Episode 49: Paul W. Swaney III of Swaney Group Capital on Creating Value When Investing in Industrial Businesses 

Episode Transcript

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

Paul: Hey, nice to meet you, Shiv.

Shiv: Excited to have you on. So why don't we start with your background and your firm and we'll take it from there.

Paul: Yeah, I started out my career in the US Navy, left the Navy in 2005, went and did a variety of different operating jobs, worked in chemicals and refining, did a little stint at Amazon, and then ran a chemical business and plant and distribution center. At the time, I wrote this book, we'd undergone a lean kind of op-ex transformation about how do you put lean and op-ex in a chemical plant where it normally doesn't go. And somehow or another, McKinsey and Company found my book, and said, we're starting up this group of newly minted operator or newly minted new ex operators instead of newly minted MBAs. So it's been about three, three and a half years they're doing mostly operations work for them, a little bit of strategy. Figured out I liked working for smaller companies versus big conglomerates. You know, got linked up with the private equity team there. Got headhunted away to go be an operating partner at a global mid cap firm. I spent seven years there working on the operations team on the investment committee. And eventually going over where they merged the ops and deal team together, and then did a couple investments in the industrial space. Left here, or left there in in 2022, hung up my own shingle. There's about nine of us now. And we're right, we have three businesses, we have an advisory services business, which is, know, ops transformation for private equity firms. We have a we have a co-invest business where we like to have, you know, operating rights on the business. And we know we're actively trying to get a control deal done, on the way to raise the fund.

Shiv: Got it. And tell us a little bit more about the Swaney Group and your fund size and the types of companies you're looking for.

Paul: Yeah, so we're gonna right now we're a fundless sponsor, independent sponsor, investor investing out of my personal account and some high net worth individuals and a few more institutional LPs. You know, we look, you know, I like buying businesses call it from three to 10 in EBITDA, right? There's much more headroom to go up that to go up that way, right? You'll get about a turn turn and a half of multiple expansion going from three to five, and then five to 10. And there's a lot more opportunities to shoot at. And then from a sector perspective, all industrial services or manufacturing though I do tend to lean over to the manufacturing side. It's just what I know. I grew up in a machine shop. My father was a tool maker. You know, I can't leave the submarine in the Navy. It's basically a big factory, right? It's a nuclear power plant.

Shiv: Yeah, totally. And on your side, guess, a lot of private equity firms focus on tech and B2B and those kinds of companies. And that's where a lot of the higher multiples are. Manufacturing and industrial and chemicals and all these things are kind of the non sexy part of the private equity world. But there's a ton of capital that still goes there. And there are a ton of great businesses there. So tell us a little bit more about that opportunity and how you see that asset class.

Paul: So we have a thesis on American manufacturing, North American manufacturing, It's private equity got its roots, you know, the original leveraged buyout firms, you know, were basically playing in only industrials and industrials companies. And it was very easy. Lots of founder led businesses that were exiting. You know, I like this space because multiples do tend to be lower. You get into a big software situation, you know, they're playing nosebleed multiples even these days, right? I think my last number is 35% of all private equity still goes to industrials and industrial services or manufacturing. So it's still a huge part of the private equity market. I do, there's a lot more, I call it news, news around, you know, tech and healthcare right now. Healthcare is having some interesting regulatory things in the private equity space right now. And then tech is, you know, multiples are high and it's not as much transactions. Nuts and bolts, GDP growth businesses where there's a clear plan to either grow the business, take some costs out or bolt other things to it. 

Shiv: Right. Yeah. think, I think that is totally a great insight. I think a lot of people outside the PE space and even in the PE space, when they're looking for deal flow and targets and volume, they're actually not looking at the manufacturing side or the industrial side, or even just how the PE firm or ecosystem is split. If you could be at a big firm and one arm of the business is entirely focused on B2B and tech companies and another arm is focused on manufacturing so investors don't really cross over between those different domains.

Paul: It's interesting. We went to the McGuireWoods Emerging Managers Conference. I do see a trend as the generalist private equity firm. It feels like it's going away, particularly from a new manager's perspective, where you say, we've got some transaction specialists and we'll bring in some industry advisors across tech, healthcare, services, media, telecom, and industrials, maybe some consumer. What the theme that we heard, this was back in April, the new managers that are getting backed are sector-focused, right and have a clear thesis, know, and, you know, ostensibly know something about something versus more financial engineering and deals, right. So the one of the things that we've kind of eight core themes within, you know, industrials that we're looking at in one of those chemicals, one of them is, you know, precision manufacturing is one of them is fixed asset support on fixed asset support for like industrial sites, you know, like wastewater support. Anything that we are touching is something that I've either owned or operated or owned operated or have been an employee of at a company, right? It certainly adds a bit of an edge to when I'm talking to the founder or the management team. 

Let me give you an example. We were looking at we're looking at an extrusion business, right? Now, it's not perfectly fungible, but I worked at a polypropylene plant, right? And the polypropylene plant had big, large extruders there. Now they were extruding, they were melting and extruding polypropylene resin. This team is melting slash extruding rubber. But that overlap, then at least I know what the dye and that you have to control dye temperature on the extruder. So when you're having the conversation with the founder, it just becomes a little bit richer, right? And you're not trying to get up to speed or have a senior advisor speak for you when you're meeting them. I can actually have that discussion. And then the other side of that is I bring my military officer team, a military professional team down to the floor with me and they always do very well in steel toe boots. They do very well, you know, meeting the line workers. It helps add some depth to the conversation and just we have a sack of money and you know, we might want to buy your company.

Shiv: Right, totally. So expand on the investment thesis a little bit more just to bring it to life for an audience. Like, what does that look like? Because you know, software companies trade at 12, 15, sometimes even 20x multiples. But in this kind of a business, how do you look at acquiring and actually creating value for yourself or your other investors?

