So, we have a lot to get to today. And where I want to start is getting inside the head of buyers as it relates to how you evaluate. And more broadly how you think about buying software companies. And where I want to start is a pretty commonly held rule of thumb, which is this concept of the rule of 40. So for those who are listening, that are familiar with the rule of 40, it essentially says your revenue growth rate plus your EBITDA margin should equal roughly 40%, or even higher, and that the closer you are to 40, or the more you exceed 40, generally, the more attractive all other things being equal. So, Jordan, in your experience, kind of buying and selling software companies, how good of a predictor ultimately is the rule of 40 of the ultimate return of that investment?
Yeah, I mean, I think it's a great question. And, by the way, thanks, again, for having me on the show. So I think if you take a retroactive point of view over the last kind of 10, 15 years of software invents investing, venture investing, growth, equity investing, software buyout investing, I think it has been a pretty good predictor, I think that's why people have kind of gravitated to it. And it's a pretty elegant way of trying to communicate the fundamental trade off between growth and profitability in a world where growth has been kind of more rewarded than profitability, particularly of late. And so you know, some people have rule 50, some of rule 40, some use it hard and fast, some don't. But in terms of like, the general notion, I think it's a good 10,000 foot view to get a quick sense for business. I don't think it's the end all be all, I think it's in some ways, it's something you look at. And it's in many ways necessary, but not sufficient. But as an as an entrepreneur, building a business, I think, whether you're bootstrapped or you've raised capital, you fundamentally have to make these trade offs as well.
Is $1 spent today worth three tomorrow, one tomorrow, or 10, tomorrow? And how much probability or predictability is there around that spend in terms of outcomes? And, you know, and again, this rule of 40, it's a dependent variable, it doesn't really tell you what's going on in the business. But it matters. Now, having said that, when you kind of broadly say, buying software, and it's probably worth double clicking on us for a second. So I'm the co founder of a firm called Radian Capital, based out in New York City, we invest throughout North America and Western Europe, have done a handful of deals. Now in Canada. Sometimes we're minority investors, and sometimes we're majority investors. And in every deal we do, we have a bunch of theses about what we think the opportunities are to drive, fundamental risk reward returns. And rule of 40, or 50, or whatever the right number is, if it's a like, tried and true classic minority deal, where we try to be helpful partners.
But otherwise, let companies run, maybe it's more important than, for instance, if we're buying a company, and we have a thesis that something's been under optimized, or there's an ability to spend money where a company has been bootstrapped before. And take it to a higher growth rate, you know, so on and so forth. And so, again, at a 10,000 foot level, it is something to look at, it does matter, but it's not the end all be all. And for any buyer, they're gonna overlay a bunch of different perspectives and theses in terms of why they're buying a business and why they think there's an opportunity. And some of them core, some of them want to see that number. And some of them might say, like, actually the worst the number that is like, maybe the better, because that means there's more opportunity if you're buying the company, right? And so I'll you asked a pretty simple question. And I gave you a long winded answer. But in summation, I'd say yeah, the unsatisfying, it depends, because it always does depend. But again, it is kind of one factor to look at.
So two things you said that I want to pick up on. Obviously, the trade off between revenue growth and profitability, the general thesis being that revenue growth is expensive. So if you're, you know, what the rule of 40 generally says, For people who might not necessarily be aware is, Hey, if you're growing revenue at 40%, you know, it's quote, more acceptable that EBITDA is neutral, because growth is expensive. And of course, if you're not growing at all, then your EBITDA margins better be 40% because you're not funneling any of that profitability into growth. So of the two variables, Jordan, do you put a higher weighting on one versus the other?
Again, I'm going to give you the unsatisfying it depends. I mean, you know, in its extreme framing, there are lots of investors in this world. And I think this is a modern phenomenon is you know, throughout capitalism making money was a good thing. I think there is a school of thought that basically says, if you're deriving EBITDA margin, it's because you don't have the next incremental project to invest in. That you cannot generate ROIC on every incremental dollar spent into the business, and therefore, you're clipping it as margin as opposed to reinvest in the business. And maybe, you know, if you take like, broad scenarios, you know, Amazon is kind of an interesting school of thought, right? Because for so many years, the tried and true traditional hedge fund investors and public market investors, you know, some like Amazon, some didn't.
But it was a little bit like, Can this company ever make money, and I think what Bezos and his team have proven is that like, day one mentality, and that extends to how they deal with profitability and cash flow. And they're always reinvesting, much of it, at least historically, in new projects and new products, and in some cases, completely new lines of business. And, and it's worked out incredibly well for them as the story has been written. And I think in technology, where there's an opportunity to, in some ways scale infinitely. Again, there's this extreme school of thought that to not take advantage of this moment in time where so many believe we're still early in kind of software and technology eating the world. That's a indictment on your business on your team, on the opportunity going forward. I don't subscribe.
Well, I just wanna be clear, I don't subscribe to that. I think that is like an extreme venture point of view. I think there's lots of reasons to be profitable. First and foremost, if you're bootstrap, and you want to earn a living like that is a completely reasonable approach to having a business. But at least in that framing, it is growth that's been rewarded most aggressively over the last 10 years. And at least for the foreseeable future, and the current market we're in, I think, that will continue to rule the day.
So how would you advise a CEO who is looking to sell her business, but her business has not yet achieved rule 40 operations? So, maybe it's in the 20s, or the 30s? One school of thought might suggest, Hey, why don't you optimize a few things, whether it be growth rate of profitability, until you get to the rule of 40, and therefore maximize your valuation, another school of thought would say that business is still a sellable business. However, your rule of 20, let's say will be reflected in the purchase price, and that the buyer will presumably buy this business with a thesis that they can either grow revenue or increase profitability. So what do you say to someone who wants to sell their business that is not yet achieved rule of 40?
I think I'm gonna say something cliche, but you run a business, like you'll own it forever. Otherwise, you will. And in saying that, first of all, let's note for all this talk rule 40. Most companies are not rule 40. That is like, that is an upper echelon metric to achieve, right. And so there are lots and lots of very good businesses that are not rule 40. And maybe that just means instead of trading for double digit revenue, multiples, you trade for high single digits right now in the software world. And that's not the end all be all. I'd also say if it's as easy as kind of putting your mind to being rule of 40, then the CEO, she probably should have done it already. So I don't know that more time is always the answer. I think, when it's time to sell your business, you clearly want to put forth the best picture, both of what you've accomplished thus far. And what you think the go forward opportunity is right? The next buyer needs to see opportunity in some combination of growth and profitability.
But the kind of end all be all magic formula rule of 40 as being binary, you will get your company sold versus you won't. I mean I don't subscribe to that. I think that's a misnomer. I think there are some venture investors in the valley in New York and a couple other kind of core cities, Toronto, maybe being another where they may have the discipline to say like, we won't do anything, that's not rule 40. But I think there are lots and lots of buyers in the world strategic and financial, and they're all looking for different things. And the key being, run a great business. Always be thinking about how you maximize asset value by creating great products, solving hard problems for customers, hiring excellent people on the team executing all those things, and good things will happen. And if you happen not to be rule 40, I wouldn't therefore say, well, it's not the right time to sell or it is a right time to sell because again, I think rule 40 in some ways, rule 40 only gets harder, not easier. So I think you got to take a more holistic view of the business and do what you think is right.
