Private Equity Spotlight: Formulating Wins in Specialized Sectors with Doug Horn
2024-05-15 00:33:12
Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company. BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs. To learn more, visit: https://bit.ly/3oPBjs8
Welcome to the Karma School of Business, a podcast about the private equity industry, business best practices, and real-time trends. I'm Sean Mooney, Blueways founder and CEO. In this episode, we have an amazing conversation with Doug Horn, Managing Director with Clarivest. Enjoy.
I am super excited to have one of our very first repeat guests on today, the Karma School of Business podcast. Those of you who have listened and maybe have listened to episode 13 before, you, might recognize the voice here. The voice is the one and only Doug Horn from Clarivest. Doug, thanks for joining us again.
Thank you very, very much for having me, Sean. Apparently, radio didn't kill the video star.
That's true. If it did, I would have been out of the podcast game after episode two. Great to have you back. I think. for those of you who maybe haven't listened to episode 13,, Doug shared a little bit more of his origin story then, and I encourage our listeners to re-listen to it, because it's a great episode, with not only Doug, but his colleague, Mohit Kansal, where you're going to hear a great interplay between them.
But on this one, for purposes of jumping right into it, Doug, can you just give a real quick intro to Reacquaint?
Hello, everyone. I'm a Managing Director at Clarivest. We're a mid-market private equity firm with over $4 billion of assets under management, and we are uniquely focused on backing owner-operators and entrepreneurs in this very big market that we call private equity. We often do that, and we've been doing it for over 30 years, most successfully as a minority or non-control shareholder. As I said, we've been in business since the 1980s.
We were founded not by a group of finance guys and political scientists like myself, if I may say, but by a group of business builders. It was really their founding vision to be the investment firm of choice for other CEOs, who weren't looking to sell outright, but wanted a partner, an aligned business partner, to help them grow their businesses. I've been at Clarivest for the past eight years or so, and prior to Clarivest, I worked and got my training in investment banking, working with much larger companies than I do today on M&A and financings. Prior to that, I started my career as an economist, forecasting a variety of commodity markets, supply, demand, prices, a whole host of things like that.
This is great. We're just adding a new question in, which is going to be about where's the economy going to be by the end of this year. There's no pressure on that. We'll give you some time, Doug. No, just kidding.
We won't do that to you. I really like your background, and that's one of the things, if you think about a firm that's been around for more than 30 years, that's about as established as you get in the vast majority of private equity. What we've really appreciated is seeing how you all have likely evolved, maybe from the early days of PE to today, and certainly, as we'll talk and you'll hear during this conversation, one of the reasons why Clarivest was named one of the top PE innovators as well. There's a lot of things that you all do really interesting, and that's one of the reasons why we've invited Doug to be back here today, so we can really do a deeper dive into some of the art and science of investing, how private equity firms think about what they want to look for, spend more time thinking about fewer things, going deeper into verticals. Maybe to kick this conversation off, Doug, can you share a little bit more about what you're looking for in a company, which I used to always call my personal yardstick when I was in private equity.
It's this idea of like, here's what are elements of value that I'm looking for in a business, and then this means that company is good, or, more importantly, will or should be good. Doug, can you share a little bit about how you even think about where to spend time in the first place?
At a very, very high level, Sean, there's really five criteria that we look at at Clarivest, and we talk about at the investment committee. It can be summarized as industry, company, management, timing, and price. Let's dissect all those a little bit. On the industry side, and I know we're going to spend a little more time later going into that, but is the industry growing? at a very basic level?
Our research goes much, much deeper than macro growth rates. We're trying to understand what does the supply chain look like? What do the customer dynamics look like? Is there ability to benefit, or is there a threat from innovation coming? That's industry.
If you're not in the right industry, the saying goes, you can have the best company in the world, but you got to be in the right place at the right time. Next, we go into company, and I think I said this on the first episode as well, people, processes, profit. There's a whole host of financial metrics. We are investors at the end of the day that we look at in terms of revenue, growth, EBITDA growth, customer continuity, capital intensity, but really that is backed up by the people that are running the business. I think even more so in the middle market.
