In The Trenches: Conversation with Michael Girdley

6:19PM Dec 13, 2023

Speakers:

Steve Divitkos

Michael Girdley

Keywords:

business

people

software

years

company

arr

ceo

buying

entrepreneurs

guess

type

operator

revenue

investor

allocators

holding

folks

grit

work

opportunities

Michael Girdley, welcome to the show.

Excited to be here.

Well, I've been a fan of yours for a long time. I listen to your podcast Acquisitions Anonymous regularly. So anybody who's listening to this should absolutely be sure to check it out. And, Michael, you are a pretty prominent voice in the small and medium size business ecosystem. So I had a really hard time trying to narrow down what to ask you, because I feel like I could talk to you for a week if you gave me that much of your time. But where I really want to drill down with you today is on this concept of holding companies.

And one of the reasons why I wanted to specifically talk about holding companies with you, is because of the explosion in interest that I've seen from young ish entrepreneurs, looking at non traditional ways to basically build up an entrepreneurial career for themselves. And I've seen holding companies pop up way more over the past year or two than I had in the preceding five years. So that's something that we're going to get to. But just a little bit of context in terms of why I wanted to discuss what I wanted to discuss today.

So maybe we can start with like a Holdco 101. Just so that folks listening, understand what it is we're actually talking about. Before we do that, maybe it's more logical to start with Michael Girdley 101. So maybe we can just start by having you tell us a bit more about yourself, your career, and what has led you to what you are doing today.

Yeah, yeah. Great. Thanks. Yeah, so my life story starts here in Texas, in San Antonio, I grew up here, I was always a computer kid, I got my first computer when I was 12. It was an Apple 2E, I used it until I broke the keys on it, which was great. And back then my parents they sacrificed so much. They spent $3,500, back in the 80s to buy a computer that's like 14 or $15,000 now, just an incredible investment in me. And it transformed my life, to where, you know, I went to high school in a school that had amazing computer science programs. And I went to college and got as far away from Texas as possible for college and studied computer science there.

And then after graduation started really the first phase of my career, which was going to work for other people, I went out to the Bay Area, and moved to San Francisco and worked at software companies for six different years. And eventually realized I was never going to be a very good programmer. And I actually didn't like it that much. So I eventually moved into the closer to the business and marketing side of things which I'd always liked more just coming from a family of entrepreneurs. And after that stint of working for other people, I ended up moving back to San Antonio, my wife and I wanted to go someplace warm.

And at the time my father wanted to retire from our family business. So that was my first CEO job was running our family fireworks business for 11 years as the full time CEO. And then eventually I started to realize I didn't want to just run one company, I loved creating the concept of creating businesses and I started a second business and I was CEO of that for a bit. And then really transitioned into what I do now, which is spend my time working on businesses rather than in them. So I'm not a CEO of anything. I own a holding company, that I'm the CEO of that holding company.

But I only have one employee and she's Chief of Staff, and everybody else are CEOs that run the businesses that I own significant stakes in. That I've either acquired or created or incubated. And I'm up to a dozen different businesses now that I sit on the boards of and that's what I spend my days doing.

So from computer scientists to Holdco entrepreneur, maybe we can start with for those who may be unaware, what is a holding company? And related to that, in what ways does a holding company differ from let's say, a private equity firm, which also owns portfolios of individual operating companies?

Yeah, so there's there's different flavors of Hold co's. But generally a holding company is defined as one that owns stakes in other businesses. And that's its primary job. So, for example, the most classic one that people know of is Berkshire Hathaway, which is Warren Buffett's company that he started with Charlie Munger 67 years ago now, I guess is how long they've been at it. And that is, you know, what's called a heterogeneous holding company, which is a holding company, that's a bunch of different types of assets that are ideally profitable and cash flowing for them. And then there are other types of holding companies as well.

There's things that are roll ups, of, say people that have gone and built a holding company that owns a whole bunch of, say, KFC franchises for example, that's a type of holding company. Then there are holding companies that buy kind of similar types of assets like software companies, I'm involved in one of those that has gotten pretty big over the past few years. And primarily there is this idea that the holding company is just a company that owns other businesses. And that's its primary function.

So you mentioned you've got 12 companies in your Holdco. Is there any connective tissue between those 12? So is it defined by industry? Is it defined by company's size? Or is it all over the map purposely so in both of those regards? Like, how would you characterize your specific holding company and the assets contained within it?

Yeah, I very much have a kind of the first type, the Berkshire Hathaway style of a very lightweight holding company that is heterogeneous of the different types of assets I'm in. So it's anything from, you know, if I works business, to a software business, to now immediate business to CEO, peer network, and all things that have been things that I felt like I had an opportunity to go pursue, and be in those businesses. And then the actual structure of what we do from a headquarters standpoint is very light. We don't have much in the way of centralization or support or any kind of cross contamination between them. Because I like I don't want to have to manage all that stuff. So I make them all very independent atomic entities.

