On today’s show, Preston and Stig talk to private equity investing expert, Doug McCormick. Doug has been an investor in Private equity for two decades. His firm in Washington D.C. manages over a billion dollars and has a track-record of success in the industry. Doug is a graduate of West Point and Harvard and serves on multiple non-profit boards. Doug is also the author of the book, Family Inc.
In Today’s Show You’ll Learn
- How does the private equity model work?
- What happens when a private equity company makes an acquisition?
- Why has private equity industry outperformed the stock market and will it continue?
- Which critical factors determine if a takeover is successful or not?
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Podcast Transcript and Summary (automated)
Preston: [00:01:01] All right so how’s everyone doing out there. We’ve got our special guest here with us: Doug McCormick. Thanks so much for coming back on the show we had such a great time the last time we talked with you so we’re excited to have you back.
Doug: [00:01:14] Glad to be back and had a lot of fun last time as well. Not as much fun as the Warren Buffett annual meeting but still a lot of fun.
: [00:01:21] Hey since you bring that up. We’ve got a group we’re going out there again this year and we’re really excited about the event. Tell the audience quickly about the event since you brought this up. What what kind of stands out in your mind about why a person should go to this. Because there’s a lot of people that listen to the show they hear that it’s fun. But like from your vantage point Doug what did you get. They’re going out to the meeting.
: [00:01:44] Yeah well first of all I would say this is it. It’s a very big very well attended event. And I think having a chance to go with you guys because you guys know the whole circuit you know where to go where to stand in line how to get good seats. So first of all if you’re going to go you’ve got to go with you because you guys got it wired. That would be the first. The second thing I’d say is listen I think it’s a chance to see history. No other investor has been as successful as Warren Buffett and he’s not going to be around forever. And just to be able to watch he and Charlie think and respond to questions Was absolutely amazing. And then the social stuff is equally good. So it was it was a thumbs up then all around.
: [00:02:29] Let’s go ahead and dive into our questions here. We’re talking about private equity and you’ve been in this space for a little bit and you understand it quite well and so I’m really excited to have you kind of teach our audience some of the things about private equity because people hear this terminology and for a lot of young people maybe just for us fresh out of their undergrad or something like that they hear private equity but they really have no idea what that means. So if you could just give us a simple definition of what you think when you hear private equity. And then if you could share how you got into the space it might be interesting for some people.
: [00:03:02] Sure sometimes describe it it’s almost easier to talk about what it isn’t. So you know very simply put. Private equity refers to making investments in equities securities in companies that are not listed on the exchange like the NASDAQ or the New York Stock Exchange.
: [00:03:17] If you want to list on an exchange like one of those there are a number of criteria you’ve got to meet regarding financial performance liquidity governance and essentially these requirements ensure that there’s enough interest and information in the marketplace to have a liquid market right so private equity investors are essentially pursuing opportunities that don’t meet the size liquidity or information or governance requirements. And as a result you see some very different attributes and these kinds of investments so I think there are five worth noting. The first is lack of information. So there’s no equity reports no published financial statements. You’re really making decisions only on the diligence that you’ve done as buyer and the information that’s been shared to you by the seller and so that makes underwriting much more difficult. But it also makes for a much less efficient market. So that’s kind of one key difference. The second is everything’s negotiated. So when you think about a public market all the terms of an equity offering are a debt offering are set and the investor determines the price. In a private equity situation you’re negotiating not only the price but you’re negotiating terms and conditions. Things like governance things like interest rates if it’s a contractual return et cetera. The third would be governance. These type of securities are often take a while to get into they take a lot of work. And so private equity investors generally buy a meaningful portion of the company. So a minority or a majority stake. And along with that significant portion comes some level of governance or control or influence. The fourth duration. On average I think private equity investors expect to be in their investment for five or six years. Compare that to average whole period on the New York Stock Exchange well under a year. So I think those are those are the four biggies.
: [00:05:12] So we hear about private equity in the news all the time and you also hear about venture capital. So could you please explain the differences and the similarities between the two.
