Episode 30: Chip Baird of GreyLion Capital on
Optimizing Companies With the LIFT Strategy

Episode Transcript

Shiv: All right, Chip, welcome to the show. How's it going?

Chip: I'm doing well thanks, how are you?

Shiv: Good, excited to have you on. So why don't we start with an intro about yourself and GreyLion and let's take it from there.

Chip: Yeah, sure. So I have been in the private equity business since 1997, always focused on the lower middle market, which generally means we define that as companies with enterprise values of $50 to $250 million. Started my career here in New York, moved up to Boston, was with a firm in Boston for a while. And then my partner, Dave Ferguson and I, we left that firm together in 2011 and we started GreyLion in 2012 and we're investing out of our third fund. We have about a couple billion dollars of capital under management across those three funds. And our practice is really there's two broad areas of focus. I'm specialized in industrial technology and then the other kind of broad bucket is what we characterize as tech enabled services and software.

Shiv: Excellent and you mentioned the EV of $50 to $250 million so basically we're talking about somewhere in the $10 to $25 ish million in revenue.

Chip: Yeah, that's right. I mean, every situation is a little bit different, but generally speaking, we will do both control and non-control. So on the non control, they can be a little bit larger. Our equity check size is 25 or 30 million dollars in the low end up to 125 million dollars in the high end. So, you know, generally that starts with companies, kind of software companies that are in that 10 million dollars of ARR range, maybe slightly less on occasion. It can go up to $20 or $30 million. Obviously, the valuation range starts to get on the high end of that of our spectrum. But given we do non-control investing as well, it opens up our aperture to those kind of companies.

Shiv: And are there any beyond just the industries that you mentioned or the verticals, like are there any specific characteristics that you look for for your target investments where they need to maybe meet certain benchmarks or metrics thresholds or other characteristics that really make it a great line investment?

Chip: Yeah, I mean, listen, like everyone, I think the lower middle market is so dependent on usually a couple of key people. So we spend a lot of time understanding the individuals we're backing. Usually that for us, that means the founder entrepreneur. It's not exclusively the case, but almost always we're the first institutional capital. So we are probably less likely to do a CDE round in a company where there are a number of other, whether it be VC firms or earlier stage investors, we tend to partner with entrepreneurs and founders and enter a business when we're the first institutional capital. I think that's sort of generally our criteria. I'd say the other piece of it is, especially in the software space, there's some different strategies. I don't think there's a right or wrong strategy necessarily. Our strategy is one where we are probably better oriented around companies that are kind of break even maybe slightly profitable versus, you know, there could be, there are a lot of software companies that are, you know, 10, $15 million of ARR that are losing five or $10 million of capital and they could be building great companies for the long term. That just doesn't necessarily align with our strategy.

Shiv: Got it. And that makes sense to not then be like a series D or E round and buying a company from a VC that has been burning capital for some time. Got it. 

And when you're looking at the founders and the entrepreneurs themselves, like are you looking for certain characteristics there beyond just, hey, this is a good operator, but certain subject matter expertise or industry experience or anything else beyond that?

Chip: Correct. Yeah, I mean, also, I think some of the best situations we've been a part of are ones where, you know, their business was born out of necessity within the industry in which they've operated. And so they've traded the business to solve a pain point or a problem. And so, you know, those are some of the best businesses where the experience from the industry, you know, was the catalyst behind starting the company to solve a particular pain point. And one of our software companies in the industrial space, in the residential construction space, the you know, essentially the founder was a CTO at a large home builder. And so he understood sort of firsthand the technology challenges within that ecosystem. And, you know, that was the catalyst for him and his partner to start the business and the business to scale, you know, very nicely because they have that, you know, deep domain expertise and understanding of the various kind of players, constituents and the ecosystem and the problems they're trying to solve.

Shiv: Yeah, it's almost like they have like a - it's called like an earned secret, right? Like they know something about a market that others don't and that leads to building a great business.

Chip: Yeah, it's just very authentic, right? It's the, you know, sitting in a seat, like a CTO seat in an industry that's going through, you know, change. Like a lot of industries over the last 10, 15 years, they've looked at technology as being an important component of their scale and growth. And if you're sitting as a CTO of one of these companies, you're clearly looking around at the environment and figuring out which technology companies can you bring to bear on your company to help enhance and augment your operations. And oftentimes these entrepreneurs find that there aren't great solutions, and that's the catalyst for them to say, you know, there's a market need for this. And they understand it on a very primary level, what that need is.

Shiv: Do you find that there are a lot of these companies out there that have won a profitable business model at a certain level of revenue, let's say 10 million plus founder or owner operated and at the same time not capitalized by another investor and you are the first investment or do you have to kind of sift through a lot of companies to find this profile?

