Episode 2: Bryce Youngren of Polaris Growth Fund on
How to Deliver Big Returns on Small Companies with a Founder-Friendly Approach

Episode Transcript

Shiv:
Alright Bryce, welcome to the show, great to have you on.

Bryce:
Thank you for having me, Shiv.

Shiv:
We've been friends for many years, so this is just another one of our conversations, but I'm excited for the audience to hear more from you and learn from your expertise. So why don't we start off by you giving some background on yourself and Polaris.

Bryce:
Great, so I am part of Polaris Growth Fund, which is a growth equity investment firm. And we focus on investing in great software and technology services companies. And to give you a little more detail on that, I'll pull up some of the criteria we look for when we're looking for companies, because we have a very specific focus in terms of the type of company we're looking for. We are looking for B2B software and tech enabled services companies. They're almost always founder owned and bootstrap companies. They're what we call vertical niche market leaders. So one of the leaders or sometimes only players in a very specific vertical market. We're investing 10 to $50 million generally based on our fund size. And as a result of that, we're generally looking at companies in the $3 to $15 million revenue range. We like companies that are growing at least 15% a year and hopefully much faster. And we like companies that are break even or hopefully nicely profitable.

Shiv:
Yeah, and that piece on the 3 to 15 million in revenue is interesting, right? Because a lot of private equity firms try to chase after larger companies. So can you expand on why you've focused on the lower end of the market here and what the advantages are or the overall investment philosophy for Polaris here?

Bryce:
Yeah, sure. Let me go up to a slide that can talk about that. If you look at where capital is raised in private equity today and where the dry powder or uninvested capital exists today, 96% of the capital is in funds over 500 million. And what's really happened is a lot of people have had success investing in technology and most funds have gone and raised as much money as they possibly can. And what happens is when you raise a 2 billion or 10 billion or $30 billion fund, like some firms, your minimum investment goes up. And most firms now that you might have heard of have a minimum investment of 100 or $150 million. And as a result, they really need companies that are scaled. And so a big part of our strategy is staying small. We're in that group of funds under 500 million, because we think there's such a great opportunity there to invest in companies. And what you find too is there's relatively few new funds that are targeting that size, and they tend to be relatively new investors and don't have a lot of experience, because the experienced groups have gone and raised billions and billions of dollars. If you look at where the companies exist, most of the companies out there are in the smaller size. We have historically, with that size range, invested in companies with 11 to 85 employees. So if you look at this breakdown of all technology companies in the country, we've screened out companies below 20 employees because there's millions and millions of those. You see that among companies greater than 20 employees, with that size, we're targeting two thirds, maybe 70% of the companies out there. So it's really 4% of the capital, chasing 70% of the companies. And if we can help the founders and management teams get those companies to a scale, organically and through acquisition, where they make sense for those larger billion dollar funds, there's a lot of opportunity out there to sell those companies for fantastic prices. And that's really what our goal is, to try and get these companies to scale, where they make sense for all the capital that exists out there, both private equity and strategic.

Shiv:
That's interesting. Would you say that that's a function of the market where when the interest rates were so low, the fund sizes kept getting larger and larger? And so it almost made it that you have to deploy more capital in order to generate a meaningful return, or is that just because larger companies give you an opportunity to deploy more capital and then you're not dividing your focus as much, so capital tends to flock towards some of those premium assets?

Bryce:
Yeah, I think investors, the institutional investors out there, the pensions and endowments, first of all, like experienced funds with a track record and those experienced funds have gone and raised really big funds. And a lot of those pensions as well now have gotten very large. And so they need to write large checks. And so they want to be in large funds. You know, we've had some large pensions come to us and say, our minimum investment is a hundred million. And we said, that's just too much for us. We don't want someone to be that large a percentage of our fund. And so what's happened, if you look in this next slide, the capital raised by funds under 500 million has fallen by 43% in the last five years.

Shiv:
Oh wow.

Bryce:
Yeah, because what's happened, the capital in larger funds has gone up dramatically and the capital in smaller funds has fallen by 43%. And we think that will probably continue because it's easier for a pension to invest in one of the large, more institutional funds out there. The other thing that's happened is there's been tremendous growth in new company formation. If you look at the last roughly - I guess this is probably 17, 18 years - we've gone from about 2,800 new information technology companies being formed every month to about 7,800 new information technology companies being formed each month. So there's lots and lots of companies out there.