And I guess, just to get into your head a little bit, I mean, why did us choose to specifically build out a holding company as opposed to pursuing other entrepreneurial models? So for example, the startup playbook, where you start your own company from scratch, the ETA playbook, where you buy an existing company and subsequently operate it. You've chosen a different playbook and a different path towards an entrepreneurial career, what specifically appealed to you about this option that maybe you couldn't get with the other two options?

For me, it's all of these choices that you know, as privileged, kind of capable people in the Western Northern Hemisphere in North America, we often get to choose what kind of lifestyle we want to live, and then use that as a way to shape the career we're going to have. And for me, the CEO of a holding company, my day to day job is incredibly different from what the day to day job of being a CEO of a single business is. And as I started to learn about what a holding company CEO does, I realized that's the life that inspired me, that aligned with my core values and aligned with the things that gave me a lot of joy to do on a day to day basis.

And so, I think it's a mistake for a lot of people to think that the vision of what they want to have is what's going to drive their life and I did the opposite, I started to realize the life I wanted to live was the activities I get to do all day, every day now. And so anyway, that's why I do this compared to kind of the typical own and operate a single business or go by when that you're going to run like, that's right for other people. It's not right for me.

So I mentioned at the outset that Hold coes, at least anecdotally, from my perspective, they seem to have increased in popularity quite drastically over the past couple of years. I guess, two part question for you. A, are you seeing the same thing? And B, why do you think we've seen all of the recent interests that we have?

Yeah, I definitely have seen the same thing. And I think a lot of it comes from social media and Twitter and LinkedIn, I think people really love writing about this model. And for a lot of people, it's very aspirational. I do think there's a level of people coming at it for the wrong reason. Like I talked about the reason I want to be in the Hold co business, and the Holdco game is because it gives me joy. I think there's a lot of people that are coming at it now because it seems cool. And like, oh, look, you know, I get to be Warren Buffett.

And the thing we don't talk about a lot with Warren Buffett is like he and Charlie Munger, who are his two partners in Berkshire Hathaway, like they are masters of PR, masters. Like you look at the whole thing they've put together and the whole narrative they tell about not working that hard and you know, eating all shucks kind of stuff. Like that's not the reality of what it really takes to put together a Holdco, like it is a lot of freakin work. And Warren and Charlie don't really talk about how for the first 15 years like they were using a ton of leverage and hustling.

And getting in there and getting their hands dirty, like to get to where they were way ahead of the game, like took a lot of that. And so I think there's been some misconceptions about it. And some people it kind of feels like when people when they got into VC when everybody was starting a VC fund like six or seven years ago. because it was cool, and everybody's doing it, it kind of feels like the same thing. I don't mean to poop on hold coes. It's the right thing for a lot of people, including myself, but it's also I see people doing it for the wrong reason.

So would you expect as best as you can tell, interests in hold coes among budding entrepreneurs, let's say three years from now, would you suspect that interest in hold codes will be as high as it is three years from now, relative to today? Or do you think it's kind of being over indexed, and as a result, it'll kind of return back to a state resembling normal three to five years from now?

I think we're pretty close to peak. Yeah. By the way, I have a Holdco course where I like took everything I've learned about hope goes for, like 20 years. And like I should be out here promoting hold codes and saying they're gonna keep growing. But like, anyway, I would much rather, I'd much rather be honest with people than to make more money. Anyway, buy my course.

We appreciate your honesty. So I guess you talked about some of the reasons that compelled you towards this model of entrepreneurship relative to the others. Many people listening to this are aspiring entrepreneurs who may be considering each of these three entrepreneur avenues. So again, startup, so founding a business from scratch, entrepreneurship through acquisition, buying a company that presumably has 10 to 20 years of history and operating it or a Holdco, as you've described it, as this entrepreneur is considering which of these three avenues might be better for her, like, what are some of the questions that you think she should ask of herself to better inform the decision of what model might be a better fit for her personality, values, etcetera?

Yeah, it's a great question. And it's something I put in my Holdco course, when we build that last year, was really encouraging people to think about the activities of what a Holdco entrepreneur or when an entrepreneurship through acquisition entrepreneur, or what somebody founding a company from scratch. Like, understand, what are those day to day activities, and visit with people who have done these type of things, or listen to interviews with people like me, you could talk about, like, what Holdco CEO does all day.

Understand those activities, and then make your decision on what you're going to go after based on those activities like which of those activities are going to give you the most joy and the most passion. And I think if you as an individual start with understanding what you're going to be asked to do all day, then you work your way towards then deciding what path you're going to take, that's much healthier than deciding, oh, this one's cool, or my mom thinks I should do this other one. And I learned this lesson, because I went through it with venture capital, like I raised a handful of venture capital funds, I spent a number of years as as part of my whole co journey, like getting into VC.