Chip: I mean, we certainly try to look at everything and we do sift through a lot of companies. Again, I don't think there's a right or wrong strategy. I think the one that we have found to be most successful at GreyLion is one where it is sort of led by that founder entrepreneur who's trying to solve a problem. Yeah, there's a frugality of entrepreneurs when they're investing their own money, their friends and family money you know, they just they they tend to think about the world maybe in a way that we think about the world, which is that that frugality, you know, creates a culture where, you know, they're spending very rationally. I think that, you know, what we have and then listening to our industry is a cyclical industry, the tech industry is a cyclical industry. And, you know, there are periods of time where I think we've seen companies that have come to market that it's clear they've lost sight of that fiscal discipline. And I think there's always a balance, right. And I think that, as I said, there are plenty of examples of companies that burned a lot of capital in pursuit of something grand. But I think having that fiscal discipline where you just like in a manufacturing company, you look at investing in a piece of equipment, or you look at investing in a piece of technology and ask yourself the question, what's the ROI? And when you're investing in sales resources, what's the ROI? And I think that's a good question. I think when, over the period of time, the last three, four, five years, capital at different points has been free flowing and inexpensive and environments like that. I think the pitfalls can be that you lose sight of that return threshold as you're looking to invest in a business, both capital and R&D and capbacks, kind of software capbacks, if you will, and then within the P&Ls as well in terms of the operating functions and the sales functions, business development functions.

Shiv: Yeah, I completely agree with that. Even just our business, like its founder led by me and we bootstrapped it from the beginning. And I feel like we make decisions very differently than some companies out there that have raised capital where we are constantly measuring ROI and looking at how much cash we have left and how much runway is there and optimizing for cash and cash out at all times. And just to make sure we're not running out of cash because that's really what keeps businesses going. So I would, I would imagine on your side, when you're working with these founders, they've kind of have that in-built discipline that when a PE firm comes in, you're kind of trying to bring that to companies, but if they already have it, that's a big advantage.

Chip: Yeah, and I think it also, you know, there are a couple of things that we find with founders and entrepreneurs. There's that frugality, which I think is helpful because it just brings that culture of discipline to the organization. I think the you know, we don't use a lot of leverage, but oftentimes we won't use any leverage, at least initially, as we're trying to scale these businesses. And so we have a business that is cash flow positive. We're not using leverage. We're not, you know, we're not burdening the balance sheet or the P&L except where we want to. And it's a very conscious investment then. There are plenty of companies, it's part of our core strategy. We call it the LIFT strategy, which stands for leadership, investment, flexibility and technology. And that really centers around the idea that these are good companies fundamentally, they have good margin structures, they have good reasons to grow and scale with their customers but they're not optimized. And so it's not uncommon for us to take profits down. So I don't mean to imply that investing is not always warranted. I think we often find that some of these companies are under-invested in certain areas. And so it is not uncommon for us to take profits down in the short term in pursuit of long-term value creation. We just like the businesses that, once you get to that $10, $15 million of ARR level, If you're not profitable or close to profitable, I think we really want to understand why and what is the rationale behind deficit spending.

Shiv: Yeah, totally. Yeah. Do you find that in being frugal as a founder and investor, and I want to get to your LIFT strategy and plan as well, but just do you find that companies are under optimized or almost like putting limitations because they're worried about cashflow where there's a lot of value that's not captured inside those companies?

Chip: I think we do find that and I think in certain functional areas especially, entrepreneurs, I think they usually are product specialists. They understand the industry very well for the reasons we discussed earlier. And so their focus and attention is all on sort of the product, the market, the selling exercise. I think there are other areas of their business where they're under invested in because it's just not their area of strength and their core competency.

It could be HR systems, could be, oftentimes, sort of, you know, finance and accounting is an area where we find that companies are often kind of woefully under-invested sometimes. So virtually all of our companies, the size and scale we're investing in, they're not going to have the kind of the financial resources within a CFO suite. And so that's one of the first areas we invest in, which helps them understand their business better through kind of KPIs and metrics and reporting that is just a required discipline as you're trying to scale a business. I think the entrepreneurs tend to run the business a little bit in their head and try to institutionalize some of that knowledge through KPI reporting and through systems. And that the F in LIFT is flexibility, which allows us to invest the way I described. And then the T in technology is not a vertical investment thesis T, it's really about the horizontal application of technology within these companies where they are systems, whether it be CRM systems, HR systems, financial systems, accounting systems, etc.

Shiv: So let's actually go through that. Let's start with the L in LIFT. So I think leadership is the first one. So talk about what you are bringing to the table there or how you're optimizing companies on that front.

