32. What can VC and PE backed operators learn from each other?

Brandon 0:05

Hello, everyone, and welcome to another episode of the operations room a podcast for CROs I am Brandon Mensing. A joined by my co host, Bethany airs, how are things going, Bethany?

Bethany 0:17

just struggling for a second, like, do I be positive? Or do I be honest?

Brandon 0:25

Again, business choice always isn't it to you, you have your actual reaction. And then you're like, Alright, I need to put my business hat on.

Bethany 0:32

Exactly. I'm recovering. I would say I had a bit of a tough weekend, we found out that a friend of ours died unexpectedly on Thursday. And unexpected deaths are always difficult. So just still processing I would say rather than good or bad. Often with a death you think about like your life and how lucky you are. But this time, it's just taking a while to settle in my body, maybe let's say, I'm just not processing it very much. So I ended up with a mixed weekend accidentally getting way way too drunk on Saturday night, not realising at all that it was a reaction to the death until probably noon on Sunday. And I'm like, Ah, yes. That bottle of whiskey at one in the morning. Seems like such a good idea.

Brandon 1:25

guards come down slowly when unexpected events happen that are tragic. That magnitude?

Bethany 1:30

Yeah. So feeling really just shattered. I would say like it's the weekends happened. It's Monday slept well, last night, but tired and processing.

Brandon 1:40

I think when there's unexpected deaths that matter to a lot, it is hard to figure out how to know how to react to how to feel sometimes. And also just like coming to grips with what's actually happened. It's confusing. Yeah,

Bethany 1:52

it's confusing. And not necessarily is like the chipper thing that everybody's tuned in to listen to today. But I just didn't think I could

Brandon 2:04

think for myself, I went out to go see Richard Gibson from air Avena. He's the chairperson there. And he's been the chairperson for about four years. Now I went to their office, which is fabulous. By the way, it's right downtown, right in the theatre district. And it's really nice to see Richard because he was the former chairperson for SwiftKey, where I worked for about four or five years, we had a really close tight relationship, I would say. And I think we're both kind of similar personality types, which is a little more level headed. And I would say logical, but just a little more reflective on what happens in businesses, I think sometimes we had a good shot. So we have this kind of funny conversation just about relevance of your career. As you get older and how you become this feeling grows inside you over time that somehow you're becoming less relevant overall to your job and your career. What happens, millennials taking hold and kind of management positions and so on, you started feeling like somehow your relevance to tech is kind of fading, I guess in some respects?

Bethany 3:01

Oh, that's interesting, because I thought you were gonna go in a different way of like, how relevant is your career stay to your life. I was at a customer success conference last week, and ended up speaking to two other women who have also opted out of the workforce at similar points in their career to me, and we end up having a big conversation about identity, and how much of work is part of your identity or not. And now that they're embarking and not working, what is their identity and who are they? Which I guess is all kind of like layered on top of of each other? It's interesting for me, I hadn't realised that work had stopped being my identity until I after I left peak, but I kept like, if I would go into on a podcast, I was introduced, and people are like, Oh, it's the COO of peak Bethany airs, I would just cringe and I was like, why am I cringing so much? Why does this feel so uncomfortable? I thought it was like you humbleness or lack of ego, of course, you know, saying they have lack of ego. So it's a really good way of proving you have ego. But when I realised that it was, I was so uncomfortable with it, because it was just not part of my identity. And it was only after I left peak and found leaving so easy, that I realised that part of it was easy for me was it hadn't stuck. And so maybe this is like all a relevant conversation, starting with death is one of the ways that I test what is my identity? And how do I identify is, if I were to lose that thing in my life, would it change my identity? And so, if something horrific happened, and I was no longer a mother, I know that my identity would still be being a mother, I would just be a mother who didn't have children. Just horrible to even say, where as if my husband and I were no longer together. I would be very sad and I love him, but it doesn't change my identity, like in no way is being a wife part of my identity. Yeah, being American is.

Brandon 4:54

I think sometimes when you work in organisations, where you're a senior level executive, you have people reporting into to your budgets, there is some level of importance placed on you in terms of the rest of the organisation. And you're kind of viewed that way, it makes you feel like you matter. I think the feeling that you get from that, for the most part for a lot of people is that the more you have of that, the more you matter. And this kind of gets to the nature of ambition and why people have ambition to begin with sometimes, which is they want more, they want bigger teams, bigger budgets, bigger sizes, and it's never big enough, and it never ends. You know, and I think to your point, being in a position in your life where that kind of mattering doesn't matter anymore. Now, it takes a bit of like an evolved sensibility, I guess. And I think a lot of that sensibility tends to come with age because you, you realise your life is finite, you have a certain amount of time in front of you. And the question as to what actually matters, versus kind of superimposed conditions around you in terms of companies and whatever else that kind of come and go. And what's left after that to your point. That's the essence of, I guess, maybe what you're saying, which is who are you? What's your identity? And what matters to you? What what's important to you? Absolutely.

Bethany 6:01

And I think it comes with age and the experience of how fleeting the things that you really want are and then how empty or back to normal you feel afterwards. So the first fundraise so exciting, the first big fundraise, it was for us Bessemer 35 million, like, Wow, there's so much money, what can we possibly do that's gonna last us forever. And it was hard, hard earned, like I've never worked harder in my life, including giving birth to two children. And within a week, Bau everything is returned to normal, that 35 million now has to get spent, all the pressures on the next quarter is still in front of you. And the euphoria and the joy is just gone immediately. And over and over again, new car, new house, like everything that you think you want, as soon as you have it will Joy doesn't last very long. My engagement ring is my only exception. Like every single time I put on my engagement ring, I still love it.

Brandon 7:04

I put my ring on every day, actually in the morning, I wear it all the time. But when I go to the gym, I take it off for gym workouts because it gets in the way of deadlifts and whatever else. Afterwards, I always put it back on. And I have a similar sensation a little bit, which is feeling of like permanence or relationship when I put the ring back on. And I get that every day or at least Monday through Friday.