Shiv:
Opportunity, especially down market, but it's interesting because, if you go back one slide, you said the amount being raised by the smaller funds has gone down and the dry powders come down. But with the larger firms, you're almost seeing them raise another round much faster, even though they're deploying more capital than ever before. So they're like trying to turn over the capital a lot faster and assign their entire fund so they might reinvest in the company that they've already capitalized or put in additional M&A investments into those businesses and then go back to the LPs and ask for even more funding so they can build even bigger businesses. Meanwhile, down market, you don't have as much attention being paid to those up and coming businesses.

Bryce:
Yeah, those smaller software and technology services companies just don't have as many great options out there in terms of experienced investors to provide liquidity and help them grow their businesses.

Shiv:
Right, and so that becomes a unique differentiator for Polaris. So talk a little bit about that in terms of how you're able to tell that story to founders for them to understand why it's in their interest to work with you over some of these larger funds.

Bryce:
Sure. Let me stop sharing this quick. So, one of the - we focus on a few things. When we invest in a new company - and actually I'll share that slide with you. When we invest in a new company, we agree with the management team and the founder on what we call a strategic multiple expansion plan. So what we really love is companies, like I said, that are leaders in a very specific vertical or sector. By the nature of being a 5 or $10 million company and being a leader in a market, they're often smaller markets. And that is a liability to the company and solving that over time can really create a lot of value for the company. So figuring out how do we help that company grow their addressable market by getting into new products, industry verticals and geographies is a key value creation opportunity. And the next question is, do we do that organically or do we do that through acquisition? And most founders have never had the opportunity to make acquisitions before because they've never had the capital to do it. So this really opens up a huge new opportunity for founders to say, ‘oh, I can acquire this adjacent product or acquire a company in Europe and expand my business there or acquire in a new industry,’ whatever the case is.

So once we've mapped that out and said, ‘what are the best opportunities and the best priorities,’ it's then a matter of figuring out what's the management team we need. What is the, what we call our strategic acceleration team, we want to use, and advisors and maybe board members? And what are the KPIs we want to track?

And, so your next question is probably, ‘what is the strategic acceleration team?’ We put together a team of a few individuals who can help with what we see as common opportunities within companies.

The first one is on the marketing side and Shiv, obviously we've worked with you a bunch too. What we find is a lot of these smaller companies generally just have two or three sales people and have not spent any time thinking about how do I create inbound leads for those salespeople. And there's an opportunity to maybe double the size of the pipeline and double the size of the opportunities. And we've seen that with a lot of our companies and that enables them to really accelerate their sales. So we obviously have done a bunch of work with you and we have an individual named Maureen who's been a part of a number of large organizations before and works with our companies on simple things they could do. And Maureen is the type of person, like our other experts, who our companies probably couldn't hire because it's just too senior and too expensive of a person. But getting a third or a quarter or a fifth of that person's time is a big opportunity for them.

Number two is a corporate development person. And that's a gentleman named Mark Koster. And he helps our companies find great acquisition candidates. What is an adjacent product that you could cross-sell into your existing customer base? You know, maybe you're serving the banking market today. What's an adjacent product, a company in the insurance vertical? So you could cross over to that. Or you want to get into Europe. What's a company we could acquire in the UK that would give you kind of a landing spot to sell your product into Europe or a beachhead to sell your product into Europe. And then the last one is a gentleman named Mark Augenstern who helps with finance. A lot of our companies just haven't had the resources to invest, to have a CFO or any kind of a financial system. And once you start making acquisitions and add debt to the business and really accelerate some of these growth initiatives, you want to be able to track the financials and track the key performance indicators. And Mark really puts in place those capabilities on behalf of our company. And that's generally a project that might last nine months. And so it doesn't have to be, you know, a full-time problem for our companies.

Shiv:
Right. So it's almost like there is three buckets, right? There's like the organic growth and that's looking at what exists currently within that core business and how do we optimize that, whether it's in sales or marketing and pricing. And then bucket two might be inorganic growth. That's through M&A and layering on acquisitions. And bucket three might be this professionalization of the business, especially since you're buying founder led companies and they may not have the right expertise in operations or finance and some of those areas that we need to really nail down and turn it into a real business.

