Episode 42: Kevin Iudicello of Realization Capital Partners on Generating Value with Secondary Investments

Episode Transcript

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

Kevin: Good, thanks for having me, I appreciate the time.

Shiv: Yeah, excited to have you on. So why don't we start by introducing yourself and your firm and where you guys focus and we'll take it from there.

Kevin: Yeah, great. My name is Kevin Iudicello and I'm a partner with Realization Capital Partners. We focus on a mix of secondary and primary technology investing. So it's about probably 60-40 secondary to primary. So secondary being buying direct, generally direct equity stakes, sort of minority positions in private technology companies from other institutional investors. So VCs you've heard of or corporates that have a stake in these companies will either buy directly for them or will do kind of the more traditional route, is referred to as primary, which is leading rounds or buyouts or control deals. And I apologize, I'm getting over a cold I picked up in New York last week, but I think I'm good to go.

Shiv: Yeah, that's great. Talk a little bit more about the types of deals, like what types in terms of size and maturity levels are you investing in terms of the companies you're looking for.

Kevin: Yeah, generally we like older tech companies that are sort of have become healthy businesses but don't really fit the VC model anymore. So, I mean, you're familiar with the venture model, but, you know, if they invest in 20 companies, sort of three or four will generally carry the portfolio returns. And, you know, a handful will fail and then they'll have kind of five or six that end up becoming nice businesses and grow and mature. But the partners have kind of moved on to the next fund and they're trying to find their next three or four star company. So it makes sense for them to kind of, you sometimes get liquidity on those middle companies that are healthy but not going to be rock stars and focus on their next rock stars and their new fund. So a lot of what we do on the secondary side is buy those companies that are healthy businesses but not quite sort of VC model businesses anymore. We're more of a private equity firm. So I give all that background because generally we're investing in later stage businesses. I think the average of the first fund was about 80 million in revenue. We look at things anywhere from 15 million in revenue and up. Generally if it's 15, it's a recurring revenue business and has some growth to it. And the check sizes are usually about five to 30 million. We'll go up to kind of 100 million, but once we get over sort of 30 to 50 per asset, we're investing out of our second fund, which is 325 million. We're managing about 500 overall. So when we get above 30 to 50 in any particular asset, we'll bring in co-investors. And we have a couple of large LPs that like to co-invest with us. I'd like to say it's because we're smart, but I think it's because they get a break on fees and carry. But that let's get up to 100 million of equity check.

Shiv: And when you say these mature companies, there's a lot of these businesses, That are, they have strong fundamentals, they have a decent growth rate. They're just not skyrocketing or potential unicorns, but they're just very good businesses to own. You're looking at, I'm assuming you're looking at businesses that have profitability or rule of 40 as some of the foundational characteristics.

Kevin: Yeah, we're big fans of Rule of 40 or other kind of measures of unit economics that the model is working. Profitable growth is very powerful, right? It gives you a lot of leverage and a lot of time to pursue the right strategy. We don't need profitability, but we certainly appreciate it. If other measures of unit economics like LTV CAC are working or generally sort of customer acquisition is being done economically, we don't mind the company burning to grow.

If the gross margins are troubling or the LTV CAC’s a problem, we have a big problem with burn because the business sort of model is not working. So yeah, we generally pursue companies with profits but don't need it if there's good growth.

Shiv: There seems to be a lot of private equity firms focused on companies like that. So how do you differentiate yourself in a marketplace that where everybody kind of wants this, you know, net revenue retention of over 100% and rule of 40 and growing 20% year over year and, you know, like all this, high NPS scores, there's only so many of those assets out there. So how do you kind of differentiate yourself?

