Episode 72: Chris Sznewajs of Pacific Avenue Capital on Investing in Companies with "Unnatural" Owners

Episode Transcript  

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

Chris: It's going good. Thanks for having me, Shiv.

Shiv: Yeah, excited to have you on. So why don't we start with a background about yourself and Pacific, and then let's go from there.

Chris: Yeah, great. My background is really a good representation of Pacific as well. So I've spent about half my time operating and fixing broken businesses and half my time on the investing side. So prior to founding Pacific about seven years ago, I was at a firm in Los Angeles called the Gores Group. I spent half my time on the operations team, half my time on the investing side. Gores had a propensity and an appetite to do corporate investitures and carve outs. I'll talk about where Pacific Avenue is as well. Prior to that, I spent six years at Bain and Company. I helped build their corporate renewal group. We went in for private equity firms and ran businesses that were underperforming. It was very different than what I did pre-business school, and we'll talk about it, but it was much more operationally focused. We really didn't look at the balance sheet capital structure at all. We spent our time saying, how do we make this business more profitable? And it was a lot of the playbook that we developed there and established there and even some of the folks that I work with there, we took to Gores and then ultimately have helped formed what we've done at Pacific Avenue. Went to business school at Northwestern in Chicago and prior to that did restructuring, investment banking, and a little bit of direct investing prior to business school.

Shiv: Yeah, and I can see that one of the interesting things about your portfolio is that you're investing in different types of industries, right? Like building products and industrial distribution and paper and packaging. So talk about that. That's a different type of, and those are different types of investments in the types of investors we usually have on where tons of people are focused on technology or software companies or tech enabled services. So why have you chosen to focus on, into some of these different areas?

Chris: Yeah, so to your point, there's folks that are geographically focused. There's folks that are sector focused. We are focused on a deal type. And for us, that deal type of Pacific Avenue is unnatural owners of businesses. It's folks that are, just not the right owners of that business and they're ready for a transition. Most of the time that's going to be a corporate divestiture or carve out, but it could be a founder run business in transition, it could be a legacy private equity asset, they're in fund seven, it's a fund four asset, they're trying to wrap up that fund, it's not getting a lot of attention. And that focus around unnatural owners, we think presents itself to a lot of, we'll call it under investment or lack of attention in many situations. And if we can come in and give it that attention, then we have the chance to drive improvement. I would just add, do have, let's call it nine or 10 sectors that we do focus on, chemicals, building products, business services, healthcare services, ag and food, and a few metals and mining, a few others, but those are what we call power alleys. They're certainly not the only places we'll invest. It is much more around the deal type and the nature of the transaction than the sector.

Shiv: And do you find that your approach when you're focusing on these, I guess, unnatural ownership situations, do you find that it gives you an opportunity to find more? I don't want to say bargains, but assets that might be more fairly priced at the very least.

Chris: Yeah, we, the way we think about it is a lot of times when you buy businesses from unnatural owners, there's some complexity that comes with it. And that complexity can come in a lot of different forms. In many cases, there's a carve out. And obviously that comes with complexity. In certain situations, the parent company or it could be a founder run business in transition, it may not come with a management team. Oftentimes, because it's been unloved, under managed, or at least under resourced, the margin profile is below what we would expect. So the complexity that we're taking on, we think allows us to have a bit more of a value slant, it doesn't, it's as a result of the complexity that we're asked to take on. So yes, it lends itself to what may be perceived as lower multiples at times, but for us, it's about, that complexity and how do we get a modest discount for that when when we're taking that complexity on?

Shiv: And how do you identify if a, if a carve out is worthwhile? Like I know there's a ton of value out there in terms of buyouts and buyouts seem to be the most common types of transactions in general, but carve outs seem to be an area that isn't talked about enough, but there are a ton of opportunities where there are these companies that sit inside other larger companies, but aren't getting the kind of attention you're, you're expressing there. So how do you figure out if a carve out is actually a good candidate to split off and give it the kind of investment that a dedicated company would.

