Balance Sheet First Investing Like an Operator, Not Traditional PE

Welcome back to the Rural Selection Private Equity podcast.

Johnny's today is Andrew Sacks, the founding partner of Maloa, a different, genuine

different approach to private equity investing.

Let's dive it.

Andrew, if you can share a brief insight to you please.

Sure.

So I was born in San Diego, raised in San Diego, and thought I was going to be a professional

golfer, but God had a different, different plan for me.

I was fortunate to go to Georgetown, study at London School of Economics, thought I was

going to be an economist, and ended up working at the second largest buyout fund for my

first job, Morgan Stanley Capital Partners, $1.9 billion, so this was about 30 years ago,

times have changed, and ended up, after that, working for some family offices, and ended

up starting my own investment firm just over 19 years ago.

And it's called Maloa, Maloa meets Endless in Hawaiian, and that really flows through

our entire thesis of investing in people and life.

Oh, thank you very much for that.

Sorry to hit a professional golfing didn't work, but thankfully you were saved by private

equity.

What are the mistakes that you see private equity firms making all their portfolio companies

and what would you suggest to correct them?

So I think private equity is actually fundamentally flawed in terms of the model they're using,

especially with higher valuations.

So the most obvious mistake is putting too much debt on a company, which now, in the

last 10 years, massive amounts of debt have been forced on the companies because valuations

are higher and private equity funds need to try to hit their IRRs, which is another, frankly,

kind of makes you make interesting decisions, which aren't always the best decisions.

I would say the second thing is timelines.

So to invest in a business and then think you're going to make proper decisions with a lot

of debt thrown on it and have to sell it in five to seven years, creates a paradigm,

which just doesn't really make sense from a long-term business perspective.

And so those are really the two, I think, major mistakes that are getting amplified and

you see it today coming out that a lot of funds are not able to sell their companies.

You do see bankruptcies with too much debt, obviously, often they're restructured because

it's private credit now.

So a lot of it's under, you don't hear a lot about it and it is private.

But I think those are two fundamental mistakes that private equity is making over and over again.

Well, I'm going to guess that you're not going to tell me that your heavily leveraged

and your whole period is two years.

So let's start with the, you know, the your focus from a balance sheet perspective and

how you how you're approaching things differently than the heavy debt cycles that's traditional

with PE.

So part of it goes to what we focus on.

We focus on family businesses, often second, third generation businesses, looking for capital

for owner liquidity and growth capital or working capital to grow.

And we do this without debt.

We do not like leverage.

We would actually rather have annual distributions to the owners and to us, rather than some

big pop at the end of the day.

And then we're often acquiring 30, 40% of a business with, with no put or redemption

right.

So we don't have timelines.

And so Maui Lola means endless.

We believe in endless timelines.

We have no problem selling businesses when it makes sense.

But are the belief that quality businesses are hard to find.

And good old thing of business also is typically not a five to seven year affair.

And so we kind of take that, we do take that off off the table.

We bolster up the balance sheet also that private equity typically does not pay attention

to.

Although with their tight time frames, I get that.

And we believe the balance sheet, culture, people are really the things that drive a

business long term.

It was obviously two names that have done pretty well out of the whole long term hold,

the Charlie and Warren.

So what was it that inspired you to adopt that model as opposed to following the herd?

Well, it was a couple of things.

So one having being economist by training.

So having a little bit more kind of long term view in terms of what are the right business

decisions and how it works.

Second is having started in private equity.

It was very fortunate.

I mean, we did old school private equity buyouts.

And obviously, like most investors, Ward Buffett is one of my idols and I've read as much

as I can try to learn from him.

So we certainly didn't invent it, but those ideas were out there.

And especially as private equity has become much more competitive over the last 10 years

and efficient market prices are very high.

That if you're able to find opportunities to invest with a great team, a great business

model, a good market.

Why would you sell that you have to pay taxes on it, you have to you have to reinvest

the money.

