in lockdown to write my quarterly newsletter, I referred to the pandemic as a Black Swan event. Technically, this is inaccurate—I, like many others, was confusing cause and effect.
While the effect of shutdowns was dramatic, true Black Swans come out of nowhere and are obvious only in hindsight. The cause of this one was well-telegraphed by global health organizations—we may not know the extent of its ripple effect for years to come.
Rather than dive into a discourse about the color of large waterfowl and how much they disturb the water, the real questions before us lie in the management of our investments—the most important being our time, energy, and attention.
And then, of course, there’s how we manage and optimize what’s in our existing portfolios.
As many investors seek their first deals or deals in industries that are new to them, familiar questions surface—and I’ve put my familiar answers below.
How much does instinct come into private equity investing?
Instinct is not really the right term. It’s more about experience than anything. Experience is just a decision that created a bad outcome (e.g., cost money) that you commit to memory. You only have to touch a hot stove burner once—experience tells you not to do that again, no matter how cold your hands are.
As you accumulate experience with investing, you learn about specific industries, deal structures, and the nuances of those deals in different parts of their life cycles. More importantly, you learn your own comfort and risk levels so you can navigate from a place of confidence.
For us at Percipio, we have learned that start-up/venture investing is not our cup of tea. We prefer established companies with relatively stable cash flows that are poised for growth and can benefit from our time and effort applying modern management principles.
For others, it’s the opposite. And deciding your path here will, again, depend on your experience, risk tolerance, and personal preference.
What do you look for in a potential investment? Has there been a time when you knew a deal would be profitable, even if the data (or your experience) couldn’t quite back it up?
I am a deep value investor. When I find an investment that has the opportunity for strong cash flows relative to the price, I will invest in it—even if it is in an asset class or an industry that I do not have specific experience.
This was the case in 2012 when I made my first investments in rental properties. I had not owned rental properties before that time, but I could see that they were deeply undervalued. As time went on, I gained experience, and was able to pay higher prices through 2017 because I had experience in the asset class, and I had built a management company to run the business. And when prices continued to rise, I had the accumulated sense to stop buying.
What are warning signs you shouldn’t ignore—even if a company looks great on paper?
This will be hard for some to hear—there are some companies that are just not worth the effort. Not every business is built to scale, sell, or even survive.
Early on in my career, I made the mistake of investing in a small contracting company. I thought I could take what was essentially “a guy in a truck,” apply some modern management practices and principles, and grow it into something bigger.
It didn’t work. And now I know better.
While a fraction of these contracting businesses grow and cross over the “valley of death” on the way to being successful scalable companies, they are rare—and most of them start with intention to quickly scale. Most sole proprietors have neither the desire or the discipline to “cross the valley”—and you should have a wary eye on those who claim to have both but lack a real plan.
How can you spot consistencies (and inconsistencies) between data and real life? Are there areas you always investigate? Questions you always ask? Employees you always interview?
I don’t think there is a silver bullet here. You have to roll your sleeves up and get into the details with due diligence. I like to use the Ronald Regan approach: “Trust but Verify.” Assume that you’re being fed accurate data, but audit by asking for supporting documentation. Does the paper back up the report? Does the seller take a long time to get back to you with the information you are requesting?
You also need to do your homework with staff and, if possible, customers and vendors. The quantitative data and the qualitative research should get along and make sense.
What about the “soft” side of the transaction—the team members, brand reputation, etc.? How do you measure the qualitative assets of a company?
If you are buying an established company, reputation is important. Does the company have a positive set of values and impression in the local market? If not, you’re essentially paying for a poor reputation—and that price should be accounted for in the price you’re willing to pay for the investment.
The strongest assets of a company—by far—are its employees. They should not be overlooked in any evaluation. Not all the employees navigate the change curve well, especially after an acquisition, but the ones that do are worth treating well and including in the process.
Thanks to the events of 2020, and every lesson we’ve learned prior, we are all better conditioned to make decisions in the face of uncertainty (after all, isn’t most of this life uncertain?). While I consider myself an experienced investor, I assure you that there is always something new to commit to memory, and I’m honored to share what I can with you.
As for my team and I, we fully intend to move while others stand still, capitalize on opportunities where others hesitate, and read the terrain with the weather-eye of a farmer who plants for the best and diversifies his crops.