TSI004: Plan The Exit From The Beginning
THE SOPHISTICATED INVESTOR
Planning The Exit From The Beginning
EE: Hello everyone. This is Edwin Epperson, your host of the Sophisticated Investor. The Sophisticated Investor is an incredible community, which is focused on education, training and collaboration to help each of our members, and that includes you, to build, protect and preserve your family’s generational wealth. Now, I believe that we truly have a unique and one of a kind educational community. For one, I believe that there are four primary markets, not just one. I believe that those four primary markets include your personal finance and mindset market. I believe the second market is your hard, tangible asset market. I believe that the third market is your stock and paper market, and I believe the fourth market is your business investing market. Now, those four markets are imperative to be able to understand and then call yourself a sophisticated investor. Today we have an incredible guest who’s going to educate us on their preferred market of investing as well as the assets that they like to invest in. Please join me as we welcome today’s guest.
EE: Hello everyone. Today we have Erik Sewell with us. Erik, thank you for being on the show; The Sophisticated Investor.
ES: Thanks for having me, Edwin.
EE: Well, we are excited about having you on. There is a lot of information that we are going to be diving into for the show. But before we begin, I wanted to let — sort of give everybody an overview of what you’re doing now. Just a little bit about your background and then we can dive right into how you got where you’re at today. For everyone listening, Erik is the vice president of a business fund. They purchase businesses. It’s called the Osceola Fund.
EE: So you’ve been doing this since 2018. It’s a fairly new position for you. Right, Erik?
ES: That’s right. Yes, I’ve been, I’d say, broadly involved in investments and financial services for the last five years. But have been in this role at Osceola Capital Management about the last year.
EE: Okay, Osceola Capital Management. Everyone listening, you all are going to get an inside look at the way a fund. They aggregate, they pool investor’s capital and then they go out and they are looking for businesses. Specifically for Erik’s company, the Osceola Capital Management, they look at businesses in the services industry, business services, tech services, and industrial services. That’s really their niche, if you will. So they pool investors’ funds together and then they go out and invest those funds into businesses and they’re buying businesses to take them to the next level, which we will get into later on in the show. But this is who Eric is, and he actually lives right down the street from me here in Tampa, Florida. Definitely excited to have you on and be able to talk a little bit more about your background. So, everybody, I’m sure when we hear that you are a fund manager, a vice president of this fund that goes out and buys businesses, maybe the first thing in people’s mind, it’s sort of like the shark tank. How accurate of a statement or how far off is that?
ES: It’s similar in ways of like how we – Some of the questions they ask and the ways that they think about businesses and industries and what your total adjustable market, your TAM, very similar. But otherwise, shark tank is a little bit more of a venture capital focus, where they’re coming in, somebody’s got a great idea or a new product and I say, “Hey, I’m going to buy 30% of your business for a million dollars or whatever the number is.” They’re usually not looking to take control of it. What we do is leverage buy outs. We look for companies that are usually a little bit more established, have been going for a number of years. A lot of times it’s a founder or a founder owned and operated and we like to come in and partner with them and say, “Hey, we’re going to buy a controlling piece of the business, but really partner with you and help you kind of take this business to the next level.” But maybe also just like kind of a little bit overview of private equity. I think venture capital would be one aspect of that in terms of the very early stage of a business. That’s a very different risk profile than companies that are more steady state. So in our fund, we look to – For all of our companies to hopefully have at least two times return at the end and some we’d like to see three, four or more times at the end. [inaudible 00:04:53]. They know that 6 or 7 out of 10 of their investments are probably goose eggs. A couple of them they want doubles, and one or two they want to be homeruns. So there’s all sorts of risk profile as you kind of go from B-C all the way up to the lower-middle market, and then middle market, and then the [inaudible 00:05:11] bracket across different styles of private equity. As you mentioned, yeah, we’re kind of in the lower-middle market. We do work with smaller companies, but usually they have been around and established for a little while.
