Value After Hours S06 E18: Ben Claremon on Devonshire Partners’ Micro Public-to-Private Equity Strat

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Tobias Carlisle is the founder of The Acquirer’s Multiple®, and Acquirers Funds®.
He is best known as the author of the #1 new release in Amazon’s Business and Finance The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market, the Amazon best-sellers Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014) (https://amzn.to/2VwvAGF), Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012) (https://amzn.to/2SDDxrN), and Concentrated Investing: Strategies of the World’s Greatest Concentrated Value Investors (2016) (https://amzn.to/2SEEjVn). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law.

Prior to founding the forerunner to Acquirers Funds in 2010, Tobias was an analyst at an activist hedge fund, general counsel of a company listed on the Australian Stock Exchange, and a corporate advisory lawyer. As a lawyer specializing in mergers and acquisitions he has advised on transactions across a variety of industries in the United States, the United Kingdom, China, Australia, Singapore, Bermuda, Papua New Guinea, New Zealand, and Guam.

He is a graduate of the University of Queensland in Australia with degrees in Law (2001) and Business (Management) (1999).

this meeting is being live streamed this is value after hours I am Tobias carile joined as always by my co-host Jake Taylor our special guest today is an old friend of mine Ben clamman how are you Ben I’m good I’m good I’m excited to be on this you know world famous value after hour show Ben and I have been wrestling small and micro cap value equities we’ve been ranking them for what 10 or 15 years now 15 years maybe longer than that yeah who’s winning micro somebody else large cap I didn’t hear no Bel we’re still going still fighting blooded beaten underwater but still fighting so uh let’s let’s kick off with um what are you up to now what what’s the you got a you got a new Venture let’s talk about the new venture yeah so maybe it’d be helpful if I just for people who don’t know anything about my um illustrious career as a public Equity investor um maybe I’ll give some background uh but uh started my career in 2007 and so I was basically in the public Equity markets from 2007 until um pretty recently well where now I’m still in public equities but just with a with a slightly different different tone um so most of that career was spent at a firm here in Los Angeles called Cove Street Capital um long only value suggestive SL activist um and so it it was really there where the strategy that I am running now was formed and and kind of um you know the the the some of the experiences there have have really like um led me down the path I’m on now so what did I see at Cove Street um so really the the main takeaway that I have from being in a kind of a firm that focused a lot on small and micro cap was that there’s just a structural lack of growth capital and capital in general but growth Capital available to these companies there are or just there are very few large check writers in this space so I’ll give you an example Co Street we owned probably eight or 10% of a $700 million market cap company um we had a really close relationship with a CEO he was on my podcast Compounders anybody who um follows that show um and uh we got a call from the CEO one day and said found our founder of this firm is sick he owned whatever 25 or 30% of the company and um the CEO said I don’t want these shares going to private Equity I would like you to buy them as as Co Street and then we said okay and we went off on a on on a on an on an experiment to try to raise $200 million for an SPV um and so what I saw was that we would have been able to buy these shares at at a at basically a negotiated transaction significantly below the intrinsic value if we had been able to raise a $200 million SPV check now what you find is that is a very challenging thing to do as a long only investor right like your LP Bas isn’t the right structure like you know we had mostly long only investors and and who who worked with long only allocators who worked with us and even if their firms invested in in privates and other things that was the other side of the house that’s the alt side of the house and so it was you know I watched you know myself and the team run around for months trying get raised this check and it was just impossible to do it given our structure um and so what that said to me was that why isn’t there somebody who’s running kind of like a hybrid public Private Structure where you could own 20% of a public company or in the right situations execute private and so you know I think if you just think about the structure of the small cap and micro cap Universe there has been a secular problem which which has been exacerbated by the underperformance of smaller micro versus the um S&P 500 and everything larger and so what is that problem that I think creates the opportunity for us um as micro cap focused investors today um and I’ll talk about the firm I’m working for and and how it and what what that actually means but small and micro cap used to be and small cap still is to some extent but small and micro cap used to be institutional strategies um you know uh I listen to Brian Bears who runs bears Capital Management and he was on a my my partner Bobby Craft’s uh podcast and he talked about when he started his microcraft strategy in 1999 or 2000 institutions were interested in it it was different there were no $30 billion endowments back then that I know of right and so what’s happened is that those guys have gotten so large those big foundations and endowments have gotten so large that like micro Cap’s no longer a strategy that they’ll fund because it’s capacity constraint if you need to write a hundred or $250 million Equity check you are not going into microc because it can’t scale this and so what happens is that there’s just very little Capital flowing into the space and the good investors graduate out of micro cap because if you’re not unless you’re willing to close at 100 or $250 million at the very most I think you know and still still want to buy small companies unless you want to close your strategy you’re going to graduate into small cap you’re going to graduate into smid and so what you’re ha what’s happened is that you know and it’s been unfortunate but we’ve seen a hollowing out of the Institutional Investor base in this space and so what that meant to me is that there’s just you know there is an or basically a lot of the space has been orphaned and and just look at the returns the Russell micro cap index has the worst performing relative returns over every long period you can look at 10 15 whatever it is look at the numbers right S&P and and obviously the larger H just crush it but it doesn’t matter right it’s been the worst performing space and so people think that it’s broken people think that the companies are broken that they’re small for a reason um and our hypothesis at at um at devenshire is that the reason these companies are small one of the reasons is that there’s a structural lack of growth Capital available to them so even if they could be larger could you know graduate from small from micro cap to small could compound right there’s there’s the inability to raise Capital whether from you know the debt markets or the equity markets hinders that ability to compound and so so um you know at Devonshire I joined a guy known for a long time named Shazad Khan who’s a lower Middle Market private Equity guy we own a couple portfolio companies at Devonshire both private companies and so what we’re doing is we are just layering on a public