: [00:05:23] Yes so I actually think the way I would describe it is I think venture capital is a subset of private equity so private equity are all things not listed on exchanges like we just talked about. And then within private equity you have growth equity which is a business model that’s been established but looking to really scale you’ve got venture capital which is a lot of the early stage stuff that we you know think about in Silicon Valley and then you’ve got things like leveraged buyout which are big mature businesses and often because they’re mature they can afford to be financed with debt.
: [00:05:55] And then you’ve got a bunch of other smaller kind of niches like turnarounds like mezzanine financing which is private debt capital but all of those strategies kind of play in the overall private equity asset class what would you say for this base.
: [00:06:12] Where do you think most private equity people. Well like what kind of market cap.
: [00:06:17] That’s really interesting. So first of all it’s a classic conversation around means and medians right. So if you think about means the averages are skewed to the very big and there’s some very big private equity firms out there KKR Carlyle Blackstone for example and they would be dealing with very very large companies billions of dollars in enterprise value. Having said that there’s probably about 4000 private equity firms out there and if you look at medians most of those private equity firms are focused on much smaller businesses like good American businesses that are not in urban areas but are a critical part of today’s economy. And those have you know kind of enterprise values while under 100 million.
: [00:07:00] We talk about enterprise value a lot in the public markets. When we talk with to be allowance unsticking I use that as one of our main metrics for filtering results and trying to find the best undervalued Pyxis using the enterprise value of the eBid. I’m curious is that how you typically look at things from the private equity side or are you looking at enterprise value a lot versus just like the value of the common stock.
: [00:07:24] Absolutely. We look at you know enterprise value relative to metrics of cash flow and depending on the business there may be slightly different metrics to look at. But to your point enterprise value to eBid I think is probably one of the most important and you know essentially enterprise value loss allows you to think about the value of the concern.
: [00:07:43] Absent capital structure could you please elaborate on that. Because it goes into the debt structure of the company and why it’s such an important starting point to have.
: [00:07:52] You know I think you know as we talk about the big landscape of private equity and we talked about leverage buy out as one of those. And so those are more mature businesses more stable businesses. One of the ways that that part of the asset class drives returns is they finance the transaction with a significant amount of debt. And you know I would argue it’s often appropriate because those businesses are slower growth businesses but more mature less earnings volatility and you know the analogy I would make is it’s the same analogy as buying a house. You know if you bought a house with no financing and the House appreciates 10 percent your equity went up by 10 percent if you bought a house with 90 percent purchase price financed with that house goes up by 10 percent you’ve doubled your equity money. Same concept in financing leveraged buyouts and there are there are numerous benefits to that. The first we talked about is you know you leverage your equity investment. The second is you’re providing a cheaper lower source cost of capital and then the third is there are tax deductibility issues with interest. And so when you add all those things together it can really help drive attractive returns for that part of the asset class.
: [00:09:04] So this is my impression of private equity that has grown a lot in the last couple of decades and that might be true or false. I’m kind of curious to hear your thoughts on that. If it is true why has that occurred and why is this become such an attractive asset class for investors.
: [00:09:19] No doubt about it. This asset class has experienced tremendous growth. So if he had defined the asset class by assets under management in the 2000 timeframe the entire market was about 600 billion of assets under management and today that’s approaching two and a half trillion. So you know kind of a 4 x growth here and as I mentioned there are now 4000 firms approximately in this market space very simplistically I think the number one reason the asset class has grown is it’s been an attractive returner. You know there’s lots of firms out there that estimate what kind of market return looks like for the asset class and most reports would say that that private equity asset class has returned you know three to 400 basis points in excess of a broad equity indices. So if the Russels doin 10 percent on a long term basis private equity is kind of done 13 or 14 percent. So I think that’s the number one reason things have grown. And you know as you kind of think about why private equity is it is interesting or why has performed well. Couple of comments first of all it should. Right. This is a very illiquid asset class. There are risks associated with being the asset class so if it’s not returning better than the public equity markets where you can turn around sell tomorrow if you don’t like the way things are going then it’s not going to you know be a smart investment. But I think at a very high level there are some things that make this asset class sustainably attractive.