So, the rule of 40 encapsulates two rather simple metrics. And in evaluating the operations of a software company, presumably, I mean, there are an endless number of metrics that buyers can look at. But naturally, some of those metrics are more important or at least more meaningful than others. So if I forced you to make an investment in a software company on the basis of 10, or fewer metrics. So you have to make the investment, but you're only allowed to see 10 or fewer metrics, what would some of those metrics be that are most meaningful to somebody like you?
So I'm going to give away a secret. I actually asked an interview question of everyone who interviews at raising capital. And I say to them, if you could only have one metric, about a business, what would it be? Oh, yeah. So I'll even pin it down more. And there's no right answer to this. This is, you know, it's completely arbitrary. And I don't think anyone can tell the whole story in one metric. But inevitably, everyone always says to me growth. And I don't think like as a standalone growth is the most important thing. I mean, if you have 10, metrics, growth would obviously be one. But to me, the metric I love the most, is gross logo retention, or gross revenue retention. And the reason I say gross net? Well, the reason I say that all is I think you'll learn a lot about a business just by looking at gross logo retention or gross revenue retention.
For people who don't know the difference during Can you explain the difference between gross and net retention?
Yes, so even here, there's a little bit of a gray area, people have their own version of calculations. But the way I look at gross logo or revenue retention is you want to look at it on an annual basis. At the start of, let's say, 2021, we have X number of customers that existed prior to Gen one 2020,2021. How many of those customers have that initial base exist at the end of the year, that would be gross, lower retention, gross revenue retention, is the same thing. So how many of those customers left and therefore customers churned, but then I also include contraction and down sell. So if a customer stays, but they're buying less from you, or it's transactional based, and they're just doing less business, I would count that as well, in kind of gross revenue retention. That's where it gets a little gray, some people wouldn't include that I do, I think it's a conservative way to look at the business, but you don't include upsells. So everyone wants to talk about net revenue, retention, and net being the upsells as well. And I'll come back to why. wide net revenue retention is important, but I don't think it's as important as gross. But that would be kind of the difference in the distinction.
To me, you learn about product, in gross revenue, or gross logo retention, you learn about your go to market capabilities. You learn about your servicing capabilities, you learn about pricing. Now you can't extricate all that information just from that number. But it's the amalgamation of all those things that exist in that number. So for instance, and every business is different. If you're an SMB business, you're gonna have structural churn that's higher than if you're an enterprise software company. And that's okay. But you just start to learn how delighted our customers, what do you think elasticity of a product is. And by the way, delighting customers, not only do they stay, but they become your referral and morality to future customers. It tells you whether or not you're selling and hunting in the right area, it tells you whether or not your product actually services, the need you think it services and the value you think you're delivering to customers. So I think, again, you have to kind of extrapolate further from there. But if you told me that a business, you know, enterprise software company has 98%, gross revenue retention, versus 88% versus 78%, I don't care if the 78%, gross revenue retention business is growing meaningfully faster. I know a lot about the quality of the business just by hearing that number. And to me, like I give me that all day long. And I think there's a lot you can do with it.
Sure. I mean, if that company is growing top line, or at least is growing, new logo counts, if the new customers coming in through the front door are leaving through the back door in a number of months, than that takes the power away from that revenue growth.
That's right, that's exactly right. Now, there's all kinds of other calculations that go into this and some of that circles back to your trade off between revenue and profitability. Like if you're bootstrapped, you have to be profitable, right? Otherwise you run out of money. So like there's all kinds of things like then tied to growth. But if you raise a lot of money just because you're growing quickly, I don't care. If you're if you're turning out 20 plus percent of your your Goes every year, even if net retention is good. Most people don't operate in infinite markets. Like at some point, if you churn out 20% of your logos every single year, you're gonna run out of space. Right? And, and so it doesn't make that doesn't mean there aren't great businesses that have 80%, 70%, 60% retention. And obviously, as you get to consumer, you're gonna see even, you can't even compare it's apples and oranges and SMB sits somewhere in between. So, this is not blanketed. But again, if you gave me one metric about a business, I think you do learn a lot in a gross retention number.
I mean, for obvious reasons, investors are looking for recurring revenue with low churn rates. I mean, Who wouldn't? But recurring revenue is is no longer kind of the only revenue stream under which SaaS businesses operate, I mean, some operate under subscription models, some operate under more transactional models for it's a kind of a per event type payments. Some revenue streams are reoccurring in nature, but not recurring in nature. And then, of course, there's their service revenue, which is, you know, generally seen as kind of like the evil revenue stream. So can you can you talk to us about from the perspective of a buyer, how do you put differentials on the valuation of recurring revenue versus reoccurring versus service versus more transactional?
You want like the satisfying or the unsatisfying answer?
I want whatever you're willing to give me.
Yeah, I mean, in this in this market, it's probably licking the finger. Some days, it feels like, listen, let's take that in sections. So recurring versus reoccurring. I think people were kind of bigger sticklers about this way back when, like, arr really has to be contractual, defined recurring revenue. And I think for a lot of reasons, people have gotten looser about that definition. At the end of the day, as a buyer, the reason you like recurring is you like the visibility and predictability of the model. That's the whole point. You start every year, not from zero, but from some number. And even if you sell nothing new, like you should have a pretty good handle on how a business performs. People have gotten pretty clever. If anything, more than anything from a narrative perspective, explaining why let's say you mentioned transactional, let's say it's payments revenue. Why payments revenue associated with a software platform, why you start to kind of blend the revenue together and not think twice about it? Because, yeah, while the payments revenue is not contractual, the way the software revenue is how a typical customer performs both the individual customer and then cohorts of customers.
And you have a pretty good sense day in and day out what those trends line trend lines look like. And so you kind of make the argument that Yeah, well, it's basically as predictable as as contractual software. So why not pay us the same number? And in many cases, that's kind of what ends up happening. I think COVID was pretty interesting, right? Because there were lots of reoccurring businesses that, let's pick a date, let's call it March 5 2020. March 15, excuse me, 2020, where there was sort of no different with March 14 2020. And then there were lots of reoccurring businesses that have been arguing for a long time that there's no difference between contractual software and transactions. And I think a lot of folks, C suites and teams are the businesses themselves, and then obviously investors around him who, you know, probably learned a decent lesson about what the real difference between recurring and reoccurring is.
So, I still don't know in this environment that people are drawing up a hard and fast distinction. I know. And that's not picking on other people. I think as I think about it for radian, I view them similarly. But I at least try to unpack really what's going on in the reoccurring piece and how durable we think that is, even when you know not that anyone could perceive you know, some sort of cataclysmic issue or problem like my COVID. But at least have a sense for like, how much shock absorption exists in the model to make sure the reoccurring revenue one way or another sort of stays on track. So kind of long winded, but hopefully that sort of answers that piece of the question, but but happy to dive back in on any of it. Services is a whole different animal. That's right. I mean, like in terms of valuing service revenue, some people don't at all some people will make Have a number like one time services or two times services? I think it sort of depends. For me personally, it sort of depends on what the services are.
I think there is a kind of dogmatic approach, let's again, let's take the extreme, let's take Silicon Valley, you know, venture investors, I think, historically, services have been a dirty word. And they try very hard to stay away from them. For me personally, like, I don't see it that way. I think for a lot of businesses, services are important, hard in his heart out. Not to mention, it also gives you a right, and a necessity, to get close to your customers really get to know them understand what they're thinking and feeling. Why they're buying your software, what other kind of products and services they need over time. So, you know, to me, services can be great. And in many ways, I'm happy to have kind of services be a means to an end. If services are just for the sake of services, that might be one thing, but if services are what's necessary to get you high gross retention software, in customers that you can kind of grow and expand with over time, then why not?