market strategy to the lower Middle Market um private Equity strategy that he’s running and we’re just opening up the world to you know all the publics involved right and so um you know I think we’ve been running full speed at this basically for for you know personally for six months and then you know my partner Shazad for a few months um and you know I think the differentiation of what we’re trying to do trying to be a like develop a premium brand in microc cap be the shareholder of choice the the buyer of choice for some of these companies um it’s really resonated um so that that’s what I’m doing I’ll stop there that was a long you know long story but I’ll stop there because my guess is you have plenty of holes to poke in in the story well my you know obviously I’m I’m sympathetic to this view because I I run a smaller micr strategy and I see many of the things that and we’ve obviously discussed this offline pretty extensively but one of the uh Playing devil’s advocate one of the things that I have observed if you if you break out the universe into S&P 500 S&P 400 S&P 600 which is 500’s large cap 400’s midcap 600 small cap and I realized that there’s a big universe underneath that that we’re not talking about there but just for illustrating the purpose as you can see the earnings in the S&P 500 have been very strong over the last few years the earnings in the 400 and the 600 have been much weaker and I think when I look at the compression in the multiples it sort of follows that weakness in the earnings and we can talk about the reasons why but to what extent do you think that the uh underperformance is deserved I think of I mean we’ve been through a weird period of time right covid and the supply chain issues and the inflation and all of those things that happened I think disproportionately affected small companies if you didn’t have excellent systems excellent processes excellent sourcing excellent pricing abilities you just got run over right and then when you ex you know combine that with Rising rates where you know whatever uh suur plus 5 used to be a mean a reasonable number and now sopur plus 5 is a really high number for most companies right so what you have is just you’ve had a compression in margins in a lot of cases right where gross margins have been impacted because companies have not been able to maintain like have pricing uh offset the the gross you know the cogs headwinds they they faced I think you know and especially when that’s happening right and you have Labor inflation on top of that you have sgna Rising right and then you have rates rising and so interest costs I mean I could see the compression right and so that to me is a fact right but it’s a very static fact right so the dynamic way to look at that is to say these are companies that um now because of all of those things we talked about are not generating as much free cash flow as they were and I’m not even talking about the non- earners like whatever there’s 20 to 30% 25 to 30% of of the micro cap universe that doesn’t earn anything so let’s let’s just take that you know those companies out um and say all right so these companies a good company for example who that has secular Tailwinds that has a potentially growing Tam right that’s operating well just got disproportionately impacted by all of the things that have happened over the last you know whatever four or five years now um and they don’t have free cash flow to reinvest aggressively into the business which that means that they’re not making Acquisitions even if they’re recreative how in the world would they raise the money because you’ve got this self-perpetuating negative cycle where if your stock price is low you don’t have a currency so you’re not going to use that to do a deal you you know I’m not going to name any of the investment Banks who play in this space but they’re going to charge you 15% to raise capital and you’re probably going to have to do it at a discount to the stock price so it’s massively dilutive and the cost of equity given where cost of debt is is really high and so how in the world do you Fund in organic or organic growth if all of a sudden you are a beholden to sside analyst world and you know investors expecting you to continue to beat and raise how do you think about investing in your business for the long run without in and and taking that hit to earnings that you need if you can’t generate free cash flow and so on the on the extreme end of the spectrum what this creates is anybody who’s levered is now really in know I would say in just broadly in a lot of trouble because rates are higher if you didn’t you know even if you have a credit agreement that’s you know expire in 2025 right you’re probably you know again you know suur plus 5 is now a meaningful number right um or or like or if if you’re going to go floating rate um and if you had fixed that expiring then you’ve got a you obviously you’re going to have a much higher rate and so the lever companies I think are going to be zombies in this space no ability to raise Capital um they’re just gonna they’re just gonna kind of like just putter along some of them will survive and some of them won’t but the opportunity we set see because we’re we are you know anybody who’s listened to anything I’ve said over the last number of years I’m a quality oriented investor I’m looking if I’m looking for a good business that is getting more valuable that has a good management team that just doesn’t have the capital to really grow and can compound much faster if they can so to me the opportunity is to vet in it is to whether it’s through a very friendly like uh public investment private investment in a public company or through a you know a full take private give these companies the ability to access that growth whether that’s inorganic or organic so you know the the the valuation that these things trade at is going to be you know I don’t know if permanent is the right word but for a long time impaired right from the public market standpoint because of that inability to grow through um the the headwinds and so to me for a patient long-term investor who sees volatility as his friend I just think that that’s that is the opportunity we’re trying to tackle it’s kind of extraordinary to see the uh the amount to which the small and micro has been beaten up through this period if you I was looking at some charts the other day it looks like if you didn’t know that there was that the rest of the market was up you would think that there was a pretty significant stock market crash in small and micro uh like it looks like it’s getting close to 2020 2009 kind of uh you know difference in performance and some of it’s deserved because the the earnings haven’t bounced and they’re down from 2021 but there’s also you know there’s the the multiples are way down too it’s all pretty crushed so I I don’t think it’s I don’t think it’s permanent but and I don’t think it’s going to go on I don’t think it’s going to go on forever like you I think it’s cyclical and I think these are the things that sew the seeds of the next the the growth comes out of this but um you must receive that objection like other objections what what what do you what do you say to that and what what what are people why do people think it’s so broken yeah I mean I think the first thing I hear from people is that this is just pure adverse selection right that anything that was good enough to grow out of micro cap has right that’s compounded its way into small caps mid whatever you know whatever you you know even bigger in certain circumstances um and so what’s left are the drgs right businesses that have you know some reason to exist but don’t have that aren’t getting more valuable