Kevin: Yeah, I I'd say there's three ways. One is sort of the way kind of everybody does where you focus on areas where you have experience and you can kind of understand the risk a little bit better. So you might be a little more tolerant of some risk for upside. So you'll make a bigger bet and outbid someone. That's generally not what we do though. The two ways we generally differentiate is, one is the secondary side, right? The secondary market is illiquid and sort of sub-billion unicorn type investing, it's kind of the Wild West out there. There's asymmetric information in terms of how much data you have on the company. And I'll get into that in a second. Sometimes there's no options for liquidity for a fund that needs liquidity because they need to shut a fund down and they have good assets there. And then the final way we differentiate, which gets back to the information asymmetry, is the reason it's called Realization Capital is we run a process to kind of position these more mature businesses for an eventual exit without a timeline. And I'll get into that in a second, but because management teams like that help and experience, we get better access to information because they want us to replace sort of a disinterested investor that might be on their board, but is investing out of an old fund, doesn't have any more capital, has long since been paying attention to sexier companies. In those situations, management wants us involved. So they give us all the information under NDA. So we model secondary a lot like we model primary, where we'll build a model for the company and price it because they want our help in sort of positioning the company for an eventual exit. And we can support the company. We could lead a new round because we do primary. And that, that, back to your question, how do we differentiate ourselves? That creates, that sort of information asymmetry in private markets creates a benefit that you can sometimes leverage.

Shiv: Can you expand a little bit more on this secondary side, that point number two is in terms of how the dynamics work and how you're able to get into some of these deals?

Kevin: Yeah, sure. It's funny. It's a super interesting market. And we source probably 95% of our deals without bankers. We work with bankers and like using bankers, but most of the secondary deals we reach out to based on knowing the kind of company we're after. And then we look for metadata sort of around it in PitchBook and LinkedIn to find those kind of companies. There's a lot of sort of, we wouldn't call it data science, but there's a lot of work that's gone into how we set those screens up and find them. But generally we're looking for things like, you know, maybe a company that hasn't raised capital in a long time, but is still growing their employees. I mean, that's an indication of a profitable business, especially if a business pivoted, where they were obviously doing down rounds, but then you can see them growing the employee base and not raising any more capital. 

We look for things like older funds, you know, so almost every venture fund is set up where there's a 10-year life to the fund and a couple of extension periods. And that's a good model for LPs. It makes sure LPs eventually get liquidity. It aligns everyone with sort of the right timeframe, gives private companies enough time to lead to an exit. But it's also a problem. There's a systemic problem with it that when you've built good companies and it's not the right time to exit the business, or you don't have the influence to force an exit, you have companies that will last longer or equity stakes, I should say, they'll last longer than your fund life. So we look at funds that are 10 years old, 12 years old, 15 years old, where they've gotten extensions and the LPs are wanting liquidity. And we'll go look at the companies in those funds and say, hey, we know this company, that company. And we'll either reach out to the company or the investor directly to try and see if there's an appetite for liquidity.

Shiv: So you're really helping the primary investors find some liquidity for their LPs kind of mid cycle before the asset is ready to take to market.

Kevin: Yeah, that's right. And generally, most funds, when they're ready to wind up, they still have one to five assets in the fund, at least venture, sort of later stage venture funds. And that's the kind of stuff we look at. On the corporate side, you could have a company that - and we've done deals with a lot of large corporates that you would know, but where they have a portfolio,

and they had a shift in strategic direction or a champion at a very high level left and they're no longer interested in sort of the functionality that made them go after the investments they did strategically and so they'll have an appetite to liquidate some of those assets and sometimes those assets are really well performing but they're just not strategic to the corporate and the corporate's so large that...

Shiv: Can you give like an example of that? Because if the asset is still good quality, why not keep it in the fund to generate a better return?