Yeah, I think that's bang on. In my experience, when when we sold our business, we had different people look at it, you know, we got valuations of our service revenue stream as low as zero times revenue, that specific revenue stream, I should say. And as high as you know, one and a half or two, I agree in that it is an overly simplistic view to just look at the quantum of service revenue and apply a multiple to it, because to your point. So for example, our services were done at the beginning. And the nature of those services were such that our software tool was being deeply embedded into the AARP and the accounting system and the billing system of whatever the company was using at the time. So the time and effort and cost required to get it in would be the same time and effort and costs and energy to get it out. And so long as you substantiate that with looking at the churn numbers. In situations like that, service revenue is not necessarily a bad thing.
Not at all, that's, that's, that's exactly how I think about it. And I think it kind of leads to the next point, which is you make money on the services? If you're making money on the services, especially like, again, you don't want that to, well, maybe you want if you're a services business, there's nothing wrong with that either. I mean, but if you if you'd like the DNA of a software company, then again, I kind of use services as important as intelligence and as a means to an end. But running profitably, I mean, it's just more money to reinvest in your business. If you can't be profitable, that may not be a problem, either, right, you just need to understand a customer from a kind of fully burden, contribution margin perspective and understand with sort of clear visibility, the trade offs you're making. So maybe I'm willing to give service away for free, maybe I'm willing to take them at a negative 20%, negative 40% contribution margin.
If I know I can get sticky 80% gross margin software into a business and be there for a very long time and be able to grow that account and everything else. And so I just find, I'm with you. One, the blanket is services are bad. I think that's crazy. I think every business is unique. If you're a lightweight widget and you don't need services, that's wonderful. But if you're an ERP system, I don't think anyone would argue at least historically that Oracle or SAP weren't interesting businesses that made teams and investors lots and lots of money, but they require services. Salesforce require services. Now sometimes they do it themselves, actually, more and more, they shifted to third parties, that's okay to like you can have SI partners, like there's lots of ways to go about it. But I think blanketed Lee saying services are bad is wrong. It really does depend on the business. And the thing most companies probably need to sharpen the pencil on is just making sure you're being very honest about the unit economics of a customer, including services.
So if a customer needs services, both one time kind of implementation services or ongoing services, then when you think about the contribution margin of a customer, they're sort of like the story you tell the market, which will show software margins versus services. But I think as a CEO, she should be very clear about the trade offs $1 spent in marketing and product and sales and everything else to get a customer and the cost to deliver and delight that customer. And in that world, like that's got to include services and I think as long as your eyes wide open about it, services can be a very powerful friend in creating value long term.
You mentioned that Radian does both majority are buyout investing as well as minority or Growth equity investing. So let's talk about growth equity a little bit. The point of raising growth equity is to spend it, otherwise, it doesn't do much good for you. And buyers of software businesses, naturally and understandably look for good unit economics, specifically the lifetime value of that customer expressed as a multiple of the cost of acquiring that customer, which is the LTV to CAC ratio that so many of us are familiar with. And in my experience, investors love that because it's, at least at 100,000 foot view suggests that you can pour more money into sales and marketing. And that's ultimately how you're going to scale the business. In my experience, that's an overly simplistic way of looking at the world. But nonetheless, a lot of software investors that I've come across love that as kind of the contemplated use of proceeds of a growth equity investment. But other than that, what are some other suitable uses of growth, equity investment? So, when you ask companies, hey, what are you going to do with the money that suddenly is going to be on your balance sheet post transaction? What are you trying to uncover when you ask that question? And what's a good answer versus a bad answer?
Alright, so I'll break it down into a couple parts. So first of all, a lot of times when we do minority transactions, there is a secondary component in our deals. Now, that's not typical. I think a lot of minority investors like more traditional venture firms don't, at least historically, and you know, right now, all bets are off, right. The second, you know, everything goes. But I think historically venture investors put money in a business to have it stay on the balance sheet, I think a lot of the companies we invest in, they're not your typical venture kind of backed businesses, they're usually lightly capitalized or bootstrapped. And they're usually breakeven or profitable. We have kind of our own kind of niche of growth equity in this world that is different than a lot of others.
And as part of that, it's not unreasonable for somebody that has a great business that's been very successful, that looks out at the multiples in this world to say and says, I've come a long way. And unlike when I started this company, and I played like, I had nothing to lose, because I had nothing to lose, now I have something to lose. And so as part of a transaction, taking a little bit off the table to make sure that an entrepreneur doesn't have to worry about their family or paying bills, that's aligning, so we actually like that. So almost all of our transactions have a secondary component. And, again, that's that I wouldn't call that the norm. But we think it's important, we want people not to do crazy things, but be reset on sort of time and risk appetite to be very kind of balanced and aligned and ultimately great partners with us and vice versa. Should we think secondary goes a long part of that, on the primary part was as majority your question.
Yeah I think off top my head, a handful of things that would make sense to raise equity is, like you said LTV to CAC, and hopefully I'm a little bit contrarian on this front. I don't love LTV to CAC alone, at least, because I think there's a lot of calculations that go into LTV to CAC, and a lot of them are kind of forward looking and kind of made up like, you're not you haven't been around for a lot of years. And you don't really know how long the customer stays. And I think people have a funny math way of calculating what the contribution margin is of a customer. So stipulate for a second, though, that somebody is kind of doing it all right. And it's clean and aboveboard. Yeah, I think, you know, taking money on to reinvest it and go to market. That's kind of the most obvious use of dollars. And there, it's the sort of predictability level should be pretty high for a business right in growth, equity investing, right?
$1 in is X dollars out, hence your LTV to CAC. And the sort of more I understand the more you've proven it, the more comfortable I get with it, then, like the way I look at it is the less risk associated with those dollars being spent. But that's not the only way dollars can be spent, dollars can be spent in geographic expansion. dollars can be spent in product and r&d expansion. dollars can be spent on M&A. And I think in all cases there are acceptable answers. It's just both the company and the investor need to go in eyes wide open about where the dollars are being spent and what the expected return on those dollars are. And as an investor they only overlay I put on it as in like, really how much visibility and predictability exists with those dollars. If you have a well oiled go to market machine.
And you tell me LTV CAC is four to one like, I get it right I know exactly what my dollar is getting me, give or take, call it within one standard deviation. If you tell me you're going to build a product that does yet exists, to sell it into your existing customer base. Well, that may be awesome. But the predictability around that's a little bit different. So then I just need to get comfortable with like, well, is that the right risk reward? Is that where dollars should be spent? You know, have you prioritized correctly? And does a deal accurately reflect, the kind of balance of the opportunity in front of us? And that's where it gets a little bit, you know, there's definitely a lot of unknowns going into that situation versus the more traditional go to market, which I think is kind of reason one people typically raise capital.
So let's let's transition from evaluating the target to evaluating the acquire. In my experience, running a software company, without exaggeration, I would get daily emails from private equity firms. Some who might know something about our business, others who probably knew nothing about our business asking in some way, shape or form, are we looking for capital? Are we looking for a buyout, ecetera? And over time, unless I had a pre existing relationship with those people, I found it pretty hard to differentiate between financial buyer A and financial buyer B. And so, you know, knowing capital is a commodity, right? I mean, my money is just as green as yours is just as green as the private equity firm down the street. So, if a CEO is wondering, how do I differentiate potential financial acquirers? So take me out the strategics for a moment, how would you counsel that CEO?