Chip: Yeah, it's not one size fits all, of course. I think it depends on the background experience of the founders and the entrepreneurs. I think our experience suggests that there's usually a couple of key people that have driven the success of the business. And we view part of our job as helping them to professionalize the other functional areas within the organization. And again, every situation is different. Some CEOs and founders and the senior team tend to be more product-focused people, some CEOs and founders tend to be more commercially focused people and selling focused. And so it depends on where their blind spots are and how we can help them cover up by adding and augmenting resources. And that's why we want to have a very flexible capital structure to allow for that investment, but it takes a lot of different forms. It often is in the area of business development.

Usually just by necessity, these founders spend a lot of their time commercially focused on customers as you'd expect they would. And so we spend a lot of time sort of mapping out where the business is today. And if you want to double or triple the size of the business, you can't be the kind of the center of excellence for everything and certainly not in sales. You need to expand the commercially facing resources. So chief revenue officers, head of sales, those kind of people are often additive as you're trying to scale these businesses. I mentioned the CFO suite, it's almost without exception. We'll find there to be sort of bookkeepers within these organizations. Software businesses, they're not terribly complex from a finance standpoint, given that they don't have any sort of physical manufacturing or inventory, but they can benefit from kind of systems and reporting, financial reporting. And so almost always will, bring our experience and help these companies, you know, hire, identify both the CFOs as well as the sort of associated kind of technology investments that are required to give you that kind of insights in your business and the KPIs. You know, people as well, you know, the kind of asset light software businesses, their assets walk in the door every day. And oftentimes, especially in the kind of post COVID environment, these can be resources and sort of disparate geographies. And so, you know, recognizing at what size and scale do you need to have, you know, chief people officer and somebody really focused on HR. And that can be, you know, hiring on boarding as you're trying to scale. It also can be about sort of measurement management and accountability within your, within your organization with respect to human resources. And I think that. Oftentimes companies might not have formal bonus programs. They might have onboarding programs. As you're trying to scale these companies and add personnel, especially in these disparate geographies, work from home, I think having a little bit more rigor and discipline around the HR function is important. Giving people very clear goals, having very clear goals, which they understand how they're compensated to what their bonus structure looks like, how to onboard people, how to integrate them in, and culturally how to create that connectivity in a remote environment is important. All the things that are required if you want to have high retention among your workforce and high levels of engagement and satisfaction.

Shiv: How much of this work are you doing pre-investment where you're trying to uncover all the different value creation lovers and whether the right people are in the right seats?

Chip: So we go through an exercise where we sit down with the founders, entrepreneurs, CEO, whoever it may be, and we say, let's look at your team today. And we ask them, what is your business, excuse me, biggest business challenge? And usually from that, you get them talking about where are the areas that they need the most help? And it usually starts with HR. And so we say, where are the areas where you believe you're deficient today, where you think you need the most help? And then we ask the question, what if you're three times the size? So what's our ambition to scale this business? And if our ambition is to scale this business from 15 million of ARR to 50 million of ARR, let's map out today, the organization, and let's prospectively map out what we think the organization will look like at 50 million of ARR. And then we sort of work backwards and it creates almost like a Gantt chart of how we need to think about scaling the organization. And we encourage them and oftentimes this is the reason why we're taking profits down in the short term is if you think about the organization today, you think about the organization when you're three times the size in five years, we try to get ahead of that curve. And so, you know, usually the first 12 to 18 months, it's a pretty heavy lift, no pun intended, to build up the organization. Just because, you know, hiring people is an imperfect science.

You don't always get it right the first time. So we try to get ahead of it by, you know, focusing on building that team out in the first 12 or 18 months, recognizing that you're not going to bat a thousand. And so, you know, there are areas where you might hire and you might have to hire a couple of times. And if you wait a year or two to make that hire and you make a mistake, then, you know, pretty, pretty quickly you're at the four or five year time horizon. So we really try to get ahead of that and focus the conversation by looking at that forward mapping of what the organization needs to look like.

Shiv: Yeah. And some of these roles are pivotal for companies to scale to that level, but it's almost like if you try to do too much at once, you can kind of get distracted. Right. So usually are there focus areas that you find end up being more important than others where you definitely need to bring on more senior roles or like as a priority, is it more sales? Is it more marketing? Is it more on the product side? Like where do you end up seeing the need for the leadership team to be expanded the most?

