Matt Perelman & Alex Sloane - The Art of Franchise Investing - [Invest Like the Best, EP.393]

My guests today are Matt Perelman and Alex Sloane, Co-founders and Managing Partners of Garnett Station Partners. GSP invests in the trillion-dollar franchise and consumer services industries. Matt and Alex started the firm in 2014 as MBA students when they bought 23 Burger King restaurants. Since then, they've invested in 26 other multi-unit businesses, from gyms to car washes to funeral homes. GSP is now a leader in its field. This discussion is a masterclass in franchise investing. We explore GSP's playbook for creating value, the power of Matt and Alex's partnership, and their approach to scaling businesses for successful exits. This conversation is special for another reason. For the last year, we've been working on a print publication that will share the very best of what we've encountered and learned every quarter. GSP, along with many others, are profiled in our first issue to be revealed next month. We are going to print a limited edition of them to start, so if you are interested in hearing first when pre-sale launches, go to joincolossus.com/print. Please enjoy this excellent and incredibly fun discussion with Matt Perelman and Alex Sloane. For the full show notes, transcript, and links to mentioned content, check out the episode page here. ----- This episode is brought to you by Ramp. Ramp’s mission is to help companies manage their spend in a way that reduces expenses and frees up time for teams to work on more valuable projects. Ramp is the fastest growing FinTech company in history and it’s backed by more of my favorite past guests (at least 16 of them!) than probably any other company I’m aware of. It’s also notable that many best-in-class businesses use Ramp—companies like Airbnb, Anduril, and Shopify, as well as investors like Sequoia Capital and Vista Equity. They use Ramp to manage their spending, automate tedious financial processes, and reinvest saved dollars and hours into growth. At Colossus and Positive Sum, we use Ramp for exactly the same reason. Go to Ramp.com/invest to sign up for free and get a $250 welcome bonus. — This episode is brought to you by Alphasense. AlphaSense has completely transformed the research process with cutting-edge AI technology and a vast collection of top-tier, reliable business content. Imagine completing your research five to ten times faster with search that delivers the most relevant results, helping you make high-conviction decisions with confidence. AlphaSense provides access to over 300 million premium documents, including company filings, earnings reports, press releases, and more from public and private companies. Invest Like the Best listeners can get a free trial now at Alpha-Sense.com/Invest and experience firsthand how AlphaSense and Tegas help you make smarter decisions faster. ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes. Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com). Show Notes: (00:00:00) Welcome to Invest Like the Best (00:07:02) The KFC Rejection and Burger King Opportunity (00:08:36) Living with Ray Meeks and Business Growth (00:12:08) Understanding Franchise Economics (00:16:12) Challenges and Lessons Learned (00:38:37) Navigating COVID-19 (00:54:37) Challenges of Rollups and Integration (00:56:01) The Importance of Culture in Business Consolidations (00:58:01) Strategies for Successful Exits (01:01:49) The Fun and Challenges of Partnership (01:09:53) Innovation in Business Operations (01:13:44) Real Estate and Financial Engineering (01:16:34) Managing Labor and Turnover (01:19:36) Investment Themes and Criteria (01:23:36) Selling to Larger Private Equity Firms (01:27:11) Maintaining Culture and Sourcing Deals (01:33:41) The Importance of Cycles and Capital Structure (01:37:18) Partnership Dynamics and LP Relationships (01:40:26) The Kindest Thing Anyone Has Ever Done For Matt & Alex

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

• 0:00Patrick O'Shaughnessy?

  I know firsthand how complex the tech stack is for asset management firms. And seemingly every new tool and data source makes the problem even worse, adding more complexity, more headcount and more risk. RidgeLine offers a better way forward. One unified platform that automates away the complexity across portfolio accounting, reconciliation, reporting, trading, compliance and more, all at scale. RidgeLine is revolutionizing investment management, helping ambitious firms scale faster, operate smarter and stay ahead of the curve. See what RidgeLine can unlock for your firm. Schedule a demo at ridgeline.ai.

• 0:35Patrick O'Shaughnessy?

  Hello and welcome, everyone. I'm Patrick O'Neal 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.

• 1:00Speaker 01

  Patrick O'Neal is the CEO of Positive Sum. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum may maintain positions in the securities discussed in this podcast. To learn more, visit psum.vc.

• 1:29Patrick O'Shaughnessy?

  My guests today are Matt Perelman and Alex Sloan, co-founders and managing partners of Garnett Station Partners. GSP invests in the trillion-dollar franchise and consumer services industries. Matt and Alex started the firm in 2014 as MBA students when they bought 23 Burger King restaurants. Since then, they've invested in 26 other multi-unit businesses, from gyms to car washes to funeral homes. GSP is now a leader in its field. In our conversation earlier this year, Mark Lazry dubbed Matt and Alex the next generation of great private equity investors. You'll soon hear why. This discussion is a masterclass on franchise investing. We explore GSP's playbook for creating value, the power of Matt and Alex's partnership, and their approach to scaling businesses for successful exits.

• 2:13Patrick O'Shaughnessy?

  This conversation is special for another reason. For the last year, we've been working on a print publication that will share the very best of what we've encountered and learned every quarter. As the world goes bite sized, short form, and full of platitudes, we are drawn to harder searching, more detailed exploration and understanding, and more emphasis on the very best people we can find, who are doing unique things in both business and investing. GSP is one such firm, and along with many others, they are profiled in our first issue of an upcoming print publication to be revealed next month. We're going to print a limited edition of them to start, so if you are interested in hearing first when pre-orders go on sale, go to joincolossus.com imprint. I really couldn't be more excited to share with you what we've been working on, including

• 2:55Patrick O'Shaughnessy?

  an in-depth profile of one of the great investors of the last 20 years, who is a cult figure in investing circles but has never been profiled or interviewed like this. So now, please enjoy the excellent and incredibly fun discussion with Matt Perelman and Alex Sloan. I can't wait for you to learn even more about them and their strategy soon. Stay tuned next month, and for now, go to joincolossus.com imprint.

• 3:19Patrick O'Shaughnessy?

  We have a chance to talk about a lot of history this time, which I don't normally do, and I'm especially curious to learn about your history because you started the firm so young, and you went through this interesting phasing of how you grew your business, which I'm starting to notice amongst lots of the people that start their firms really young, is they go through this early, what I'll call like SPV phase, where they're just doing whatever it takes to get deals together, get capital together, have great deals, not lose money, hit home runs early on, to earn the right to go into the fund structure and then into the firm building side. We'll talk about all three today. But to begin, I really want to hear the detailed version of the story about the original Burger King deal, and maybe even before that, just how you guys met and thought about and talked about what you might do together.

• 4:04Patrick O'Shaughnessy?

  I just think these early days are so critical for what the thing ends up becoming, and I actually remember hearing about you guys, I didn't know your names, but I heard about these young guys that had partnered to buy Burger King, so it was going really well, and I was like, okay, file that one away. So it's funny to be here with you today.

• 4:21Speaker 02

  Our story is Matt and I grew up together, so we've Known each other all our lives. I was at Apollo, Matt was at Catterton. We went to business school. The plan was to go back to Apollo and Catterton after we graduated. While we were there, we developed a thesis around franchise consolidation. And we found a deal to buy five KFC restaurants in Vermont. And we thought we could sell the real estate for more money than they were asking for the whole business. So we hired fancy lawyers and accountants that we had no business hiring for a deal that small. We didn't know any better. We spent all of our savings on diligence. And the day before we were set to close, we got a letter in the mail from KFC telling us we were rejected as KFC franchisees. The reasons they gave were, one, we had no money,

• 5:06Speaker 02

  so we didn't meet the million dollar financial requirement. Two is, we had no restaurant experience. So they told us we didn't meet the operating requirement. And three is, they told us we were in college, and therefore too young to be KFC franchisees.

• 5:18Speaker 03

  Yeah, other than that, they loved us.

• 5:21Speaker 02

  That was how we started. And look, obviously, we were really disappointed. And we were upset, but we also thought we were on to something. There were 150,000 tier one fast food franchisees in the country at the time. And our hypothesis was, how many millionaire restaurant operators are there? It just felt like a supply and demand mismatch. Rather than looking for a deal and then seeking approval, we said, let's go to the brands themselves. Let's tell them our stories. Let's see if any of them will approve us as franchisees, maybe even introduce us to a deal, to an operator. And all of the brands rejected us, except for Burger King. The Burger King management team introduced us to a guy by the name of Ray Meeks, who was a 30-year franchisee. He had 23 Burger Kings based in the Garnet Street train station in Henderson,

• 6:06Speaker 02

  North Carolina. His business was not doing well. It was headed for a restructuring. And Matt and I spent the summer between our first and second year of business school, living with Ray and his wife Cass, and then Henderson, diligencing the business. We bought that business in August of 14. We're going back for our second year. We added management talent, we added data, capital, a capital allocation plan, and grew that business from those 23 locations to what is today the Burger King franchisees who are 1100 stores, a public company. And so that's how we started and we realized pretty early on while we were building value in that business, that there was a much bigger opportunity where we could take the playbook that we were developing while building value there of adding technology, of adding data,

• 6:50Speaker 02

  of adding management talent and growing these businesses with M and A and new unit development and remodels. And we could apply it to what is a much broader set of businesses, which is the franchising, multi-unit consumer services businesses. And fast forward, it's been 10 years and we built an investment firm to go after and capture that.

• 7:08Patrick O'Shaughnessy?

  What was it like living with them? That sounds like a very unique experience.

• 7:12Speaker 02

  We have so many stories, Patrick.

• 7:14Speaker 03

  Yeah, we used to say the media rights are worth way more than the company. Hopefully 10 years later, that's not still true, but they were terrific people and it probably

• 7:23Speaker 02

  They still are.

• 7:23Speaker 03

  Yes, they are. It probably looked a lot like my cousin Vinny. We were diligencing our partnership with them, diligencing the business itself and trying to figure out where the most highest returning places we could be spending our time in capital were within that business. And to Ray's credit, he was in his mid to late 60s at the time and never had a financial partner. And he really embraced us and our ideas with open arms.

• 7:46Speaker 02

  It's funny, Patrick, we give Ray so much credit and Cass because fast forward, we manage over $2 billion of capital. We've done 27 different platform companies that all look very similar to that Burger King deal, but we were from different worlds. Ray was from Monroe, Louisiana, never met a Jewish person in his life before meeting me in that. We were in business school at the time. We were 26 years old. We had, again, we had no capital to speak of.

• 8:10Speaker 03

  It was just like he drew it up.

• 8:13Speaker 02

  And he and Cass embraced us and the humility, what we've realized over the years is that we always need a Ray in each of the platform businesses that we build, right? Ray, we'd go around the Southeast buying Burger King franchises. Ray was the president of the Southeast Burger King Franchisee Association for 30 years. He knew every single one of these franchisees, helped build the system. And Ray would introduce us to these people and he'd say, I'm Ray Meeks, these are my partners, Matt and Alex. They call us the two Jews and the general. And he would say, now which one's the general?

• 8:44Speaker 03

  And he would give us credibility and say, look, these guys are going to treat your people right. They're going to do what they said they were going to do. You should trust them.

• 8:51Patrick O'Shaughnessy?

  I was talking to Dan Schwartz, who was the CEO of Burger King for a long time and a key partner for you guys, obviously an amazing guy. That itself is an incredible story, worth reading a case study about. When talking to him, it was clear that sometimes these businesses are quite misunderstood. The franchisee franchisor model, sometimes at the corporate level, those things are intermingled in a way that makes it hard to figure out the business. What was it like for you guys to learn about just that one specific constellation of franchises of Burger Kings? What did you learn early on that was surprising? What do those businesses look like? For those that don't understand them, just let us into the room as you were figuring it out for yourselves that summer.