Kevin: Yeah, no, it's a good question. On the corporate side, it's generally because they've made a larger strategic decision that's at a much bigger scale. So we haven't done a deal with SAP. We've looked at some stuff. But SAP, for example, if they had a bunch of assets they did off either in their venture fund or off their balance sheet, and then they replace one of their chief product officers and they set a new direction, the new direction to them is more important and more monetizable than 5 million of gains on a minority position. So they'll just make the decision to liquidate that whole portfolio or that whole set of companies. That's the kind of thing on a strategic. On the venture side, it's the same issue of sort of end of fund life and their LPs are pressuring them for liquidity and they're kind of sitting, maybe collecting asset management fees, depending on how their extensions work. But they also are just tired of getting K-1s and they want the fund wrapped up. It's been 15 years. So they'll pressure the GPs and the GPs will say, okay, well, we can't force to sell the company or it's not the right time to sell the company. So let's talk to others about liquidity. And if the company is doing well, you know, we're fundamental underwriters, so we'll underwrite the business and value their stake with the waterfall, taking into consideration all that. And I can talk about how we underwrite, but we'll pay up for growth in those situations, you know, where the company's doing well. Yeah, just one other interesting part of that. You know, if companies do large rounds, like high valuations - there's a lot of this happened in 21 and early 22 - and then proceed to kind of miss their numbers. We look cheap, our valuation comes in low versus the sort of headline valuation that last round because they didn't deliver what they said they were going to, right?

If the company on the other hand did a round that was sort of at market and then beat the numbers they used to forecast the round or otherwise have been growing really well, we're really, we're competitive because we underwrite what's happening in the P&L, not based on sort of discounts to the last round. And the reason I bring that up is a lot of secondary investors, especially with larger deals, they'll look at the marks that the selling investor holds the assets at, and they'll just offer a discount to that.

Shiv: But if that's the going rate in the market and they're updating the marks basically based on market value today, it wouldn't have put you at a disadvantage if you're kind of more aggressive on that valuation. And more just asking just to understand how you see that because especially in the last couple of years, people have taken a lot of down rounds or updated their marks to be at a lower valuation than let's say when they were raising in 2020 when money was much easier to come by. How do you look at-

Kevin: Man, you just hit on something that is sort of the psychological crux of our existence. It's funny. What I tell you is there's a huge... So as venture funds mature, they get more, I guess, sophisticated from compliance perspective, financial perspective on their marks, right? Early on, venture investors are subject to an exception where they don't have to register with the SEC. They want to be straight with their LPs and they're credible, smart people, but there's a psychological drift to wanting to keep marks high. The net result of it is earlier stage funds or smaller venture funds, their marks are almost always above market, at least recently, especially with the - you because I'll mark to the last round of like 2020, 2021. And then the CFO will have a fight with the general partners and the CFO will say, look, I did the comps, you know, we should mark this down. And the partner will say, ah, like, you know, here's the pipeline and here's the new product direction. And they're really going to turn this around and they're going to grow. So I want to hold the mark where it is. And generally they win that argument and the mark stays kind of overinflated, even when the company's done somewhat poorly. And the reason I say it's the crux of our existence is that creates kind of a psychological boat anchor where they've got a mark and they know it's overmarked, you know, or they've at least had the debate internally. They don't really want to tell their LPs that they were carrying it too high. You know, we're stuck with a negotiation where they really should mark it down before they sell it, because if they want the liquidity, you know, they're going to need to sell it at market, not at what market was about 2020.

Shiv: Right. And nobody, nobody wants to sell, nobody wants to look like the asset depreciated. So, and so it's like buying a house and then trying to sell it for a lower price point two years later and nobody wants to do that. But that is also kind of the reality of the situation too. Right? So, are you finding that you have to almost play ball with them and, meet them halfway or, or, you know, kind of be more aggressive on the valuation?

Kevin: You know what it does? It ends up introducing just time into the negotiation, to be honest. We try to help, to be honest. We share all the work we do. We do a ton of work to value these companies. We value secondary positions a lot. We value primary, build a whole model, do, you know, IC memos that are 30 pages, you know, we do a ton of work and we share it with the VC we're potentially buying from or occasionally we'll buy from executives too. And we tell them, like, these are the risks we see. These are the cases we're forecasting. You know, here's the case where everything hits right, new product launch does well. Here's the case where the wheels fall off the economy and things go poorly. And this is the, these are the comps we're using. This is the exit multiple this is all the math and here's what we think the business is worth. And when it's less than the marks, we say, well, you know, tell us, talk to us about how you're marking, you know, and we'll tell you, we'll figure out like what's the difference and should you have a discussion? Do you want to talk to your LPs? And that discussion is all very upfront and frank and helpful to them and us. Where it comes into some friction is if it is overmarked, you know, they're in a position where they need to tell their LPs they were holding it too high. And sometimes that's easy and the investors are just straight with them. I mean, these companies go up and down, right? Like there's companies that are growing really well, but they were just, the valuations are so high in 21, they would come down anyway, even though they're growing.