And I discovered I really didn't enjoy the activities of VC, like, it's not that much fun for me, like I enjoy much more what I'm doing now. And so, you know, I think that's where I would encourage people like, understand what the activities are, and then pick which one is going to be right for you. And if you once you understand that, like you can't go wrong, creating a career you're going to be happy with if you're doing activities that like really excite you.

So when I speak to aspiring entrepreneurs, at the risk of speaking to generally, a lot of folks often classify themselves in one of two buckets, kind of the investor types, those who are most interested in the investing part of this equation. And the operator types, those who are most interested in getting their hands dirty and becoming operators. On the surface, it feels to me that please correct me if I'm wrong, it feels to me like Holdco entrepreneurs are likely more like have the investor orientation. So I ask you a bit of a strange question. Because you're both, you're both an investor and an operator. But if you had to pick one, which one do you think best describes you? And how do you think that should inform the decision of this aspiring entrepreneur who's who's kicking tires on the idea of a Holdco?

Yeah, I understand we agree with you. And I tried to tweet about this idea of like, I call them operators and allocators. And if you look at them, they're like, you see those pictures of where the two ocean currents meet each other, but stay separate, like the Pacific or the Atlantic Ocean meet and they're like, very different. Like, they actually don't need on social media very much. When allocators read my stuff, they realize very quickly, I'm much more in the operator bucket, right? Operators are people who go out and make stuff happen. They're the Man in the Arena, so to speak, and then you have the allocators who are you know, the guys placing bets in the stance, right?

And there's nothing wrong with either one of those lifestyle choices, but I agree with you like they're totally different. Based on my experience in social media, and what I do every day, I feel like I'm in the 75 to 80% Operator bucket and the rest is allocator. So I feel like I can bridge a bit but ultimately like part of what I didn't like about VC. And part of what I don't like about public market investing, and all that kind of stuff is like, I want to get in there and have an impact, and make my world a better place. And when you're an allocator, you never directly do that. It's always indirectly at most. And so, I totally put myself in the operator bucket.

And I think you're hitting on the next point, which is, a lot of people get confused, thinking that they could go live straight away the Warren Buffett lifestyle, where it's just like, oh, I just sit back and collect checks and go to Dairy Queen on Tuesdays. And like, they forget all that operator stuff those guys had to do to get to this place. And so, that may be part of where I'm kind of not as bullish as I should be about the future of holding companies. It's just a lot of these people. Like, they're gonna get really surprised that it's not just sitting back collecting checks.

Right. So you mentioned your 12 companies spanning multiple different industries. So if your holding company isn't vertically specific, which it sounds like it isn't, I guess, can you walk us through the benefits to portfolio companies of being housed within a Holdco? Like what additional synergies or sources of value is created for them by virtue of being owned by Holdco?

Yeah, well, I mean, first of all, they're my company. So they have no choice. That's the first answer. But look, I think there's, there is a lot of things in my case that are beneficial to these companies. So number one, like I'm spending my days coaching, and helping CEOs and coaching and helping the companies through good times and bad, like I'm learning things, and I'm able to cross pollinate those across the groups. I'm able to see when there are times that they have a candidate who's maybe not a fit in one company and can go work at another one, or, you know, one company was recently downsizing.

And we took a great person from there, and we moved her over to a company that's growing. So there's that kind of cross pollination that can happen. There's a level of me learning things, and I can help out with other stuff. And then recently, we've started to create mechanisms in which the folks can have connections that don't involve me. So for example, in November, we had my very first kind of portfolio conference, and I hate the word portfolio, but it was just like, all the companies in the leadership got together, and we brought all the C level people in and everybody brought issues that they were dealing with, and we like process those as a group.

So we're doing that kind of stuff as well to create kind of the benefit of being part of the network of people I'm involved in. So you know, those are all there. And then I have other opinions about all that stuff. But yeah, that's the those are basically a lot of things. And then lastly, if I'm able to have income in companies that are, you know, a variety of those things, in theory, the whole portfolio is going to be more resilient, right? Because it's very different compared to just having and being all in on just owning one business.

So how do you sell a business owner on the merits of selling to a Holdco, outside of the price that you can pay? Let's consider capital a commodity that substantially anybody can offer to sell or so a search fund might say, hey, I'm an individual operator, I don't have a portfolio, I'm betting the next 10 years of my life and career on continuing the legacy that you've built. A private equity firm might say, hey, we're gonna allow you to roll X percent of your economics grow this thing by 10x. And you'll actually make more money on the second bite of the apple than the first and hey, we've got outsource recruiters and all these accountants and lawyers and folks who can help you. On the kind of softer or non quantitative side, what is the value proposition that you offer to sellers have businesses that they find to be particularly compelling?