People are really what drive value creation and the businesses that we're investing in. And then, lastly, is processes, understanding what is going on in the business today, that's yielding the results that we're looking at, and how is that going to project into the future, and what are the changes or evolutions that need to happen within the company to support the value creation strategy?
For our listeners here, whether you're running a company right now, or you're aspiring to be a private equity investor, either through the deal side or the upside, that is the master class of what you need to think about in terms of a framework of what makes good or could be good. I'd encourage everyone to think about that, particularly if you're an operator right now, think about your own business through that lens, because it's going to make you better. And if you're thinking about investing, this is going to be something that's going to slow the noise down tremendously, because I think, Doug, you did a really good job of articulating the things that matter as a business builder. And so I think that's a great kind of setting the stage here. So you've got your yardstick, you're looking at companies.
Now, how do you narrow the aperture of your lens, because there's still a whole world in front of you that you could spend time on?
Particularly at Clairvest, but other private equity funds too, we focus by industry. We actually call them domains. How do we become the master of our domains? Each partner at Clairvest covers somewhere between one to three different industries, where we're actively seeking out companies within our chosen investment thesis. At Clairvest, we're running somewhere between 10 to 12 different domains at any given time.
But I would even separate that to say about half of those are well-established, we have a long track record in them, we've pursued multiple investments over our track record. And the other half might be either adjacencies to existing domains, where we're seeing some interesting trends, and we want to go out and go research and meet entrepreneurs in different industries. Or they could be completely net new industries that are driven by some of the themes that we're tracking at Clairvest. And, in particular, industries where we think we have a competitive advantage.
I like a lot about how you've kind of each individually picked areas where you're going to be better at fewer things. How do you go about, in some ways, kind of distilling down the entire economy down to individually within that smaller subset?
It's really a combination, and it's a group effort, may I say, around what is going on in the economy? What are the big changes that are happening? Where is growth happening? And we combine that with what is the quality, what are the characteristics of companies within specific subsectors of the industries that we want to participate in? At Clairvest, we meet on an annual basis and develop a strategic view of what industries do we have exposure to today?
And what industries do we want to keep? Which industries do we want increased exposure to, right? So, just as one example, a number of years ago, we looked at the amount of spending and the amount of evolution that was happening in the healthcare space. And we said, hey, this is an area that we've had some experience in. Let's spend more time there because of the quality and the characteristics of the companies there.
Importantly, we also overlay what is effectively an industry overview and industry outlook. And this is where I think a lot of the art comes in, is where do we find mid-market companies? Where do we find companies in our snack bracket that are winning? And probably even more importantly, that are entrepreneur-owned, right? Because there's a lot of industries out there that have been well picked over by either the public markets or large cap PE.
And so for us, we want to see a thriving, very active, lower middle market company base of folks that are making acquisitions, that are growing, that are beating out large incumbents. And by combining those two, we know that it could be a fertile ground to go look for new investments.
As I listen to you speak about these things, Doug, and then I reflect back on how we kicked off our conversation, one thing that I'm curious about, you know, how much this has really helped in this kind of process is, when you start off, you say you start off as an economist. Has that helped you in terms of how do you frame, like from the top down, where to spend time?
I always start with what are the big themes that are going on in the world, either geopolitically or economically. And remember, we're long-term investors, right? So for me to predict what's going to happen over the next 12 months doesn't super help me to choose and select good industries. But if I'm trying to place capital over the next decade, then I do need to have a little bit more of a forward view. And our firm needs to have a little bit more of a forward view to say, hey, what are the big changes that are happening?
Where are strategic companies need to be built? And how do we go help those companies achieve their missions?
