In The Trenches: Conversation with Royce Yudkoff & Rick Ruback

8:34PM Jan 26, 2024

Speakers:

Steve Divitkos

Royce Yudkoff

Rick Ruback

Keywords:

multiples

rick

royce

ebitda

company

business

work

firm

small

hbs

market

ceo

buy

concentration

partnership

searchers

investing

thought

great

students

Royce, Rick, it is such a pleasure to have you. Thank you so much for joining me today.

A delight for us.

We're thrilled.

Well, I have a lot that I want to talk to you about. So I'd like to dive right in. And maybe a place to start would be for anybody who may not be familiar with your respective stories, perhaps each of you can tell us a bit more about yourselves and your career trajectories, including what led you to what you're doing today. So Rick, maybe we can start with you. And then we can move on to you.

I got a PhD from the University of Rochester 25, I'm kind of straight academic, went to MIT, then moved over to the Harvard Business School, and have basically taught most of the classes at the school in corporate finance, have done most of my research in mergers and acquisitions, valuation, that kind of thing. And then was teaching a private equity course, a course that I helped co create. And we wrote a case on Abry, Royce's firm, and Royce and I became, well, what's the right way of saying it Royce? Royce and I recognize that we got along pretty well. And we would work together very well.

And so when Royce decided to step back from Abry, he suggested that we do something together, which I thought was a fabulous idea. I had been thinking about this hole in the curriculum on small firms. And so we decided we would do something that was different from what we both had done. Royce doing LBOs and private equity, me studying mostly large firms and a little bit of private equity, small firms were new to us. But it wasn't new, like physics. Because it was still in business. It was still in finance. So that started us on this journey.

I'll be brief, because Rick covered our shared experience. But I graduated from the Harvard Business School many years ago, it was a positive and transformative experience for me. I wanted to become an entrepreneur, but I wasn't sure how to do that. And so as I figured that out, I joined Bain and Company as a consultant, I really liked it, and eventually co headed their media and telecom consulting practice. And through that, with the person who eventually became my co founder at Abry partners, we saw an opportunity in the broadcast television business. And we left to form a private equity firm that specialized in the media sector, telecom sector.

And I co headed that firm for a quarter century as we built it up into a middle market, traditional PE firm with sector specialization. I'd always been interested in coming back to the Harvard Business School. And while I enjoyed my PE journey very much, I reached a point where I really wanted to do something different for my life. And that's where Rick's narrative and mine merged together. You know, we had hit it off, there was an opportunity to come back to the school. And together we've built this course program in a way that builds off our experiences, but also led us into some new markets that we hadn't been in before.

Fantastic. The plan today is to divide our conversation into roughly two segments. The first will be exploring your career trajectory and Royce, I'm going to talk to you quite a bit about that. We'll then move on to characteristics of a successful small to medium sized business transaction Rick, I'm gonna lean on you quite heavily for that. And Royce, you just touched on it in your career overview, but I want to dig into your Founding of Abry in 1989. Because as you said, prior to co founding the firm, you co lead Baynes media practice alongside your eventual business partner.

And I'm familiar with your story, and as I thought about it on the surface, moving from a well compensated management consulting role, to co founding a middle market private equity firm that had not existed and they had no guarantees of success. That feels exactly like the entrepreneurial leap that many of your students probably would struggle with making today. So I guess I just want to get inside your head a little bit. If you can rewind back to 1989. And can you just tell us about how you thought about making that leap? What was the self talk? How did you think about the risks and what might perspective entrepreneurs who are contemplating something similar learn from your experience?

That's a great question because students hover around this risk all the time as they think about not going to traditional elite HBS employers and cutting out on their own through search and students struggle with it. And I see my own experience as I watched them do this. I distinctly remember my last day at Bain where I flew down to New York City to say goodbye to a fortune 100 company that had been my client. And like other Bain partners, checked into the Palace Hotel and walked over and went up to the lovely executive dining room of this company towering above Manhattan. And we had a great lunch. And they were very nice to me.

And then I flew on to Baltimore, where we had just acquired our first broadcast television station, and I checked into the airport, Red Roof Inn. And as I my budget, rent a car in front of my room, my neighbor was parked there, and it was a van that was decked out as a gigantic hotdog, and it was labeled, eat Oscar Meyer wieners. And as I sat there in my car, right, I thought to myself, What have I done. And the truth is, you know, I was I was white with terror at this decision to sort of leave certified America and you know, all the things that a firm like Bain offered. Now that I look back on it, what I realized is, that was just ridiculous.