EE: Excellent. So when somebody hears this, they may be thinking, “Oh, wow! Erik, you must have gone to the most prestigious schools and you have got to have family and business that have been doing this for decades and generations and generations. I want to dispel that myth, because I, like yourself, am working at an industry right now that if you look at my background, I have no business being in. I think that we carry a lot of similarities and that both you and I came from completely different backgrounds as far as what our precursor career was before getting into the fund management space. So walk us through, what was it that you did, and I want to dive in to your previous job briefly. But before that, where was this epiphany that you wanted to get moving into the investment, fund management space?
ES: Yeah, quick background of myself. I grew up in Florida, in Tallahassee. Playing a lot of sports, basketball and baseball at West Point to play both sports there. Then followed on with 5 years in the army as a field artillery officer. I wasn’t a Special Forces ninja such as yourself. Had a good experience there and a lot of good, learning soft skills and learning how to work with people and lead, all that kind of thing. But it was kind of an eye-opening experience to get to business school. It’s like, “Hey, our goal is to maximize profit.” In the army that’s like you consult your budget, and if you don’t get your budget, you don’t get it next year. That’s how you manage your budget. It’s a different way of thinking about, you know, you’re kind of getting into an investing mindset and everything when you’re in the army, and that’s awesome. Yeah, I think I was just really always intrigued by business and how do you create value in any given industry. I’ve always kind of naturally inquisitive and wanting to learn how things work and values. So that’s something I got into a business school. I was at Raymond James for 40 years prior to Osceola now. Kind of a corporate strategy and operational role, but a lot of those strategy projects had different flavors and pieces of investing than Raymond James. It’s a large diversified financial services and investing company. I think I also have that passion all along for wanting to be involved in kind of the small business space and maybe one day would be an owner/operator of a business, or what I really love, and this role here is that I get to work with lots of owner/operators of different companies and different industries and seeing what works well and what doesn’t. Trying to get in and help out and create some value.
EE: That is excellent. So for the listening audience, you live here in the greater Tampa Bay area. Do you only invest, does your fund only buy companies and invest in companies in the Central Florida area, or regional, or are national?
ES: I would say we have a preference for local, even southeast regional companies. But we do what’s kind of known as a buy and build strategy or where we like to do consolidation. We look for industries where there’s a lot of fragmentation. So sometimes maybe we buy a company that’s [inaudible 00:08:37] southeast. But then to add on another significant piece, maybe it’s in the northeast or could be the Midwest or west. So we can acquire companies anywhere in the U.S. But we do have one company that we’ve been investing in recently that is based here in Tampa. So we do like to do local deals.
EE: I do like that idea of you’re looking for a fragmented industry and then you’re going in, you go through your analysis, your underwriting, if you will, when you’re looking at a business to purchase. I’m sure part of that underwriting or that strategy is, “Okay, this business, are there peripheral services or components to this business that we could also purchase to help feed the engine, if you will, feed that monster that fuel.”
ES: Yeah, definitely. Definitely.
EE: Real quick for those who are listening. Erik worked at Raymond James, and you worked right next to, I believe – And correct me if I’m wrong, was right next to Mr. James. Correct?
ES: Mr. James. Yeah, Tom James. Yeah, he’s an incredible person. He built Raymond James, which is a fortune 500 company now. He’s the CEO for over 40 years and has really built that into an amazing company. That was a great experience getting to work on projects with him and other executives at Raymond James. He’s forgotten more about investing and both of us together will probably – Yeah, he’s got a great mind for it. I think, also, really important thing to me is really values [inaudible 00:10:14] business and doing business the right way a long-term focus. I think that is what I like about private equity is that usually you’re investing on a 3, or 4, or 5 or more year time horizon and you’re not driven by quarterly earnings. Having to make a number every quarter. You’re able to say, “Okay. Hey, here’s a long-term growth strategy for how we’re going to get to in the future.” We can build towards that. I think that’s something that Raymond James has done really well, and despite being a public company, is long-term mindset. Not trying to sort of game the system to try to hit your next quarterly earnings.