Paul: Yeah, so I want to buy something at five times, six times, you know, that's three to five in EBITDA-ish, maybe a little bit more, and underwrite a clear path to doubling EBITDA in three different ways. One is, you know, we're going to take some cost out, you know, using the Swaney Group operating system on you, whether that's, you know, procurement or planning or manufacturing excellence, you know, supply chain negotiations. And the second is on the commercial side, whether it's going to be pricing. Most of these founder led businesses don't work on pricing or they have like a uniform pricing model. They don't take care of their best customers, the best. It's just very, you know, he will do a price increase, it's 3%. And then the last thing potentially is if we have some M&A add to it. So my partner, when I was at the bigger asset manager, taught me, it was the best guy I could have been paired up with. He taught me that he had been so successful because he was always wrong about something. So he always wanted optionality, right? If the market goes flat and it doesn't grow at GDP, can I take some SG&A out? If I can't take any SG&A out, can I take out some COGS? If I can't take on any COGS, I carve out a business unit to bolt something to it make the offering more fulsome? If that doesn't work, can we aggregate a bunch of little smaller companies? So that was always his mentality. So long as I have optionality, then I don't have a problem, right? And that's why I don't take brand risk. Like I'm never gonna, not that I would know anything about this, but I wouldn't buy like an underwriting Yeti cup. It's a $40 high gross margin business, but that can immediately go out of trend, right? That's one of the reasons I don't, I don't like anything with pen stroke risk like regulatory for healthcare, right? I want to make sure slow, boring, nuts and bolts businesses with a clear upside plan.

Shiv: Talk about the cost side, because I think this is one of the things that's quite different inside an industrial business versus let's say a B2B technology or software company, because the costs on the B2B side are often just software developers or paid media ads. It's engineering expense, but there's no physical hardware and inventory and just supply chain that you need to kind of work through. Talk a little bit about that, give us some details on how you perceive that cost takeout and how you manage the supply chain and all the different factors involved.

Paul: Yeah, it's interesting, right? Nothing scales like a software business, right? It's, it's very, very good. That said, though, I have a friend that she went and was an operating partner at Vista for many, many years. And she said there was always copious cost-on opportunities, particularly in like back office and marketing and ad spend and stuff. So I don't want to say, you know, there's not really cost opportunities in software and tech, because there always are. And that's how that's how Vista has made their money, right? But, you know, it's very, it's much more tangible, right? The the best case situation that we can be in is, if you have a backlog of orders or you're not selling new orders, because the plant is maxed out. If you don't have physical capacity, that's a cost problem because then the math for building another factory, you're not gonna, in most cases, you're not gonna build another factory for five to $15 million, even if it's small, it could be 50. So that's thing one is how do you free up capacity at the site so that you can get more product out? That's always the play I would love to make. It's very positive, you can go in with a transformation story. So adding capacity is thing one from a cost. And I think if you want to take it down, really cost per unit, right? Cost per unit time. All so that's thing one. 

Thing two that I find particularly with like founder led businesses is raw material suppliers. Founders tend to be a little superstitious and they don't like swapping raw material suppliers, right? So given a like for like, they'll have a single sourced, whether it's chemicals, whether it's steel, whether it's zinc, whether it's any raw materials, they'll tend to have a long-term relationship usually with somebody. Probably haven't bid it out in five to 10 years and then they will take it and they'll just eat the price increase. Given a like for like quality, you got to be very, very careful to do this. You can't just cut over quickly. I want to have two suppliers for raw materials and then swing 30% of that volume back and forth every year. So you've got basically capacity, then raw material cost, then you've got indirect cost, indirect cost, indirect procurement, all your shared services, your IT spend, your IT spend, your finance, you know, finance and back office, your, your sales expense, right? That's usually, particularly from the founder led side, that usually is the founders usually entrepreneurial, right? So they're out selling and they put more sales team in the organization and they're just solving individual micro problems, right? And so shoring that up, getting more systematized. Some of the things we've done before is outsourcing inside sales team. done that really, really successfully outsourced inside sales team. So that, you know, leads are just coming to the plate, come into your plate, right? I've used account reps, right? It's 1099 team members. They put an extra couple pages in the back of their catalog, right? You get sales dollars efficiency on that. And then, you know, biggest cost to is anything that's like non-core to the team, like HR, benefits administration. There's usually two or three people running around the business that are handling all that stuff. And a lot of times that's a lot more effective kind of managed by an ADP or something like that, right? That's simple part of the playbook.

Shiv: Talk about the the first piece, the capacity, because I think that one is super interesting and also just Just a capital expenditure because inside these companies there are super expensive machines you have real estate you you have all these assets often having amortization attached to them and depreciation attached them. Look, how do you navigate that level of because you're kind of stuck with that no matter what right and in some cases you might be taking on like a burden of potentially replacing machines or needing more machines. And that kind of gets needs to get factored into the value creation process.

Paul: So EBITDA is an imperfect metric in industrials, right? It's a much better metric in software. You we tend not to buy big heavy plants or look at big heavy plants, right? Like a big piece of refinery equipment, it's falling around, it's falling apart around you all the time, right? You know, if we go down to kind of like one level less than that, know, kind of batchy manufacturing extrusion, know, extruders 300,000 to a couple million dollars, right? But all that stuff has to be factored in. And the diligence process gets a little wonky because you got to figure out how much cash the business is actually generating. That's key question. How much cash is this drawing off? Right. And, know, we've lost a couple of deals in the last six months, actually three or four based on a Q of E, right? EBITDA marketed, you know, the somebody brought us a deal was three and a half, four in EBITDA really thrown off one and a half to two in cash, right? You know, there's 500,000 of one time capex in there that just happened to happen, happened to happen last year. And right. And it's a deal because right then the valuation multiple swings. Right. So that is a huge thing you have to look at. And that's one of the reasons, you know, I liked, you know, having the experience of it in so many factories. I think I've been to about 200 factories in the last 15 or 18 years and like knowing what breaks, knowing, you know, what's, what's a burden. Like I have a sore spot for vacuum pumps and like, I know you're going to have to replace them once a year. And if I don't see that on the list and they got vacuum pumps, they're going to, they're going to have to be rebuilt. So you just have to kind of know the space well enough for getting an advisor in that can walk you through that if you're going industrials.