And it's just an issue of like, how do we manage that with LPs and are we raising a new fund? And are we going to be calling that same LP when we're sending them a markdown? So what that does is it ends up adding a lot of time where they're not prepared to do that yet, or they want to do it in six months after they finish a fundraise, or they're going to do all the marks in next quarter. So it lengthens the time.

Shiv: Like, yeah, until they're ready to have this. Aren't they almost incentivized to not have that conversation or like hold longer till let's say interest rates come down. Everybody's kind of holding their breath for that to happen for almost like a year now and it hasn't happened. And so doesn't it almost incentivize them to wait? And but I guess you have like two dynamics, the LPs want liquidity. And at the same time, in order to liquidate, have to lower, bring down your marks and you may not want to do that. So it's kind of like you're in conflict with yourself a little.

Kevin: You know, I had a... You're absolutely right, by the way. I had a conversation with one of the partners. We were looking at a pretty large stake for a really old fund, of a fund that's done incredibly well. And I was talking to one of their partners, and they've got new funds now. And the discussion we ended up having was, you know, this is a kind of 200 million revenue business that's growing single digit to maybe 15%, probably won't grow faster than that. It's profitable. It's a nice software business. But that's kind of not what your LPs are paying you for, his LPs. His LPs, because they're early stage investors and he's got a tremendous track record. He has invested in a bunch of really large companies and his LPs are paying him to go find more of those, not to manage a slow growth, private equity type company. The reason I bring this up is, eventually, I think people come to grips with that, that, our time is really better spent elsewhere. We should liquidate this. Because if we wait until it grows into where the mark is or where we'd like to have it exit, we're going to be spending a lot more time on it when we should be spending time on what we're good at and what the LPs are paying us for.

Shiv: Right. And no matter what, like as you spend more time on it, your IRR is not changing. It's like you're going to, it's going to equalize to some degree, no matter what you do. So it's almost better to just move on to the next thing and do what you're really good at and focus on the stage of companies where you can add the most, most value.

Talk to me about the underwriting piece. Like you mentioned that you have a unique approach to that. Like what are some of the things that you're doing to understand the value of these companies so that you're getting in at the right price?

Kevin: Yeah, it's funny, when Jason started realization - Jason's my partner, he started it several months before I joined him. When I joined him when we raised the first capital, he had done some things in SPVs. I thought this is great. I started a company when I was younger and then I spent a long time doing M&A joined Jason and we really started it off, I thought this is great. can build the ultimate model. And I'm a nerd, you know, like I used to do a lot of Excel modeling and it's interesting to me. So we built this model that basically forecasts the companies across seven different cases where case one is a bear case and case seven is the bull case where everything goes right and case four is kind of where we think it's going to shake out and you know it's Gaussian, it's sort of normal distribution where case four is pretty highly probable. So we probably weight all seven cases and we discount all that back to, we look at a five-year hold for the company and we exited it at the fifth year and then we look at either the security we're buying or the security we're creating in a new round and we price it based on the returns we need based on those seven probable cases. And each case has its own waterfall where it runs through all the preference stacks and liquidation preferences and the convertible notes and all that stuff.

And it can handle tons of classes of securities and participating preferred and all the sort goofy stuff you see. Because when you're doing secondary, you really have to understand the cap table because these cap tables, when these businesses get mature, they get messy. So it handles all that. And then we price using that. And then we sort of - if we get to agreement, we refine it with more information, talk to management more, and come to something we can close around.

