My brother in law owns a PE firm, and while I’m in Texas he, for the 2nd time, invited me to sit in on the process of them buying an ice cream and a toilet paper company (relatively small private businesses each for approx $50-100m). I did the same thing almost two years ago when I visited, they were buying another business, and I forgot how fascinating it is to watch. These guys are brilliant, work incredibly hard, and know how to tear a business apart piece by piece.
Two Completely Different Investing Worlds
What struck me again is how completely different their investing world is from mine. It’s almost like lamb and tuna fish. They’re looking at purchase price, financing, operations, management, costs, what they can improve, and ultimately what someone else might pay for the business. I’m mostly asking whether this is an extraordinary business I would be happy owning if nobody offered to buy my shares for the next 10 years.
PE can buy a business that needs them because they can actually do something about it. They can change management, restructure the balance sheet, cut costs, change pricing, make acquisitions, improve operations and create their own catalysts. As a minority shareholder, I can’t do any of that, so I need the machine to work without me. I consider this a big advantage.
An Exit Clock vs. No Clock at All
Their clock also starts ticking when they buy because eventually there needs to be an exit. My ideal investment has no clock at all. If I find an extraordinary business that can reinvest growing amounts of capital at high returns for decades, selling it may eventually become the biggest mistake I could make.
There is also an interesting difference in leverage. PE can use financial leverage to amplify returns, while I would much rather use time as leverage. Let retained earnings, reinvestment and compounding do their thing for 20 years while I sit there and try not to interrupt it.
They can make money through transformation while I’m usually trying to make money through continuity. They might buy a business because they believe tomorrow can look dramatically better than today. I’m usually searching for a business where the economics are already extraordinary and the runway is so long that my biggest contribution is simply leaving it alone.
No Universal Definition of a Great Investment
Even valuation plays a slightly different role. A PE buyer can sometimes turn an ordinary business into an extraordinary investment through a great purchase price, smart financing, operational improvement and a successful exit. For me, the dream is much closer to business quality multiplied by reinvestment runway multiplied by time, with the price I pay determining how much of that future compounding I ultimately get to keep.
Watching them work reminded me that there really is no universal definition of a great investment. A mediocre business can be a phenomenal PE deal, while an extraordinary company can be a terrible stock at the wrong price. The perfect investment for someone planning to sell in 3 years can look completely different from the perfect investment for someone hoping never to sell.
Maybe understanding an investment requires more than understanding the business. You also have to understand the game being played around the business and what your particular advantages are within that game. They buy businesses with an exit in mind, while I try to buy businesses that make the exit unnecessary.
Pretty interesting day so far to say the least, I am off to lunch… 🌹