• 9:27Speaker 03

  I think it's important to give some of the background of what those businesses look like in terms of the partnership between franchisee and franchisor. So if you look at Burger King, and this is broadly true of any of the big tier one brands, at the store level, you're generating somewhere between a 15 and 20% margin before paying the brand their royalty. And that royalty is usually four to 5%. And so that means that after paying them their royalty, you're generating, call it mid to low teens in terms of struggle, EBITDA margin, take away a couple of points for G and A, and you're down to high single digit, low double digit EBITDA margin business. That means that at the end of the day, you as the franchisee are effectively getting, call it two thirds of the profit, and the

• 10:09Speaker 03

  franchisor is getting a third. It is a real partnership in that regard. And I think a lot of people, at least when we first started investing in the space, don't appreciate that. Importantly, there are different incentives, right? The franchisor cares a lot about growing the top line because they're taking a royalty, which is tied to the top line. The franchisee cares a lot about driving the bottom line. I think we relatively early on were able to figure out where the different incentives between franchisee and franchisor lie, and how to utilize our skill set, which had been capital structure and team building and that sort of thing, to help grow the equity value of these franchisees while keeping the franchisor super happy vis a vis investing in high returning remodel projects, new unit development, things that grew their top line.

• 10:54Speaker 03

  But for us, we're also really healthy ROICs and very attractive capital projects.

• 11:00Speaker 02

  The truth is, Matt's saying that the incentives are not always aligned. That's actually not true through cycles and over time. It's very hard to kill these brands. And at any given time, perhaps the franchisor is trying to sell dollars for 98 cents, which is not good for the franchisees. But for the franchisor owners, they can't do that through cycles and still have a brand that's valued at multiples and these businesses are very, very valuable. So through cycles and over time, that is a true partnership. But any given time, the incentives aren't perfect.

• 11:31Patrick O'Shaughnessy?

  How would you explain from the perspective of someone out there that might want to buy a single one of these things and run a single Burger King or a single Domino's or a single something, how to think about the structure of one of those businesses? What are the components? Talk about real estate, talk about ongoing maintenance needs, the things that seem simple, run a Domino's, earn a X number of dollars of profit a year or something. But I'm sure they're just a pain in the ass to run and complicated. So just maybe at the unit level, you can pick any franchise you want. What is it like for one of these people to own and run just one of these and then build up from there?

• 12:02Speaker 03

  There's three costs that matter in these businesses and those costs are people, the labor line, cost of goods and rent. Those costs are the vast majority of what's driving the overall profitability or not in the P and L, aside from obviously revenue. They're difficult businesses to run that are people intensive businesses with potentially a fickle consumer, depending on where you are in the cycle, that in large part relies on the brand's advertising strength and the overall brand strength. So I would not necessarily recommend somebody go and buy and operate one single unit because I think one unit is relatively risky. You could have a traffic pattern change or bad weather for a quarter and that can dramatically affect your results and the equity value.

• 12:43Speaker 02

  The Walmart could move.

• 12:44Speaker 03

  Yeah, the Walmart moves a mile away to a different traded area and now your volume's down 10%. And in these businesses, which are relatively low margin businesses compared to the SaaS software stuff of the world, if you have a 10 or 15% drop in revenue, that could be 100% of your earnings at a 35 or 45% flow through or change in EBITDA divided by change in sales. Alex and I have focused on scale as relates to both franchisee rollups and overall rollups. In our view, scale, more locations, different geographies, and an overall broader exposure to geography and markets that limits a lot of the Walmart moving, or the weather, or traffic pattern shifting. And historically, we've gotten paid for that

• 13:26Speaker 03

  scale and diversity because it does provide a less risky, more stable business.

• 13:31Speaker 02

  One of the things we realized pretty early on, and when we started this consolidating Burger King, there really were only two institutional firms doing this. Not that we were in any way institutional, but there were sort of two private equity firms at the time that had done franchisee consolidations. And so there wasn't a lot of today, family offices and middle market sponsors, and even sovereign wealth funds, they love this business. Rewind 10, 11 years ago, that really wasn't the case. What we realized pretty early on was that the relationship between the franchisor and the franchisee was extremely important. And at the time, people were tired. Baby boomer retiring, perhaps next generation didn't want to take over the business. These businesses needed to be remodeled. And I'm

• 14:14Speaker 02

  talking about franchising generally, not necessarily specifically Burger King. When you'd go to a franchise convention, get to the bar, and the conversation was, oh, they this, and you believe they did, oh, the idiot this, and just very critical of the franchisor. What we realized was, if you're going to become a franchisee, these franchise agreements, they're very much franchisor favorable. If you're going to take that view and mean it, you should sell and get out. Today, and even back then, we will only get into a system where we feel fully aligned with the franchisor, and with the management team, and with the ownership group. That's one of the reasons why our relationship with Dan is so important, with the 3G folks, with the board, and with the management team there, because you're going to have disagreements, and that's very normal. It's normal in any partnership or any relationship. But the spirit of those disagreements have to be in the best long-term

• 14:57Speaker 02

  interests of the brand. And so we took what at the time felt to be a little bit of a different approach, whereas we went in and said, we want to be your best partner. And you have a remodel program, we want to remodel more restaurants than anyone. You want to build new locations because that grows your business. We build- More burrings than anyone else during the first four years that we built that business. And obviously, we didn't do this out of the goodness of our heart. We did it because we believed in the unit economics. We believed in the returns. But there were things that you could negotiate with the franchisor that perhaps they didn't value that really helped the downside protection. For Matt and I, rules one through nine are don't lose money. Safety principle is what really matters. You know, rule 10 is to generate great returns. And we care a lot about structural protections and downside protection that the brand can

• 15:42Speaker 02

  give you, that these franchisors can help you with to help on the downside for us to be willing to take the risk of investing that capital and remodeling building new stores.

• 15:51Speaker 03

  And historically, there had been a real need for private equity and institutional capital, both a need at the franchisor level and a desire for private equity firms because of how high returning the capital was. For example, when we first invested in the burking business, 23 stores with an $8 million remodel slash capex obligation, it sounds like a huge number, but that $8 million was some of the highest returning capital we've ever deployed. And I think a lot of franchisees then, and it's probably true now, just stared down the barrel of the absolute size of needed investment, potential investment, and it scares them off. Or when you actually double click and even before getting into how you can finance it even more effectively, even on an unlevered basis, those returns are dramatic.

• 16:34Speaker 03

  For the first few years that we were doing remodels and investing in the brand, those were north of 30% unlevered returns. And then because of how big these brands are and how long they've been around for it, you can actually get really attractive financing. And then the point Alex raised about franchisors can give franchisees things that the franchisees really value that's no skin off the franchisor's back. In almost every franchisee deal we've ever done, we've been able to negotiate for the brand's right of first refusal. Meaning if you own a unit in a particular system, in a particular state, it has to go through us before it can trade to a third party. And that's hyper valuable to us for all the obvious reasons. But from the franchisor's perspective, they aren't buying stores, at least historically, they don't want to operate stores.

• 17:18Speaker 03

  And so that's a way to really incentivize us to deploy capital in the system without taking away any economics from them.

• 17:24Speaker 02

  Coming back to your initial question, Matt, the other nice thing about doing franchise consolidations is you have access effectively to the entire system's P and Ls over time. So Matt and I, we are very much believe in underwriting businesses through cycles, particularly if you're going to pay a franchise fee to operate someone else's brand. And in the world of franchising, you have so much data. So even we were buying a 23 unit Burger King franchisee back in 14, but we were able to access effectively the 7,500 other Burger King franchisees P and Ls, and we could look at them historically. And we could also see, Matt talked about the remodel returns on that $8 million remodel liability. We could diligence how those remodel dollars were spent and what the returns were across the other thousand Burger Kings that had been remodeled at the time.

• 18:08Speaker 02

  And you could do a cohort analysis to understand what was the trade area, where was the Walmart, what were the demographics, what side of the street was the restaurant on? And you could make a much more educated underwrite about the impact of that remodel dollar versus if you're buying a roofing business and you just don't have access to that same level of data.

• 18:28Speaker 03

  The other interesting thing in the franchise ecosystem that's not true of a typical deal is it's a tri-party negotiation. You have buyer, seller, and franchisor. And franchisors can do things to effectuate that transaction that's in everyone's mutual interests without reducing their economics dramatically. If we have 50 units of whatever brand and we're buying 10 units that perhaps need a lot of capital or they're underperforming for whatever reason, the franchisor can offer to reduce the royalty associated with those stores for, let's say, two years. And we're buying a 6% margin business because it needs some TLC and help, and they're going to reduce the royalty by half. So say they're paying 4% before that.

• 19:11Speaker 03

  So now our cash flow has gone up by a third for two years, which really helps us finance it. And we can redeploy that capital into high-returning projects related to that bolt-on. And from the franchisor's perspective, they're probably thinking about that as an add-back and the overall improvement in royalty, which trades at a far higher multiple or lower cap rate than whatever we're buying the franchisee at typically. That's value enhancing for them over the long run.

• 19:36Patrick O'Shaughnessy?

  How much variance is there at the unit level across some of these systems? If I looked at today, the very best performing Burger Kings versus the very worst, or whatever, it doesn't need to be Burger King, can be anything. Seems like variance of the unit, obviously the franchisor wants that variance to be super low because then financing is easier and performance is better and more people want to be a franchisee and on and on. So I'm sure that franchisors are always incentivized to drive down variance at the unit level, but you guys have probably seen more data on this than anyone alive. What have you learned about unit variance, performance variance within a given system?

• 20:10Speaker 03

  From the top line, it varies a lot and a lot of that is based on location and brand strength. So within different systems, you'll see dramatically different average unit volumes. And even within one system, you'll see dramatically different average unit volumes. Alex and I have taken the view that it's a lot easier through technology to change the variance in the middle of the P and L than it is the top line. Yeah, it's really hard to take a million and a half sales per box unit and make it 2 million. But if that million and a half dollar box is generating 11% and we can see that the food cost variance and the labor matrix is off by 300 base points, we feel really good that through technology and the fact that we've done this with over 3,000 locations over the last decade, you can really, I don't want to say easily,

• 20:54Speaker 03

  but with high confidence narrow that gap over a three to six month period.

• 20:58Speaker 02

  You might be surprised about the variance. You might think it would be tighter bands than it is in the middle of the P and L, in part because franchising is a huge tent. There's been so much capital that's flooded into the technology to help manage these businesses in a multi-unit way and franchisors help make that tech and the standard operating procedures available to their franchisees. But depending on the system, the franchisees don't always listen.

• 21:23Speaker 03

  A lot of operators will base labor just based on what their anticipated dollar sales is. And they said, so last Tuesday I did 10,000 sales. This Tuesday I think I'll do 10,000 of sales and so I need X amount of people. If you actually double click on that and you can do this pretty easily with technology, we're less focused on the dollar of sales. We're more focused on the number of Transactions because transactions is what drives labor, obviously not sales. If you take price by 10%, you don't need 10% more labor. And then also there's factors that go into a labor matrix that are impossible to do by hand. But with technology, you can do that pretty easily in terms of what's the weather? What are the traffic patterns? Is there road construction? It's as localized as is the local high school football team playing tonight? If they are, probably going to need more people.

• 22:08Speaker 03

  And it usually results in us adding labor at the peak hours to drive throughput. And so you get rid of the veto vote of people walking in saying, this is too busy. I don't want to stay here and taking away labor at the shoulder hours. Because the shoulder hours are smaller, both in time and dollar size than the peak hours. We're overall adding labor dollars, but the margin goes up because it does drive the top line. And there's meaningful operating leverage to that. That's a huge part of value creation for us.

• 22:35Speaker 02

  On that point, it may sound nichey talking about franchising, but franchising is a massive part of the US economy. It's over trillion dollar part of the US economy, but it's also a very small world. We've spent the last 10, 11 years at every franchise conference, meeting every franchisee, every franchisor out there. And we've traveled to meet all of the multi-unit franchisee operators over these years. And we've make a point, we ask the same questions. We have detailed notes from all of them on how they manage their business. We try to take a nugget from every single one of them. The best one sort of early on was a Taco Bell franchisee who would literally do labor by 15 minute increments. And you'd think, based on the weather and all the factors that Matt mentioned, you'd think that means they're reducing labor.