Chris: Yeah, so that is, I would tell you, one of the harder parts of our jobs because by definition, if you think most sellers of businesses are selling it because they think they're going to get peak value, a founder, a private equity firm, and certainly there are some corporate sellers that are selling businesses that it's at the top of the market and they're trying to maximize outcome. But in many situations, our sellers are selling it because it's been deemed non-core, non-strategic. And so now we're in an environment where we are buying something that somebody else doesn't want. And by definition, that means there's probably something that at least they see that's wrong with it. And so we have to do our diligence and say, why is this business unwanted, unloved? And what we come down to and how we ultimately make the decision is there is a lot of corporate selling businesses that are just, not good businesses. They're in industries that are, there's been a technology disintermediation maybe before this week with the tariffs, but there's been Asian imports have wrecked the market. There's some structural reason why they can't be competitive anymore. Those are not assets we want to own. We want to own businesses that are in attractive sectors but may have a story because they haven't been given the resources to be successful. The strategy that they were running was inconsistent with the corporate parent and therefore it's underachieving or potentially underachieving. So it really sits with, we playing in attractive markets? And then can the asset that we're buying participate in an effective way and win in those attractive markets? There's a - we see an endless number of businesses that are, you know, determined private equity melting ice cubes or declining end markets. Those are not businesses we want to own. Those are, there are certain investors that do that, that do that well. They're valuing the life of the cash flow stream. They may not put any terminal value on the asset. That's not what we want. We're valuing, obviously, the cash flows, but the terminal value is critical to us. And that comes with buying in industries that are attractive where we can ultimately have a growing business that's generating a bunch of free cash flow.

Shiv: And so is that the determining factor that the carve out has free cash flow and it has a predictable revenue engine or is more mission critical in the industry that they're kind of operating in? Like, how are you figuring out if what are those some of the good characteristics?

Chris: Yeah. Yeah, ironically, we look for what in a different part of the market, but we're looking for recurring revenue. We're looking for a distinct competitive advantage. We're looking for contractual revenue and we're looking for non-cyclical revenue. Now, you had mentioned the term good free cash flow. Many of our businesses are not achieving great free cash flow. They're not cash flow negative, but they're certainly underachieving. They may be operating at 8 or 10% EBITDA margins and the industry is at 20 or 23 or 25% EBITDA margins. And our job is to get under the hood and say, what's driving it? What structurally is it? And if it's, again, macro headwinds, we don't want that. If it's self-inflicted wounds, the term we use hasn't been corporatized. They wrecked the business for reasons not on purpose, but because they have other things they're focused on, we can undo those things and we can fix those things. So if they're self-inflicted wounds, they're in industries where, again, traditional private equity loves to play because ultimately we're going to sell this business. Recurring revenue, non-cyclical, potential for high free cash flow, contractual. Those are all the attributes we look for. We have to look under some more rocks to get there, and it's not perfect when we do it because by definition, we're buying businesses that people haven't invested behind.

Shiv: So how do you underwrite a deal like that where maybe there isn't a management team or the company hasn't or the thing that you're carving out hasn't gotten the type of investment that you would need to figure out. Is this really a truly good business that has the potential to grow? Like how are you figuring that out?

Chris: Yeah, so there's two components to everything. One is, and the most important is price. Depending on the level of complexity, There are businesses, we've done carve-outs where we've had to hire over 50 people. We've had to hire full management teams. We've had to build sales forces. We've had to move manufacturing footprints. That's a complex level of carve-out. We're in the business of making money for our investors, and so we have to adjust that complexity and price it into our business model. How do we practically say, is this a business that we can fix? That's where our operations team come in. And so I talked about my background at Bain and then ultimately Gores on the ops team there. And then as I formed Pacific Avenue seven years ago, we have a very, very detailed ops playbook and it tears apart the income statement and the balance sheet. And we start at the very top on the income statement and we've got a set of modules and we look at it and say, okay, for revenue, what are the components? Well, it's volume and price. Okay, what can we do on the price side? And we've got some pricing experts on our team. On the volume side, okay, what can we do? Do we need to look at e-commerce? Do we need to look at our go-to-market strategy? Do we need to look at our product portfolio set? Do we need to look at our sales force and our sales force incentive? All those different modules, we do that on the revenue side. Then we do the same thing on the cost of goods sold. Where are we sourcing? What is the makeup of the product? What is our manufacturing footprint? Where can we get better? We do the same thing on the G&A side. And then we ultimately do the same thing on the balance sheet. And we're running our companies through this playbook. And that's the beauty of our ops team. It's an iterative process. We're that in diligence. And then we redo it again once we own it or once we've signed on the business. And what falls out of that is we've got some very clear output around our operational performance improvement plan. And then the probability of how successful we can be improves over time, obviously, as our diligence gets better, our ownership gets better, and we can put the right team in place. And then it's all about how do we resource those initiatives. So everything is dependent on price, right? Because we're in the business of buying assets, but the confidence to know what price you can pay and the confidence to know if you want to own the asset goes back to the operations team and that value creation plan that they can come up with in conjunction with the carve out. Again, those two are almost dueling the carve out and the operational performance improvement plan.