Oh, man, it's a good question. And it's a fair question. And I want to reiterate something you say, cuz I say entrepreneurs all the time, like, yeah, particularly in 2021, capital is absolutely a commodity. And in any equation between investor or buyer, and company, company is the scarce resource. So hopefully, everyone kind of understands that going in. Now, having said that, firms spend a lot of time a good firm should spend a lot of time thinking about in that world where you sell a commoditized product, which is typically not an easy thing to do. What are the goods and services that you're wrapping around it to add value? And there's no one right answer, right? Like, every firm is different. So I don't, I know what we do at Radian to try to, every single day, earn our keep, and make ourselves look and feel different, and ultimately get to know companies in the right way, you know, enter the patient correctly.
But then also, every one of our portfolio companies, I think, would hopefully speak to who we are and what we do, and you know, how we partner with them? And so, different strokes for different folks. Given this is probably not a question about going deep on Radian, and this is just broad, like, yeah, I think it's really hard, I don't envy the situation. I have a pretty good sense these days, even my CEOs, like just how many of these emails they're getting, and it starts to sound a lot like just white noise. I think the things that matter over time, if I were in the shoes of an entrepreneur, is one, what specifically am I looking to accomplish? Like, I would say, not in sort of a negative way, but everyone's sending a lot of emails, and in most cases, they don't really know much about your business. So I don't think you should, like, I don't think you should overreact one way or another, to starting to get a bunch of emails, I think, back to the point, like, do what's right for your business.
And it's probably what has worked for you thus far to get you to where you are, and just keep doing it. And so point being, I wouldn't be attracted to capital, because it's out there. If you think raising minority growth capital, because you have opportunities, and you understand what those opportunities are, and you think it's the right thing for you personally, for your team, for value accretion, then you should do it. And if you're going to do it, then I would do it in a thoughtful, systematic way. I might sort of use some of the emails, I've seen a lot of them 98% of them are generic and pretty awful. But every once in a while, I think a firm, present company excluded. Hopefully we do this every time but I think there are firms that send also pretty interesting emails, or willing to make a connection or an intro or just do something to stand out. And I think that's one way to think about it. I think the next way to think about it is, none of this is reinventing the wheel go out and talk to folks that that have been through the process before.
You can ask them out firms that you've received inbound on or or firms they've worked with in the past and really just start to get validation, no different than customers in your world, talking to or potential customers talking to existing customers like that exists in our dynamic as well. Right? Our companies are our customers, right, we work very hard for them. And if we're not doing the right things to delight them over time. That's that's going to hurt us. So I think all that kind of goes into it. But first and foremost, like, capital's cheap out there, I get it. But I still would do what I think is right for the business. And so if you need money, be thoughtful, go get it. If you don't, then, you know, I think you can nicely reply or just ignore and say, you know, now's not the time, if you're going to do a majority transaction, you're going to sell your business. I think it's a whole different set of answers altogether minority investing is so much about the partnership, right?
Like we are, it's cliche again, but we're kind of get married, and we're gonna spend a lot of time together. And the duration could be three to five years, or it could be much longer, right. So I think it's really important, not that price doesn't matter. But price is just one of many factors, I think the closer you get to selling 100% of your business, obviously, price becomes more and more important. And in that world, it's a whole different ballgame. I wouldn't give somebody a proprietary look at a majority transaction, or a buyout, unless you're in unless there's some super idiosyncratic situation. But instead, you'll probably hire a banker or an advisor, ecetera.
So let's talk about the market a little bit, kind of from a more of a macro perspective, because you've mentioned it a few times, I mean, both public and private markets are extremely robust right now. And in the situation of a company, who is looking to, let's say, do a minority, a deal, or a small majority, so that this CEO is looking to stay on with the business, this owner CEO now could be a great time to sell because valuation, valuation levels are so high, credit is so cheap, there's a lot of capital out there, etc. But is it not true that the downside of getting a high valuation now is that the growth and value expectations over the coming three to five years are going to be kind of commensurately high in order for the new owners to to get a suitable return on that investment? So, I guess what I'm asking is, is a high valuation in a market like this for a CEO who's looking to retain an equity position in the business? Is it a bit of a double edged sword? In your experience for that owner slash CEO?
Absolutely. I think all fundraising is a double edged sword, people celebrate, you know, on Twitter, and TechCrunch. And all these places, like high rounds at high valuations. And we used to always say, or still do it, you kind of have a lot of empathy for entrepreneurs that we work with, it's a blessing for a couple of minutes, and then it's a burden. And I think that's not to scare people off from it. I just think at the end of the day, the more money you take, and the higher the valuations go, the less optionality you have as an entrepreneur. Meaning exactly what you said, if you take somebody's money at a price, and you get an offer to sell 6, 12, 18 months from now, but it's only slightly above that price. And either because structurally, or just because from a partnership perspective, you don't think it's the right thing to do, you're now just playing for a different target. And as that target shifts higher and higher, the probability of success gets harder and harder, right? There are less, there are less buyers that a billion dollars, and there is that $100 million, and there is a $10 million.
So I think for sure there are, for every action, there's reaction, there's absolutely ramifications for taking on partners and raising capital and doing it at prices that aren't sustainable. Or maybe they are sustainable, that came across harsher than it is. But but I think it's up to the entrepreneur to like I would say to you to an entrepreneur, if I was talking one on one, like, if it was, it was a close friend of mine, it was you, right? I'd say like, hey, at the end of the day, that doesn't mean like, that doesn't mean don't go out and get kind of commensurate value for where the markets paying for your business today. But it is to say, be very clear eyed about what this means. And if and when the macro environment shifts, or multiples change, like, understand the implications in terms of for you personally, but then obviously, for every one of your shareholders and for your team, because it is not without cost, right. And you can use that word cost very loosely, there is costs associated with taking on partners and raising capital I prices. And the higher and the more extreme, the more you maximize kind of price today, the harder you make it for tomorrow, and that is just a fundamental trade off.
The other thing I would add to that just based on my experience is, we're talking about small to medium sized business owners here and in in in businesses like that at the risk of speaking to generally it is more likely the case that the business is kind of overly dependent on the CEO or maybe a handful of the leadership team. Then would be the case in like an enterprise company. And I think in my experience, one of the biggest misconceptions that SMB CEOs have are kind of twofold. One, when I sell my business, all of my risk is off the table, the day the deal closes, that I think is probably the biggest myths about selling your business. And then dynamic number two is, when I want to sell my business, I am guaranteed to sell 100% of my shares, because that's what I want. In my experience, both of those things tend to be not true more often than they are true.
Well, those two are interrelated, right? If you could sell 100% of your shares on day one with no vesting, no earnouts, no handcuffs, then I guess you are right, and say you're here gone free and clear. Your points, the right one, most transactions don't have a critical component of the team allow the CEO with the ability to sell everything kind of free and clear and wave goodbye to the company and walk away. That's wildly atypical.
Exactly. And that would be the case for, I don't know this to be kind of mathematically true, but I would imagine maybe the top decile of all software companies. But when I first asked you the question, I added the kind of caveat that you're asking the question, we're contemplating growth, equity investment, but but I think that double edged sword is relevant for business owners who are contemplating, you know, 100% sales, majority buyouts.