• 23:19Speaker 02

  It actually typically means adding labor, which is actually a really important point. You can think about it, labor is the most important part of these businesses. They're people businesses and getting labor right is the key, not only to the middle of P and L, but it really is the key to top line. Get satisfaction, net promoter score, intent to return. And in any one of our markets, our consumer typically is our team member. And the customers are typically family members of the teams, cousins of the teams, teachers of the teams, nephews of the teams. So you have to factor that into how you treat your people.

• 23:51Speaker 03

  And just to put a finer point on that, it's a virtuous cycle. Meaning the better labor you have, the better your customer experience, which means that they come back more often, which drives sales growth, which means you have more margin, which means you can hire better team members, which leads to customer satisfaction and thus your sales grow. And so it is a virtuous cycle. The other thing that I think is important to touch on is we invest in simple businesses. We're investing in multi-unit businesses throughout the country. They're not particularly difficult to understand. The nice thing about that is if you show our team at Garnett Station, the top line of a multi-unit business, the rent structure of the multi-unit business, and what the resultant margin is, we can tell pretty quickly, good, bad, or ugly,

• 24:32Speaker 03

  and how we would go about improving it. Sometimes we can't improve it. It's too good. But because these are simple businesses, and we've seen thousands and thousands of them over the last 11 years, with sales, rent, and the output, we have a pretty good sense of where the opportunity is.

• 24:47Patrick O'Shaughnessy?

  What, if you think back on most thousands, was the most surprising or confusing presentation you ever got? Where you looked at something, you're like, holy shit, we can't figure this one out as intuitively as you just described?

• 24:57Speaker 03

  We've looked at countless and countless Taco Bell deals over the last 11 years. Taco Bell is the darling of the franchisee investment universe. It only comes positively, meaning same for sales always seem to grow. It has higher level margins than the competitors typically. New units are created at really attractive cash and cash returns. The remodels always seem to work. It just seems to go up and to the right, and we can certainly be too cheap for our own good. And we've just looked at those businesses for the last 11 years and said, seven times, that's crazy. Eight times, that's crazy. Who's paying these prices? And we've missed every Taco Bell deal. And we probably would have made money on every single one of them had we invested. I think we're probably, hopefully, better at this today than we were 11 years ago when we started

• 25:41Speaker 03

  this at my dorm room kitchen table. But that's something that we've consistently missed, and we'll probably miss again.

• 25:47Patrick O'Shaughnessy?

  What's your theory as to why? Why is that an outlier?

• 25:50Speaker 03

  Two things. They have better marketing than most. Think about the various Taco Bell iterations of commercial and marketing that you can think of, all the way from the Chihuahua up to Pete Davidson recently. And they have a really compelling operating model. Food is reheated and so whatever they don't sell that day, they're able to reheat and sell following day, which we can all debate how delicious that is or not, but it does drive. Tastes amazing. It seems to work and marketing drives a higher top line. Their food cost model drives a higher store of EBITDA margin. That allows for more money to be reinvested in the boxes. So they look better. And the top line drives more advertising dollars, which what's forces more people to come in.

• 26:35Speaker 03

  Human beings, at least in America, are very Pavlovian. If there are more Taco Bell commercials on TV this month than the same month, the prior year, there's probably going to be more people who show up to Taco Bell. And with comps that have gone up every single year for 12 years, that's really driving that flywheel.

• 26:51Speaker 02

  As we think about our business, about trick, sort of, we think about, you asked, why is that? You were referring to Taco Bell, but why did we miss it? Something that I come back to a lot. I think when we got started, we were certainly guilty of value traps and buying things because they were cheap and cheap for a reason. And so we talked a little bit about our Burger King investment, which again, happy to spend more time on. But it's funny, our second investment was not a good investment. We lost money on it. And it was in some ways, it was the best thing that ever happened to us. We call it tuition today. We did a consolidation of an auto services franchisee. Our view was it's very low cash flow multiples that we're buying and sort of let's go after it. And it ended up being a terrible deal. That was really eye opening for us and said, huh? First of all, roll ups are really hard. And if you look over time, roll ups are not a great place to invest.

• 27:36Speaker 02

  The zero rate world notwithstanding, go back before that. It's a tough place to make money consistently. And we always joke, it's tough to make less than five times your money in Microsoft Excel in a roll up.

• 27:46Speaker 03

  I don't think it's ever happened.

• 27:48Speaker 02

  But in reality, particularly through cycles, again, we look at everything through cycles and think about that. It's really tough to make money in roll ups over time. We plan to do this for the next 50 years. And for us, every single deal has to stand on its own. That's our underwriting. We're not going to justify one deal by saying we could buy the next one at a cheaper multiple and pro forma and run rate. We're creating this thing for X, Y, and Z. We've really, pretty much since 2015, 2016, evolved our investment philosophy.

• 28:14Speaker 02

  Although we still very much believe purchase price matters and we're very valuing it, we also really believe quality matters. And we have a saying, you don't get paid for degree of difficulty. And we really believe that. So if we're going to do a roll up and do a consolidation, we're only going to do it in industries and in businesses that are high quality. And we have very clear definitions of that. But I would say we've missed Taco Bell. We always said, oh, it's so much more expensive on a relative basis from a valuation perspective, that we sort of missed the very important part, which is also higher quality.

• 28:42Patrick O'Shaughnessy?

  Can you take us back to the most stressful moment you can recall with the auto services business? Sounds like that taught you a ton of important lessons. So I want to hear the lessons, but I'm more curious about the actual felt experience of being stressed out that maybe you did a bad deal, you're trying to fix it. You're in your late twenties. It's not like you're seasoned vets at this point.

• 29:01Speaker 02

  Yeah, that is very funny. We are, Matt and I, we're entrepreneurs, we're founders. We run an investment firm, we invest for a living, we run a business. And the initial auto services franchise deal, I think that's when we first realized, and again, I said it was the best thing that happened to us because it was early on. On the one sense, the Burger King investment went really well, really quickly. And that, in retrospect, actually wasn't great because we thought, oh, this investing thing, we could do this. And it was very humbling to get beaten up and very quickly. And we moved too fast in that investment. We used too much leverage upfront. Sell Eastbacks on stores that shouldn't have been sell Eastbacks, and we can get into that. But we couldn't have made more poor decisions if we tried, which was truly impressive.

• 29:43Speaker 02

  We hired young people, put them in positions of power, gave them tons of incentives. And turns out, at least in our opinion, these operating businesses, that's very challenging to do. I think people can do it well, and that's a skill in its own right. But for us, we very much believe experience really matters. And today, we only hire people with decades of experience building value in exactly what we're trying to go and replicate. Also, no one had ever consolidated this franchise system before. We were the first ones to ever do it. It had historically been one unit, one owner. In our view, some businesses just aren't meant to be consolidated, perhaps. And we weren't able to benefit from the technology that had been invented to manage these businesses in a multi-way. We couldn't draw from board of directors or management teams to learn from their mistakes, to benefit from their successes, or ultimately to sell to one of these successful players. We call

• 30:28Speaker 02

  it tuition because this was the first time when we had a really big problem. And it was severe, it was big. We were able to ultimately recover 30 cents on the dollar in terms of the invested capital. Thank you, Forty. But, look, we were able to engage a consultant who had, by the name of Howard Norowitz, who has worked with us ever since. And at the time, he was consulting with us to help us navigate what was a restructuring, but for a very small business. We couldn't afford to hire, as a firm, one of the big restructuring advisors, or even frankly, the smaller ones. And the business wasn't big enough to support that type of expense. But we really needed the help. And we found a guy who had 25-year background in distressed investing and in workouts,

• 31:09Speaker 02

  gone to West Point. And he did it at an hourly rate. And Howard's just terrific. We call him the left tackle of the firm. After he finished with that restructuring, we asked him to join us full-time, take a big risk on us, because he was doing very well and was going to go to an established bank. But we convinced him to join us. He was our second, I think it was our second or third employee at the time. He was our partner. And Howard's job, technically, runs capital markets, but his job is to make sure that nothing like that ever happens to us again.

• 31:39Speaker 03

  And that's been the only deal we've ever lost money on, which I do think is a huge testament to Howard. He has helped us think through structure and plan around contingencies that frankly, without him having joined the team, I doubt we could say that was the last time we ever lost money.

• 31:54Patrick O'Shaughnessy?

  What was the deal itself? How much money did you invest to buy? What was the structure? How much leverage did you use? What was the setup of the deal?

• 32:01Speaker 02

  Fortunately, at the time, it was a relatively small equity check. So we invested $3 million of equity. We borrowed another $5.5, $6 million to buy, or to have the opportunity to buy and convert 16 Mako's throughout California. Another key learning, we don't tend to invest in that state much anymore, given what's happened vis-à-vis regulation and whatnot. And then we 100% debt-financed the next $6 or $7 million to go buy another, call it 20, locations. And the issue was upfront, we thought we were buying them particularly well. We were acquiring them at three or four times what had been historical cash flow. And it's not a particularly cyclical business. And you could dilute that, given it's been around for 40 or 50 years.

• 32:46Speaker 02

  The problem was because we had no technology to operate these things in a multi-unit way. And as Alex mentioned, it's a core part of what we do today. As the owner of these individual locations left, we bought the business from them. There would be an unbelievable amount of theft. It was a mostly cash-based business that would occur when there wasn't just that level of oversight on a unit by unit level basis. And because we didn't have the technology to manage that, we had to add more and more G and A to help counteract that theft and drive operations. And that led to what was a three times deal, pretty quickly becoming a six or seven times deal, times leverage, times we had sale lease backed a lot of the real estate to use the proceeds to buy the next one and the next one. And we were just wildly over levered.

• 33:29Speaker 02

  It's a big reason why we don't lever things upfront anymore.

• 33:32Patrick O'Shaughnessy?

  Talking about capital formation in the early days, what was it like to raise equity capital for some of these deals? When you didn't have a track record, you were really young. Obviously, the Burger King deal went well, so I'm sure that helped to start. But then you had this deal that didn't go well and you had to keep raising capital. What was it like in those early days?

• 33:49Speaker 02

  Yeah, it's funny because today there are people who will call us an Apollo and Catterton spin out, which is hilarious because we were so young when we left those firms. And actually, those firms have been extraordinary to us and some of our greatest mentors and supporters. You could not have done it without their support. Without their support, to this day, by the way. But the reality was we were 26 and we were associates at those firms. I don't think we knew where the bathrooms were. Other than crying. That was the crying room. But look, we were really fortunate. We were put in business by a number of family offices, people who we had gone to school with, their families or known through friends of friends. And we were bringing deals to these people to help them to raise the capital. It wasn't a blind pool of capital. We were saying, here's the transaction, here's the deal.

• 34:34Speaker 02

  Would you consider investing? And that was initially how we raised the capital for the Burger King deal. And then, once the Burger King deal got going and went well quickly, that's what allowed us to then raise money for other deals. And then in 2019 was when we said, okay, we had done seven deals. They had largely gone well, with the exception of one, the track record was very good. We said, let's raise a fund structure. And initially, the idea was let's raise a three-year fund structure. See, do these investors want to invest in a fund structure? Do we want to invest out of a fund structure? There are pluses and minuses to commingled funds, as you well know, and we could spend hours talking about those considerations. And then COVID hit, and we did two equity deals in that fund. And the rest we did, and we were buying distressed debt loans in

• 35:18Speaker 02

  other franchise and multi-unit businesses in industries that we either had analogous assets, or we had looked at previously where the data and the tech that we had put in place to help manage our businesses that were giving us real-time information, gave us real insight so that we could underwrite them and move fast. And that really worked, and that worked quickly. And in 21, we transitioned from a family office LP base to our first institutional fund. And then we invested that one over the next two years, and then raised our most recent fund in 2023, which is majority. Still have the family offices put us in business, but today, mostly the institutional piece.