Yeah, well, I think there's opportunities around, you know, taking care of their legacy. Them knowing the way you're going to treat the business, I think is definitely there. There are, I think ways of, well, no, I think those mean, for me personally, those are the big ones. Other people who are acquiring there are a lot of things that you talked about, as ways that you can see a benefit from the whole thing. You know, one of the companies that I'm deeply involved in is a software Holdco called DuraSoftware. We started out in 2017. And part of their pitch to software sellers is since we're a permanent hold model, they know we're going to take care of their teams, and we have a track record of doing that and their legacy. So a lot of that also kind of plays in and it really is just situation by situation. For me, a lot of it is like it's me. People know they get to work with me, and I'm pretty transparent about who I am and what's important to me.

And how do you think about control, are you buying 100% of these businesses, majority stakes only Do you do any minority stake? So I guess what is your stance on the idea of control? And how does that stance compared to like the quote unquote Holdco average stance on the concept of control?

Well, for full transparency, since asset prices went crazy, four or five years ago, I've been doing a lot more incubation of companies and I have been acquiring them. Like it to me, the last handful of companies that are in my whole go, are ones that, you know, I've started from scratch. I have been part of buying a bunch as part of the software stuff, and I sold a company last year. But I've been doing a lot more incubation and also, because I really liked that. I think that's another way to create Holdcos. But you know, in terms of, I just totally lost my train of thought.

We were talking about how you guys think about control and how that compares to how most other Holdcos think about control, if there's a difference at all, between the two.

It's really interesting. The older I'm getting, the more I like, control. You know, it's because I can have the most impact. And ultimately, like, that makes me happier. At one point, I sat down with my business coach, and I went through all the stuff I'm involved in, and he said, do you notice a pattern here? And I was like, what do you mean? He's like, look at all the stuff you're unhappy with going on your life, it's stuff that you can't make change, and you don't control it. And I was like, oh, that's really impactful. So these days, I really try to have control.

That's not always a for sure thing that I can always make happen. But I think that's my model. And I like it better. And it's kind of that operator mindset, I think that we talked about before. Look, I think by and large, most of the Holdco models I'm seeing these days want to have control. They want to be able to impact changes on things when they want to. And yeah, that seems to be more than normal, compared to maybe in days past.

So how do you balance the push and the pull of industry specify specialization versus the potential benefits of diversification. So for example, like the most famous or well known, vertically oriented Holdco, of which I'm aware of would be Constellation Software, they by God knows how many software companies and they bring a sort of playbook to those software companies, which eventually kind of creates value in that they're very familiar with the business model.

And like you said, that by far the best known horizontal Holdco is Berkshire. And I can see benefits to industry specificity. And I can see benefits to industry diversification, how have you thought about the push and the pull of both of those strategies? And in your experience, which one has proven itself to be more valuable over the years?

I think they could both work. I mean, I'm not trying to duck your question. But if you look at it, the way people should put together Holdcos and structure them and finance them should be in response to the market opportunity that they see. You know, and the Warren Buffett horizontal hudco of of heterogeneous assets. Well, they went out and they discovered, you know, as they were buying these things over the 60s 70s 80s and 90s, like they had an opportunity to go by the railroads. Well, when the guys putting together Constellation, were putting the other Constellation, the software behemoth, well the railroads that already been bought.

There's no more railroads left. And so they created a structure, I think that played very well towards the software market. So that's what I tell people, it's really about structuring your Holeco in a way that works best for the type of assets you're going to have. And not starting with the structure and then trying to fit it to a market.

A mutual friend of ours Brent Besure, has this famous line, I'm sure I'm gonna butcher it. So apologies, Brent, if you're listening to this, but he said, every business has the everything tastes like chicken layer of business, which is to say, despite the specific widget that you're selling, every CEO has to deal with culture and incentives and hiring and firing and all of the things that are completely independent of the widget that you are selling. I guess is that your observation? Do you find that you can create similar types of value with a fireworks company as a software company? Obviously, there's some percentage that's specific to fireworks retailing and software but is is a greater share of the pie that everything tastes like chicken lair of the business in your experience.

100%. Yeah, and what I've actually done in my Holdco is go and standardize the systems that people will use to do the tastes like chicken lair. So everything from strategy and visioning for the business to how do we do you know, our organization, how do we structure ourselves to, you know, how do we do sales? How do we do hiring? All that stuff I've standardized, and for me that's made it immensely powerful. Because I know that I can go out and have gone out in the world and found the best to breed for these systems. And then everybody uses them. So there's a level of standardization that that makes my job easier as well. But yeah, that's 100% right. Whether you're in finance, or whether you're in a 3PL in Ohio, like, you still gotta hire good people, and you start out to run team meetings, like none of that's very different. So 100% agree with Brent in that regard.

I mean, this is more just a personal curiosity. But how does one effectively spread their time across 12 completely different operating companies? I mean, obviously, there's only 24 hours in a day, there's only one Michael Girdley to go around. I mean, can you just talk us through what are some of the major mistakes that you've made over the years with respect to delegation and time allocation? And what have you learned in both of those regards over the years that listeners might benefit from?