I think that makes a ton of sense. And one of the things that I think has made the private equity industry successful as it is versus maybe some of the challenges that I would perceive in public market investing is you get to think and act over long periods of time versus managing on a quarterly cadence and kind of like chasing your tail, if you will, as kind of like the momentary blips in time, kind of change things. You can think further, longer, and act accordingly. I'm also interested in, Doug, how you think about this kind of focus. You individually and collectively as a firm, on these fewer domains, what kind of advantage does that give you, as you're thinking about adding value for your limited partners, your companies that you're partnering with, and ultimately, collectively being successful?
Let me chop that up into two components, sourcing investments, and then value creation. In terms of sourcing investments, there's 5,000 private equity firms in North America last I checked. And so we want to know where we want to be aggressive before an opportunity crosses our desk. And we actually, in many cases, want to create those opportunities. And to do that, we can't be splattered across the United States, across every single industry, given the size of our firm.
So we really need to be focused to develop the relationships that are going to ultimately prove to be useful and productive over long periods of time. When we have that focus, we're able to really make sure we're committing time to developing those relationships, not only with business owners, but also a whole group of folks in the ecosystem in these industries. Just like our kids, they tend to organize over time around their interests, industries also organize around one another. So if I want to be in the aerospace and defense industry or the waste management industry, I've got to go where these companies are versus focusing on a regional basis, for example, which I know some private equity firms do as well. So that focus allows us to develop that network.
And so part of that's related to sourcing, but part of. it's also about our knowledge base. We are more educated partners to our management teams, given the time and resources we commit into these industries, which is often, at the very least, a multi-year effort. This is not a one or two month effort. And then ideally, that translates, when we're actually in companies and sitting around the boardroom table and giving advice and being a sounding board to our management teams, that we're coming at it from a little bit of a different lens from these folks who live and breathe the industry every day.
But at least we're very educated and knowledgeable investors. And we've seen what goes well, what goes wrong, what are the suppliers out there that we can bring into these industries? What's the right strategy to pursue? So these are things that without that groundwork, without spending time on the ground, we would really not be very effective business partners to these owners.
Once again, I really appreciate your perspective there, because it's the art of alpha, right? How do you create more value than the rest of the market in a differential way? is in some ways, being able to know a lot about that company and its industry before you even meet them. And so you can not only think about informing kind of your value creation plans, but also knowing what you want beforehand, and then also knowing where not to spend time. So it frees up so much time.
But in order to get there, and we'll talk about this a little more when we go into a deep dive, it's a lot of hard work. It's not easy. You can't just do it. You don't do the hours and hours and hours and the miles and the planes to do this stuff. It's not easy.
And it's not the glamorous stuff that makes things successful, but it's part of that tenacity and grit that I think is so important to the industry.
You made an interesting point around miles. We found it's a real competitive differentiator, particularly in the post-COVID world, to actually show up in person, whether it's a trade show, having lunch with someone, going to meet a company at their headquarters. By meeting people in person and really getting to know them, but also getting some context on what's going on in their company, in their industries, that allows us to really round out our knowledge base when we're trying to figure out which opportunities do we want to aggressively pursue and which industries we want to spend even more time in and go hunt for new opportunities.
I think that's a great point. And one of the things is I've thought a lot about what's happened in the world since we've gone through this COVID era is, as a species, as humans, we're, by nature and by DNA, tribal and communal. And for the vast majority of our time, save some of these pandemic or great periods of kind of duress, we've been in person, as a people, and it's genetically encoded into us. And then, for a period of one to two years, maybe three years, we were broken into these tiny digital boxes. And in some ways, it's thank goodness we had these, because if we didn't, it'd be even harder, while we're kind of broken.
But when it kind of opened up, I think those that have come back to our genetic encoding for thousands of years have benefited. And even as I think about our company, when we were in these little tiny digital boxes, you could just feel the culture falling away. You could see the production dipping. You could see the sense of belonging just eroding. And when we brought everyone back in person, it was like a rocket ship took off again.