• 35:56Patrick O'Shaughnessy?

  Seems like the right time to talk about COVID. It has to be the worst possible imaginable scenario for what you guys do, and completely existential, I'm sure, like in March and April, you were not having your best days. Talk through that entire experience.

• 36:08Speaker 02

  Some people say COVID wasn't a cycle, it was only a couple of months. If you aren't owned our portfolio, it was a cycle. I think, literally, other than owning perhaps a cruise ship, or a Hudson new stand in LaGuardia, we had about the scariest portfolio in the history of private equity, standing in our office on Sunday, March 13th, 2020. We had a portfolio that was 100% foot-traffic dependent. We don't use a lot of leverage, but when your portfolio goes to revenue zero, any lever, a dollar of leverage is over-levered, obviously. And, yep, we had that. And Alex and I, obviously, never left the office. The two of us would walk there every single day. And after we had our ritualistic morning cry, we went to work and battled, and we're really proud. I think the team is really

• 36:52Speaker 02

  proud, the LPs are really proud of what we did. We didn't lose a single company. We didn't have to put in a dollar of rescue capital. We didn't breach a single covenant. And we give our partner, Howard, and our team, a lot of credit for that. We put a one. Lot of liquidity and thoughtful capital structure into these businesses upfront, obviously not predicting COVID, but predicting cycles that enabled the portfolio companies to both play defense and then quickly play offense by acquiring competitors in June of 2020, acquiring competitive real estate, acquiring competitors debt, do things that at the time, people thought we were crazy, maybe that generated a ton of value for the firm, for the portfolio companies and for the investors, and we were really proud of that.

• 37:34Patrick O'Shaughnessy?

  How did you solve the problems early on? Revenue went down so fast, it didn't come rocketing back. What were you literally doing?

• 37:40Speaker 02

  We shut the businesses, we furloughed.

• 37:42Speaker 03

  We mothballed the companies.

• 37:43Speaker 02

  We mothballed the businesses. We furloughed everyone, we talked to our CEOs. We love that analogy of, we felt like airline pilots. Matt and I, we'd be in the office every day. We talked to all the CEOs first thing in the morning. They're on the battlefield. Those are the guys and girls that are actually running the businesses day to day. Matt and I would sit there, we'd talk to the LPs, we'd give them updates on what we're seeing in real time. We'd watch a movie, literally just to pass the time, and then CEO would call. You'd get on the phone, you'd throw out, deal with an issue. Suppliers, Chapter 7, liquidating, if we can keep the stores open. We don't have any hammer of patties to sell.

• 38:16Speaker 03

  Our Burger King CEO at the time, Dan Accardino, literally stood up in distribution and refrigeration business outside our stores with frozen food trucks in the span of three days because our distributor went Chapter 7.

• 38:29Speaker 02

  Wow.

• 38:29Speaker 03

  It was insane.

• 38:30Speaker 02

  Getting more capital into some of the businesses or helping our franchisees. We own a number of franchisors, lending our franchisees liquidity or capital to stay open.

• 38:39Speaker 03

  That was a good point. Had the franchisors not had that liquidity, the franchisees would have died because we were the bank.

• 38:45Speaker 02

  And we were also helping our franchisees understand what all the government programs were and whether they were eligible, how to go after it. Obviously, speed really mattered. Think back to all these government programs, getting in the queue early, figuring out which banks were facilitating some of these government programs and which weren't. And we have a great management team, so they were really nimble. The CEO of Kona Ice, our largest food truck business in the US, incredible founder and CEO. That business is an events-based business, so they park out of churches, little league schools, and obviously there were no more events. So Tony stood up in the course of two weeks, software to allow Kona customers to get franchisees' trucks at their homes and their driveways.

• 39:25Speaker 02

  The franchisees of Kona were all levered and a few of the lenders were not providing for interest in M word holidays. So we had to find another bank to go buy one of the loan portfolios.

• 39:36Speaker 03

  We had to back to back it off the Kona franchisor balance sheet. While we were negotiating a Main Street loan and it was wild.

• 39:42Speaker 02

  It was whack a mole. It's funny, one of my mentors at Apollo, we would talk to pretty often. And he said to me, he said, you'll look back and this will be the most fun you ever had. And I thought he was nuts. In some sense, it really did make our firm.

• 39:55Patrick O'Shaughnessy?

  How long did the most acute part of that last? How long was there that degree of coordination and whack a mole?

• 40:01Speaker 03

  I think by May, we were seeing green shoots in the portfolio. And for our businesses that were located not in Northeast, West Coast major metro, which is the vast majority of our businesses, there was real opportunity to reopen and start recapturing all that share. We knew by May that we were going to make it, I think.

• 40:21Speaker 02

  There's that milking quote we have hanging. Liquidity is an illusion. It's always there when you don't need it and never there when you do. We looked at that every single day and were prudent about going on offense.

• 40:30Speaker 03

  Certainly by May or June, we knew at least that the investments we had made in March, April and early May were working. Alex mentioned, but we had a lot of insights as to what was going on in the economy. Cause we own and operate several thousand locations. We get daily sales on them. One of our better investments during that period was we bought 60 something million dollars, I think $65 million of the first lien debt of the largest Pizza Hut and Wendy's franchisee, which entered bankruptcy immediately as COVID began. And it's a business we knew well, we had diligence that we had looked at buying it previously. But when we really started what was going on in our burking, the drive through part of the business where people were destocking their pantries and they were heavily utilizing drive through.

• 41:14Speaker 03

  And because the dining rooms were closed, we had pretty minimal labor costs and profitability was going through the roof. We really tripled down on that Pizza Hut and Wendy's investment. And that ended up being, I think, probably our best debt investment ever.

• 41:27Patrick O'Shaughnessy?

  One of the things that stands out when looking through the businesses that you've invested in, one of the thoughts I had this morning, looking through it was just, holy cow, there's so many of these multi-unit concepts that I've never even frigging heard of. I was looking through the timeline of ones that you've bought. Some of your the franchisor, like you said, sometimes your collection of franchises. Talk through the taxonomy of these things. Burger King, obviously, everyone's heard of. Taco Bell's, everyone's heard of. But some of these other things you bought, I had never heard of until looking through your deck. There's food, there's pet care, there's automotive services. How do you think and chunk the world up? Okay, this is in this category, this is in that category. What are the major categories? And I want to start there, but I really want to get into what are the different features? I'm sure there's trade offs in all these different things of the kinds of businesses that they are

• 42:11Patrick O'Shaughnessy?

  for those that like this category for investment.

• 42:14Speaker 03

  Yeah, to your point, we've invested across a number of different multi-unit categories. And you mentioned food and beverage. Auto services is our second biggest one with car wash and collision repair. Health and wellness, particularly gyms and fitness is a category we've played in a bunch. And then pet services, you mentioned as well. Look, obviously, the end market or the end consumer of a Burger King business versus one of our more successful deals was a funeral home roll up. For example, there's obviously very different end markets. The ways that we go about driving value in those businesses in terms of professionalizing them and thinking about building versus buying the next location, that's identical.

• 42:56Speaker 03

  And we overlay our quality bar onto these various multi-unit businesses, which we can do because they're simple businesses. And so when we think about what quality is to us, there's a couple heuristics we use before we double click and dig in. But everything we've invested in, every multi-unit business we've invested in over the last few years has been the number one highest average unit volume, sales per box in its category. Every concept has at least 20% store level margins. This is true of the last five or six years, which is top decile for multi-unit. Everything we invest in has sub three-year paybacks on new builds, which is important for us because it provides both downside protection in terms of capital deployment at high returns, but also meaningful equity value, growth potential.

• 43:39Speaker 03

  And on the consumer side, they all have the number one net promoter score in their category. The category could be Las Vegas car washes, or our wow business is one best car wash in Vegas the last five years in a row. And they have to have the number one consumer intent return in their category or my. And all multi-unit businesses, different verticals, but wildly similar in terms of how you can think about investing in them, how you can think about underwriting, building versus buying the next unit, and how you can think about quality as relates to the competitive set.

• 44:08Speaker 02

  The majority of our investments is thematic. And in order to qualify for an industry, the industries have to be highly fragmented by number of units, not percentage. That's very important. Two have to be organically growing for not just our hold period, but the next buyer's hold period. There has to be real industrial logic to the consolidation. So it can't just be more is more. It has to be more is better. It has to be done successfully before by other private equity or strategics. We very much believe, as I've said, experience matters. Experience, boards of directors is a huge part of our GSP playbook. And finally, why us? One of our mentors and very successful investor said whenever he looks at a private investment, he always says, why am I so lucky to have this opportunity? Am I the 50, the

• 44:51Speaker 02

  schmuck who's seen this deal? And every one of our investment memos, the third page is always the why us page. Our franchisee deals have led to company operated models. Takes us on average, three years from when we first start looking at a theme to when we get a deal done. We have a whole process for how we source deals. And every single transaction we look at, we have to have an edge. There has to be some reason why we're a strategic buyer. Why do we have a right to own this? What's one or more examples of that? Is there a common why us answer? Taking a step back, when you just think about multi-unit and consumer services, franchising more broadly, we live in the greatest country in the world. People take it for granted. People take for granted how massive the US economy is, common rule of law, financing. And we estimate for the size companies we target, again, we don't really

• 45:36Speaker 02

  invest on the coast, it's over a trillion dollar TAM. It's a massive market. And in some sense, we're building a firm to serve as real partner capital to baby boomers and small business owners. So there's 10 trillion of business value that is expected to transition over the next two decades from baby boomers. There's 6 trillion, or whatever the number is, of private equity going after that market. Our mentors and LPs calls us a build to suit firm for the Leonard Greens, Oddaxes, Sentinels of the world. And we love that framing. We're building a firm. We want to be the partners

• 46:17Speaker 02

  of choice to these founders, business owners, entrepreneurs throughout the country and bridge that bridge to Wall Street and position their businesses to maximize value.

• 46:27Speaker 03

  And just to provide some color there. So we've done 27 different deals or 27 different businesses. We've been the first institutional capital into 25 of them. So the vast majority of the time, we're partnering with a founder or with a family or with an entrepreneurial management team and we're buying anywhere from 50 to 90% of the business. And then we are helping them not only turbocharge the growth of that business, perhaps the family over the last 30 years built up 50 unit business and we're saying over the next five years, we're going to build it to 200 units. It's obviously a different trajectory that requires meaningful investment in terms of GNA, but we're also professionalizing the business and diversifying the sources of those cash flow streams across markets and geography. To Alex's point, to sell it to a private equity firm,

• 47:12Speaker 03

  typically one or two notches above us on the size food chain of private equity.

• 47:17Speaker 02

  The first seven or eight years of doing this felt like we were in the wilderness of the wrong side of what LPs were looking for in institutional firms. We cared a lot about purchase price. We talked about that. We use very moderate amounts of leverage, tons of liquidity, and we sell things. We sell companies. All of our funds have been top 5% in each of the fund vintages in terms of DPI and DPI is returning capital. That's a big part of our model. And the first thing we do whenever we invest in a business at the first board meeting is what we call writing the SIM exercise. So we actually write the The sale. We write the sale memo, the sale document that we want the investment banks to take out to private equity firms and strategics five years later. And every single decision that gets made

• 48:00Speaker 02

  over the next five years, or in our case, three years, refers back to that document. And we are constantly thinking about the exit and the sale. And our sourcing process is very clear with our prospective partners. That is the goal. Investors give us a dollar. Our goal is to give them $3. Back, every decision we're going to make is so that when that private equity partner sits around their investment committee table, they're talking about this platform that they have to own. We want each of our companies to be at the very top of our private equity firms hit list.

• 48:30Patrick O'Shaughnessy?

