Orlando Bravo - The Art of Software Buyouts - [Invest Like the Best, EP. 257]

My guest today is Orlando Bravo, co-founder and Managing Partner of leading private equity firm, Thoma Bravo. Thoma Bravo manages over $90bn of assets and is best known for investing in software and technology businesses. It was Orlando who led the firm’s early entry into software buyouts some twenty years ago, and he has overseen more than 350 software acquisitions since. There are few, if any, people better placed to discuss private equity and software investing. Please enjoy this excellent discussion with Orlando Bravo. For the full show notes, transcript, and links to the best content to learn more, check out the episode page here. ----- This episode is brought to you by Tegus. Tegus has built the most extensive primary information platform available for investors. With Tegus, you can learn everything you’d want to know about a company in an on-demand digital platform. Investors share their expert calls, allowing others to instantly access more than 20,000 calls on Affirm, Teladoc, Roblox, or almost any company of interest. All you have to do is log in. Visit tegus.co/patrick to learn more. ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes. Past guests include Tobi Lutke, Kevin Systrom, Mike Krieger, John Collison, Kat Cole, Marc Andreessen, Matthew Ball, Bill Gurley, Anu Hariharan, Ben Thompson, and many more. Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here. Follow us on Twitter: @patrick_oshag | @JoinColossus Show Notes [00:02:36] - [First question] - His belief about an opportunity/capital mismatch in private equity [00:04:26] - Adjusting his own approach to take advantage of seemingly niche opportunities [00:06:13] - Differences between software businesses they invest in versus traditional ones [00:08:25] - Outline of how he runs their four-hour portfolio meetings [00:09:53] - Overview of the very first deal he ever made in the software sector [00:14:01] - The dissonance between the average SaaS company and the ones they try to manage [00:18:22] - Major contributors that allow for their higher margins [00:20:16] - Common mistakes of companies that mis-invest capital for growth only [00:22:28] - Defining what market leader means writ large [00:23:45] - Why the subsector of cyber security is such a good opportunity set [00:26:25] - The evolving nature of the private equity world in general [00:28:41] - Where returns will come from going forward [00:31:47] - How good the opportunity for returns in this style of investing today is [00:35:32] - Lessons learned on knowing when to exit or sell a position [00:37:59] - How short their holding periods can be and how much influence they can have in such a short time [00:40:04] - Surprising things about deal-making that he’s learned over his career [00:41:20] - Difficulties and points of frictions in deals that still exist for him today [00:43:11] - What part of the deal-making process he loves the most [00:44:30] - If your job title has a C in it you’re not allowed to complain about it [00:46:27] - Deeply held beliefs about operating excellence [00:47:33] - What the word service means to him given everything we’ve talked about [00:50:27] - How we do a better job of inviting talent into this space [00:52:51] - How decentralization will define the 2020s and beyond [00:55:48] - What is most interesting about Web3 that might affect cyber security [00:57:42] - Where there is a lack in innovation in private equity today [01:00:45] - Advice for young talent for building their careers [01:03:16] - The kindest thing that anyone has ever done for him

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

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• 0:43Patrick O'Shaughnessy?

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• 1:26Patrick O'Shaughnessy?

  $300 per call, not the $1,000 or more that others charge. If you're curious about Teegus, call the top performing investment manager you can think of. They're probably already a Teegus customer and they'll point you in the right direction because customers, myself included, love Teegus. Visit tegus.co/patrick to learn more. Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts and you can access all our podcasts, including edited transcripts, show notes and other resources to keep learning at joincolossus.com.

• 2:13Speaker 01

  Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.

• 2:38Patrick O'Shaughnessy?

  My guest today is Orlando Bravo, co-founder and managing partner of leading private equity firm, Toma Bravo. Toma Bravo manages over $90 billion of assets and is best known for investing in software and technology businesses. It was Orlando who led the firm's early entry into software buyouts some 20 years ago, and he has overseen more than 350 software acquisitions since. There are few, if any, people better placed to discuss private equity and software investing. Please enjoy this excellent discussion with Orlando Bravo.

• 3:10Patrick O'Shaughnessy?

  So Orlando, when we talked the other day, we were kind of fishing for places to begin this conversation. And the one thing that stood out probably more than anything to me was this notion that there are probably more opportunities for great return in private equity than there is capital in terms of committed capital in traditional fund structures. That just seems like a very strange idea in what seems like a bountiful period of capital availability. I'd love you to expound on that idea to begin here. What's behind that opportunity capital mismatch that you see today?

• 3:39Speaker 02

  Well, Patrick, first of all, thank you so much for having me.

• 3:41Patrick O'Shaughnessy?

  My pleasure.

• 3:42Speaker 02

  I really appreciate it. Look, the proof is in the numbers. You see growth equity investors, whether they come from private equity world, venture world, or hedge fund world, investing those growth equity funds in a period of nine to 12 months. Then on top of that, you see what you would call the traditional private equity community, the control investors, that would take usually four to five years to fully invest a fund, doing it in... 12 months, 24 months. We at Tomo Bravo have always invested fast and sold fast. There are many, many, many reasons for that. But now you see the whole committee doing that.

• 4:24Speaker 02

  And the reason is the market, both for private equity and obviously for gross investing, is becoming much more tech oriented. And these tech companies are going public and are achieving scale faster than you could raise capital to go out and invest in them. And that is only going to get worse. Even if you look at assets that are at scale, a billion dollars plus, they're now compounding in the SaaS world at 20%, which means they'll double every four years. It's more of an issue of where do you decide to spend your time to go invest or buy a business?

• 5:00Patrick O'Shaughnessy?

  How do you think about it from the perspective of Tomo Bravo and the challenge you have in front of you, which is you have to raise funds, you have to have those funds be reasonably diversified, the size of the equity checks may be growing. You mentioned it's crazy that some of these companies are doing $2, $3 billion of revenue in what might seem like a niche area and growing fast. So how do you adjust your business and your model to be able to take advantage of these opportunities?

• 5:24Speaker 02

  Well, our philosophy has remained the same since we started doing software 22 years ago. The tactics are always evolving. On the one hand, the investing tactics, the deal tactics and the operating tactics have evolved within the same philosophy umbrella about them. So in investing, the challenge 10 years ago was winning the deal and finding the right deal. Deal pipeline generation was a big thing, and then your win rate was obviously extremely important. Now the challenge is it's more of an investing challenge. Out of all the opportunities out there, which one do you decide to focus on?