over time that are often run by people who are not that sophisticated when it comes to either operations or things like Capital allocation and corporate governance right so what you’re just looking what you’re looking at is that just a bunch of broken businesses that that are public because of some historical accident or historical reason um and you know Pro can remain public but you’re never going to make any money there and so that’s that is the first criticism I hear and I I think the way I would frame it and I’m not going to talk about any individual companies but that may be true 85% of the time let’s just say that’s I mean that’s a totally arbitrary number but let’s just say it’s true 85% of the time that still leaves 15% of the time where it’s not true and if those 15% of companies that don’t fit that characteristics those characteristics but but are tainted by the micro cap taint right then you’ve got the opportunity for undervaluation so I think the point is if you just paint the mic cap Universe which is very diverse in terms of earners versus non- earners versus Industries right like you’re looking at there’s a lot of companies in the space and it’s very diverse so to paint them all with the same brush I think misses you know a big opportunity to seek out the best companies in the space right and so our job is to distill you know we’re starting you know we could talk about why but we’re starting in the nanocap space which is we defined as aund million and Enterprise Value because you know we’re private Equity guys now it’s that’s that’s more important than than than market cap um but you know so you know $100 million Enterprise Val value and lower and you know we’re starting with that universe and Distilling it down to the handful of the best companies in this space where there’s a significant reinvestment Runway which is that where the companies are unable to access in the public markets so if it were true that this these companies you know were broken then they wouldn’t have a high return reinvestment Runway so you know I think the idea is is to find those ones that that are you know kind of like you know are the exceptions to those rules which I think broadly can be true in the space um but the cool thing about what we’re doing is that we don’t need we don’t need 200 companies right we just we just need to be able to find a couple new interesting ideas per year right and I think that is an Evergreen space um for us to make money um the the other objection that we hear um is is kind of an is a is a kind of is a cousin of that which is that these these companies are small for a reason right it’s not even necessarily that it’s broken but that there’s a limited Tam there’s a limited End Market you’ve got customer concentration you just have small company problems that are going to Forever keep these companies small and you know again that’s going to be true x% of the time that you’re not going to find you find a business that can continue to to to exist and and be moderately successful but you’re never going to make money there right and so we those something that didn’t have the reinvestment runway we’re going to shy away from right um and then I guess the last thing is is that people have a huge amount of skepticism for the management teams in this space right like look micro cap is filled with some characters go to a micro cap conference and you will meet some interesting interesting people right and there are without any question there are some promoters and borderline frauders and some like creepy people who you clearly would not want to partner with and that’s whatever there’s something about the Wild Wild West nature of micro cap that attracts kind of unscrupulous people um but I mean look I’ve been doing this a pretty long time I’ve met hundreds of different CEOs I think I’m pretty good at figuring out like who’s you know just totally promoting something that doesn’t exist and look you can look at the business model and say does this make sense is it proven has this company generated free cash flow you can screen out a lot of things that you might might not want to invest in as a private Equity investor very quickly and so I guess my contrarian perception regarding the management teams in this space is that there are plenty of B and B+ management teams who just need more bandwidth to become better and where does that come from well in a situation where there was a take private right you would you would give they would basically give another one one of their arms back right they won’t have to be talking to investors a third of their time they won’t have to be filing KS and q’s and and doing transcripts and talking to bankers and all the things that these managers do that take away from running the business and so one of our pitches to the management teams that we’re discussing this with is that and by the way I should say everything our our premise is that this is a management Le buyout our value ad in addition to some governance Capital allocation incentives and and maybe some operational expertise that we’re going to layer in our value ad is being a bridge between the C the public market and the private Market through our Capital base right and so this is a management Le buyout and if you so our goal is to take a B+ management team and parachute three seasoned Financial people with an operating partner and help give a give them their bandwidth back and then help help them turn to an A Minor and a a management team with our support and I just don’t see a lot of shareholders who are that active right and and helpful in this space it’s not I’m not denigrating anyone who’s a public markets investor it’s just like when you’re running a 30 or 40 stock 50 stock portfolio sometimes at micro cap how much time could you devote to one company you know this is going to be you know our first deal our first take private our first big investment in company this is going to be our baby and we are going to parachute four people in there to give management extra Bank with help on strategy help on operations make sure that corporate governance is tight make sure that compensation is aligned with what the Company’s trying to achieve and make sure that they have a capital allocation Northstar to me that’s a lot a lot of low hanging fruit in these companies comes from just like just checking those boxes and making sure those things are properly organized so folks JT has had to run he was in the airport you might have seen he had a flight he had to catch um so there’s not going to be any veggie State uh but we’ll get an extra helping next week maybe um just before we move on I’m going to give a quick shout out to everybody I know we didn’t do it last week because we were a little bit bit crushed but Menino California what’s up P Kaa Norwich UK Santa Domingo Dominican Republic valaro what’s up Dubai Malmo Bangalore Chapel Hill Verona Italy Verona Italy nice Prince George Tallahassee Nashville New Delhi Milton keing San Diego Hong Kong Napo Greece antp London Town ptia Israel nice um where do you see the existing management teams in micro cap falling down like what is the when you’re reviewing all of these deals is they all all of these public companies because they’re all publishing when you see them um what what do you see as the most sort of common error or the the most glaring sort of hole and what they’re doing yeah I mean I think in terms of permanent Capital impairment where do you see that happen it’s mostly in in capital allocation whether you make a deal that doesn’t work out or you bring on Leverage for something right or you build a plant where you you know like you could you can’t make it work but I think when you