Chip: Yeah, again, I think it's not one size fits all. It depends on the capabilities of the founders and where their strengths are. I think it also depends on just the rate at which the company is scaling and the strategy around growth. Is it acquisition driven growth? Is it all organic driven growth? Is it product extension? Is it geographic expansion? All those things matter as you think about where you need to invest in the organization. That's where I think it starts with, tell us what your biggest business challenge is, tell us what your biggest opportunity is. Another important exercise that we go through at the front end with entrepreneurs is, I think there can be in these companies, especially companies that have a lot of opportunity and they're seeing their business scale very nicely, a little bit of a shiny object syndrome where people can get distracted in the organization by diluting their focus with just chasing shiny objects. And I think entrepreneurs, their, I think their genius and creativity, you know, can also, you know, impair their ability to focus sometimes. And I think that, you know, working with entrepreneurs and the, you know, the best entrepreneurs are ones who are sponges, the ones who sort of want to learn. And we'll sit down and we'll kind of map out the strategic priorities of the company. And we sat down with one of our companies and I think they had like 53 things on the list. And we said, you know, you just can't, you can't, you can't be that diluted. You need to focus. And so what we did was we said, listen, well, well, all 53 things may be important. Eventually let's focus on four or five, the sort of key big rocks that we can move that will have real impact in the business in the short term. And, you know, once we finished number one, then we can jump to number five. Once we finished number two, then we can jump to number six. And then. You know, kind of measuring that and reporting on that and establishing a framework, you know, again, it's not uncommon for these companies not to have the rigor of board meetings and regular sort of measurement along your strategic plan. And so, you know, we try to bring that discipline as well where we're having in a very organized way, a conversation around, you know, what does the HR mapping look like and measure it sort of quarter over quarter? You know, what is the product map, you know, roadmap look like? You know, what is the inorganic opportunities? Let's talk about where we want to you know, make acquisitions where we want to lean in. And I think that just bringing that discipline and focus by narrowing the focus is super helpful.

Shiv: Yeah, I think that ongoing measurement and almost like a feedback loop to make sure that you're on track with whatever the initial plan was is critical because we've seen companies lose their way where they may set out a plan and then a couple of quarters later that focus is lost. So I think in that that accountability framework is essential.

Chip: I think it's also helpful when you're talking to your employees, especially as you're scaling your workforce, which hopefully these companies are growing and that means they are scaling their workforce. It allows you to communicate in a language where it's relatively simple. So if you have three or four, four or five kind of important strategic priorities, as you're engaging your workforce, everybody is singing from the same hymnal. They all sort of understand what those three or four kind of key priorities are. And I think that's important to sort of promulgate throughout the organization. Here are the three or four things that matter. And they all know what the mission is. I think without that sort of focus and discipline and without communicating that focus and discipline, I think that's where companies can go awry or they can just be, you know, either people aren't aligned and understanding of what the mission is or they just can, you know, there's a propensity for for different functional areas within the organization to get distracted.

Shiv: Yeah. And you mentioned this, the fact that some key leadership roles, you may not get it right the first time and it's not an exact science. And we've seen that with critical roles like chief revenue officers or chief marketing officers, they're 10 years off in less than two years. And so how do you determine that if somebody has, has missed the mark on what the expectation was or, and how do you prevent that from happening as much as possible? Because the better that that success rate is the less the number of false starts that you have and you can create more value.

Chip: Yeah, I think one of the pitfalls or challenges that we've encountered is as you're trying to build an organization, professionalize an organization, there's always a balance between the entrepreneurial spirit that is a critical ingredient of the company's success with the professional experience that you want coming from perhaps somebody who came from a larger organization. And we've seen oftentimes people who come from a large organization, they may have deep domain expertise and ostensibly may have kind of the right resume to help the company. But if they're used to operating in an organization that's too large, they just aren't accustomed to navigating the challenges of an entrepreneurial business. And they aren't used to operating with the skinny resources of an entrepreneurial-led business. And so I think what we try to do is, you know, marry up the experience, but have a, you know, try to find individuals that do possess both that sort of experience, having worked with some larger organizations, but they've also gone through a period in their career where they've worked at either start, not even at startups, but younger companies. A combination of the two can be pretty powerful. One thing that we do that we found to be very helpful for the companies is, so cross-pollinate. And so, well, if we're interviewing a CTO, we'll have two or three CTOs within our portfolio, you know, we think very highly of. We'll have them on behalf of the other company interview CTO candidates. You know, head of sales candidates, the same thing. CFOs will oftentimes tap into our existing portfolio where we think we have real talent and we'll ask them to participate in the interview process on behalf of their sister company. And I think that does a couple things. One, I think it just, it's somebody who's sitting in the role, who's performing at a very high level. They understand what is required to perform at that high level at that size of a company. They should have been there, done that. And they can, I think, just help identify characteristics within an individual as you're interviewing them. Do they believe they have the requisite skills to help the company? So it's having two or three people who have that direct experience helping you hire.

It also then creates a network of connectivity among our portfolio. And we do these roundtable sessions within different functional areas several times a year where we'll have a digital marketing summit where all the digital marketing professionals from all of our portfolio will get together. And it creates that sort of connective tissue where all the companies are different, of course, but there are commonalities and challenges they face.