Because had everything not worked out, I could have gotten a job that was exactly at least as good as I had before. For one thing, I could have gone back to my former employer, I might have lost two or three years in the climb in that company, but over a 30 year career, that wouldn't be material. And I could probably have gone to other employers who valued my entrepreneurial journey even more, and I totally didn't get that at the time. But I totally get that now. And it's one of the things Rick and I tried to sort of share with our students.

I often say half jokingly and half seriously that an MBA from HBS is the world's best insurance policy against career risk. So if you're fortunate enough to be the holder of such an insurance policy, to the extent that you do have entrepreneurial ambitions, in my heavily biased opinion, of course, you owe it to yourself to give it a shot, because your downside is capped due to that insurance policy. Royce, what about your family and friends at the time? I mean, you did your undergrad at Dartmouth, you graduated from HBS, you worked at Bain, that's quite a pedigree backgrounds.

And now you know, you're staying at the Red Roof Inn, and you're presumably taking a big cut and compensation and prestige. Did your family or friends think that you were absolutely crazy? Did you have to explain what you are doing to your spouse or friends several times over? And did they think you are completely off your rocker at the time?

My wife was very supportive, because she came from a family of small entrepreneurs. So she thought that was the natural state of being and that it was unnatural to work in someone else's company. So I was just very fortunate in that way that she was completely supportive of this. My friends, most of whom did work for traditional post HBS, you know, white glove employers actually had a surprising reaction, they all thought this was sort of great. And there was a little bit of vicariously living through me without, you know, all the anxiety. So, they were really sort of very supportive and not regarding this as quirky as it, you know, could be seen. I felt a tremendous level of unasked for support from them, I would say.

So you both have experience in we'll call them larger mid market businesses. And what I'll refer to as micro cap or lower middle market businesses, Royce in an investing capacity, Rick in a research and academic capacity. So Royce, maybe we'll start with you on this question. But Rick, I'd be curious to hear your thoughts as well. What are some of the major differences between investing in larger businesses like you did an ABRY versus smaller micro cap businesses typically targeted by search fund? So I'd be curious, like what is very similar about investing in these asset classes? And what is very different?

Well, thank you for asking me first because that as Rick and I like to say, that gives me a chance to take the free spot on the bingo card, because I know my partner, Rick will have a few things to say. But I'd say at least one thing is similar and two things are different that similar thing is you go through a similar valuation exercise on the company's modeling, you know, questions that you ask and answer. The two big differences are one, the multiples at which these companies trade are so much cheaper than middle market companies for several reasons, but one of which is you do not get the institutional bid you get in mid market equity.

So companies that would trade at eight times EBITDA for a middle market company will trade At four times, if it's a similar business, but it's a small, firm. And as Rick likes to say, and I love this expression, the magic is in the multiple, that's one of the great reasons to be in this market. And the second is a second big difference. And it's a disadvantage, just as the low multiple is a big advantage is you're almost always dealing with first time sellers. And so they don't know how the process works. Their data is lousy and not prepared for sale. Sometimes they're anchored and off market terms.

And you really have to hand walk them laboriously through the sale process in a way that you almost never do in mid market private equity, where your counterparties are experienced investment professionals, I'd say those are the similarities and differences in my view. But Rick, your thoughts?

Yeah, I would say it's the that the biggest difference that I find between big firms and small firms is that small firms are small. And while that sounds really stupid, what I mean by that is that everything about them is small. So it is a scale problem. So if you look at it, the management bench is quite small, the scope of their products tend to be quite small, the reach of their customers tend to be quite small. Their relationships with other professionals, for example, banks are quite small and limiting. So for example, when a big company undertakes a new project, it never asked the question about where they'll get the money, they're governed by does this new project create value?

In a small business, it is often the case that it is liquidity and the ability to finance a project that determines which projects get taken, not just the value. So you see, all those come from just being small. And it is a very different set of challenges. If you go back to the 1950s, there was work, you know, sort of before the efficient market theory, before the great work done at the University of Chicago and at MIT. On capital markets, people used to do work on corporate finance. And they would study things like how do you make investment decisions? And oddly, it wasn't the net present value decision. Because Net Present Value requires relatively frictionless and liquid markets.

That's where that theory comes from. Instead, it was how do you maximize your return with a fixed set of dollars, and it was about odd linear programming exercises and things like that, that seems so foreign today. But those concepts which people used in the 1950s, that same intuition, they used in the 1950s, for big firms, that same intuition really dominates the thinking of small firm CEOs.