Shiv: Yeah, yeah, that's great. And just to dive a little bit deeper into this. So I get it that the price that you're coming in at makes sense. And ideally you want to be below or at value. So let's say you do come in below value. It's still the thing that I'm maybe would love for you to expand on is that there's still this risk on the carve outside because you're having, let's say you were buying a fully established business and you're buying out the entire company. There's an executive team, proven go to market, product market fit. Net revenue retention, like we can start going down the list of metrics and you kind of feel like it's a really good asset. With some of these carve outs, feels like some of those answers are not there. But so you're kind of having to write underwrite the risk in some way. So how do you do that? Because even if you come in at a below value price, you're going to have you're going to have to deploy capital in order to capture the value that's there and there's inherent risk in that. So how do you figure that out?

Chris: Yeah. Yeah. So I would, you know, in my view and something we're really focused on and it comes through in your questions, there's a difference between risk and complexity. So we're in the business of putting capital to work and, and therefore the only risk that we take is losing capital. Okay. Complexity is carve out, complexity is operational performance improvement plan, but risk and losing capital. So our job is to understand the complexity and then model that into the risk. That's complexity. Again, we only have one risk in our business. That's do we lose capital or do we make money on the capital we invest? So if we can price things appropriately to where we can say the risk profile, assuming none of the things we want to have happen get done, am I at risk of losing my capital? If I'm not, then I'm not taking risk. I'm taking on complexity. And now you step back and say, if I can build my entire organization around managing that complexity, how I structure my transactions, and we might use earn outs with our sellers, we might do other things that we might share in the upside, they may maintain a minority stake so that they're incentivized to help us work through that complexity of the carve out. Obviously the operations team, when it talks about the performance improvement plan, all of those pieces now, I can build my organization to manage that complexity, then I can say, now I'm appropriately adjusting for the risk, which is price, complexity is operational. And it may sound like a distinction without a difference, but we're very careful in how we train our team. Risk is losing capital, that's it. We don't take any other risk because that's what we're measured on. Complexity is all of the other things that move around that do inform risk. And so that's how we come to how do we price our assets because price is how we play with risk.

Shiv: Yeah, that's a great distinction and I think worth highlighting. Are there specific metrics or KPIs or benchmarks that you look at to help you figure out the distinction? And for example, like I understand the risk of losing capital, but then complexity can be something that maybe doesn't have good net revenue retention, but that it has inherent risk with it because to find, let's say 105% net revenue retention may not be possible in certain circumstances. So how do you underwrite some of that and are there certain numbers that you look at to figure out if it's more of a risk question or a complexity question?

Chris: Yeah, so there's a host of things. On the risk side, there is an extreme example. We're rarely getting to this. You're not winning deals at this. if you are paying below net asset value, are you taking risk? And again, you think of net asset value, if it's something we're tracking, rarely are we able to be at that value. And that's certainly not something we're trying to pay at orderly liquidation value. I can sell everything in an orderly process. I can pay off all my liabilities. And if I do that and I get my money back, have I taken any risk? My view is no. Now, of course, if my analysis is poor, then I'm taking risk. So that's the extreme end. Again, that's not how we buy businesses, but that's kind of the benchmark of, that's where I know I'm risk-free in theory, assuming my analysis is right. Then on the operating, so and then from there, it's okay. What are the market comps of a business that's underperforming it? By definition, what I love about where we play is we focus on unnatural owners. Ultimately, that's a lot of carve-outs. When you get a carve-out done, we've done over 50, our senior team, you expand the buyer universe and with the expansion of the buyer universe, you create value. So we have a high degree of confidence. We've never had a failed carve-out that we're all automatically creating value. Now, is that enough value to satisfy the return thresholds that we have in our investor's desire? No, but that gives us some protection. We can, we know a business gets a discount in many cases for a carve out. So what is that premium or return to more market normal multiple once the carve out's done? That's part of what we're quantifying. What discount do we need? And that can be as low as 5% and can be as high as 25 or 30% from a normal market multiple for us, depending on the complexity of the carve out. And then on the operational side, it is about probabilities. I walked through at a high level, the different operating levers that we're pulling. Our team has done a really nice job of finding a way to say, okay, here are the things I'm confident I can get done. Here are the things that I need to do a lot more work. And here are the things that they are out of whack with industry norms, meaning our competitors and the peer group are achieving at these levels. I don't know how I'm going to fix and get to these levels yet, but my instinct tells me if I change some things, I can get at least closer to that. And so a lot of our underwriting is, look, we have the stuff that we know we can change. That might be cost takeout, that may be pricing. Then there are the things that we feel good about, but further diligence. And then there are things that they're not right. They're definitely underperforming relative to the comp set and the peers, but I don't know how we're going to get there yet. And we apply a different probability to each of those. And that helps us say what can we get at. But we spend an exceptional amount of time understanding where the industry is and understanding where the peer group is and saying, okay, what are these guys and what is this company doing that's working well and what is this company doing that's not working well that's leading to a suboptimal or less than benchmark result?