And so by having the different sort of functional areas have that connectivity across the portfolio is very helpful both in hiring but then also in onboarding and helping them sort of navigate the speed bumps that invariably occur as you're trying to build a business. We find it to be very, very powerful.

Shiv: 100 % agreed on both of those. I think that competency screening is something that I think is often missed in the hiring process where somebody could be a good interviewer, but really understanding when it comes down to making a function more mature or taking it to the next level, that competency screening is a big variable. So I think that's a great call out. Let's shift to the investment portion of the LIFT strategy. So, talk about this concept of reinvesting earnings you mentioned earlier, bringing down your profits in the short term to build a bigger business. Let's talk about your approach there.

Chip: Yeah, I think the one one thing that I'll give you an example, just easier to describe it with examples. We invest in a software business where the company is generating really good cash flow was probably doing 18 million of revenue, ARR and probably seven or eight million dollars of free cash flow. So a nice free cash flow business growing very nicely. And the ownership structure of the business was sort of a you know, an older individual and kind of cats and dogs shareholders that were looking to distribute that cash every year. And the CEO, you know, was obviously obligated by shareholders to distribute that cash and didn't have the flexibility necessarily to invest. That wasn't what the shareholders were looking for. They're looking for a more balanced approach to shareholder distributions vis-à-vis, you know, growth initiatives. And when we sat down with them and said, you know, help us understand the opportunities. And this is the company that had 53 different things on their list, all of which were pretty exciting. And, you know, we said, tell us about your cash flow and where have you been limited? And the first thing he said was, you know, I've been really limited in my ability to invest. And while we are a nicely profitable business, I could dramatically increase the revenue growth profile in a very economically efficient way if we could invest more. And so as part of that recapitalization, we monetized a bunch of the cats and dogs shareholders that were looking to receive those distributions annually. The older individual, we monetized him partially, not entirely, such that he was less focused on cash flow distributions. And then we gave the CEO the flexibility to put together a three-year plan focused on those four or five priorities where we enabled him to invest considerably. And so the business was such a high free cash flow generator, we didn't necessarily take profit down, we probably held profit flat as revenue was growing 25, 30% a year, at 85, 90% gross margins as these software businesses do. So all the sort of excessive cash flow that we generated, we allowed him to reinvest in the business and we reinvested a couple different ways. From a product standpoint, we went through sort of a buyer build, you know, decision with different product sets. We wanted to build the moat deep and wide around this business. And so we had a couple of, you know, product areas enhancements we needed. And so we mapped the market, we helped them map the market and look at different, you know, kind of small tuck in acquisitions that were really sort of product fit acquisitions that we made. And then balance that with augmenting our development team to allow us to, you know, all the areas where we felt like we were deficient from a product standpoint, we allowed them to invest pretty heavily. Whereas I think under current course and speed, it probably would have been a three to four year investment period to accomplish what you wanted to accomplish. And we probably accomplished it in 12 or 18 months because we accelerated that development and acquisition program. I think those are areas where we're willing to invest pretty heavily with a view towards changing the slope of the curve, which is how we describe our LIFT program is really about thoughtful investment where you have to have the discipline of return. I mean, I think we, I think the, as I said earlier, I think that, you know, the period of time where, you know, capital is free flowing and I don't think there was necessarily that, you know, discipline on return, but, you know, we found that with that right framework and discipline and measurement, we're more than willing to take profits down meaningfully in some cases to drive long-term value creation.

Shiv: Yeah. And how do you, how do you figure out that threshold? Because I guess if there's a high amount of EBITDA and free cash flow, keeping it flat or decreasing it a bit is a reasonable risk, I guess. But is there a, is there a rate of return at which it makes total sense versus like, Hey, below this amount, we're not going to let our, our growth rate be below, let's say 20%. If our EBITDA comes down significantly because it kind of changes how we see the business. So what are, are there thresholds through which you're kind of evaluating those decisions? And I know I would assume it varies case by case.

Chip: Yeah, I mean, it's really various case by case. I mean, I think, listen, our return threshold, I think is, is, um, you know, what you, what you'd expect. And I think the way we think about it is, you know, looking at sort of current course and speed, you know, what do we think that the outcome will be? And if we're going to invest, uh, it's gotta be, uh, you know, to augment that outcome. Right. And so it's gotta be, you know, value enhancing to, you know, to all shareholders. And, and, and I think that the biggest thing that I think these companies lack is a process to determine that and a framework to determine that. And that's oftentimes because they don't have professional CFOs and they don't have any. And I think this is the, we got to be careful too because I think the instincts of these entrepreneurs have been pretty good, which is why we want to partner with them. So we don't want to kind of hamper those instincts too much. But we also want to bring a little bit of discipline where if we're going to double the size of the Salesforce, let's establish the right KPIs as we're looking to double the size of the Salesforce. And why are we expanding geographically, are we expanding the product footprint, are we expanding the different verticals? And that I think is the framework that we bring to bear, which is kind of thoughtful investment and treat P&L investment and capital investment almost the same way where you've got this sort of return threshold and then measure it, looking at it every quarter. Okay, we've added these salespeople, let's go almost sort of individual by individual and what are the metrics that either embolden us to continue to pour gasoline on the fire or sometimes the results are not what you'd expect and you've got to have the discipline to pull back as well and sometimes retreat.