when you see like a nonse secularly declining business a business that has a reason to exist and can grow and stuff like that the way that you really see these companies permanently impair capital is through Capital allocation and so I’m a governance guy I’m a capital allocation guy I mean those are like my my filters right so I’m always looking for that and I just think I think companies don’t get good advice I I don’t know that the lawyers and bankers that give these companies advice I think there’s there’s I think there’s a conflict of interest in a lot of those situations I think it’s it’s explicit when you have you know an investment banker in the room nothing against my banker friends but there’s a transaction oriented nature to that job and I get it and I get why it exists and I get why they can be helpful but that doesn’t mean they’re always helpful so I think that to me um you know situations in which you just see small companies do things that where you read the press release and you’re scratching your head like who G who told you this was a good idea who suggested to you that this was a good use of capital or this was the right way to raise capital or this pipe or this convert like you know convert which is going to crush this company like why why was it done this way and so I think it’s because like being a small company look being a CEO is a 247 role I recognize that I just think a small company you wear a lot more hats and it’s hard to have the bandwidth to really exceed in investor relations and strategy and operations and capital allocation and so it’s and look I don’t you know not everybody has a North star in capital allocation and I’ll say like return on invested capital is the Northstar free cash flow is the you know is a is a is the other Northstar if they’re two northstars for any firm that I’m looking at those are the things that we care about and that’s not always deeply embedded right in in a company word and management team if you came through sales if you came through marketing if you came through operations right like it’s not always just like you know whatever like the things that you learn as a public company investor and the way to think about businesses like you know whatever you’re going to go to burshire this week right like like how many times do you you know how many how many of these micro cap CEOs have ever been to a Burkshire meeting right and so I mean I think that that is where we can be the most helpful not even just like helping like make good decisions avoiding making bad decisions can be really helpful right and so I think that’s that’s one place where like we going to be given my experience in the public markets and my governance and capital allocation Focus I think that’s going to be loow hanging fruit for us the other place where companies um struggle is what I would call small company problems and what what really hurts these companies is things that like single product re like um like lack of diversity of products lack of diversity of customers a lot of these companies have C customer concentration lack of diversity of end markets or regions right they’re selling regionally or they’re not selling globally right and so what happens and I always talk about this small companies have trouble taking punches so you’re a public company things are going to happen to you either it’s going to be a CO it’s going to be a March of 2009 it’s something’s going to happen and the problem with small companies when you have small company problems and customer concentration and Market concentrations all of those things is that a punch can knock you out right if you know a big company like a Honeywell right like they can take plenty of punches honeywell’s still going to be around because it’s got breadth and depth and and diversification small companies don’t have that and if you have a management team who doesn’t deeply understand Capital allocation and you know has that like whatever they take a punch right sometimes it can be The Knockout and so I think that ability to grow and diversify your customer base diversify your Revenue base make sure that you are not too dependent on you know like single lines of businesses that is where companies often fall down because they because the management teams are so consumed with trying to grow what’s there that and and and trying to maintain what’s there that they don’t have the C the bandwidth and the time to really think strategically and operationally about how to to to to become more resilient um and and and look there there like bigger companies when when there’s a downturn guess what they do they buy up all the little competitors right small companies that don’t have access to Capital when there’s a downturn even if they’re operating well they don’t get to they don’t get to go on offense right they always are playing defense and so putting one of those companies in the hands of a private Equity Firm any any private Equity Firm who has access to Capital and who have LPS that want to continue funding this business just gives you so many more options one you know the the punch you take is probably not a knockout because you know it’s you have the capital base to support you but secondly when you take that punch and everyone’s taking a punch in the industry right you can you might have access to Capital to go on offense and so those are you know whatever anything can go right or wrong for companies but the capital allocation and then just the structural issue of being a small company is really where you I think often see permanent Capital impairment in these comp companies uh one of the reasons that I got into small and micro cap was this document that I read Darwin’s Darlings or uh the endangered species report which was put out by Piper Jeffrey and the three guys who made that went on to found a firm which did was very successful for a long time and is now gone but their focus was that was written about 1999 and they they identified that there were all of these companies similar problem to the one that exists today they were talking about the Russell 2000 there are companies that don’t qualify for the Russell 2000 list they’re too small for the 2000 and despite the fact that they’ve got very good growing earnings um you know good business probably still an owner operator in control they’ve just got these very depressed valuations because they don’t get into any of the indexes and all the indexes seal flows and their solution to it I think they ended up calling themselves Discovery or Navigator or something like that their solution was to become activist but I don’t know how you know they sort of they were little bit before that sort of golden age of activism where you saw like the Bob Chapman and Dan L writing the 13d letter that was really nasty and sort of that got all the attention and then there was the pop in the share price because they had here’s the problem we’ve identified it now that there’s going to be some energy devoted to solving it or kicking out the management team why go from public markets to taking these things private why not just take that uh intermediate step where you you take a uh a pipe you know private investment in a public Equity get a board seat take some control and try and rightsize them from from that perspective that would would that be an easier proposition than sort of a take private do you think oh there’s a lot of directions I’m going let’s let’s let’s start with the yes the answer is it could be and it part and our structure allows us to do that but let’s let’s let’s let’s think about what micro cap activism traditionally is I I see and having been at a firm that had an activist tilt right and and and we were we were