Shiv: What is, just start, just jump in, what is the metric? Cause I totally get it, EBITDA doesn't exactly tell you what the free cash flow of the business is. So how are you figuring that out? Are you just looking at cash on cash? Like

Paul: EBIT's better. I like EBIT, but it's just you can't bid off EBIT, right? can't be nobody else is like, what is this? So you kind of have to bid off EBITDA, but you know, free cashflow conversion, right? You know, I've seen some extrusion businesses like like aluminum that we're looking at. It was like, you know, 12, 15 in EBITDA, but it's really six, right? I mean, it's just like a horrible service that, know, you got to replace a bunch of stuff every single year. You can fix that efficiency ratio if you, you know, one of the projects that I do less often would be maintenance efficiency, but you got to get to a bigger business, you know, call it 100, 200 million revenue that's got 20 or 30 maintenance techs run around, right? Because the way you know, it's not doing as much maintenance as possible. It's doing the right maintenance and monitoring it so you can hit something for it goes down hard. Right? But that's the, know, I mean, look, a, you know, I'm pretty familiar with packaging lines, right? You can always get a 1957 Chevy to run like a 1957 Chevy by replacing parts and doing proper maintenance, but it's never gonna perform like a refinery, like a Ferrari, right? But there is a system that you can get with operator maintenance to reduce your overall maintenance cost, keep things properly cleaned, lubed and inspected, and then use that as a way to drive down your maintenance costs. That's a three-year play, it'd be much more for an asset you're gonna kinda keep and hold in the portfolio.

Shiv: Are you spending time on that during diligence to look at the machine life cycle and potential replacement costs and beyond just what's on balance sheets and what you're seeing in terms of EBITDA?

Paul: So I would never do a manufacturing site, manufacturing company purchase without hitting every site. The amount of time you're gonna get on site is variable. If it's in a banker process, you might get two hours, three hours, four hours, even at a million square foot site. I've been in that situation before. The key is to go out to the floor and just let's very obvious things, right? It's how clean is the site? Is there rust on the machinery, right? You can, mean. It's stuff oiled, right? It's talking to the operators and asking them, how often does this go down? When's the last time you replaced a drive motor? Right? If they know these things on the floor and the floor workers know what happens to the machinery and are like in tune with the machine, it's a little hokey, but you can get like qualitative information. You have to underwrite a full replacement of basically half the kit… 

Shiv: Oh you do? You're saying you're doing that no matter what?

Paul: One of our scenarios is you have to go what that we run. Our guy in Santiago and in Columbia, he runs is, what if half the plant broke major break couldn't fix it? How does that affect the cash flow situation? Where does that affect? How much debt can we put you have to run that scenario? 

Shiv: You have to, yeah, because there's so much risk you're taking on.

Paul: So much risk, right? And that's why we like things that tend like, you know, there's a as an example, something we're looking at right now is a consumer products manufacturer non branded. It's sort of like a contract manufacturer, more B2B, then B2C. They're doing like mixing and blending in some large, what looked like KitchenAid mixers. You're gonna put them for $200,000. I got six or eight of them. It's fine, right? Where you get into the thing is if you have one piece of equipment on 30 million in revenue, like one main extrusion lines and maybe some, some packaging or finishing things, that gets to the point not as underwritable because if you throw you know I mean you can always replace a die or place a screw in the extruder but at some point if it goes down hard you got to underwrite a major rebuild and a major loss of revenue during the time you're fixing it.

Shiv: Yeah, right. Exactly. Because not only is it broken and there's a cost, but you can't service revenue now. 

Paul: Exactly.

Shiv: Let me ask you, how often are deals falling apart at this stage? I would imagine a lot of these deals fall apart right here. 

Paul: So I've had more things fall apart on quality of earnings, on quality of earnings versus, the, versus like CapEx and yeah, that tends to be a little bit more. that's where I would say this. That tends to be, if I get to somewhere, or we've kissed like 12 frogs in the last year and something's always happened. The, but if I get to the point where it's CapEx, I might lean a little bit, right. And then say that, but I, I try not to look at things where 100% of the production goes through one piece of equipment. 

Shiv: Right, right. Because yeah, you don't want that risk because you're deploying all this capital. Side question is because you're talking about cash and EBITDA and all these things and valuation is pertaining to that. In a lot of these cases, especially if they're family run and family owned, and I have friends like this who have two or three generations worth of a manufacturing business, there's a lot of volume and revenue that is cash based that for tax evasion purposes, for lack of a better word, people are doing off the books. So how does that get factored into the valuation? Because from the family businesses standpoint, they are incentivized to keep that. And it, the business is worth way more to them than appears on the, on the balance sheet. And then you as an investor are being asked to pay for that, but you can't see it properly.

Paul: Yeah, I haven't seen the like revenue games as much. We have a process where we'll do like a litmus check quality of earnings and how so we're invoices to GL codes and stuff and the team we do that pretty quickly. I would like to make a bid. What I have seen is, you know, and it's almost ubiquitous. I've seen a founders lifestyle, like run through run entirely through the P&L and like I this one gentleman had a $2 million travel line item. And it was on, like 25 in revenue, right? It was like a meaningfully big number and. I'm gonna get credit for some of that. you know, one of the, you're going to sell your business, here's a tip. If anybody's listening, you might want to clean the P&L up before a couple of years before, instead of taking the tax, the tax benefits.

