Bootstrap Companies Succeed Without Big Venture Capital

Five out of six of the fastest growing companies in the US grow with capital from sources other than traditional venture capital.  How about the banks? Talked to an entrepreneurial banker lately? Didn’t think so. Bootstrap companies are creative in finding capital, often out of simple necessity.  This often creates stronger companies because an abundance of capital did not allow them to delay addressing their flaws.

Capital Imbalance in Need-vs-Supply Creates Contrast to Larger, Publicly-Traded Companies

The chart here shows research done at Pepperdine University on the capital shortage for smaller companies.  My fund, Greybull Stewardship, works to fill this need for capital that is not being met by traditional venture capital and private equity funds.

Bootstrap Offers More Opportunities

This dynamic among smaller companies stands in stark contract to the dynamic for larger and publicly-traded companies.  Since 1997, the quantity of publicly traded companies has fallen by half, to 3,200.  While the quantity of dollars under hedge-fund management has increased by 2,500%.  It is no wonder that hedge funds have under performed lately. So much capital chases so many fewer publicly traded companies.  If an investor seeks an edge, she can more likely find it in the smaller valuations. An edge in the larger valuations now becomes harder to find.

Traditional Private Equity and VCs Can’t Exit So They Don’t Enter

Bootstrapped company owners have the traditional problems of growing companies — expansion opportunities, family wealth diversification. But they don’t have the traditional sources of investment capital. And, those traditional sources also may not be aligned mutually with objectives for growth rates, exit timelines, governance, and more.  At Greybull Stewardship, our goal continues to be the perfect capital partner for bootstrapped companies. And then we place as few restrictions on the company as possible from the fund.  We grow as it makes sense. We do not force a sale on an artificial timeline.  Greybull does this because we started out as company founders, not investment bankers. We believe that providing this freedom to pursue the best strategy for the company leads to the best long-term financial returns for ourselves and our investors.

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Roger Murphy’s Significant Life & Murphy Business Brokerage

Murphy business brokers

Roger Murphy

Living a significant life that has a significant positive impact on others is a great accomplishment.  I believe that the investments of Greybull Stewardship are a force for good in the world and have a significant positive impact.  That is certainly true for business brokerage generally, Roger Murphy, and Murphy Business.

Roger Murphy, the founder of the leading business brokerage firm, Murphy Business, had that type of significant impact before he passed earlier this winter.  Greybull Stewardship invested alongside Roger in Murphy Business starting in 2014 and increased our ownership in subsequent years.  We were honored to know him. And to be business partners with him for a few years.

Contributing and making places for others

One of the leaders of the Murphy organization in the Mountain West for a number of years was Ezra Grantham.  Last year, Ezra wrote a wonderful note to Roger about the significant impact that Roger and his organization had on many people.

Hi Roger, I thought I would touch base and give you some reflections I have:

They did a survey of a group of senior citizens in the last part of their lives to determine what their worst fears were? They expected fear of a lack of enough money to finish out, or fear of poor health would be at the top. To their surprise the number one fear was ” a lack of significance.”  Either that they had not done anything significant in their lives , or were no longer significant to anyone else. When they were gone nothing would be left behind and they would be soon forgotten.

Recruit and mentor others

With you and Murphy Business I see the opposite. You have not only lived ( and are living) a significant life, but you are contributing and making it possible for so many others to do so as well. In my own case in the 8-9 years I was fully active with Murphy I earned a nice sum in commissions and then sold out for a nice multiple. All made possible by you and the system you set up. More importantly than that was being able to recruit and help mentor some other good folks who will have their own story to tell. For all of us it’s more then earning a living . It’s the pride we have in having the tools and backing to do a good job for our clients and the pride we have in being able to feel like we have been successful ( significant in some way).

So my hat is once again off to you  my friend. You have been significant in my life and I thank you once again for all you have done for me. Have a great convention and KEEP UP THE GOOD WORK! 🙂 Ezra

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Founder-Led Companies Return Three Times S&P 500 Average

A study in 2016 from Bain & Company shows that over the past 15 years “founder-led companies deliver shareholder returns that are three times higher than those of other S&P 500 companies.”