Now, it plays into the typical private equity model because they like to raise fund over

fund over fund.

But to me, it's not really investing.

It's more capital aggregation, which you see today with the KKRs and Apollos of Carlisles

where they're just getting the money out.

And it's been lucrative, but then they just keep fundraising.

So we take a very different approach.

We also focus on the SMB market, the small and the middle market, small, the middle market

businesses, which typically have been overlooked.

The got more action lately because of platform businesses reaching down, trying to grow.

But we believe the small middle market businesses are the backbone of the United States, which

has the most dynamic economy in the world.

And we think it's really important that these businesses are supported because that's

what drives our community and our economy.

Interesting.

So how does that work from a, you know, do you guys not therefore work in fund cycles?

And I'm assuming that you have your LPs will have a different expectation additionally

from there as well.

So it's a great question.

I think one of the key differentiators, we don't have any institutional capital.

So we do have funds, we're on our third fund today, over 19 years.

So that also tells you a little bit how we're different than most private equity funds.

Most would have probably twice that or three times that.

And so we work with a fund, but it's only high net worth individual investors.

The fund does not have a, it has a period of investment, but it has no time period for

holds.

And as I mentioned, investors like it because we distribute cash on an annual basis.

So it's not their only holding.

This obviously is a part of a diversification strategy among high net worth individuals.

And so fortunately, the returns are there.

And then also I think there's, you know, there's the emotional part too.

These are people who are wealthy.

And they want to be investing, they want to make money, but they also want to see positive

outcomes that are good for our community and our world.

And I believe the capitalism, small and middle market business, one of the most powerful

forces in the world for creating wealth, for impacting people's lives, creating jobs,

impacting the communities.

And we love it.

So and then from a talent perspective, obviously, you know, my run executive search firm.

So I'm always thinking about your executive teams and your portfolio companies, your reference

that early of the importance of it, those guys are all predominantly chasing the equal

quality event because that's where their payout happens.

How are you structuring things differently given that long term hold in order to incentivize

and obviously attract the best people to grow the companies that you've acquired?

So we're big believers in equity for management, for top management, not necessarily for

all management, but then also having bonus programs annually in terms of the success of

the company.

I'd say one of the mistakes I made early in my career is being too analytical, maybe

more my economists, the hat, and not realizing that fundamentally the success of a business,

especially over the long term as people.

And so we've become quite critical and I think a lot more intelligent about the underwriting

of the people, starts with the leader, but also the team around them.

And that really plays into culture.

And what kind of culture are they creating?

And we find that certainly there's lots of entrepreneurs who want to grow a company quickly,

get the big pop.

There's nothing wrong with that, but there's leaders out there too who are a little bit different

who have spent 15, 20, 30, 40, 50, we have a company that's 93 years old, building with

their employees and their family.

And so yes, the big pop is important, people like it, but at the same time you're throwing

your company into the wood shipper potentially of private equity and what's that going to

do to their people, what's going to do if they put a bunch of debt on it.

And certainly I don't fault anyone for taking the big pop, but this is an alternative.

No different than I think one of one of another alternative is esaps and where a leader

and owner will choose to do esaps, there's certainly some upsides and downsides to esaps

and I think we're an alternative under that thing.

Someone who doesn't, we say it's kind of like having your cake and eating it too or another

bite at the apple or second first bite at the apple where you know you can take some

money off the table, bolster up your balance sheet, little growth capital and if you want

you can sell it in a number of years, but it really depends on the psyche of the owner

and the entrepreneurs.

So you turn to us, just a quick mention of a long-standing partnership with Grata.

As you'll probably know, the private equity scene is constantly evolving and deal flow is

moving now to proprietary and data-driven processes.

Grata provides you with the data and information of over 7 million private companies.

So if you're looking to improve your proprietary deal flow and improve the data access and

reach out to Grata today, now back to the podcast.