And it's not only, I think, an advantage for those who do it from an investment standpoint, but even just from an operator standpoint. For us, to the extent that someday we have a competitor, I hope every day that they choose to do virtual. It's like, yeah, you should do that. That's awesome. And so, just as business builders, I think that's a great observation and piece of advice.
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net to learn more and start a project today. So, Doug, what I'd love to do here is maybe transition into going into a deep dive. Into one of your domains. And I know one of the areas where you spend a lot of time is aerospace and defense. And maybe, to kick this part of our conversation off, can you give us a little insight into how did you get into this industry?
Why did you choose this as one of the areas where you're really, really focused?
We made our first investment in the aerospace industry about 13 years ago. And today, aerospace and defense, A&D, now represents just under 15% of the capital we're managing. And more than a decade ago, we saw some very compelling features in the industry. One is that there's long-term contracts. As you know, recurring revenue is really important.
There's different styles of recurring revenue. But when you have a long-term contract with a government customer, it's very compelling. The second one, which I don't think a lot of people quite realize, but it's either an acyclical industry at the very worst, but some people think it's actually a countercyclical industry because government budgets sometimes go in the opposite direction as the economy. And I think importantly for us, the next two features are, I think, somewhat uniquely Clairvest, in that there's a good degree of innovation within small and mid-sized companies in this sector. And so for us to be successful, we need, I'd say, not a VC style rate of change, but a healthy rate of change in these industries to create opportunities for new entrants.
And then fourth, probably as importantly, a lot of the business builders in the defense industry come from military backgrounds. At least in our experience, we've been in awe at the leadership qualities that they come with into the business world because of their training. And we find when, if you think of what a good business partner is, it's a complimentary skillset. So we come with a very analytical mindset. We're really good at M&A.
We're really good at financing. We're really good at some of the big picture stuff. But when you think of the qualities that it takes to operationally lead these businesses and grow them, you put those two together. And we like to say it's an industry where we can really run a private equity playbook within an entrepreneurial enterprise. It's these qualities that really brought us into the industry over a decade ago.
And since then, we've made four different investments in the industry. But I would say all in different themes. We've sort of continued to track the industry. Not one company has looked like the other. And we are also evolving our thesis along with the industry.
The A&D industry, I think it's tremendously interesting for all the reasons that you shared. And I remember looking at it in past lives, trying to get a sense for this business. And I think to the point that you alluded, it's one that also has kind of its own way of doing things. There are different jargon. There's people who've come from very specific career tracks.
And when I looked at it, it was kind of daunting. I was like, I don't even know where to get started. So how do you think about developing know-how in an industry vertical that's constantly evolving but also has kind of barriers to entry to get to know a space like this? Really any space.
We love industries where there's either a compliance barrier, which there is in aerospace and defense, or a complexity barrier, which there also is, not only from a technical perspective, but, as you mentioned, the amount of acronyms that are prevalent in the industry. It seems like every day I'm learning a new one. And all I can say is that you're sort of building a tower. You're incrementally building your knowledge base. We probably evaluate somewhere between 50 to 100 different investments every year.
We're going to 10 to 12 different conferences every year and meeting influencers in the industry, owners of businesses, industry experts, ex-government officials. We're doing a healthy amount of desktop research as well, tracking industry news. Also, in this industry, there is increasingly a data analysis component to it, a big data component to it, given the amount and quantum of data that actually the government releases, it allows us to track where the budget is going. And so oftentimes our domain thesis is in line with pulling together all those variety of different sources and that texture of what's going on in the industry to build up that conviction on where we want to play.
What I really loved about what you kind of shared, Doug, is, I think, so often in kind of current life, many people want the easy button and no concept of delayed gratification. And what I heard there is this is like a decade of work plus, and this is doing the hard, gritty, constant, effort type activities that are needed to get good at something. And I think it's just a great lesson, particularly for those who I think are starting off in their career, that there's no easy button. You want to get good at something. It's going to take a lot of hard work.