Bethany 7:24

So like what matters versus a car. And

Brandon 7:28

then just coming full circle back to the relevance piece. I think there is a key part of this, which is if you have financial freedom, it gives you the the opportunity to kind of think in ways that you do I think to be honest, because if you don't have financial freedom, you're really thinking about this question of relevance. Do I continue to have the right skills? Do I continue to have the right abilities to work within these companies and to be highly effective and get paid what I get paid? Essentially, what is this question of mentorship is so important, I think in people's lives, whether you're younger in your career or older in your career, where having something that can really reflect back to you, and help you think through challenges and issues that you're having and concerns that you have, from a business point of view, I think is incredibly powerful and incredibly useful and very much underused by a lot of people. And then the other piece, when I work in companies really historically, it's always been heads down. And by being heads down, I didn't do networking, per se, but I did a little bit but really not a tremendous amount. And kind of like the whole learning thing kind of goes by the wayside outside of what I'm literally learning day to day, week to week in the business itself. The notion of allocating a time, an hour or two, to read a book or to listen to something that is not directly going to benefit my company. I just stopped doing allocating time in my calendar just like I do for my workouts in the morning. allocating time for some level of networking, some level of learning that isn't directly relevant to the company, but more generally is useful for myself in terms of the direction that I'm heading has to be maintained and just prioritising that and calendaring it effectively whereby it actually happens, then it makes sense.

Bethany 9:02

I always love when I connect the dots or my brain connects the dots between completely unrelated things. And so I feel like there's always learning to be had that is not obvious. It'd be some other concepts sitting in a different world that you can suddenly pull in and see a pattern or see a way of addressing something. I feel like this happens to me and my life on a nearly daily basis. And this is something else has happened as I've gotten older, she's been very aware of my energy and what's energy giving, neutral and energy sapping and sometimes you just have to, if something doesn't naturally happen, and you feel like you have to force yourself, it's probably because it's massively energy draining and then it's like it goes into the should pile. For me it sounds like networking for you is a bit of a should pile rather than a energy generating one. So are there other ways that you can meet People that is not networking ways that you would actually give you energy and happens to have the added benefit of meeting people. All

Brandon: 10:09

right. So we have got a wonderful topic today, which is how does I see oh achieve success and a p backed business, we've got the perfect guest for this. And Sam Smith, he is the founder and managing director of pep talks where they focus exactly on that, which is how to get management teams up to speed on P expectations. So with that, let's go on a quick break. And when we come back, we will be back with Mr. Sam Smith.

Bethany: 10:38

I am delighted to welcome Sam Smith of pep talks to the podcast today. Sam has an illustrious career working in and around the private equity space. And we thought it'd be really fun to spend some time sharing what it's like the VC world what it's like in the PE world, for all of us who are always curious about whether or not it's greener on the other side. It's certainly more lucrative on one side than the other. I would say. Welcome, Sam.

Sam Smith: 11:06

Thanks, Beth. Good. See, for

Bethany: 11:08

those of us who don't know a lot about private equity, which for our listeners, I think we'll just call PE for ease for the rest of the episode. What is the commercial model?

Sam Smith: 11:19

Well, there are a couple of commercial models, there's the commercial model by which private equity as an investment case, need themselves to return to make money. And then there's a commercial model that's slightly different for each portfolio company. But if we just take the example of let's just say the three of us want to establish and set up our own private equity fund, and let's call it pep talks, capital, I quite like the sound and ring of that, if we were to do that, what are we going to do? How do we get started? And what does the business need to look like? So we need to go and raise some money. And let's target 500 million, because that's sort of classic mid market private equity, fund size. Here in the UK, there are other versions of private equity. There's the sort of mega buyout, large cap sort of private equity world, which you get to hear about a lot in the newspapers, and how they operate is slightly different. And then there's this sort of turn around private equity world, which you might also hear about, I'm generalising for the mid market, which is the largest segment of the private equity world, you're talking about investments with enterprise values of anything from 20 million to five or 600 million, you know, that's a sort of big chunk of the private equity world.

Bethany: 12:29

A quick question on that is you're talking about enterprise value in the VC world, we almost always like we understand valuations. But we mostly think about recurring revenue. So what would be the recurring revenue of a 20 to 500?

Sam Smith: 12:45

The valuation is based off an EBIT, da number, and EBIT, da number and a multiple number. And the multiple is set really by the market. So what other businesses in your sector and industry have been sold for recently over the last 12 to 24 months, that really sort of sets the multiple along with a whole load of other things, which we can get into later. But really, valuation Evie is based off a multiple of EBIT dA. So some of them are recurring revenue, but they're not really multiples rarely does happen. Rarely are they multiples of revenues.

Bethany: 13:19

I'm trying to get a feel for what a 20 million to 500 million you said was the top end of mid market,