• 6:08Speaker 02

  What are the top three or four in our private equity business that we want to buy this year? And why? To think that through, it gets even more complicated because we look at this as a positive, but over the last five years, we have been buying growth, not earning returns through just operational improvements. It's earning returns through that plus being correct on growth. And that's harder to do as well. Now, the market is serving us, on the other hand, these phenomenal growth companies that did not exist 15 years ago in software.

• 6:46Patrick O'Shaughnessy?

  How would you describe the difference between the kinds of businesses, software businesses, that you're focused on versus those that a traditional later-stage growth equity investor, maybe coming from hedge fund world or from the VC community, that has become so dominant and so popular in the last 12, 18 months? What are you doing most differently from those more minority-type but late-stage growth investments in some mature tech businesses?

• 7:14Speaker 02

  Well, first of all, in our private equity business, we are also involved in growth equity investing from a perspective of buying a minority interest. These companies that will be market leaders, some of the biggest investing differences in our flagship fund, we are buying the market leaders of today, the number one player in that vertical market, in the case of apps, or even horizontal market, or the market-leading company in infrastructure software, or the number one player in different segments of cybersecurity. But the most important difference is where do we get the source of our returns from?

• 7:56Speaker 02

  In our flagship fund and in our private equity, in our control business, we are looking to fundamentally improve the way that companies run, both bottom line and top line acceleration. And we do that only in partnership with the existing management teams of these companies. It is a very fundamental approach to operations, which is very intensive.

• 8:24Speaker 02

  For example, every month, we have an ops review at each of our companies for four hours at least with the CEO and all of her or his direct reports. And we are there looking to solve operating problems by being creative and inspiring existing management to think differently about operations. They know their businesses so well, they know their markets incredibly well, they have the following of their employees. But we bring to them an approach that is different and hopefully very value add to their already existing activities.

• 8:58Patrick O'Shaughnessy?

  How do you run one of those four-hour meetings? Is it really standardized across the firms? Just give me an outline of how those are run and operated themselves, the meetings.

• 9:07Speaker 02

  It really is standardized and it's not that different from what you would see the best strategic buyers run their different business units. And what we do is we have, our board meeting is very short because those are approval processes, those are general items that the board given its corporate duties and fiduciary duties needs to get through. We start with that so we can get that out of the way. And then what we do is we review the P and L of every functional area of that business, whether it's customer support, professional services, marketing, sales. And we review the P and L and the activities in case the company is organized differently

• 9:51Speaker 02

  of every business unit, of every geographical area. And we do that with all of the direct reports of the CEO together in the room because they have to collaborate through this. Everybody owns their area, but it's tied to everything else. And we're constantly looking at best-in-class metrics for each of these functional business unit or geographical areas. And we're also able to engage in a creative dialogue with the leader of those areas in terms of how to improve it so that then we can take more of those profits and reinvest them in growth. And that's the model that we pursue.

• 10:27Patrick O'Shaughnessy?

  Would you take us all the way back to the very first deal? I think it was Profit 21 was the name of the firm that you did in the software world. I want to start there because obviously this has become an absolutely dominant trend in the world of investing, of businesses, et cetera. But back then, when you did your first one 22 years ago, it was a very different situation. I think the evolution from then to now is really important for people to understand. So talk us through the unique dynamics of that deal, how you came to it, how you got the idea, how it was financed. I know that was very different back then. I would love to hear the story of the first technology software deal that you did.

• 11:03Speaker 02

  Profit 21 was a deal that our team originated because we had an investment theme at the time, after the dot com bubble burst in 2000. We were looking to do something different than all of private equity, really. We were searching for it and Carl told me my mentor was open minded enough to allow us to do that. The theme that we had at the time was you can buy software maintenance streams. Remember, it was all on premise, right? Two years ago, you can buy software maintenance streams less expensive than almost any other form of recurring revenue in different industries, media, radio, which was popular then, transaction processing.

• 11:47Speaker 02

  And the quality of that revenue is even more sticky than those categories. Now, the challenge was that that universe, which is a challenge today, by the way, but the challenge then, having us not done that before, was that these companies were unprofitable, especially coming out of that bust that happened in the year 2000. We had to say theoretically, with 90% gross margins, these businesses can be high cash flow generated and therefore good candidates for a fundamental control type of investing. In doing our work, we came across Profit 21. The company was for sale. We were able to succeed actually without much competition. That was interesting.

• 12:30Speaker 02

  It's one of those unusual deals where there was not that much competition, even though there were players starting in the software industry back then that were very good and had similar ideas as we had. It was interesting because that company had never made money before.

• 12:46Speaker 02

  Now, it wasn't losing all kinds of money. It was close to break even, so management did care about that. That wasn't a completely irrelevant concept to them. Secondly, the company had never done an ad or an acquisition, and the company had inconsistent bookings performance. We bought the business, and part of the reason was the price looked great, at around two times maintenance revenue, one times two. Imagine, remember those days?

• 13:10Patrick O'Shaughnessy?

  Charming.

• 13:11Speaker 02

  Exactly. Those were the days. And we decided, through meeting the person that became chairman of our operating committee, that the best approach was to back existing management, for all the reasons that I mentioned before that existing management has, and they really wanted to win, but have them work with our operating partner in terms of improving that company. And of course, three years later, you end up with a success story of high margin, good growth, six Saturn acquisitions, and it was a great investment. That experience really made us very passionate about the possibility of working with existing management that deeply cares about that business, that doesn't move from company to company,

• 13:55Speaker 02

  that lives in that environment. They provided software for small and mid-market distributors. So they knew all the distribution customers, they knew the culture, they knew how they talk, how they trade, how you have to discount it. They loved that world, they were good at it. And if you can marry that with an operational approach, as my partner would always say, everybody needs somebody to learn from. If you can marry that with what we would bring, you would not only have the possibility of great success, but also it was a good approach to doing business. It felt really good. And then we did a second deal, and the same thing happened with existing management, and then a third one, and so on and so forth. So we quickly developed this as our mission.