And then from that, you're going to get tremendous benefit over time, but you got to realize it's going to get hard before it's easy and it never stops. So you're always going to be working at your craft. And I think that shines through. And it's an important lesson really for anyone, right? You're just not going to hit the button and say, okay, I'm going to be great at this.
Yeah, it definitely tends to be cyclical. It's hard, then it's easy, then it's hard, then it's easy, then it's hard, then it's easy again. What we have figured out is that we're talking a lot about knowledge base and developing industry ideas and conviction, but equally important for us is our reputation and how we act, both externally to different stakeholders, but also within our portfolio companies. That's really our best reference check over time to sustain our results and our success.
There's all these pearls of wisdom, Doug, that you're dropping. that I like, I'm actually writing downside, is this idea that it can take years and decades to build a reputation and 30 seconds to ruin it. And so, just like everything else, think about the integrity of how you do things. Think about doing things the right way. And the hard work element of business and life are equally important and go hand in hand.
And maybe, to take this to the next kind of stage of our conversation here, you've done this work, it's the thousands of hours, it's the doing things the right way. How does that then help you, as an investor, see opportunities to provide the fuel to help these companies get to the next level?
I can share a recent example about our latest investment in a company called Nextech Solutions, which is a defense contractor providing high-end technical engineering services. And so, if I step back, four or five years ago, one of the key trends that we were tracking within the defense community was the pivot to modifying commercial off-the-shelf technology. And the need for defense companies to really support that effort for their main customers. And in addition to that, we were also tracking the need for, I know this sounds crazy to say this in 2024, but the need for information technology or IT to be pushed to the battlefield edge. And so the amount of technology that occurs both in the United States is always advancing and innovating.
But on top of that, when you're sending soldiers or running operations overseas, the amount of technology that goes right now into the field is accelerating. And that requires a whole host of different support system for the customers. We had identified that trend and we went out and set out to go meet companies that were servicing those specific customers, but also had those specific capabilities, and came across this company in 2021 and met the owners of the business. And that precipitated our latest investment, which really was started with an idea on where the industry was going and trying to match that with, hey, where are there really good entrepreneurs? Where are there good owner operators that are themselves pursuing a growth strategy that may at some point need the assistance of a private equity partner to help them get to where they want to go?
I think that makes a lot of sense. You're able to understand what was coming before even probably the company even knew it and then give them the fuel to take it to the next level.
Yeah. And I would say importantly too, it allows you, we do meet a lot of companies in our travels and there's only so much time in the day. So part of our role as private equity investors is to figure out where do we want to overinvest our time and where do we want to plant seeds, and where do we want to make sure to develop that conviction? You really need that conviction, because if you don't have that conviction and that passion, there's other people that'll come through and provide the solutions that you may be perfectly suited to provide.
Once again, another great point. The one constraint I think every one of us have, no matter what line of work we're in, and the biggest constraint is hours in the day. And how do you allocate those? Once again, what I really enjoy about our conversation here is the consistency of how do you spend more time, being better at fewer things and narrowing the aperture of that lens? Because it's really easy to go left and right.
And one of the things I probably invoke way too much on this podcast, but I think it's so true is this Jim Collins, good to great, you got to be a hedgehog. Don't be a fox running around. You can just be better at fewer things. It not only helps you be better, but I think you find more satisfaction in things. And so, maybe, bringing this all together.
And if you think about all of this, as an investor, Doug, what's your perspective on this focus, this domain, expertise? What does this all mean? Not only in terms of being, maybe having more insights, but also just your success as a firm, success as an investor, success in being able to support the ultimate growth trajectory and value creation of the companies that you're partnering with.
It allows us, I think, unique access to opportunities that some of our competitors don't get by going through this industry domain process and put it in those hours, as you said. So one is, we see opportunities that others don't. And even on those opportunities, I'd say we have a higher win rate, even though our number may be less than some of our competitors, of the true opportunities that we're chasing. And it really starts with that research component and developing that conviction early on. But remember, there's also people involved, and we are purposely developing relationships and trying to build that trust well in advance of doing diligence on a particular opportunity.