  As I think about the features of these different unit level businesses, I'd love to take everything you've learned and apply it to somebody that wants to start a new concept, something that doesn't exist yet. And I'm curious what variables pop to mind to for me are obviously brand, I'm sure is really important, but I'm curious what you've learned about what a good brand is in this kind of space. Something like frequency of use could be interesting. Auto repair, I'm not doing that very often. Burger King, maybe I'm doing it three times a week or something. So here's how something like frequency plays into this. But if you were just to teach a class at Harvard or something like, okay, everyone in this class wants to launch a new concept that hopefully can get to thousands of units or something. What advice would you give them about the variables to focus on or think the most about?

• 49:12Speaker 03

  I think the thing is that drives success in a lot of these multi-unit businesses is both obvious statement, the unit level economics. I mentioned earlier that we're only investing in concepts that are north of 20% at the store level in terms of store level cash flow. And so building a business that has a cost profile that enables that, I think is critical. I think being on the right side of tailwinds, whatever those tailwinds are for a particular industry is critical. Everyone knows the Buffett quote of the management team with a great reputation meets an industry known for difficulty in the industry survives with the reputation intact. Yeah, I think that's critical. Don't bet against tailwinds. I think figuring out who the ultimate end market and payer is critical.

• 49:54Speaker 03

  The collision repair business we invested in, we love businesses where the customer, the decision maker is not the ultimate payer. So in that scenario, insurance companies were the payers. And so you would win based on service, reputation and brand, not price. If you get, God forbid, into a serious collision wreck, your insurance company is paying for it, whether the Dow's at 40,000, 30,000 or 10,000. And I think that's critical in terms of driving a cyclicality.

• 50:21Speaker 02

  I will say though, Patrick, I think it's really hard to build a brand. Build new concepts. We're not smart enough to do it. Plenty of your guests who are, and that's amazing. We would say we're not that smart. We love what we do. We think it's very simple. And the US consumer, what a consumer likes in Texas may not be what they like in Ohio. It may not be what they like in Arizona or in California or in other parts. And we have a few of our friends in public markets investing and it cracks us up. We call it hedge fund math when they're looking at, oh, Chipotle has X number of stores per head in this market. And pro forma run rate, looking at other sort of public restaurant or other multi-unit concepts and trying to apply those growth rates. And it was like, it is really hard to scale these businesses. And for us, when we look at a concept and think about underwriting growth,

• 51:03Speaker 02

  the quartile analysis is one of the most important parts of our diligence process. So we try to see how dispersed are the unit economics? Is it quartile one is driving all the returns? And is there inconsistency, I should say, in the quartile analysis? And that's because if we're underwriting growth and we're growth investors, is the next unit going to look more like a quartile four unit or a quartile one unit? And we won't invest in concepts that don't have consistent quartile analyses because we just, our view is, again, it's really hard to predict the future. We're not going to take that risk.

• 51:33Speaker 03

  Yeah, we have a consolidation, a roll up. We call them regional fortress restaurant brands. It's called authentic restaurant brands. We go around the country buying these regional businesses that are beloved by their customers and their core geography. We always say if a brand has customers who have tattoos of that brand on their arm, that's an ARB, authentic restaurant brands type of brand. But importantly, we do not take those brands to new markets. That's really hard, to Alex's point, just because everyone in Pittsburgh loves Promanti Brothers, which is one of the brands we own in that consolidation. That doesn't mean that people in South Carolina are going to, just because perhaps the demos in certain submarkets may look similar. It's also why we tend to focus a lot on purchase price. Our view is if you buy something at a really high in-place free cash flow yield

• 52:18Speaker 03

  or relative high in-place free cash flow yield to generate a really attractive return, you don't need to believe that you're taking it to new markets and convincing consumers to try it. Meaning if you buy something at 12, 13, 14, 15 times cash flow and you're underwriting, making three X, particularly in an environment where perhaps you can't get

• 52:34Speaker 02

  As much leverage as you used to, you need to really grow that business to make that return. Whereas if you're buying something for, let's say, six and a half or seven times cash flow, there's just obvious mathematical, obvious reasons you need to grow it far less to make a similar M O I C at the end of that rainbow. And we're not smart enough to buy things at 20 times EBITDA and generate 3X M O I Cs off of that. That's really hard.

• 52:56Patrick O'Shaughnessy?

  I love how in your deck it says rollups are really, really, really, really hard. Fun to put stuff like that in a deck. So maybe one reason for each really, you've done a lot of these. When people fail trying to do a rollup, what would you say are the three or four, one for each really reasons that they fail?

• 53:13Speaker 02

  One is leverage. Two is integration, not integrating these businesses. Three is a lack of appreciation of culture. And we haven't really talked a lot about this, Patrick. We've talked a bit about culture at our firm, which we take extremely seriously. Talk about our core values, but this is, it's a big part of what we do. We also have enormous respect for the culture at our partner companies. And while we have an entire G S P playbook for how we institutionalize, professionalize, add data and technology to these businesses. We worked very hard to do it in such a way that honors and respects the culture at each of the businesses. And what we've found is in consolidations, too often people just view them as numbers on a page. They just view it as Excel math. But again, these are people businesses and they're real customer relationships that matter.

• 53:55Speaker 02

  And if you agitate the wrong person, fire the wrong person, we call press the red button, you can blow yourself up. And the other problem is people, we've found is they fool themselves with this sort of adjusted EBITDA, run rate EBITDA, pro forma EBITDA nonsense. And in a world of zero rate and with leverage, perhaps you could sell these things like the hot potato to the next buyer. But people forget in part, the Trump tax cuts, they capped interest deductibility at 30% of EBIT. So you look at some of these consolidations and you say, how much of that adjusted EBITDA actually turns to cash flow? Okay, how much leverage did you put on this business? Now rates went up by 500 basis points. Did you buy caps and swaps on the debt? If you did or you didn't, what is your tax rate? How much actual cash flow is there in these businesses?

• 54:39Speaker 02

  And that's what sort of scares us about some of these consolidations is how much.

• 54:44Speaker 03

  Of the EBITDA that you're underwriting actually turns into cash flow. And we're very focused on that in part because of our Mako experience. But also, again, we're students of history. When you look back at some of the failed rollups, I think a lot of it was believing the pro formas and the run rates. And when you're acquiring things and when you're in super acquisition mode, you can always have those adjustments. The problem is when you say, wait a second, what do I actually own? How much of that is real? And can I maintain the culture at each of these local businesses in order for those cash flows to persist and grow?

• 55:14Patrick O'Shaughnessy?

  I don't think a person would say that they write the sales sim as they're doing deal. And in your deck, it says, ring the bell. When there's the opportunity to sell in our target range, we sell. We create liquidity for our investors. That demands the question, what returns are great in this category? And I'm curious, levered, unlevered, any way you can slice and dice it. What defines great in a world where the S and P kind of delivers, I don't know, eight, nine percent long-term return, something like that, sometimes more, sometimes less. Justify illiquidity and fees and all this stuff that comes with this kind of model. What kind of returns are you targeting? And what distinguishes great from good?

• 55:49Speaker 03

  Look, we always say our mission at GSP is to generate excess return per unit of risk and to do it with consistency. So whenever we're looking at a deal, we price it to generate a three X. That's our underwrite, a three X M Y C in five years. We've had 10 exits. The weighted average of those exits has been meaningfully above three. That's happened in a shorter time period than five years. So historically, we've beat that. We've also had the benefit of investing behind the US consumer for the last decade, which is a terrific place to be for all the obvious reasons. Our view is if you're investing in any of these brands and you can create the new unit for sub three times,

• 56:28Speaker 03

  or you can buy the next incremental bolt on and attractively high free cash flow yield, you should be generating three X plus. We certainly don't feel like that's heroics. I think it's far more heroic, the people who generate three, four, five X outcomes, investing in businesses at two or three times the going in valuation that we do, just because your free cash flow yield, if you're buying something at 15 X is going to be pretty low. Super simplistic, one divided by 15, knock off some taxes and working capital and that sort of thing. You need to really grow the hell out of that business to generate a 3X.

• 57:02Speaker 03

  In our world, perhaps oftentimes because we're starting smaller and a smaller, less diversified business is just fundamentally more risky and worth not 15 times. Our view is we've been doing this for 10 years. We're pretty good in terms of professionalizing and scaling these businesses. We should be able to beat that 3X on the right.

• 57:22Patrick O'Shaughnessy?

  What about leverage? You've mentioned several times that you're conservative in how much you use. It sounds like you backload it. You don't use as much upfront. You put maybe put more on later once you've gotten your arms around the business. But what is a normal range of leverage to put on this sort of strategy or this? If you think about it, the deal level or platform level, how much leverage do you feel like is appropriate?

• 57:40Speaker 03

  So for most of our consolidations, we're actually starting with 100% equity.

• 57:44Patrick O'Shaughnessy?

  Is that really unusual?

• 57:45Speaker 03

  I think it's unusual. Yeah, I think it's probably unusual. It's also just because we've done 27 of them and more and more from the one that didn't go off, certainly than the other 26. But in large part, that did not go well from leverage upfront. And by the way, had we used more leverage over the last 10 years, at least in Microsoft Excel, our returns would be a lot higher. But we probably wouldn't have the sub 1% loss ratio that we have today. I think that certainly would have tripped us up in COVID. And so oftentimes we're starting these consolidations with zero leverage, but we're entering a start small, scale fast consolidation at a nearly 20% in place for cash flow yield. So you don't need a ton of leverage to make the math work.

• 58:25Speaker 03

  Once we get these consolidations scaled and professionalized to call it north of 10 million of cash flow, then we're back hovering the business and swapping our equity cost of capital for debt cost of capital and whatever that is today, eight, nine percent or so. And that undrawn development line of credit revolver, whatever it is, that's enabling us to continue the consolidation and to do it in a really capital efficient way. And to de-risk it because A, we've replaced our equity with someone else's capital. And B, the business is bigger, more scaled, more professionalized and more able to absorb the things that come along with leverage.

• 59:01Patrick O'Shaughnessy?

  You guys work together in like a fairly uniquely intimate. You've known each other your whole lives, like you said, so it's like a really cool partnership and setup. When are you two today having the most fun? If you audited the last year, let's say, you mentioned the four things that you do, building the firm, sourcing, fundraising, problems. What would you both say is the most fun part of what you do together as partners?

• 59:24Speaker 02

  We're really lucky, Patrick, for a lot of reasons, but we have each other. I don't know that it comes across in the podcast, but our partnership is really special. We value it as much as anything in the world. We believe it's a big part of, certainly a big part of our culture, and we believe it's a big part of our success. And we have a working style that's perhaps not the most efficient in the world. We sit next to each other or we share an office. We sit next to each other in our office. We take every meeting together, we call together, we trip together.

• 59:52Patrick O'Shaughnessy?

  I've sometimes felt bad texting one of you. This feels like I'm cheating or something.

• 59:56Speaker 02

  Yeah, exactly.

• 59:58Speaker 02

  You just know that when you text one of us, it's screenshot and it's sent to the other for not sitting next to each other. We do everything together and that makes it really fun. And we really believe in that expression that the lows are so much lower than the highs are high. But because we have each other, we do always have fun. And even at the hard days, we're going through it together. Our process is we disagree all the time. So don't get me wrong, we fight all day long. And it's funny for the new members of the team who joined that sometimes it's like get nervous because it's like mom and dad are fighting. And no, it reminds us to explain that this is just how it works around here. And that's very much part of our process. Matt's a curmudgeon, he's always agitated, he always thinks everything's a disaster. My wife is so fortunate.

• 1:00:40Speaker 02

  But we can't figure out whether this started with sort of me being too excited and Matt therefore getting agitated. Because when Matt's really excited or something, I'm agitated. So it's our process is we take the other side of things. We work with an incredible executive coach, a guy named Jim Kachalka. I don't know if you know Jim, but Jim's amazing. And we've worked together for, I don't know, seven, eight years with Jim. And we work on our partnership, we work on management and the team and our ambitions and culture. And Jim is also part of our process. We don't make any decision unless it's unanimous, right? The investment committee at our firm is me and Matt. We would never do a deal unless we both agree to it. If one of us doesn't want to do something, doesn't want to hire somebody, doesn't want to go on a trip, we don't go. And Matt's very funny. I hate to admit that, but he has the same jokes.