• 14:35Patrick O'Shaughnessy?

  I'd love to zoom out and talk about the software industry, maybe even the enterprise SaaS specific sector of it, where you've done a lot of your work, and some of the weird features of it. You mentioned some of these businesses have 90% gross margins. Everyone heralds software as like the best business model ever. But I think the average public market business, or maybe even the private market ones, they lose a lot of money still. And obviously, there's reasons for that. But I'd love you to just walk through what seems like a huge dissonance between the average SaaS company and the type of company that you're trying to run and manage.

• 15:07Speaker 02

  There is no difference in the business model between that average and what we're looking to do. In essence, when you see us buy control of a business, we are underwriting our plan, not what is going on in that company. In many cases, we're buying breakeven businesses or businesses that may be losing money. That's not the way it's going to be run in partnership with management going forward because the model would break and you couldn't support some debt into that transaction, which is highly accretive to the equity. The challenge is for the market inefficiency here is that public investors, who are extremely smart, creative, highly educated and great,

• 15:51Speaker 02

  for some reason, they believe that investing in growth, quote unquote, is the same and goes hand in hand with losing money and having a negative margin. And those two concepts are completely different. They many times have nothing to do with one another. And many times, high profitability leads to higher growth. Because what high profits means really is that first, you have operating management that innovates correctly, that runs those different functional areas in a way that is operationally sound.

• 16:33Speaker 02

  They measure all their activities. They look at inputs versus outputs. They readjust to what is working. Being highly profitable also means that you have a good enough product and you're charging a price for that product that allows you to produce that profitability. Where, for example, the yearly increase in the value of that product merits a price increase that is higher than your labor inflation. A key point today in this inflationary world. If you do that really, really well and you provide so much value to your customers that you capture some of that in your price and every day you become better at your operations because you learn from the past and you're actually measuring this, it means that you have more money.

• 17:19Speaker 02

  To invest in tactical growth, which is sales and marketing or distribution, and more money to invest in strategic growth, which is product development, R and D and new initiatives. See, when you're highly profitable and you're growing very fast, it also means that management is making the right investment decisions in growth. You're an investor, you see all kinds of different sales channels. Well, if you lose money and you can lose money, sure, you'll try it all. You'll try direct sales, channel sales, insight sales, web sales, marketing, you can try all kinds of marketing plays. When you're really profitable, it means you're doing the right ones that fit your product and your business and what your customers need. And the same thing is in R and D.

• 18:03Speaker 02

  You could have 20 R and D initiatives. And if one works and you grow really fast, that's great, but how about the other 19? I can get really passionate about this. The other fallacy that I see with investors in this space is saying, well, this company is growing really fast now, it's 200 million in ARR, which is plenty of scale, by the way, to run and profit. And I'm going to model what management told me, which was a 30% operating margin in year four. And I understand why they're losing a lot of money now is they're growing at 50%. But see, the operating world doesn't work that way. That company in year four is not all of the sudden going to change. How they plan, how they think about initiatives,

• 18:47Speaker 02

  how they tell their direct reports what's important and what's not. It just doesn't work that way. They'll never get, you gotta start now to get.

• 18:56Patrick O'Shaughnessy?

  What do you think most explains? I think I have these numbers roughly right. The average SaaS company maybe in the category has a slightly negative EBITDA margin, losing money on an EBITDA basis. I think probably your portfolio is closer to 35 or 40% EBITDA margin today. That's a huge gap. What are the major explanations that make up that 40%? I mean, you've started to talk around some of the attitude differences, but like literally, where do you think that change in margin most comes from versus the average SaaS company out there that's loss making?

• 19:27Speaker 02

  I think that comes from investors really incenting management teams just on top line. We work in a free market capitalist incentive based system. And if you're running a company and your investors tell you, I don't care about the bottom line at all. Go grow revenues as quickly as you can. That's the directive from the shareholders. And that's what's most likely going to happen. Now, when were those investors, at what point in time did they become indoctrinated in this business model? We can have a philosophical discussion about that.

• 20:02Patrick O'Shaughnessy?

  Yeah, I'd love to hear.

• 20:03Speaker 02

  Right? Is it that early on, VCs teach these companies that way in order for them to, of course, grow and win in their markets? That's, that's the great thing to do. But also by doing that, do these companies need to raise more money? And therefore there's more room for investors to get the equity. And then so on and so forth. It's very interesting. And one of the things is it's just so important to say is we believe in both high growth and high margin. And they're not mutually exclusive. One actually drives the other, right? Because when you also get growth, you should drop to the bottom line a higher margin than your existing margin in your business. In software where you have the marginal cost of your product is nearly zero.

• 20:45Speaker 02

  You do have to provide support and of course you have to pay for the distribution.

• 20:49Patrick O'Shaughnessy?

  If the business models fundamentally are the same and we're dealing with companies that all have high or very high gross margins, where does the most misinvestment tend to cluster and happen? Or is it just spread out? Like are people over investing in R and D and trying too many things and over investing in different, as you said, different sales channels that maybe aren't smart and profitable just to get top line growth? Are there most common mistakes that you see amongst these companies that are sort of misinvesting capital for sake of revenue growth only?

• 21:17Speaker 02

  It depends on the project. This is, as you know, a project based business. So we don't subscribe to the view of applying 500 things to every single company. We subscribe to the view of every company is different, every culture is different. And what are the top three at most things that need to be done in order to make this a successful operating investment? Fundamental investment. The thing that I can tell you in general is so many of these companies, they have such high gross margins and are winning in their marketplace, are making a lot of decisions based on gut feel. And gut feel has served these companies well.

• 22:02Speaker 02

  If not, they wouldn't have been the market leaders that they are today. There's once again, nothing wrong with that. What we see that we bring to them is an analytical approach to decision making. Everything being guided by the data and the numbers. Now, there's a big exercise in being able to gather the right data by functional area, business unit area, geographic area, because you have big buckets of revenue, big bucket of cost, you have applications, you have all kinds of complexities. So when you let those operators know where exactly do they stand on direct revenue and direct cost in their activities, what they do creatively always exceeds our expectations,

• 22:44Speaker 02

  even on top of our metrics and processes, many of which are relatively widely known by the great companies out there. And once again, it's coming back to desegregating these P and Ls to give people the visibility of how their decisions are impacting that profit and loss statement.

