Episode 144: Alex Abell of RCP Advisors on
Evaluating Lower Middle Market Managers and Operational Value Creation

Episode Transcript   

 

Shiv (00:12.75)

All right, Alex, welcome to the show. How's it going?

Alex Abell (00:15.119)

It's going well. Thanks for having me.

Shiv (00:18.124)

Yeah, excited to have you on. So why don't we start with your background and RCP and then let's go from there.

Alex Abell (00:23.343)

Sure. So I'm Alex Abell, Managing Partner here at RCP Advisors. RCP is in its actually twenty-fifth year this year. We're celebrating our anniversary. We are a fund of funds platform in private equity focused very exclusively on what we call North America small buyouts. Another name for it sometimes is lower middle market, but basically focusing on managers that have fund sizes under a billion dollars.

And so I've been here for about just under 12 years now. And we have a team that goes back in some cases to our founders. So we've been doing the exact same strategy for all those 25 years.

Shiv (01:03.798)

Yeah, and you're connected to RidgePost Capital. So can you expand on that relationship and also kind of what your focus is in more detail?

Alex Abell (01:10.147)

Yeah, absolutely. So RidgePost Capital is essentially our parent company and we are a wholly owned subsidiary of RidgePost. RCP was really the initiators of creating RidgePost as a holding company so that we could acquire other strategies. So we have folks that do venture capital, we have folks that do credit, that are all focused on what we would generally call nicher markets, where we think there's an advantage to having focuses on smaller investments and smaller funds.

And so the creation of RidgePost was quite a long time ago now. We're now public and traded on the NYSE. And RCP operates as I think the still the largest platform.

Shiv (01:52.035)

Got it. Okay. And so help us understand that 'cause we've had some other funds of funds on the podcast before. So talk about how you go about this. How do you determine which funds to back and how does that connect to an overarching strategy for your firm?

Alex Abell (02:07.084)

Yeah, so for us, we track about twelve hundred managers in the lower middle market. It is a niche, but it's a very large niche. I think one of our biggest advantages because we're specialists, because this is all we do, we are generally meeting with hundreds of managers every year. And maybe we're only investing in ten or twelve. So it's a highly selective process. But because we're focused exclusively on this area and probably one of the largest allocators to the lower middle market in the United States and Canada, we have a great deal of market intelligence on the entire market. And so we meet with managers on a regular basis even years in many cases before the fundraising. So once they start to come back to market it's very important for us to sort of already have an opinion of at least what are the issues that we're going to be doing due diligence on. And part of the reason for that is that our part of the market is in some ways very similar to venture capital in that the best managers are heavily oversubscribed. They can pick and choose who their LPs are, their fundraises don't last

particularly long in many cases. And so our ability to develop those relationships over long periods of time prior to them raising their next fund is really critical to both getting access and then being able to do a good job of our due diligence. And what we're looking for for really any manager is, I guess, the best way I could describe it is something about the team, something about their strategy, something about their process that we find unique, differentiated, something that they're — I sometimes call it their superpower. So what is

their manager superpower. Sometimes managers have more than one superpower. It could be how they source deals, it could be how they add value to the portfolios that they're managing. But every manager generally should have something about them that makes them unique and differentiated. And then what we're looking for is that that is attached to something about them, either their process or who they are and their expertise, that makes it a repeatable strategy. Something that not only has produced returns in their past funds, which is obviously very important, but that we can

look at it on a deal-by-deal basis and see how they've implemented that superpower in order to do well in deals on an ongoing basis as well. And that gives us a lot of comfort when you're investing in a blind pool.

Shiv (04:20.014)

Yeah, are you looking at these unique capabilities using metrics or specific benchmarks? Like how are you figuring out which managers are worth backing versus others?

Alex Abell (04:33.484)

Yeah, I mean it's both. So the qualitative component is extremely important. So our specialization has allowed us to have developed very good networking within the ecosystem that we operate. So the ability to do references on these managers, not just obviously the references that they give us, which is important, but also the references that we can get to of people they've worked with in the past, former employees, intermediaries within the — it could be the banking world or it could be within the

placement agent world who've represented them or know them. So being able to sort of pinpoint a lot of off-list references, not just on the team and the manager, but also on things like their value creation team. If they're having a — you know, the group of operators, that's really critically important. That gives us, let's say, the qualitative view. And then what we want to do is match that with quantitative analysis. And one of the things that's really difficult about private equity is the evaluation of track records can be very tricky. So in most cases when you're evaluating