Shiv: Totally. Yeah, because you're basically deflating your EBITDA.

Paul: You deflated your EBITDA and look, it's like, you know, I'm not going to say everybody does it. I will say it is very tempting to run. It's very tempting, right?

Shiv: A lot of people do it. Lot of people do it. Yeah. Yeah. That's, that's totally true. Talk to me about the capacity piece. I know we kind of went on a tangent there, but, what are some ways that you're looking at free of capacity? Like for example, like if, if a company can, say produce a hundred units a day or per month, what are the levers available to them to increase capacity without, investing in another factory, more machines and, cause that CapEx is just, I'm assuming ruins your underwriting. So you kind of have to figure out within whatever's there at the current moment.

Paul: I have yet to find a company that didn't have at least 30% latent capacity in their factory. And I will say that again, I have yet to find a company that did not have 30% latent capacity. The best manufacturing companies in the world from like process manufacturing or Toyota and Procter and Gamble and Daner. And like a Procter and Gamble like a diaper line will run at 85%-ish, what we call overall equipment effectiveness or OEE. I've yet to go to a middle market founder led business that was over 50 OEE. And the losses associated that with how many times it stopped and jam a day, how many major maintenance downs you have a day or a week. Are you running the thing at the full speed? How long does your product changeover process take? How much scrap are you making? How much quality errors are you making? Each one of those levers has a different playbook that we've codified over the years to attack. It's going to be like dealer's choice. Like you roll the dice. The biggest one that I can say happens to most sites is long change over times. And the other side of that too is, is, a reticence to actually perform changeovers. What I always tell the sites is guys, you're thinking about this backwards. You want to amortize your changeovers and your product grade changes so don't have to do them as often. I want to make you, I want to make you a change over expert, right? So if you can treat this, if you can move from being a, you know, from being like, you know, me changing a tire on the side of the road to the F1 pit crew changing a tire, those are two entirely different processes. 

And then I like buying high skew diversity businesses. That's one of our themes is like serves aerospace or serves defense, high SKU diversity. If you have like 200 core SKUs, if it takes you four months to make all 200 of those SKUs because of changeovers, you can't get product to your customer for four months. If you shrink that time down, you can cycle your product in a wheel and then also add capacity. 

Shiv: How do you do that? 

Paul: Machine up times the biggest one, killing change over time, right product is machine setup, right? I mean, lots of simple things. How do you standardize the setups between shifts? Right? Every production line I go to, you got the night shift operators, the mid shift operator, the swing shift, operative day shift, they all run it a little bit different. Right? They all run a little bit different. They all like their set points. Sometimes they slow the machines down. They don't want it to they don't want it to break or drop. You want what you want to do is run it as fast as you can get it where it runs most of the time. And then when it does go down, you want to problem solve those micro events and then you can open up the operating window and get the machine to actually run better. And a lot of that's going to be involved. this went down because you're running faster. You messed up this suction cup. You messed up the suction cup on the packaging line change it wore out. You're gonna have to replace that more often now. And you can't do this by yourself in an engineering team. You got to have like trained 200, know, 150, 200 operators out there finding these little efficiencies every single inefficiencies every single day. So you can problem solve them individually, right? And it's six to 12 months to get from, it a 40% OEE up to a 50% OEE, but that basically adds you 25% of a factory, right? For basically no, for no capex, some op-ex likely.

Shiv: Right. Right. Well, how do you, how do you operationally figure that out on your side? Because, you know, in software companies, PE firms will have operating partners that are maybe sales experts or marketing experts or product experts. In this case, it's the barrier or gap seems to be a ton of technical knowledge and know how that is very specific to a particular business because every manufacturing business I assume has different machinery and very different details associated with that. So is there somebody on your team? Do you hire outside resources? Is it you? Like, how do you, are you figuring that piece out?

Paul: So I'm what I will call a manufacturing generalist. I've been to a lot of plants. I got a little bit of a spike in chemicals, a little bit in packaging and distribution, but not an expert, right? So the key to this is all about a respect for people. I am never gonna know an individual production line better than an operator or maintenance tech specifically that's worked at that site for 30 years, right? But I can apply some structure and a framework to get those team members to get all their good ideas on paper and get all their new, the things that they wish they had before, right? And basically facilitate the process. Where the expertise comes in more is from a credibility perspective, right? Like I've been in situations where some private equity associates, I'm like, can you please get some steel toe shoes and not walk in here with your Gucci loafs, right? And so like, we have just enough manufacturing experience that we can go in and be credible and help extract the ideas from the operations team.

From an underwriting perspective, I've personally just looked at enough factories that I can walk around and say, okay, I could count pieces off the line or I'm out there an hour, I'll count how many stops the machine had and say, hey, this is 30, 50 or 60. And then I can underwrite an eight to 13% increase pretty comfortably outside. It's usually much more than that, but I won't underwrite it. And that's one of the things I'm working on now is training my second generation to how to go out in the factory and look at the different spots and how to spot opportunity at a high level. Because you got a dual mission, right? You got to get the investment done and build a relationship with the team, but you've also got to spot opportunity simultaneously. You're kind of having a conversation with the team and asking good insightful questions, but you're really scanning around and taking pictures of things that you think could be accretive to adding to the capacity.

Shiv: It's almost like a, like a moat or a competitive advantage to have that because even if another investor wants to go into this market to buy companies, they may not have the technical know-how to navigate the ins and outs of different industrial businesses. So you kind of need to have that in-house.

