Interviewer (4:49)

Over those 15 years. What has compounded exponentially and what has compounded linearly.

Jesse (4:55)

Atif won't be surprised to hear me say this. I'm so uber focused on talent. It's the part of the business that I like the most. I think that has really compounded exponentially for us. We have, we mentioned that we showed at our annual meeting the series of slides about what makes us special and why we're able to produce great results. One of those things was all the boomerang talent that we've had at the portfolio level. We had a page that was just focused on CEOs and founders who have done business with us on a repeat basis. And we have people on there that hadn't just done like two deals with us, they had done three deals with us and they'd all been successful. And I think when you're able to build that network of really good people who want to keep coming back into the Renova's ecosystem and they happen to be friends and connected with really good and really talented people and they're pulling their people in, I think that network effect is really special and it compounds.

Atif (5:42)

There are so many thoughts that come to me. One of those is our own evolution. When we started the business, we were really deal guys and had really good training and experience putting deals together. Over the last 15 years, we've elevated our role from just deal leaders to fund managers and from there to firm owners. And what that means is that as we've studied different models, we have become good at not just doing a great deal at the deal level, but delivering great fund products to the LPs where we are generating not just good deal returns, but good gross returns and most importantly, great net LP returns by recycling capital by using really innovative financial capitalization at the fund level. So those things have resulted in very significant growth in terms of the results that we've been able to produce. So that evolution obviously continues. And brand is something else that has had a pretty significant impact that 15 years ago nobody knew who we were. Today, thanks to all the transparency that third parties are bringing to our end of the market. Through rankings and through a lot of benchmarking, a lot of investors, not just here in the US but globally are able to find us. And raising capital has become a lot easier than it was 15 years ago.

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Interviewer (8:39)

Jesse Atif, Brad. If I gave you a hundred points in terms of what drives the company, how much comes from the three of you versus your hires and this machine that you built in terms of talent?

Jesse (8:50)

That's a great question. For the first fund, it was really the three of us that did everything. We raised the fund, we sourced all of the deals, executed, did the portfolio management work ourselves, and so certainly all 100 for fund one. And the goal has been to shift that down over time. And we have been very successful in doing that. Now we think of ourselves really. We've gone away from being players. We're still playing, but we're playing player coaches. And we've organized the firm to with a specific intention of enabling really good and talented people, coaching them up, working with them, developing them and seeing them spread their wings and being really successful. And now we're at like a point of our own individual careers where, like, nothing makes us happier than seeing people get it. I was saying just as we were kicking off the podcast, that we just completed an internal call where we announced all of our internal promotions for the year. I mean, it was kind of an emotional event for many of us. Like, there is great pride in and seeing the people beneath us succeed.

Interviewer (9:48)

Was that something that was difficult to cultivate?

Atif (9:50)

There's a lot of learning that goes as you build a firm as investors, you take a lot of pride in putting together the best deal possible, the best financial structure, the best executive team, and doing both financial and operational engineering to get to a great outcome for the investors. This is something we take so much pride in and that becomes a DNA. But when you are building a firm, it's not about the best deals you do. It's again, delivering a great fund for the investors. And that means not just doing your job well, but creating an environment for your team members.

Jesse (10:31)

Fun one, as I mentioned, it was just the three of us doing the entire thing. And that was a function of starting in 2010. It took us two solid years just to get into business. No paycheck. And so we were really careful with our management fee dollars in the early years. Before Fund Fund 2 comes along, we start bringing in some institutional investors. In fact, our. Our largest institutional investor in Fund 2 is still our largest institutional investor today. And they asked us a really simple question. When are you guys going to start building the team? And they were walking us through about, like, why we should do this, giving us comfort. Hey, you're going to be around for a while. And Atif says this sometimes. Some of these institutional investors, they believed in us more than we believed in ourselves. And that helped get us started on really investing and thinking about Renovus as an enterprise. And we have so fully embraced that, you know, 10, 10 years later, after our second fund was raised, that today this is what we have. We have a large team. We have a director of people we work with, an executive coach. And so it has been a gradual thing, but we've gotten some great advice that's helped us, you know, make that transformation that we very much needed to make.

Interviewer (11:35)

That's my heuristic for who you want to surround yourself with people, people that see more in you than you see yourself. And similarly to that, I look at the heuristic of who you want to hire is somebody that is going to do things that you never even imagined. So you bring somebody in, not only do things as good as you or even better than you but come up with things that you didn't even think about.

Jesse (11:53)

Absolutely. This concept, I think like Netflix Popular popularized it of talent density. You have a talent dense organization that just raises everyone's game. I think our people, our best people, they're raising his game, they're raising my game. It is awesome to have people around us, even if they're less experienced. But you just see their passion and competence that makes everyone better, including us.