a manager, the most recent fund is probably the most relevant fund to analyze. It usually has a similar strategy, maybe it's closest in size and types of target companies. The team that invested that is more than likely the team that you're evaluating today. And the funds that are further in the distance, which are more realized, can sometimes be very different in terms of strategy of what that manager might be doing going forward. And so part of the difficulty that

a lot of allocators have in evaluating private equity track records is that things like vintage year benchmarking, which has been sort of a standard in our industry for years, are very difficult to do on less mature funds. So even if you look at some of the biggest benchmarks that are out there, in their footnotes, they'll say things like managers will jump around quartiles within the first six or seven years of their existence. But that doesn't really help you when you're dealing with a fund that might be three or four years old and you're trying to evaluate them. So for us,

Alex Abell (06:33.224)

one of the unique things that we have as a big differentiator is our data and analytics platform called GP Scout and what it really allows us to do is sort of forget about the funds — we obviously look at fund level benchmarking as part of our analysis but we can actually dig deeper into the deals and what we can do is look at every deal that manager has done

and compare it to all the other deals we have in our database, over 50,000 deals that other managers have done in the same time period, same subsectors, and the same size ranges. So for us, size is really important. We're investing in smaller companies and our managers. And we can see whether or not that manager has outperformed on a deal-by-deal basis, not just at the fund level.

Alex Abell (07:18.774)

And the other big important distinction that helps us evaluate whether a manager is actually creating alpha in the portfolios, even portfolios that are younger where they haven't had an exit maybe, is we also collect tons of information about the operational data of these underlying companies.

So we know what the revenue CAGRs are, the EBITDA CAGRs, the margins at the time that they enter, the current margins of these companies, whether they've been shown improvement or retraction. And what we can do in a similar way is that if a manager is, let's say, pitching me, and we're in a meeting, maybe we're on site in our offices, and they say, yeah, we've grown this healthcare services company 20% revenue CAGR over the whole period.

It sounds good, but I don't know if that's good or not. Because if I look at our data and we have 30 deals that were done in a similar time period, and the median of that 30 deals is 35% revenue CAGR, then all of a sudden that manager's revenue CAGR doesn't look very good. So benchmarking is a way of sort of controlling for time, and comparing similar types of investments over that same time period. And so we can do that not just with outcome — like marks and like the ultimate realization of cash on cash returns — but we can actually

Alex Abell (08:31.618)

see whether a manager is in an operational sense improving those companies compared to their peers. And that's a really critical component, especially in the lower middle market where we focus, because in the lower middle market, you're generally dealing with relatively small companies compared to most private equity. So in our world, we're generally focused on companies that are under 200 million of enterprise value, and the vast majority are under 100 million of enterprise value.

So these are three to five million dollar to twenty million dollar EBITDA companies. And 75 or 80% of them are family-owned businesses that have never had institutional capital.

Alex Abell (09:06.132)

So these are companies that have areas that they can improve. And your manager's activist strategy of actually creating value in these companies and growing them creates a ton of value in returns because not only are you growing these companies that are small into companies that are bigger in scale, which makes them much more attractive to the people that have capital above us — it makes them a much more interesting company for them to buy — but they're also improving the operations of those companies. Management teams are being replaced and upgraded.

And all of this creates the ability for it to become a very attractive asset to the majority of the capital that's raised in the private equity markets, which is in funds above them. And so for us, being able to sort of identify these components, not just the vintage year fund level returns, but really how these managers are doing in terms of operational performance is really critical in evaluating where they can generate returns going forward. And as an allocator, we're dealing with a blind pool when

we're doing fund investing. And this is one way to sort of validate through more data points that this manager is actually good at what they're doing.

Shiv (10:14.146)

Where are you guys finding this proprietary data for GP Scout from? Because a lot of this is proprietary data. So just help us understand how you have this unique insight if you're not necessarily involved with those companies?

Alex Abell (10:26.37)

Yeah, so the reason is because we are evaluating all of these managers that come to market with their funds that are in our area. So every year we probably have three hundred managers or so that are coming to market. We take meetings with all of them, we collect information and data about their portfolios with all of them. We have regular updates with most of these managers in between fundraisings where we get a lot of information and data that we can use. And so because we are as RCP one of the largest allocators in the lower middle market in terms of dollars,

that gives the general partners a lot of incentive to work with us and provide us information about what they're doing because they want us to invest. And that is very beneficial for us. And so we can write big checks into these funds. We're usually one of the top investors from a size perspective in most of the managers that we're investors with. That also attracts people that want us to be LPs in their fund. And that allows us to collect a lot of information about these folks, which is very helpful.