You know, I read something recently that said something to the effect of no business stays small on purpose. And given that we are purposely investing in small businesses, I'd be curious to get thoughts from either of you on good reasons versus bad reasons why any given company is small, and there are some obvious answers to this. So you know, if it's in a highly competitive saturated market, selling a commodity like product, where margins just keep going down and down. I think we understand why companies like that stay small, but maybe things that are less obvious than that, in your experience, what are some quote unquote good and some quote unquote, bad reasons why any given company is still small, despite often a few decades of operational track record?

Rick, and I like to say you want to buy a small firm that is small for the right reasons. And one of the best reasons is that they operate in a niche that small, so it's not that competitors are scarfing up their customers or that no one wants to buy their product, it's that they've focused on a small niche. And within that niche, they're a devastating competitor. And those can be great businesses. They just don't naturally grow to large businesses, but you can make a lot of money and have a great life owning one of them.

Sorry, Rick, you know, if you look at the the venture capital world, for example, I mean, it's a completely different investment model, obviously, and in their world, TAM or total addressable market is one of the most important metrics again, very different model. But Royce, are we to interpret your answer as given the power of being a dominant player in a very small niche, having a small TAM is that kind of an acceptable trade off or perhaps a prerequisite in the investing decisions given the focus on the niches?

It's not a prerequisite because different investors have different styles of course, and isn't it? You know, there are people who are growth oriented in the small firms space But yes, I think that if you buy a great enduringly profitable business that dominates its niche, and the amount of cash flow and equity value is sized to who is buying it. There's nothing wrong with staying a small business a small bit profitable business. For sure.

Royce, if we go back to your time at Abry, I'd be curious to learn some to learn about some of your your more meaningful or memorable failures or disappointments and in this case, meaningful can mean mistakes from which you learn the most, mistakes that had the largest financial impacts on the firm, maybe a mistake that had the biggest personal impact on you. Do any mistakes come to mind in that regard?

We never made a mistake, Steve. Yeah, somehow in life, you always learn more from mistakes than you do from successes. I think sort of two big learnings that stand out for me are once very early in the firm's history, we did a lot of due diligence on an acquisition, it was actually our first prospective acquisition. And late in the process, we discovered something that sharply limited the company's prospects, and we had a painful decision about whether to cut that off. But in retrospect, it's just so clear that it's much cheaper not to do a bad deal than to than to actually try to fix one. That's sort of obvious when you describe that at such an abstract level, but in the moment, it can be very difficult to just pull the parachute on something you've worked very hard on.

The other thing I'd say is, having acquired a lot of businesses, if I could only have one characteristic that I could pursue, it would be recurring revenue. I think one of the things I have learned through successes and less good outcomes is that one consistent characteristic of really good later stage buy outs is very sticky customers. And all the things that come with the type of business where your customers don't think it's in their interest to switch vendors, things like pricing power often come with that. So those are two things that I've learned over scores of acquisitions, where someone really well in somewhat us so.

So just a quick follow up on that. And, Rick, I'd be curious to hear your thoughts on this. So given Royce's important importance that he places on the percentage of revenue that comes from recurring sources, which I totally agree with, especially for a first time CEO, and that creates things like pricing, power, customer, stickiness, etcetera. That is all reasonably intuitive. But I think where the tension comes with most of the acquisition entrepreneurs that I work with is, yes, I'm looking for all those things. But it's very difficult to find that type of business at three to five times EBITDA.

And given that the magic is in the multiples, to use your words, how do you think about that trade off? Is it possible to buy a business like that, that demonstrates such attractive economic characteristics of three to five times EBITDA because I have searchers asked me quite frequently do I think the days of trying to buy companies for three to five times EBITDA are gone? So I'd be curious to get your thoughts on that question.

Sure, well, first of all, it very much depends on the size of the acquisition, the smaller the firm, the lower the multiple in general. So I think it's really hard to find a business that you can buy for three or five times that has 75% recurring revenue, and EBITDA of five to $10 million, that's going to be really hard. But I think there are lots of businesses in a million to $2 million of EBITDA space, that have those characteristics, that is to say, have lots of recurring revenue. And will transact for three to five times, they often have lower growth prospects, but low growth prospects often come along hand in hand with recurring revenue.