Shiv: Interesting. So it's almost like a, like an actuarial exercise. You're kind of like figuring out likelihood of outcomes and, and what, what actually ends up being the value in each of those cases more than looking at - are you looking at things like value creation levers, or is it more this data driven and probabilistic type of approach?

Kevin: It's both. When we can create value, meaning we know we have the ear of the CEO because they want to help with certain thing or we have a board seat, we definitely look at value creation levers. And to be honest, we look at them anyway. They're always part of our investment committee memos, like how can we create business? What have we learned while we were doing diligence and underwriting that we feel like we can improve? We're always looking at that. But in the situations where we're a minority, you know, really minority shareholder in a really large, mature company, we're realistic about how much influence we're going to be able to have. But most companies, we, you know, can get the ear of management and help, and we want to help. We view it, we view helping management, and that's part of the reason we run that kind of later stage process of realization, which I can get into, but we view helping management teams and other investors as existential for our business because our secondary investing comes from other investors. So we have to try to create value for other investors around the board, for management teams so they'll all work with us again. And that's generally true in investing anyway. Your reputation is important. So we take that kind of help seriously.

And the probabilistic side, after we had built that first model, one of the early deals we were working on with - one of our anchors is Jasper Ridge, which is a really large multi-family office. They're awesome. And there was a guy there, there's two guys, Mark Wilson and George Phipps that were instrumental in helping us get started. And George was - we were looking at a deal and we were talking about the likelihood of certain real big triggers in that deal. And that was driving valuation. And it was, it was with, he and Jason and I were talking about how can we incorporate this into pricing and what's probability weight it. And then we expanded that into seven cases and that's kind where we came out with the structure and everything else.

Shiv: Yeah, the reason I asked about that, mean, we, that's what we do is help with value creation, but it's an interesting idea because I'm a huge fan of data and probability. I mean, I'm into poker and golf and it's all about distribution and figuring out what's the most likely situation that can come up in a, in any scenario. And in, these kinds of cases, like, yeah, there are value creation levers, but then there's also like a likelihood of success. There's the market that you're in, and specifics associated with the customer, the customer set that you're going after. And so it's almost like a band of like low and high or like likely scenarios that can happen. And taking an actuarial approach almost as a, almost more rational because you're not over indexing on an idea that you're enamored with.

Kevin: Well, to your point, each one of the seven cases has its own P&L and kind of projection. within those cases, we're looking at all the value creation levers, right? We're saying, like, OK, in this case six, the channel's going really well, our direct sales are falling off because we have to hire a new salesperson for direct and, you know, or here we're fixing the churn, you know, based on, you know, X, Y, Z strategy. And so we'll incorporate that into certain cases where that'll kind of define the case or those value creation levers and how sort of effective they are, or, you know, how much do we think we can actually influence the CEO and how much buy-in we have to the strategy. So we'll incorporate that into those cases.

Shiv: Is that common? I'll say this is one of the fewer times I've heard of an approach like this. I've heard like a sensitivity analysis, obviously, that people do, but this seems like way more technical where you're looking at multiple variations of the P&L, in this case seven at least, that you're saying. On your side, it's something that you guys do at your firm, but is this more common across the board and other private equity firms and investors?

Kevin: It is in private equity. It's probably not as- we probably do more cases than most firms. Usually there's kind of three cases, you know, downside, mid-side, up-side. And then there's a lot of work that's done within those, you know, in those cases. So doing seven is a lot, but you know, we find the distribution is helpful.

And there are a lot of variables to play with with some of these businesses. And sometimes the cases look very narrow. Like if the business is very mature, like the market’s defined, you're looking at like a contraction of 5% up to an expansion of 10% across seven cases. Sometimes they're very - and profitability is the real metric you're watching. Sometimes the cases are really narrow, but sometimes they're really wide, especially early stage venture-backed companies. what we find is venture investors generally don't use that kind of financial discipline, not because they're not smart, but it's not really necessary. They're betting on big market swings, management teams, and certainly they're betting on execution, but the reality is the product market fit and other sort of really big metrics are really what's going to drive value. So it's less often you see kind of financial sophistication they're underwriting and it's more often their underwriting is very detailed on the market and the product and the tech and like how it's - and the management team. And we do that too, but it's, I'd say we're probably more sophisticated financially than they are and they're probably more sophisticated with go-to-market product stuff than we are. Because we generally invest after product market fit.