Shiv (11:22.636)

Yeah. I think that's a huge competitive advantage there. Talk about the benchmarking. You mentioned looking at different vintages across different funds or evaluating a particular business in a certain way. Walk us through that. How detailed are you getting into there and can you pull up some examples or help us understand how you have done that in real time?

Alex Abell (11:43.181)

Yeah, in terms of the operational benchmarks for sure. I can give you an example of a manager that I worked on when we were doing the underwriting, and this is a good example of sort of marrying the qualitative evaluation with the quantitative. So we had a manager that was in the industrial space, and they were doing a lot of deals where they were paying a pretty high multiple. And so again, one of the data points that we can collect is data on valuation. What are managers buying

things at and what they're selling things at. And one of the key components of returns in our part of the market is value creation. But what that leads to is also what we call multiple expansion — the ability to buy something at eight times EBITDA and sell for 10 or 12 times EBITDA. And part of the reason that people are able to get that is because for every dollar of cash flow, the people that are buying our companies in the bigger part of the market, they're using more leverage, they have a different cost of capital, they're willing to pay more

for a scale business. So we were doing an evaluation of this manager, and what we were seeing was that they've been in operation for 25 years, their focus is industrials, which of course has a lot of cyclicality risk in it. And they were paying pretty high multiples for their portfolio companies.

And a lot of industrial strategies we see with managers tend to be more value oriented, to be honest with you. So we tend to see folks that are buying kind of C companies in the manufacturing space and making them either B or A companies. And what these folks were doing, and this is the strategy that they were articulating to us, was they were buying A companies in industrials — companies that were higher quality in their mind — and they were willing to pay a higher valuation multiple.

So again, nothing wrong with that strategy. And their belief was that they were experts in the space and they had the ability to create value in returns, even with buying companies for maybe a full valuation.

Alex Abell (13:38.561)

And so as we were on site, we were talking to them. We're like, well, what does that mean — better companies? Because that can mean a lot of different things. And some of it was very qualitative, where you'd be like, well, these are certain end markets that we like to either stay away from or that we'd like to lean into. But some of the quantitative metrics, one in particular was margin, EBITDA margin to be specific. And for them, what they really were focused on was companies that had high EBITDA margins, because in cycles, they tend to be a buffer from the downside.

And so one of the things that we did then after we had that meeting, we went back and we looked at our data. And what we would expect to see, if what they're telling us in their narrative was accurate, was that the companies that they were buying at the time they were buying — the EBITDA margin of those companies — was significantly higher than the EBITDA margin of other companies in the industrial space that were also being bought by private equity during that time.

Alex Abell (14:35.052)

So we were able to see that they were higher on EBITDA multiple, but also the margin of the EBITDA that they were buying at the time of the entry of that deal. And what we found was that they were buying companies at significantly higher EBITDA margins than what the rest of the market — their peers basically — were buying at. So we were able to kind of validate this idea, this narrative that they were selling to us in their marketing, that we are buying higher quality companies,

yes, and paying more for them. And that's a strategy that we have decided that we want to embark on. Now, whether or not that strategy is a good strategy or not is another question. And we did some work on that idea as well through our data — what have you seen from a performance perspective on let's say value-oriented versions of that strategy versus the more fully priced version — and so that is an example of how we can use our data to validate the narrative we're hearing from a manager

Alex Abell (15:33.599)

and to validate their strategy. Now, again, it doesn't necessarily lead us to a yes-no decision by itself, but it gives us a lot of context about what we're seeing about that manager's information and data. And so I think that's a good example of something that kind of marries the qualitative assessment — because part of our assessment also is talking obviously to the CEOs of these companies or the entrepreneur owners and being able to validate that they are operating companies that they think are higher quality along these different dimensions.

Shiv (16:02.965)

Yeah, I think one of the biggest advantages here is that you have access to so much data that you can kind of contextualize a lot more discussions. Like one of the challenges is that every year companies are different, the valuations are different, the returns that these GPs and LPs are seeing are different. So it's very easy to kind of get caught up in one fund that's maybe overperforming or seemingly overperforming, but in reality it's just the market baseline

for that particular vintage. And I think that's a huge advantage that you guys have here, especially as you're investing in multiple funds.