definitively not looking for problems to try to fix you know we became activists when there was a problem and we think that when we thought that things were not going well but Micro cap act like that that like aggressive micro cap activism is often looking for things that are broken to fix yeah and I think that is a very difficult strategy in micro cap to be successful at right like so what you get on the board and you have two board seats but if you’re guess and so so you’re the dog that caught the car guess what kind of car you caught you caught a broken car and and so it’s not like they have a a great divion he wait until it breaks down and goes into the ditch and then you catch it yeah that’s right that’s that’s one way to do it that’s that and then look that that’s the bank that’s the bankrupcy way of playing this SP right or like distressed right and I think there will be getting to the zombification of some of the lever companies I think there will be some really interesting distress plays in this space I don’t think that’s going to be our you know our Focus um but I think anyone who’s in this distress World should be looking at these over levered micro caps to see if there’s opportunities there um but you got me off track with the uh sorry sorry sorry but but so but microc Capital activism is often like looking for problems to fix we are want we want to be the antithesis of that in the sense that like I want a business that has a growing town that is getting more valuable over time that has operational momentum meaning that they’re executing well on that that have a good that has a good management team and it’s just undervalued and underappreciated by the market now I think those opportunities are very very far few and far between as you go up market cap I was a smid cap PM I mean e like whatever you say about large cap and how competitive that is even smid right I found that when when you when I saw value a you know whatever in a in a in a good business that was for some reason had clouds over it the market would close that Gap so quickly that that there was just there was so little time to do the kind of research process that I wanted to go through to be a and to be able to invest like the companies would run before I even got there I think it’s because that space is so so competitive and you can even multiply that as you go larger and larger there is so much capital and so many smart people available like who focus on whatever smid to large cap and to Mega cap that you just don’t have a Long window to find Opportunities and act on them in micro cap because of the structure of the market that we talked about the hollowing out of the investor base because of the lack of flows into the space because of the you know the illiquidity of some of these companies you just have a longer time frame in order to be able to diligence these companies so my thesis and hypothesis here is that it’s not that these companies that if you’re executing well if you grow for 20 straight quarters guess what the Market’s going to recognize that eventually but you just have but as an investor in the space you have more time to get on that train before it’s completely left the station because of all those structural elements so to your point Toby it’s like this is not it’s not that these things are permanently undervalued it’s that you just have a longer time frame versus like the two weeks you have with A7 billion company okay so now so that’s so like I’m just trying to dispel the idea that like we’re going to be going in here in trying to fix broken things like that is the opposite of what we’re trying to do but our structure allows because so here’s here’s here’s what I in observing people who have tried to do this either Public Market investors doing take privates or you know kind of the private Equity guys coming into the space and trying to do deals what I’ve observed is that you need a flexible structure and a flexible mandate so let me give you an example let’s go like if let’s just say there was a situation like the one I discussed where you know there’s an opportunity to buy 25 or 30% from a selling shareholder get you know near control but not control get a couple board members right a traditional private Equity Firm would have trouble executing on that strategy because you buy 25 or 30% and then what right what if there is no take private opportunity what if there is no other check so then you’re kind of like you you own you own a lot but you don’t own enough to to do anything you know to take it private and so then you’re stuck right and so I think a lot of people wouldn’t even want to write a check there because um their mandate prefers take privates and then the public investors as you know unfortunately what we saw at Co street is that even if we wanted to own 20% of a public company a $700 million public company there’s no raise way to raise the money so I think there’s a structural lack of capital available for said situations which you like the ones you you you brought up whether it’s a pipe whether it’s a you know buying out you know founder or a selling shareholder um so I think the way this could really work for us is to do like a two-step buyout a situation where we bought 20% today and then we bought the other 80% 24 months later where we’re you know we’re on the board you know it it’s more like an Insider transaction not not insider trading but an Insider transaction versus a you know kind of just coming from the outside trying to write a big check um because I think in micro cap you just have to be more flexible you have to be able to buy common stock you might have to Tender for shares you might have to at times File 13 DS um we don’t we have no interest in going hostile but like yeah maybe that’s maybe that’s something that has to happen at some point but you have to have a lot of things in your tool kit to be successful here that I don’t necessarily think is as true as you go up market cap um and then when you combine that with the fact that like this strategy even though you know a TI private strategy microcaps can scale and way more than a public Equity strategy can um you’re just not going to attract a lot of competition right there’s a like I put out a white paper on the strategy you can go to my substack compounder substack and you can see the white paper and people are like Ben why did you put that out there you gave away your strategy I’m like you please come and try to copy this thing because I’ve been spending six months at it and all I hear is how it’s going to be really hard and almost impossible to execute so please come try to copy it because I’m you know because we can learn from each other right and so so I mean I just you know I think the the simple answer to your question is that there’s to be successful here you have to be willing to do things that other public investors might not be able to do and then the private investors can’t do right and so having a flexible mandate with a capital base who understands that the things that make this strategy not work are too many constraints you know like too many silos like is this public or is it well I don’t you know if you can’t if someone can’t see that it’s a hybrid and there’s no firm that can say well do you talk to the alt guys you talk to the long only guys I don’t know right like like if if if there’s all these institutional constraints that that stop um you know you like investors from putting money in and that and those are your LPS then I think you’re going to struggle so our our Focus has been on family offices because you know it’s just a much more entrepreneurial group in general like the very large family offices look just like an institution