Atif (12:15)

Talent that we are hiring, they have a lot of new ideas, new competencies. They're better at AI than we would have ever been. So we've learned so much about AI adoption within our firm and how we can push that out to a portfolio companies from one of our associates. So yes, there is this flywheel effect that Jesse was talking about. You learn from your junior people, they learn from you. And in a way what we talk to them about is that we are looking to bring in more entrepreneurs in the firm, not more managers. And we are also constantly screening people not just for their pedigree and resume, but for their potential. Just talking about, how do you do that?

Interviewer (12:57)

How does a fund manager go about sussing out, I guess somebody's soft skills or somebody's future talent versus their track record of completing this is spending time.

Atif (13:06)

With them and having a good sense of who you want to bring into the firm and who you do not. Jesse was mentioning to you our chief people's officer. She's someone who had never done any HR work. Jesse got to know her through his time with his local church and she had such amazing people skills that Jesse kept talking to me that we need to bring her on. And then Jesse approached her a couple of times. She said, no, the person who was running our IR was actually an asset manager at Vanguard. But we saw in her the passion, the detailed orientation, which many times you don't see in other IR people. So we are really screening for attributes, not for people's backgrounds. And when we are hiring our people, we tell them the first couple of years are on us. Even when we are hiring who you may consider plug and play investor who comes from a brand name private equity firm, we say to them, look, we do things slightly differently. We pursue the same kind of deals that you may have been at your firm, but we are operating at the lower end of the market. We have more of a valuation discipline that you may have seen at your firm. We are willing to do more volume that you may have seen at your firm. So it is. And it takes them at least a year. But once they get it right, they really start to perform and become believers.

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Interviewer (15:54)

And I want to get into your portfolio construction later, which I think is fascinating. But on the LP mix, you mentioned that that institutional investor came in fund two and now they're one of the larger investors. How has your LP mix evolved from Fund 2 to Fund 4?

Atif (16:06)

When we started in 2010, it was right in the midst of GFC and there wasn't any capital available for first time managers looking to start a blind pool of capital. So. So through Jesse's research, we stumbled upon this program run by the U.S. small Business Administration called the SBIC program. Except that that program was really for mezzanine investors and for people who had a lot more deals on their track record as we did. But the best thing about that program was for every dollar of capital you would raise from third parties, the program would give you two additional dollars of capital. So essentially the UN Small Business Administration became our largest LP in our fund one with 67% of capital coming from them and the rest primarily coming from family offices and high net worth. So fund two is really when we made the transition, not complete, but Beginning to make transition from that investor base to bringing in a large university endowment, insurance companies and start building that base to our last fund, Fund 4, where instead of the SBA being 67% of our capital is less than 20, we've been able to retain all our large accounts and really proud of the 130% re upgrade from our existence. Meaning investors who gave us $500 million in fund three, not only they have kept that investment with us, but on top of that they've given us another $650 million. So we've been able to keep our existings but expand the LP base and over time diversify away from the capital that we've been receiving from the sba.

Interviewer (17:53)

As I mentioned, you were oversubscribed. There's a lot of demand. How did you pick and choose which LPs you wanted to add to fundfor?

Atif (17:58)

So how did we select our LPs? So I would say it's a matchmaking process. Obviously our existing are the ones who know us best and they always have the first dibs at the available capital that we're looking to raise. And they came in very, very strongly. So they filled up most of the capital need that we had. And beyond that we've been very strategic. There are certain areas and certain types of capital that we think could be a base for our long term success and growth. So we brought in one large state program and we feel that could be a way for us to build that type of investor base. For the first time we went outside the US and got a number of high profile institutions and family offices in Europe and the Middle East. We think that we can significantly expand that. So while availability was limited, we used those limited slots to bring in what I would consider strategic investors who can really help us grow our capital base.

Interviewer (19:05)

And that's just geographic diversification.

Jesse (19:07)

The new investors, largely people like we're very confident that the capital base is going to be stable over a long period of time.

Interviewer (19:13)

And to your point, it's not just the relationship with the person, it's also the quality. I just interviewed the former CIO of utimco, the second largest endowment in the world, and I learned they're going to be the number one largest endowment in the next 10 years because they get one and a half $2 billion from the state of Texas from oil reserves every year. So kind of knowing where what's going on with the underlying capital base is also really valuable versus a pension fund that might be overfunded or other pools of capital. Otherwise great relationships but they might be in a difficult situation from capital base.

Atif (19:41)

Absolutely.

Interviewer (19:41)

So one of the most interesting parts about your fund is your portfolio construction. Tell me about your portfolio construction and how did you come about with this unique structure?