EE: There you go. Okay. Well, excellent. You’ve had the ability to work next to someone who I’m sure you garnished a lot of wisdom and insight from, and that’s invaluable in this business. That’s fantastic. Fantastic. Now you work there. You worked with Mr. James there at Raymond James for about four years, four to five years. Then you made this transition over to Osceola Capital Management. What was the catalyst to make that transition if you don’t mind me asking?
ES: Yeah. I think it was – Like I kind of mentioned briefly a minute ago, was a longer term desire to get into smaller businesses. I think I had kind of the stream of one day owning and operating my own company. Yeah, I think when you’re just getting started out, it’s kind of – It’s hard to figure out, “Okay. What exactly company do I want to invest in? Do I have the risk tolerance to go [inaudible 00:11:49] or whatever, a lot of leverage and buy a company right now? The experience to go and operate it effectively?” So I started looking for other opportunities to get experience [inaudible 00:12:01] and I’ve met up with the partners here at Osceola and have gotten involved here and really love it. Like I said, I think being able to work with a number of different companies, that’s almost even more fun.
EE: I had asked that you fill out sort of a questionnaire, sort of spur the conversation and to provide insight and really direct in. In a minute we’re going to start diving into the meat and the potatoes of the investing and really some key things that the listening audience can take away. But one of the things that I always ask someone is who is somebody that you follow or who is somebody that has had an ongoing influence in either your business life or your personal life that you would either recommend or that you say, “Hey, this is what I’m a big fan of.”
ES: Yeah. That’s an easy question for me to answer and my friends [inaudible 00:12:51] will smile, because I mention this person a lot. But Elon Musk I think is very influential. I think he’s the greatest business and the most influential business person of this generation I think, has the potential to be of all time. I think he combines a number of kind of attributes that is like weights very heavily in. I don’t think he’s the smartest person that ever lived, but he’s – Yeah, he has a very high risk tolerance. He sold PayPal I think after he founded – Or is a cofounder of PayPal. I think like $180 million. He invested every cent in SpaceX and Tesla to the point that he was having to borrow money for rent.
ES: They both almost failed, but now you kind of see where they are today. Tesla’s stock is a little down right now, but if people are looking for stock recommendations out there right now, that’s mine.
EE: Well, there you go.
ES: You heard it here first. But I think he’s got like kind of this first principles approach to engineering across a lot of different disciplines and thinking about, “All right. One way to think about how to innovate is to say, “Okay, something is like this now. How do we make it incrementally better?” It’s like a lot of improvements in society or incremental improvements. That’s great and really helpful, but he kind of like takes it down to the base physics and laws of the universe [inaudible 00:14:21] and the elements of a thing and saying, “Okay. Well, people are making a spaceship over here for this much. What’s the cost of the materials for that spaceship and why does it not cost basically what the cost of the materials is?” Everybody was like spaceships until this point have been exorbitantly more expensive than what the materials cost, because of all the contracting and everything that you have in there. I think there’s a number of areas that he really excels that it makes him kind of a unique person that’s flipping a number of huge industries on their head.
EE: He is for sure doing that. So I wanted to dive in to the – Our listening audience is comprised majorly of people that are wanting to take their investing acumen to the next level. They’re wanting to find strategies, formulas, techniques, underwriting and the way that they evaluate and look at investment opportunities. I think the advent of shows, and I hate to point to TV as proof of anything. But you see shows on the rise like The Prophet, Marcus Lemonis’ The Prophet, who goes in and buys underperforming, very small businesses. Then all the way up to the shark tank. Where, like you said, venture capital. They’re coming in right at the ground floor. There we’ve got a lot of risk, a lot on the line, but they have the contacts and taking it up the next level. So those shows have really sparked curiosity and, “Well, I’ve got some money sitting in my 401 (k). I’ve got some money sitting in a self-direct at IRA, or I just have cash that’s just sitting around, and I want to do something unique. I want to have a big impact in either my local economy or maybe the greater regional or even national economy.” How do I go out and find a business to invest in and what can I be looking for as far as red flags or these are things that I need to stay away from or things that are big green lights.” So that’s really where I wanted to spend the next portion of our show together, is diving into your role, and your company is really at a high strategy level and you personally – Or I say at a high strategy, but you are also getting involved, like you said, with the business owner themselves. How do you go about finding a business? If there’s an investor right now that’s listening and he or she has money and they want to go out and find a small business. Where would they find that business?