but the the the people who have a few billion a few multi-billion Dollar Deals but but not like 90 billion right like those are like much more likely to be run by an entrepreneur or a family of an entrepreneur or someone not an outsourced CIO and they can kind of see that the lower end of the market cap spectrum is where the value still is and you can put meaningful amount of money to work here um and and not have to pay the multiples that now the PRI the private companies trade at which is you know and I I’ll stop but I think you know you and I have talked about this about how what used to be a private Market discount in a lot of ways has turned into a private Market premium for certain businesses and business models where there’s so much lower Middle Market private Equity chasing these deals it’s better covered by the little bankers and brokers who cover the space and the private Equity firms are chasing a good deal way more than our chasing good micro cap deals so the objection of private Equity firms is just that it’s it’s a hassle to try to take a public company private because there’s there’s so much more compliance regulatory obligations on the board so on and so on how receptive are the management teams to to to your approach and so I let me let me say right up front like I am not going to dismiss in the slightest that perception of the lower Middle Market and the Middle Market private Equity firms that take privates are hard right if there’s anything that I have heard over and over and over again about when I when when when I’m talking about this strategy is just how heart TI privates are right you have outside shareholders who can object you have a board you have to convince you have you know the POS the possibility that like even after signing an an Loi right there’s a go shop where like someone can out bid you and so then what do you want to do do you want to bid more do you just get you go you basically get to the bottom of the night that someone takes a deal from you right and if you don’t have the capacity to own shares right that’s just broken deal costs like and and a huge opportunity cost of your time so again that gets the flexible strategy where you might you might need to buy a few million dollars of the common to protect you so that you at least make money if someone takes a deal from you so um it is 100% true that there is more it is much harder to go from what we’re doing you know trying to do what we’re doing where we’re buying a public company then you know a lower Middle Market private Equity Firm calling the proprietor of the 12 location industrial distribution business who owns 100% And is in his 60s and you know his or her 60s and their kids don’t want to be in the business and they’re going to sell right like that’s a much easier transaction to close like of course there’s some uncertainty of not not closing but it’s just much easier to close right but the point is is that’s that’s you at least the the anecdotes and the stories I hear from the the lower M Market private Equity guys is that that’s the reason they don’t even start the process of looking at the publ because they perceive it to be so hard um so so let me you know so I just I just you know I I just I wanted to I just I just wanted to make sure that I didn’t that no one thinks that I am um underplaying how difficult that is and and and and how how how much of a you know and how how high a hurdle we’re going to have to to jump through okay so now to the management question so let’s just put ourselves in the shoes of a micro cap CEO over recent times okay so the index that I am either part of or not part of depending on you know how big my company is has been the worst performing Index right so that that means just the base rate is that I like that this company has been you left behind by everything larger I used to be have some access to Capital at least debt Capital because rates were low well now I don’t even have access to cheap Capital there well Equity Capital right I mean if your cost of debt is now 10 to 15% what’s your cost of equity right and so now Equity is really expensive and if you combine that with the fact that the perform performance of these stocks hasn’t been particularly good right then you you just you’re just you probably don’t have a currency right you can’t raise Capital right you probably have to pay someone 15% if you wanted to and if you want to do a deal right in use stock well I mean you’ve got to find something that trades at a lower multiple than you do to even make that make sense right so these being a micro cap CEO and I’m you know friendly with a lot of these people has been a distinctly unglamorous job over the last number of years right some of the small company issues that I highlighted and the issues with Co and the postco period have just exacerbated how hard it’s been to be a small company executive right and then you’re and I said you’re always dealing with you know some service providers and and and people who are for lack of a better word trying to trying to like take money trying to make you spend money with them as opposed to doing other things with it and so um you know very few people come to management teams and say we would we like your business we like the way you’ve been running it we would like to help you fund the next leg of this company’s growth right in the micro cap space that is not something people hear very often um because of all the structural things we’ve talked about right I’m not saying they never hear it but I think it is just more rare and so the that that pitch that a management-led buyer of a company that has all the characteristics we’re looking for and um can have access to Capital in the private Market that they can’t be accessed in the public market is without question resonating with people because it’s just so rare that anyone comes to them with that opportunity and so we have this big hairy audacious goal of being a premium brand in this space and being a shareholder of choice where like we would walk into a room because of our track record of executing deals and helping companies grow either as public companies right through some kind of of of of of like non you know like non crazy duded financing or as a private company our track record suggests that we are business Builders I will say one thing about the changes in rates and how that’s going to impact private Equity is that you know obviously a lot of private Equity was successful due to a 40-year decline in interest rates right rates going down from 18% to zero was a really nice Tailwind for a lot of private Equity firms who focus more on you know fincial some degree of financial engineer I think with rates where they are today and multiples where they are today like if you look at the pitchbook data on low on Middle Market deals in 2023 the average multiple was 11 times so if you’re paying 11 times and you’re paying 12 to 15% on your debt how in the world are you going to hit a 25 irr the only way you’re going to do that is by growing the business really fast um so business building is going to be the only way I think that private Equity generates returns um and so we want to be known as business builders in this space we’re not I mean our goal is to use like this is not like traditional leverage buyouts right we are we want to use we want to we want to add extra Equity to these companies in private so that they can continue to grow so that they can continue to make Acquisitions in compound right so this is a a debt a light debt um you know very um you know uh business building oriented framework right which I think distinguishes us from I think some of the perceptions of what private Equity has stood for