Atif (19:51)

Our portfolio construction has the a number of attributes. First, we believe in starting out small and over time building our position. So if we are looking to invest $100 particular business, we missed out at 50 or less. And over time, as we professionalize the business and we scale the business through acquisitions, we put in more capital. So building position over time is the first thing that we think about. Secondly, because we operate not just in middle market, but at the smaller end of the middle market, we look to create a diversified portfolio for every fund. So we have typically around 15 or so active positions per fund. If we have early wins, we give the profits to investors, recycle the cost basis. So have some of our capital make return more than once. And through that, we end up investing on average 120% of the LP capital. And for that capital to have a compounding effect on the overall net returns of the fund. This helps us keep the spread between growth to net returns for investors low and overall deliver a really good fund product for the investors.

Interviewer (21:12)

You guys have figured out what private equity has taken a long time to figure out, which is if you have a great company, why are you selling it four or five years later to your competitor? We're going to keep on investing and helping that company grow.

Jesse (21:22)

I'd like to say that we figured it out right away, but it actually is a learning of ours. Atif Talks likes to talk about our both our worst deal and our best deal we ever did. It was in a company called Red Nucleus. And this was done out of our second fund, which is, which is a great fund. But, you know, it was a business that we bought with $4 million of EBITDA. We took it to 12 million of EBITDA and sold it. Did very well for our investors. And then that company continued to grow significantly after we exited. With the team that we have put together with the strategy that we have been executing as we've grown our knowledge and grown our confidence by observing what, you know, upmarket GPS are doing, we've realized that we're able to do this. And so now there's no kind of dogmatic approach on our part that says, okay, when you double the ebitda, now it's time to exit. And as a result, we have, you know, a business that started with 4 of EBITDA and today is 50 we have another one that started at 3 and today is 90 of EBITDA. So I think that's actually, you know, a practice that we're proud of today and we think makes a lot of sense. But it's one that has been a.

Atif (22:18)

Learning of ours over time within these investments. Not only that, we're growing our ebitda, we're improving the quality of our businesses so we make as much money from growing the EBITDA multiple. So we on average have been able to buy these smaller businesses for mid single digit EBITDA multiples and we sell them at teens of multiples. So that has a compounding effect.

Interviewer (22:39)

Family offices have been doing this for decades. I spoke to Sam Zell's partner Mark, Mark Soter, who continues to run his, his foundation's family office. Also Brent, be sure he's in the Midwest. He has this 30 year fund where they figured out that a. First of all, if you make a fund that lasts longer or you're making decisions over a longer time horizon, you actually build healthier businesses. If I asked you guys to flip something in three years versus holding it for 10 years versus regardless of how good of a guys you are or your incentive is just going to be to build a fundamentally different business. What's corrupted that process historically is these two to three year fund cycles. You always want to be showing momentum. So everybody ends up owning slightly worse versions of the business downstream because of these short term over optimizations.

Jesse (23:23)

There's a lot we could talk about here. I think a lot of private equity has become what we say internally as investment banking. Plus there's a very short short term orientation that's kind of crept into the industry. And it's not just among the GPS managers, the executives, the C suite executives, you know, throughout the economy they're now all trained to think this way. It's like they're just thinking, okay, I'm going to get hired, I'm going to exit in two years and then I'm going to be onto my next private equity thing. The next thing I find and I actually do think that if you can get your LPs to support this and you yourself can think differently, there's a great opportunity if you can be a little bit more long term.

Interviewer (23:58)

Why do founders lower their valuation in order to partner with you?

Atif (24:01)

So selling a business by a founder is perhaps the most difficult decision they ever have to make at a professional level. It is an emotional decision. It is a, a game changer financially for them. So they are very diligent about it. They look for a number of things and price is just one of those things that they look for. First of all, they look for a counterparty, meaning a private equity firm like us that is transaction worthy. An entity that understands their business has sector expertise, that has a really high close rate, that once we sign on a piece of paper that we are interested in the deal that we would get to a closing of the transaction. So they care deeply about those things that the counterparty they are dealing with is transaction worthy. And that is one area where as of late, Private Eddy has gotten the bad rep justifiably or unjustifiably. So we position ourselves as not just another New York based LBO shop, but rather a founder owned, founder led firm that is based in Philadelphia and on location. We use it as a strategic advantage to give the message that we are a different type of a firm and we understand what it is to run a small business that's looking to become a mid sized business. Beyond that, they do care about price, may take a few dollars less, but they are looking to get a fair price. So in that respect, purchase price matters. But beyond that, in our model we encourage them to roll over 20 to 25% of their stake. So they want to believe that the rollover stake could be worth more than the cash out they receive on day one.

Interviewer (25:51)

You guys both embrace this contrarian philosophy that I share, transparently popularized by George Soros, which is invest, investigate, put in.

Sponsor/Host (25:58)

A little money and learn more to.

Interviewer (26:00)

Get an insider edge. Tell me about that philosophy and how do you internalize that philosophy into your fund?