: [00:10:47] One is the overall supply and demand equation you know there’s a lot of capital out there and there’s certainly a lot of capital that’s come into this market but it’s also a very big fragmented market in terms of where this money can go reside in terms of the deals. And so I think the supply demand equation has been favorable to private equity. You know I talked about the inefficiency of this market in terms of there’s no information out there and that makes it very challenging to get good deals done. But it also creates real opportunity where we think you can find real value because of just the inefficient nature of information. Another aspect of why this is such an interesting asset class is it it actually solves real problems. And what I mean by that is when you’re trading stock in the market it’s buyer and seller directly as a secondary share and the company is really not a participant in that transaction. When you think about private equity you are solving a corporate finance need capital or a company needs capital to grow. And they’re raising capital from you or a founder or an owner needs capital to execute a succession plan or a consolidation strategy. And in all cases I think those are win win scenarios not just buyer and seller where one wins and one loses. And so I think that’s a big contributor as well.
: [00:12:04] So if we have this one scenario where you as a private equity company would go in and just outright Baliol a company and you will just get all that net income back to you. Basically everything would be business as usual and you won’t really interact with that company. Then the other scenario you would be really obvious is that the private equity company will go in send the experts perhaps even since the management and basically not only get the strategy but also all the nitty gritty operations. What are we closest to are those two scenarios.
: [00:12:40] If you have to say what a typical case would be like it should think about we just described how this markets experienced tremendous growth and as it’s experience tremendous growth it’s matured a lot as well. And so you know I generally break it down into three stages when people first started doing this in the 70s and the 80s. The real value driver was price price discrepancies real discounts to the public markets and then in the 80s and 90s a lot of the value was driven by leverage. And you were able to get much higher leverage reeds at that point. And so you could finance a much greater percentage of the deal with cheap capital. And in today’s market I think both of those two previous sources of value have been kind of commodities if you will and to be successful you’ve got to be a really good underwriter which means you need to specialize in certain industries where you have a competitive edge and then you’ve got to figure out how to drive value or do something different with that asset over time. And so lots of firms that develop different strategies for that but common strategies are bringing operational expertise to the party or bringing unique industry expertise to the party so you can really help grow the business. And so I think to a certain extent organizations are evolving to be strategic buyers and they come at it from a financial perspective but they’ve got to bring more than capital to be successful interesting.
: [00:14:00] So I would imagine that you’d see a lot of private equity firms really specialized in certain niches. Is that is that true.
: [00:14:07] Yeah I think it’s specializing in niches or specialized in a business model. So you can define your core competency as we know everything about aerospace and defense. You could define your core competency as we know certain types of business models distribution transportation let’s say. Or you could define your core comps.
: [00:14:25] As you know we have operational capabilities to drive you know enhancements and operations talk to us a little bit about the negatives because I think a lot of people that would hear this be like wow you’re getting 3 percent more than the than the public markets. This sounds like a lot of fun and really interesting stuff but like what are some of the negative sides of private equity that I think a lot of people maybe don’t think about or miss lack of liquidity.
: [00:14:51] Right. So these are generally 10 year limited partnerships. And so you know the duration between the time you invest your capital and you get it back is going to be a very long period of time. So you kind of got to be comfortable with park in this money for a long time and not expecting to get at it. And if you do need to get at it in many cases you’re taking a significant discount to avoid that liquidity. The second thing is you know we talked about this inefficiency in the market lack of transparency that also exists in terms of trying to find investments as a retail or an individual investor. And that’s good news and bad news but it’s very hard to identify good deals. And candidly it’s very hard to identify good teams. So if you think it’s challenging to underwrite a business where you can see the business you can see the financial performance and you can evaluate the businesses it performs today. Imagine trying to underwrite a team that’s going to invest in those kind of businesses and you’re trying to evaluate consistency of strategy quality of Team Teamwork team’s ability to source deals and add value. And so that’s a challenging process as well. The last thing I would tell you about the market is I think averages are deceiving and what you see in the market. I think it’s one of those markets where persistency of performance is very high. And what I mean by that is if you look at the public markets and you look at top quartile performers in the period let’s say a year or five years and you compare that to top quartile the next period the pull through between high performers in both periods is often relatively low. But in the private equity space you see persistence where if you are a top performer this period you are likely a top performer in the next period. And I think that’s indicative of an inefficient market. But what I also think that means is it’s very hard to identify good managers and it takes a long time and a unique skill set to do that.