Sam Smith: 13:24

they would be doing sort of between 2 million of EBIT da, one and a half to 2 million of EBIT, da, two 50,000,005 100,000,600 700 million enterprise value businesses probably doing closer to 50 6070. Even up to 100 million of EBIT da multiples vary hugely across different sectors, shapes and sizes of businesses. So tech tends to get really high multiples anything with good recurring revenue streams, it's going to get a higher multiple, but you know, professional services, recruitment, those sort of sectors might get a multiple of six, eight times EBIT da versus 15 to 20 times. It's really, really broad. And there's a private equity fund out there for every size of transaction. So if we just go back to the idea that pep talks, capital wants to raise 500 million pounds, we need to raise 500 million pounds as our private equity fund to go invest. We're going to do that by going to a bunch of institutional shareholders, we call them LPs, limited partners. So we're a general partner, venture capitalists, probably a general partner as well. And we go out to limited partners to go and sell them. Our story really, in our story is an investment strategy. We will have a strategic approach to doing deals. That could be we're backing first time entrepreneurial businesses and that lower enterprise value sort of range to professionalise them to really gear them so they can accelerate their growth. Or we might be doing buying builds we might be bolting businesses together. Might be doing you know many more than Two or three strategic acquisitions might go and do 20 acquisitions in three to five years, it might be carve outs, but the point is we have to go to the LPS with an investment strategy, they're not just going to give us the money. So we have to have a point of difference, because there's lots of people out there trying to raise money. The second thing is we need a track record, they're not just going to give us the money, because we've got a good idea, we need to show them that we have delivered, usually, as partners in other private equity funds, so we have gained our own personal track record, or we might be an investment banking. But we can point to some great successes, where we have taken institutional money, deployed it and returned large amounts of capital, we're gonna go and raise that 500 million, we're gonna go on the road, gonna go and speak to a lot of people, we're going to use a number of advisors to help us do that, we're going to sell our story. And we're going to get the commitments of 2030 5060 100 different LPs are going to commit their money to us. And they come together as a fund of 500 million. couple of key points, though, they're not going to say his 500 million, they're going to say his 450 million, Beth, Brandon, M Sam, and we want you guys to come up with a 50. So usually, they're committing 90%, and they want 10% from us. So that's going to come from our own pockets, that's going to be our money. And it's the money that we've made through our careers, the three of us are going to be the managing partners of this fund. But we're also going to hire a group of partners, and every partner we hire, we're probably going to ask them to invest into this fund as well. And various sort of quite complicated ways that we allow them to invest. It might be through salary sacrifice, for bonus sacrifice, it might be through the course of transactions, it might be a lump sum up front, but everybody in the fund has got skin in the game over that fund is going to be 10 years in lifecycle. And we are going to spend five years and every funds the same every private equity fund has 10 years typically to deploy into return. And we are going to probably spend five years investing five years returning classic on paper, that's what it looks like in real terms. You know, the trains are coming in and out to the station and different timescales, we might bring a business in and sell it within two years, we might bring a business in and not sell it for eight years. But we're managing this fun to deliver return back to the LPS. And really the metric they're going to measure us on is we need to deliver at least twice money back. So we raise 500 million, the pension funds, the Life Assurance funds, sovereign wealth funds are going to expect billion back at least two times money. And if we don't show them along the ways that we're close to tracking to at least deliver two times money, we're going to struggle to raise another fund. And we don't live as a private equity fund through 110 year lifecycle, what we're doing is we'll spend three or four years investing this fund. And fairly quickly, we'll be looking to do some exits through this fun to show that we're deploying money and returning money, and we're doing what we're saying we're going to do. And we might do two or three exits within that 10 years cycle fairly quickly, three to five years in, and then we'll hit the road again and raise another fund. You don't wait until the end of the fund until it's completely mature to go and raise another fund you want to be doing it sort of in transition. So private equity funds will be managing if they've been around for some time two or three or four funds at any one time. So

Bethany: 18:13

all of that is very similar to the VC world. It's just the expected return is different.

Brandon: 18:20

Have you ever seen mixing the tracks so to speak, so if you're a venture backed company, and at some point of the venture train, because you need to feed off that venture trade in terms of your your next round, getting to the right metrics, say getting new investment and moving on to the next round until you theoretically IPO in this case, or you fail on a pathway somehow enough to sell off to a strategic investor and so on. If you ever seen a venture company get off that track, and somehow restructure the company to get on the private equity track. So the VC company isn't meeting astronomical expectations. They've stalled out to some extent, but it's still a big and reasonably sized company and reasonably successful, maybe not on the VC scale. But on kind of normal scales, I guess. Is it actually possible and have you seen a venture backed company transition over to private equity?

Sam Smith: 19:05

Yes, you definitely see venture backed businesses transition into private equity ownership. And sometimes with the sort of real unicorns you might get some private equity money sitting alongside venture money, but it's rare. It's definitely rare because private equity as a transaction is using debt as an instrument. So a classic leveraged buyout, a management buyout, typically is using debt in the transaction to fund part of that transaction. And if you're using debt, you have to be cash generative, you have to be profitable, because you've got to pay the interest on that debt on a quarterly basis. And ideally, you want to be paying down that debt through the course of the investment. So it's very rare. And I would say that those venture businesses have to be into that highly cash generative, highly profitable, and some of those go that way. The big difference for us if we've got private equity capital, pep talks capital The big difference is that we need to two and a half times return out of every deal we do. So venture, I think we'll look at a deal and say, Okay, well, we know that 80% of these aren't really going to work. We like these businesses because of their model and their sector, and they're looking to sort of change the way their industry works. And they could be unicorns that we know, statistically, we've got a 20% chance or 10% chance of getting a great return. But when we do get a return, it's going to be astronomical, and it's going to pay for the rest. That's not how private equity works at all. If you get private equity investment, as a management team, they are expecting a very minimum of a two times return. Because otherwise, we're going to be out of business, right, we're not going to have to raise another fund. And

Bethany: 20:41

I think that's where when I alluded to how lucrative one is versus the other, it comes into play, there's an element of risk and an element of glory. So in the way that the VC world works, there are many more businesses, there's a lot of money floating around, but as an exec, you're most likely not going to make a life changing sum of money, or very few people will, because you don't actually own very much of the business. And the chances of it becoming a unicorn are quite small. I've been fortunate enough, that might not have been a unicorn, but it wasn't a failure either. So we were able to get some return, and a decent return because that's like everybody always thinks about the failing or the massive homerun, but actually a lot of businesses will do well, just maybe like PE level, well, not VC level well, and but in private equity, you're more cash constrained, you have to run a real business. Well, if you deliver the growth that you need to deliver, you are guaranteed to make a significant sum of money as a management team. If

Sam Smith: 21:47

you deliver your plan, and you delivered the numbers, you will make money as a management team and things as a management team. Yeah. That again, the brackets of how much money you make vary hugely. Again, depending on the size of the transactions and the debt, really, the debt has a significant impact in the capital structure, in terms of whether management make money, pep talks, capital can still make a one and a half times return. But the management team might not make anything. And that's because of the capital structure. That's because of the debt. What does that look like?