• 1:01:25Speaker 02

  They're all the same. You get to know him better, but you go, they're largely the same. And yet for some reason, they are. Scares the team sometimes because he's extremely serious. The guy has a photographic memory, he's like mental math in his head, whatever. But he can go from just totally joking around and very funny and making fun till there's a mistake at page seven, screaming it. It's wild to watch. Probably hard to work for the two of us because you don't have one person, you're working for two. But you don't say. We're very lucky to be doing it together.

• 1:01:52Speaker 03

  I would say the most fun part is that we get to do it together, doing this shoulder to shoulder, side by side, which is awesome. I would say the other most fun part, I think you agree with this, Alex, is getting to know the entrepreneurs, getting to know their families and then figuring out with them what the path of success is. And we've been fortunate that we've had some unbelievably impressive partners over the last decade and just getting to know them and seeing whatever the crease is in terms of what the opportunity to grow and scale their business and for whatever reason why they need someone else's help or counsel or capital or whatever it is, that's super fun. And then ringing the bell with them at the end of that rainbow.

• 1:02:31Speaker 02

  It's a great point. I was listening to the Brad Jacobs podcast with you and he made a point that he doesn't buy businesses from people he doesn't like. That's so rang true to us. We won't hire an asshole. We won't do business with jerks. Life's too short. So much of our process is building that relationship with these founders. Because when you think about it, we're partnering with people for whom their business is their identity. They're part of the social fabric of their communities. Their families work in the business. Sometimes they are second or third generation part of the business. And it's an extremely big deal for them to take on institutional capital and partners. For us, so much of our process is building that relationship so that when we do invest,

• 1:03:14Speaker 02

  we're very close to our partners and very close to their families. They're close with ours and we have a whole program for spending time together. And again, I said, it takes three years when we start. Working in an industry till we get a deal done. Sometimes it takes three years and up from when we first meet a partner till we get a deal done. So much of our diligence playbook is building that relationship to make sure that after closing, we don't destroy that culture with our playbook. Haven't talked that much about the playbook, but on average, we're enhancing same-store sales, organic growth by four to 500 basis points from pre-closing to post-closing. We're enhancing margins by 250 basis points at the store level. We're redeploying cash flows at a 20 to 40% return on capital. And these are businesses that typically, when we first invest,

• 1:03:59Speaker 02

  the founder thinks about success based on how much cash they have in their bank account at the end of the year. And we totally flip that mindset. We say, success is how many 25% plus IRR projects can we possibly find? It's a huge part of our playbook, new technology, new ways of doing things. And how do you do that without destroying the culture? So much of that work is done upfront.

• 1:04:20Speaker 03

  The other best part, I guess there's a lot of best parts. It's like how our marketing is the most important thing. There's like 40 things.

• 1:04:26Speaker 02

  Ever and over.

• 1:04:27Speaker 03

  Is seeing the incentive structures that we put in place alongside the family or the CEO pay out. We do all the obvious stuff in terms of management option pool and that sort of stuff. But over the last 10 years, we've come up with, I think, additional creative ways to incentivize people. And for example, for any team member, CEO down to regional manager, every new dollar, not rollover, but every fresh dollar that they write into a deal, which is obviously same security as us, side by side with our security, we give them one-to-one additional options on that dollar. So put aside your base management option grant. If you write a check, not rollover, if you write a check for another 100 grand, we will give you on top of that, another 100 grand in terms of option allocation.

• 1:05:12Speaker 03

  And seeing people do that, and then three, four, five years later, when it pays out and holy shit, it worked. That never gets old. It's another added benefit of selling businesses.

• 1:05:23Patrick O'Shaughnessy?

  Quite refreshing. So many people are, we want to hold this franchise forever and the power law this and the.

• 1:05:29Speaker 03

  We're not power law people. Sounds great. We're more driven by consistency and I think. It's part of like, we've never had a zero. We certainly don't plan to. But if you look at our returns, it's the opposite power law.

• 1:05:41Speaker 02

  Our view is not every business is meant to be grown to the sky.

• 1:05:44Speaker 03

  Not right, exactly.

• 1:05:45Speaker 02

  Not every business is a hundred bagger. Stan Schwartz, who we talked about, Dan has this line that you don't actually know until after you've owned the business, whether this is a business you want to own for a long time. I don't know that you guys have had that conversation. It's one that he said to me years ago that really stuck with me. There are certainly businesses in the portfolio that we want to own for a lot longer than the three and a half years that is historical, but we're operators. We ran our breaking business. We know how hard it is. These are people businesses. We know how hard it is to run these businesses. We're very tuned to cyclicality and the challenges. And we also, we want to have a reputation as good sellers of businesses. One of our mentors who built a big investment firm taught us that early on.

• 1:06:23Speaker 02

  This is a repeat game for us. And obviously there's a limit. We don't want to be the schmucks that where the next buyer makes the hundred times their money every time. We typically roll over a churn of M O I C to benefit from the continued compounding. But we really do want to be known as someone, when you buy a business from us, you're going to do well with it. And it's set up for success and to win because we plan to do this for the next 50 years.

• 1:06:44Patrick O'Shaughnessy?

  What this feels like to me is that you are general contractors that unlike most G C's have also had experience at each line of the subcontractor jobs. Maybe it's because you did it together. You started young, you had to figure it out, but you weren't doing this at some big firm with plenty of resources and then just recreated that setup at a new firm. You had to build it brick by brick and that gives you this ground level experience. I'm guessing it makes it very hard to bullshit you in diligence and things like that. And it makes me wonder about innovation. You mentioned that each of these businesses is really driven by real estate or rent, cost of goods and labor. And so maybe that's an excuse to talk three times about innovation. What do you think is the trajectory of innovation in these three areas?

• 1:07:27Patrick O'Shaughnessy?

  You heard a lot about Domino's Pizza or something being amazing at technology that makes the things run better. And that's innovative, but at the end of the day, I'm still doing something and a pizza shows up and I eat the pizza. The product innovation seems less, maybe I'm wrong about that, but talk about the vectors of innovation as you see it, having been so close to the ground truth in each of these categories.

• 1:07:46Speaker 02

  As funny as you mention Domino's because Dennis Maloney, who ran digital and technology at Domino's for 15 years and is responsible for so much of that, is one of our operating partners, is on a number of our boards and is incredible. Tech adoption is a huge part of that GSP playbook, is a huge part of that same-store sales growth and margin enhancement that we talked about. For us, though, it's not inventing new technology, it's asking the folks like Dennis to join our boards and to help us think through, for this business, what is the best in the world tech stack that's out there and let's go adopt it and implement it at the businesses. Marketing is another example. We have a guy by the name of Fernando Machado, who's an operating partner for us. Fernando, if you ask anyone in the marketing world, Fernando is widely considered one

• 1:08:30Speaker 02

  of the great marketing executives globally. We first met him when he was working for Daniel Schwartz at Burger King, winning every award around the world, building tons of value for RBI and for franchisees. And having Fernando on boards and helping us think about diligence, questions as simple as we were talking the other day about our Wow Car Wash business in Las Vegas and whether they should sponsor the local hockey team and how to think about that, how to price it and what the sort of strategy is. For typical small businesses with eight figures of EBITDA, they don't have access to people like Fernando to help. I also talked about rent and that's another area we do love to talk about because most people look at rent and they see a fixed expense. But the reality is, it's just a contract. It's like anything else, it can be renegotiated.

• 1:09:14Speaker 02

  It's an area where you can create tons of value. These businesses, particularly where we do business, which is not major metro, whether it's a funeral home or a Burger King or a car wash, if our brand doesn't work there, unlikely that another brand is going to work there. So you actually have a fair amount of negotiating power with the landlord. And then these are just contracts, they're typically from the beginning 20-year contracts, but things happen and they change and perhaps the Walmart moved away, but maybe they've moved closer. Maybe Chick-fil-A has come in and taken some market share or another car wash brand has built on you. And most people we find look at rent and they think it's a fixed expense. That's a contract you can renegotiate and that doesn't just mean you can lower the rent, maybe you actually can increase the rent, but in return, the landlord will pay to remodel your

• 1:09:56Speaker 02

  Or location, or there are other terms of these leases that sort of coming back to the earlier franchise negotiation point that we know really matter to landlords, things like, where is the guarantor? What is the term of the lease? And how much financial reporting requirements are there? And then there are 1031 buyers, sort of moms and pops, doctors and lawyers, and then there's the REIT market. People sort of look and rent and they say it's fixed, when in fact, that's actually a huge area of value creation. And it's also funny, investors, LPs, we've found, don't love to hear people, at least in our experience, GPs, talk about financial engineering. That's fine. But one of the things we love about the areas we invest and in

• 1:10:32Patrick O'Shaughnessy?

  The financial engineering.

• 1:10:33Speaker 02

  Financial engineering opportunities. We talk about purchase price matters and structure and rollover and liquidity and leverage. So at least back is a great area to create value when you're not growing earnings. We typically use the real estate proceeds to de-risk part of the DPI and returning capital to investors and shareholders. Part of the reason why we do love this part of the market is in addition to all of the tech and data and management, things you can do to grow the businesses, you also, there's a fair amount of financial engineering you can do to de-risk and help with safety principle.

• 1:11:03Patrick O'Shaughnessy?

  How often do you own real estate? Or does the thing you're buying on real estate that you then sell, or you want to buy the real estate or you don't, does it differ by category type or theme type? Say a little bit more about the actual ownership of the asset, the real estate asset itself.

• 1:11:16Speaker 02

  So we're rarely holding real estate for long periods of time. Alex alluded to it, but there's a pretty different cost of capital between our operating companies and the landlord. Every business we own has a lease. And at the end of the day, that's just effectively off balance sheet financing vis a vis the landlord. And perhaps cap rates in our world used to be five to six, and now they're seven to nine. But the inverse multiple of five or six cap or a seven to nine cap is still meaningfully above where any of our operating companies are created at. If it's a seven cap, that's about 14x. We're not buying any of our businesses, at least today, for 14 times.

• 1:11:53Speaker 03

  And so there tends to be a pretty big gap in terms of financing costs and potential value creation to be had if you can shift some of your operating company cash flow into what looks like a property company cash flow. And so we rarely buy businesses that have real estate upfront because it's a perfect market, sophisticated sellers are pricing that appropriately. What we do oftentimes is either we're figuring out through diligence, how many of the leases are perhaps below market in terms of what their rent level is. Maybe the Walmart moved closer to you five years ago and now your sales are 2 million instead of a million. And so the rent looks lower than it could or should be.

• 1:12:34Speaker 03

  That means you can buy back that property, reset the rent to a higher amount and capture the spread between selling that cash flow at a six cap. And having created the portfolio company for six times, the difference between 18x and 6x there. Or oftentimes a lot of what we do is building new locations. And in that scenario, there's a multi-trillion dollar development industry that exists to capture the spread between development costs and exit costs. And our view has been, why shouldn't we capture that? And so a lot of times we'll buy a piece of land for X million dollars. We'll develop the site on it and then we'll turn around and sell that piece of land in a sale leaseback to a 1031 or a REIT buyer.

• 1:13:15Speaker 03

  And that not only reduces your all-in build costs, perhaps from a four or five times creation multiple down to a two or three times creation multiple, but it provides for more liquidity because you're getting that capital back. You can decide to reinvest it in the next unit, either buying or building, or you can de-risk your equity by paying out a dividend and increasing DPI.

• 1:13:33Speaker 02

  We're able to do this and take advantage of it across the portfolio in part because that arbitrage works because we're creating the opco cash flows inside of that for 14 times in the example that Matt gave before, so that there is arbitrage. It's not always the case in multi-team investing in part because if you're buying the platform at 15 times EBITDA, that arbitrage doesn't exist.

• 1:13:54Patrick O'Shaughnessy?