: [00:16:45] Is that because they just get a bit of deal flow.
: [00:16:47] I think it’s they get better deal flow success perpetuates success. And I also think they continue to develop their skill sets and their capabilities. And you know this is an area where you’re not just competing on capital you’re competing on human capital. Right. So I think a lot of times at least in the market that I’m in which is the lower end of the middle market entrepreneurs are not only picking capital solution they’re picking a partner and as they evaluate a partnership they want to work with people they like people that they’re aligned with and also people that they believe can help them build a better business.
: [00:17:23] So I know if if I was young and I was listening to this and let’s say I had fifty thousand dollars in my pocket I’d be wondering how can I invest in something like this. Like how how is that possible and is it possible. I’m kind of curious how you see that.
: [00:17:38] Yeah it’s absolutely possible. And I think it’s a mixed bag candidly but there are a number of very large private equity firms that over the course of the last decade have gone public so KKR Carlyle Blackstone Apollo I think all those four are public now. And so you can participate by buying an equity interest in a business that’s investing in private equity. There are also apps out there that are you know investing in those kinds of businesses so that’s an option. We started off the conversation by talking about what a great time we had at the Berkshire Hathaway annual meeting. I would argue in many ways you know Berkshire is a private equity holding company you know. So you think about some of the big assets that they own and bought Burlington Northern Heinz Geico. I mean those those are essentially are private equity plays. And so that’s an interesting way to play private equity. And then you know I think there are there are some ways that individuals can play directly not to a private equity investment professional but was angel investing networks out there I think investing in real estate in some ways is a private equity play and then many of us are involved in families that have family businesses and to some degree that family business is private equity interest.
: [00:18:52] So you’ve been in this business for a long time Doug and you both seen the successes and also the less successful ventures. So what would you say if you could come up with the common denominator of what separates the good deals from the bad ones.
: [00:19:08] Yes I guess the first thing I’d say is if anybody has been in the business a long time and they’re not talking about both their good and bad deals they’re not being genuine here because everybody is kind of both sides of that equation. And I think the first thing is it starts with good underwriting. You know. It’s often in this business when you’re a long term investor it’s hard to win on the buy because you buy so well that you’ve really created value but you sure can lose you know Warren Buffett as one of my favorite sayings which says when a management team with a reputation for brilliance tackles a business with a reputation for bad economics it is the reputation of the business that remains intact. So very simply put you know good managers it’s hard to overcome a bad industry even if you have a good management team and that good industry good business model starts with good underwriting. I will say the second thing though is because you’re a long term master. You’ve got to have a good team to go execute and take advantage of the opportunities in every deal that I’ve been involved with. Even if they’re good deals there are always periods of struggle and so you’ve got to acknowledge that.
: [00:20:09] And you know put the team in place that can execute against those those struggles. And I think competitive advantage is ephemeral. So you know if if you’re not continually moving continually improving your competitive edge is often you know kind of quickly eroded. The other thing that I see is when we underwrite something. There are a number of unknowns but I take a lot of comfort when I see situations where there are multiple levers for improvement and I essentially look at that as if I’m buying a decent business with embedded options and what I mean by that is there’s options to growth through acquisition. There’s options to grow geographically through opening new entities. There’s options through pricing or through supply chain management. And so when I’m underwriting that I don’t know for sure which of those options will present themselves to me. But I take a lot of comfort in. There’s numerous ways to kind of drive value in this business and we’ll figure out you know of the five we’ve identified two three or four that can really help get us home. And then listen I think in every good deal there’s some element of luck.
: [00:21:13] Talk to us more about you brought up competitive advantage. This is another big buzzword that Buffett and Munger always talk about as an enduring competitive advantage. I know from my own personal investing experience this is something that I think has matured where I didn’t realize how important this was when I first started investing but now when I look back I think that that’s one of the most important things that I can look out next to price and all the others. But this competitive advantage piece is so important can you explain why you also think that that’s so important to the audience.