Shiv: How do you look at investments where there's not necessarily a direct ROI? And bring this up because you mentioned investing in founder led businesses where not all the value is necessarily captured and not everything has been professionalized. And there are areas like finance and admin and HR that they're not really revenue generating areas, but they require investments to professionalize. So. How do you look at that as an area of investment and that likely brings down EBITDA but doesn't have that return?

Chip: Yeah, those are clearly harder. I think large and small companies, if you go to a large company and you ask them, show me your return for a new ERP implementation, I think they'd probably have some framework, but it'd be tough to pin them down on it. I think the same is true of small companies. I think what we encourage them to do, and this is where the network is helpful. We ask them to talk to other CEOs in our portfolio who have already gone through that process of hiring the CFO implementing some of these functional systems and just ask them the question, do they believe their organization is better off? And, you know, it made me actually probably probably about 100 % of the time, the, you know, the CEOs would say that when you get the right CFO in the seat, or the right Chief People Officer in the seat, they just they asked, you know, they make comments like, I can't believe we operated this business without that, you know, functional capability.

And that's where I think it's a little bit of trust, and I think that's where entrepreneurs, the best ones, have this aptitude to learn and leverage the experience of others. And so talking to other CEOs in our portfolios and just asking the question, help me understand the value of benefits you got out of bolstering your CFO suite or your Chief People Officer human resources capabilities. And I think that's where you can, if they're struggling with the return or they're struggling with the investment, I think that's where there's gotta be a little bit of trust and faith. And we've done this enough times to know that there's, well, maybe hard to measure. It's undoubtedly creating return potential for the business.

Shiv: Right, right. Yeah, I think it's being more conservative there, but then finding the right places where it can help create more value in other areas because that maybe that problem is off the CEO's plate so they can focus on some other areas as well. So that's great. Let's talk about the next one, which is flexibility. What you mentioned debt and other other vehicles to support the business. What are some of the ways in which you're optimizing companies there?

Chip: Yeah, I mean, flexibility for us is a couple of different meanings. I think on the front end, as we think about just structure our investments, I mean, we have a mandate that is pretty flexible in terms of we can be control investors, we can be non-control investors. You know, sometimes we'll use structure to bridge a value gap, as is often the case in the lower middle market where, you know, these high growth businesses are sometimes hard to value, especially if they're break even, they're not generating a lot of cash flow. And so they can be challenging the value of businesses to grow at 30, 40, 50, 60% a year. And so we'll use structure in the front end to try to bridge a value gap with an entrepreneur. And that can be pretty helpful. And then the flexibility on the balance sheet and within the P&L is really just about never having to make a decision about long-term value creation for the sake of short-term profits. And so whenever we, if we use leverage, when we use leverage, which is about 50 % of the time, our initial investments will have zero leverage. And these, these can be, you know, these can be good cash flow businesses. The software business I mentioned was, you know, $8 million of free cash flow, we put zero leverage on that business. So that we didn't have to have a discussion about trade-offs between sort of balance sheet P&L and debt service. And so, that flexibility is really important in focusing the conversations in the boardroom about long-term value creation, not any considerations around balance sheet issues that would occur if we invested in the business in the short term. And then it also creates a situation where the capital structure is very simple. So if we use leverage, it's senior only debt, relatively inexpensive cost of capital, today's environment, all that is expensive, but relatively inexpensive cost of capital, few if any covenants, these aren't complicated capital structures, which one just is easier to implement and execute, does provide that flexibility. And the lenders are, if things don't go well, which I think we always say growth is not linear. So there are, you know, there are speed bumps along the way. If things aren't going well, when you start out with relatively low leverage, you usually have the flexibility with your debt partners to work through it over time. And that's served us well. You know, COVID being the best example of that, which obviously nobody anticipated, but several technology companies that were low levered or under levered, you know, during a very challenging time. And, you know, we didn't have to, we didn't have to take our foot off the gas. We were able to, in some cases, double down on the business during a tumultuous time. I think that's a function of, you know, balance sheet flexibility that we employ.

Shiv: Yeah, and we've seen this with other companies where they have too much debt on the balance sheet and the amount of cash required to service the debt now is significantly higher and that's hampered their ability to be more aggressive.