Therefore, we at Greybull Stewardship focus on those founder-led, or founder-involved, companies. We study how they are conceived and managed. And we study how best to support founder-led companies with capital and with support for their growth and long-term prosperity. We have written here about how founders need better financing options.

founder

Movie poster for The Founder featuring Michael Keaton

Founder-Led Companies Crucial for the Economy

Bain’s Chris Zook and James Allen write: ‘‘The Founder,” a new film starring Michael Keaton, tells the story of McDonald’s Corporation founder Ray Kroc as he turns a few small restaurants into a ubiquitous international chain. It’s a tale of founder-driven corporate growth. Something that has become too rare today. This breed of entrepreneurial spirit makes for a good story. But it’s also crucial for the economy.”

Continuing, Zook and Allen write: “We analyzed examples of sustained success at 7,500 companies in 43 countries, visiting many in person, to determine what made them stand out. Great founders imbue their companies with three measurable traits that make up what we dubbed ‘the founder’s mentality.’”

“First, insurgency: The founding team declares war on its industry on behalf of under-served customers. Mr. Keaton’s Kroc announces in the film that the McDonald brothers’ fast-service approach is akin to revolution.”

“Second, an obsession with how customers are treated—an attention to detail that borders on compulsive. In his autobiography, Kroc discusses not only burger patties, but even how high they could be stacked and the amount of wax on the paper slips between them.”

“Third, these companies are steeped in an owner’s mind-set. Too often in business, the founder’s vision becomes distorted. Managers seek short-term profits by cutting corners, alienating customers and employees. Companies that maintain the founder’s mentality constantly reassess internal spending. But their goal is to root out bureaucratic barriers to free up underused cash. Kroc was able to create an army of mini-founders by perfecting the franchise model.”

Founder Mentality Creates 50% of the Stock Market’s Value

Moreover, Zook and Allen emphasize: Those companies that continue the founder’s mentality “create more than 50% of the net value in the stock market in any given year.”

In summary: “Too few companies have a driven founder at the helm. An owner’s mind-set governed by a sense of insurgency and a front-line obsession are what’s needed to turn America’s anemic recovery into a turbocharged one.”

Similarly Zook and Allen published research in July 2016 saying “that of all newly registered businesses in the U.S., only about one in 500 will reach a size of at least $100 million in revenue. A mere one in 17,000 will attain $500 million in revenue and sustain a decade of profitable growth. Despite their rarity, these successful firms are a bedrock of the U.S. economy.”

Zook and Allen, partners at Bain & Company, wrote “The Founder’s Mentality,” and published these comments in 2016 at Harvard Business Review Press.

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Investment Asset Class Taking Shape: Smaller, Fast-Growing, Backed by Not-Traditional-VCs

Harvard Business School now catches up to a business trend my investment fund, Greybull Stewardship, has been focusing on for years — the increasing frequency of great businesses that have gotten to nice levels of profitability ($1-3 million) by bootstrapping (i.e., no traditional institutional venture capital).  In the Wall Street Journal just before Labor Day weekend, Harvard Business School Dean Nitin Nohria wrote an Op-Ed titled “Appreciating the Big Role of Small Business.”  “The most visible manifestation of Harvard’s increased focus is a class called Financial Management of Smaller Firms . . . MBA students learn in the course how to seek out, purchase and run small companies,” Nohria writes.

“The class has become so popular that we now offer three sections a year, with a wait-list clamoring to get in.”

Best Investment Class in Private Equity

To me, this asset class of smaller, fast-growing, not-traditionally-vc-backed companies is the most attractive investment in private equity or venture capital.  In this category are strong, fast-growing businesses that avoid the start-up risk of an ‘all-or-nothing roll-of-the-dice venture capital’ while achieving attractive returns.  The businesses are also less expensive than traditional, larger private equity acquisitions because of the inefficiencies of finding them.  This is a recipe for attractive investment returns, particularly on a risk-adjusted basis.  As a result, Greybull Stewardship is in the top quartile of venture capital returns according to Pitchbook — giving greater than 20% net IRR’s since inception.