: [00:21:47] I’m I’m a work in process and you know my experiences caused me to think about things differently. But you know I have a lot more confidence in my ability to underwrite the quality of a business model than my ability to underwrite growth in a market. So for example you know you think about trying to project GDP growth or the growth of an end market like oil and gas or commercial aerospace. I think that’s really challenging and in many ways it’s a little bit like a coin toss but if you asked me to underwrite what makes a good business model and you think about the attributes of that once you’ve identified that I think those attributes are likely to be persistent. So for example we look at things that have very low customer concentration. We look at businesses that have barriers to entry. We look at businesses that have relatively high variable costs because that allows you to navigate changes in the marketplace. We talk about value in terms of multiples of cash flow but we talk about quality of businesses as a product of return on tangible capital how much cash flow the tangible assets of this business generate. And so I think that’s a much more durable way to underwrite and get comfortable with the investments that you’re making and you’re obviously looking at the trends of those and how they’re progressing over time I’m assuming as well. Absolutely yeah. And you know it’s kind of interesting. All the analytics are quantitative and they focus on the metrics but it’s easy to forget that those metrics are driven by people. And so you know it really is a combination of financial capital and human capital that create a successful situation.
: [00:23:25] Now I’m curious when you think about a discount rate for the business that you’d be looking at one of the frustrations with a lot of people that are Warren Buffett style investors that are doing these calculations for intrinsic value and things like that they go to a business school and they’re doing these cap and models and they’re using the prices of other businesses and the volatility of other businesses to determine what they think the risk or the discount rate should be. You know my personal opinion is that that approach is so backwards. I’m kind of curious how because in private equity I would think you’re not doing no cap M model you’re doing what you think your risk is and then you’re assigning that as your as your discount rate.
: [00:24:07] Let’s talk about DCF and discount rates and cap in general so it’s tremendously theoretical. And so it’s interesting but I think it’s interesting not because of the answer it gives you but because of the process that forces you to explicitly make assumptions.
: [00:24:22] Right so when you’re doing that analysis you’ve got to make assumptions about growth rates you’ve got to make assumptions around exit. And so those are all valuable accesses to kind of worked through. But I think the answer doesn’t really drive how we think about what we’re going to pay. So first of all the great thing in the private equity market is you pay a combination of what you think it’s worth but also what you think you have to pay right because again it’s a negotiated transaction. So we think about the analysis we do as what can we afford to pay what’s the top end. And then if we can we obviously try to do better than that. But as we think about the actual modeling you know we think about it in the context of a five year hold period what can we pay assuming a certain capital structure. We’ve been out in the market we’ve talked to lenders. We know how much leverage they would provide at roughly what rates. And then we do a forecast over a five year period and we generally assume we’re going to exit the same multiple that we bought in at. And the combination of those things drives a certain return profile and we would expect on deals that are in our kind of wheelhouse that those pencil out somewhere in the 20 to 30 percent IRR over a five year period kind of timeframe. So you know that is a a planning process not necessarily you know the gospel but that’s how we think about the process.
: [00:25:45] And do we have an internal rate of return model for this. In other words a threshold of how much return you’re expected to get if you invest in this opportunity.
: [00:25:55] Absolutely. No it’s for us it’s not so much in theoretical what is the cost of capital it’s what’s the IRR to the investor.
: [00:26:03] Yeah that’s where I just get so frustrated with academia’s because and I think this is the frustration that Buffett and Charlie also have because they talked about it at the shareholders meeting every year as you know the price were you. You’ve come to some type of agreement as to what you think the price should be within a range. You’ve done your estimate of what you think the future cash flows are going to be like. You’re not going to not do that. So the only unknown that’s left that you’ve got to solve for is the discount rate. So you’re like solving for the discount rate whereas you know you go to I guess I’m on a rant here but you go to these business schools and they’re doing the calculation in reverse where they’re solving for the recalculating what they think the discount rate should be which in my opinion is the risk that you’re assuming by buying at that price right.