Shiv: How much, right, exactly, because it's more mature. how much of the - as you're doing the modeling and you see, okay, like in our top one or two scenarios out of the seven, these are the things that have to hit. So how much effort are you then putting into making those items a reality, whether it's product-related or pricing-related or go-to-market-related or team-related?

Kevin: As much as possible. We want to help as much as we can. I mean help do DACs. We've been between my partner and I, we've had I think 11 CEO or co-founder roles. And we've lived through about 110 - well actually now I'm including some principals with us, but we've lived through about 110 M&A deals. And when I say lived through, I mean like right in the middle of it, like one of the sort of five or six people that are driving it. And if there's any opportunity for us to help create value with the management team, we wanna do it. Whether it's building a channel, building an integration, thinking about strategic partners, and maybe I'll get into that kind of process a little bit. But the one thing we do with lot of mature businesses and the reason for the name Realization and because the nature of our investing is generally more mature businesses, we like to work with management to identify the kind of five to seven most likely eventual acquirers without any timeline on exiting or bank or process yet or anything like that, and we go to them and say, we coordinate, these are the targets, these are the interactions we've had. Because what we found is when we looked at those 110 M&A deals we've done or so, we looked at which one of those deals traded out of market on a relative basis. What were the deals that really traded with a premium? And what were the characteristics around those deals? And then we thought, well, how do we put those characteristics in place years before you know, it's time for liquidity, where you can really build that up. Because what we found was, and when you've been on both sides of M&A deals, and M&A is still kind of the, I don't know, it's like 70 or 80% of all the exits, when you've been on the, like for example, the buy side of an M&A deal, the way it actually works is there's a product manager or, you know, an executive vice president or someone that's championing the deal at a particular buyer. Call it Salesforce or someone else, right? And because they know they can use that functionality, they've heard it from customers, and so they're the ones that are after the business. Now, they have to report to a committee, and if you have a good company that you're selling, you're gonna ask for a high price, right? Where that person that's championing the deal has to take a lot of risk that they're gonna be able to deliver revenue against it. And it ends up being kind of a career bet for M&A, right? That EVP or product manager is kind of betting their career that this is gonna go well.

And so they need to be really comfortable if they're going to go in front of their board and fight for a price that's a little higher than they wanted to pay. But the way you get them comfortable enough to do that is that kind of four years before it happened, right? Where you meet him, he knows the executive team, you do a joint venture or joint selling arrangement, it goes really well, he sees the commercial traction, he sees firsthand the value your product is creating at the customer, sometimes at his customer, you do integrations, you know, and so he's had years of watching this work, right? And so then he's very comfortable that he can do, you know, a ton of revenue and he'll take more risk in the pricing. And so our goal when we work with management teams is let's do that with the five to seven people. And a lot of times it's just a cadence of interaction with that the guy we were just talking about or the woman at one of the others or the management teams, it's making sure you touch them on a frequent basis. And hopefully it's through a joint selling or some other sort of method to see commercial traction, but it's building a cadence of interaction that might seem like a waste of time in the next six months or a year, but over three years, it's going to create more value than just the sort of sales lift you get out of it.

Shiv: As I'm hearing you talk about this, and we talked about the secondary side, like why not go the full buyout route, given how involved you're getting within these companies? Why take the secondary route where you're providing some liquidity, but those previous investors are still kind of involved, right? And you're in there and there's more stakeholders to manage. So why not go the route of just taking full control of the asset and going through some of these playbooks?