Alex Abell (16:41.646)

Yeah, I mean there's certain sectors and subsectors that can outperform during periods of time. And that's what benchmarks are really for — to control for the time period. So for example, I remember looking at a manager who, the marketing deck had a deal, an IT services deal back in let's say 2015 or 2016, and they did like a 3x. And of course if you get a triple your money deal, that generally is a good deal. And it is a good deal. But we want to remember we're not

just trying to see whether they've done well, but how are they doing against their peers during the same time period. So what we were able to do is look at all the different IT services deals done in that same time period, and it happened to be a very good time period to be doing IT services deals. The median was 3.6 or 3.7. So while a 3x looks really good if all you're working off is the marketing deck — and maybe the data room that you're being given that information — it's hard to put it in context. And so by being able to

have a much broader set of information about what deals have been done over time, the outcome of those deals, and different metrics — either just performance outcome or marks or operational metrics — we were able to see that yes, this manager did really well on that deal, but more than 50% of the deals done at the same time period were actually better. And so that puts that in perspective. The way I think about track record evaluation as a limited partner, and I've been doing this for 25 years now, is that

Alex Abell (18:11.416)

we're always dealing with an incomplete picture. Like a puzzle. Maybe we have certain pieces of that puzzle that we can put in to try to see the picture — which is whether they're good or not at what they do, and more importantly, whether they can do it in a repeatable fashion. And I think our data advantage has given us the ability to put more of those pieces into the puzzle to have a clearer view. Not perfect, because again, we're dealing with a lot of unrealized noise in historical

Alex Abell (18:41.296)

track records that you never know how that's going to outcome. And again, as we all know, past performance isn't necessarily a predictor of future performance. But what we know is that we feel like we have a higher conviction in being able to identify the managers that — the way I would put it — have a higher probability of being in that top quartile or decile. We don't always have every manager in the top quartile or decile. But what we're looking to do is have our worst managers being good and our best managers being exceptional. And if we do that in a portfolio over and over again, as we have for 25 years, you lead to really consistent outcomes.

Shiv (19:19.437)

How are you doing this on the operational side? I get the looking at the fund or thinking about getting the right return for the fund based on the companies you're investing in, what valuations you're investing in. But what about operationally getting these companies to perform at a level that actually creates organic value inside these businesses so that the funds can exit at a multiple that actually returns the fund at a healthy level or above, let's say, market benchmarks?

Alex Abell (19:44.367)

So as a fund of funds, we're looking at managers, and what we're really looking at is the capabilities and resources related to what we'll call value creation — operational value creation. And over the years, that has meant very different things. So I've been doing this a long time. And it used to be that way back in the day, managers would have like an advisory board of operators —

a bunch of ex-CEOs — and they would sort of maybe sometimes put those CEOs on the boards of their companies or at least talk about that as being a resource they can draw on. And that kind of operational relationships that a manager is bringing to bear on their portfolio, I would say, is table stakes today.

Alex Abell (20:27.992)

What that means is if we don't see somebody that has some sort of form of operational resources, it's very rare now. Especially in the lower middle market where that value creation is so important as part of the returns because we don't use leverage the same.

And so what we've seen is a mix of other types of structures that have been very successful. Some structures are where you have an operator or an ex-operator that's actually part of the general partnership. And maybe that means they're part of the investment team or maybe they're equal status. So one of the things that historically we've seen a lot in private equity is that operators have always been very much second class citizens compared to the deal professionals.

But we have seen a bunch of models where they've elevated those people to be essentially equals with the deal professionals in terms of status, but also of course economics and carry and things like that, and decision making. And we've seen those models work really well, where you have operators that are part of the process from the very beginning. They're part of the deal teams. And the other model that we've seen that's really gotten a lot of traction with a lot of managers for the last, I don't know, five or ten years is what I'll call

sort of this in-house functional team. And so what I mean by that is — again, historically a lot of the way that private equity firms were using operators were sort of these ex-CEOs that were retired and maybe they've done a deal, now they're sort of looking for the next deal. And what sometimes can happen is that that person may have a lot of expertise in healthcare,