Jesse (26:06)

We love Stanley Druckenmiller, who we famously learned from George Soros and read everything that he says. And of course he's a public markets investor and more of a trader. But what we have taken from that statement and applied to our business is the view of, as we talked about earlier, building a position over time. When we enter into a new business model, there is a huge difference between owning something in that in that segment and not. And buying something, even if it's only a $5 million EBITDA business, buys you a seat at the table. There are people who will talk to you that will not talk to just the private equity firm. There are other business owners. There are things that you get invited to history conferences. There's a big network of things that open up to you once you invest. And I can maybe just illustrate it through an example. We exited a legal services business called harbor last year and it was a thesis that we built in 2021 and made our first investment in early 2000 and we ended up doing 10 add on acquisitions over the course of our ownership period. The difference between what we saw was when we didn't have an investment and what we saw when we did have an investment was night and day. And the add on acquisitions that we sourced, we believe many of them we don't see if we don't have something in there. And so investing in something allows for a much greater investigation of something even when you start really small. So that's how we apply that thorough system to renovas.

Interviewer (27:29)

It reminds me of a diligence question I like to ask towards the end of the process, which is what am I going to find out in the next board meeting that you're not telling me right now? People don't always, and usually they don't answer that honestly, but that's really what you're trying to suss out, which is what am I going to find out within the business that I could never really find out? That's not in the spreadsheets, that's not.

Sponsor/Host (27:45)

In the data room.

Jesse (27:46)

I'm a big believer in how you phrase a particular question and I'm now going to use that question in all of our diligence sessions going forward. So thank you for that. You do learn so much about a business after you own it. That's a fact that every GP will at least admit to you privately. And obviously investing it involves making decisions about an uncertain future. And so as the future unfolds after you make the investment, of course you're going to learn a lot. What we like about our strategy of doing follow on investing and building our position over time is that if you could decide between investing all of your money in a company in day one or investing the same amount of money over a three or four year period and you could stop at any time, you would obviously choose that second road 10 out of 10 times. And so we really like that. We like getting smarter, gaining conviction, investing accordingly, or losing conviction and stopping investing accordingly. So we love that strategy.

Interviewer (28:38)

As a thought experiment, if you could invest $1 in the business to get access to information and be on the inside, obviously you would do it. So it's a question of what is the right sizing of the first check in order to make it more valuable than potentially the downside. It's not a matter of if that makes sense as a strategy, it's a matter of sizing.

Jesse (28:55)

Then our strategy is really a question of business durability. You know, we we invest in very small companies. There is such a thing as too small. You know, if you invest in a $2 million EBITDA business as the first thing you buy in a fund, is it even a business? And so that's how we think about that question.

Interviewer (29:11)

If you could go back to 2010, when you were first starting Renovos, know a lot of mistakes, a lot of lessons learned over the last 15 plus years. What's one piece of advice that's timeless that you would have given a younger version of yourself that would have either helped you accelerate your career or helped you avoid costly mistakes.

Atif (29:26)

Think of the business we were starting not just as a project business where we are doing deals, but like an operating business. Build a business that would be there forever. That means to take more risk early on, to invest more in the team early on and do things that would pay off dividends, not in five or 10 years, but over 25, 30 years. The reason why a lot of young investors like us have a three to five year horizon is that early on in our careers, there were multiple recessions and you got fired and you became unhirable. So there's been this mindset of feast or famine that at times are good. Grab whatever you can versus investing in a business like most of our founders do, who we buy from, they're never building a business to sell. They are building a business that may be transferred over to the next generation. So having that longevity to the business really helps you build a business that does good deals, but overall, over time builds enterprise value.

Jesse (30:42)

I love Atif's answer there. And it aligns actually really well with the coach that we've been working with, you know, personally for, for many years now. When we hired him, and this is what he says to us now, he's like, you guys hired me to help turn Renovas from a great fund into a great firm. And it wasn't something that we thought about in 2010. In 2010, it was about, hey, let's try to get into business together and build a fund. And somewhere along the journey, somewhere in fund two, we really think started thinking about Renovas as a firm.

Interviewer (31:12)

Well, Jesse, Atif, you guys are growing legends in the private equity space. Uh, it's going to be very fun to see where you guys go over the next 10 years and we'll have this conversation maybe in a couple of years and, and check in. And it's been a pleasure just sitting down and thanks so much for sharing your story.

Jesse (31:26)

Thank you. And we welcome doing that again with you.

Atif (31:29)

Thank you for having us.

Interviewer (31:30)

Thank you guys.

Sponsor/Host (31:30)

That's it for today's episode of How Invest. If you're a GP with over 1 billion in AUM and thinking about long term strategic partners to support your growth, we'd love to connect. Please email me@davidisburgcapital.com.