Yeah, I've made a lot of mistakes. So I think a very common one, from a Holdco perspective is, it's very easy, especially when you're going from one company to not get out of the way of your designated CEO, or person that you put in charge of the business, whatever their title might be. I've hired CEOs in the past, and I looked up, and I was like, Oh, I'm doing their job for them. And that was something I had to learn really quickly. Because they were unhappy, I was unhappy, the company was confused. Everybody was making less money and ineffective. So not getting out of their way was was definitely something that I've learned how to do much better.

And it's even simple stuff that goes with that, like, if you're going to own a company, and you want somebody else to really be the CEO, like get the hell out of their office, like I don't go, I have an office by myself, I used to office with a Portco. And it was just a mess, because I would be like pulled into stuff I shouldn't be in and everybody was confused, like, why I was around like, just wasn't good. At the same time, I've made the opposite mistake, like not seeing things that were going to be a problem and being too slow to act on them.

And some of that is just experience and feeling that you have to get over time, watching companies and feeling their ebb and flow and the vibe and all that kind of stuff. That's the other end of the spectrum. And I don't know a way to learn that stuff other than just doing your best and being introspective, when you make mistakes and doing better than next time and getting a feel for it over time. But I've made mistakes in both ends of the spectrum there, the easier one to fix is the getting the hell out of the way, because you just rip off the band aid and let the CEO be a CEO. And go from there. But yeah, I would say those are the two big ones for sure.

Right. Given the increased interest in Holdcos as an asset class, for lack of a better way to put it, I presume that three to five years from now, there will be a group of great Holdco entrepreneurs, there will be a group of good ones, and there will be a group of less successful ones. In your experience, like what do you think will separate the great Holdco entrepreneurs from the good ones? What are they either doing or not doing to attain that classification of great?

Yeah, a million percent. I think they will have gotten into it, and created a Holdco CEO role for themselves that has them tap dancing to work every day. And I think the ones that will burn out or will quit, or the ones that got into it for the wrong reason, or discovered, hey, like, I really don't like all this context switching that I have to do, and I don't like that I am, by default coaching CEOs rather than bossing them around. And I think a lot of those people will burn out and give up. And that may create buying opportunities for people like me, but fundamentally, I think that's the big distinction, like getting into this game.

Like know what you're getting into, and then make sure you're going to truly love it. Because I think you and I both know, the people that get ahead the most in life are the ones that can set these 10, 15 and 20 year plans and just execute on him for that long period of time. And greatness and Holdco world I mean ultimately requires that just like it doesn't everything else.

You mentioned the concept of hiring great CEOs and getting out of their way. I'd love to ask you a follow up question in that regard, because the domain that I deal with as a search fund investor is entirely first time CEOs and that creates both opportunities and challenges. But broadly speaking, over the past decade or so my eyes have truly been opened to the art of the possible with respect to highly inexperienced CEOs that would otherwise have to work like 15 additional years to get the opportunity to sit in that seat. So as someone who has hired many different CEOs, and presumably like all of us, you've had some good hires and some bad hires, what have you learned about hiring experienced CEOs versus inexperienced CEOs and do some types of industries or business models or situations lend themselves more appropriately to one versus the other?

I'm probably pretty opinionated on this. I guess I'll give you my strong opinion. I have seen little correlation between the success of inexperienced versus experienced CEOs. The biggest correlation is people that have just like a very high end of the spectrum of grit, like the people in my portfolio and world who outperform, they just want it more than the next guy. And it doesn't mean they're more talented or more smarter, or they have better skills coming in, or any of that stuff, like the ones that win every single time just have greater grit and want it more than the next few folks. Now, that doesn't mean that you can hire just some junior person for an established 50 person company who just wants it more like they just don't have the skill set and the ability there.

But ultimately, like whether somebody's coming in having already been a CEO, whether they've been a CEO someplace else, where they've been a SVP of sales somewhere, and they're right on the cusp of being ready. Like none of that correlates very well to outperformance would correlate it every single time is how badly do they want it? And how hard are they willing to work for it? And how are they going to act when adversity hits them? And so, I ended up being somebody that wants to hire for that much more than I care about whether you've done it before or not.

So how do you test for grit? Like, what questions do you ask that inform your opinion on the extent to which someone has the requisite levels of grit?

Yeah, so I have a whole hiring system that is based off of a couple of off the shelf systems. And one of them is the top grading system, which some people love and some people hate. But core of the top grading system is this idea of behavioral interviews that go through a candidate's track record. And the idea is that a candidate's track record is the best predictor of their future behavior. So people that are going to have grit coming into a new job, are people are going to have demonstrated grit in the past. And so as I'm doing these behavioral interviews, to identify folks who have grit, I'm just basically trying to understand their story.