Bryce:
That's exactly right. We tend to have very product centric founders who have great product organizations and built a fantastic product. But a person like that rightly has not focused a lot on the finance organization and so helping to build that up.

Shiv:
And so when you look at the companies that you've invested in, or even the ones that you get pitches from, or you end up having meetings with, where do you see there being the biggest opportunity for them? Or what's the order of operations at least? Like, do you think it's first getting finances and metrics and all of that in order? Or is it just discipline on the go-to-market side? Or is it just building that M&A roadmap and acquiring businesses in terms of creating value as quickly as possible?

Bryce:
Yeah, I would say it's number one, the go-to-market organization. I think what all of our founders are focused on and what we're focused on is how do we accelerate growth? How do we get this product and this message in front of more potential customers? I'd say number two is looking at product adjacencies. And that's could be expansion of existing products or, or maybe acquiring products. And I think once we've had time to focus on that, the acquisition roadmap is really something you build over time. It's probably a year or two before we're ready to make an acquisition. You know, we're often building out the team and we're building out the sales organization. We're getting the financial systems in place to be ready for that. And so really, when we come in, we're... the first year or two we're trying to build that roadmap so we're ready to make acquisitions and we have a menu of options lined up a little later down the road and I'd say last is finance and getting that reporting in place.

Shiv:
Right. And a lot of these things are kind of happening in parallel too. We've come across a lot of companies in this range of the 3 to 15, maybe 20 million, and it's kind of shocking how many companies can grow to that scale, but still potentially be either founder led sales or completely like a sales led go to market. But the engine or the go to market motion is not sophisticated enough where they know who they're going after, how big the TAM is, what channels are going to be best suited for, the type of product that they're selling, or the type of sale that they've got. Do you find this as well in your experience in coming across these companies?

Bryce:
Yeah, absolutely. Absolutely. I think one of the biggest things we can bring to our companies is just having seen companies like this in this $3 to $15 million range grow into larger companies. We've had companies grow as large as $375 million of revenues before we exited. And so understanding what it takes to get there and what challenges and speed bumps a company is going to come across and what's the most efficient way to get there I think is an important value we can bring to our founding teams.

Shiv:
Right. And then when you look at other levers like pricing or product management and all of that, like how are you prioritizing these ideas against each other? Because one of the risks is distraction, right? Even new product development, you can easily spend a ton of resources in creating like an adjacent product and you can cross-sell and upsell, but then it distracts you from the core business. So how do you manage those against each other and how do you figure out where to focus on first?

Bryce:
Yeah, I think it's just an iterative process. You know, one of the things we like to do in all of our companies is bring in an outside board member, someone who has some real experience and relationships in a particular vertical market. And once you've got a good board of, call it, five to seven people, I think it's just spending a lot of time doing research and then debating these different growth initiatives. Because, you're right, often we might have 20 different growth opportunities and the key is to narrow it down to two or three, where you focus your resources and hopefully have the highest chance of success.

Shiv:
Right. And that might be enough to get that company from 10 million to 25 million alone. You don't need to do the other four or five ideas that you've got.

Bryce:
That's right. That's right.

Shiv:
Yeah, and maybe we can, this is a good time to touch on an example. You had mentioned TRG and the story there. Do you want to walk the audience through that in terms of what you did with that business before you exited it?