That is to say, if your customers are sticky, your competitors or customers are also going to be sticky. So they tend to be low growth. And there's a segment of the market that's very excited about high growth and and so firms that are low growth, about a million, million and a half dollars of EBITDA that have 75% recurring revenue going to attract the attention of most funded searchers that feel have a need to buy a business that's growing at 15, 20, 25% a year and has EBITDA in excess of four or $5 million.

I think that makes a lot of sense. And I have to ask a follow up question to you, Rick, because when I was still a student of yours in 2012, I think I recall you saying that searchers, and their investors shouldn't be overly focused on high growth rates. Both because growth creates a lot of unseen operational challenges for a new CEO. But also because certain levels of growth may command new, understandably, an entry multiple that's too high for a search fund. So it sounds like I'm recalling this reasonably accurately, please correct me if I'm wrong, but I guess my question to you is, as a community, how should we think about the importance of growth in our acquisition targets?

I think the space, the small firm acquisition space is really bifurcated these days, from the time when you were a student, there are searchers, who are looking for small firms with high recurring revenue, and are eager and focused on buying them at multiples below five. And I think there are other groups of investors who have more capital to deploy, who want bigger transactions who want high growth rates. And they're looking at higher multiple firms. And let me make two other comments on this. The way I think about this is that you can think about acquisitions in the small firm space ETA as either small PE, or small VC.

And the high growth marks segment really is small VC. And I think about the high recurring revenue smaller company as small PE. So to say that, that's number one. Number two is that, I don't know, if we can tell which strategy is dominant. Because what seems what is clear, is that some people who purchased at high multiples, were able to sell at even higher multiples, in the very frothy markets that we've experienced over the last decade, which is just fabulous. And so, I am always telling the value investor side of my brain, gee, these other people sort of reject this value investing idea, and they're getting rich, and you know, you're still a poor academic.

But I think that's one cycle. You know, we haven't seen a full business cycle and and who knows, if we ever get to the point where you're buying at, while backs, but markets go south, and you know, there's a replay of 2001 where the tech market goes down, and suddenly all the software firms that are valuing it 15 to 20 now, soon will be valuing at eight to 10, you're always gonna be a lot of unhappy investors.

And we're going to get to the concept of our community moving from at least specific to software from EBITDA multiples to revenue multiples, and what might that mean for both the investors and the searchers themselves? Before we get there, one concluding question Royce as we continue the arc of your career, I'd be curious to know a little bit more about how and when you knew it was time to step back from your day to day role at Abry? You mentioned earlier that you were just looking to do something different with your professional life. And the follow up question is for tenured CEOs listening to this who may be thinking through how and when they should step back from their own companies, whether it's selling hiring a successor, whatever the case may be, what might they learn from your experience making a very similar decision?

Well, I was very happy running Abry. I metaphorically, I ran to work every morning, it wasn't that I didn't really enjoy my job. I had done it for almost a quarter century. And both I and my co founder, we're starting to ask ourselves the question, look, we could do this for another 15 years. And if we did that, at the end of it and looked back at our lives, would we be happy with that decision? Or would we feel like we led too narrow a life? And the question almost answers itself. I mean, obviously, we were starting to feel more and more that way. And it coincided with the fact that it was a good time for the firm to do a transition transition business was doing well. We had a immensely talented group of senior partners underneath us.

And by the way, for me an opportunity came up to team up with Rick at the Harvard Business School but but it was really driven by this sense of managing, managing my life. It in the fullest sense, I remember that sort of, at the very end of that I was working late one evening in my office and my co founder, came into my office and said, I always felt this was like a scene out of Charles Dickens The Christmas Carol, where Jacob Marley visits Ebenezer Scrooge. And he said to me, Royce, when we started this thing we had more time than money. And now we have more money than time and we should act accordingly. And I thought to myself, but didn't say because it would only encourage him, I thought this was a really good piece of advice I've just gotten. So that was behind it.

Super interesting. And beyond the opportunity to work with Rick, as well as your desire to give back to the HBS community is something that I share as well. Was there something specific about academics that just, you found kept pulling you towards it?

Well, I'd always been interested in academics than both when I graduated from college, and when I graduated from HBS, had seriously considered going down a path of trying to become an academic myself. So yes, and it always interested me, I always liked and respected the profession deeply.

Okay, let's move on to the characteristics of a successful transaction. And, Rick, let's start with you. I'm curious, in your experience, what are, I don't know the top one, two, or three business or transaction characteristics that tend to be most predictive of good outcomes in a search fund transaction?