Kevin: We do look at buyouts, and we've done a few, and we're constantly looking at them. We like them for that same reason, because all the things I'm mentioning that we try to do as a minority investor, as a board member, obviously you can really execute around if you have control. The main reason we don't do more buyouts, frankly, it was one of your earlier points, actually. It's just a very mature, well, well-capitalized market. Every PE firm in the world is going after them. Every banker in the world is going after them. It's always a process. It's almost never unbanked. So we still do it. We still look at them all. We just bid on something. We're talking about a bid later today on a buyout. But it's just crowded.

Shiv: Yeah, it makes sense actually. It's a way to differentiate yourself in the marketplace and then the market finds you in certain circumstances where other players may not be as interested. And then you're internally building the process to create value in those scenarios, which is maybe different than going just the full buyout route.

Kevin: Yeah, and it's funny, there's this, everybody's pursuing like those - this is another one of your earlier points - but everyone's pursuing those like, you know, 115% negative net retention, like high gross margin, profitable growing. And we are too, but everyone overlooks, like there's a value for that business that's growing at 8% and a 7% EBITDA margin.

There's a value you can invest in that business and make a decent return, like a risk-adjust return that's great. We like that better, right? Because so many people just say they're used to venture and where growth drives everything, and they just say, if it's not growing at 40%, we don't want to touch it because we just go after those 40% growers.

Shiv: I never understood that. Like I get it that you want, I get venture wants to find the next Uber. I understand their model there and how they're going to make that work. But I never understood why a profitable company that's going 10% year over year, that's a great business to put money into because you know, you're going to get a cash on cash return. And you can pretty with a high degree of certainty predict what that will look like.

I never understood why some of those companies just don't get any attention because there are a lot of good businesses out there that are overlooked because everybody's looking for that perfectly shaped investment asset to put capital into.

Kevin: And it's funny, you know we bought - So we bought a minority position from a really well-known VC. And it was a business like that. It had grown. It was a really good business, nice, big business, healthy. But this is a really successful VC. And he had moved on to five or six more funds and done a lot more companies. And he was still on the board. And we took his board seat and bought him out. And we were so excited.

He had more important deals to really focus on. So he was not all that active with the board. And we were. We're really excited. like, we love this business. Here's all the things we think we can do. Here's what we want to talk to you about. And that kind of reinvigorated management a little bit, I think. And that company went from growing at 7% to the next year - and they had a little uplift from the pandemic, but they grew at like 35 % or something the next year. So sometimes just being excited about that company that's no longer excited, their investors weren't.

Shiv: That goes a long way. Yeah. Well, you’re almost being plugged into it with good intentionality, right? Where you're focused and you're trying to prioritize and actually support the management team. 

Kevin: Yeah, and it's great business.

Shiv: I think, I think part of the issue is just there's always a bigger company to land a bigger deal to close and kind of like this - There's always just another deal to chase after. Right. And, some of these companies get, get overlooked. So I've always been perplexed by that.

Kevin: The only sometimes downside to our thinking is we're, and this goes back to the rule of 40 argument, we're sort of burn averse, which makes us, I'd argue that the boards I'm on for earlier stage businesses are probably frustrated with my appetite for profitability and the stability it brings with it. I get into this discussion all the time with CEOs.

We're investors and I'm on board of a company called Sight Machine. And John, the CEO there, is awesome. And he is growing like crazy. He's doing really, really well. And the company's doing well, but I'm always fighting with him about burn. And we end up in the right place. We end up in a balanced place between burn and growth. But I'd say, I'm sure we're not the typical kind of growth at all costs sort of investor.

Shiv: That can be a good thing too, right? Because, again, coming back to the actuarial thing that we're talking about is, I think operators and entrepreneurs or CEOs, have this, there's like an inherent optimism in those people where they think everything is going to hit. And that's just not true. And market dynamics change, customer landscape changes, how much people are willing to spend changes like so you might think all 10 of your ideas are going to hit maybe two will actually hit, right, so being disciplined goes such a long way and also just preserving cash - cash is the - preserve as much of your cash as possible because that guarantees continuity but then certain businesses, yeah, you have to be more aggressive and take a more measured approach and maybe be okay with burning capital but I do think a lot more companies could benefit from looking at cash first as a way to operate the business so you're also more in control of your destiny and you don't have to 2X your business every three years. You don't have to, but you can have a very good business still,