Shiv: And as you, that's great. Thanks for that walkthrough. And as you think about building value inside these companies and the process that you go through, what are some of the most common areas and like, is there an order of operations that you're looking at? I think you touched on some of those pricing and cost takeouts, but walk us through that.

Chris: Yeah, so if we start with the end in mind, our belief, this is not, there's nothing science to this, growing businesses sell for more. And so yes, there are times where corporates are fat. They've got costs to take out. That is honestly not often. Corporates are generally have wised up to the game of being efficient on the cost side. It's how do you reinvest in this business so that it can grow? In theory, we've underwritten and said to ourselves, okay, they're in a growing industry. So why are we not growing and what investments do we need to make to allow us to grow? Sometimes that's R&D, sometimes that's just the go-to-market strategy, sometimes that's a sales force. There's some really unique things that corporates do that don't make a lot of sense that impact the business. And if you're an entrepreneur or you think like an owner of that business, you would never do them. We, our emphasis, of course, we like to cut costs. If it's available, I will tell you that may represent 20% of the value creation plan, oftentimes less. It's almost always with the lens of we can then reinvest that back into the business. That may allow us to go do some add on M&A. That may allow us to add an extra R&D person. That may allow us to add three more salespeople and cover this geography better. That may allow us to invest on an e-commerce site. That may allow us to do marketing that we need to do to win. Or, that may allow us to buy the next piece of equipment so that we can be more efficient. We take a much longer term view of payback and it is with the lens of growing businesses sell for premiums. We want to drive growth. We purposely bought in growth industries and if we can do that, we can win. There is no consistent theme. Look, we love price, right? Price is great. It drops right to the bottom line. In theory, it's very quick. You gotta be smart about it. You have to make sure that you have the reason. Obviously our businesses typically compete in competitive markets and so you have to provide a better service. And so you always gotta go back to first principles. Why and how am I gonna be able to get price? And what do I need to do to ensure that? So there are very few quick levers. It's much more peeling the onion back and then saying, okay, what is driving these things? What is creating the lack of margin profile and then what do I need to do to resource it and what do I need to do to win.

Shiv: How big of a role does your ops team play into that process and how much are you leveraging them to build a value creation plan?

Chris: We are not leveraging them. They are building value creation plan. So they are the team. One thing that's very important to us is the M&A team, our investing team does not get disconnected though. So the M&A team is responsible for leading the deal. They're responsible for directing and working with the ops team, but it's a symbiotic relationship. Now we step back and at the end of the day, my job is to hold our investing team accountable for their deals. And if they make money, they're on the good side. And if they obviously don't make money, we need to change it. The ops team is a resource for the M&A team. And if the M&A team isn't comfortable with what they're getting from the ops team, then they don't get any excuses. They've got to go figure out what they need to do to make this investment successful. Now, that being said, if our ops team is being underutilized or they're being outsourced and we're using somebody else, then clearly we don't have the right ops team and we don't have the right relationships. We don't have that issue. We have an exceptional ops team. They’re our partners at the table. They're developing the plan in conjunction. The deal lead and the ops partners are setting the strategy. They're both sitting on the board. But there is one throat to choke. That's critical to our investment approach. But our ops teams are, they're, they're huge. They provide massive amount of leverage, both in the carve out and the value creation plan. I'll just add one piece that I think is important part of our culture. When we close or sign a deal, the deal lead of course stays involved, very involved. The ops partner gets intimately involved. Our ops associates, and we're typically putting two associates on every deal, now report directly into the ops lead and the deal lead. And they are the resource for the ops lead. And we purposely said we're not going to build a junior set of resources for our ops team. We want our deal guys to be great at the ops side as well. And the best way they can do that is learn from the top ops professionals in the industry, which is our team. And so when they are making investments and they're saying, yeah, this is a complex carve out, they've been in the middle of it. They've helped set up the payroll with the operating partner. And it forces us to have a lot more associates because our associates, 50% of their time may disappear for three or four months when we close a deal. But they are really learning what it means when you buy a company. so that now when they go back and they're assessing in diligence, yes, people say that's a complex carve out. Now I know what it means and what it's gonna take and what complexity I'm taking on so that I can price that when I'm setting what we're gonna pay for this asset.