• 23:01Patrick O'Shaughnessy?

  You mentioned when we talked last, the notion of market leader being incredibly important as a term and concept for the type of firm that you target. Maybe just describe in as much detail as you can what market leader means. I mean, there's probably some obvious definitions, most revenue in a category or something, but what are the dimensions of the concept of market leader to you and the firm?

• 23:22Speaker 02

  It's a different question in software than it is in many industries, given the past days of innovation. For us, it's the best product in however we have defined or the industry has defined that software so far. That is really, really important because these product cycles do take a lot of time. And in the SaaS software world, especially around cyber, CIOs don't want to buy, chief security officers, chief information officers, don't really at the end of the day want to buy the number five, six, seven, eight product in the market. These are extremely important strategic solutions and they will converge on the top two or three over time.

• 24:07Speaker 02

  Making that product call in these companies is very, very important to us. That's where the investing and sector knowledge comes in to make that, help make that decision.

• 24:19Patrick O'Shaughnessy?

  It's really interesting if you look at and aggregate your portfolio, it's probably bigger than any cyber company that exists in aggregate. It's one of the biggest software portfolios in the world. But when you dig in and look at some of the portfolio companies, probably most people wouldn't recognize the majority of these companies despite their significant size. I think some of that's because of the emphasis on cyber and security. So maybe you can just walk through why that subsector has been such fertile ground for you? And maybe why more people aren't able to name these companies? I mean, it's sort of a strange dissonance that you've got this massive portfolio. The returns have been spectacular, the margins are what they are, and yet there's less familiarity with this space and the business model.

• 24:59Speaker 02

  What a great point. It's a bit of a source of frustration when taking companies public because of that. Because these are heavy enterprise technical solutions to corporate customers. It could be SMB, small, medium-sized business customers, or it could be the largest companies in the world. But these are not therefore consumer household names. And you can't go to a cocktail party and ask somebody about how their kids are using Snapchat or not, and have those continuous discussions and be a user as a consumer of them. And for that reason, actually, the public markets,

• 25:42Speaker 02

  that 2.7 trillion market cap that is sitting in the SaaS world today. There's a lot of valuation and efficiency around these companies. Because when things get volatile, I know, so we always say volatile means down. Nobody says the market is volatile when it's going up. It's like, well, it's, it's, that's like a Wall Street, maybe broker term to not scare their clients. That was developed, but when the market is down and things are bad and public investors are trying to figure out what they own. Some of these names get left behind because how much time did they have to understand them? When there are so many of them and they provide complex solutions. So they're also in the world of extremely smart public investors and highly competitive

• 26:27Speaker 02

  market for, for returns. There's a lack, given the growth that enterprise software has had. There's a lack of investors that just specialize in this. Right? You'll see T M T groups, you see tech groups within these public investment firms. But do you see just enterprise software only? Typically not. And now that's a limitation on what we believe are some great assets that are out there. But that's also an opportunity for others to focus on.

• 26:59Patrick O'Shaughnessy?

  Maybe say a little bit about the evolving nature of just like the private equity fund world itself, its size, its opportunity, the opportunity for return. Maybe we start with SoftBank. SoftBank seems to be the whipping boy for people making fun of their fund size and their presentations. But maybe they got something right in terms of how much capital they formed to be able to go after some of these big opportunities. What do you think about that landscape today? Sort of the private equity fund size and competitive landscape?

• 27:29Speaker 02

  Look, at first, when they had that big theme, that size fund to do minority investing, I have to admit that I was skeptical about it. Now I am highly impressed with the whole thing. He was very forward looking, ambitious, he'd say. The world of technology and software, it's going to create these massive companies that are going to stay private longer and that have huge hands. And there's room here. For a differentiated, very large source of capital that can move quickly and entrepreneurially in order to serve the needs of this new world.

• 28:14Speaker 02

  I'm highly impressed with it. I don't know the details of the performance, so I can't comment on that. But the concept now just makes perfect sense to me, and I view it as quite visionary at the time, I guess, and hence the fund's name. As we see it today, there is no limit to the fund side. It's not even close to what the limited partner, private equity community in general can provide. It is so far outpacing the capital being allocated to the sector when, once again, you have a company at a billion dollars growing 20% a year without the benefit of ad hoc acquisitions. And many of these companies are highly acquisitive.

• 28:57Speaker 02

  And when you add to that the importance of buying some of the players that have the best technology in the space, this is just really only getting started. And it's going to be a challenge for the whole investment community around this to adjust to this new world.

• 29:13Patrick O'Shaughnessy?

  If we think about the potential source of return for you and your LPs through history and then prospectively, maybe one convenient way to break that down would be like operational improvement, multiple expansion, or hopefully not contraction, and leverage as a source of equity return as well. How do you think that's changing? Like you mentioned, it's funny thinking about profit 21 for two times revenue. That's changed a lot, so multiples have expanded a lot, and that's been one source of return for this style of investing. How do you think going forward, we should think about where return will come from across those three categories?

• 29:49Speaker 02

  Let me take the easy ones first. Leverage has always been very little for us because if you look at our first five years in software, 2000 to 2005, there was very little leverage in the industry. Maybe in 2004, it kind of got started. Credit Suisse was one of the first syndicated type lenders in investment bank, but before that, you had to do almost like maintenance revenue loans with private banks. Wells Fargo was great at doing this at the time. The market was very, very tight and very small, and therefore, there wasn't a lot of leverage back then. In hindsight, groups like us earned it on operations.

• 30:32Speaker 02

  And then multiple expansion obviously happened. I don't think people were underwriting that, but it's only happened. But in those times, 2000, 2005, there was very little leverage staying in that component. Leverage came into the market really in 2005, but that was short-lived because the financial crisis came in in 2007. Then by the time we were sort of out of the financial crisis, 2011, really, by the time you can build your pipeline of deals and look at buying market-leading companies, then the software as a service transition was well on its way. So now the targets that you're looking at are higher-growth SaaS companies that are becoming the business of their customers. We made that transition.