100%. Like it comes back to I made the point, everything's gray, right? Nothing's black and white. But I made the point that like, hey, if you're a minority investor, you can take a minority investor, who your partner is really matters. And there's other factors in price. Again, it's not it's not binary, it's a scale, like, the more you're selling, I think the more prices, price is always very important. I would never want to minimize price. But again, I kind of use this term before, I think it's true here, too, like a minority price is kind of necessary, but not sufficient, the partnership really matters. Well, if you're selling 51%, the partnership still really matters. If you're selling 90%, the partnership matters, but less than if you sold 51%. And that's where all this kind of gets very gray, right? It's just not black and white. But I think the points the right one, very often, buyers of all shapes and sizes.
At a minimum, like every once in a while you find a situation where let's say a strategic wants to own the company, they want a product and they want some customers, and they couldn't care less about you, or your team as as kind of Cavalier as that sounds. And in that situation, like, yeah, maybe are kind of done, you're free and clear. But in most situations, you know, buyers buying the company, because they like what they see. And they think there's opportunity ahead. And in liking what they see and what they're buying, obviously, I mean, everyone talks about it, the team is the most critical component to any business. And so when you like, it's not tangible in the way that IP, or product or customers are tangible. But the team really matters. And so as a buyer, if I'm buying the team, then I need to create a structure to incentivize them and keep them.
And vice versa, you as the seller are going to have some amount of kind of interest or stake with me both financial, but also opportunity cost, right your time. I've seen golden handcuffs on deals that are as long as four or five years. I mean, so it obviously matters as part of the transaction. And yeah, it to the extent you're probably closer to this, Steve, but to the extent there are lots of entrepreneurs out there that think they just going to show up and sell 100% of their business. Yeah, I would just reiterate once more like that is wildly atypical.
Yeah. So let's let's move on to kind of the company operating under a private equity parent, just to get kind of for CEOs who have never worked under private equity ownership. Let's dig into that a little bit. So, after you've acquired, at this point, you've acquired a number of businesses. When you kind of first get into a new business, what would you say are some of the more common areas that you see that represent, you know, the biggest areas for improvement, or the biggest areas of oversight or opportunities for low hanging fruit? I mean, every business of course, is different. But at a general level, Are there areas that you see more frequently than not that represents areas for improvement that maybe CEO should start thinking about now, kind of well before they sell their business?
I mean, the answer is yes. And always, once again, the caveat being it depends. I think generically, the two most important things are you can't manage and scale a business over time if you're not measuring it correctly. And so I always find one way or another that companies can probably do a better job instrumenting and measuring what they're trying to accomplish. And that's across all facets of the business, that's go to market. That's product, that's human capital and talent. They're just better ways to have real visibility into how a business is performing and really understanding the levers of a business. Because the corollary to what I just said is like, you can't manage a business if you don't measure it. And so and that means a lot of things a lot of people now. Like, in this case, I'm the suit, I'm the PE guy, I think everyone's always afraid, like, Oh, my God, like PE comes in, and they make me like, you know, Institute all these different monthly reporting PACs, and quarterly reporting PACs.
Everyone's different on this front, we try not to do that, like we ask as Radian, and of our companies, we don't ask for anything, we wouldn't want the company measure for themselves, and that they use. But I guess a lot of the time and effort when we get into businesses, is kind of convincing companies that measuring this stuff is really important. Again, not for us, but for that. So I think that's kind of broad strokes, one. Because once you kind of measure something correctly, it actually becomes very easy and obvious where the bottlenecks exist, and how to prioritize piece by piece, what you fix them what you grow and win. But again, if you kind of lack that visibility across the cohesion of the business, it's nearly impossible to do. I mean, every once in a while you find a founder that does it from gut, and they get it mostly right. But that's hard. That's really hard. And so I'm measuring managing type of guy.
Second is just generally speaking team, you know, I think especially smaller businesses, you need to be like, you need to understand that when you started the company, the problems and opportunities that existed in front of you are not the problems and opportunities that exist in front of you today. And the people that were right to help you get to a certain place may not always be the right people, or they're the right people, they're just not correctly positioned for what you need tomorrow. And that can sound tougher than it is which like, is a way of saying like, no loyalty, like, I don't think that's it at all, like I actually I tell my companies, I subscribe to this all the time, if somebody is willing to, I don't know if I can curse but bust their ass for the company. If someone busts their ass for your business, like they should always have a place at your company. But over time, you need to be maniacally focused about getting the right people in the right seats, and upgrading talent.
So if somebody was a loyal person that business for a while, but they're not kind of making the grade at a certain leadership position, or they're not the right person to be promoted into a leadership position, like you can't be afraid to go out and hire outside talent. And I find like with the best people in companies like they welcome this just more people to learn from and grow with. And success begets success. But especially with smaller companies, like I realize it's hard, there are personal dynamics at play. And so, generically speaking, I'd say being maniacally focused about the quality of the team you have, and recognizing, again, that every day presents a new set of challenges and opportunities such that you know, six months and 12 months at a time, companies are sometimes totally different than what they were.
And then that way, like teams have to change, they have to evolve. And I think people are just in general, even for us, right? Like I run a business, it's same thing. I think more often than not, you always feel like you were too slow, not too quick on some making some of those changes. And again, I don't want that to come across harsh and that it is, but it is about kind of growing and scaling and creating the opportunities for success going forward. Not rewarding what's been done in the past.
Yeah, that's bang on, that's bang on. I mean, in my experience, we often used to say at a board level that the people that got you from zero to 5 million, are not necessarily the same people that will get you from five to 20 million, and those in turn are not necessarily the same people that will get you, you know, to 100 million plus. And during my time as CEO, we more than doubled the number of employees in the company, and yet, our turnover rate for the employees that were with the company when we first acquired it, was upwards of 50%. And it was largely based on this idea that different types of folks can often be required to get the business to the next level. Because when you go to that next level, you're basically playing a completely different ballgame in some cases.
That's right. That's right. And that's gonna be two points to make that one, culture is important. So you don't want to be a sharp elbow tuck culture, everything's off in it, or maybe you do. I mean, you want to be specific, and you want to be intentional about your culture, if that's the culture you want, and that works for some places great. But so this is not to say culture isn't important and treating people and team members the right way isn't important. But it is to say exactly what he's, the way you frame that, I think exactly right. Like, companies grow and scale, they change and you need to adapt to the times. And a lot of that starts with putting the right talent in the right places. Second thing I'd say, and this is kind of like the inward looking the mirror CEOs are not immune to this, actually, it's maybe as arguable that a founder is the first place where it becomes most acute about how the role has evolved, and whether or not they're well suited for the sort of go forward. And that doesn't mean fire yourself, it just means understand your weaknesses and surround yourself with people who can compliment you on that.
And as a prime example, everyone starts a company on day one, they sit down at their kitchen table with a blank sheet of paper, metaphorically speaking. And what you're trying to do is build from scratch and make the impossible possible. And the cliche zero to one, that's very different than running a company doing 5 million of revenue, or 10 million of revenue. In most cases, you're not being as creative, you're not being the innovator, like you're becoming a manager. And those are just different skill sets. And some people adapt and love it, some people hate it. And again, that doesn't mean you have to move yourself out, it just means really be clear about where you're strong and where you're not. And the best leaders, they don't hide their weaknesses, they embrace their weaknesses, and they find the right people to come in and complement those weaknesses, who won't be yes, folks, but to actually drive them and push them in the areas where they need the most amount of help
For CEOs who are looking to sell, but they want to stay on with the company. Tell us what it's like for a CEO, who is used to having absolute autonomy and absolute control. What's it like working underneath a private equity parent? And let's focus on kind of the differences. And of course, we could probably spend the next couple hours talking about just this alone. But generally speaking, are there things that a CEO kind of needs to do that she never used to need to do? Or maybe, vice versa, things that she no longer has to do that she used to have to do? Can you just kind of talk about life under private equity parent for a CEO?