over recent times um especially since we’re also not coming in saying you know our first lever is to fire as many people as possible to rip and replace management that kind of thing this is a management led by out um and you know frankly when when we get feedback on this like it’s very refreshing because people the very few people come to them with these like a very solution oriented approach uh it’s been there’s some research out there and I’ve covered this in some of the books that I’ve written that the capital structure Arbitrage or the capital structure activism seems to be easier and a sort of shorter route to generating returns than the operational improvements so I guess you’re not really talking about operational improvements you’re talking about things that already doing well and and the real problem is that they’re just not getting enough attention from fund managers and so on and so by taking them private you can you free them up to sort of concentrate on the Core Business while you and the other Executives sort of focus more on the capital allocation side of it at some point I I assume that you’re raising these are funds that have sort of a finite life cycle to them so there must be some exit strategy at some point right is that and and then on top of that I guess the related question is is that how you’re incentivizing management yeah I mean I don’t want to incentivize management just based on an exit right like we we want to incentivize them for operational Improvement margins improvements right like some some and growth obviously so some some combination of you know growth and and and profitability is really the way that we would look at at at incentivizing people but yeah I mean of course traditionally the way this has worked is that in a deal where we do a management led by a management would get some promote and some percentage of the of of of the of the carry right and that’s and that’s how we that’s how we can pitch someone on come work with us you versus being a $35 million market cap public company that no one cares about right you have you have a opportunity to make a lot more money with us so um you know so so the the incent I think the incentives are actually much more aligned right if if you if someone owns as much as we do um uh sorry the question the first part was uh just you’ve got a finite period of time if if you’re raising for a fund and then uh yeah I was just tacking the the incentive question on top of that I know that there are other models so there’s a good model um can’t believe I’m blanking on his name I’ll come back to it in a moment you keep going yeah so um there are two paths here right and I think traditionally the lower Middle Market private Equity guys started off as independent sponsor where they raised specific spvs per deal um and then once you’ve done two or three Deals you raise a fund a blind pool and then you have the discretion the family offices that we talk to because we think that’re they the the the right base of investors here given their forever time Horizon you know the the the they don’t necessarily have the need and desire for company to be bought and then three years later you start dressing it up for a sale in hope that you can f it right because there’s tax consequences there so the family offices we’re looking at and talking to um appreciate the ability to um not have a blind pool that has a set time Horizon but want to be more opportunistic and the SPV structure gives you that ability right so you you you create an SPV you do the take private um you know the and then your LPS have the choice of what to do if this thing is compounding really well in in the private markets and is growing it and you know it’s growing the Acquisitions being growing organically I mean to me you know that’s a that’s something that you could own forever and in a traditional fund structure you wouldn’t have that ability um and so we are as we’re discussing this strategy with people I think our primary route to getting deals done would be through an SPV structure and look I’ve talked to some people some private Equity guys who have been independent sponsors their entire and and raised an SP fund by Fun SPV sorry SPV deal by deal SPV forever right they have like 10 or 12 Port codes and that’s what they focus on because they think the fund structure is actually kind of the the the the the worst way of going about it because and and one of things that’s been highlighted to me is that if you have a home run in the fund um but then a a bunch of you know dogs right in addition to that right like your fund returns are going to be mediocre or or or terrible right because of of of what’s happened um and so you don’t make you you may not make any you know you may not make any carry but in the situation where you don’t go deal by deal a couple deals go south and obviously you never want that but you know in some ways it gives you the ability to benefit if you really create a lot of value in a in in a in a in a in a in a deal so you know I’m a public markets investor you know kind of in my history and so the traditional way to go about it there is that you raise a fund or you raise a long you you raise an SMA um and and we would be open to working with a family offices or a group of family offices who wanted to seed the strategy with a certain amount of money that could create a farm team where we could own some of these St some of some stock in these companies the ones that we’ want to own you know you know I’ve got this thing where I I want to invest in companies that I would intellectually be Cappy owning 1% of 20% of or 100% of and so we have everything we do has an eye towards control I don’t want to just own 1% of a company in perpetuity I think a passive strategy in micro cap where you just you know you whatever you’re you own 100 one one 1% positions it’s not that’s just not for me and I don’t think that’s a good strategy I think you have to be more active when you’re in micro cap um but yeah but a fund where we could have a farm where we could establish the farm team and in a situation where you know we got to the the end of the line of a take private and someone else took it from us at least we would own some stock and make some money so you know I I kind of feel like I’m swimming in parallel Lanes here with our primary go to market is going to be through V spvs and um let me say I I need to say this because um I’m an investor first I’m not a transaction guy I’m not never been an investment banker and so again nothing against investment bankers but like I think if you come from that background you know you might have a slightly more transactional nature here like and and and like the idea of getting a deal done versus the best deal could could I think if you just used to that world could kind of permeate your your thinking um but I’m I’m trying to do great deals and so you know only things that we would put our own capital in so you know that the timing of such could be could be months it could be hopefully not years but it could be months and so we want to be really um careful and judicious about what we take to people because we want to you know we want to have the reputation that we’ve done a lot of work on these companies and that we can you know that we have a an roach that can both that can a resonate with the management teams and LPS but also sustainable and repeatable so we’re you know we’re you know unapologetically not going to be jumping you know just trying to jump in the pool as fast as possible to get deals done but yeah but probably you know you know if if things work knock on wood we’re going to be in the position to have you know as we’ve distilled the universe you know