• 31:18Speaker 02

  We went to pursue at a higher valuation world, the higher-quality, faster-growth company. Instead of looking at values and reminiscing on what we were talking about, the two-times maintenance revenue, one-times revenue, and saying, "That's no longer here. We're really sad about it." One or two deals can we find that are quote-unquote "cheap" relative to the market? We looked at that in a positive way and said, "Wait a minute. Our first 10 years in software, because it was an on-premise industry, you could only buy really solutions that are back-office oriented, that are automating paper-based processes, important things, but nowhere close to buying SaaS businesses on the front-end of their customers

• 32:02Speaker 02

  and that are really becoming their entire business. And of course, you have to pay higher multiples for that, but with that comes a completely different growth and TAM and value proposition. And then on those, the multiples are high, and therefore, the leverage component is not nearly the majority of your capital structure.

• 32:21Patrick O'Shaughnessy?

  If you think about this prospectively, how do you think about, then, if we set leverage aside, operational improvement and operational fundamental growth versus multiple expansion from here? Like, when you're underwriting a deal, are you assuming that the multiple would sort of stay the same? Obviously, that hasn't been the case historically, but things have come down a lot in public markets, you know, as we're talking today. But some multiples are still crazy, crazy high for software businesses. How do you think about the mix and what can be relied on going forward? I guess what I'm really asking is like, how good is the opportunity for returns in this kind of investing today?

• 32:55Speaker 02

  We have never subscribed to The View. Based on where we all come from of buying high and selling higher. A lot of us are the product of the dot com bubble burst. So we live through that and in that environment, even when you had in your portfolio software or not, you have to go do quite a bit of operating work. And we almost have still PTSD over that environment. So every time we make a decision, we still think, does that look anything like that? And you know, our partners talk us down and just like, no, it has nothing to do with that. That was 22 years ago. It was just a, this is a completely different business. But that's the conservative nature and culture that we have,

• 33:38Speaker 02

  which by the way, sometimes has limited us to pursuing yet other things. You know, one of the biggest mistakes we've made is not doing more deals. There's not unlimited capital in the world, so we're happy with what we've done in the past. In terms of multiple expansion, it depends how you look at it. You can say that groups like us even model multiple contraction because the EBITDA and the earnings and the operating income isn't there today. So it may look as if you're paying a pretty wacky price based on the earnings today. So we don't necessarily look at our entry that way and match it up with certain exit because we're really thinking about revenue multiples and then creating an engine

• 34:21Speaker 02

  where the profitability then comes in and makes a fundamentally sound investment that you can exit based on earnings, not just on revenue and revenue growth. In terms of how attractive the opportunity is, I can talk in general about that. I can't talk about our specific model for that. The public market opportunity in enterprise software is so good today. These assets at the current valuations on average present a compelling investment opportunity. One way to look at it is currently the standard Porsche 500 is trading at around 23, 24 PE. And the S and P grows earnings at 7% a year. If you buy the index.

• 35:07Speaker 02

  Based on that growth, you'll own it at about a 16 PE in four years. The profitable software index, that's the thing, is the profitable. Which you do, you do have a large enough number of companies to call that an index. It's not like there's just seven or eight. When you look at that profitable index, it's growing earnings at 20% and it's trading for a PE of 32, 35. It just depends, maybe it's a 30. If you buy that without counting the superior business model of software where you produce a lot more cash flow than the DAP and all those dynamics, you will own that index also at a 16 PE in four years. And what would you rather own?

• 35:51Speaker 02

  These recurring revenue, almost 100% recurring revenue companies with much better terminal growth rates that have sometimes the ability to really break out in terms of their performance? Or the S and P 500, my answer is pretty clear.

• 36:05Patrick O'Shaughnessy?

  One of the other really interesting features of your history is the speed sometimes with which you sell. There's some great examples here of very short hold periods. And I love the idea of exploring why and when to sell an asset. Almost all the attention goes on why and when to buy something. And obviously, we've talked about the features of market leader and the changes and dynamics of multiples and all those great things. The stickiness of these and importance of these businesses to their customers. But no one talks about when to sell. And you had some really interesting ideas here and your own history has been, I think, kind of distinct in the short holding periods. Talk us through what you've learned about selling wealth.

• 36:43Speaker 02

  So traditionally, we have not been afraid to sell. That has been how we philosophically think about exits. That's a very important point because I do see a lot of people in our great community really being nervous about that. How would that make them look? Is this the right time? What ifs? And you can get quite paralyzed on that. There is nothing wrong with putting up a good return, leaving the company in great hands, whether it's private equity or strategic, and having them make a lot of money out of it. As a matter of fact, we feel that for the private equity community, so that's the most visible way of tracking our assets, that when they get sold to a strategic.

• 37:26Speaker 02

  The companies that we've sold were very, very proud that they've done really well for other funds. And the way we say it is that means they want to work with us more. And we have a similar limited partner community in all of these vehicles. So that's a good thing. We have a strategic buyer that has bought three companies from us. And I'm sure that they bought the second one because they liked the first one and so on and so forth. That means we have a good relationship there of selling. See, but that's what happens when you work with existing management and you put really good processes in place. And that existing management is not mercenary. They belong in that business. They have a mission about what they're doing. They stay, they continue to do well, and that gives you a longer road

• 38:11Speaker 02

  for wherever that asset ends up at. The word that we use on selling is you should lean on selling when a strategic buyer approaches you. Because if they're here today, likely, it's likely that they won't be here tomorrow because they'll either buy something else, they'll either build the product organically, or next year they will change their set of strategic initiatives.

• 38:32Patrick O'Shaughnessy?

  I love that concept of the strategic approaching you as a sign to sell. What a clean, like, simple heuristic. How does that play out in holding periods? Like, how short can these holding periods be? And if they're less than a year or two years or something like that, I think there's been examples like that. How different are their companies really from when you bought them to when you sold them? Given that they're already big and it's hard to change things, how much difference can you affect in a company in that short period of time?

• 38:59Speaker 02

  You sound like one of our investors here when they do do the elements. I like this. I'm used to this one. That is the whole byproduct of working with existing management. When you work with existing management, you can develop your business plan with them way before you close that deal. And sometimes you've got to work on it before you close the deal, in case there's a big lag between signing and closing. And therefore, in these software companies that are people-based, that move very quickly, you can make changes very quickly. Now, if you come at it with your approach that existing management has made too many mistakes, if people make that judgment, then whatever you put on paper on your model, you may have to look at again.