Alex Abell (22:02.265)

but not all healthcare companies are the same. And so depending on how close a match their experience is, what we saw with some private equity firms is they bring in this operator to be on the board, and they were trying to sort of apply what they knew to a company that was, yes, a healthcare company, but a totally different type of company. And it wasn't really valuable. And so what we've started to see now is private equity firms really focused on

bringing in functional experts. And what I mean by that is one big area, of course, is HR and hiring. So instead of using outsource providers — headhunters or things like that — most of these small companies, you are adding to the management team, you are replacing folks that are not ready to make the jump from a $7 million EBITDA company to a $30 million EBITDA company. And there's a lot of hiring that goes on. Well, a lot of teams have brought that function in-house because not only are they generally hiring for their portfolio platform,

but oftentimes there's acquisitions being made within those platform companies. So you're bringing in sort of functional expertise in-house. Another example would be for software or technology native services — what we've seen is a lot of managers bringing in experts in digital marketing, bringing in experts in pricing structures. So they're not bringing in a CEO — what they're doing is they're developing a team in-house

that can almost like a SWAT team be deployed sometimes even before the deal closes. So they'll bring these folks in — one is a way of selling themselves to the seller, to be the preferred buyer, showing that we have these resources. In our market, most of the sellers, again, are sort of entrepreneur owners or family-owned businesses. And I would say most of the deals we see, there's some form of rollover.

So that seller is going to be a partner with this private equity firm for the next three to five years, and they're going to get a tremendous amount of return above and beyond sometimes what they originally got out of the first event. So for them, being able to have confidence that this manager has resources and people available that they like and trust and have a plan for how to make their company that much better, that's really important. So we've seen managers start to bring a lot of these functional things in-house instead of relying on a more amorphous advisory role.

Alex Abell (24:20.879)

I'll tell you — go ahead.

Shiv (24:20.887)

No, I was just going to jump in and say that that definitely resonates with our experience. Like when I first started this business in 2019, there were way more advisors and board members involved. And then as time has gone on and the PE sponsors that we work with, they'll have an operating partner that has either deep expertise or is kind of like a quarterback on making sure that the right resources are coming into the organization and then

we get tapped every time marketing is an area that needs to be addressed in diligence or post-close and we're able to be that functional expert inside these organizations. And I'd say historically that was a harder sell because people in these operating roles felt like they had a handle on it because they had industry experience or relationships and that was kind of what the business was relying on. And we've seen that shift completely to more functional expertise.

Alex Abell (25:16.527)

And look, I think it's valuable and from an LP's perspective, one of the things we like about that as well — again, every structure is a little different — one of the things that's a big question mark that LPs should be asking whenever they're evaluating the operating resources that a GP is using is who's paying for it.

Alex Abell (25:34.658)

So many of the outside resources generally are paid by the companies themselves. But that means the LP is paying for it, because those are — the majority of it is being paid by capital that we own those companies with. And the other models — the GP is paying for it out of the management fees.

Alex Abell (25:59.374)

And what we've started to see is a lot of GPs create almost like separate mini companies — they're just pass-through vehicles, but they're LLCs sometimes — where that's how the operators that are part of your team get paid. So from the companies usually through that LLC and then paying these operators. And the LLC is generally not made to create a profit. But it's made to facilitate the ability to have all these multiple people that they can

Alex Abell (26:29.297)

utilize across, let's say, 10 or 15 or more companies within these managers' portfolios. And usually billed at some sort of arm's length way. And again, understanding how the GP is actually doing that as an LP through your due diligence process is a really important part of gaining the trust that what they're doing you feel is not just effective, but also effective from a cost perspective for the LPs.

Shiv (26:55.281)

For the LPs, yeah. The thing — I think that model works a little bit better than having almost like a captive team in most cases, because for the GP the economics break after a certain point. Like you can have a few operating partners depending on the number of portfolio companies you have, but if you try to build out a full team, the economics stop working for the firm in terms of the firm's own margins and operating capital. So almost

Alex Abell (27:22.767)

And that's yeah, that's more extreme in our part of the market, because we're dealing with funds that are generally pretty small. So the median underlying fund size in our primary fund portfolios is right around five hundred million dollars. So most of the managers at a five hundred million dollar fund are not getting wealthy on the management fees. They're hoping to get wealthy on the carried interest.

Shiv (27:43.307)

On the carry, yeah, exactly.