We've already talked about the most important one, which is recurring revenue. Obviously, high margin is right up there. But that's really a summary statistic for so many things. A low concentration is one of my favorites. I always feel like when we're in businesses that have high customer concentration, that that becomes a problem that really, really keeps the CEO up at night, and is just overwhelmingly distracting. And so customer concentration is something that I would like a root canal. That is to say, I get more root canals than I want. And we end up with companies that have more customer concentration than we want, but it's a really unhappy thing.

And transactionally, the thing I find is most challenging as a transaction characteristic is when there are multiple equity owners, it is very, very hard to get to the finish line in a deal. And what I mean by that is, if you have say, a founder who's in her 70s. And along the way, she brought in a CEO that she decided to give 40% of the firm to, and so now you have a 60% owner 40% owner may be separated by 20 or 25 years in age. That's a circumstance it's really hard to get agreement on both parties on actually pulling the deal, because their incentives are just so so different.

How do you think about other forms of concentration? So when we're buying small businesses, it is my experience that there is usually some type of concentration, sometimes it's specific to the customer. Sometimes it's seller concentration, key person concentration with respect to either the seller or some of her key employees, sometimes there are supplier concentration. Is this just kind of like an inescapable reality of investing in small businesses or do these keep you up at night as an investor in the same way that customer concentration would?

They would, and one of the things that is really challenging is when you manage a small business, you can often reduce costs by allowing more concentration on the production side, either by having more specialized labor. So that's the individual that you can't get by with by eliminating redundancies by not dual sourcing those things all result in short term profits but long term problems. And so I don't like any form of concentration. look, the reason why people want to be small business CEOs, in part is because they want they want to be independent.

They want to make their own decisions and when you have either a supplier or a customer that effectively is such an important part of their business your business that if they were to leave it would put the business in challenge, that's not the life you want to lead. So I think you should trade off a little bit of profit margin, trade off a little bit of profit margin, to reduce concentration and any way you can,

I'd love to double click on the idea of seller or key person concentration, because this is something that I see in so many of the transactions that I evaluate as an investor and certainly something that I saw in the company that I purchased many years ago. If you were to believe every seller of a business, she works 15 hours a week, she golfs four times a week, and this is a part time job at best. However, when you dig in two or three levels, then you find that she works 80 hours a week, and every sale goes through her, which is all to say that you can't necessarily take a seller's answer at face value. As you guys evaluate the companies in which you invest, what are the types of things that you like to know to help you get smart on key person risks specific to that seller who is often the founder of the business?

Well, let me just say that I often find that it is much easier to transition between owners, then people anticipate. So the evidence I have on this, isn't great. But the evidence that I have is that I think is pretty compelling is that almost everybody signs long transition agreements, and imagines relying on the departing CEO for six months to a year, and most of them last two or three weeks. So what that means, and the businesses thrive. So what that means to me is that people are not nearly as irreplaceable as they think. Royce and I are, of course, the exception.

And you as well, Steve, but generally, I think we can substitute in owners relatively easily. Now sometimes, there's a technical person, that is really essential. And that goes back to my earlier comment, which is, you have to think about that. And whether you can build in the redundancies, or at least understand the underlying job market. You know, if you need a PhD in chemistry, you should before you buy the business, you should understand what PhDs in chemistry get paid, and how you'd recruit one if you needed one.

I agree with everything Rick just said, I'd add two points, when you're looking in the first place for businesses with very high customer recurrence and stickiness, it takes a bunch of pressure off these transitions, versus businesses where every sale is a new sale, and often the co founder or owner has to be involved in that. The second thing I'd say is that one of the things I think most searchers do well, in their due diligence, is they ask themselves the question, Can I do that job? Can I be that person who's running the company, as they get to know the company and if they can't, they don't buy the company. So so then the transaction transitions go surprisingly quickly after you've screened for something like that.

I remember my own transaction, I thought I was eminently wise by signing my sellers up to a two year employment agreement. I detected some key person risk, and I was a first time CEO. So I wanted the time and the opportunity to have transfer of relationships, introductions to key industry players, etcetera. And Rick, to your point within nine months, both of them are entirely outside of the business. So another data point to add to your data set, though nine months is actually still reasonably long in the grand scheme of things. Let's get back to entry multiples, because we've alluded to it a little bit today.

But I still remember when I was a student, I remember both of us speaking many times about the importance of buying a company at let's call it four times EBITDA. And as a result of that, you get a 25% EBITDA yield as a result. And that's obviously very attractive on the surface. But I guess the question is, and I hope I word this adequately, at what point does a first time buyer risk becoming quote, unquote, blinded by a good purchase price, and as a result, they become willing to accept challenges and imperfections that they would otherwise simply not be willing to accept?