I guess yes, and no, because I've met a lot of private equity firms. And it's a pretty, pretty wide gamut, just in terms of what folks are like and how they approach the world. But I think generically speaking, as a founder of a small business, let's say you own 100%, like, everyone who runs a company and sits on the board of a company has a fiduciary responsibility to all its shareholders, right? That's the thing that should drive everyone. And that doesn't matter whether or not on PE or not, actually, in fact, it's a nuance, but like, there are many situations with companies where I have to take off my investor hat. And I have to be very conscious about wearing a board hat and really thinking about what's right for the business. But coming back to your question, like, as a founder by myself, my fiduciary responsibility is just to myself. And I think as you grow, and whether that's taking on investors giving equity to employees, like you can no longer do what's best for you.
I mean, you really have to think in the context of what's best for the company. And that takes on a whole host of kind of opportunities and implications. Probably too many to listen name now. But I think even just that mentality shift at a 10,000 foot level, then sort of dictates everything that comes beneath it. So, you know, budgeting and planning, product roadmapping, all these things that are required to build a business, in theory, you know, you can get away pretty fast and loose when you're on your own. I think the more people around the table private equity or otherwise, like they don't live in your head, they don't understand. And so now there's this whole other level of communication and transparency that has to exist, then in and of itself takes time and is a skill set. Right? And so, again, that has all kinds of implications, like what do you present? And what do you talk about? And what does it mean to run effective board meetings?
But ultimately, everyone's kind of on the same page, like, people may disagree about what right answers are how you get to ultimate outcomes, but like, everyone, private equity or otherwise, if they're on the board, if they're responsible for business, they should be doing everything that's in the best interest of the company to maximize long term value for shareholders. And I think more so today is becoming not a law today yet. Exactly. But we're getting more to a place where it's not just shareholders anymore. It's also employees, its customers. It's the public at large, right? There's this whole other element kind of ESGS that all comes into it. Think bringing out a private equity investor kind of illuminates some of these points are making and making it more clear. But again, if there are other shareholders in your company besides you employee options or otherwise, you have a fiduciary responsibility, you should already be doing those things. But taking it to the next level requires a whole skill set about managing upward and having communication. I don't think about it this way. But in a sense, we all have bosses and for a CEO, a board is your boss. And if you went from not having a board to a board like, well, there are implications to that.
So, you talk about this issue of control. So let's say that a private equity parent has control of the board. How do you decide what types of decisions go to a CEO? versus what types of decisions stay at the board level? Is there a certain dollar figure above which the CEO needs permission from the board? Are there certain types of decisions that are pre agreed upon? Is it more organic? How does the CEO and board agree what types of decisions can be made by the CEO versus decisions that have to go to the board?
I mean, every situation is different. I like the idealistic approach of having it be very organic. I think that's the right way. Like, ultimately, we back people first and foremost, and then backing those people, we entrust them to continue to run and build the business the way they have, because they've done a nice job. And we think they can continue on into the future. Obviously, all decisions can't be made at the CEO level. But I think the best PE firms in the world, they try not to micromanage, they don't want to micromanage, they have their own day jobs to do. I think keeping it to the most important highest level decisions is is where a board should get involved. So when dollars are involved, you know, a specific dollar figure. It depends right on size of the company, and size of the investment, all those kinds of things. But if you're going to make kind of fundamental investments in the business, if you're going to shift priorities or strategy, if you're going to paint the 12, month, 24, month 36 month vision, I think those are kind of board discussions.
Obviously, anything to do with capitalization is usually a board discussion. Should we take more equity? Should we take on debt? Should we sell our business? Should we merge? All that kind of stuff is a board decision. And then obviously, CEO, specifically as a board decision. Compensation can be a board decision, but again, not micro, like I would never tell a CEO how much to pay for an exact person, what typically happens with you know, it depends on the size of the business again, but like with a Comp Committee, you'll set kind of bands, like if you're gonna hire an SVP of something, hey, you can pay them anywhere from X to Y. And within that range, like you have full autonomy to do it. If you want to pay them more than Y, it's not a no, it's just that should kind of rise to the board. Things around general housekeeping rise to the board, making sure obviously, first and foremost, hate to say this in 2021. But there's no funny business, no fraud, things of that nature.
There's usually an audit committee, things like that. I think that all kind of goes to the board level. But I think the right dynamic between a CEO, a C team, and a board is some people, again, everyone's different. I hate board meetings, and I don't think of myself as like, as like some entity that has to be reported to like, I just think that's a waste of time. If you have a good board, you need a lot of smart people in a room. I'd much rather discuss the future and talk about big priorities and strategic initiatives and really debate it with the best and smartest people you can get in that room, because that's ultimately what's going to help you make better decisions. And that, to me, is a good board meeting. And that to me is kind of the board fulfilling its responsibilities, not day to day making decisions or telling a company what they should charge a customer, at least in the micro.
If you want to have a strategic discussion about packaging, and pricing, I think that's a great board discussion, you want to talk about what customer X should pay. That's unless customer X is some ridiculous number or a large percentage of revenue. Like that's probably not a board discussion. So I don't know if that that's kind of a clean answer. But I guess I'll default to the bullshit answer, which it always depends, right.
Yeah, and of course it does. I think that's actually really helpful. So let's move on to the acquisitions themselves. Another I mean, I don't know how widely held this belief is but I think some SMBs, CEOs put a little bit too much stock in getting a letter of intent signed, in the context of selling their business. I mean, ultimately, there are very few in the average letter of intent. There are very few truly legally binding provisions usually confidentiality and action inclusivity are kind of the two most important ones. But I want to talk about broken deals, because I think what a lot of CEOs don't understand, to the extent that they should is that even after a letter of intent is signed, deals fall apart all the time, for any reason, any number of reasons I should say. So in your experience, after an LOI is signed, but what are some of the more common reasons why a deal doesn't get done? Is it change the macro environment? Is it the company missed a Quarter or two? What are some of the more common reasons why a deal would fall apart post LOI?
Yeah. It sort of depends. Again, I hate that I keep saying that, forget it. It doesn't depend. It obviously does depend. But what we'll pretend for a second, I didn't say that. You know, strategic versus financial buyers matters quite a bit in this answer. But at the end of the day, each stage of a process should put a investor or acquirer in a position to have more confidence and sort of communicate that level of confidence back to the team. And IOI versus LOI. I've been in this business a long time. And even I don't really understand the difference between the two. I'm not sure there is. LOI versus term sheet, you know, in theory is further along. And obviously, term sheet to binding documents, there's a big difference. First and foremost, I'll kind of answer your question, but also come back to something you said, your level of conviction and confidence that you should have in an IOI, or an LOI, should be reflected in the process itself.