• 39:43Speaker 02

  Because did you really model the disruption of changing leadership? The time that it takes to get new leadership? The time that it takes that new leadership to learn the business before they can take action? Because good managers like to spend some time really understanding what is going on before they have a point of view. And you could be two years into it before doing that. So, we feel that our approach is very difficult to do. Because you do have to inspire people to think different. And that requires a lot of trust, a lot of patience. It requires knowing that people move at different speeds of getting some things and not getting others.

• 40:26Speaker 02

  It's a journey that we love, but it does allow you to run efficiently quite quickly. And therefore, you're open to the changes that happen in the strategic buyer market.

• 40:37Patrick O'Shaughnessy?

  What do you think would be the most surprising things about what you've learned about deal-making to those that have never done it before?

• 40:45Speaker 02

  On the one hand, it's really not that hard. If you really look at the big picture, if you have a great idea of something that is very compelling to you, that you understand deeply. Pick up the phone, call the counterparty. People are a lot more open than you would think. Just go for it. Of course, you're going to have to raise the capital. But if it's a good idea, you'll be able to raise the cap. It's going back to one comment that you and I have spoken about is right place at the right time. It's hard to go wrong in the US economy, in private equity, in software. I mean, that's all a phenomenal combination.

• 41:27Speaker 02

  Now, on the flip side of it, when you look at each tactical detail during the deal process, that could seem difficult and you just have to live the journey many different times. And there's so many small decisions to be made that lead you different ways on that deal that the more active you are in doing that and the more experience you get, the more obvious it would look to.

• 41:54Patrick O'Shaughnessy?

  Even with your great experience, I have not been through this nearly as many times as you, but it's just shocking in the few times I have, the amount of details that come up and how hard they can be to get through. I suspect that having done so many deals, there's still difficulties. What remains difficult each deal or most deals for you despite your huge experience?

• 42:16Speaker 02

  See, the key is separating the things that really don't matter from the ones that really, really matter. Because you're right, there's a lot of details and how crazy can you go over each one of them? Right? The division missed the month in this area. That call with that division did not go as well. Do you really have management buy-in? Also, some of these things you don't really know until you close the deal and you're working together. I still think that the most difficult thing is that you have to earn it every single time. It doesn't matter what your past history is almost. And however many years and however many deals,

• 43:01Speaker 02

  what matters to your potential management partner and to that board is now. They appreciate the past somewhat. I'm not saying they don't, and that's very nice of them to do. But what matters is what you do now. And earning it each time is hard. That's why my other answer is if you haven't done it on. Try it because it's just as hard for somebody to convince the counterpart and just work with them that has done it 500 times and then for somebody that's doing it for the first time. Sometimes doing it for the first time is an advantage because you may not come with certain judgments or experiences that may allow you to be more open. And by the way, that deal that you're doing is the most important deal of your life, which then they appreciate as well.

• 43:45Patrick O'Shaughnessy?

  What part of the process do you still enjoy the most? What stage or what part of this do you wake up with the most energy and excitement?

• 43:53Speaker 02

  There are two, and those are easy. One is I love the competitive dynamics of the team. Absolutely love it. I learn a lot from our peers. I love the game. I really, really do. I joke with my colleagues that when the deal activity is low and all depressed and looking at two useless things, right? I just absolutely love that creative element of it. One of the things that I love about the deals is doing the right thing, sticking to your word, being open with people on very stressful situations because these companies sometimes have never gone through a transformational event that is this day. The second thing, and this takes longer, that I really love about our business is making

• 44:37Speaker 02

  those promises to existing management about how we're going to behave, of what we're going to do together, and seeing them tell us two to three years after the fact, reminding us of those meetings and saying, you know what? You never change your mind. This has exceeded our expectations. It really worked. This was the best time we've had, and we've had those comments before, and that means the world to us. And I really enjoy that personal.

• 45:04Patrick O'Shaughnessy?

  You have this fantastic phrase, I just love it, that if your job title has a C in it, you're not allowed to complain. Say a bit about that idea, and then I'd love to explore any other similar ideas that you have about leadership or running companies well.

• 45:17Speaker 02

  I appreciate you noticing that. I didn't mean that for CEOs of our companies.

• 45:25Speaker 02

  Well, I have a great relationship with us and so does our team. It's just in general, the C-level title has proliferated. I remember it got started during the first dot com movement, where you have the Chief Development Officer, and these are big jobs and they deserve that title. But when you get it, you have so much responsibility for other people. And there can be so much drama in our organization, so much internal competition that becomes unhealthy. People that care deeply about their jobs and are equally competitive, that need your help in parsing out what matters from what doesn't matter. Your role is not to increase that level of drama

• 46:08Speaker 02

  and potentially useless conversations and non-value creating anxiety. I'm not saying you're positive just to be positive, but a big part of your role is telling people, you know what, that's okay. Go make a mistake, it's okay. Or if one of your colleagues erred, go help them, we can fix this. Just let me know as far in advance as you can, and we can do this together. Because for all those things that you can quote-unquote complain about, you can actually find a positive and say, ah, this happened. Why don't we try this? And that'll become something so much better. And that creative, positive approach,

• 46:50Speaker 02

  especially with young people now that are so talented, but have so many ideas, that that positive collaborative creative approach should do so much.

• 47:01Patrick O'Shaughnessy?

  Are there other deeply held beliefs like that one about operating excellence that pop to mind from your experience working with so many operators?

• 47:10Speaker 02

  Really good leaders delegate quite a bit of authority and responsibility. And they have the experience to know when to get involved to help and when to not. They make things a lot more simple. We have a lot of experience and we continue to learn a lot about leadership, management, operating management. C-level executives that think about how every decision that they make impacts the P and L. That's big. There's not a lot of them in the world that really think that rigorously, the P and L impact of every one of their, of their decisions. And also...

• 47:51Speaker 02

  You can be, a leader can be both strategic and growth oriented, as well as detail and operationally oriented. You see it, and when you see that, you just should establish the closest partnership you can, because it doesn't happen too often.

• 48:07Patrick O'Shaughnessy?