a handful of things to take to our LPS in in in you know in the coming months do do you see any body in this space who’s already doing what you’re doing is there any sort of uh model competition yes so I would say if like you know we would love to be the little brother of P2 which is a group that has done um they bought Blackhawk networks like they this is like if you want to know what we’re trying to do we’re just trying to do what P2 is doing in um in in the micro cap space um and they’re investing much bigger companies so it’s not they’re not they’re not even in playing in the same world as we are but that’s the model that they are running where they invest in these companies and and and then you know obviously if there’s a situation where there’s a take take private available right they you know they raise an SPV to do the deal like that that model where you have a public fund and and that being a farm team for take privates um you know or or you know a venue for take private I think is is the model um there are other people um who have been doing something like this you some a lot of you may be familiar with milroad um milroad has a public strategy and they have done a number of take privates there there was a company called RG Berry that kof actually owned when when milro bought it um you know they’ve got a good model their their idea is like you’re going to buy x% in the public markets you’re going to agitate um you know it’s kind of an like an AC of strategy in a lot of their Holdings and they’re going to agitate for Change and if if the stock if they if if if they agitate for Change and it happens the stock remains undervalued they bought x% at hopefully a low price and then they can buy the other y% you and take private at a you know and and they’re cost basis is lower because they already owned like whatever 15 or 20% um it’s a good model um but you know it’s taking those guys a really long time to do it and so it is you know it’s what that is is evidence of how hard this is to get right and having the right LPS and and doing the right deals um you know and so there’s a couple other firms I mean I think privet um is a public a public micro cap oriented firm that did a that did a deal um but I mean it’s just it’s it’s just like here and there right like like like uh one thing that I am concerned about right like and I’ve heard this from allocators is like if you are if your main role is to run like a 50 stock micro Cap Fund like that’s a full-time job right like that’s a lot of Securities that’s a lot of management teams that’s a lot of people to be watching over in terms of capital allocation to execute to take private like like in some ways that’s gonna that’s a full-time job right so I think it’s hard it’s a little hard to be like um you know run a traditional micro cap strategy and then to execute take private and I think you know some of the players who have tried to do that are run have run into that situation um so the simple answer is um the capacity the capacity constraints in this strategy the perception that micro caps are broken the lack of institutional Capital available for such a strategy means that there’s like unlikely to be a lot of competition going forward but it but I want to pretend that you know we’re not going to run into situations where strategic or a financial sponsor could be a better owner of something and I think that’s one thing that you know I’m really focused on is as we’re approaching these companies like if it is really clear that we could that we that we’re not the best owners of something we have to have the we have to have the humility to say you know what this is not this is not for us there’s a strategic there’s a sponsor who already has a platform here like we just we can’t be the best owner or we just don’t understand you know we have we don’t have enough history with the business model um and so that’s you know we’re going to be highly selective in everything we do we don’t need to do 20 deals you know you know over three years if we got if we did a deal a year and you know whatever because this is going to be labor intensive it’s G be time intensive um you know that would be a great outcome for us we got a we got a about 30 minutes leftt Ben if uh you had to uh wave a if you had to look into your crystal ball what do you think will be the industry that you uh do your deal in yeah I mean I think it’s it’s I think the odds are that it’s going to be an industrial or like Focus company some kind of manufacturing business or some you know somebody who provides a you know a small component that goes into a larger piece of Hardware or that in OEM assembles um because I like businesses like that because they have often provide Mission critical systems and structures that um uh you know that if the device fails without them so the so they can often be specked in um they these companies have pricing power because if you’re only if you’re Mission critical part of a larger system and you’re only like whatever less than 5% of the cost you know there’s some price and elasticity there so I love businesses like that so I I like you know I I I think we need to be really clear about where we can be Best in Class I do not think we can be best in class in software there are plenty of if constellation is willing to write a $20 million check we’re not going to be competive there and that’s fine we don’t need to compete with constellation um I Banks we’re not going to do banks um I think there’s there there’s a long roll up for micro cap Banks I just don’t think we’re going to be Best in Class there biotech just there’s no phds here we’re not going to do biotech so so part of this is like just understanding where you’re not going to go um but I think if if if this you know just given you know my I’ve been a generalist my whole career but I think in the industrial space is where you can find a real business that has you know all of the characteristics that we want but it’s just unsexy and boring and unsexy I think for private Equity are the best businesses right because you pay a fair to a low to Fair multiple for a business like that you can layer on all kinds of improvements you know operationally and from Capital allocation basis and you know you can own the business forever right so I I think you know I’d be surprised if if uh it wasn’t industrial but you could also say business services was is would be a close second yeah I like that um folks want to follow along with what you’re doing or get in contact with you how do they go about doing that yeah thanks Toby thanks so much so um you know you can you can look me up at Devonshire Partners um B claremon at Devonshire partners. Co is email address you can follow me on Twitter at Ben claremon uh you can follow my sub substack compounder substack um or you can follow the Compounders podcast there’s a lot of different ways to get me um I like you know like to hear from people I I like I’d love to hear if if anyone listens to this and thinks this guy’s totally full of crap and this will never work please reach out to me and tell me why because I’m looking to I just you know the old the old quote from an investor who who just passed who said um all I want to know is where where I’m gonna die so that I don’t go there I wantan I want to know where the where where this strategy goes to die so please reach out whether you like it or you don’t like it I want feedback cuz like I’m a I’m a learning machine and I’m a continuous Improvement and I hope that the next time we talk about this I even my my Approach is even more refined well Charlie yeah thanks Ben clemon uh folks we’ll be back same bat Channel same B time next week see everybody then post Omaha