: [00:26:52] Yeah I think I think there’s merit to it in the context of it allows you to figure out another data point in the marketplace right so I can look at similar businesses that are public similar business models and see how the market has kind of evaluated that risk profile. But it’s datapoint right. And I wouldn’t put more into it than that. We look at multiple data points we look at just straight up multiples of cash flow. We look at IRR we look at DCF we look at pressin transactions we look at public comps and then this is where it becomes more of an art than a science. I think you look at all that stuff and figure out what’s most appropriate.
: [00:27:28] There was a great response thank you. So Doug now that we heard about some of the good deals that you made I don’t want to put you on the spot I guess yet undoing anyway. Could you tell us about some of the mistakes that you made some of those deals and perhaps even some of the things you complete neglect it in whenever you did your due diligence of the company.
: [00:27:49] Yes. So first of all I think let me go back to one thing I said when we were talking about good deals all these deals have challenges so you got to expect them you know we kind of joke it’s there’s no such thing as a 20 percent Bill. You know we’re pricing these assets with an expected high return and implicitly that means I’ve got significant risk here. And so I think a lot of the game in my mind is setting yourself up to avoid long term impairment. And what I mean by that is you know these things will go through cycles and there’ll be tough times but if you can avoid long term impairment you generally can find a way to work your way home to a decent outcome or at least an outcome where you haven’t lost significant capital. Where I find you run into real impairment risks. That’s hard to navigate through. I think businesses with real customer concentration can lead to real drivers of impairment. And then you know we talked about capital structure and that drives a better return because I’m using leverage the reverse of that is if you’re too aggressive with capital structure and you hit a bump in the road it’s very difficult to kind of course correct.
: [00:28:58] And so you know we think about leverage as a double edged sword. We want to use it to leverage returns but we try not to take the last dollar to give ourselves kind of a zone of error or a margin of error in a way that we can navigate you know kind of Murphy’s Law if you will.
: [00:29:14] And listen we talked about teams on the positive side teams bad teams can be an opportunity or a liability if you find a situation where you have a bad team if you’re willing to make changes that actually can be an opportunity. But I think you’ve got to go into the deal knowing that you think change out the management team and be committed to doing that. But I find generally you know on the deals we struggled with we thought we had a management problem we probably didn’t act soon enough.
: [00:29:40] Talk to the audience about the term impairment so they understand the terminology they’re centrally.
: [00:29:46] Think about the stock market you know the stock market goes up the stock market goes down. And I still have value. The good news is the concern has not been impaired and over time I can still kind of grow my money back if you will and impairment essentially means you’ve permanently diminished value in the asset. So a good example is a bankruptcy right at that point in the cycle you were forced to turn over the keys to another owner essentially. And so there’s no way you can kind of overcome that impairment.
: [00:30:17] Ok so Doug you have written a book and Stig and I have both gone through your book Family Inc is the name of the book and writing a book is really time consuming. I mean it takes a lot of effort to put a book out there and when you look at the revenues that a book generates it’s often not worth the effort to write a book. So the reason I ask this is because you’ve dedicated so much of your time and energy to writing a book and I’m curious what motivated you to do this like why did you put this out there for people.
: [00:30:52] Yeah well so first of all let me let me make this reaffirm something you said I’m pretty sure that I’m violating minimum wage laws. If you look at how much I’ve read in the book versus the hours invested so that I can promise you there’s not a money making event. And unless I did it because I’m passionate about the topic and I think there’s a big opportunity to have an impact on people and really change the way people are thinking about financial literacy I argue it’s one of the biggest challenges that we face in America today. There are so many trends out there that are making it harder for people to navigate their life in a way that’s financially secure. You know it’s job mobility it’s wage stagnation it’s increasing cost of education it’s diminishing social safety nets and it’s increased life expectancy. You throw all those things together and the skills required to create a life where you’re financially secure are dramatically different than they were 20 years ago. The problem is we’re still we’re teaching this topic the same way we did 20 years ago. And so my book is really an attempt to give people an actionable framework where they can make good decisions for themselves and help identify the big decisions that really impact your financial security over a lifetime.