Shiv: Right. And when you're, when you're diligencing an asset, are those same ops folks helping you figure out the potential inside the target investment as well?

Chris: Yes. Yeah, it's been a big shift in our firm. For a couple of reasons, we didn't have the resources and two, we didn't have the program. But today, our deal leads are at the discretion of when they bring the ops team in. But what we're finding is if we can bring that ops team in earlier and they can provide, it's really a one pager of their work for the value creation plan. That then gives the deal team more conviction to how they want to play a process. Typically, that can help us pay more, that can help us decide, we really want to dig in and run ahead in this process and play to win is the term we use. So they're getting involved early and earlier, still at the discretion of the deal team. But that conviction is helping them go to the IC and say, hey, I want to spend a million and a half dollars. I think we can win this business because here's how much the opportunity set is. And we're going, yeah, great. And without that, the investment committee is going, do we really want to spend the money? What are our chances of winning? How are we getting there? So that integration is critical.

Shiv: Yeah, yeah, and I'm seeing that pattern across all kinds of PE firms where ops folks are getting pulled in early into the deal process. How much are you leveraging your ops team, but also outside consultants and firms as part of that process on the value creation side?

Chris: Good question. So we have a couple different ways we work with third parties. Because we're generalists in nature, we're looking for a deal type as we talked about. Obviously, there are sectors we go deep in. We partner with operating executives who have specific sector knowledge. And when we say that, what does that mean? That means they can help us recruit talent into the organization because they know people in the industry. They can help with M&A because they know who the add-ons are and the players. They can help with customers and suppliers. So they have real functional expertise by industry, which obviously in many cases we lack because we are general. Those folks are involved. We say, know, the term we use, they ride shotgun with us in diligence, ultimately hopefully will sit on the boards with us if the deals get done. That's a key piece. On the third party consulting side, it's a huge piece. So we have subject matter experts on our operations team, but we believe that there are functional expertise by sector that are better. So we have a couple of sourcing partners that we work with that are fantastic. And those sourcing partners, some are really nuts and bolts, running reverse auctions for us on commodity procurement. Others are, hey, we look at the makeup of your product set and we're saying, how do we decontent? How do we create a different supply chain for you? We've got folks that are experts on the freight side. We have individuals that, at times we've got some pretty good pricing expertise, can be helpful on the pricing side. In certain situations we have carve-outs that are either too resource intensive and we may use third parties to help program manage that. So we are definitely using consultants. That is typically at the discretion of our operating partner who's saying, I don't have the bandwidth or we need this expertise to go do it.

Shiv: Yeah, that's one pattern that we've seen is that even when you have capable operating partners, they can only go to a certain level of depth with every company that they're involved in. And sometimes a much larger transformation or analysis is required. And in those cases, external folks are brought in. Talk a little bit about that. What are you doing post-closed? Because you're building this value creation plan during diligence with the ops team, now the plan actually needs to be executed on. How do you approach the operationalizing of that or the execution of that?