Bethany: 22:20

And what are you looking for? Like? How do you know it's a good business that you should join?

Sam Smith: 22:24

Okay, well, the amount of leverage the amount of debt in the business is a good indicator. But let's just say going back to pep talks capital, we've raised our 500 million, we're going to be backing businesses with enterprise values of about 100 million. So let's take 100 million transaction that we found and we're going to do this deal. This is sort of the classic sort of capsule structure that we might go with. So we need to write 100 million pound check. 40 million of that we will capture from bank debt will go to banks or debt funds, private debt funds, and there's a proliferation of these debt funds. Now in private equity market, actually, more debt comes from debt funds than traditional high street banks. But we will go to that bank and say, look, here's this business, this is what it's doing in terms of EBIT da and Cash Generation. And this is the strategy in the plan, will you give us 40 million quid for 40 million quid in terms of the debt package, we need to raise 100 to do the deal. And a big part of the private equity expertise is going out sourcing our expertise and doing deals is sourcing that debt. And structuring that debt in terms of the best terms that we can get in the last 10 to 15 years has been an amazingly cheap, it's been a fabulous environment to do private equity deals. Whereas now it's a lot more expensive. Last year debt rose hugely in terms of interest rate charges, you know, you might be paying 8% on an interest charge on a we call it senior debt on the loan. In the old days, you might have only been charging three 4%. But we've got first thing and we got to do is capture that senior debt 40 million quid The next thing we're going to do is probably put about 55 to 59 million pounds from our fund 500 million pound fund 59 million is going to come out of that and into this deal. But we're not going to structure that 59 million just purely in terms of equity. And you sort of think private equity, surely that's all going in this just equity. No, no, no, we're cleverer than that. What we're going to do is put that 59 million in as a loan Note, so this too, is a loan. The difference between this debt versus the senior debt is as a business, you're going to have to pay an interest on that senior debt quarterly, and ideally pay it down. It's exactly the same as your mortgage, you've got to service that mortgage, and ideally repay the mortgage. With the loan note, you don't have to pay us anything in terms of interest through the course of the investment cycle. But at the end of the cycle, as we exit, you're going to pay us a compound interest rate. So what that means is every year, that debt is becoming more and more expensive. So we put 59 million in three to five years down the track. that business will be owing us a lot more than 59 million back because it's a compounding interest. And typically, loan notes are at eight to 12% on an annualised basis of the debt, so that's the loan Note element that's really important. It's an expensive piece of debt. And the compounding makes a big difference in the management teams, because obviously, if we can get the deal done, and as a management team, we can turn the business in terms of accelerating growth and value into two and a half years, we're going to pay a lot less for that debt than we would do. If it took us six years. To get to that valuation to understand you see, where I'm getting on the last piece, there's only a 1 million left, that's going to go in to the equity, and what private equity are great at saying to the management team, well, what we're gonna do is discount some of that equity, sweat equity for the management team. Because we want your skin in the game as well, as much as we've got so much skin in the game, as a private equity firm 10% of the fund has come from us, we want a bit of this, your skin in the game in this, but actually we're going to make this as reasonably priced as we possibly can for you. So management are gonna have to pay for it and how they pay for it. Again, that's a whole different topic. But it's not necessarily hundreds of 1000s of pounds up front, you might pay for it on the exit, you might pay for it through your bonuses again, you might pay for some of it up front and some of it at the back end, but effectively your private equity are discounting the equity value of this 100 million transaction to bring and stimulate the management team in so that they are energised to really grow this business. And they're sitting alongside almost the interest of the private equity fund. So that's the classic capital structure, senior debt loan note, and then a sliver of equity. And that equity is maybe 10 to 20% of that is held for management 10%. Typically for management teams. Now, that's just roll that forward. That's the valuation when we do the deal, let's say four years later, five years later, we've done a pretty decent job, we've grown EBIT, da, we've probably slightly improved the multiple, we've been cash generative all the way through, and we've been paying down some of that senior debt, that bank debt, and the valuation of the business has gone from 100 to 170 million. Okay, so let's just think of that 100 270 million. How does that break down? Let's say we've paid down half the bank debt. So the bank debt isn't 40 million anymore, it's 20 million. What's really good news for management teams is a big and makes that sliver of equity worth more. Next, that loan Note component that was 59 million, when we did the deal, 45 years later, that's actually can have a value more like 90 million. See how private equity and making money management team aren't making money out of that. That's the private equity return. So now the 60 million left, and that's 60 million, that's the equity value. So the equity value has, has risen significantly, and the management team and let's say gonna get 10 to 20% of that. So that's 60 million, that's going to be six to 12 million going to management team says 12 million. So really, the private equity return is going to be 138 million. So we wrote a check for 100 million using only How much did I say 59 million of our own money. And we've got a return of 138 million 670 million total Levy, gotta give the bank money back management team, we're going to take some equity, but we've got a bad 130 130 840 million credit coming back into the fund. Hey, presto, we've done a great job. Not a brilliant job that isn't okay, return,

Brandon: 28:28

I would still like to join pep talks private equity, it sounds like a fabulous return stamp.

Sam Smith: 28:35

Yeah, yeah, remember, we got to give a billion back, we're gonna turn the 500 million into a billion. So if we're doing 10 deals at that sort of return level, we're just about getting there, we're not going to be making shitloads of money as a private equity fund I'll cells. For us, personally, we're gonna be doing pretty well. But we're not knocking out the park. The tricky bit is under private equity ownership is if it doesn't take us four years to get to that valuation, it takes us six or seven, eight years to get to that valuation, that low note component is going to become a lot more expensive. And secondly, if we're not generating the cash through the growth that we would like to we're still growing but not throwing off as much cash as we'd like, we're not gonna be to pay down that senior debt either. And that's why sometimes management don't make the money because the investments been held for too long. So that's why the management equity might erode in value. Private equity, firms still make a return not a huge stellar return but they're going to you know, it's not a disaster and management are gonna get a much smaller check as a result.