And did they have it in the past? And you can even see, do people have grit when they're looking for their first or second job out of college as a very young person? Because if you start to dig into their high school years, and their college years, their early first jobs, you can start to see like, what happened in each of those jobs? And what did they do when they faced adversity? And it becomes very telling of what they did then, because it's going to be exactly how they're going to keep behaving when they come and work with you.

Yeah, let's transition to software specifically, you mentioned that a big part of what you do is in a holding company called neuro software, and as a former software entrepreneur, myself and current software investor, this is all very close to my heart. So as far as I'm aware, Dura acquires small software businesses across a wide range of industries. And I guess my question for you is, what is your view as we record this in December of 2023? What's your view on the state of software valuations for micro cap businesses? I mean, anecdotally, the most common valuation range that I see is somewhere between three to four times ARR.

And I've noticed that that has been rather stubbornly sticky. I mean, 12 to 18 months ago, the public comps are trading at like 15 times revenue. Now they're trading at five to six times revenue. But in both of those time periods, I've seen three to four times ARR as roughly kind of sort of the median. I mean, I guess the question for you is, how similar or different is that from what you've been seeing on your end? And just your commentary more broadly, on the state of software acquisitions in December 2023?

It's been a wild ride over the past number of years, for sure. I think people make a mistake to think about the software industry as being very homogeneous. There are situations for sure, where three or 4X ARR makes total sense. Like if you're in a pure SaaS business, and you have amazing metrics, and you're growing quickly, like all that stuff, can totally underwrite. You know, there's other corners of the software market, that are very different, where Dura plays much more is looking, you know, in much more kind of stable, often enterprise and B2B often requires a lot of people to deliver type ends of the software market subscale.

We're buying companies in the three to 50 million a year ARR range. And that's a different beast from bigger companies that are growing quickly or pure SaaS, and some of the companies will buy our license models as well. So, valuations down in other corners of the software market can be very different and oftentimes considered very differently. For example, I mean, we look at things as EBITDA base buyers, right? We're not going and buying multiples of ARR. In fact, when we'll go through investment committee and look at stuff, a lot of times when we talk about multiples of ARR, we don't care. Like because we're a different type of buyer.

So, I think that's point number one, like, it's tough to use a lot of these rules of thumb, for valuing the software market, just because it's much more bigger and diverse than a lot of people give credit to. And for sellers, that creates a challenge, because a lot of them will hear things like oh, well, you know, I heard software businesses are trading for three times ARR. And it's like, well, actually, it's all over the place. It can be sometimes Arr, it can be three times EBITDA, it can be zero times EBITDA, depending upon your model in the business. So I think that's there. More broadly, what's going on in the market is, more and more money continues to flood in.

You know, if you look at how much money just Constellation by itself is deploying, last year, I think it was $1.2 billion, and acquisitions. And they did some big stuff. But also, like, that's just a lot of money to go acquire software companies. And then there's all kinds of new platforms that have sprung up Duras, one of those that are serial acquirers. We've acquired five going on six businesses this year. So, you know, really aggressive with M&A timeline. And then there's other folks that have also received private equity backing and stuff like that, that are also out buying as well. So there's a lot of money in the space.

I think we're reaching a point where if your platform doesn't have an angle that you can leverage. You know, it's tough as an independent to be going or buying software businesses at this point, just based on where I'm seeing kind of multiples and the amount of capital chasing the existing kind of deals out there.

Yep, I totally agree with that. So I'm going to ask you a question that you have partially answered. But I think it's important to get your answer explicitly to this, because I'm invested in several software specific search funds. And I know anecdotally, that many of those entrepreneurs are kind of banging their head against the wall, when they hear you say, we're an EBITDA buyer, because they're probably saying to themselves, Michael, where are you finding these companies? I've been searching for two years, and every, every founder wants three to four times arr. So the question for you is, does a software company automatically command a revenue multiple, just because it is a software company? And why are why not?

Well, I mean, I think the short answer from my perspective, and I may be talking about it in EBITDA, buyer bias here. You know, it's impossible for things to always command a revenue multiple, I mean, say the company has negative gross margins, just as an example, like, there are tons of software companies out there that there's no way they should get an ARR multiple. So that would be my approach to it. And I think ultimately, the multiple or the rule of thumb, you should use to value a business is totally dependent upon what your core investment thesis is going to be.

I mean, we are not buying, in our case, highly growthy assets. So ARR multiples, make a ton of sense, when you're expecting growth to continue and possibly accelerate. When you're gonna rent stuff for yield or cash on cash returns, EBITDA multiples are much better as a as a way of thinking about it. So, I don't know if I'm answering your question or not. But that's how we think about it.

No, you are indeed answering my question. And part of me asking that question was selfish, because I agree in that software companies don't necessarily command an EBITDA, or pardon me a revenue multiple by virtue of the fact that there's offshore companies, right, like, it's much more nuanced than that. So in a way, maybe I'm just looking for someone else to say it. I guess related to that, is one of the things that I've been trying to coach my entrepreneurs on is this idea of, hey, there's more than one way to buy a software company.