Chris: Yeah. So, and I'll go back to the dual themes. There's the carve out side of the world and then there's the operational performance improvement plan. Those two are converging and competing for resources at all times, at least in the early stage. So first it starts with management. We are fortunate and we buy businesses in a lot of cases with great teams and some cases without teams. In some cases with individuals who don't have aspirations to run a standalone business, but, it starts with putting the right team in place And once we have the right team in place and the right incentive structure in place, then then we can get rolling on on the the dueling past the carve out So carve out is critical. You have to stand up the business, you can't fail at that and you got to get that right and we've got a actually implemented some really cool software that allows us to track it There's a dashboard that that I is managing partner can pull up on any deal at any point in the carve out and okay, where are we at? What's green, yellow, red? Where are we missing things? And we've got a communication style that works with the deal team. The carve out's obviously more tactical and so you can do that. On the strategy and the value execution plan, it starts with getting it all on a page. So once we own the business and once we have the team in place that we want, we're pulling massive fact bases together. We're getting into the trial balances. We're understanding sales trends. It's almost like a data dump of all of our diligence that we're putting in front of the management team. And now we're saying, okay, here are the modules. Let's go through, is this one relevant? Here's the data that supports it on the trends. Hey, these seven customers we've won with and we're growing share, these three we're losing with. Let's dig in and understand, hey, again, what's driving our success or our failure? And then it's all about getting it all on a couple of pages so that that strategy on a page it's then now making sure that that translates into our ops team and our deal leads are having weekly calls with our management teams What are we doing there? Then it's in the monthly operating review, which I'm sitting on almost every board What is what are the key levers that we're trying to pull? and the operation side and making sure that they're a priority for the whole management team and then obviously to board meetings as well, quarterly board meetings. So each level, it's a consistent and constant kind of what are our priorities? I'm a huge believer of it. If it's a priority, we spend time on it. And if it's not a priority, we don't. In multiple occasions, people will hear me say, did we agree this was important? And people are like, no. And I'm like, well, you guys keep talking about it, but I'm gonna leave the room because we all agree that it wasn't important. I'm not gonna spend time on this. The answer is if it's important, let's put it on the list. If it's not important, let's not talk about it. We don't have time to not focus on our most important things. So it's ruthless prioritization and then execution with resourcing.

Shiv: Yeah, I think that's such an important skill is just saying no to even good opportunities when you have a focus area. One follow up I had as you were walking through that is as you're looking at these carve outs and you're working through some, it feels like a really big transformation in some ways, right? So how do you as a fund or as a firm set expectations for what you want to see happen in year one, year two, as you kind of go through your whole period here with these assets, like, because expectation setting, even just to get a management team in place, can sometimes take three to six months and they have to find their stride. Like just that piece is like half a year for sure. And so how do you look at expectations?

Chris: Yeah. Yeah, well, I'm even going to go back a little bit further. It starts with putting the right capital structure in place because our businesses are going through massive transformations. And so we're not going to be buyers that are putting five and six turns of leverage on our businesses out of the gate where we've got very tight covenants and we're underwriting to kind of a perfect pro forma adjusted EBITDA where we need everything to fall into place so that we're meeting our covenant requirements. So it starts with just giving the business breathing room to do that. Then we work really hard. talked about the right team, but putting the right incentives in place, there is no ambiguity. We are very clear to our partners and our management teams, here is what we're trying to get to. Here is what we think we can sell this business for. If you disagree, of course, let's have the debate. And here is what this means for you. Okay, and so that end state is in mind from the day we meet the team, where we own the business, I should say, or sign the business, when it's a new team, when we're recruiting professionals, we have a one pager and we were saying, every 1% of the equity, it's worth $4 million or $5 million if we do these things. Now, that's the output or the end state. Now, what are all the levers to get to that end state? And that's where that checking in comes in. look, you are absolutely right. First year budgets are a mess. Take the carve out standalone, all of that. take oftentimes or in certain situations, a new management team. And so what we're doing is we're ensuring that our management teams are getting bonuses if they're doing the right things. We're not worried about numbers. We don't worry about quarter to quarter. We don't have to. That's why we built the flexibility into our capital structure out of the gate. We look at every situation and say, something isn't right. That's not a risk. That's an opportunity. That's something we get to fix that we get to drive performance improvement from. So it starts very much with the incentives, very clear expectations of the end state, and then, now we've got to get to all the steps to say, if we're a 8% margin business, how do we get to 22% margin? And if we get to 22% margin and we grow at 6%, here's what that means. And if we do that, here's what we can sell it for. Here's all the support. We had a big session last week with the new management team on a deal and we laid it out. We had Banker come in and pitch what we can sell this business for if we hit these certain metrics. And for us, it's commonplace. Like we know that, we expected that. The team was blown away and they sat there and said, gosh, you mean if I can cut another half million of costs and I'm gonna sell this business for 12 times, I'm generating six million of value and guess what? The team has 10% of that, so we're gonna get $600,000. I'm really, really excited to go do that now versus before it's just, hey, we need to cut costs. And so just bring it back. We want folks who wanna get paid. That's how we work. So creating very clear incentives to make that work.