Bethany: 29:36

I think that might be where like, if we're looking to crossover to what can we can learn from the VC world is growth. Obviously we know how to grow spending a lot of money, but I think we've also learned elements of efficient growth, or what growth looks like and how to do it because I now understand the importance of figuring out how to grow as quickly as possible it In a way that's affordable because otherwise, as a management team, you're not going to make any money.

Sam Smith: 30:03

I think what's interesting is that both are trying to capture market share. So a VC backed business is all about capturing market share, isn't it and spending money to do so. Whereas private equity also is trying to capture as much market share as they can but generate as much cash flow whilst doing so. I'm

Bethany: 30:20

not actually sure, I think there's a slight difference. It's some venture backed businesses are looking for market share. But the difference is very, a lot of them are looking to create a market in the first place, and then win the market. And that's where the unicorns tend to come from, versus being in an established market and winning market share, which is why it's expensive. However,

Sam Smith: 30:40

VC backed management teams incentivized, what's the structure look like? Share options,

Bethany: 30:45

its share options. And so it'll generally be so the VC world, for most people in the business will have some level of share options, like every single person from the receptionist through the CEO. But how many share options you have will vary widely across those teams. And then it tends to be structured based on your role, and your salary. So it'll be a percentage of your salary and effect. And sometimes it's structured, sometimes it's not. And then it'll have a, generally a four year vesting schedule. And you'll have top ups throughout the time so that you continue to stay engaged. So every year or two, you'd give your top performers a bit more, then at the point of exit, it depends on what the articles look like as to whether or not you'll actually be able to leave with your shares. I mean, obviously going in everybody's saying that you leave with them, but there's like a good lever bad lever provision. And it depends on if that good lever provision is de facto a good lever, and the business has to prove and you have to be clearly a bad lever, or de facto is a bad lever. And the board can just decide that basically, anybody who dares leave is a bad lever, and you have to negotiate hard to be a good lever. So it's kind of like a something to know on your way in, then, let's assume the vast majority of businesses will treat people well on their way out, I think this might be a HMRC thing, you basically have 90 days. But I don't know if it's HMRC, or just the way the articles tend to be drafted, you have 90 days to exercise your options. And that will be at a strike price. And what the strike price is and how it's been set varies on each set of shares that are issued, or each option grant. And that strike price can be anything from one P to 10 pounds, or 20 pounds. So it could be a check, you barely notice. Or it could be a massive check. And at that point, you have to decide whether or not you believe that it's worth holding on to those shares. Or if you're employed at the point of the exit, you will pay the strike price as part of the sale of the shares. And so you hope that the strike price is 10 P the shares are sold for 10 pounds. And so you earn the difference between the two. And that's quite significant. You then have to pay tax but you know, that's how it works. So you basically don't own your shares until a few years out from when you're granted them. And when they vest.

Sam Smith: 33:35

It's sort of good leave or badly. But provisions are definitely there in our world as well. Actually, the office I'm sitting in where I'm talking to you from is one of our advisory members in pep talks are called Jameson corporate finance. And they specialise actually, you cannot do deals, certainly secondary or tertiary deals as management teams. without some serious advice behind you in terms of your equity and investment structure. If we sell our business that we've invested in 400 million 270 million valuation, we sell it to another private equity fund, which happens an awful lot, the management team will stay in most cases. And what's great for management in this situation is they roll 50% of what they've made in the first transaction into the structure, the capital structure I've just described into the second transaction and they then are sitting in the loan note as well as the equity. So actually a second or third turn for private equity for the management team is brilliant because they're really para pursue against the private equity fund their first time deals, you're usually sitting in that thin sliver of equity at the top of the capital structure, not in the loan Note unless you're an entrepreneur and rolling in. So you need really significant advice as you go through those transactions as a management team to structure to make sure that your your investment is sitting absolutely perfectly alongside the private equity fund. But in first time deals if the management team late Leave, a few of them are good levers. If you're in a secondary deal and you've done a great job, you've got to an exit and you might leave halfway through the next transaction, it's much more likely that you'll be a good lever and that sort of situation. First time deals, probably not going to get a lot of equity back, or even allowed to keep your equity. If you leave before the transaction before the exit, I completely see why you need that vesting. As an incentive, as an important part of the equity incentive and a venture capital back business. Usually as the shares, the equity doesn't fully invest until the transaction, but the typical hold periods are about four years, four and a half years. So back to pep talks capital, we don't want to be holding businesses for too long, we want to be raising the money deploying the money and returning the money in a nice three to five year cadence. And that's a healthy fund a healthy firm with a good transaction track record. At

Bethany: 35:55

newvoicemedia. We raised money every year. And every year I'd be like, cool, more money than we know what to do is and then the next and they will be like definitely don't need another round. Well, this will get us through and then boom, here we go raising again, it is up to the secondary service like yeah, come on, we just never raising like let's let's not pretend that this is the round to end all rounds. But your its value accretive each of these times, right? Like, and this was before the crazy times this was more similar to where we are today, although people weren't quite as risk averse. And so you're looking at a valuation is increasing on every single one of those rounds. And so previous investors have the option to stick or come out, he does, you'll have some of the early sees who might take some money earlier in the process. So you're producing a lot of mini moments along the way. But as a leadership team, you're making way more value for everyone else than you are yourself unless your options or vesting. But it's interesting that you say around like Cliff vesting, because that's used to be how it was in the VC world. And previously, but in America, it became time vested, and ended up moving over to the UK where you just couldn't hire good talent with a cliff vest, because of what Brandon's talking about and knowing that you're not going to see an outcome for 10 years. And so you need to be able to be rewarded for what value you've driven. While

Sam Smith: 37:20

there were two things on there, it takes longer, and the probability the chances of delivering success are less, and the risks are much higher, that it's a much riskier sort of scenario and playing field. The private equity landscape is it's not without risk, but it's a completely different psychology. It's about backing, good, strong, proven businesses, irrespective of size, that can demonstrate they can really capture growth in their market and become dominant players in those markets.