Chip: Yeah, I mean, we certainly see that across the ecosystem where you'll talk to companies all the time where 100 % of their free cash flow is going to debt service. And that's a, you know, you're making trade-offs every day. If you're 100 % of your free cash flow, sometimes in excess of 100 % of their free cash flow because they're picking interest or whatever, you're definitely making trade-offs, you know, short -term versus long-term in that environment.

Shiv: Yeah. Is that because the debt is being used to stretch the companies out beyond where they should be? Or is it just because of the market environment where that was so cheap, people were putting this on the balance sheet, but they didn't like account for the fact that maybe they were running too fast because of how cheap the money was?

Chip: I mean, I think this is where it gets back to, and I don't mean to be critical of other strategies. There are a lot of different strategies that work, I think, and it definitely varies by the size and maturity of the company and the nature of the company. But I think there was an environment where you had a very inexpensive cost of capital. You had lenders willing to lend off top line as opposed to the bottom line, right? Thinking about sort of multiples of ARR and other mechanics, which when debt's very inexpensive, those metrics work. The financeability of a business also with the tax deductibility rules changing, with the maximum leverage in interest deduction, those rules changing create then when rates double, you're borrowing at five and a half percent, a lot of things work when you're borrowing at 12% and this is all floating rate debt or mostly floating rate debt. So I think that there's a generation of people who do the modeling in organizations like mine that have never had to model a forward library curve or so for a curve now, I guess, right? And there's a lot of learning going on right now with the you know, with volatility of interest rates. I assure you that when people were putting on these sort of max leverage deals, nobody, and they had floating rate, sometimes they hedged, sometimes they didn't. I think that rarely were people looking at a forward curve that we've experienced, right? And again, nobody has a crystal ball, nobody anticipated the forward curve would look like this, but I think it just is a reminder to us, you know, one that we are investing in these smaller companies and we don't ever want to make those trade -offs. And two, I think it's just, it's been a bit of a recalibration for the whole industry, certainly the tech industry about, you know, what is prudent leverage for these businesses.

Shiv: Yeah, it reminds me of that Michael Porter thing, which is that strategy requires trade-offs that are painful, right? And I think your approach here with finding businesses that are founder-led, first institutional capital, profitable, or at least break even from the beginning, kind of connects to this idea also to use debt conservatively because you're betting on the business that you're acquiring as the vehicle for growth and not necessarily trying to expand it too quickly to validate your thesis. Yeah, I think that's awesome. Okay, so let's shift to the last one, which is the technology side. How do you leverage that to grow these businesses?

Chip: Yeah, so as I said earlier, it's not, you know, this is not technology as an investment thesis. This is technology as sort of the horizontal application of technology across different functional areas. And I think like we talked about it, it might be hard to, you know, to have a conversation with a founder or entrepreneur about the merits and value of hiring a CFO and bolstering up the finance and accounting suite. You know, it might also be hard for them to get their mind around, you know, implementing ERP systems and the return associated with that spend. I think the CRM systems is an area where oftentimes companies are running off of spreadsheets and so implementing CRM and measurement systems. I think within digital marketing, different systems that you can employ to help you be more effective and efficient at managing and monitoring your spend, which and depending on the company, these companies can spend a fair bit on marketing and sales. And so having the CRM, having the digital marketing systems implemented to allow just more efficient sort of managing monitoring of your spend. I think that we've seen that the investments pay for themselves in spades just through efficiency and allow you to scale and not lose control of the business. HR systems is another area where that's an area where most of these companies, their HR departments are pretty, pretty skinny if they have them and their HR systems are pretty limited. And I think that implementing different HR systems. And so the businesses, while it's ironic that they are, you know, software technology businesses within their own tech stack, they can be a little arcane. And so we just try to bring to bear kind of a view and we map across again, this is where I think our portfolio and experience is helpful as we engage these companies is we do obviously a technology review of the business, both the product technology stack and diligence, but also the kind of horizontal application of technology across these different functional areas and identify the areas we think we need investment in. We have that honest conversation with the founders to say, as part of this LIFT strategy, we think we need to implement XYZ system. And then we use the portfolio and company CFOs, how to sell, et cetera, to help them understand and evaluate different systems. And so if you're looking to implement an ERP system, you can talk to three of our CFOs that have implemented ERP systems in the last couple of years and which systems they evaluated and which systems are right for them. And so that's where I think the cross-pollination can be very helpful as we're looking to implement these different systems.

Shiv: How do you balance the timeline to implement some of these technology platforms? And as an example, like on the marketing side or sales side, oftentimes companies consider switching CRMs or taking on a big infrastructure project. And while you're doing that, you kind of feel like you're being productive, but the value generating activities like actual revenue generation is getting less attention. So how do you balance those needs within a business?