Alex Abell (27:48.066)

And for us as an LP, that's one of the reasons we like these managers of this size because we're very aligned. So they generally are only making money when we're — when we're paying them their carry, and that means we're making money as well. And so what we tend to see is that the structure of these operational teams and how they use them can often evolve as the manager gets bigger. So as the manager gets bigger and bigger, we go from seeing a lot of outsourcing — and even outsourcing in the sense that, like you said, it could be an established

Alex Abell (28:18.069)

group of people, but their paychecks are being paid by the companies — to a point where that you might be bringing certain people in-house sometimes just to manage that group. So it might be someone who's like the quarterback. Their job is to figure out what we have in-house, what other types of resources like you guys that they could bring in as a way of adding value to their companies. In almost every case, they're still bringing in outside parties for various very specific tasks. Because it's very hard to get a team that has

Alex Abell (28:48.089)

everything covered as part of that process. And that's really important. But I think what we're seeing is that from an LP's perspective, those resources and finding a way to create a very systematic process of how you deploy those resources is one of the things that can differentiate a manager. And as we look at — are we going to invest in one of 300 managers every year? — that being able to see that process and really a well-thought-

Alex Abell (29:17.809)

out process that sometimes begins even during the due diligence process gives us a lot of conviction that they have the ability to do this in a repeatable way. They're not just buying their catches.

Shiv (29:27.391)

Mm-hmm. What do you make of — because one of the trends, especially with valuation multiples — operational excellence is more important now than ever before. These companies need to create enterprise value organically more than ever before because previously you could just layer on M&A and kind of scale the thing, find efficiencies and flip it. I'm hearing that a lot of GPs — having

a unique angle to value creation and building that in-house is critical to winning deals and passing those hurdle rates and generating the kind of return that you would want as a fund. So how do you marry those two ideas? Where at the same time some of these funds are too small, they can't really afford an extensive team, they have to rely on external partners, and then also still having a unique perspective that allows you to actually generate alpha for the fund?

Alex Abell (30:24.493)

Yeah, so again, when managers are small and their funds are small, you're really leveraging — as an LP as we're evaluating them — we're seeing how they're leveraging their own networks. Because they may not be able to bring those team members in-house, but do they have the relationships with former people that have done all these things, that they can then have the companies hire?

So again, they're not bringing — they don't have a big team themselves necessarily at a three hundred million dollar fund size. But as they grow, they start to bring resources in-house. But what's critical is that those GPs, the senior people, have worked with those people in the past and have ideally proof books. So one of things that we see often, which is also very common sometimes in the venture world, is repeat CEOs — where a manager has worked with a CEO, they've been successful in another company, and then they go out and

there are actually some GPs that have a very specific strategy where they bring on a CEO that they've worked with in the past to go find the next deal. And they are going out there and sourcing alongside of the general partners and the investment professionals. They are when they find interesting companies, helping do the due diligence on those companies with the idea of implanting that CEO as the CEO of that company once the acquisition occurs. And usually, as part of that, it often requires that CEO

to put a bunch of their own money into the deal to make sure they're aligned with the private equity fund.

And so what I would say is that for smaller firms, finding unique ways to leverage the relationships they have to add value, and then as they grow, they can expand that network in a more robust way because they just have more resources to throw around — both internally as well as externally. So what I think is critically important, that we've seen, is that most of the GPs that have been very successful — you mentioned sort of having a playbook — and I think that's really important. So we've seen some GPs

Alex Abell (32:25.105)

that have had very rigid playbooks, where they come in and say, okay, here's what we're going to do to your company. And either you're on board or not, and you can pick us or don't, but that's what we're going to do. And that sometimes is very successful. There's a couple of really big firms that have grown over time because they've done that very well. But I would say that most of the managers we meet are trying to find a partnership really with the existing owners, because again, those owners tend to have a big share of the equity. So what they want to do is make sure that owner is okay with the

plan that they talk about ahead of time of how they're going to — what they're going to do. And I would say the most successful GPs that we've seen generally have a very specific way they attack the same types of problems in their companies. So we have one manager that I like to say has a great saying about — they don't buy the A assets all the time. What they buy, he describes it as companies with crooked teeth.

Alex Abell (33:22.787)

And what he means by that is that there's something about that company that they can identify they're not doing very well. It could be retention rates for a software strategy, it could be manufacturing efficiencies, but they have the expertise as the GP because they've seen it before in previous deals. And the crooked teeth metaphor is we can put braces on it. It's something that can be fixed — something that we can identify that can be fixed — and once you fix it, you have a very

shiny nice asset that you can sell. And those are the strategies I think that have done really well — where they're very good at identifying those things ahead of time because of the expertise of the investment professionals and also because of the outside and internal resources they can bring together.