ES: Yeah. So deal sourcing – Yeah, it’s something that we spend a lot of time thinking about and actually doing. Every private equity fund kind of talks about how to get deals. That’s a really important thing and ideas you buy an attractive valuation. You have a strategy to improve the valuation of that company. Then ultimately, down the road, looking to sell at a higher valuation than what you started. The market has gotten very competitive, private equity landscape. The last five, certainly the last 10 years, there’s been a lot more money in the market and LP, limited partners, with dollars that are going to private equity funds. They’re out looking for deals. Private equity back in the day kind of used to be more or so like the middle market and the sort of bold bracket, the really large deals. That’s the most of what the private equity was focused on. But as more [inaudible 00:17:55] come into the market, you’ve seen more and more people going further into the lower-middle market kind of where we played. We even kind of could go even a little bit lower than that. I think a lot of times the lower-middle market is defined as kind of $3 to 5 million EBITDA is the bottom of it. We’ll do deals even smaller, $1 or 2 million EBITDA. If we like the strategy and we think we can build it to something that’s going to be successful. Yeah, to your question about the sourcing, we look at a lot of ways of finding deals. What I mentioned here in Tampa was completely proprietary through kind of a friend of a friend that we had. I said, “Hey, I see what you guys are doing. You guys should really talk to this person over here.” We’ve had a couple of other deals like that, but we also get deals sometimes from investment bankers and business brokers. So that’s a way to find deals as well. For an individual looking for a deal, it’s usually going – Best bet is going to be through like a business broker. They’re usually, I would say, anything up to $2 to 4 million EBITDA just depending on the business. But it gets into an investment banking process. Those investment bankers are going to have a buyer list of people that they know are either PE funds or strategic companies that are out there that are much larger that be interested in that particular company. It might be hard for an individual to get on those buyer list. They might even know that a certain investment bank has a certain deal till it’s already sold. So if you’re an individual, I think finding business brokers that have deals, especially if it’s for a certain industry or location that you’re looking for, is probably the best bet. Obviously, the best thing in a private equity fund like Osceola is a great way to do that. Also, you get a little bit more diversification across the fund investments. We have also opportunities for co-investments, for limited partners, where if they really like a certain deal that we’re investing in, they can come alongside us and say, “Hey, we’re going to put more money to work in this particular deal.”
EE: Okay, excellent. Much like in my industry. So we’re raising capital for people that are interested in investing in the mortgage industry for the cash flow. You have mentioned this several times, the security, right? The ability to mitigate your risk, which is huge. Not being overexposed in anyway, and that’s something we’re going to talk about here in a little bit. But what I hear you constant – Like what I hear you saying is, really, their own personal network. Like getting out there and meeting business owners, chambers of commerce. In your local community, getting out there and networking with those business owners and putting it out there like, “Hey, listen. I’m interested in purchasing a business.” Then, of course, knowing what type of business you wanted to get invested in. Of course, there’s always the ability to invest in a fund. Again, because it brings in to that the key of aspect of any investing, which is diversification and investing in a fund like Osceola Capital Management gives that to the investor. One of things – You filled out a couple of topics here, and I wanted to start diving in to these topics, Erik. For somebody that’s going to invest – And I see it right here. You had mentioned small companies often have a few risks or opportunities to be aware of. I love the fact that, obviously, in your role and in my role as well in my business, my focus is to make sure I am covering my downside for my investor. How can I mitigate and control the risk? What processes? What procedures can I have in place so that when something goes bad, how can we mitigate that? How can we quickly move beyond that and manage that? Your response to this question was immediately, “Hey, there are certain risks, and there’re opportunities,” and everybody likes to focus on the opportunities, and very seldom does someone even recognize, much less focus on the risk. So for those listeners that are out there and they’re like, “Okay, I know where I can go and find a deal. I’ve got the capital. I can go and start networking with business owners and putting it out there and I have the ability to operate to purchase and invest.” But let’s be aware of the risk. So walk us through some – And you had named three risk here that someone needs to be aware of if they’re wanting to get invested in the business market. Let’s talk about those a little bit.