If somebody has gotten to know you, for two days, has looked at a couple of spreadsheets, and has had, you know, a few conversations at most, a couple hours worth of conversations. That is not a set a high confidence IOI or LOI, I don't care what words are being used, right? There's just a lot to learn. And the more that's still outstanding to learn in terms of kind of key risks. Any one of those things can derail a deal. Like you said, you know, people haven't looked at contracts with IOI. People probably haven't talked to your customers at an IOI stage. People may have looked at your data and maybe P&L, but they haven't really unpacked every kind of KPI and benchmark are okay, are you using to run the company? People have spent a lot of time with the team, which is really important. And any one of those could be a factor. You pointed out macro environment. That's just like, yeah, obviously, we're kind of close a deal in oh eight, or maybe even early 2020.
Like, yeah, that happens. I think more often than not, macro swings don't really come all that often and just knock people off pedestals. But it happens, it's that's kind of the uncontrollable one, but it's kind of just the known knowns in a deal. And so in this balance of kind of rushing to get to an LOI, a CEO, she should understand like, there are trade offs. The faster you get to an LOI, the more there's still to do on the other side of the other way, so so you just got to find that find that balance. Now at the same time, you don't want to have lots and lots of people going deep forever to try to get to an LOI because that takes time and effort and every kind of acquire in the process is going to suck up cycles. So it becomes a full time job, I'm sure you saw yourself, selling a business is a full time job on top of your already full time job, that probably is 100% of your time, and then some so so it's hard. And so you got to like always kind of strike that balance.
But hopefully that gives you kind of a sense, but but it is to say like, as you move along the process, you should feel like you're ultimately the best buyers are going to uncover everything about your business. So in that way, owning it early, presenting the data, having your your kind of ducks in a row in terms of like before, when I was saying measure to manage it. If you're measuring the business, right, if you have lots of visibility on your company, if you do a good job, kind of closing books, like all that kind of stuff will go a long way and making it easier, but people are going to need it all. And if they don't have it, even if they're signing an lmia or a term sheet, they're going to need it. So that will eventually be introduced into the process.
So, when selling my company, which which absolutely is a full time job, as you correctly mentioned. I've written this in a blog post before that the question that I was understandably asked most frequently, and is almost always the first question is something to the effect of, so why are you selling and naturally, there are kind of good answers and bad answers. And of course, buyers, just being prudent need to make sure that the CEO isn't selling because she sees some massive headwind on the horizon, and she wants to monetize your investment before then. They obviously want to make surethat she hasn't lost conviction in the future of her business. And she thinks its apex and its plateau. And this is as valuable it's ever going to be. So it is naturally very understandable why someone would ask that question. But I noticed that buyers were always particularly interested in the answer. So I guess, as a buyer in asking that question, you know, what are you trying to tease out? And what differentiates a good answer from a bad answer?
Yeah, I think what's interesting about any process is there's massive amounts of asymmetry in both directions. And what I mean by that is, I have asymmetric information over any one CEO, because I do this for a living. And I've done lots and lots of deals, and I do, you know, call it on average, four deals a year. So when I get into deal making, like, this is old hat, when you get into deal making, it's your first time, or maybe it's not your first time, but you certainly probably don't have as many at bats, right. So there's a lot of newness, there's just corners, you don't even know how to define to be even be able to see around. Well, the same is true when it comes to information very specific to the company itself.
You have asymmetric information over me when it comes to the business. No matter how much time I spend with you, no matter how much due diligence I have done, my team has dug in the data we've kind of parsed, there are going to be things that you know about your business that I won't. And in that way, like, you know, we're always evaluating risk and reward. And that isn't to say every deal is perfect. Far from it. It isn't to say we don't get things wrong, we do. But it's kind of like the known knowns versus the unknowns. And asking a generic question, and actually finishing that one thought and coming your question like, I'm okay, getting stuff wrong, if I'm eyes wide open about it. I really don't like in a world. And I'm not gonna say it's never happened, where I get something wrong that I didn't see coming, right?
Like, if I take a conscious risk, there should always be risk and reward, nothing is with certainty. And if a deal doesn't go the way it should, because of eyes wide open on that risk, it didn't pan out the way we wanted it to I would never come down on my team on that, we as a firm like that, that's good investment making. It's almost like Annie Duke thinking in bets, like outcomes is not the same thing as decision making process. It's the unknowns, that sort of unacceptable, right and in that world there, but I kind of started by saying there will always be unknowns. And so you just want to get that unknowns to a smallest box as humanly possible. And asking an open ended generic question like, why are you selling? Well, the answer, because that's how capitalism works. And every PE person turns around and sells businesses eventually. So the answer is because that's what we do. And asking a generic question and feeling at a CEO in that context, like you can learn a lot, what you say and what direction you go, and what you've grasped on to?
Are you confident in your answer? Are you overly defensive? In your answer? Do you point the things that seem reasonable? Do you not? We talked about it earlier, but are you rolling with me? Or like, if you're selling 80% of your shares, like where's your money going? Because I'd like to think my cost of capital is higher than your cost of capital. So I'd be curious where you're putting your money and like, so all those kind of questions feed into it. And that's at least one step in the direction of what the buyer or the PE, firm strategic or financials is trying to kind of ascertain and tease out.
So that's actually a perfect segue into the next and final group of questions that I want to ask. And all of them kind of fall underneath this umbrella of the expectations that buyers have of a CEO at the point of or after the sale. So we mentioned earlier that in the spectrum of SMBs, the smaller you are at the risk of speaking generally, the more likely it is the CEO is asymmetrically important to the operations of her business. Now, we also just talked with the fact that buyers, of course, want to make sure that, you know, she's not selling because she doesn't believe in the future prospects of the business she's not selling because she wants to take 100% of her chips off the table and kind of just be done with it. And of course, buyers also want to make sure that the business isn't going to completely implode without her, right.
By the by the way, there's nothing wrong with the CEO saying, back to the last question, there's nothing wrong with a CEO saying they want to take understand the chips off the table. We get that all the time. Just being kind of clear and concise and consistent about why you want to do it in the context of the opportunity is important. If you say you want to sell it all, because this is the top well that's not a great answer. If you say you want to sell it all because you've been at it 10 years and you're tired and you want to retire to a beach. And you've done better than you sort of ever expected for you and your family? Like, that's an acceptable answer. Now, some people may feel differently about it and may have an implication on price, like all those things, but there's nothing wrong with any answer. As long as it's consistent.
That's the interesting point. Because, you know, in my experience, like in trying to sell a business I tried in 2018, didn't work. And then ultimately, in 2020, it did work. And over the course of, you know, those two processes I spoke to several dozen potential buyers. And I found that anytime I gave them the answer that you just said, which is I'm tired, I want to move on, I want to do different things. I think I've taken this business as far as I can go. It's just time for something new in my life, I found investors to be somewhat I don't know if skeptical is the right word, but they were quite probing after I gave that. So, is that indeed an acceptable answer? Or is this just a matter of, you know, buyers just being, you know, prudent and doing their jobs and making sure that that is indeed, the reason for selling?
Yeah, I mean, it's back to the asymmetry point, you know a lot of things I don't know, and we don't know each other, like, we haven't really built that trust and rapport yet, in a world where I can take everything you say on face. And so, almost like good scientists, like PE firms will dig in and sort of come to their own conclusions on sort of what you're saying. I'd say, when somebody is willing to sell in full. Yeah, I think it raises a flag, not one that can't be overcome, right? Like, if it's not an ageist comment, like, if there's a 60 year old entrepreneur who wants to talk about retirement, I might think differently than if I saw a 35 year old talking about retirement, right. So so there's, there's kind of like a balance. At the end of the day, like, I this is not even investor comment. It's just life like, you know, there's no better answer than the truth. Right? Because there's no way a truthful answer wouldn't be consistent and wouldn't be the right one.