Chip: Yeah, I mean, I think it starts with the people mapping first and making sure that you have the right people in the seats who have the experience, who know how to do it. The worst thing you can do is try to implement technology without individuals that know how to both implement it and then harness it. And, you know, we've definitely experienced, you know, we've learned the hard way that notionally trying to implement systems without kind of real ownership and understanding and experience. You can end up spending a lot of money, wasting a lot of time and not getting much for it. And so we, as we think about kind of mapping a technology investment, it's part and parcel with the kind of people side of the business and mapping the senior leadership team. Do they have the requisite experience? So if we're going to hire a CFO, let's hire the CFO first.

Let's have an understanding of what their capabilities and experience are around implementing ERP systems. And if we know that we need to implement an ERP system, as we look to hire a CFO, that might be one of the criteria we use to evaluate the right CFO candidate, someone who has gone through an ERP implementation. Because until you've done it, you haven't done it, and it can be pretty painful. And so that could be part of the hiring criteria if we know that we need to implement it. Same with hiring a chief people officer. If you know that you've got to implement a system or a head of sales if you know you've got to implement a new CRM, having an understanding of what their experience capabilities are around leading that effort are important. Because you're right, the depth of experience in these companies is pretty skinny. I mean, there's not multiple layers. And so these critical people at the senior level, you need them to be focused on the core business. And balancing that with the investment is part of the trick.

Shiv: Yeah, we've seen, we've seen executives burn all their political capital and trying to change a system and then not do the thing that they were hired to do. And then they get let go because they were kind of spinning their wheels over the infrastructure project.

Chip: You know, we've had the same, we've wasted a lot of money and we've had to unwind decisions because they weren't the right decisions, they weren't the right people executing. And so, you know, we've wasted a lot of time, a lot of money and probably more importantly, it's a lot of big distraction.

Shiv: Yeah, exactly. And so along a similar thread, like how do you monitor or just make sure that the company is not over-investing in technology? Like as an example, over the last year, we've seen a lot more churn in certain technology companies that aren't as mission critical as they used to think they were and their seat contraction and all of that, because the value that they were bringing their customers didn't actually necessarily need that. And as an example, in marketing, like you could actually hire or - excuse me - invest in 10 different software platforms and really HubSpot and Salesforce is more than enough to do 95 % of what you need to do. So how do you make sure that they're not over-capitalizing?

Chip: Yeah, one of the things we do - I don't say uniformly, but with reasonable rigor - is at the budget, during the budget season, which for us is generally in that sort of fourth quarter, as we're going through the budget process, the CFO's job as we're going through the budget process is to look at all of our subscriptions, all of our kind of technology subscriptions, all of our service subscriptions, and almost do a zero-based budget on the subscriptions. And that's both in terms of do we have the right systems? Do we have the right number of seats? And we've often found that it can be everything from telecommunications subscriptions and services to software services to offline subscriptions where over the years, people just sort of sign things up and you can end up with 40 seats where you only need 20 seats and you're paying 2X what you should be for a particular technology. And you know, making sure that as part of the budget process, we do a zero-based budget around, you know, technology spend and somebody's got to own that and be accountable and responsible to, you know, kind of double checking on, you know, you know, what are the, you know, what are the use cases? How many people are using it? Are we utilizing all these seats? And, you know, the fact creeps in. We, we had it and, you know, the, I'm thinking of where we have one of our companies that probably has two extra number of seats that they needed and we discovered that through the sort of budget process and the rigor I described where we're just paying too much because nobody owned it, nobody was focused on it. So just making sure that at least annually you're going through and asking yourself those questions.

Shiv: Yeah, I think that zero based approach is something that would serve pretty much all companies. I'd love to keep going, but I know we're running up on time here. So with that said like, what is the best way founders are listening and they want to engage more with your firm? What's the best way for them to find you and connect with you?

Chip: Yeah, listen, you can go to GreyLion.com and you can always find us there. You can find us all on LinkedIn. And we believe in meeting face to face and we'd love to come and see you. We spend a lot of time on the road in various markets across the US and there's no better way to get to know somebody than just getting in front of them and spending time. So please feel free to reach out and I think if you want to get to know us, the first thing we'll do is we'll introduce you to CEOs with whom we've worked. They're the best indicator of how we are as a partner. And we have a passion for what we do. We are heavily aligned with our investors and the team here. We're heavily aligned with our CEOs and that we believe in what we're doing. We're excited about what we're doing and we're passionate about what we're doing. And it starts with a conversation, so feel free to reach out.

Shiv: That's awesome. And we'll be sure to share all of those links in the show notes. And with that said, Chip, thanks for coming on and sharing your wisdom. I think just the LIFT framework and everything else that you shared will be really great insights for anybody listening, whether it's a PE investor or founder. So I appreciate you doing this.

Chip: Yeah, thank you.