So in the past, I'd say since 2019, what I've observed is what I'll call like, a very common archetype of software transaction. This is we're paying three to four times ARR for a company that's growing revenue at, let's say, 30% a year, their EBITDA neutral. We're paying, as I said, a revenue multiple, we're putting a million dollars on the balance sheet to fund future growth. We're putting no debt on it. And that stands in reasonably stark contrast to the type of deals that folks in my ecosystem usually do which is buying at a mid single digit EBITDA multiple, putting leverage on it, not necessarily having to grow the company that much to hit our targeted return.

So, as a result of all of that, I've been encouraging folks to look at, what I'll loosely refer to as different flavors of software acquisition. So for example, maybe you buy an on premise business and an EBITDA multiple and your investment thesis converted to a SaaS business seven years from now you sell it a revenue multiple, or maybe you find a service business that solves a business problem that ought to be solved by software instead. So you buy at a service multiple, and you sell at a software multiple. Then there's the constellation style deal where they, you know, buy it in EBITDA multiple, have a reasonably healthy earn out.

Increase prices on the existing customer base, and use that high margin revenue to invest in other assets. So I guess my question to you is, from a Dura perspective, how are you guys thinking about it? I mean, I just listed, I don't know, three to four types of archetypes of deals, like, do you guys tend to pursue one of these flavors or archetypes more frequently than others?

Well, there's a couple other ones I think you didn't even mention, there's people that want to do distress deals as well, that are distressed for one reason or another. You know, for us at this point, like duras not really interested in doing that kind of turnarounds. It's not really interested in doing, reshaping kind of incubation style stuff. I think those have gone into the like too hard bucket for us We are much happier to pay up a little bit more for something that is going to just be of a higher quality and already fixed because it's just a nightmare. No offene these businesses are often distressed for good reason, you know.

So that's just our philosophy at this point, we'd rather pay up for quality businesses, so kind of headed down the Berkshire path a bit in that way. But I think you bring on a good point like those, when you see folks like us avoiding opportunities like that are getting out of the way of some of these deals, that creates an opportunity for other people. Another one is like, is there hardware involved? Like people have a very homogeneous view of hardware kind of the same way they have a homogeneous non nuanced view of the software market, which is not all hardware is created equal.

If you ask me what I want to be in a business that has custom PCBs and chips and all that kind of stuff. Like that's a really hard business. Because of all the atoms involved in that stuff. The cycle time is really difficult and gross margins are usually challenged. Or you tell me hey, like, we're actually a software business. That just happens to have off the shelf hardware, and it's sold as an appliance, but it's all commodity stuff, and you just call up CW and they send it to you. Like, that's very interesting to me. But you see a lot of investors acting irrationally, about anything that involves hardware, just because they're just a lot of time very robotic in they're thinking.

So I think that's where you can look and say, like, okay, what are these things that other investors have passed on. And they were maybe being irrational bypassing on them, and I can go create value there. And the turnarounds are, they're hard workers and other one customer type. I mean, there's people that don't want to be in B2C, I'm one of them, like, you can go find opportunities and all that kind of stuff. And so that's where I would encourage people that are looking for more opportunities now. Because look, all these bigger platforms, if for straight down the fairway stuff, like you're not going to compete with a Dura or a Constellation or somebody like that, like good luck. We have too much scale for you to be competitive, you just need to find something that the platforms don't want to do.

Another kind of caricature of a software deal that I see investors kind of thoughtlessly overlook is when service revenue is relatively high as a percentage of total revenue. Now, I guess looked at on the surface, yes, you know, contractually recurring software revenue is more structurally attractive than like time and materials type service revenue. I get that however, in my experience, harden is harder, which means if it takes me six months to implement this ERP system, and as a result, I generate a lot of one time service revenue.

A, I will generally annually have more add on service revenue, configuration, new users, etceera. And B, that's probably reflected my customer retention because once they become a customer for a year or two, chances are they're not going to spend another six months and another $100,000 with a new vendor. Is that something that you see is under the category of investors ought not to just like blindly and thoughtlessly overlook those types of profiles of transactions.

Yeah. 100%, and a lot of times they don't want to do it just because it's hard. And that's where I think there's opportunity if you're a searcher that's willing to take on a hard project. And there's a lot of really great businesses that are super services heavy. And you look at it, a lot of these big enterprise software companies have big enterprise services arms as part of it. IBM is kind of the classic example, though. They were maybe more of a better example 20 years ago, but I think another one, they are of a business that's actually turned into an enormous software business is McKinsey.

I mean, people don't talk about how much they've acquired all these pieces of software that now they go in to do consulting engagements, which is very services heavy. And on the back end, they sell people software subscriptions, and turn them into recurring revenue. It's just a beautiful, a beautiful business. So yeah, I think that's another place where just because it's hard, and you can't fire out money as fast as private equity would want to like, there's opportunities there for folks that are willing to sign up for something that everybody else is being irrational about.