  What does the word "service" mean to you as it relates to all of this that we've been talking about?

• 48:13Speaker 02

  I just feel that the best guide as you pursue your journey in the world as an individual, as a business leader, as a philanthropist, what are you about? What is your mission? And therefore, what is your company's mission that you're involved in? What is your foundation's mission that you're involved in? The more you can understand what you're passionate about and have an opinion on, the more those worlds converge and become the same, and the more clear your path is on what you spend your time on, on how you make decisions, and on why is it that you're driven to help others? In what way?

• 48:57Speaker 02

  I can tell you, for me, my mission is to provide opportunities to talented people, especially young adults, that otherwise wouldn't have that chance. When we look to buy a company and the company has issues, because many times in private equity, you buy, something has happened. The company misses numbers, they missed the product cycle. Something made them more open to an ownership change, especially in the public markets. Well, we work with existing management. Now, these are the most talented people in the world. But I do feel that we're giving them a big opportunity to do things differently, create wealth, and do it in a way that is collaborative and good for their own organization.

• 49:41Speaker 02

  We adapt ourselves to their culture. That is very meaningful to us. If I look at the work that we did when we started our foundation, the Brown Family Foundation and Hurricane Maria, the way we did relief, because we have no experience in doing hurricane relief. Well, we used the same philosophy. We went directly to community leaders that run those communities, that know their people, that live in it, that know the problems, that have the following of those disadvantaged communities, and we backed them. What do you need? You drive it, we'll back you, that will help you. In terms of measuring results and supply chain issues and everything else that they have going on.

• 50:24Speaker 02

  When I think about the overall different areas of the foundation, we have this wonderful Rising Entrepreneurs Program, where we look to give these young, talented entrepreneurs in Puerto Rico capital, access to VCs in the US, access to our CEOs, one-on-one mentorship, a program of how to build and run a business that we build, that is, we are backing people at the source and hopefully giving them an opportunity that they otherwise wouldn't have.

• 50:50Patrick O'Shaughnessy?

  I really love the mission of representing a sort of on-ramp, if you will, for talent that doesn't come from the entrenched systems. And I wonder, as you think about business, growing accepted truth that talent is now the constraining factor, capital no longer is. Maybe back when you did the Profit 21 deal, capital was a constraining factor, but now there's plenty of capital. And today, what we need more of is talent. How do we do a better job of on-ramping the kind of talent that you're focused on bringing into the system? Seems like there's a lot of room for improvement there.

• 51:25Speaker 02

  Big time. One of the great openings that we all have is when different investment groups, and I'm just talking about finance now, and it's beginning to happen in tech, but when different investment groups said, what are we really doing about being more inclusive and about hiring different people and more diversity and mentoring women for leadership positions in private equity and investing, running these companies? That whole memo that our community got, I don't know, seven years ago, is actually now also opening up.

• 52:04Speaker 02

  A world of where do you get this talent from? And we have now so many great case studies that as we move people up to our organization that have different backgrounds, many of them did not come from Harvard or the place where everybody looked to recruit. Once again, that's an incredible institution. It's nothing against that, but talent is everywhere now. And our community, our industry, we're lucky to be a lot more open to different places. And therefore, people therefore that did not go to the schools that we went to and that therefore not like us. And one young person at Toba Bravo told me this years ago, which I always use, and I thought it was so insightful.

• 52:48Speaker 02

  And she said, don't think about culture fit. Think about culture add. And the way we think about it is, why have we been lucky? Of course, right place at the right time has a lot to do with it. But also our culture has a lot to do. It's not our metrics and our processes, other people have that. It's how we come together as a culture to make decisions. And what does that culture stand for? It stands for being open minded, being collaborative, thinking differently. And is that culture therefore consistent with having a homogeneous group? Absolutely not. We have to move it forward.

• 53:25Patrick O'Shaughnessy?

  What an awesome idea, culture add, not culture fit. I mean, it's like an elegant, that person's very smart. That's a really, really interesting distillation of the concept. It's also kind of a good excuse to talk about this notion of decentralization. You mentioned this in leadership too, that the best leaders run pretty decentralized, push power and authority down onto the experts versus being a micromanager. And I think you think this coming decade is going to be defined by decentralization. I'd love to hear all the ways in which you think that that is true. It's a big buzzword, obviously, but an important one. How do you think that will define the 2020s and beyond?

• 54:01Speaker 02

  Let me go back to operations. When you have these organizations that run in a very centralized way, I feel that these leaders are tricking themselves into thinking that success was due to them. It's actually, success is in spite of that. Because when everything needs to flow to the top, it just takes too long to make decisions. You're too far removed from the day-to-day operational realities to be able to really make good decisions. You can empower people as a leader. You can instill your philosophy, your values, a mission. But by doing that and letting them be their own artists and making their own right

• 54:45Speaker 02

  or wrong decisions that are closest to the action, you're going to just do so much better. Organizationally, if we were doing organizational behavior in business school, I would really, really argue for organizing yourself in that way. And we have done that. At Tom and Robin, we worked with CEOs on this similar philosophy. When therefore you extrapolate this to the world of technology and you think about Web 3, which stands for really the exchange of ideas around the world, regardless of national barriers, cultures, places, you name it.

• 55:25Speaker 02

  You have ideally an interconnected network of ideas. And where everyone that has a passion for something that's similar or a similar subject or a similar something, they're contributing to that community in an open way to find better ways, faster ways, more equal ways. And that is being inputted in this sort of centralized system or database that is an interconnected decentralized process of collaborating. That is just incredible. And that's one of the reasons why I'm a big believer in the tokens and currencies that support this system. Because they are the collateral for the system.

• 56:10Speaker 02

  They are the ways of measuring the value of each of those communities and systems. And they're as real as any currency created by an old set of rules and financial system.

• 56:21Patrick O'Shaughnessy?

  We were talking earlier this week about some of the security and these protocols and their potential. I remember when I first got interested in, say, Bitcoin, it was the security angle that was really interesting to me, like the encryption algorithm, the cryptography. Given that you've spent so much time in this world of security and cybersecurity, how do you think all of this affects that world in the coming decade? Like, what is most interesting to you about the technology of Web 3? You just outlined sort of the ethos of Web 3, but what about the technology side? What pattern matching do you see, given your unique experience with technology and specifically, security companies?