Paul: So I mean, the industrial ones were the first sector focused firms. There's a firm I've worked with bumped into on an asset called American Industrial Partners. And I don't want to apply, like you can't learn this stuff. It's not that complicated, right? There's a gentleman there named Dino that I mean, I've walked the plant with him and I wouldn't know that he grew up in finance, absolutely. He grew up in a plant and he can talk mass flow meters with the best of them. So it's like, it is a learnable skill. Right, but that's where I think the theme in the industry is you're going to see the sector focus kind of come back versus generalist, you know, kind of a low interest rate environment. We do, we buy what's available.

Shiv: Yeah, it is, it is more rare though. Like I think not everybody has a person like that, guess, or at least it feels like to me, maybe, maybe we haven't interacted with as much with folks that are doing these kinds of investments, but it does feel like the, the variable. Cause for example, in software, like all the different components are similar. The tech stack is similar. The code base is similar. You might have the same payment gateway, you know, like over time you, everything looks very similar, but I think in this case.

Paul: I think yours is way more confusing. Right? Like I honestly, I'm like, I would never touch somebody's like, I wanted to maybe dip my toe into like, some obscure supply chain tech software, right? Like, you know, that was like, clearly overlapping to me. This is how I look at it. Factory, you ship some stuff in the front door, you do something to it you ship it out the back door. It's that simple to me that that what you do, what you're shipping in and shipping out and how much of it is a little bit different, but that, but that the point you're making is valid. It's like what you're comfortable with and what you know. 

Shiv: It's funny.

Paul: And nobody can know software and healthcare and manufacturing. It's not possible.

Shiv: And it's a lot to know about. Yeah. it's whatever you're in, the other side looks more complicated, but for the people inside of it, maybe it's more second nature.

Paul: Yeah. I met a guy I met a gentleman off Twitter that does that does software investing spike small cap software investing and anytime I have a software question I give him a call like anytime it's and it's and he's like and I know he's like this is the most basic question ever but then he called me the other day he's like I'm thinking about carving this carving this FDA regulated business out I'm like this is what you have to watch out for you got what they're gonna come out look at this when it transacts.

Shiv: That's great. Actually, I have a funny story, completely random, but my first job was in a manufacturing plant and we made stuff and I broke a machine on the second day and that was how I got fired two days in. That's how you know you're destined to be an entrepreneur. Two days in, shut the line down for like two hours. They were super upset. So when you're talking about uptime and everything, I'm like, that story came back to me.

Paul: So I'll tell you what, an old manager of mine made a mistake as an engineer that put a 40,000 pound piece of solid plastic into a chemical reactor. And like they had to shut down for three weeks and cut it out with hydraulic chainsaws. And yeah, stuff happens. I would be lying to you if I said I didn't pull my fair share of boners in manufacturing sites, but you know.

Shiv: That's funny. Yes, I'm assuming it happens more than that. I have a secondary question. As you talk about increased capacity. So what the people that I know in the manufacturing space that own these types of businesses, I find that they don't even have some of the most fundamental things in place from a go to market sales marketing perspective to actually drive up demand. So increasing capacity is one part of the equation. I totally get that. But then you can have all this increased supply and not the demand to meet it. So how much work do you do on that side? Or is it just a case of like, there's just so much demand that if they can just manufacture the supply, they can sell it to existing customers and, find more revenue that way?

Paul: I find one in about one in four times, it's they could go sell as much as they want and they can't make it. Which is the worst situation to be in. It's such a missed opportunity. I find most of the time. So if you think about how these founded, most entrepreneurs that manufacture things were either or engineers that sold something and had some customers. And then the manufacturing became an afterthought. Nobody goes out and says, want to start a manufacturing business to make things. It just doesn't happen. They start a business because they see a market need and they get in there. So you've got this entrepreneur founder and they go, I got to build a plant. I got to build a plant now. Or I was making it my machine shop, we should scale up. the manufacturing becomes an afterthought because really, sales is the most important part of business. It's painful. When I was going through the global financial crisis and we'd gotten enough capacity at the site I was managing, we had to shut the site down. We didn't have any sales because it was all construction products. And nothing happens in business till you get a sale. So but most of these founders, they started sales professionals, but they get to a point. Like we were looking at this diamond cutting tool business. And we get to the point he was making, like he was paying himself, I don't know, million dollars, million and half dollars of a year of dividend. And I mean, he had a couple places, place Park City, he a place out in the Bahamas, I think. And it's like, he just didn't have the energy to go selling it. He's like, why is where he was at, right? And then we dig under the hood, there's no outbound reach, no outbound at all. They're just taking, if somebody calls, you might get another order, right? You're not gonna, no new product introduction, right? They get, the founders will get to this like spot where it's like, do I really wanna go build another plant, right? So those are the things we like to tease out is like, is it potential to grow the market? Is it potential to get new customers? What are the current processes? I totally agree that they don't have any processes. It was one guy.

Shiv: There's no tracking. There's like one sales guy usually.

Paul: Nothing. It's exactly right. It was a, it's a founder, maybe another sales guy. It's exactly, which is, it's great. So then you go, we'll just add some salespeople. I tend not to do it that way. I tend to go, Hey, let's get catalog reps first. So we can try them out, cause sales guys are hard to hire. I mean, they're, hard to hire, particularly with a product I'm sold before, but Hey, you can get this, then bring one over as a, as a full time, if possible. And because you don't want to go, the only thing worse than, than like not calling is getting a bunch of orders and not being able to make them.

Shiv: And not being able to fill. Yeah. Yeah. It feels to me like the order of operations would be increased capacity. There's definitely existing customers that will buy more from you if you're able to produce more. But then from there, like what would these businesses that I've met and seen that they don't actively have a program to acquire more partnerships or more of these referral people that like, cause in every manufacturing sector, like there's a lot of related businesses that have the same set of customers. So going after those types of people, there's no inbound motion. There's no website that's properly set up. Like there's all these fundamental things that aren't in place. Like even just, there are people, it seems crazy, but there are Google searches for things like steel manufacturers and they will not advertise for stuff like that. And so it just very basic playbooks can yield like returns for decades because there's no competition for things like that. For whatever reason, if the founder is comfortable and there's a pretty good business to be had, they usually don't have enough of an incentive to execute on those things.