My hypothesis in Greybull Stewardship is that the quantity of these business has grown larger than people expect, and grows faster now.  They grow because it costs less to start-up attractive businesses (overseas programmers, Amazon Web Services), plus more information and education are available easily to these entrepreneurs, and it is easier for these firms to access and distribute to larger markets immediately.  All of these efforts were much more expensive years ago, and often necessitated traditional venture capital investment for the companies to reach scale.  That is no longer true.

Advantage of Greybull Stewardship for Investors and Investee Companies

For investors, there are three ways to take advantage of this attractive investment class: a) buy a business yourself, b) back a search fund (see below for links about search funds), or c) invest through an investment vehicle like Greybull Stewardship.  Buying a business yourself has obvious downsides and headaches.  Most importantly, one would not be well diversified which is critical in this asset class.  I also think that Greybull Stewardship is much better set-up to invest in the most attractive of the companies in this asset class — much better set-up than the most obvious other option, search funds.

This is because search funds have three major flaws that all increase their risk: a) by definition they change the management team (risky in and of itself) and therefore only attract sellers who fundamentally are bailing out of their business for some reason, b) their goal is often to “fundamentally alter their [the companies’] trajectories” according to Nohria, which is often difficult and risky, and c) they must also time everything just perfectly to sell themselves again in a few, short years (per the search fund agreement with investors), which also increases risk.

For potential investee companies, Greybull is a much better choice for the best of the companies with a management team who wants to stay at the company, who has a lot of equity and who wants to keep a significant amount, and who doesn’t want to be forced to exit the company in the future on a time frame that may or may not be best for the business or for minority owners.

As the investment world continues to expand, I think this trend is healthy for investors identifying newer categories and sub-categories of venture capital and private equity.  It is a natural evolution.

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Culture Eats Strategy for Lunch

The massage school where I am a co-owner, the National Holistic Institute, recently had our annual all staff gathering in Northern California.  wowIt is a big investment, but also a critical culture investment to get everyone on the same page.  In a school, the interactions every day among students, staff, and the public number in the thousands or tens of thousands.

There is no way to train or provide an employee handbook to handle all of those critical interactions.  The only way to do it is to get on the same page with culture and values — what we like to call the unwritten understanding of how we do things.

This year, we had an observer, Drew Sanders, an expert on business management and building high-performing teams.  Drew has joined us here at Greybull Stewardship to assist the management teams at our companies when called upon.  In his email newsletter, here is how he described the meeting.

Is Your Culture a WOW! Or a Whatever? by Drew Sanders

One of the benefits of helping companies work on turning groups of people into teams is that you get to visit a wide variety of settings and environments. A recent trip to a professional college had us buzzing and prompted the above title. This team of 125 teachers, administrators, and service staff were on fire from the very beginning of the two-day long all-hands meeting all the way until the end.  Every member of the team was making a sacrifice to be present, and the business itself was closed the entire time. Thinking of the total cost to the enterprise would make most owners blink, yet like clockwork for years these days are reserved to fill up the tanks of the people that make the company tick.  If your current culture is more of a Whatever these days than a Wow, see if implementing a few of these tips we gleaned will help.

An initial idea to consider is having a common way to signal the end of a situation or event. Most companies will have gatherings, and even with the best clock management they can run long. With attention spans waning you increase the chances of having the end of your meeting being a dud, which sends your people scattering and potentially lacking vigor. Consider having something everyone does together to officially signal moving on to the next task. Think of a football team clapping their hands as they break the huddle. Your group should have its own authentic act, but as corny as it sounds it brings your people together.

Another tip is to allow your long standing employees to talk about their experiences at the company. You will be shocked at how seriously they will take this, and it signals to everyone that commitment to the company is honored and appreciated. You needn’t have a perfect culture to accomplish this, and the people you are honoring will have had challenges along the way. Regardless, this ceremony binds your people to each other and your enterprise.