And ultimately, you know, that means there are certain buyers that aren't the right fit for you, then so be it. Now part of it depends on like the PE firm itself, like some PE firms have a playbook. And they have a bench of CEOs, and they don't even want the CEO to stick around. Right. And we are kind of the other end of the spectrum, when we invest in businesses, minority or majority, were most typically backing the team. So we want the team to stick around. And if somebody's saying they're gonna go, it's not that I don't believe you for your reasoning, and I don't think you're calling the top per se. But I may not, like it just may not be what we do, right? I don't want to do organ transplants for businesses, at least on day one out of the gate. So that's where there's just kind of a whole balance. But back to the point, you know stuff I don't know, if you give me an answer, that there's an element of it that could be kind of viewed and in a negative light, well, then yeah, I am gonna stay skeptical until proven otherwise. And it's something I'm certainly going to have to dig in and explore.
So what would you say to a founder or CEO who is being asked to roll some equity, for any number of reasons. But this CEO comes to you and says, Hey, I don't want to hold a majority or pardon me a minority position in a liquid private company, or somebody else is in control of the major decisions? I don't want that I'm not interested in that. What would you say to that CEO, other than the fact that hey, this could be the difference between you getting this deal done or not? How would you counsel that CEO?
I mean, I would start by saying, well, there's a difference between wanting to work in that position, or willing to have equity role in that position, right? Those are two different things. The kind of work in that position, I think is a very different answer, right? Like, that's more of a life answer. Like, hey, what do you want to do and what motivates you and where your skill sets and where your passions, and Is this a good fit or not? Right? Let's say I was talking to a friend, not a deal I was involved in or whatever like that, those are the kinds of things I would raise, when it comes to the equity rolling perspective. It's just part of the equation, right? If you're an entrepreneur, you want a business and somebody asked you to roll 20% when you get 80% in cash.
There's value associated with that formula, so that 20% that's rolling like It's an option value. If you don't believe in it, or you don't think there's a lot of upside. Again, like that is a signal is not great for the buyer, right. And so, let's use round numbers, I promise my investors 25% Plus, not promise, right, like me here, nobody goes to jail over this. But our target investments are 25% plus net IRRs. In the context of multiple asset classes, public markets, private markets, debt, real estate, that's about as high returns, as you in theory would find. In order to drive that returns, it means the deals I'm doing, on average have to come out there. And if like, if I'm buying your company, and you don't think, well, if you don't think I'm capable of driving those returns, like, I'm going to try to feel that out. If you do think I'm capable of driving those returns, then I think you view it as a cost of the transaction, right? Like, you get your 80%.
And you get the option value on the 20%. And it kind of is what it is. If you're totally passionate, you need every dollar to go do something else, you want to start a rocket company or, you know, buy a house on the beach, or whatever it is you want to do. I mean, you could still make the case. But yeah, there just may be some scenarios where we're ultimately you, you do lose some buyers, because again, back to the asymmetry point, they don't know you, there isn't that long term established trust, then if you're literally sitting there saying, I'm not even willing to roll 20% of my money with you, knowing that I have a mandate, it is illiquid, but I have a strict time horizon. Right. Like, you know, it could be a long term time horizon, but I can't run this company in perpetuity right, at some point I have to sell. And if you're not interested in having any of your kind of dollars tied up in that, then yeah, I think like, it certainly should raise some questions. So yeah, I'll pause on that.
So if a CEO is not necessarily planning to sell in the near term, but let's say she's planning to sell two to three years from now, something like that. And in for whatever reason, her specific desires are that, hey, I want as close to a full exit as I can possibly get. So, she's educated enough to understand that maybe there needs to be a role, maybe there needs to be a seller, maybe there needs to be internet, whatever the case may be. But at the end of the day, she wants to get as close to a full exit as possible. And she doesn't want to work with the company for any number of reasons. What are some things that that CEO should start doing now two to three years before she sells? What are some things that she put she should put into place people she should hire systems, she should use things that she should start doing now with a view towards kind of that ultimate end game?
Yes, yes. And yes. Can I just say that? I mean, it's all interrelated to some other points we talked about earlier. The more you commoditize yourself as a CEO to a business, the less you'll be viewed as critical to its future success. And the more freedom you're going to have, ultimately, in terms of negotiation, leverage, and optionality. If you're running every facet of the business, if every customer mentions you as the salesperson by name, and every customer talks about getting you on the phone, when there's problems, ripping the cord and jumping out that window is not gonna be so easy. If, if there are a lot of capable and competent people on the team, it's decentralized at the top, there's real leadership and structure in place, there's a machine that seems relatively strong and durable, and it's chassis, then getting out is is easier, right?
It just is. People may still want your knowledge and skill set. So I'm not gonna say it's a guarantee. But again, like, I actually think there's a good rule of thumb for every CEO in the world. The more you commoditize yourself as a CEO, the better off you are, right, like the best CEOs in the world, like they do three things. They think about vision and strategy. They think about team and talent. And they think about capital markets and capitalization in general, everything else is is kind of a distraction to a CEO and but to get to that place is really hard. You don't end up there on day one. Like you got to build towards that. And so the same answer I think that makes the best CEOs in the world the best CEOs in the world is also the same answer that allows you to probably have a looser tether to the business if and when the time comes to sell.
That makes a ton of sense. Final question for you today, Jordan, and it's a bit of a curveball. So I will ask for forgiveness in advance. If you could scream something from the proverbial mountaintops, and every SMB, CEO could hear and digest what you're screaming, what would you say? I probably should have furnished you with this question in advance, but I want to see you sweat a little bit.
Alright, that's fine. I think I'll stick with something I said earlier, there's nothing more important in building your business and the team you surround yourself with, and all the implications that come with it. And never forget that. Most businesses, have you ever heard the sports analogy, like basketball or soccer, like basketball, you're as good as your strongest person soccer, you're as good as your weakest. Companies are a lot closer to soccer than they are basketball. And that's not just quality of talent, that's also culture and morals and everything else that goes with it. It's probably a good answer for life. Be very conscious of the people you surround yourself with, and have little in the way of tolerance for people that don't meet your bar.
That's very wise. But very, very wise, I often say and this was consistent with my own experience that you only really realize the power of team when you make a really good hire, and a really bad hire. Both of those help illustrate just how important the people you surround yourself with are. I mean, from the CEOs perspective, particularly the senior management team level, because my goodness, a good hire can make your life a lot easier, and a bad hire can make your life a lot harder.
I totally agree. And maybe, yeah, I think that's absolutely well said. And the last thing I'll say, cuz maybe people don't hear it enough, like being an entrepreneur, I mean, sometimes you have to be insane. You're trying to do something that hasn't been done before, right? It's really, really hard. Go easy on yourself personally, right? You'll have good days and bad days, nothing is a straight line. I don't care how many books are written about the successful companies, nothing is a straight line, everyone has volatility. And I think the more you allow yourself to weather the ups and downs without beating the crap out of yourself, which I think is pretty similar to a blog post you wrote, I think that I think the better you're going to be, the healthier you're going to be, the better you're going to be, the better leader you're going to be. And the more your team will take your views, you know, proverbial but hopefully for everyone, this isn't life and death. And so if you do the right things, you stay passionate, you keep a vision, good things will happen to hard workers in the long run. I believe that.
Incredibly well said and very wise and what a perfect place to end. Jordan, thank you so much for your time today. I really appreciate it.