Paul: So it's also mind share, right? It's like return on mind share. I talk about that a lot, like return on energy and like, what do you do? That's one of the things that, know, as we've gotten in co-invest type things, it's our, a hard no for us is like, like if we're put money in this, we will take, one of us will be on the ground, right? Part of that is to organize and do some of those processes. Part of those is to kind of keep the trains running on time as we're adding KPIs, as we're adding systems. And then it's, you know, look, I've seen a lot of underwritten value creation plans with 12 to 15 initiatives on it. In my experience, those don't get done. Do three meaty things in year one, knock those off the list, set a proper governance, add another thing in. When it comes off the list, add another thing in to do. And, you know, I mean, I, it's very few people can do seven or nine things well, right? And the one thing I said, another gentleman on Twitter said, a lot of founder led businesses cap out at 2 million EBITDA because they haven't brought the talent in that can actually like entrust or get anybody, know, get to the you know, get on the next level, right. And that's, know, one of the things like I can't wait to drop we have a ex Navy SEAL Lieutenant Commander, Trey Fisher, that is next on deck to go to an asset and like everybody loves him immediately. He's very jovial. He listens to the guys he runs around, you know, runs around steel toe boots, getting him to slot new initiatives you know, particularly to a little bit of admin, most of these founders are 60 and, do they really want to go set up an external outreach system? Probably not.

Shiv: Yeah, it's not really a priority. Yeah. And you brought up something that's interesting is, you know, a lot of these founder or family run businesses, as you're coming in as an investor, or often you're, let's say you're buying out the firm, like there's a risk. you, how much you vet the team? Because I feel like in a lot of these companies, there's like one or two people that know everything. And then everybody else is kind of like a doer. And so there's this big gap between people who really know the business and there's like a continuity risk associated with the acquisition. So how do you see that?

Paul: Yeah, it's a it's a really good question. So I don't want really want to walk away. Deal with the founder goes right, I want to do at least 12 months of transition, prefer to put them on a three year consulting agreement. You know, in the three, otherwise we have signed that they had signed previously that fell apart. The founder was like, three year consulting agreement, I want you to go to the trade shows with us. You go to the trade shows with us. It's very, important, right, because it takes about two to three years, two to three years to hand over a good relationship, right? And if you're going, if you're serving bigger clients, we were talking to a, we're looking at a business that had a, they, like, they had large chemical manufacturers. You almost have to like, marry yourself to them until the procurement person like swaps out. And so they know you as the new person that's been servicing the account. Oh this business has been serving us. this is just our contract. That is the biggest risk in buying some of these, these founder-led businesses from an assessment perspective, I don't do a lot there. Our plan is to equitize everybody in the business. There's a lot of like, is an ESOP worth it? Some sort of equity type or equity like incentive package, whether it's an exit bonus, for the, I'm making this up, top 10%, top 5% of the team. It's just good business. It's good business. But that is the biggest risk I find is the founder risk, key person risk.

Shiv: As a person, you're the key person. And I guess your way of managing that is trying to incentivize them to stay for at least three years. Do you try to put in like a management team after the fact? And how do you underwrite that? Because that obviously increases your cost base.

Paul: So my goal is to would be to second, is my goal is to second everybody at as an asset. Sorry, second one of my mid level professionals, we call transformation directors at every single asset. That is killed 25, 30% of our things that we put a binding potentially binding bid on they just don't so I'm starting to introduce it now. They just don't want to do it a lot of founders. Some founders want to sell their business get a liquidity event, keep 20% and then run it like nothing else has happened right like they haven't had the change. That's, that's, mean, it's like, you they just want, want to, they want to, they want to swipe the ATM machine, but then just, you know, kind of go away. That's not, it's still my business. Right. So that's, that's thing one, there. So I want to have one of my mid-level professionals around, you know, set up whatever you want to call them. don't care. Chief of staff, project manager. Doesn't matter. It doesn't matter. And then that person is learning the business from the founder, right. Learning the business from the founder, building the relationship with the founder, getting stuff done on a cost side, cost side out or, you know, sales side out so that in 12 months when the founder wants to step away, maybe we put the founder on the board and he, know, he gets a pretty good gig or she gets a pretty good gig, you know, know, a $100K a year to show up to, you know, I don't know, 12 meetings a year. if you're lucky and then, you know, moderate, and then we can, you know, help get the person back in there. I also want, you know, on every deal we've been negotiating, it's like, you know, we'd like you to roll 10, 15%. So their second bite, you know, the second bite at it. We were looking at some the other day, the founder was like, I just want to walk. I'm like, it's a little used car sales. you're like, you know what I mean? You drive it on the street, the wheels fall off.

Shiv: For sure. For sure. Yeah. I think the people side is the hardest thing because that continuity is critical to like whatever your thesis is to making that come true. So that makes sense. Last thing I want to ask you is there's a grab bag of other things that come about with a company like this, like workplace safety and insurance and things like that. Like how do you factor that into your decision making?