ES: I think the first one that I had mentioned is client concentration. Whenever we look at a deal, like you mentioned, it needs to be something that makes sense, “Hey, we think this is a growing market or this product we really like,” or there’s something attractive where there’s a projection that, “Hey, this business looks like it’s going to grow.” That’s what usually kind of initially piques our interest. But then, obviously, we want –At that point, we need to think about the rest. That’s where we would – That’s usually like the main considerations that we’re making about. Do we or don’t we want to do this deal or how could these certain risks affect the valuation that we like and ultimately what we would be willing to offer to buy the business. The first, like I said, would be client concentration. You see a lot of time with small business, because a lot of times small businesses provided some service to – They kind of have a couple of eager large companies. They have this niche kind of product or service that was of use to that company. So that’s what’s sort of sustaining the business over – It could be many years. Maybe they have a relationship there or maybe they work there at one point in the past and they feel very comfortable with that relationship. For us, when we come in and invest, it’s a little more of an arm’s length kind of thing and like we’re like, “Okay. Okay. That’s great. We made a lot of money there.” But if you walked away tomorrow or something happened to that relationship that’s out of our control, that risk that we were not able to take. We really encourage owner/operators to try to diversify those kinds of risks as much as possible. It’s amazing to be sometimes we talk to owners that they’re looking to sell a business and they talk about, “Oh, I’m like this great salesperson.” This is getting a little more in the key man risk, which is [inaudible 00:24:20]. “I’m just a really strong salesperson. I have all these great relationships and everything. But I’m getting to the point where I want to retire and kind of step away.” Then it’s like, “Okay. Well, you’re the person with all the relationships, when you go there isn’t going to be any more business left.” It’s just like, okay. You’re kind of at an impasse at that point. Owners that are able to really create value or able to create kind of a system that runs autonomously. I think some operators and small businesses have a hard time doing that sometimes. But in the end, realizing that the business is worth more. The less involved you have to be on a day-to-day basis is kind of an important point for them to consider, especially when they’re thinking about the long-term value of their business. Client concentration is a big one that we look at. We usually like to see one client that has more than 10% or 15% of the company. If it gets larger than that, usually we’ll try to create some sort of contract that this client falls off for some reason that will have some sort of kind of downside protection there. So it’s usually how we’ll think about that. Next one I would mention is cyclicality, and especially everyone’s kind of aware in the market that we’re in now. We’ve been on a pretty long kind of bull run and sort of on a 6 to 8 year cycle over the last several decades. Usually, there’s kind of a recession or a pullback. So for the last 3 or 4 years people have been kind of thinking, “Okay. When is the next one going to hit?” So a big kind of thesis or philosophy of our fund is investing in either recession resistant or counter cyclical investments. Things that are going to be just as strong or not stronger in a potential downturn. So that’s always kind of a consideration that we make in investments. But just thinking about the broad market, I kind of thought about that a lot and when is the next recession going to happen. I think there’s always bubbles in the market. I think there’s going to be something around student loans at some point. I think student loans are just out of control and tuition at schools that students are racking up all these debt. But my point is I don’t think it has to be every 7 years. There’s a subprime mortgage crisis or whatever. Ultimately, growth in the economy is a function of technology development and [inaudible 00:27:03]. Technology growth curve is kind of going almost exponential at this point. The level of productivity that people had just with smartphones, which is really Blackberries back in ’06, ’07, ’08, and iPhone was just coming on the scene. Think about the level of productivity that people had back then compared to now. It’s night and day and just continuing to increase. So some stocks would go up, some would go down, but in the end the overall productivity of the economy I think is turning strongly upward. So it’s my two cents on how I think it doesn’t necessarily have to be downturn right away. But there’s sort of thought in the private equity space that, “Hey, prices have gotten pretty high and there may be a drop at some point.” So that’s where our strategy. We try to come in at a lower part of the market that’s not as efficient, not as competitive. You get in for a lower multiples and then can kind of work your way up into more like the middle-market with investment.