Having been in a, what I would assume Morgan back then was a highly leveraged environment

with the portfolio companies, when we just use the term free cash flow for simplicity,

what's that like from a portfolio company perspective, when the worry isn't the interest

payments, the constraint doesn't sit on having to get your dollars to work, probably as

hard as you should do, or you have to because literally the cash is so constrained.

What does that change, as you mentioned in the term culture, but what does that change

as an organisation not having that, or just let's put it in the positive frame, having

free cash flow and not having the highly leveraged debt burden sat up of your head?

I would call it simplicity, it's freedom.

You have the freedom to make the right decisions, the right long-term decisions, and with debt,

and I think most private equity guys, well, debt's good because it sharpens your focus

and makes companies really perform, but at the same time, that could be true, but when

you're talking excessive amounts of debt that are eating into your free cash flow, businesses

need to build their balance sheets, businesses need to invest in their people, and it

straggles you.

You're making decisions for how can I last for the next 30 days, 60 days, six months, two

years, and I would say not only debt, but also just gearing up to sell the business.

You run a business very differently if you're planning to sell it a year from now as opposed

to keeping it for 10 years.

One of the things that we think about in one of our investment critters is a business

that we're going to want to own 10, 20 years from now.

That, I think, drives us to good decisions.

Debt, while if used properly, it can certainly juice your IRRs, is not a positive relative

to a business and how it's a run.

It can maximize shareholder return if done right, but it's also asymmetrical risk and forces

with that decisions.

We're not fans.

I would rather take a lower IRR, a little bit lower return with a lot less risk, and especially

over a much longer period of time, because a beauty of compounding cash flows, you have

a 13% IRR over 10, 15 years.

That's a very impressive return in terms of the actual dollar amounts.

Now with debt, you could have a great IRR, but actually not have that big of a return

relative to your multiple of investment, and so that maybe that's a difference too.

The debt really focuses you and gets you to focus on that IRR number.

We say we focus on piles of money, and that's over the long term, and I have to give credit

to Ed Mathias, one of the founders of Carlisle Group, who actually told me that term piles

of money.

We focus on piles of money, and I think that's pretty clear as to what that means.

I'm always intrigued, because the private equity world, when we look at the big players

and the longer term players, which is still a relatively new term, really a new industry,

but if we look at portfolio companies, there's probably still a lot of this around chasing

the ex-Danaheer people and chasing the kind of big blue chip world class manufacturing

and the surname place for people that have had that experience and value that.

You've obviously had some of that, I would guess, within Morgan Stanley in that exposure.

What was something that you experienced at Morgan Stanley that you went, do you know

what I really liked, whether it be the pace, whether it be the standard of operation,

the quality of work, whatever it would be?

What was the kind of a single thing or a couple of things, if you must, that was I'm glad

I learned that from that institution, that business?

It was, first of all, just from the educational standpoint, to go in as your first job,

and I would, anyone interested in business, and I know it's harder today, but to be able

to go into an analyst program and work there and learn from people, it was just incredible.

Just in terms of how to value businesses, what free cash flow was, how to model.

I think these things are incredibly important, especially in the age of AI, because you need

to keep your critical thinking and a bit afraid that that's going to go out the window.

I think it was really, and the other thing with Morgan Stanley, as I mentioned before,

is the ability to, if I look at what private equity does fundamentally, it basically

reuses the wheels of capitalism.

If you're doing it well, you're allocating capital in a capitalist system to better outcomes,

which is better outcomes for everyone, and I love that.

I love the intersection of capitalism and community outcomes and growth, and I think

there's a lot of negative around capitalism, and I get why, because it's certainly everyone's

votes need to rise, but I think it's still one of the most powerful forces, and that,

really, I got that at Morgan Stanley, and it was also, this was in 1996, so things

were, even though private equity kind of started in the late 70s, this is really the beginning

days of private equity, so it was a lot of fun.