Shiv (34:08.565)

Yeah. I think that's a really great insight, which is that a lot of these firms, especially on the lower end, can benefit from having that unique approach outside of what let's say a traditionally larger firm like Vista or Insight might be deploying with larger teams. How do you as an investor in these types of funds — how much of the operational side is factoring into your decisions versus the data side that we

talked about earlier on the call when you're benchmarking against other funds and things like that? What's the determining factor?

Alex Abell (34:44.429)

Yeah, I mean — it's going to sound like a weak answer, but it depends. So again, all of that's important. I would say that today there's very rarely a case where we find a manager attractive that doesn't have a strategy that is heavily emphasizing operational value creation.

It is so critical for the types of companies that our managers are focusing on in the smaller part of the market because we are not generating a lot of returns from leverage. The leverage use in our part of the market is significantly lower than what

Alex Abell (35:20.427)

we see in bigger deals. So it's not financial engineering, it's really growth. And it's generating growth through improving something or multiple things about what those companies are doing. And I would say the way that the data works is that it's a way of validating our thesis when it comes to things like their operational value creation.

So the data helps give us more conviction that we see proof points that that's worked. So when we do an evaluation of a manager, our focus is very much at the deal level. We are going through case studies of every deal. We're looking at investment committee memos. We're looking at how they identify risks and sort of the upsides in these companies. And then we're looking at what happened. And what we want to try to do ideally is sort of pull a thread through every deal that shows a common denominator

Alex Abell (36:09.871)

of how they got to a good outcome.

If there's a situation that's very one-off — I've had GPs that have pitched me and said, well, we did really great on this deal because one of our partners' roommates from business school had somebody who was an expert in this particular area and we were able to bring them into this deal because we couldn't find anybody else, and then the deal did great. Well that's a horrible story for an LP, because how many roommates from business school

have specific expertise in a deal you've done? That's not a process. That's not something that's repeatable. So for us, the data helps us validate that they are doing what they're saying they're doing in these portfolios and gives us a more clear picture of them.

Shiv (36:57.471)

Yeah, totally. I think leveraging both of those areas and combining them into some sort of a unique perspective is the key. So that's definitely helpful. What about on the people side? Are you evaluating the leadership teams? Are you underwriting the assets inside these funds as well? How involved are you getting at the micro level of these funds?

Alex Abell (37:18.563)

Yeah, all the above. So we're looking at every underlying asset. One of the things that RCP does — we've been talking mostly about primary fund investing, but we also have a secondaries fund and we also have co-investments. So we have a lot of people in-house that have expertise in direct deals and understanding and evaluating underlying companies in all these portfolios. So we utilize that as a way of looking at their past funds, most of which maybe have a lot of unrealized information in them, and doing an evaluation — really a bottoms-up

evaluation of what that fund is likely to do. We call it mark to exit. So we talk to the manager, they give us their predictions, we look at the underlying companies, we put in our own models as well, and we get a sense for what that fund's outcome is going to be maybe five years from now. Now, we're not always right, the GP's not always right, but what we're trying to do is get a sense for the potential of those underlying portfolios. So looking at their assets historically on the primary side, when you're investing in what is

generally going to be a blind pool — or maybe there might be a deal or two in there — is really important to understand. And then the people is critical, because at the end of the day you are investing in a blind pool as a primary fund LP. And what you're really doing is taking a bet on individuals.

Alex Abell (38:35.171)

Not just the individuals, but obviously their strategy and how they work together. But at the end of the day, who those people are, whether we think they're great investors or not, is really critical. And the way we figure that out is through a variety of ways. One is our interactions with them over many, many years. So most managers that we back, even if we haven't backed their previous fund, because we're a specialist focused only on this market, we've been talking to them in some cases for 10 years. We've gotten to know them pretty well. The other thing that gives us a big advantage is because we are a co-

Alex Abell (39:05.135)

investor and we'll look at deals from managers that are not in our portfolio, we get to see a lot of how the sausage is made behind the scenes. So when we're looking at it from a co-investment point of view — even before we might be looking at it from a primary fund investment point of view —

we can see what kind of risk they're willing to take. We can see what kind of due diligence they do. And so it gives us a really interesting insight into the quality of that manager, those individuals as investors. And of course we're doing references — on people that have worked at the firm previously, maybe not working there now. We're trying to do as many off-list references as possible on these individuals. And that gives us — again, being a specialist and focusing only on this market gives us an advantage

there as well because we have lots of relationships in this ecosystem — with other GPs, with people that have worked for those GPs as CEOs, with their intermediaries. And so that helps us sort of coordinate on the quality of that individual's abilities. One of the things about our part of the market is that most of the — because we're capturing a lot of these groups when they're in their first couple of funds — we actually have an emerging manager fund that does only first and second time funds.