So maybe a more succinct way of saying this is there's a point at which a company is cheap for a reason. So at the risk of asking too general of a question, where do you guys stand on the spectrum of buying a fair business at a great price versus a great business at a fair price? Rick, maybe we can start with you.

Sure. I think having a business model that's established and enduring ly profitable is the place you start in any transaction. If you think the business is a turnaround I mean you can buy businesses that have been great but are now lousy and at low multiples. But that's not something that we encourage our students to do. It's not something that we like to invest in, because we want to have a business that has an enduringly profitable business model. So I don't think it is a trade off between low multiple crappy business, I think there are always, there are always issues in a business. But I think the biggest issue that you give up when you try to find a low multiple business is you're giving up maybe a potential for growth, or at least an existing Salesforce that's able to drive growth, and you're probably giving up a lot in size. So you're more in that $1 million range than a $5 million range of EBITA.

I want to pick up on Rick's last point on size. One of the reasons Rick and I have always been so excited about this marketplace, is that you can buy very good businesses at these amazing multiples, because they're small, you're not buying them at these multiples, because they're crummy businesses. And, and that's an amazing opportunity. So we don't for one moment think we are trading off quality for price.

I guess a follow up would be how small is too small, because there is a point at which you know, you risk effectively buying somebody's job as if, as opposed to buying a going concern business and small businesses have their own challenges with respect to both purchasing them and operating them. And I get asked this question a lot, which is like, what is the minimum EBITDA that would get me interested? And of course, people people want a number, and I'm not sure I have that number. But as a very, very loosely held rule of thumb, if something is below a million dollars of EBITDA, I tend to think about it as guilty until proven innocent, which is to say, you know, are we buying somebody's job? Is this founder doing the job that would otherwise need to be hired out to five different individuals under a new ownership group? How do you guys think about this question of like, how small is too small?

I would just say, see one or maybe both or one of our most successful businesses, I believe at EBITDA of around $650,000 when we bought it, and we've owned that business for seven or eight years, and it's, you know, doing fabulously well, it just have a lot of potential. So I think it's about potential, it's not about the level of EBITDA, I think the level of EBITDA allows you to buy at a low multiple, but then you have to put your thinking cap on, and look carefully at what the potential of the business is, what the margins of the businesses is, why customers buy from the business, you have to ask those questions. And not every business that has $750,000 of EBITDA is going to be a great investment. But there are those out there that are great investments. And that's why they call it searching.

I agree with all of that. I would only add that, Steven, I'm sure that in other podcasts you've discussed traditional funded searches versus self funded searches. And so I won't spend a lot of time on this. But as your listeners probably know, if you sell fund your search, and then raise money to buy the company, once you have the company in your sights, that searcher generally ends up with a lot more ownership in the company, which allows those types of searchers to focus on smaller small firms, the six $700,000 In EBITDA, because they own such a large part of it. And often they can get financing that's very attractive on those companies too. So I think there are other toggles that adjust for size that can make it a very financially rewarding experience.

Sure, I mean, one of the challenges that I've seen with respect to companies that generate let's call it $600,000 of EBITDA in my experience, more often than not, these companies are quite under invested in people and tools and processes and internal software systems and etc. And as a result, I almost always assume that margins at a minimum, but usually the dollar amount of EBITDA will go down substantially during year one in ownership doesn't always happen. But that's kind of my default assumption.

And in some instances in the small businesses, like I said, the owner is sometimes occupying the job of at least, you know, one to four people that would otherwise need to be hired under a new ownership group. So sometimes I have a concern that says, hey, you have 600k of EBITDA today, but your two senior hires away from having 150k of EBITDA, and that doesn't leave a lot of cushion for a first time CEO to make first time CEO mistakes. How would you guys think about that?

Well, I think that's really important due diligence question whenever you're buying a small firm, and the smaller the firm, the more important that is, but I think you deal with it through due diligence.

I also think there's a lot of false. There's a lot of professionalization let me take back the false thing. I think there's a lot of professionalization, that just doesn't make sense. There's a lot of CRM systems and technology that's added to firms that are well beyond what those firms need to run. Steve, you're in a generation where people can't find their way home at night, without looking at their phone and using some software. So So I find our students go in, and they find a business that's running really well and very efficiently, but does not have a bright shiny CRM system. And the first thing I want to do is take 125 or $150,000, or that $600,000 EBITDA you talk about and build a new CRM system.