  But about on the labor side, I remember doing research for an investment one time and some stats about labor turnover. And first I thought it was annual turnover and then it turned out the data was was actually weekly that we were looking at. Insane fall offs and someone that shows up for one shift that then doesn't show up for a shift the next week or something. So management of the labor force seems like, one, incredibly hard and two, therefore a critical part of margins and whether or not this thing works and a risk factor and all these kinds of things. Is there innovation in this part of the world? And just maybe what's your general commentary on the labor force that makes these things go and how difficult that is to manage?

• 1:14:31Speaker 03

  So if you look at the average location we own, every time we have to retrain somebody or train somebody, a new employee because of turnover, it costs us about $3,000 to five thousand dollars to train them because they're not productive for the first amount of time. And you do that across 20 to 40 people per location, times 12 months in the year, times a couple thousand locations. And you pretty quickly realize that the more capital you can deploy to lowering turnover and recapturing that three or five

• 1:14:59Speaker 02

  Highest rate.

• 1:15:00Speaker 03

  It's like the highest ROI you can have, exactly. And so in addition to incentives and paying people more to retain them, to drive guest satisfaction, which drives sales, which drives more money through the door to pay people more to retain them, there are a number of tech solutions that we utilize where you can have more frontline employee engagement and ensure that we're doing everything we can to lower turnover. And if you look at the fast food business, for example, industry average is north of 100% turnover. So we're not being unrealistic and saying, we're not trying to bring that down to 25. But if the industry average is 130 and we're at 110, that 20 percentage point gap is worth an unbelievable amount of money to us. It is one of the benefits

• 1:15:43Speaker 03

  of investing in businesses that perhaps are 15 or 20% EBITDA margin businesses and not 45% margin businesses. Obviously, 45 is better than 15. But the difference being if you take a 45% margin business and you make it 48%, you certainly have grown equity value and that's great. But if you take a 15% margin business and you grow it to 18%, that has a far more outsized impact on the underlying equity value, just because the swing as a percentage in terms of EBITDA growth and overall free cash flow conversion is much more meaningful. And that's where we play.

• 1:16:15Speaker 02

  Now, the truth is also on the reverse. So operating leverage works both ways. Obvious statement. We've found over the years, the best predictor of success in a multi-unit business is the tenure of the general manager. And that is in part why firing people and hiring new people or having a culture like that, that's really not the answer in our experience. And so much of what we believe good management is focusing on our people, focusing on training, focusing on, we talk a lot about incentives, bonus plans. Turnover is something we spend enormous amount of time on. Our best CEOs have industry-leading turnover statistics.

• 1:16:51Speaker 03

  And part of their KPIs and bonus is related to their underlying business's turnover.

• 1:16:55Patrick O'Shaughnessy?

  I'd love to do a lightning round of some themes. And in each theme, what I'm really curious about is why you think it's interesting and also the things that matter as you're looking at them. So in each of these cases, I think you believe in the beta of the thing. But then there's lots of choices within that category that you might invest in. So what are the attributes that you would pick one and not pick the other? So maybe we'll start with auto services because we talked about that quite a bit. So yeah. Why auto services and what within auto services are the attributes that you think drive success?

• 1:17:23Speaker 03

  We love auto services businesses that take advantage of the fact that the US has an 11 and a half year average age of car on the road. This is a car economy. There's almost as many cars in the country as there are people and they tend to be very old. And so we like auto services businesses that take advantage of both the age of the automobile, the car park in the US and the fact that for the majority of the US, the car, particularly in 2024, is their largest asset. And they're going to be inclined to need to fix it to get to work and that sort of thing. And we focus on mission critical auto services businesses. And the one business we lost money on that we referenced earlier, that was focused on what we call cosmo-ision, cosmetic collision,

• 1:18:06Speaker 03

  where we're changing the paint color of a car, things that are discretionary and cosmetic. Today in auto services, everything we own and invest in is mission critical and it tends to be paid for by the insurance company.

• 1:18:17Speaker 02

  We also look for how will technology impact these businesses? And so you look at EVs and EV adoption, we don't want to have to take a view about EV adoption curve. That's again, we're not smart enough for that. We'll leave that to somebody else. And so when you look at, for example, collision repair centers, you feel pretty good regardless of EV adoption. Just when you look at the cost to repair these cars, the trends are very much in your favor. You look at tire retail, which is where we have a consolidation today. In fact, EVs, the torque is actually harder on your tires than non EVs. And so that's a business we believe will persist or in some sense benefit from EV adoption. Same thing with car washing, irrelevant. So we are very much afraid of Amazon risk or technology risk. We're trying to take a bet one way or the other.

• 1:18:57Patrick O'Shaughnessy?

  What about health and wellness?

• 1:18:59Speaker 02

  It's a tough place to invest, actually. So we love. Love health and wellness. It's real tailwinds. It's very much on trend. Gyms are a challenging place to invest. We've made a number of investments there, mostly in Planet Fitness, which is a gym franchise or the largest one. But when you think about, we're very much afraid of fad risk. So we talk a lot about how do businesses perform through cycles. We're afraid with gyms, even though the unit economics can look really good when they're working, because you just don't need a lot of people working at a gym. How do these businesses perform over time? And how do new entrants impact these gyms?

• 1:19:31Speaker 03

  We're very afraid to invest in the next curves, which had X amount of thousands of units in 10, 15, 20 years ago. And today, obviously, does not. One of the reasons why we like Planet Fitness, it's so big. The ad budget is so much bigger than the next five guys combined, that there's a real moat in terms of the fact that they have 20-plus million customers across the US. And the brand really does mean something.

• 1:19:53Patrick O'Shaughnessy?

  What about early education? That's one that popped out at me.

• 1:19:56Speaker 02

  Quite a lot. It's multi-unit business. Wary of regulatory stuff. And where the government reimbursement is, we're always looking at how do these businesses perform through cycles? So, and importantly, we have zero government payer exposure across the portfolio. We're afraid of fad, similar sort of fad risk there. We're afraid of how these businesses perform in recessions and through cycles and over time. And that's a business where your people, similar story, but maybe even more extreme. The customer experience and the people part is extremely important there, whenever you're dealing with kids. So we love the category, but there are a number of things to watch out for.

• 1:20:32Patrick O'Shaughnessy?

  What makes you like it, setting aside the risks?

• 1:20:34Speaker 03

  The secular growth is unparalleled. There is just more people spending more money every month to put their kids into extracurricular programming than there was the same month last year. And that's been consistent. Obviously, take away a few months from COVID, over the last 10 years, and the vast majority of the growth in that category has been driven by traffic, not price. You can't ignore that. You have to spend time on it.

• 1:20:55Patrick O'Shaughnessy?

  Talk a lot about selling. Talk about the buyers, often other private equity firms. What do they want? What are they then going to do? There's got to be return left on the table for them, obviously. Talk about this interesting chain of this capitalism chain, so to speak, where you're doing one Specific part of the value chain, but then you have key relationships with upstream buyers. We haven't really talked much about that. So you don't have to name them, but if you just think of the concept of a buyer that you've sold to before, who are they? How big are they? How much money do they manage? What are they looking for? That SIM that you imagine when you buy the business, what's the perfect SIM to them? Help us get in the mind of the person that's buying these things from you.

• 1:21:34Speaker 03

  So we have, call it 2.3, 2.4 billion of AUM. On average, we are selling these businesses to people who have two to four times that amount. So they're five to $10 billion private equity firms. We are typically scaling these consolidations up to, call it 15 to 40 million of free cash flow. That's where we found is a real sweet spot where you have just very large addressable market of potential buyers. You have all of the US middle market that spends time in these businesses, looking at them. And you even have some of the larger guys who are coming down market to start a consolidation and then grow it dramatically. So we build these businesses up to 15 to 40 million of EBITDA. And then we sell them to larger private equity firms.

• 1:22:15Speaker 03

  I think in large part what they're looking for is consistency, professionalization and scale across multiple markets. And at least in our rollups, we've gotten paid historically to show that it works, not just in one micro market or DMA, but that we have a consistent track record of doing it across markets. So we'll start a rollup that's in two DMAs and four years later it's in seven. And importantly, the band of outcomes within those seven DMAs is very narrow. So they can underwrite, yes, I'm going to pay a higher price on a free cash flow basis or a lower free cash flow basis than perhaps these guys created it at. But they've built the professional engine for me to take this business from 50 to 200.

• 1:22:58Speaker 03

  And we've gotten paid from taking it from 15 units to 50. And we're more than willing to roll over a turn of MOIC and be as helpful as we can possibly be. We've stayed on the board several times of businesses we've exited to larger private equity firms, all of which have gone so far. And I think that their view is these guys have de-risked this platform in terms of its professional. There's a really healthy tech stack. It's diversified across several different markets. They can lever it in a way from day one that we didn't feel comfortable doing when it was a fifth the size. So there's just a natural return that comes from the cost of capital arbitrage there, obviously. And then they're betting on the fact that we took it from 15 to 50 locations and they can take it from 50 to 200.

• 1:23:43Speaker 02

  We've learned so much from staying on the boards of businesses that we've sold and rolling over and watching some of these firms and how they create value. And our goal in any time we travel, we make a point to go see every one of our competitors, even if we're not traveling for that business. And discipline we learned early on from Incredible Operator in franchise world was very easy to hate on your competitors. The goal in every single competitive site visit is to take three nuggets, three positives. You can't walk out of a competitor without seeing three positive things from that site visit. We do the same with sponsors. Sometimes we'll joke that you don't want to meet your heroes because we feel good about proud of our own firm, but we always try to take what are the positives away from it. And in every one of the boards that we've been involved with and the businesses we've

• 1:24:25Speaker 02

  been involved with after we've sold the business, we've learned a lot that we can then take to our businesses.

• 1:24:30Patrick O'Shaughnessy?

  What do you think of the major risks to your franchise? So you've achieved one level of escape velocity, right? You've got big teams, sophistication, history, data. You've got all this stuff that would make you better suited to be a buyer than the next 26 year old at HBS or whatever. So you've gotten to a certain level, which is awesome, but very often firms at that level start thinking about, we don't want to lose this position. So we think about risks. What would be the things that would have to happen in order for historical returns, which have been in excess of your targets, to somehow be way below your targets? Even if you're working your asses off and your team's great and you do sourcing well, do all this stuff. What do you think would have to happen for forward returns to be materially worse than past returns have been?

• 1:25:11Speaker 02

  We believe our culture is a huge part of what has driven the returns and what allows us to win deals and build value for our partner businesses. And Matt and I are very focused that as the team has grown, we have 25 best professionals, 20 operating partners and operating executives, got a team of 11 in the back office. How do we maintain that culture and make sure that we maintain the ownership culture, the values that we believe have made us successful? And we send out every year our two favorite books as a holiday gift to all of our partners. And one of them a few years ago was the Michael Dell autobiography, Play Nice But Win. It's a book we loved. And one of the takeaways from that book was as he was growing his business, he felt that the challenger culture was what allowed him

• 1:25:55Speaker 02

  to win against the sort of coastal, larger players. And he wrote down his core values and he sent it out to the whole team. That really inspired us. We did the same thing. And our core values document hangs in the bullpen in our office. We send it out every quarter along with our quarterly letter. We talk about it all the time. Maintaining that culture for us is the thing we worry most about as we grow and we're extremely focused on it.

• 1:26:15Speaker 03

  I think that's right. The only other thing I would add is I think to the extent we've been successful over the last 10, 11 years, we've been able to price quality. And sometimes that means X free cash flow yield, and sometimes that means a lower free cash flow yield for higher quality. And I think to the extent that we can continue to price things well and not overpay, I think that's driven a lot of the results so far.

• 1:26:38Patrick O'Shaughnessy?

  What do you think is the most unique thing about how you source relative to others?