Alex Abell (40:20.739)

Even our core fund, we may have fund threes and fund fours. That person usually came from another private equity firm at some point — either one that's gotten big, they left and they started their own firm. And in most cases, we have connections to people at those private equity firms that they used to work for. And again, that gives us a huge amount of insight. Now, sometimes they were more junior — they might have been a vice president at that time or pre-partner. But we get a lot of definitive opinions about them too. They might say, that was the best

VP we've ever had at our firm. He's amazing. Or we might hear the opposite, which is we counseled him out, he had this problem or this problem. So from a people evaluation standpoint, when you're dealing with as an investor as a limited partner, that is always a critical component because you are trusting them to invest capital in assets that don't exist yet — I mean the assets exist, but they're not in their fund yet. It's very different than things like secondaries or co-investment where we have a very

specific thing we can evaluate. Here absolutely.

Shiv (41:22.421)

And you're way more plugged into the actual investment. Yeah. Are there situations where the qualitative side has outweighed the quantitative side? Because something can look like a great investment on paper or with data, but the qualitative side kind of overrules that or outweighs that.

Alex Abell (41:44.014)

Yeah, absolutely. So we see all the time groups that have good track records and they've done well compared to managers, but there could be something that we identify that's not related to the track record that gives us pause. There's a million things that could be. It could be everything from this person has an anger management problem.

We've gotten references of people kicking in the walls of their office and berating employees. And so that's one qualitative thing that's kind of extreme. But less extreme versions I would say are things like hoarding of economics. So again, if you're — sometimes founders will take a disproportionate share of carry compared to the amount of value that they're creating at that moment, and what that ultimately can do is create destabilization in the teams. So

even though they've done really well up to that point, let's say all the more junior partners are getting much less carry than they would in most other places, as an example. Well, that creates a big alignment problem that would be worrying to me because those are the folks that could leave. And if we believe they are important to backing in that strategy, then that's a qualitative issue that can override the fact that they've done really well historically, because that team stability might be at risk.

Alex Abell (43:03.917)

And I was going to say the other thing that we often look for that's again very qualitative and hard to quantify is the interactions among the team and the dynamics of decision making. And that comes a little bit from just having experience of seeing dysfunctional interactions. A good simple example would be a situation where sometimes we'll take meetings where one partner will dominate the conversation, and even when another partner is trying to add a point, they get

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

Shiv (43:52.841)

Mm-hmm. Totally. Yeah. I mean I think on the people side, especially having GPs that understand how to grow companies that aren't just doing financial engineering — I think that is a huge lever inside PE firms. And then having operational expertise that can actually create enterprise value — that is a more rare find than I myself expected. But as I work with more funds, it's clear that there are gaps in a lot of firms, especially in that seat.

Alex Abell (44:20.909)

Yeah, I mean one of the things that we have seen — again, it's not the most common, but we tend to like is when those operational people with really significant operational experience are really part of the investment deal teams. Where they are not off in a corner being the ops team, they are part of the general partnership. And we've been very successful with a number of managers that have had that kind of expertise as part of the leadership of the firm, not just

a resource that they go and hire for a specific company. But it's rare still. We don't see that as the norm. The norm is still mostly investment deal partners and that kind of experience.

Shiv (45:01.673)

Totally. We're coming up on time here, but as we close off, Alex, if people want to get in touch with you or learn more about RCP, what's the best way to do that?

Alex Abell (45:11.419)

Sure, they can email me directly at [email protected]. Our website is rcpadvisors.com and there are a couple of links in there that you can certainly click on to reach folks here. But yeah, we're happy to chat with folks and we always say as well — if you're a limited partner out there listening to this, we're always very happy to share information about managers and trending things like that, so feel free to contact us.

Shiv (45:39.829)

Yeah, awesome. And we'll be sure to include all that in the show notes, Alex. And with that said, I appreciate you coming on and sharing your wisdom. We haven't had many funds of funds on the call. And I think especially with the way you guys are approaching things with the data side and how involved you are with these firms, I think there's a lot of unique insights that you brought here that the investors and operating partners and even CEOs can learn a lot from. So I appreciate you doing this.

Alex Abell (46:01.712)

Well I appreciate the opportunity and it's been a great conversation and thank you very much.

Shiv (46:06.414)

Thanks, Alex.