I just didn't like the, and there's definitely a place for the Danagers, and whether it came

out of GE, but I love the thing, it was a little bit impersonal, because it was so big,

you're making big investments, and I love working with multi-generation businesses that

maybe aren't as complex as a chemical manufacturer, but are just as important in our communities,

and really have a more at the ground level, I guess, because I've been in the communities

for generations, and to me, that was the thing that I guess, it was kind of my aha moment,

saying I really love what I do, but I want to do it a little bit smaller and a little

bit differently, and that was my conclusion.

So you've got something else that's fairly unique, and not something I've seen before,

and that's, well, the accelerator program isn't a unique concept, but the middle market

accelerates better programs as you guys have referenced on your website, certainly is.

Tell us about it, tell us about the outcomes, tell us about how it's going.

So I have to give credit, the accelerator idea was from my partner, Kai, who had been

involved in an accelerator, and then actually ran an accelerator, and obviously there's

not been any middle market accelerators, most PE firms acquire companies, so it wouldn't

really make sense for a company to come into an accelerator to be acquired, we don't acquire

companies.

We look to invest, as I mentioned, acquire 30-40% of a business, and so it was just a perfect

fit relative to bringing in, and we decided to focus initially on Washington, D.C., we had

our first cohort this past year.

We brought in three businesses that were all excellent businesses.

I would say there are the small middle market businesses no quite receive as much attention

from the private equity industry, and it was a huge success.

We were able to impact them in ways over a couple of month program that I think that they

appreciated, and then we obviously able to work with three exciting businesses.

We're definitely going to do it again next year, and it's just the small middle market businesses.

We call them two boring businesses, which means they're profitable and make money, so

me it's not boring at all, but that's the term within private equity, and we love to

focus on that.

You certainly hear it more and more now, I think, as you hear some stories of private equity

kind of moving into that space, but that focus on the accelerators, done a great job, got

our presence out there, telling our story.

It is unusual.

Our story relative to not wanting to control the business, not wanting to throw a lot of

debt on it, no timelines, and so the accelerator is a way for us to celebrate that, and then

also impact three companies.

We thought it was a great success, I'm looking forward to doing it again.

Absolutely.

What do you read, watch, listen to the recommend others to check out, please?

I've been reading the Wall Street Journal since I think I was 15, I do read, I'm a big

believer in reading everything.

I say there's always three sides to the story, their side, your side, and the real side.

I'm in Washington, DC, I do read the Washington Post, I do Apple News, which I highly recommend

to anyone, aggregates tons of different publications.

I'm a constant reader of books, I'm constantly reading, I love CEOs, bios, and talking about

what their path and mistakes that were made.

I love reading anything about War Buffett, Charlie Munger, any types of books.

We believe, and this gets into also how we invest in terms of the people, we believe

in kaisen culture or self-actualization is what we call it, but constant improvement,

right?

I mean, we're all fallible, we all make mistakes.

To me, it's not where you are, it's what direction you're moving, and constantly trying

to improve and get better.

So we're voracious readers.

I watch occasionally the podcasts, do watch all the all-in podcasts, which I think a lot

of people watch, but I tend to be more of a reader, I'm 53 years old, so I still

like feeling a book, and then spend probably about an hour to two hours a day reading just

the news and what's going on.

I do think in private equity, you have to be quite astute about what's going on, whether

it's political, business, other outside events, because these businesses are impacted by

many things.

How has anybody wishes to get in touch, do they get to reach out to Andre?

All the easy way is Andrew at malloaink.com, M-A-U-L-O-A-I-N-C dot com, and always I've

said I've never had a bad meeting, and I'm always willing, I've built my career on business

karma, so always constantly willing to help people if I can, and always excited to talk

to entrepreneurs.

Well, thank you very much for coming on to the private equity podcast, Andrew.

Thank you for having me.

It a pleasure.

And thank you very much for everybody for listening, until the next time, keep smashing

it.