Finally, give your new employees a chance to answer a few key questions in front of the group, and make sure they are made to feel very welcome. One of the questions can be serious enough to let the entire group know that not just anyone qualifies to be on this team, and we are all looking to make a contribution. We really liked the question; what do you intend to contribute to our purpose, mission, and objectives? As newcomers stand in front of a group of warm fellow teammates and are given a resounding ovation after they share their answer, you are well on your way to having a culture of Wow vs Whatever.  Here is a short video about how Zappos built a culture of Wow in Las Vegas where the call center employees are motivated to keep customers on the phone longer….

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The Business Cycle Also Rises – Hard-Earned Wisdom of Business Cycles

business cycleA business cycle increase the degree of difficulty in managing a business.  Watching (and experiencing) some unconnected sectors undergoing big cycles right now has me thinking about cycles.  Here are some big ones currently: a) Silicon Valley start-up valuations declining after a 7-8 year boom, b) oil prices bouncing around a 20-year bottom, c) interest rates nearing the end (one of these years) of a 30-40 year decline and therefore super high prices for bonds, d) private post-secondary education in the US hitting a 15-20 year low spot after boom times after the financial crisis, e) beef prices as seen through the Stockman Grass Farmer newspaper, f) commodity price declines and therefore subsequent declines in farm land prices and farm capital equipment makers (John Deere), g) big, processed food manufacturers starting to have declining volume after having growing volume since World War II, and h) stock market bouncing around a 7-8 year high.   I am sure there are many more; these just came to mind quickly.

Business Cycle Lessons Learned

Business cycles are a fact of business life.  Ok, how do you manage through the cycles?  Here is some wisdom I stole from Warren Buffett and Allan Nation of the Stockman Grass Farmer (one of my favorite observers of business). And I am sure they have borrowed from others:

  • Build a balance sheet to withstand the slow times.  So logical, yet so difficult to do.  Warren Buffett says that if you have a highly variable income, he suggests saving 40% of annual profits in cash and liquid investments.  Debt can often create big problems for cyclical businesses particularly because it is easy to load up on debt in good times (see the comments on lenders below).
  • Keep your wits about you — do everything you need to do but also do not over react.  You are never as smart as it seems at the top of a cycle and never as dumb as it seems (mostly!) at the bottom of a cycle.  Keep your wits about you and find the right balance between changing the things you must and not over-reacting.  Most importantly, do not think you are a genius at the top of the cycle when you can be a little cautious.
  • The top of the cycle is not normal.  We always remember the high points; but we need to remember that a high point is not normal.  We cannot build our businesses for the best of times, we need to build them to work in all times.
  • Keep fixed expenses low.  There is no better protection than to be maniacal about keeping fixed costs low.  This is important protection against difficult times, because it is often just too difficult, too slow and too disruptive to change fixed costs when a company is in trouble.  In recent years, I helped a company get out of a bad lease that was 5x bigger and more expensive than what they needed.  We got lucky to get out of it, but no one wants to rely on luck for success.
  • Keep headcount as low as you can, and avoid large swings in headcount.  At one Berkshire Hathaway annual meeting, Warren Buffett put up a chart of the headcount in the Berkshire Hathaway insurance operations compared to the premium volume written by year.  There was huge swings in premium volume as Berkshire wrote a lot of volume when premium prices were high and wrote very little when premium prices were low (very difficult to execute, by the way).  At the same time, the insurance personnel headcount did not fluctuate much.  He explained that he wanted to keep the headcount low as a general rule and also help give those insurance people confidence that they can turn down insurance deals when pricing is low, and not just write volume to stay busy and keep their jobs.  Plus, it is just too painful to make big changes in headcount in a down cycle if we let headcounts get too big in good times.  This is also very difficult to execute when employees are screaming for help in busy times — which means that a constant effort to find more efficient methods and keep headcount low is important.
  • Lenders lend money based on your industry, not your specific business.  Bankers tend to lend money at the height of the cycle and get antsy at the bottom of the cycle, exacerbating things.  I had this happen to our private post-secondary school business.  As Nation writes, “Your lenders probably know a lot less about your industry than you do and he judges the safety of your loan by seeing how other customers in your industry are doing.  If one of those customers gets into trouble, everyone in that industry is in trouble, because he will slam the lending window shut.”
  • Watch leading indicators (your customers and your customers’ customers and other players in your eco-system).  Here is what Nation writes about the cattle business: “What is confusing, particularly to cow-calf producers, is that there normally is a considerable lag when it appears that your buyer will continue to pay you high prices even though his sales price is falling.  So, we tend to do nothing and continue on as if we were going to miss the financial bloodbath affecting everyone else.  But, we never do.”  In private post-secondary education, it is obvious on a macro scale that the government will have tighter and tighter budgets into the future and that the traditional (public) institutions were likely to fight back against the rising market share of private institutions to protect the flow of financial aid money.
  • It is helpful to have “two games”, not just one game in a cyclical market.  As Nation wrote, “The only way to take (inventory) profits out of a cyclical business was to sell out and go do something else until the market has bottomed out and then buy back in.  This is why my Dad always said you had to have two games going in order to play one well.  There are times when retreat is the best strategy.  While this strategy is obvious in hindsight, it is almost impossible for most of us to do.  Another problem with this strategy is: what do we do while we are waiting for the market to bottom?  I have not seen many people who can sit on a pile of cash for years without doing something stupid with it.  You must have something that can keep you occupied and that runs on a different price cycle.”
  • Regulators are fighting the last war, and therefore can exacerbate cycles.  In banking, lenders seem to continue to be reacting to the financial crisis and still are not lending to small businesses because of the increased regulatory cost of every loan and the regulators somehow prefer large company loans.  In private post-secondary education, regulators saw the booming enrollments of 2009-2012 with very high profit margins for the public companies, and decided (maybe rightly in some cases) to do something about it.  Their actions made the private post-secondary decline deeper and even more difficult than it otherwise would have been.  In California, over half of the private schools have gone out of business in the last four years.
  • Your customer’s health is what counts.  From Nation: “What really counts in all forms of business is, ‘How is your customer doing?’ If he is doing well, you will too.  If he isn’t, you will eventually feel his pain.”