Brandon: 37:52

When it comes to leadership in private equity, what do you look for, for those folks to be successful? And in particular, when you think about the CEO, is there any elements for that CEO role that you really desire and look for to ensure that P company is going to do its trick? I

Sam Smith: 38:08

think the sort of character traits that you want from management teams, there's got to be a degree of entrepreneurialism about them. They're not true entrepreneurs in that they're not starting with nothing and on their kitchen tables, but they have this sort of entrepreneurial element to them. This is an unready here. Again, I'm generalising I'm largely talking about the executive team, but you want to in the management, the senior management team as well. So there needs to be this element of can do will do psychological strength, after belief and commitment that you get from entrepreneurs, you need them to be strategically strong, they need to be able to understand how to shape the strategy and craft the opportunity for the business. But at the same time, they've got to be really operational, they've got to get into the stuck into the weeds. If we think about the mid market, that range that we're investing in, these businesses aren't usually big, and they're bigger than venture, but a few 100 employees, rather than sometimes less than 100 employees at the lower end up to, you know, a few 100 less than 1000, typically. So in terms of what needs to be done in the business to drive value in a very short period of time, a massive amount needs to be done. So these people have to get operationally really stuck in they got to get their hands dirty. They don't need huge amounts of resource around them to deliver what needs to be delivered. They understand how to do that strategically and operationally. So often, they've actually come from much bigger businesses. If you're bringing executives into this CEO role. You're probably from a headhunting perspective, thinking about people who've run businesses that are much larger than this business today. So we go back to our 100 million valuation company, we actually want to hire as investors, we're thinking about the CEO role, we're probably thinking, right? We really want to bring somebody in who's who can run a business. It's more like three or 400 million in terms of enterprise value because they're gonna have that skill set and experience base to really accelerate how we get stuff done in this what has been maybe quite an entrepreneurial business so far. So they could they know how to scale they're like, and I guess the real trick in terms of the CEO role specifically, is as much as you want to sort of triple the value of this business. And that usually means doubling the EBIT da, if not more, you're not looking to double the cost base, you're keeping the cost base as lean as you possibly can. And CEOs in the private equity world, multi sectors, multi size businesses, so we're massively generalising their job, their purpose for being is to really professionalise the operation and allow it to scale without tripling the cost base

Bethany: 40:44

that's really interesting in that you're looking for people from bigger businesses to come in. Because in venture, it's almost always the opposite, that when you get the people who are in from big businesses, and I've worked in businesses that are three 400 people, so it's not size wise that different. They can't handle it, and end up putting too much bureaucracy in want too many resources, slow the business down and put in things that are not valuable. I'm generalising that every so often you get somebody who gets it. But it's almost always the wrong hire.

Sam Smith: 41:19

That's the danger of when you go out to bigger businesses to find those hires, you're looking for a really special person, because the chances are, then they're not going to have that mindset about them, they're not necessarily going to have that entrepreneurial edge that you're looking for, they're not necessarily going to be comfortable with getting completely back into the weeds. But that's the difficult thing about finding talent for private equity. You can't just grab somebody who looks good on paper and talks a good game, in terms of operational professionalisation, they've got to have that psyche about them as well. Otherwise, they won't transition into the smaller business. And then they become a nightmare. It kills it culturally.

Bethany: 41:57

And so then why don't you look more for experienced VC execs to move in. It's like, if you go for big businesses, it's too slow paced, too much bureaucracy. Look at VC businesses, it'll probably be too fast to pace and wanting to spend. But it would seem like it's a closer skill set.

Sam Smith: 42:17

Our world of private equity tends to bracket talent very firmly into boxes. And that's one of the sort of downsides and risks to talent acquisition is that you do ignore people because you have a sort of bias in your judgement, that they're just not going to be able to make that transition. So one of the biases is actually unless you've got private equity experience, as an executive, you can't actually do the job, which obviously we don't believe in, and then we trained private equity backed executives, you can definitely get the theory and the understanding, you do need that psychometric profile of that entrepreneurial, hands dirty, get stuff done, work at pace, and think like an owner. So there should be a sort of pipeline of talent from VC into private equity that as long as they've run businesses have enough of a scale, because that's the challenge. If you're going to double A EBIT, da usually involves going internationally, which I'm sure most venture businesses are doing the same thing. Usually it involves some m&a, you're just taking on challenges that are much bigger and Meteor than perhaps the business has done before. And that's why is this theory we actually need people who've run businesses two or three times the size, and good CEOs and good management teams are thinking about shaping their organisational structure for tomorrow rather than tomorrow being you know, three, five and 10 year Windows rather than this business today. You're not going to be this business today for very long. Well,

Bethany: 43:43

we know that like I just think there's a lot of transferable skills. So I'm gonna sell why you should be looking at VCs or why you should get more of your clients like a VC.

Sam Smith: 43:52

I think in your world. I mean, what I'm really fascinated in this conversation to find out is in the private equity world, you're looking at sort of 1520 30 40% sort of annualised growth. Sometimes you're getting 100% annualised annualised growth, but probably rarely, again, I'm concerned, I'm generalising but in your world, you want 100% annualised growth, that's sort of basis of what you're after. So when it comes to hiring people and building scale and professionalising, you guys, I think are doing it at a much, much faster pace than we are. How does a business double in size in terms of employees in 12 months,

Bethany: 44:27

hire a coo

Sam Smith: 44:31

coo Oh, do that.