Bryce:
Yeah, sure. We invested in TRG, which was called The Roberts Group, and it was owned by the Roberts family. We acquired a majority interest in the business and the founder and his family maintain a meaningful stake in the company. The company was a leader in managing data and subscriptions primarily for large financial institutions. So investment banks like Goldman Sachs and Morgan Stanley, that type of customer, JP Morgan, and then large asset managers like Fidelity and Vanguard, and then hedge funds and things like that. Often their third largest line item is data, right behind people and then real estate. And so some of those groups might be saving, might be spending $200 million a year on thousands of different data providers, Bloomberg and FactSet and all those types of things. And by helping them manage those contracts and figure out that people weren't using subscriptions, et cetera, we can help them save 10%. And so if you're spending $200 million, saving 10% is a pretty spectacular value proposition. But it was a pretty focused and targeted market. So a few of the things we did there, about a year after the investment, the founder came to us and said, I really wanna become chairman, operate at a higher level and start to slow down a little bit and I'd like to help you recruit a new CEO. So we recruited a new CEO and behind him, hired a new CFO, CRO, CTO and Chief Product Officer. And one of the keys was really building out that revenue organization, both the marketing side and the sales side. And we really wanted to expand across all of those vectors. We talked about products, industry verticals, and geographies. And a couple of the keys here were two acquisitions that we made. We acquired a company called Screen, and Screen was the most comparable company to TRG, but was based in Europe. So we were the leader in the US, they were the leader in Europe. And putting these two together was really combining the two market leaders and gave us an opportunity to sell our product. There was focus a little higher end in the market on the big institutions in Europe. And it would have been nearly impossible for us to build out that sales team in Europe. They had seven salespeople in seven different countries. And hiring a person in Italy and then a person in France and a person in Germany. would have just taken us forever and been hard to find the right people. And then we also acquired a business called Priory Solutions that had a kind of library management module that was similar, you know, related to us because a lot of this data was coming out of some kind of library function. And that did two things. That got us into some new industries. They had a lot of customers in law and consulting and accounting. And also brought us a new product that we could sell into our existing customers. So as a result of those two acquisitions, we then had new products, new industry verticals, and new geographies. And we went from probably a $100 million market opportunity to a $500 million market opportunity. And when we sold the business, that's something everyone asked. What are the vertical - you know, what is the market opportunity that you're addressing? And one of the really nice things in this particular situation, we were able to acquire those two businesses entirely with debt, in part because of our relationships and our being invested in the company. So the founder and his family took no dilution as a result of these acquisitions.

Shiv:
Oh wow.

Bryce:
And helped us grow the business to about four times the size it was when we invested. And the founders on their rollover equity, may return, I'll call it greater than 10X, on the money that they rolled over. And they had very low expectations on what they could get for that rollover. And the fact that they made more money on the rollover than they had on the initial was a tremendous, happy surprise for them.

Shiv:
Right. I mean, that goes to speak to the quality of the acquisitions that were bolted on to the platform. The CEO is Steve Matthews, right, of this one? That's

Bryce:
Correct. Yeah.

Shiv:
Right. Yeah, I met him. Yeah. So talk a little bit about this piece, because I think building the right management team is critical to achieving this kind of an outcome. And I'm assuming when you're dealing with founders, this sort of scenario comes up frequently when you've invested and now it's almost like a buyout and... Eventually the founders either want to exit the business or somebody is brought into to lead the business outside of the founders. So how much - how does that process look like and how much effort is going into building that right management team?

Bryce:
Yeah, it is really all over the map. Probably half of our founders are younger and they wanna continue running the business and they wanna continue being involved day to day. And that's fantastic from our standpoint. They're the ones who built this business and they know it better than anyone else. And then we have, maybe half the business that we invest in, the founders, maybe around 60 years old, and they'd like to start to slow down. Part of the reason they're doing this transaction is they'd like to take liquidity, but they don't necessarily want to sell all their business. They think, first of all, there's a lot of opportunity with their business in the future, and so they'd like to continue to own a sizable portion of it. And number two, they have a lot of their identity tied up in the business. You know, they're the founder of this ex-business, and they want to continue to be chairman and continue to guide the strategic direction of the business. They just don't want to have to spend 70 hours a week doing it. They'd like to do it 20 hours a week or something like that. And we're very flexible. It's really, you know, we want the founders to find something that's the right fit for them.

Shiv:
Right, and finding the right management team that can kind of pick up the ball from them and run with it is also the key there, right?

Bryce:
Yeah, absolutely. So once we figured out that founder dynamic, it's helping build the team around that. And I think, hopefully when we invest, we have good relationships that we can help find really talented management team members and better recruit them to knowing that there is a multi-billion dollar private equity firm invested and they're planning on growing this business aggressively and there's going to be an exit generally, you know, about five years after we invest. So they know that they'll have an equity payday as well. That's what's really gonna attract them to the business. And so yes, bringing in really seasoned sales leadership and marketing leadership and product leadership and technology leadership. Those are the resources that a CEO needs to really take his business from that five or 10 million revenues to hopefully 20 to 40 million.

Shiv:
Right. To make this type of a change, it takes time, right? Like you're kind of almost resetting the table for the business and building that foundation in some ways. And so talk about your hold period and like what type of horizon you look at for your investments to actually generate that type of a return that would be satisfactory for your fund and also for your LPs.