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Network of Experts to Support Greybull Companies

“There are always more smart people outside your company than inside your company.”
We are utilizing this idea in our strategy to assist our portfolio companies in Greybull Stewardship.
network of experts

 Network of Experts

As we think about the future of Greybull, we have been thinking about how to best help our portfolio companies — if and when asked to help.  The first piece of our philosophy is to create the environment for our CEO’s and management teams to do their best work.  Usually, that means getting out of their way.  Occasionally, a company requests assistance with an initiative, a project, or a decision.  When asked, we love to help.

 Assistance for our companies

Once asked, we are building a Network of Experts to assist with anything that a company may need in any function.  From Accounting to Sales, to HR, to Marketing, to Technology, to whatever, our goal is to have ideas and a way to bring experts to assist as needed.  We love this strategy because:
  • Every day brings more free agents, consultants, and independent folks who have world-class skills.  Some people predict that half of the workforce will be free agents by the year 2020.  There is a robust supply of high-quality individuals available to us.
  • High skills and talent.  Not only are there a lot of these people, they are talented and skilled.  Particularly with the ever-changing and ever-evolving skills required in business, this network will always have more skill and talent than could ever be built inside one investment firm.
  • It is efficient.  It reduces the overhead at the Greybull fund level, and it reduces overhead at each company.  Plus, it is efficient for portfolio companies so they don’t have to start their search for help from scratch.

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Cheers to the Greybull All-Star Management Teams and CEOs

I love the companies Greybull Stewardship has invested with and I love working with the all-star management teams running those businesses.  As we turn the corner into 2016, those are my overwhelming thoughts and feelings.
cheers to Greybull CEO's