• 56:56Speaker 02

  I'm more interested in the social movement that it represents, actually, about that empowerment, because it's also a movement that allows so many people that have not participated in our financial world or our economic system to actually participate in it fully and potentially win and potentially do better because of that openness and that constant exchange of ideas. I do feel that blockchain could present better use cases than database software in a number of areas. And in the enterprise, that is so early. I'm constantly looking for use cases that could replace SaaS and database software as we know it.

• 57:42Speaker 02

  And there's some, but not that many, because that world is more focused on creating a financial system and on the consumer as well. But there are some now on the security side, and you probably have a lot to say about this. There are some phenomenal CSOs and security experts that really are extremely worried about it. And we're trying to figure that out from our own investments in SaaS software, cybersecurity in SaaS software. We're really early trying to figure that out.

• 58:15Patrick O'Shaughnessy?

  Going back to the world of private equity and investing, where we opened our conversation was all around this unique evolution of size and scope of these businesses. What, if anything, do you think is broken about the private equity model? Like, where does there need to be innovation? You've talked about middle market innovation, continuation funds, things like this. Weird price distortions versus what public price might be on a business. Just give me a sense of maybe what needs innovation or might be a little bit broken in the private equity world and structure specifically.

• 58:45Speaker 02

  All those, you mentioned some good ones. Continuation funds, long-dated funds, the world's colliding between venture, hedge funds, private equity, SPACs. All these are ways that the financial community has been looking to innovate in order to match or try to keep up with the innovations that are going on in software and tech. Isn't that interesting that it all kind of happened together at the same time? Because we're all trying to pursue, how do we finance and get involved and participate in these companies? It can't be in the old way only.

• 59:29Speaker 02

  You would not be able to address the opportunity and improve upon the challenges that were being served up to look at as investors that's out there. So I would love to see one huge innovation across original, what I call the original sources of capital, sovereign wealth funds, pension funds, even endowments. And that is to start looking first and foremost at software as not an industry anymore. So not looking to measure how much, quote-unquote, exposure you have to it, because it is the entire business of companies. If you have, for example, if you look at verticals, you will have companies that focus

• 1:00:12Speaker 02

  on manufacturing, retail, hospitality, real estate, like we have RealPage, and they have nothing to do with one another, except they're called software. They're more and more running the entire business of those segments. And I think that's coming. But even a bigger one is to have these pools of capital not differentiate private equity from their venture allocation, from their infrastructure allocation to others, and create almost these barriers.

• 1:00:43Speaker 02

  To where capital should flow. Why doesn't an investor group look at a given big segment? And say, I'm going to look at software. And in that segment, I am agnostic as to whether I'm going to invest directly in the public markets, manager in the public markets, in private equity, in growth, in ventures. What is the best way to deploy capital in that ecosystem? And that will open up the free market and capital flows into their most efficient ownership structure and their most efficient use.

• 1:01:19Patrick O'Shaughnessy?

  I normally wouldn't ask this question, but your specific interest in young talent, even though it's a cliched question, I think you're the right person to ask. What advice would you have for those young, talented people early in their careers about building a great career? Like, what does a great career or the great careers that you've seen unfold? What do those share in common that could serve as advice for young people that are ambitious and want to get going?

• 1:01:44Speaker 02

  I'm such a big fan of young people because every graduating class, my experience in working with them as they come up through our associate ranks is every younger class is better than the predecessor. They're more knowledgeable, they're deeper thinkers, they care more about the social impact of their actions, they're more philanthropic, they're more mission driven, they're more complex. But my first big piece of advice is the world is waiting for you with open arms. You can do anything you want. Now, of course, you're going to have to work hard at it. You're going to have to learn through making mistakes. You're going to have to listen carefully to mentors, see what mentors fit you better.

• 1:02:29Speaker 02

  But it's all open. Private equity, for example, if you think it's mature, it's just getting started. People thought that when I was interviewing in 1998 out of Stanford Business School and Stanford Oscar, I got those comments from some great leaders in private equity. There is kind of mature and it's hard to get in. No way, look where the industry is now. And the same applies for whatever your passion and your interests are. A certain amount of confidence in a humble way is very important. You will accomplish what you want. The second thing is do what you want to do now. Don't do something in order to do something else later. Some young people ask me, well, do you think working at a company is a good way for me to get into venture capital?

• 1:03:14Speaker 02

  Private equity. I say, look, if you feel that right now you really want to work in operations at a company, go do it. Go crush it, but don't do it to do something else. If you're really interested in venture, go work in venture. You will develop your own set of weapons in that environment and your own skill set to make you different. And then the third one is keep your ears open, your heart open, your mind open. Because there are mentors all around you that legitimately really want to help you. Who do you decide to listen to? Because they all want to help. Individuals have that in us.

• 1:03:49Patrick O'Shaughnessy?

  It's a great excuse to ask my favorite and traditional closing question that I ask everybody. What is the kindest thing that anyone's ever done for you?

• 1:03:57Speaker 02

  Oh, my gosh, there are just so many. And I don't know how far back to look at. A friend at Brown, when I was ready to go to law school, to really grab me, take me to buy some wingtip shoes. Because that's the way you were supposed to dress and put my name to be interviewed by Morgan Stanley on the door at 2:00 P. M. And I got that job and it pushed me into a different career and probably into what I'm doing now. I had this great mentor from Puerto Rico, who unfortunately passed away years ago. Who worked so hard with me to leave New York to go to Silicon Valley in 1994. Because that's where he saw a big opportunity for me.

• 1:04:42Speaker 02

  I go back to all these career things that people did for me that have helped me globally.

• 1:04:49Patrick O'Shaughnessy?

  Wonderful stuff. Orlando, this has been a total pleasure for me. A totally unique perspective that you bring to bear, even though I've done a lot of these with great investors. Your style of investing is different from any of that I've done before. So appreciate the insights that have resulted from such a neat career. I thank you so much for your time.

• 1:05:06Speaker 02

  Thank you so much, Patrick. I really have enjoyed this.

• 1:05:10Patrick O'Shaughnessy?

  If you enjoyed this episode, check out joincolossus.com. There you'll find every episode of this podcast, complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week. [Music]