EE: I want to take a real quick detraction, and we’ve got a few minutes left and then we’ll wrap it up and we’ll give everybody a way they can reach out to you. How they can talk about whether they’re a business owner/operator, like you had said, and maybe they’re looking to exist their business and they want to discuss with you ways that they can do that, or whether they’re an investor and they’re looking at diversifying their capital. One of the things I did want to talk to you about though was – And you had mentioned this briefly, is the accounting. I think that owner/operators are a very in the detail. So I’m sure you’ve heard of the phrase you’ve got to work on your business, not in your business. Owner/operators are notorious for working in their business. They know every detail of every aspect of their business. That’s what makes them successful. But when they start positioning themselves to want to exit, which I’m sure there are some owner operators that are listening to the podcast. So if somebody has a business and they’ve got in their mind, “I want to retire. I just want to move on to something different.” How can I position myself to look attractive to somebody like yourself?
ES: A big point is like working yourself out of a job. As I was kind of saying earlier, is the more you are running all those day-to-day functions, it’s great that you understand what they all are and how the business actually works. But the more that you’re involved in doing those things is probably going to create less value instead of more at the end of the day. Yeah, you’re mentioning kind of like the accounting and marketing I think are two other areas that we look at in companies. I guess those are areas I always – Or not always, but a lot of times see there are areas for improvement. A business owner had developed a great product or a service or got kind of a niche in a certain industry and had built a great business. But a lot of times, just the basic kind of financial accounting and reporting of how that business is truly operating is not where it could be even – Just bringing on some kind of base level of [inaudible 00:30:23] on that. It’s kind of the old adage of that you can’t manage what you can’t measure. The more you’re able to measure things and show quantifiably how your business is performing. You may know in your head as an owner how it really is, but am I going to be able to convince other people that unless you can put it on paper and show, “Hey, this is your financials, here’s my key operational metrics, my KPIs, how the business is performing.” Just being able to show that stuff will dramatically increase the value of many businesses I think that we’ve worked.
EE: Well, there you go everyone. That’s key advice to takeaway. If you have a business that you are potentially looking at exit. Make sure you have solid financials, and I think that’s something that probably every business operator/owner struggles with, is getting into the details of their accounting and really taking an honest hard look at their books. Because sometimes that can be scary. You could take a look at and you think, “Well, we’re doing this and we’re doing that.” Really, you’re doing something completely opposite and it’s not until you get your books right that you start to realize that. Erik, I’m sure there is so much more we could talk about and I would love to offer, extend a hand of, “Hey, come back on the show sometime in the future.” Love to have you come back on and talk about maybe some more ways that you guys analyze and look at opportunities to either purchase or for your investors. For the time being, if somebody wants to reach out to you, we have your LinkedIn profile, which we’ll put in the notes. They can connect with you in LinkedIn as well as your Twitter handle feed or your twiddle – Your Tweeter handle. Are there any way else or any other way that someone can reach out to you that you want to offer to them on the show?
ES: Well, I’ll put on my email as well. It’s firstname.lastname@example.org. I can send that over to you so put it in the notes.
EE: Excellent. Excellent. I sincerely appreciate you coming on the show today and we will look at another day to have you back on and we can dive into some more ways that you’ll analyze businesses and how you keep your investors’ risk mitigated and downside covered. So it’s fantastic. Thank you for being on the show. I appreciate it.
ES: All right. Thanks everyone. I enjoyed it.
EE: And that wraps up our show for The Sophisticated Investor. Thank you so much for joining me and joining our guest today as we dove into the specific assets and the market that they invest in. Please join us again when we dive in to more investing techniques and strategies in different assets within different markets so that we can help you, the listener and our community member, build, protect and preserve your family’s generational wealth. This is Edwin Epperson, your host of The Sophisticated Investor. God bless and have a great rest of your week.