Another thesis that I hear with increasing frequency is this concept of like the venture funded orphan company. So much so that I wrote a blog post about it, I don't know, six to 12 months ago or so. So for folks who might be unaware, these are companies that raised venture capital, but they probably fit under the category of like, good business, bad capital structure, not all of them, but perhaps some of them. So these might be companies that are growing, I don't know, 10 or 15% a year, which pales in comparison to what a VC firm would need it to grow at, in order for it to be worth their time.

And perhaps these are companies that just never should have raised VC in the first place. But maybe did because of how frothy the environment was in 20, and 21. So I did a bit of work on this. And my conclusion was basically, this sounds good in practice, and intellectually, it makes sense. However, under the cold realities of the real world, this tends to be just really hard to find really hard to execute on, particularly for an inexperienced buyer for particularly for a first time CEO. I mean, to what extent have you seen this thesis play out? To what extent are you hearing about it? And is this a thesis that is worth pursuing for a prospective acquisition entrepreneur?

Okay, I'll just go ahead and say it, I'm pretty dubious about the thesis. And there's been several times over the past five years, either myself or friends have gone out and tried to find these type of companies who are quality businesses, but they're misscapitalized, and everybody wants to sell at a reasonable price. And you can get a steal of a deal and go in there and fix things up and turn into a great business. And A, I have never succeeded in finding a company that was worth buying. That like was a non venture success. And you wanted to actually go spend a couple years of your life trying to turn one of these around and make it into a great business. And the second thing is like, they happen every once in a while, but I'm rarely seeing announcements of people buying these things and turning them around.

Like, that just doesn't happen. And I think my current thesis is most of these businesses that are failed venture businesses, the reason they're failed venture businesses, because they're just not actually very good businesses. And I know people are raising money on these thesis, and they're going to go buy these things at fire sale prices out of the stuff, and I hear about it happening every once in a while. But when I look at it, either they're really hard, or there's just not that many of them. So I'm not a big fan of a thesis. I just don't think it's got legs. That's my two cents.

Yeah, that's consistent with with my view as well. Sounds like a good idea in theory, but in practice, it just tends to not work out for all the reasons that you just articulated. When you and your team at dura are evaluating a new software investment, to what extent are you considering AI in making investment decisions? And how do you guys think about whether AI is a net positive or a net negative for any given target company?

I think whenever you look at buying a technology centric business or a business in general, you have to understand what's going to be the future impact of tech in general. For example, even if you're buying a Main Street business, and you're totally betting it the the the main asset that you're buying there is Google listings, you have to start to think about what's going to happen to Google over the next decade or so, it's coming fast that you'll just ask your phone like hey, give me the best two plumbers in town and connect me to them. That's the way the internet is clearly gonna go versus you crawling through Google Maps listings, right?

So you have to think about if your business is based on that, how are you going to navigate all that in the future, whether it's a software business or not. So in general, we take a look at every single business we get into and try to understand like the level of like durability of it based on the technology, whether it's AI or anything else coming along and go from there. So in general, I'm in the AI is going to be like the calculator and Microsoft Word, and is going to make our existing humans a lot more efficient and effective, but ultimately not replace existing jobs or existing employees for most companies. And that's generally how we're seeing it happen in the case of the software businesses we acquire and operate as well.

So is it fair to say that when you guys are looking at any given software business, you're looking at the extent to which AI can make it a more productive or leaner or more efficient version of itself, as opposed to asking the question, hey, how might AI make this company completely irrelevant in five years?

I would say it's the opposite. We're looking at all technology, including AI and thinking, okay, are we picking up nickels in front of a steamroller here? And so yeah, that's generally generally how we do it. And then operationally, it's one of the tools we'll deploy to make the business better.

Michael, we've covered a lot of ground today. Is there anything that has been left unsaid in our discussion today, knowing that many of our listeners are prospective entrepreneurs, many of whom are kicking tires on the Holdco business model?

Yeah, well, actually, I did a course on Holdco's last year, and in two days from now, Wednesday, the 13th of December, we're launching my second course ever, which is a smaller course, totally focused on the modern day way to go find businesses to buy. And that's everything that I've learned over the past years of going out and doing M&A, both directly and indirectly, on the seller and the buy side, like how you should actually do that now. Because the thing I've realized is a lot of the advice out there is just way antiquated, it's like, oh, go browse listings and call brokers. Well, brokers don't answer your phone calls, like think none of that works. So we're going to launch that on Wednesday, and my team would be very happy if I promoted it, like I just did. So we'll announce it then. And hopefully people bite, it'll also be much cheaper than my Holdco course, which definitely make people happy.

Michael, you are a man of many talents. Thank you so much for joining me today. And thank you for being generous with both your time and your insights. We really appreciate it.

Yeah, appreciate you Steve. Thank you.