And there's usually two things wrong with that one, the company doesn't need a CRM system like that, and to the CEO doesn't the new CEO doesn't know enough about the company to actually design an efficient system. So I think that that idea that you buy a business for 650, and then you have all these expenses, I think part of that is some of that learning, of course. But part of it is just unnecessary. It is the CEO wanting things done in a kind of orderly fashion that they're used to from your consulting job and their manufacturing job that may not fit this particular company.

That's so interesting. Anecdotally, would you say that more mistakes are made over investing in technology or under investing in technology with a new CEO and a newly acquired business?

Well, it's not like we have an empirical study on that, Steve, but I think it's best to live with the sticky notes for a little bit.

Or is it simply a matter of making decisions before you have the experience and context to truly know how big or how sophisticated a system we actually need? Or, you know, we tend to over engineer and put Salesforce into an organization that, you know, needs barely more than a set of Google Sheets.

Right? That's what I meant by living with the sticky notes.

Yeah. Makes a lot of sense. Okay, great. Let's conclude with a couple of personal questions. So given all of your success, between the two of you, one would be forgiven for looking at both of you, as people who just hit home run after home run every time that you step up to the plate. I mean, that's certainly something that I thought when I was when sitting in your class. So in light of that, I'm particularly curious to ask both of you, what areas of your current professional life do you still feel like you've yet to master? So whether it be leadership, teaching, investing, or even mentoring students, where do you to still feel less sure of yourselves?

Well, I'll speak for myself, and I'll be interested in what Rick's view on this is. But I don't think that characterization reflects how we actually think about our everyday job, I think every day is game day for us. And when we show up, we are intensely focused on executing a great class or, you know, writing a case that's just superb. And I don't I don't think there's this sort of nonchalance of we've done this so many times and it's worked that that all this comes easily I just don't think that's Rick's or my mental state, as we do this.

Yeah, I agree with that completely. I would think of us playing major league baseball or my I would be dropped down to single A really quickly. Because I think it's really hard to do things. Anything well. Hitting a fastball is not something I can imagine. I will say that I spend a lot of time working on my teaching on a typical day of teaching case that I've taught many times before. I'm up at 4:30 or five in the morning and fretting over the teaching plan for a couple hours before I even imagined going to walk in the classroom. And so I still work hard on that. And I think I always will. New case development is always a challenge. It's always hard to think about how our students will perceive and process a new case.

Particularly when you take cases that are a little bit off the beaten path. We did a new case this year, that I was really fascinated by and I think went very well. But it was really hard to do. And it was about a small coffee shop chain in Park City, Utah that employs people with intellectual disabilities. And it was a really interesting exercise to explore how small businesses can really change people's lives and make a hugely positive impact on a community. But it was very far afield of the kind of businesses that we talked about in our class. And so it took a lot of work and a lot of a lot of sleepless nights for us to think about how we would actually teach it and how our students would perceive it.

So now, I'm going to ask you to to speak highly of each other. And the question is really like, why do you guys think that your partnership works so well? And the reason why I asked that question is because one of the things that I just loved observing when I was still a student of yours was how different you both seem at a surface level. But obviously, on the things that matter, there are certainly more than enough similarities between the two of you such that you've created such a enduring and successful partnership.

So I guess, question one is, why do you think this works? So well question two, maybe even the more important question is for prospective searchers, and prospective entrepreneurs who are currently debating whether or not they should a partner, or be partner with a specific individual, like what might they learn from your experience, creating and now growing and nurturing this partnership?

Wow, that's a hard question. I'm gonna let Royce go first.

Well, thanks Rick, I guess I have a couple of thoughts. I think, one, it's certainly one of the reasons the partnership has endured so well, not just in its productivity. But in the joy we get from working each other is there's a real sense of mutual respect. And respect for the accomplishments that each of us has had even before teaming up in the other's eyes. So I think that's a very important, that's a very important quality in any partnership. And I think the way we measure the partnership is really on the results that we have as a partnership, we don't really spend time, what did I do yesterday? What did he do yesterday?

But are we kind of achieving our shared goals, and those qualities, which we both naturally come to, I think, lead to a strong and enduring partnership. And more importantly, I think, as MBAs think about partnering with someone, they should be thinking about whether those two values rank high, you know, that sort of respect for the other person and this sort of sense that a partnership is about shared success, not some accountant checking on who did what, last month. The one other thing I just can't help but comment on his I know that students regardless is very different.