 Greybull All-Star Management Teams

Here are some of the reasons why:
  • Working with wise, energetic partners is so much more enjoyable than managing employees.  Nothing against employees, but that type of relationship can be more tiresome for both parties.  I love that Greybull’s CEO’s and all-star management teams are smart, focused, responsible, and getting stuff done — real partners.
  • We complement each other well.  In a partnership, it helps to have clear domains of responsibility and expertise.  Many things are joint decisions and discussions, and it is also great when we all do not have to think about everything.  I love that I can bring my and Greybull’s expertise to our endeavors in some areas, and I love having the experts manage their business.
  • We created a lot of value in 2015.  During the year, we undertook many growth initiatives, tackled many challenges, had to evolve our businesses and thinking, and got stressed about many things.  It was a difficult year, and it was easy to get caught in the anxiety and responsibility of doing it all well.  When I look back on the year, it was worth it.  We grew our profits, expanded the moats around our businesses, and created value for Greybull.  That feels good.
  • I learn every week.  Because good partners bring unique knowledge and skill, I find myself learning every week.  I love that.  Every Greybull company has good tactics and strategies that are evolving and interesting.  Every industry is interesting.  I feel a little guilty to be learning so much from my partners. I hope they can learn a little from me as well.

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Evergreen Investment Capital Gains More Traction

This idea should be obvious:  Most companies will not do their best work if forced to grow artificially fast (think growth hormones). venture_capital_industrial_farming

If you aim everything toward fattening up for an exit time; if you force-feed unnatural energy like corn or capital, binge on antibiotics, and then hope the market remains alive for that highly processed output, you will not thereby be green, nor in charge in five years.

Evergreen doesn’t flip out at 4 years

Traditional venture capital is this force-fed, binge-eating, industrial-farm version of artificially growing companies.

That may not be fair — it is not all bad.  It works well for a small subset of companies.  It makes no sense for the rest of us to emulate that model when it isn’t appropriate for the vast majority of companies.

Evergreen Capital for Evergreen Companies

My fund, Greybull Stewardship, is built to be an alternative.  Our capital and structure are evergreen.  We do not force companies to grow artificially or to exit on a specific timeframe.  We are free to do what is best for the business over time.

Inc. Magazine this month included a good article, written by Bo Burlingham, on the growing movement of founders to finance their company in a manner so they do not have to sell.  Evergreen models for their company and their financing are particularly attractive to people who have played the venture capital game a few times and realize there is a more modern, better way to build a company.  The Inc Magazine article also includes an infographic that makes the case for not selling.  It is worth reading.

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Dodging Bullets Keys Investment Success

Great investors have skills to seize opportunities and get into good situations.  Equally as important can be the skill at “scrambling out of bad situations,” as Charlie Munger would say, or “dodging bullets” as it sometimes feels when helping companies solve challenges.  investment dodging bulletsAt the Berkshire meeting this year, Charlie mentioned a few times how “scrambling out of bad situations” was an under-appreciated key to Berkshire Hathaway’s long-term investment success.

Investment Bumps

This year has been a year where several of my investments dodged bullets.  The companies are doing well, we are creating great value, and there are always challenges being thrown at us.  We sometimes need to dodge a bullet.  A bullet is usually not a life or death thing for the company, but it can be.  This summer, I also read this book about Elon Musk, Tesla, and SpaceX — it was fascinating to read about the company-threatening bullets Musk dodged with Tesla and SpaceX.  The stories about Travis Kalanick, founder of Uber, also have many tales of the bullets he dodged in earlier start-ups and business situations before he hit on Uber (plenty of bullets there as well).

Dodging Investment Bullets

Here are some things I have found helpful in dodging bullets (with still plenty to learn) with private company investments:

  • Identify the bullet — do not fool yourself.  It may be uncomfortable to face a difficult situation, or admit it is there.  The first step is realizing a bullet is in the air and not trying to kid yourself about whether it is flying toward you or not.
  • Keep calm and be rational.  It is important to keep emotion at bay, focus on the task at hand, and make rational choices.
  • Intention, attention, no tension.  Once the bullet is identified, it pays to work hard on the challenge, but also not to work so tightly that you paralyze yourself.  This is a phrase used by Marci Shimoff in her research on happiness and achieving goals.  It is effective to state your intention, give the goal plenty of attention, but also make sure one does not have too much tension around it.
  • Put in the effort to create options.  Nothing is more valuable in business than having options to choose among.  Running out of options is truly when you can get stuck.  Thus, I have always found that it pays off to create options, no matter how much work it requires (often double/triple/quadruple the work).  Sometimes the process of just doing the work of creating options is helpful as it feels better to be doing something than just sitting around and hoping things work out.

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