Paul: So I don't want a company to have bad safety, but I'll take it. So there's a metric called EMR, which is experience modification rate. If it's a 1.2, you're paying 20% more for your worker's comp insurance. That's an opportunity for me, right? I'm hyper passionate about safety. Every human being deserves to be able to go to work and show up and take care of their family and come home in the same condition that they went every single day. Right? Like that is a, that is a fundamental human right from my perspective. Not everybody thinks that way. Not everybody prioritizes it. The irony of this though is safe plants are correlated with efficient plants. Right? Because if there's, there's stuff on the floor and it's falling over and the machine's not clean and there's oil leaks, right? And people are not using their, not using their PPE. If somebody gets, even just culturally, if somebody is not wearing their safety glasses and a chip hits their eye, the whole plant. You may not turn the equipment off, but the whole plant is distracted. The whole factory isn't really working hard that day, but just trying to see if, see if Jimmy's okay. And so like that's even if there's a safety problem and you know, we look at OSHA metrics, it's like recordable rate. If they are above benchmark, that's the best way to get in there and drive like real change because it's the best case. Cause nobody can argue you go guys, we got to clean safe performance up. You know, PPE is not going to be an option. This is important. You know, you got to lock and tag out your equipment. Like that's a great case to get in there. You know, as like I hesitate to say Trojan horse because it's just a horse, but you get that in there and you start that and then you go, this really is getting better. They really do care. And then you can peanut butter in the efficiency initiatives too. Right. So it's like, I'm, it doesn't scare me. There was a business I looked at before that made the news that had a horrible safety record. And there was a question in our investment committee, like, should we do this? And I, and I was like, this is an easy fix. The team is not locking out their equipment and people are turning it on and they're turning it on and the team is getting, you know, candidly, like some amputations. And one of the things that the founder of the private equity firm said is like, we're going to get the best safety person on the board of this business. If we're going to do this, we're going to make it right. And that's pretty good conversation. We didn't end up running the bid, it's, I could have fixed that in six months. It's just, you want to spend the money and do you want to actually fix it? 

Shiv: Do you worry about the legal exposure in situations like that? 

Paul: If I mean, if they've got a laundry list of all workers comp claims, it's more legal due diligence that you have to fight through. You know, I can size them. If somebody's got three open lawsuits, it's probably a deal killer for me. If I was, know, if flash forward 10 years, we're looking at a 20 million EBIT business. I mean, it would have to be very, very bad to scare me away. I like that. I say risk. not really a risk. Improving safety is almost the most underwritable upside you can have. 

Shiv: Yeah, it's a really interesting take on that. would have before I asked the question, I was thinking about it as a potential detractor. But as you're speaking, it's like, yeah, it's a, it's a clear value creation opportunity, because if you can improve that along with that improve efficiency and capacity kind of goes hand in hand. So that that makes a ton of sense. 

Paul: It's, it's, I have found cases of bankers trying to massage safety numbers down. they're bad. They look better. it's like, it's, it honestly, it's, I just look at insurance costs. I look at rates because they have to give me their OSHA 300 logs, which is the annual reporting form. have to give like, and look, they killed two people might be too much to go for right now. I mean, it might be too much to go for. 

Shiv: Right. Yes, that would be bad. That would... Well, we shouldn't laugh. That's actually pretty bad. But yes.

Paul: Right. No, no. I mean, it's, right. It might be too much. It's, mean, it, cause it's absurd. The reason you laughed is because it's absurd that that happens in the United States. It's absurd. It does happen. It's like, there's a lot of people buying roofing businesses right now. That's in vogue. That is one that I actually might shy away from because like 40, I think I got this stat like 40, 45% of all falls where your feet are over 10 foot are fatal. And yeah, it's way more than you would think. It's, it's, the feet have to be over 10 foot cause you fall hit your head, You hit your head, you break your neck. It's brutal. Brutal. I think somebody dies, more than one person dies every day from a fall in the US.

Shiv: Wow. Yeah. So I mean, things like that I would have thought would be a detractor, but as you're speaking about it, it's like, it's a way to also make a good impact in these businesses, right? Because if it's actually a way to improve the human experience at work and also helps create value, it kind of goes hand in hand. It's a different type of take on the cultural side of the business. 

Paul: Yeah, we had a field services business at my former employer. And you know, no fault of the employee. He was a road worker, and somebody blew through a cone and unfortunately killed, pinned him against a truck, killed him and his poor wife was pregnant. You know, and it's, you know, the firm, I think they paid, it paid his salary for multiple years, multiple years. was just, it's just a sad, but so anything you can do to help that is like, it's not just good business. It's good. Just, it's just the right thing to do, right? Like it's the right thing to do.

Shiv: Yeah. It's a good cause. Yeah. So I think that goes along with the thesis of the types of companies that you're investing in. So you kind of have to factor that in. And I think it's interesting because in B2B companies, people talk a lot about culture as like culture, culture, culture. And in manufacturing, industrial, these types of companies, I feel like culture is talked about way less because it's just more about making sure the trains run on time and delivering whatever you set out to deliver. But as a result, I feel like experience of people in those jobs is just not as good, but it's just as important, if not maybe more important because manufacturing process is so dependent on people that like, from a continuity perspective, retention is really important of people as well. So investing in that makes just so much sense and it's a form of culture in these kinds of businesses.

Paul: Yeah. So it's, we talk about like six things that we're assessing any production system on. You know, one of them is, is leadership behaviors. And one of them is culture and capabilities and op-ex other stuff, but that you can take two identical plants. And the one with the positive culture, positive safety history can get out two times as much as the exact identical equipment, exact same number of people, exact same cost bases purely on culture alone. The, the book I wrote, what's dated, I wrote it when I was still when I think it was like 30. but it was cultural, cultural kaizen, the whole thing is about culture and or culture and change. And I think people have to understand that, you know, it's not just it's not just like, you know, the what snacks you have in the break room, right? You know, in particular, manufacturer working with things that can kill you, they literally can kill you. Right. And so culture there is just is just as important as, you know, everybody's happy at financial services firm.

Shiv: That's awesome. One thing you mentioned that I just want to touch on this as well as you mentioned Kaizen and Six Sigma and Lean Manufacturing and all the stuff that Toyota made popular and like how much of that are you bringing into these companies? We talked about manufacturing process, but just dive into some of the technical stuff there.