But I think we who understand each other pretty well actually regard ourselves as quite similar in values and you know, what we care about? So it's always a little funny to me to see that students reaction to us being so different. And I acknowledged as some stylistic differences, but substantively, I actually think. Rick, I don't know what do you think?

I think we're very close need we have kind of a shared background in so many ways. Our families have had similar journeys. And so as well, he says, I think we're really very much the same. But you dress so much better than I do. Steve, in the years since you were in the classroom, Royce has this new phrase that he uses all the time. And he says that he's in charge of, you know, we divide each one of our classes in between planned activities and unplanned activities, you know, planned discussions and unplanned discussions in the classroom. And he's in charge of the planned ones. And that really rings true for me and what works really, really well in the classroom for us.

I think the reason that works really well in the classroom is our minds just work in different but highly complementary ways. Royces are sort of focused on getting making sure we get to the finish line and teaching particular key concepts. And I'm focused on I don't know if I would call it more creative, but more flow, trying to take people from where they are, to where they're going, where we want them to go to. And it's kind of a different technique that we both do, but we both, you know, I would have a very hard time doing what he does. And I don't think what I do would come naturally to Royce. And so there's some deep complementarity there.

And the mutual respect thing is really important. We have very different professional backgrounds. And one of the things that happens often when a place like the Harvard Business School tries to bring people like Royce in is that they don't really understand what we life time academics do and what we value and why we value what we value and why getting it right is just so important. And Royce deeply understands that and deeply respects that and it's really been a joy to work with Royce in every way. That's critical.

Just out of curiosity, do you guys have any practices or rituals that you follow regularly to keep the partnership healthy? So just for example, I know two co CEOs who have a weekly SEO, they call it a same page meeting. I know some who, you know, make it a point to spend time with each other outside of work once every week, for example? Do you guys have any like regular practices or rituals or tools that you guys utilize to make sure that the partnership remains healthy?

Well, it's not an agenda item. But one of the things we do episodically that's, I think a favorite of ours is we convene after class, periodically during the term in one of our offices and hold what we call it call a Board of Education Meeting. In which we pull out a bottle of single malt scotch and share some glasses and reflect generally on how the term is going. I think that's a powerful contributor.

I love that.

We do too.

We also check in I think regularly, we'll just make sure that we're balancing the workload, we tend to do different things. Both in the classroom and in our investment activity, we tend to be better at different things. And those things occur at different levels in different time commitments. And so I think both of us try to check in with the other and make sure nobody's feeling hard done by. And so we try to go out of our way to balance the load, I think.

That's fantastic. I mean, it is in any partnership, whether it is a commercial partnership, even a romantic partnership, I find one of the larger challenges is trying to escape 50/50 thinking. The idea that, you know, hey, I did the dishes yesterday, so you should do the dishes today. And scorekeeping for lack of a better phrase can often be highly detrimental to any relationship. Is it just the complementarity of your skill sets and the different things that you guys work on respectively, that addresses the propensity for us to scorekeep or engage in that 50/50 thinking?

I don't know, we don't keep score? I don't think do we Royce?

No, I really don't. And as you said, we check in enough but it's out of the spirit of balance. I Steve I really think our focus tends to be on Are we together accomplishing, you know the level of results we want to accomplish? And that's what we're focused on.

And we've not reached a moment in our relationship where there's something that Royce wants to do that he hasn't been able to convince me it's a really good idea or something I want to do that I haven't been able to convince him as a real Good idea. And that's true across our teaching, research or writing, and also on investing. So maybe this underlying similarity and underlying values is what drives this synergy. And makes it so smooth.

Well, I could talk to you guys all day about this. But of course, we do have to wrap up. I mean, look, I would just say that search funds the concept of entrepreneurship through acquisition has utterly changed my life from graduating from HBS in 2012 through today, it has changed my life in every way conceivable. All for the better. Now we've had some bumps along the road. And without the two of you and Jim Sharp and other mentors at HBS, there's no chance I would be where I am today, financially, emotionally, commercially, etcetera. So I hope you guys don't get tired of hearing the words. Thank you. Thank you for introducing this model to me. Thank you for evangelizing it. Thank you for continuing to support people like me even a decade after I graduated. I hope you guys realize the impact that you're having on people's lives just by doing what you do every day. So thank you so much. And thank you so much for joining me today. I really appreciate it.

Thank you, Steve. That's really thoughtful.

Thank you, Steve. It's been a delight to chat.