Kevin: Yeah, and that ladder point that you made is really a good one that I find unless people have experienced a lot of exits, they kind of lose sight of, which is the optionality. If you're profitable, it goes way beyond the benefit of sort of rule of 40, you know, valuation-wise. It lets you be patient with an exit, right? If somebody brings you an offer that you don't like, you're just like, well, great, we're creating value, we're growing, we'll talk to you again in a year, you know? And that's really the biggest lever point of getting decent valuations, right, is the ability to say no. And it has to do with capital markets too. You don't want to be in a situation where you have to raise equity at a time when the markets are terrible. know, when valuations are down or public markets are awful. So, and we factor that in and, you know, our - when we're thinking about exits in the cases where the business is profitable, we look at multiples that are maybe a premium to what the rule of 40 equivalent is, because you have the time to be patient about accepting an offer and getting a strategic exit and things like that. Whereas if you're burning and growing, it's good, but you need to raise capital when you need to raise capital and you need to take it.

Shiv: You're in less control.

Kevin: And if you're lucky and you're going great, you should have enough interest that you'll get the high end of the market, whatever that is. But that might be the high end of a shitty market. But you still have to raise.

Shiv: Yeah. In general, most companies are not in that position, right? So you kind of - the founders lose out in most cases in those scenarios. So - because if you look through the preference stack, even if you do exit, all your investors are to get paid out first. And then you get whatever is left over, which may not be that much more than if you had just kept it for yourself and bootstrapped it and grown more steadily, right? Which is, which is something I don't think founders understand that preference stack and how it works as they're raising capital in the earlier days. And then they learn that later on in their journey about how it actually works, even if they've gotten advice along the way.

Kevin: Yeah, it's so important to understand that because it definitely, you your return profile is dramatically different than just kind of dividing by the percentage you own. And we do see a lot of early stage kind of founders not kind of getting, you know, what the structure implies or the preference stack implies. Now there's ways, you know, the market sort of makes up for that and like carve outs and recaps and and we do stuff like that to make it kind of fair for the CEOs and entrepreneurs, but it is critical to understand that stuff. And your other point about optimism is funny. You have to be, if you looked at the statistics of the number of businesses that are successful versus failing, you have to be an optimist to start a company. I speak as a crazy person myself that's done that, like, you know, but. But you have to be a little bit optimistic. And a lot of times when we're looking at those cases, management case will be up there in like case six or seven because they're always optimistic that they're, to your point, all these deals in the pipeline are gonna hit. We're different than everybody, we're better than everybody. So we try to measure for that optimism and we want it. Like they need it to be successful. But you have to kind of hedge for it too.

Shiv: Totally, yeah, you have to have both sides of that to make it work. I see we're coming up on time. So before we close off, just if people are listening and they want to learn more about you, there's a ton of PE firms that listen. How can you get in touch and potentially work with you guys?

Kevin: Yeah, I guess what I'd say is we're always interested in talking to other institutional investors about liquidity, especially growth stage and up kind of companies, especially in funds they want to wind up. We're also interested in, like I said, control deals. We're fairly new. We only really raised the first institutional fund in 2020 or closed in 2020, raised in 2019. So I think we've known bankers from other firms that we've been with, but we're just kind of getting our name out there. we'd love to talk to banks to, you know, to do co-investment, lead rounds, buyouts, that kind of stuff too. We're, we love what we're doing. We're busy, but we always wanted to play more capital. So be excited to have any of those conversations.

Shiv: Awesome. And yeah, with that said, we'll definitely include all of that in the show notes and make sure all the links are there as well. And with that said, Kevin, thanks for coming on and sharing your wisdom. I thought there was a lot of great content for founders, for entrepreneurs, for investors as they think about their companies and their funds. So I appreciate you coming on and

Kevin: Awesome note. Thanks for having me. It was a great conversation. So really appreciate it.

Shiv: Thanks, Kevin.