• 1:26:42Speaker 02

  I think a lot of our best deals come from the virality of relationships within the portfolio itself. We've had a number of really successful deals and ultimate outcomes that were sourced by relationships driven by CEOs and founders that we had previously done business with. That's gotten a lot easier today where we have 27 of those people, times X amount of network and Y amount of phone calls versus seven, eight years ago, there were five of them. Our goal is to be the capital partners of choice for founders and business owners around the country. And that is how we built our firm and that's how we approach every relationship. It's a repeat game for us.

• 1:27:26Speaker 02

  Part of why we tell founders, we're going to disagree and there are going to be ups and downs. But if we screw you somehow, it's not just about this one deal. It's about how you talk about us in the market. And we give a list to every prospective partner of everyone we've ever done a deal with. And we say, call them all. And we encourage them mostly to call founders and partners of companies we've sold. So they can see they don't want to work with us. So there's no longer any sort of incentive for them not to tell the truth. And what they'll say is, we do what we say we're going to do and we work really hard. We are difficult, we're rigorous, we're analytical. There are bumps in the road, but our incentives are aligned and we have fun along the way.

• 1:28:06Speaker 03

  The other thing which relates to that in terms of sourcing deals is we're relatively young. We're both in our late 30s and a lot of people who graduated college at a similar time period that we did. We graduated during the GFC. The world's been pretty up and to the right since then. And there's been a lot of investors who have incredible track records since then. And how much of that is beta versus alpha? A lot of it tends to be levered beta. And I think we're smart enough to know that we have massively benefited from that. And because of that, we are students of history. You've seen some of the books in our office and we've sent you them. We have pretty much every finance book written from 1979 to 2023. We read them religiously. We reread Predator's Ball, which is the story that starred them all every January.

• 1:28:51Speaker 03

  And we have a very healthy appreciation of cycles. And having an appreciation of that and how it informs capital structure and valuation and liquidity. I think we have a better appreciation of that than most people our age. And certainly not nearly as good appreciation of it of people who have lived it. But fortunately, we have mentors around us who have.

• 1:29:11Patrick O'Shaughnessy?

  Why do you read Predator's Ball every January?

• 1:29:13Speaker 03

  I think that people our age don't have a full enough appreciation for what Michael Milken both built and set into effect in terms of his creation, in terms of high-yield securities spawned the ability for private equity to exist at the speed, size, and scale that it is today. And we always get disappointed when we interview younger people and we ask about that time period and they look at us like blankly. And I think a lot of the thoughtfulness of that era, and obviously there were excesses too, but a lot of the thoughtfulness is lost amongst people in their 30s and 40s today. And I think it's important to reread that and appreciate it. And it's inspiring. You had people in that book who are our age who built some of the

• 1:29:56Speaker 03

  most incredible, successful companies on earth when they were even less experienced than we were at the time with far less of a roadmap. We stand on the shoulders of those giants and benefit from that. They didn't have that.

• 1:30:08Patrick O'Shaughnessy?

  You mentioned how pioneering they were. What is your philosophy of cap structure? Because so much of what Milken did was, I guess, create the opportunity to have a philosophy of cap structure in the first place. You just had to go all the way to the 30,000-foot view on capital structure. How would you sum it up?

• 1:30:23Speaker 03

  I think I would sum it up in terms of liquidity in downside scenarios is always worth more to you over a longer period of time than max leverage is in an upside scenario. And what does that mean for us? That means entering with low leverage. That means never maxing out firstly in debt capacity. In the downside case, firstly in debt is by far the easiest thing to raise, particularly if you have baskets and caps and availability for it. And when Microsoft Excel maximum leverage works wonders in real life, it can lead to poor decision-making and zeros, both of which we actively try to avoid.

• 1:31:00Patrick O'Shaughnessy?

  You've said cycles so many times. Maybe it's just an opportunity to ask what that means to you. Is that just variance in demand for lots of different reasons? If you had to think about what is a cycle? Why do you care so much about cycles? How would you describe it?

• 1:31:12Speaker 03

  Yeah, I think a couple of thoughts on cyclicality. One is private equity, at least in the US, has a tendency towards recency bias, both in terms of what they think the underlying cash flows of a business is. The distribution of outcomes tends to skew towards what's focused a lot on the last 12 months and less so on three years ago in terms of underlying earnings, as well as what is the right multiple for this business? It's the last 12 deals have traded at X, so it's probably close to X. I think both those things ignore that, at least in our world, where everything we touch touches the US consumer, there's cyclical elements to both those things, both in terms of the underlying cash flow and what the appropriate market multiple for these businesses is. And so we like to diligence not only the earnings streams over cycles,

• 1:31:57Speaker 03

  but also the valuation across cycles. The other reason why we're so focused on cyclicality, and it's probably because our portfolio was so in the eye of the storm of COVID, is never waste a good crisis. Some of our best deals were done in April of 2020, in the depths of the COVID crisis and God bless, undrawn debt financing and committed equity capital, but we have the luxury of being able to go on offense at those times. And that's where, at least in our experience, you can really generate the excess return per unit of risk you're taking. And we certainly wouldn't be able to do that in 2015 as much as we can in 2024 because we didn't have fund back then. We didn't have committed capital. We probably weren't able to get the size of undrawn committed debt facilities,

• 1:32:42Speaker 03

  as well as obviously equity as we can today. But today, with 2.3 billion of AUM, tons of undrawn capital, both in the fund and the portfolio level through D-LoX, development lines of credit and that sort of thing, shame on us if we can't take advantage of a crisis.

• 1:32:57Patrick O'Shaughnessy?

  What's the closest you guys have ever gotten to like a terrible argument or a terrible disagreement between the two of you in all these years?

• 1:33:04Speaker 03

  We disagree every single day about everything. That's the process that hopefully drives at least the outcomes we've had so far. But I would say it's never personal, but it's always personal because we know each other so well. But in a loving way, like here is your bias that you're bringing into this, you effing idiot. Because we've known each other for over 30 years, you can say those things and go out to dinner that night. And that's Tuesday. You have to remember, we have three meals together, four days a week. Every Monday through Thursday, breakfast, lunch and dinner, every single day for 11 years. There's things that I could say to him that if I said to my wife, I'd be living on the street.

• 1:33:41Speaker 02

  And what do we do on Fridays?

• 1:33:42Speaker 03

  We have breakfast and lunch on Fridays, but not every Friday dinner.

• 1:33:45Speaker 02

  It is very special and we're very sensitive to it, very sensitive to Matt and Matt's very sensitive to me. But that doesn't mean we don't scream at each other. And I do think I give Jim a lot of credit for that because we work at it. We work very hard at our partnership. We've been through a lot together. Our partnership is extremely solid and we have the confidence to know how important that partnership is for what we do.

• 1:34:08Speaker 03

  I think we also both recognize that there's a 0% chance we could do this by ourselves. Some people can find that incredible to be able to withstand the woes by yourself and still fight back to the highs. I couldn't do it. And the galaxy would agree that he couldn't do it. And having the other person to balance, yes, this is awful, but here's the light at the end of the tunnel and we gotta fight. And by the way, you have to fight. There's no alternative. If we were ever very low at the same time, that'd be really bad, but that hasn't happened yet.

• 1:34:37Patrick O'Shaughnessy?

  I've been in scenarios with you guys and your LP investors a few times. And I've been in lots of those scenarios with lots of other combinations in my last 15 years. It stands out that you have a notably good relationship with your LPs, both professionally and personally. Maybe just say a word about that. What drives that? How intentional that is? How you think about that side of the business? It's one of your two customers, right?

• 1:34:59Speaker 02

  We work for LPs and one of our core values is accountability. We say all the time in our business, LPs, LPs, LPs, we work for LPs. Everyone on our team knows that. We talk about it all the time. What isn't the best interest for LPs? That's why we're so focused on alignment and. Not taking fees or anything else that's in any way not aligned with our LPs making money. And so we view that relationship as extremely important. We're also, again, we've mentioned the word cycles a lot, but we want LPs who really understand what we're doing and what we're building and appreciate it and who will understand that in cycles, when things inevitably recession comes, the sales decline, who are going to be excited

• 1:35:41Speaker 02

  to invest additional capital behind our platforms when we call additional capital or say the opportunity is there. And so that's part of why we spend so much time on our quarterly letters, not just the sort of intro few pages, but also company by company. It's why we spend a lot of time with our LPs and our partners and we really want them to understand our investment philosophy, how we approach the businesses, the management teams, so that we can do this for the next 50 years.

• 1:36:09Speaker 03

  We've benefited massively from our LPs over the last 11 years. And we were originally put in business by a number of family offices of people who had built asset management firms. And those people have, I'm sure, forgotten more about investing than we'll ever learn. And we did and continue to lean on them and rely on them for everything in terms of guidance and mentorship and being as thoughtful as possible about building the team and whatever the problem children in the portfolio are. And Royce Yudkoff, who is our HBS professor, or professor of business school, rather, who founded ABRE, he was the R Y in ABRE. He took us under his wing 12, 13 years ago and forever changed our life by his guidance

• 1:36:52Speaker 03

  and introducing us to ABRE LPs and just being there for the darkest days of COVID on the phone. And we wouldn't be here without people like that.

• 1:37:00Speaker 02

  Managing other people's money is an enormous responsibility. We take that responsibility extremely seriously. We don't just view it as, oh, we're providing a service and they have to invest it somewhere and They're not a supplier, they're a customer. They are a customer and we are extremely customer focused. And we're also, all of our money is invested in our funds, every dollar we've made. And we're terrified of our wives, whom we love. And we take the responsibility of managing other people's money extremely seriously. So spending time with them, getting to know them, making sure they understand what we're doing and how we're doing it and our approach to it, I think is just a part of that.

• 1:37:36Speaker 03

  Was the comment about it being terrified of our wives, them thinking that we're over allocated to our funds?

• 1:37:43Speaker 03

  Because mine does.

• 1:37:45Patrick O'Shaughnessy?

  Good excuse to ask my traditional closing question, get two answers. What's the kindest thing that anyone's ever done for you, each of you?

• 1:37:51Speaker 02

  For me, and I know Matt will agree, the kindest thing anyone's ever done for me is my parents and how they raised me and my siblings. Matt was raised similarly, but I was given every advantage growing up, education, otherwise. My parents still are extremely involved and dad was on the board of our school and went to every game and parents helped us with homework. They were home for dinner every single night, very loving, supportive family role models. They were also extremely tough and their bar for success, ambition, hard work was always extremely high and is extremely high. And we're forever thankful to them for our siblings. And we talk to our parents, our siblings, our family, each other every single day and we're forever grateful.

• 1:38:36Speaker 03

  Yeah, I would certainly agree with that. My parents are as important, impactful, meaningful and motivating as Alex is, who I know very well and love dearly. My wife and Alex's wife have also picked us both up off the floor many times over the last 11 years of doing this together. And we'd be broke and destitute certainly without them.

• 1:38:57Speaker 02

  I do have to add, one of the best learnings from my parents was picking the right partner. And certainly my wife, I'm not sure I could say I picked her, she more picked me. I'm forever grateful to my incredible wife, but also partners in life. And Matt is much more than just a business partner, it's family and I want to make sure I add that to the list.

• 1:39:12Speaker 03

  I also should mention, my wife has known Alex longer than I have. They went from preschool through college together. And it's a true story, GSB is her brainchild. She was the one who really suggested we start working together 12 or 13 years ago. And then look, the guys at RBI, Restaurant Brands International, who owns Burger King, they gave us a shot to enter their system and become franchisees when every single other tier one franchisees were shut the door on us when we were 26 years old. And I don't think they did it out of the goodness of their heart. I think they thought that we were on to something and we could help them consolidate. Their system and grow their royalty stream, but we are forever grateful. Dan Schwartz, Paul Freeborg, Alex Macedo, we simply wouldn't be sitting here today had they not seen something of us back then.

• 1:39:57Speaker 02

  It's so true. Paul Freeborg, who's been my mentor for 20 years and was on the board. Daniel, Josh Cobza as well, Macedo, and Brian Feinstein, who I know you know and have interviewed, who was extremely helpful in that as well.

• 1:40:10Patrick 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.