Brandon: 44:32

I mean, part of the trick of the trade and this is probably a very large difference between private equity and venture capital back companies. But there's a tremendous amount of effort put into talent acquisition and onboarding for new employees. Because what you are very wary of as a CEO is when you're hiring a lot of people in a very short timeframe, your process by which you hire people, vet people to ensure you're going to the right people with the right talents, the right seats, you need to do a very good job to ensure that when people land you've got the right person. And then the Part B, Part of the plan is the onboarding to ensure that they understand their roles in the company. And they're aligned and focused on what needs to be done. And making sure that that onboarding is watertight from a process standpoint to ensure that they are ready to roll post that onboarding in the sense of they know, their job is then able to focus looks like a lot of the effort that I put in from a CEO perspective is to ensure that we have a strategy, the strategy is clear, the people on the ground are aligned and focused on that based on the structure and processes of the company that we've set up in this case, and taking this very diverse set of folks that have all come into the company within a very short timeframe, and getting them all aligned rules responsibility wise, and also within their functional groups and cross functional groups highly focused on what needs to happen. Do

Sam Smith: 45:46

you use operating models to do that? Is there a sort of playbook that you use to try and drive engagement around value creation, because that again, that's the challenge for us, you, you know, these these businesses are trying to get everybody really focused on, we got to do the three or four things and we do them execute them really well, we're going to triple value.

Bethany: 46:05

The things where venture businesses struggle is to identify and really stick to focus, because the world is your oyster. And it's really scary, because you were mostly disrupting a market or creating an especially that in category creation, figuring out product market fit, how you're going to place your bets on which geography which persona, which vertical you're gonna go after, and then sticking with it and aligning everybody is really hard. And you're also attracting people who are entrepreneurial and excited and have 500 ideas. And everybody wants to do their ideas. And so there's a lot of stripping back and a lot of figuring out what is the most important thing today. So one of the things that we have done is year long strategy plans, and year long OKRs, but then run on a quarterly cadence. And pretty much by the halfway point what you thought was your year long strategy or your OKRs? I shouldn't say strategy no longer is. So I almost think that there's no need to do year OKRs. And you're really pushing in a quarterly cadence with weekly check ins for movement, and holding people to account and expecting changes week in and week out. If you've nothing happens, and you check in at a quarter, you've just lost a quarter of the year. And now what are you going to do? So it's a lot of operational excellence in the detail every day,

Sam Smith: 47:39

I think you guys are probably much better than that than we are driving a focus on value creation is a difficult thing to get right. And in both circumstances, I guess we're flying the aeroplanes and reengineering the engines as we're flying, which, you know, in our world when a business is growing? Well, anyway, this sort of operational bandwidth pressure on the business just to do the day to day, let alone drive the changes through that really kind of sort of make an incremental difference to value. But going back to that talent, point, I just wonder whether you're sort of guerrilla like in terms of techniques that you use to attract talent. Because if you've got to double your team sizes, if you got to hire 150 people this year, you know, I just, I wonder how you do that? Do you have a go to talent market approach? Well, we

Bethany: 48:25

have a talent team, that's one of the first things that you end up doing is bringing talent in totally. And then you were worried about investor branding as much as corporate branding. And you build a pipeline. And you also offer out money for referrals. And so you're good people bring new people in. And it's again, it's like a sales process. So you figure out what your ideal candidate profile is, like, you figure out the markets where the talent is, and then you mark it to those areas, they get very well known. And then that attracts the talent in that

Sam Smith: 49:00

onboarding, as part of that preparing these people to manage because I guess, if you're building scaling that quickly, you've got these quite sort of junior managers then having quite large teams heavy degrees of responsibility to getting stuff done, and they may not have that management experience previously. So

Brandon: 49:18

this is one of the flies in the ointment. I think, to be honest, you have a tremendous amount of young people joining the organisation that don't have a lot of experience in corporate environments, or scale ups in any form. And your line managers are also quite junior to your point. So how you set them up for success is critically important. And I think, what is that job? What does that responsibility look like? What is the person expected to do in terms of being a line manager and being a good line manager in this case, and in previous companies that I've worked for, we've done after the fact remedial exercises to get line managers up to speed. And I think if I was to join my next organisation, this would be higher on the list to be honest to ensure that these managers are going to be successful. And I think a lot of the attitude at least historically, is that we're here to get the job done and to focus on the goals of the company, the strategy, the company to execute our OKRs, and whatever, and why management is a means to an end just to ensure that that focus is there. And what gets lost in the mix a little bit is being in a position where the line manager is, you know, effectively coaching that individual and powering that individual having the right conversations to ensure that there's a level of empathy, caring for the individual, some of that stuff gets pushed to the side of the sentence. And that I think there's just a recognition that needs to be more more focused on it.

Bethany: 50:30

And everybody has to learn quickly, because you have individual contributors who have become line managers who have line managers who have become managers of managers, you have managers who have become leaders, of managers, of managers of individual contributors. So everybody's learning that new technique while trying to deliver while trying to figure out all the rest of the issues. And so investing in l&d, specifically around how to manage is critical. And then also, something that we came a bit late to the party on at peak, I am a huge proponent of is people analytics, I just did not understand how important people analytics are. So that is all of your surveys, Flash reports, looking at your attrition looking at the hiring rates, and really understanding your people data internally as much as what you look at externally. Because that's where you can see how good managers are actually performing because you can track like, who were the unhappiest teams who were the happiest teams, what is the feedback going on from those teams, but it's also critical for any level of Dei. So diversity, equity and inclusion for blind spots are just like who's been put on pips, who has performance management who's being promoted. And when you look at the numbers, you can start to see trends that you don't see as individuals. And so, for me, if I ever do a full time job, again, making sure we have a really good HRIS and people ops person and look at our numbers that internally is one of the first things I'd be doing.

Sam Smith: 52:07

I think that's an area that venture is so much stronger at. And a lot of the businesses that we might back as pep talks capital, have a very sort of low level HR function. That HR function is about managing risk. It's not really about people strategy, we see that businesses that are under P ownership and having to scale quickly, they have to get their heads around. Okay, well, we need a people plan here. And I think, you know, even though your businesses aren't throwing off the cash or generating the profits, yet, you're getting much quicker into that people strategy and organisational design than a first time private equity backed business. And it's a lot to learn from you guys.