: [00:32:07] You really have these awesome tools on the Web site and you will definitely link to them in the show knows where. It’s very clear that you look at yourself and your family as a business and you know it’s all lined up with findings of statements that you can directly apply. I don’t know if it’s because I know you and I know your background but I couldn’t help but think Is this not just seeing yourself as running your own company perhaps even a private equity company. Is that the right to protection of that that’s absolutely correct.
: [00:32:44] And you know a little bit of history on how some of the key concepts of the book of all for me my inspiration for the book is a product of my experiences as a young private equity investor. And so I’m working on a number of portfolio companies looking at making investments and what I realized is many of the tools and analytics that we were using to assist the portfolio company could actually be applied to my personal finance situation. So you know essentially I are we’re all in the business of selling our labor into the market. So you’re in the business of you I’m in the business me you can make that leap then the same kind of tools and logic apply that you know we teach folks in business school we should be thinking about that in our own personal financial decisions. Now I’m not saying that means you need to make every choice that is the financially optimal choice but I think at least it forces you to understand the financial implications of the choices you make.
: [00:33:39] So for me personally whenever I started my own business and I and I had to do my own income statement and my own balance sheet and cash flow statement and I was literally you know doing the double entry accounting on my company. That’s whenever I personally felt like my understanding of how to assess the value of another business just kind of went exponential and it was very helpful for me to be doing those calculations and figuring it out because when I looked at another company’s books I was like oh well that’s that right there is not good because in my own personal accounting when I would do that that would be a really be a red flag. So what I love about these tools that you’ve developed is that you’ve basically allowed any person off the street who doesn’t own their own business to basically be doing these financial statements on their own on themselves. And I think this is my personal opinion for people listening. If you go in there and you play with some of these sheets that is developed you’re really going to improve your understanding of how financial statements work. It’s going to help you when the next time you look at a public stock or you know maybe you get interested in private equity some day all this stuff is going to really help you understand the value of a business and to understand the plumbing of how the the money moves through a business how it moves through your personal finances. I just I love it so I’m just you know if I could give it a plug for people I highly recommend that you check out these tools that develop well thanks pressin and for you for what it’s worth.
: [00:35:09] I agree with you. You know if I can encourage folks in school to take one course that they can be an accounting course and not because you want to be an accountant. But it is the tool. It’s the communication the language of business. And I think it just gives you so many such perspective as you apply it in other fields. And so I think you know causing forcing yourself to sit down and kind of think through what a person’s balance sheet looks like and include non-traditional assets like lifetime value of labor lifetime value of Social Security and think through what the implications of those things are on your investment choices. I think that’s a really valuable exercise. You know I encourage people to do it periodically so you can see progress on the balance sheet or essentially accumulation of net worth. Having said that just you know if if that’s not your thing if you do it once and force yourself to kind of look at it I think that’s still very eye opening.
: [00:36:01] So going back to the background. Very curious to hear how you would equate that to a buzzword like intrapreneurship which is something that you always hear these days so you intrapreneurship on one hand then accuracy and another. How similar do you see the up in the end.
: [00:36:20] Yeah I think I think it’s there are very similar activities on different ends of the spectrum but so first of all I consider myself a private equity investor. I consider myself a financial entrepreneur.
: [00:36:33] And essentially what that means is my skill set is not technology or software my skill set is capital and I’m trying to apply that in an entrepreneurial environment. And so you know I would argue if you’re an entrepreneur and you’re trying to create a business you still are taking your intellectual property and your human capital and you’re combining it with financial capital to create a business and in that case your primary tool is your intellectual property your human capital. I’m kind of coming at it from the other side of the equation saying I’m trying to find businesses that have a capital need. My primary tool is the capital but I’m also using my intellectual capital and human capital. And so I think it’s almost a matter of mix you know so an entrepreneurs kind of nine parts human capital one part capital and a private equity investors you know probably 9 parts Capital One part human capital but it’s really they’re both very similar activities. When you think about taking an idea strategy and operationalizing it through labor and a combination of capital.