Shiv: Yeah, I love that answer on the capital structure because it's almost, it sets up the culture and how you're going to handle this because a lot of firms will put too much debt on an investment and now they're kind of handcuffed. And there's no way around working fast or hitting aggressive sales results or actually generating a certain amount of EBITDA that and then you might need to aggressively cut costs in order to kind of get there.

Chris: Yeah. And it doesn't allow you to take some of the bets or the harder decisions that you have to make. You know you hear this theme, but risk is investing capital structure. And then there's the operations. We're constantly trying to marry those two to drive the right returns, but they're inseparable. But they have to be broken down to their own individual pieces.

Shiv: I guess the flip side of that, and I'm curious because as other investors listen to this, I'm sure they have this question, is the benefit of adding more leverage is that it helps you improve your internal rate of return and it's easier to kind of cross a hurdle rate. So how do you kind of navigate that? Because now you're deploying more of your firm's primary capital to generate a return. So how do you see that?

Chris: Of course. Yeah. Well, I mean, you got to be smart on what you pay for the business. That's step one, because if you overpay by definition, you got to more leverage on it than you want. So you have to be disciplined. And two, you got to get a lot of operational improvement. And so one of the things that we're really proud of is we may over-equitize our businesses, but our ability to return capital quickly is critical. When I think on a pre-fund basis, we did five or six deals, if our investors gave us a dollar, we were giving it back to them in 13 months on average. In fund one, if our investors give us a dollar, we're returning it on average in about 18 months, certainly within 24 months. So folks have a bit more of an appetite to say, okay, you may be over-appetizing, you're de-risking, but if I'm getting my money back quickly, obviously you can still drive a very high IRR and our returns are top decile. And so we're excited about that and our investors are excited about that. But you got to buy it right, you got to buy it appropriately, and then you got to drive that operational improvement. And we work really hard at a stated goal of doubling EBITDA on every business we buy. That is not simple, but we're trying to buy big assets of scale where there's a lot of levers to pull.

Shiv: Yeah, I think that's such a crucial point because firms that are obsessed with IRR and putting debt on to optimize for that, it's almost like you get into too much of a financial engineering exercise more than a value creation exercise. And I think kind of what you're saying is, yeah, we're going to take kind of a structural risk to put more of our equity into a deal, but we believe so much on our value creation plan and our ops team and the strategy, that long term it pays back more because we're generating more value for the companies that we're investing.

Chris: That's right. That's exactly right. You got to take a longer view. Again, for us, if we get that capital back quickly, it takes that pressure off as well because we're returning capital and we're proving to our investors that value creation has happened. When you return capital, you get your money back. You know you've created equity value. Now it's just to the upside. And then look, we go back, business is carved out, the right team's in place. We've started to approach the margin profile that we like. We have no problem putting a what I'd call a more traditional private equity capital structure in place. We just don't feel the need to do that on the buy because of the, I'll call it the trauma that we're running our businesses.

Shiv: Yeah, that is awesome. And I think I would encourage a lot of firms that are listening to actually think about this more because I just find that PE firms in general are not investing enough into value creation. And that's really where alpha has generated. So I appreciate you sharing that. And with that said, we're kind of coming up on time here. So Chris, like for you, just what would be the best way for folks to reach out and connect with you or learn more about what you're doing over at Pacific Avenue?

Chris: Yeah, so we did launch a new website about a month ago. My contact information's on there. I love talking to founders of firms, guys and gals just starting, folks that have established their firms. To me, it's a bit of lonely position. There's not a lot of folks I can talk to that have built firms. And so I love when folks reach out and we're excited about what we're building. It's very early days for us still. And we've got some exciting deals and some additional fun things that we're working on that hopefully we'll announce over the next couple of quarters. yeah, it's been a fun ride to this point. And I feel like we're in the first or second inning of what we ultimately want to accomplish.

Shiv: Yeah, that's awesome. And Chris will definitely link the website and your contact information and all that in the show notes so that anyone listening, whether it's a founder or another firm can definitely reach out and connect with you. And with that said, I appreciate you coming on and sharing your wisdom. There was a lot in here that I think other firms can learn from. And even myself, as I'm thinking about carve outs and some of the things that you talked about on capital structure, I think there's a lot of great takeaways. So appreciate you doing this.

Chris: Thanks for having me. Appreciate it. Great dialogue. Thank you.