Bryce:
Yeah, we're generally targeting a five year investment. And it really is dependent on facts and circumstances. It's been as short as two or three years and as long as eight years or even longer, depending on what the opportunities were and how the business grew and everything like that. But certainly that's our target when we're coming in. And so yes, we want - when we start our investment, we want to really make those investments upfront to help the business grow. So often generally we're taking down earnings because we want to invest in new sales team and leadership and marketing capabilities and product and all those things we talked about. And that's both leadership and people doing the work and with the hope that those will really start to pay off over the next few years before we all exit the business.

Shiv:
Right. And so that's almost like in that first 100 days period, that time period, you're trying to do as much of this as possible so that it starts to pay off in that five year hold period. Yeah.

Bryce:
That's right.

Shiv:
In terms of sourcing deals, given that you're looking for more of these founder-led types of businesses, how actively are you looking for these deals and how do you find the companies that you're investing in? Is it purely like an outbound process? Is it referral-based? Like how do founders find Polaris?

Bryce:
Yeah, we get some deals through referrals from other founders. We get some through investment banks, but most of them come from our direct outreach program. We have analysts and associates who are doing a lot of research over the internet to find companies that we think meet those very specific criteria I talked about earlier, you know, that fit those very specific criteria. And then they're reaching out. And what we find is that a lot of these founders are getting called by a lot of firms, but what they don't realize is that 90% of those firms might be, you know, KKR size or Vista or Home or something like that. And they are too small for those firms. All they could potentially be is maybe an add-on acquisition to some larger platform, but they couldn't. continue to be the independent company that the founders often want to be. And so we spent a lot of time flying to cities to try and meet with companies. Once we find three or four companies that might be potentials in a potential city, one of us, myself, my partner, Dan, or some of our colleagues will fly out and try and meet. And really it's about building a trusted relationship with those partners, because it's a very big decision to take the business you've spent sometimes 15, 20 years to build. And building that trust takes time. One of the keys for us is really trying to build a reputation as the partner of choice for founders. I think a lot of private equity firms and individuals get a bad reputation for how they deal with founders. we've really gone out of our way to be as founder friendly as we could possibly be. And we tell you that all of our founders are references for us. If there's a founder who we're talking to, we'll give them the full list of founders we've ever dealt with and said, talk to any of them about how we are to work with. And we think that's very different than other firms out there. And that just comes down to treating founders and management teams as valued partners and with real respect. And I think also hopefully because we're so focused on a very specific type of company, we'd like to think we've developed some level of expertise in vertical SaaS and technology services companies of this size. And then the last thing is we advertise our return, what we've done with founders in terms of their rollover in the past. And our founders, on average, have made close to five times the money on the capital they've rolled over in our companies in the past. And so seeing that track record of success is hopefully instills confidence in them. But it's really spending time with those founders trying to convince them that we're the best partner for those reasons.

Shiv:
And also for the sizes of companies that you're investing in, there aren't that many firms that are actually paying that much attention to those types of companies, the way you are.

Bryce:
That's right.

Shiv:
The larger businesses may get that attention, but the smaller ones aren't.

Bryce:
And if they do, it's, you know, there's some firms out there that are trying to put together eight or nine different companies into one.

Shiv:
Right.

Bryce:
And a lot of founders, that's not what they want. They want to see their business continue to be the platform business that maybe goes and acquires one or two other businesses. But, you know, their business and their employees and their company continues to be the lead entity.

Shiv:
Yeah, we get those kinds of inquiries all the time too, as a consulting firm where somebody's building a larger consulting platform and they wanna think of us as a bolt on or add on. As a founder, you wanna control your destiny and finding a partner that believes in your vision and is willing to back that is harder to find.

Bryce:
Yeah.

Shiv:
Yeah, so totally hear you on that. So this seems like a great place to stop the conversation. Bryce, to leave it off, what's the best way people can get in touch with you and learn more about Polaris?

Bryce:
Yeah, you know, founders especially can email me anytime. B. Youngren at PolarisGrowthFund.com.

Shiv:
Excellent. We'll put that in the show notes and if you can share those slides, we'd love to include those in the show notes as well so they can get that information and that as a resource. But again, thanks for doing this. This was a great episode.

Bryce:
Thank you for having me, Shiv.

Shiv:
Thanks, Bryce.

Bryce:
Take care.