: [00:37:39] All right. So I’m really curious to hear your response to this one here. If you could go back to being 22 years old you could you could meet your 22 year old self. How many. The phrase this if you can go back and meet your 22 year old self you just graduated from West Point. You just threw your hat and you could give yourself just one two pieces of advice about investing. What would you have told yourself knowing what you knew back then what would you tell yourself.
: [00:38:09] Oh man so advice about investing. So this is my advice to young investors. I think you’re asking right.
: [00:38:15] Yeah well and so and after you’re done with the investing advice what would have been your life advice. So I want to get that next. OK.
: [00:38:22] All right. So so you know I think young investors make a couple of common mistakes. The first is return over dollars.
: [00:38:31] And that concept is everybody focuses on IRR. People want to talk about my return on an investment and in percentage terms I think dollars gained is a much more relevant metric. And so I don’t want a 20 percent return for six months that’s 10 percent. Big deal. I want to invest in businesses where I can compound for long periods of time which results in multiples of capital returned. So you know 20 percent for five years returning multiples of capital that’s the name of the game. And I didn’t you know early on. I think I thought about return and be damned what the duration was.
: [00:39:10] And I think duration is another concept that is hard for young people to deal with but the name of the game here. You know Warren Buffett talks about time as patience and conviction.
: [00:39:20] And so when you believe you’ve got you know your well-founded in your conclusions you’ve got to have patience to let the market do its thing for a young person that’s often very difficult.
: [00:39:31] All right. And then if you need a moment to think about this one feel free. So what is the life advice I want to hear this one.
: [00:39:39] Yeah I honestly it’s a little bit of the same applied to your personal situation not your investing situation but it has to do with duration and I think being able to think long term being able to make choices that have long term payouts is a real competitive advantage strategic advantage. And I wish when I was 20 I had thought more about what these decisions would what the ramifications of these decisions would be when I was 50. And I think when we were 20 we think about what it’s going to be like when we’re 20 and a half. And so forcing people to think longer term.
: [00:40:15] You know Bill Gates has a really interesting quote I don’t know if you’ve ever heard this. He said people way overestimate what they can do in one year and way underestimate what they can do in 10.
: [00:40:25] Yup yup. I think it’s right. And I think that’s a real competitive advantage. It’s a real competitive advantage as an investor if you’re able to look past the noise of a year and think about 10 year time horizons. It’s a real competitive advantage. As an entrepreneur you know just a life life choice as well.
: [00:40:43] Thank you for the response Doug. I can definitely say for me I wish that I had applied both of those two pieces of advice when I was 22 and just running out. So my last question is a question that we are always very excited to ask of authors. What is your favorite book and why.
: [00:41:02] You know I don’t know if it’s a favorite but the one that I’m most interested in right now and have really enjoyed. It’s called Lead yourself first. It’s inspiring leadership through solitude. And this is written by a guy Mike Erwin who’s who happens to be a buddy of mine. But essentially Mike studies leaders throughout history that have used solitude as an important tool for creative thought using your moral compass emotional balance and confronting tough problems. And so he studies people like Eisenhower Martin Luther King. So I love the historical aspect of it but I also love the timeliness of it.
: [00:41:39] You know I think technology has a lot of unintended consequences and in today’s environment if you don’t purposely carve out an environment where you’re going to not be disturbed and you can have good quality solitude I think it’s very hard to have any kind of deep creative thought these days. And so it’s a book that I enjoyed but has been impactful in the way I’m trying to spend my time today.
: [00:42:02] Doug we can’t thank you enough. Brilliant answers here. And if people want to learn more about your they want to check out some of these tools work and they find that.
: [00:42:11] So the name of the book is Family Inc. Using business principles to maximize your family’s wealth. And I have a Web site so that’s Family Inc. Dot com Am I I’ll y.
: [00:42:22] I see dot com and as you we’re so nice to to describe there’s a bunch of tools there that help an individual create financial statements as if they were a business. That’s a balance sheet and income statement. And I think just going through that exercise Wolf for she to think a little bit differently about you know things like your labor assets.
: [00:42:41] So it was worth the time.
: [00:42:44] Thank you so much Doug. You really enjoyed the interview. All right guys. That was all the Preston I have for this week’s episode of the SS podcast beseechingly again next week.
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