When you think about the dividends that that pays, once you've actually closed the transaction, it's actually amazing. Because in the situations where we don't have that, we are probably spending the better part of a year developing that rapport with our management partners in one way or another. And so if you've started to plant those seeds earlier on, you're really accelerating the magic that happens when you combine a value creation strategy, a more formal professional value creation strategy, with that entrepreneurial talent, that go-get-em-ness, that drive, that initiative that we find in all of our partners. And so our ability to really plant our feet in an industry, get to know people, really not only presents unique opportunities and unique at-bats, but after that's when the magic really happens. Because we're sitting around the table and saying, hey, like we know these people, we trust them, right?
There's mutual trust built. And there's a common understanding of what resources we bring to the table, what know-how, what expertise, but also a deep respect for the business they've built, their skillset, their strengths. And it's really only in that dynamic that we're able to generate the returns that we've had over such long periods of time.
I think that's a great summation, Doug. And for our listeners that are building their companies right now, I think you hit home the importance of, when you're going to get capital, finding the value and searching for the value of an informed partner who's bringing something in addition to capital, who's bringing a perspective, who brings built-in know-how, built-in ways to help create even more value than has been done before. And so I would really encourage anyone listening, just like think about what Doug has said here, because when you're bringing in a capital partner, you bring in the capital, you get them. It's not just, here's the check, and let's run. So really think hard about bringing in someone who's going to be additive in ways, in addition to providing fuel, to kind of help you go further.
So thank you for sharing that. Maybe to kind of bring things full circle here, we've talked a lot about, like these great kind of nuggets of wisdom here that I certainly have written down. And that's one of the things I like most about these conversations is I get to benefit from the hard-earned lessons learned of others, because if I have to figure them out myself, I'm in a lot of trouble. And so, Doug, if you were kind of to go back to the Wayback Machine and dare to think about 22-year-old Doug, what would be one of the pieces of wisdom that you would impart upon your former Wayback self?
There's one thing that comes to mind, and I definitely didn't create this kernel of wisdom, but someone once reminded me of what it was like when you were learning to play tennis, and the tennis instructor would come and say, hey, like you can't hold the grip so hard, right? Because you're actually a better, effective tennis player when you're holding the grip just right, but you're inclined to kind of hold it harder because you think that's going to make you more effective. I always remember that kernel of sports wisdom, because I think it applies in life and business, in my career. And I definitely have not mastered it, but even in my older self, I still need to remind myself not to hold that grip too tight, because I can be more effective when I don't.
I think that's an amazing metaphor, and not just because we just had a team tennis outing. This is fresh in my mind, but it probably will fix my stroke a lot too, now that I think about it.
But you're right, it's just when I was coming up, I was so tightly wound, and it was just so easy to get wrapped up in the moment. And like, how do you just kind of ease up in those type of things and kind of go with the flow a little more? And you kind of, in some ways, it's consistent with this conversation. If you can kind of remove that tension, go with the flow, you're better at what you need to do. And your life's probably going to be a lot more enjoyable because you only got one match in life to play.
I love that pearl of wisdom there and look forward to sharing that with my kids pretty soon. We'll see if they listen.
I'm still learning, I'll be honest, but I'll try and remember it.
All right, Doug, this has been a really, A, insightful, B, educational conversation. And I've really appreciated the opportunity to do a deep dive with you in a topic that really matters, not only about the business of private equity, but the business of, in many ways, kind of life, at the risk of being way too introspective here, beyond my capacity. But I think it's been really interesting on a number of fronts. I've learned a ton of things I wish I knew before. So thank you so much.
It's an honor to be here, Sean. Thanks so much for having me again.
Absolutely. Talk soon.
That's all we have for today. Special thanks to Doug for joining. If you'd like to learn more about Doug and Clarivest, please see the episode notes for links. Please continue to look for the Karma School of Business podcast anywhere you find your favorite podcasts. We truly appreciate your support.
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