Paul: Yeah, so I all those words are great. The bottom line is every organization needs a system for improving things, right? You're always getting fought in manufacturing by inflation, right? I mean, it's been really bad lately, right? You're always your inflation is always working against you. Ostensibly, you give every operator a two and a half to three, three and a half percent raise every single year. And that's going to hit you. Maintenance cost of parts are going to go up every single year. So if you're not squeezing juice out of your existing kit with a with a structured process and a structured system, you are getting, making less and less money every single year. So that's kind of the underpinning. What you call it or what you do with it, it depends on the industry you're in. If you're at a big refinery, Six Sigma makes a lot more sense. It's a little more technical. You need statistical tools. I've done projects like that. If you get down nuts and bolts to assembly manufacturing, it's all about, know, Lean and Kaizen and 5S and kitting, just on time parts. And the key is to make your system for the site fit for purpose, right? Your metrics that you're measuring, how you schedule production is all caught in this like management processes that we we assess for most of these companies have none of it just hanging whiteboards and having structured discussions in front of whiteboards and planning out your day and scheduling better. You can implement that initiative in one to four weeks. And one of the guys on our team, Ben says you can't avoid a whiteboard, we put a whiteboard because you can't avoid it, right? Everybody wants to put this in Excel and make some interesting. Put a whiteboard up, it's a six foot by eight foot whiteboard, we made 57 units. So that's the baseline to it. Once you get that OEE up from 40% to 65, 70%, it takes a little bit more technical tools. You're analyzing mean time between failure of little pieces parts. You probably have to hire a process engineer. None of the companies we looked at yet have had more than one process engineer and it probably wasn't the best one. But as you get more and more mature, you need more and more technical tools. But the problem is when you go more more technical, you get less with the culture and the hands on the operator. I would rather have 150 operators train, that we've trained to do Kaizen projects, to do single point lessons, to do A3 problem solving. It'll shut the line down, you know, figure out what broke, fix it, sketch an idea, start back up, submit it to procurement. I want like a hundred people improving things versus three engineers in a room, right? It always works better. You do get good enough at some point, you got to do all them. You got to do both. in the to get from 40 OEE to 85 OEE is probably a 10 year journey, seven to 10 year journey. But that's that's literally doubling your plan. Some of the best we look at are like five to 15% OEE. So like you can get up to 30 double you double your output, then get up to call it 50 to 60 add 50% more from that. And it's mean, it's, it's meaningful. Like you, you should never have in most cases, I shouldn't say never. I've yet to find a private equity business that I've toured backed business that I've toured the plant or founder led business, that I would said we have to build another plant based on the growth they have.

Shiv: Yeah, it's really interesting to hear you talk about that. It's like in order to make all of this, these process improvements, you really need buy-in and execution at the frontline because those are the people that are actually executing on this stuff daily. Can't just be done in a room on a spreadsheet. It has to be executed. One of my other jobs that I had back in the day was working at the backend at FedEx and in the manufacturer, sorry, the, package processing area. And we would, there was just so much process and technology involved in order to make that thing run. at the frontline, everybody was super empowered to be able to do certain things. And so you can kind of see why FedEx is as efficient as it is. How much technology are you bringing into these companies like software or, you know, tracking and cameras? You know, there's all these all these innovations happening in the industrial manufacturing sector. Like, are you bringing that into these investments as well? 

Paul: Short answer, not very much is needed, right? So I have a friend of mine that he only does, I think he's like a three or four turn CEO with a 3XX at each time, something obnoxious. He will not do an asset that needs a new ERP. He will do a warehouse management system. But you lose two years if you're putting in a ERP system. probably not, right? Family offices, if you own a family office in the business, it's a little bit different discussion. But the tech I would bring in would be, like a standalone scheduling package that fits down in the shop floor, right? A, how do we get a new product wheel better? What's the most efficient way to do the product wheel? It's, is there a maintenance system, right? That I can put on an iPad with an OtterBox on it that, you know, we've got five or seven, 10 maintenance decks that they can, they can look at it more effectively, very simple, discrete tools that probably aren't adding up into a tech stack, right? And then you want to prepare that. And so the part of your sales story you can get is like this, this company, we've got everything set that if you guys want to integrate it into your ERP, you're good to go. Right. That's, that's part of the self-still. Right. And then they can say, now, once you're over, making this up. When that works till you're a hundred, 200 million in revenue. After that, you're going to have to bite the bullet. If I own an asset that I, you know, we grow from 30 million revenue to 150 million revenue, we will do it. It's a good problem to have, right. 

Shiv: That's a good problem to have, yeah, exactly.

Paul: It's a good probably, you know, we probably did recap it two or three times, it'll be fun. But you lose all improvement for two years. Like what you're lying about. 

Shiv: That's awesome. Paul, we're coming up on time here. So I would love to keep talking. I have so many more questions, but with that said, if people want to learn more about you, where can they go and find you? And we'll also link out your book, but just any details that you can share, we'll, we'll share with the audience. 

Paul: Yeah, so you can find me Paul W. Swaney III on Twitter, also Swaney Group Capital is on Twitter. Shameless plug, we will start Q3 of next year hiring. Our class will start hiring kind of May of next year. You know, transitioning veterans or kind of ex-investment bank, one year investment banking. Application will go out in Q4, early Q1 of next year for a May start. Looking to hire five to seven, maybe eight more people.

Shiv: Awesome. We'll be sure to include all that in the show notes. with that said, Paul, thanks for coming on and sharing your wisdom. Very different episode. We often have a lot of B2B or technology investors, and this was a very different take and I got to explore that with you. So appreciate you sharing

Paul: Super. Love to have you come down to St. Petersburg to the office. happy to, happy to buy dinner. 

Shiv: Only if you take me golfing. Otherwise.

Paul: I got a couple of guys that will definitely take you golfing. Yep.

Shiv: Excellent. All right. Thanks, man.