Brandon: 52:45

Yeah. And I think the other piece that gets kind of missed sometimes is the efficiency with your talent acquisition. And onboarding is incredibly important, because the amount of time you end up spending on interviews, both yourself personally, but also the wider company is ridiculous. Sometimes, especially if you're hiring massive batches of people, you have half the company's interviewing versus actually doing the work in this case. So being watertight on that interview process to ensure that only the people that are needed to be there are there. But you're also being rigorous enough to ensure you're getting the right candidates in this case, there's a bit of a balance there. But the efficiency part of it is incredibly important. It's a big part

Sam Smith: 53:20

of the CEOs job in your world as it is the CFO, also a bit of a CPO, or does the CPO sit alongside you.

Bethany: 53:29

I think this is one of those difficult to answer questions. It has ended up being a part of the job I think because we're more operate strategically our operational strategy aligned and thinking through it as yet another process. Whereas a lot of Chief People officers have come through either mitigating risk or talent and might not be thinking quite a strategically so partnering with the CPO to think through the way these areas that our brains and actually work like this is helpful.

Sam Smith: 54:04

I think that analytics piece is a real value add into private equity as well. I think it would be fairly rare for first time deals that have been led by entrepreneurs now, maybe by a professional management team or have sophisticated business people analytics. And I think you can't really have a people strategy. You could spend a huge amount of time hiring and resourcing but unless you understanding what's going on under the bonnet is really you could be wasting an awful lot of your time.

Brandon: 54:30

How do you engage and incentivize employees in a P backed company because in the VC world generically, there are three elements that we tend to use. And the first one is this concept of vision, mission, purpose, whatever you want to call it. We are here on a mission. We have a tremendous vision for this company. That's really exciting. We're on a mission to get from point A to point B, we're creating a marketplace. There's huge crazy fun dynamics at play here. That's tremendously exciting. So that's kind of point A. Point B is people come into the company with having are all sorts of opportunities to be promoted. Because the company is growing in size. There's all sorts of roles that are populating themselves. And if a junior person is doing a phenomenal job, within a very short time period based on thresholds, they should be able to get to some other position that they desire in this case. And then the last piece of the puzzle is really just the ESOP share option grant incentives where everyone has a stake in the the game here a little bit in terms of our success, but I'm just wondering, in the P back companies, how do you do it? What does it look like to get folks really excited?

Sam Smith: 55:28

I think if you're gonna do it, well, I think the right way to do it is virtually identical. But because these businesses have come from, they might be carve outs from large corporates, they might be having been led by a very sort of charismatic sort of all in entrepreneurial leader, the right path for our businesses that we invest in is they take this route and adopt a very similar sort of model to incentivize and engaging this their talent. But sometimes they're starting from a base that's completely different. They need to go through that sort of transition. I think it one of the mistakes that some private equity bank management teams can fall into is sort of using the private equity vocabulary of EBIT da and multiples and arbitrage and exits in the wider employee community. And the thing is not everybody, again, I'm generalising some private equity backed portfolio companies will incentivize their whole team, the whole employee base, you know, everybody, the cleaner receptionist, right up to the Chief Exec. And if you can do that, that's fantastic. But not everybody has the opportunity to do that. And if you're in that sort of first case, well, then you have an opportunity to educate everybody in the business around what it means to be private equity backed. And what's so fantastically great about it, because everybody's in the same position, everyone's incentivized, but if they're not, and you're using this recovery in terminology, you can lose engagement very, very quickly, because the staff base, the employee base, the people who are going to do a massive amount of the work and sit there and think, Well, this is this is for the private equity shareholder, and for you guys to make loads of money. So we would encourage teams and CEOs and leaders to follow the same route, engage around a sense of purpose, why do people come to work? What makes this business cool they don't quite have, that sort of changed the world dynamic that your businesses often do. But this is a successful business, then it's adding to that society and community that sits within, it's throwing off. It's creating employment opportunities, it's throwing off tax generation, which is going back into the community is providing a service that you know, their customers buy into and require. So you've got to find a sense of purpose in a business that really drives the emotional engagement, people have got to think I'm proud of the business, I'm coming to work for whatever that business is, whether you're manufacturing widgets, or whether you're creating sort of healthcare software, that could be the solution to a diagnosis. So I think it needs to be similar. And then obviously, you're using the the incentivization, and the equity to do that. And exactly the same as you career opportunities. There's two types of equity, I'd say for management teams and executives, and for employees and lower level managers in these portfolio businesses. If they can get through a first investment period, that first three to five year window, their career equity, the value of that experience is huge out there in the market. Because as I said, right back at the beginning, private equity tend to like to bracket people and go, Well, if they've done it before, if you've done it before, and you've seen a return, you've actually delivered or been part of an exit, or you've been part of a business that's been through an exit, you then know what's involved here, you're familiar with the playing field, and therefore, probably the risk of taking you on and you'd be able to deliver what the spec requires you to delivers is going to be much lower. So actually, we often say to management teams like you, okay, sometimes you're not going to make the return that you would expect to from the equity, the next time around, you've got a much higher chance. And because there are three to five year windows, you know, four years, four and a half years, typically as a whole period, they come and go, you know, you're into four years fairly quickly, and you can find yourself another job. headhunters is what I used to do for a living my first business, that's what we did, you know, you you are looking for people who've been in these businesses before. So some

Bethany: 59:11

fascinating conversation, have loved it so much. Thanks for joining us today.

Sam Smith: 59:16

My pleasure. I've really enjoyed talking to you guys as well, you know, just I think there's so much to learn from the venture experience. And I do think, you know, private equity should be looking beyond the world of the private equity backed portfolio talent pool and the larger corporate talent pool. We should be casting into the venture world as well. So I'm sure there's great talent now. No, there's great talent there. So it's been great to talk to you. I wish you'd come back and do another episode because we've got lots of other points I'm sure we could cover.

Brandon: 59:43

Thank you Sal Smith for joining us on the operations room. If you like what you hear please leave us a comment or please subscribe, and we'll see you next week.